Select Committee on Treasury Minutes of Evidence


Exmination of Witnesses (Questions 320-338)

SIR HOWARD DAVIES AND MR JOHN TINER

TUESDAY 13 NOVEMBER 2001

  320. You have these papers, do you not?
  (Sir Howard Davies) Which?

  321. Prior to January 1999?
  (Sir Howard Davies) Yes.

  322. Does the Treasury have full access to those papers?
  (Sir Howard Davies) Yes.

Dr Palmer

  323. I would like to clarify one answer which you gave my colleague Mr Laws. You said that the actions taken with regard to allowing Equitable to continue advertising were best for policyholders as a whole. Would you also describe the decision as best for new policyholders?
  (Sir Howard Davies) I think that would be a very difficult question to answer because that would depend on what else the new policyholders might have done if they had not joined Equitable Life. I think that would be very difficult to answer.

  324. With respect, you did find yourself able to answer the question for all policy holders. I think there is a reasonable doubt whether that decision was helpful for new policyholders. It sustains the view that new policyholders were to some extent used to rescue the old policy holders.
  (Sir Howard Davies) That is certainly not the way I would see it but, as I say, it is difficult to answer in relation to new policyholders because it would depend on what they would have done with the money otherwise.

  325. Have you had any complaints from new policyholders?
  (Sir Howard Davies) We have had, yes.

  326. Do you not have some sympathy for these complaints, that they basically have been misled by the advertising to support the business as a whole?
  (Sir Howard Davies) Whether they were misled by the advertising I would not think I could say was definitely the case. I certainly have sympathy with new policyholders who came into the Equitable Life during the course of this. I think that they, like any policyholders, have a reasonable assumption that they are going into a company which will remain a going concern and they find themselves policyholders in a closed fund. Closed funds are not necessarily in the long run particularly bad places to be but this one is a closed fund which of course is somewhat unstable at the present time and therefore think that we are at the point at which there is maximum uncertainty and maximum unhappiness about the policyholders who came in because they are not quite sure what the stability of the fund is going to be. That of course will be considerably clearer, we hope, if a compromise scheme goes through in the early part of next year but I recognise that at the moment it is a very unhappy time for those policyholders.

  327. In defending policyholders do you feel you have a duty to try to defend the interests of each group of policyholders or do you feel that you only have a duty to protect policyholders of a company as a whole?
  (Sir Howard Davies) I think that we would say that we had a duty to protect policyholders and in certain circumstances, such as the compromise scheme, it is necessary for us to look at the position of different groups of policyholders and reach a view as to whether their interests are being properly represented and whether they are being treated fairly, so yes, on occasion we do interpret that as meaning that we have to look at particular groups of policyholders.

  328. But you do not feel that your position necessarily has to be in the interests of a particular group of policyholders if it would benefit the collective of policyholders?
  (Sir Howard Davies) There are certain absolutes and there are certain relativities if you like in that clearly if a group of policyholders has been given guaranteed benefits then I would say that that is an absolute and we should ensure that those guaranteed benefits are being met in the way in which the fund is handling itself. There are of course other circumstances and the compromise scheme is one where essentially the task that the company faces and something that we must look at when they have produced their final version is to produce a scheme which attempts to take account of conflicting claims by different groups of policyholders which are extremely difficult to quantify with any degree of certainty because they rest on legal claims and the probabilities of success attached to those legal claims. In those circumstances one has to strike a balance between the interests of different groups and there is a need to weigh that up.

  329. Let me raise the statement made on 16 July 2001 by Equitable Life where they announced the reduced pension policy values by 16 per cent. Among the reasons for this they said that the decision could not be delayed because stock markets have fallen, maturity values exceed the value of the investments and, "As a mature fund, a large number of policy holders are currently retiring and taking their benefits." Do you consider that this is a reason for not delaying the action? Do you feel that in a fund where a large number of policy holders were not yet taking the benefits they could have just waited and hoped for the best?
  (Sir Howard Davies) That was a decision for the company to take. We did feel that they had taken that decision taking into account the interests of different groups of policyholders and the difficult position that they found themselves in was that retiring policy holders were able to take away a significantly larger sum than represented by their asset share given the way the markets had moved. Of course retiring policyholders were not subject to the market value adjuster which had been put in place by the company and which of course has now been put in place by many other companies as well to ensure that people who leave the fund do not take an "unfair" amount of money with them. That could not be done for retiring investors where there is no market value adjuster on the amount of the fund. Of course other companies will do that typically by changing their terminal bonus rates from year to year and because for most other companies the terminal bonus represents a much larger proportion of the total return than it did in the case of Equitable who had a policy, as the Committee knows, of distributing bonuses along the life of policies and therefore had much less flexibility at the end. They were faced with having to do this in a rather stark way in the way that other companies were able to do by adjusting the levels of terminal bonus which of course have come down in the last year or two quite significantly from what they were in the late 1990s.

  330. I do take the point. However, the point that I was asking you about is whether you feel that it was relevant that a large number of policy holders were coming up to retirement imminently. Do you not feel that any assurance company should be taking an actuarial view of the balance of benefits and assets and not hoping that the situation will correct itself if there is an imbalance of the kind that you describe?
  (Sir Howard Davies) I think in taking the decision in July the company was taking the view that it could not just hope that this balance would be corrected and that it had to take some action to deal with it. I would emphasise that the particular action they took was a decision for the company. We do not make those decisions. We have to satisfy ourselves that they are decisions which a sound and prudent management could reasonably take.

  331. How does your regulation of closed funds differ from that of open funds? Do you have different requirements for reserves or about the value of investments compared with the value of the policies?
  (Sir Howard Davies) Yes. There are certain differences. Of course there is little in the way of conduct of business regulation because they are not selling. In the case of the reserving etc there are obviously things like future profits items which have to be looked at very differently because you are not taking on new business and generating future profits and also of course, as the fund matures and pay-outs increase, there is typically a shift away from equities to gilts to reflect the maturing nature of the fund, so we have a special team that looks at closed funds, of which there a large number, many dozens of them, which takes account of those particular features in setting their reserving requirements.

  332. Would you feel that closed businesses need to take greater account of the value of maturing policies compared with the value of investments or do you feel that this is something which is equally important to open funds?
  (Sir Howard Davies) It is important to every fund although it might present itself slightly differently in the case of closed funds. I think every fund has to satisfy itself that it is not getting into a position where it is robbing Peter to pay Paul too much.

  333. But in their statement of July 16 Equitable Life sought to draw a distinction. They said: "However, because it is closed to new business the Board must take greater account of the value of maturing policies compared to the value of investments underlying those policies", which appears to mean that if it had been an open fund they would have encouraged new investors to underwrite the gap for the existing investors. Would you agree with that?
  (Sir Howard Davies) I would not have drawn that conclusion. I think that the greater account could refer to a number of things. Because of the particular position of the Equitable Life and its bonusing policy they were particularly affected by this movement, but there is inherent in all life funds a set of redistributions if you like through the fund. Immediately normally the writing of new business imposes a strain on the fund. The writing of new business is not a way of solving a fund's problems which is perhaps part of the background to why I do not think it is right to characterise us as using the new policies to bail out the old because in the normal way if you put on a new policy you have to reserve for that to start with. It does not help your reserving policