Examination of Witnesses (Questions 140-162)|
MP, MR JON
TUESDAY 30 OCTOBER 2001
140. That was obviously a substantial difference.
Do you not think, looking at the Baird Report, that at various
points during 1999 there is a real tension inside the FSA between
its role as a prudential regulator wanting to keep the institution
going, wanting to see if it could trade out of the position which
it was in, and its role as a conduct of business regulator, trying
to advise people who were writing to it, complaining to it about
a number of aspects of the Equitable's behaviour in that period?
Would you agree that there was that tension?
(Ruth Kelly) What the Baird Report shows clearly is
that if there was a tension there should not really have been.
The two arms of the regulator needed to take a coherent approach
to the problem and if they had done so, they might have spotted
earlier the problems which later emerged. The prudential regulator
is much more intimately involved with the company, as you rightly
say. It has the company's solvency under close scrutiny at all
times; whereas the conduct of business regulator takes a much
more stand off approach and has relied upon people coming to it
with complaints. My reading of the report was that not many people
did that, particularly in certain critical periods. One of the
rationales behind the creation of the integrated regulator is
not just to provide a consistent approach but to introduce a much
more risk based approach which will concentrate resources appropriately
on key issues, particularly the conduct of business ones which
emerged in the actual case and which were not subject to that
risk based regime.
141. If there was a failure of the FSA as a
conduct of business regulator, where would the ultimate legal
and financial responsibility of that lie?
(Ruth Kelly) As far as I understand it, the position
is that the PIA is still currently a self-regulatory organisation
and will remain so until the formal transfer of powers at the
end of November, despite the fact that its employees are employed
by the FSA and the FSA is responsible for monitoring how it complies
with the rules. It is a very odd situation but the PIA would be
responsible. What I read from the report is that they did fail
to operate in a coherent fashion and that it is essential from
now on that these two sides of the regulator liaise in a much
more coherent way over particular companies and particular issues.
142. You do consider the possibility that there
was conduct of business regulation failure and, if there was,
under the terms of the old Financial Services Act 1986, the responsibility
for burying the dead of that particular episode would lie with
the life insurance industry itself?
(Ruth Kelly) I am not saying I think there was a regulation
failure on the conduct of business side. I am saying that Baird
very clearly shows that there should have been a more consistent
and coherent approach to these issues. I am determined to see
that that now happens, which is precisely why I have been pressing
the FSA on this point. As I understand it, you are right. If there
were evidence of failure, it would rest with the PIA and then
it would be the industry which would be responsible.
143. Policyholders who are making decisions
about their financial future do the best they can with the information
they have available to them. In this instance, they found that
their reasonable expectations had been built on sand and in the
Myners Report there is severe criticism of how transparent the
industry is. If there had been a better definition of PRE, do
you think that the Equitable Life episode could have been discovered
(Ruth Kelly) That is a really interesting question.
The nebulous nature of policyholders' reasonable expectations
has been a recurrent issue throughout regulation. It is something
to which the Baird Report clearly suggests more attention could
have been paid over the years for which the FSA was responsible.
As I understand it, that concept is going to change when the formal
transfer of powers is handed over to one of fair treatment for
consumers. The FSA is going to be devoting its efforts to establishing
precisely how that can work in the best interests of consumers
but policyholders' reasonable expectations have been an issue
which has bedevilled the industry for a long time.
144. While pursuing a similar line of inquiry
with Sir Howard, I asked him if the concept had had its day and
he agreed it had, with only a month to live. That leaves me with
some concerns about existing policyholders not just for Equitable
Life but across the insurance sector altogether, given that policyholders
still have what they believe are their legitimate reasonable expectations
from their policies. Would it be useful at this stage, even now,
to properly define their reasonable expectations and have some
sort of definition that has a legal bearing?
(Ruth Kelly) What we would run the risk of doing is
precisely to replicate one of the accusations that has been mounted
against the issue of insurance guidance to insurance companies
and that is to try to second guess how a court might interpret
policyholders' reasonable expectations. There is a real danger
of doing thatand then the industry and the policy holders
place too much weight on how the regulator, which would be the
FSA, interprets those legal issues. That is now a matter for the
FSA to look at before the end of November. It is probably not
the appropriate time to reconsider policyholder's reasonable expectations,
as it is devoting a lot of its resources to understanding the
new concept of fair treatment of consumers.
145. I understood completely what both you and
Sir Howard said about fair treatment but what I do not see is
the transition between one set of concepts and the other and how
consumers can have some understanding of what their legal position
is, what their consumer rights are in this situation and what
applies for them, given that they have policies that they have
taken out under one set of suppositions and now they are looking
into a whole new future. What protection is there for them?
(Ruth Kelly) In some respects, that is precisely why
the test cases were mounted in Equitable Life's case, to try and
understand how a court might interpret policyholders' reasonable
expectations and whether Equitable Life's practice was consistent
with that interpretation. As it turned out, the House of Lords
decided that it was not. Clearly others in the industry will have
been following that interpretation closely but I do not think
there is a very strong case for use of the regulator now to be
advising on how that test case might apply to other parts of the
industry, although clearly that is something that you should be
putting to Howard Davies.
146. The only reason that anyone would have
a motive for a guaranteed annuity arrangement would be to protect
themselves against the position where the interest rate went down
at some point in the future so that they had a certain base for
their expectations of a pension. That is the basis upon which
these policyholders that we are talking about were asked to invest
and yet, at the time when the interest rate did fall and they
were in need of this sort of guarantee, it was removed from them
in such a way that this terminal bonus arrangement left them in
no better position than someone who had not opted for this to
begin with. It must be plain that that is not a reasonable expectation
of a policyholder. It is a situation almost amounting to fraud
(Ruth Kelly) The interpretation which the House of
Lords put on Equitable's course of action was that it was not
consistent with policyholders' reasonable expectations. There
were other views prevalent at that time and other legal opinions,
including that sought by Equitable Life itself, which couched
these issues in much more vague terms than were subsequently arrived
at by the House of Lords. There were different attitudes as to
how consistent that policy practice would be for policyholders.
147. It seems to me it is worse than that because
the last time we had a session on Equitable, when we raised this
sort of question, we were told this practice was common throughout
the life insurance industry.
(Ruth Kelly) As far as we understand it, Equitable
is rather unique in that it neither imposed an explicit charge
for its premiums, nor built up any concrete fund to meet those
guarantees. As I understand it, it was fairly unique, if not entirely
unique in the industry, for acting as it did. Other options were
pursued by different insurance companies when these issues first
emerged in the late 1980s.
148. The government actuary said to us that
the process of virtually abrogating GAR and putting it into a
terminal bonus was prevalent throughout the industry. In addition
to that, we have the rest of the Baird Report that tells us about
an appointed actuary also acting as a chief executive. We have
the whole question about the adequacy of reserves. We have the
question of different figures given to the regulator compared
with the figures put into the accounts and then we have this strange
reinsurance policy added in. This is on behalf of Equitable, a
company which was the oldest life insurance company and the gold
standard of the life insurance sector. Does it not make you worried
about what is going on in all these other cases if that is the
best one behaving in this sort of way? Should not the Penrose
Inquiry really be investigating the life insurance sector beyond
Equitable, not just the issues arising from Equitable? There is
a tendencyand there has been this morningfor us
to be pursuing the regulators but they are a decoy. These are
the people that we ought to be pursuing in the inquiry. Can you
assure us that the Penrose Inquiry will indeed be pursuing this
type of question right through the life insurance sector, not
just with Equitable?
(Ruth Kelly) I think there are two responses to that.
The first is I thought it important that the lessons of Equitable
be learned and to see what lessons could be learned from that
particular experience for the whole of the life insurance industry.
His terms of reference are clearly set out to enable him to pursue
his agenda and I very much hope that he will interpret them to
the full. The second is that there is a separate study being conducted
by Ron Sandler which looks at the incentives behind the long term
retail savings industry, which will also be able to consider some
of these largely fundamental questions for the life insurance
149. The other danger is that the Baird Report
and other means have revealed quite a lot already which implies
that there is something rotten in the state of Denmark. Are we
to wait until the Penrose Inquiry has reported before any of those
issues are tackled or can we expect those issues to be tackled
in the meantime, despite waiting for Penrose?
(Ruth Kelly) Not only can we expect them to be tackled;
I am absolutely determined to see that they are tackled, which
is precisely why, on publishing the report, I wrote to Howard
Davies asking him to report back to the Treasury on the actions
which had been taken to implement those lessons and recommendations
by 20 November. I am expecting a fairly substantive document outlining
how the FSA intends to take that forward. What Penrose cannot
do and what I cannot suggest is that the Penrose Inquiry will
somehow be bound by the conclusions which emanate from this report.
Penrose has a much wider remit. He is able to look back at history;
he is able to look at other key participants; he is able to look
across the market place at prevailing practice. He wrote to me
to say that he cannot feel bound by the conclusions of the report.
However, he accepts, I accept and the FSA accepts that it is important
for them to make progress immediately, particularly on aspects
which involve consultation with the market place, for instance,
and reviews of their activities, and for the Penrose review to
feed into that, to try and gain the best of both worlds.
150. Could I declare an interest as an Equitable
Life policyholder? Why did the Chancellor tell this Committee
in March that there should not be an inquiry until the Baird Report
had come out?
(Ruth Kelly) I have not seen the proceedings of that
Committee. The nature of the problem has changed significantly
over the latest period. The reasoning behind the launch of the
Baird Report in December 2000 was that the FSA should learn immediate
lessons for the way it conducted its own stewardship of the Equitable
Life and the industry over its period; that it should learn the
lessons as it set up its own structure before the formal transfer
of powers. On top of that, it became very clear to me over the
summer that policyholder concern and concern from Parliament and
indeed the Treasury Select Committee itself was very great on
these issues; that the issues were not something that we could
in any sense choose to ignore; that there might be wider implications
for the industry and that the issues themselves on their merits
deserved a full, independent inquiry. That is why I decided to
go down that route.
151. Originally, the Treasury's position was
that an independent inquiry might prejudice the policyholders'
decisions on the compromise deal.
(Ruth Kelly) Once it became clear to me that an independent
inquiry was to be launched or should be launched, I had a choice
as to whether to await the Baird Report, which was to arrive at
some time undefined, and to announce an independent inquiry as
a response to Baird, or to act quickly and to set up the independent
inquiry as soon as it was practicable to do so. I had a balance
of issues to consider when making that judgment. One, as is very
clear, is the speed with which Lord Penrose could get down to
the work and the speed at which the report could finally be completed
and the lessons learned both for Equitable Life itself and the
rest of the industry. Another issue which was quite high on my
agenda at that time was a desire to totally separate this independent
report, as far as possible, from very delicate decisions which
are being taken by Equitable Life policyholders as we speak. They
are in the process of considering the compromise offer. I wanted
to make absolutely clear, first of all, that I did not see this
inquiry as in any way relating to the issues on the table of the
compromise deal and therefore the earlier the announcement the
better. Secondly, I wanted to use the opportunity to say very
clearlyand not to mislead peoplethat I did not see
at that time a role for public money to support in any sense a
lifeboat for the Equitable Life Society, as I was being counselled
that that was a view that was currently being held by certain
policyholders. I used the opportunity to do both things, to separate
the announcement of the inquiry from the compromise deal and to
set straight the record on the Treasury view of an injection of
152. Returning for a moment to the section 68
order and the solvency for which you had responsibility, the section
68 order on 11 September that rejigged the Equitable balance sheet
to the tune of £1.1 billion, was the Treasury aware that
that order was passed on the advice of the government actuary's
department that pre-dated the House of Lords decision?
(Ruth Kelly) I do not think this was ever brought
to the attention of ministers and we relied very heavily on the
advice of the FSA for these orders. It is clear from Baird that
a full assessment in the round was not presented together with
the section 68 order.
153. The answer is yes; you were not aware.
Is that right?
(Ruth Kelly) I do not think we were given the full
picture of events.
154. You were not aware that the advice was
flawed because it was the advice of your own department, the Government
Actuary's Department, given before the judgment that was relied
on of 11 September?
(Ruth Kelly) As far as I understand it, the FSA presented
this to the Treasury as a routine regulatory issue, together with
their advice that it should be granted.
155. Can I ask you to comment on Sir Howard's
admission this morning that there were management failures? You
defended the single regulator structure. Do you agree that there
were management failures at the FSA?
(Ruth Kelly) Baird clearly shows that things could
have been done in a different way.
156. Do you agree?
(Ruth Kelly) This report was never intended to lay
the blame at any particular person's or institution's door. That
is clearly set out at the beginning of the report. It is clearly
written with the benefit of hindsight and the lessons which it
draws are based on that assessment. Having said that, I do think
there are issues which come out in this report which are of public
interest and which Lord Penrose himself will want to take into
account in his report. If anything, I think this report shows
that a single regulator is the way forward, that what we want
to do is to see the benefits flow as quickly as possible from
the joint approach.
157. The single regulator has admitted to management
failure. Do you agree with that?
(Ruth Kelly) I did not actually hear the earlier hearing.
158. Do you think there has been management
failure or not?
(Ruth Kelly) The report itself says, although I stand
to be corrected, that senior management could have taken a closer
interest in some of these issues. To that extent, with the benefit
of hindsight, it is clear that it would have been very helpful
had senior personnel of the FSA taken a closer interest in events
Chairman: Following Mr Fallon's statement
about declaring an interest, a number of us discussed that earlier
this morning and, given that we were looking at Equitable Life
itself rather than legislation I ought to declare that I have
an interest and maybe some other Members have.
Mr Ruffley: I have.
Mr Plaskitt: I have.
159. I too. Why was no target date set for Lord
Penrose to report? There are an awful lot of people out there
who are very anxious to get a result quickly.
(Ruth Kelly) Lord Penrose is probably the single most
appropriate person to conduct this inquiry in that he is a very
senior commercial judge but he is also an accountant by a previous
profession. He is eminently qualified to carry out this inquiry.
What he made clear to us in accepting his responsibilities was
that he first of all wanted to familiarise himself with all of
the particular issues surround Equitable Life; that he was not
in a position to say exactly how he thought his inquiry would
proceed, what evidence he would need to see etc., but he still
had to become familiar with all of the issues involved. I thought,
under those circumstances, it was better for him just to get stuck
in and to make progress as quickly as possible. I remain of the
view that he is an incredibly determined man who wants to get
on top of this as quickly as possible and to report back to us
as soon as he is able to.
160. Do you think it is possible that he might
not even be able to report back during this Parliament? The BCCI
investigation has been going on for ten years, I believe.
(Ruth Kelly) I am absolutely sure that what he wants
to do is to make progress as quickly as he can. It would be ridiculous
however for me to speculate on how his inquiry is going. I have
no day to day contact with him and it is up to him what courses
of action he chooses to pursue. Clearly, the routes which he chooses
to go down will very much determine how quickly he reports, but
that will be up to him.
161. I do understand that we have to leave it
to him but can you express an opinion from your position on whether
it would be welcome in the interests of the large number of people
out there who are waiting for the results if he were able to complete
his investigation within this Parliament?
(Ruth Kelly) I think Lord Penrose understands the
urgency of this inquiry and is determined to get on top of the
issues as quickly as he can.
162. Would you be disappointed if we did not
have a report from Lord Penrose by the end of next year?
(Ruth Kelly) I think it is unlikely that we will not
have a report, given his determination to pursue the issues.
Chairman: Can I thank you very much,
Minister? You have not experienced that side of the counter before
as a Treasury Committee member. I hope the experience the other
side was novel for you. Can we thank you and your officials for
your attendance this morning?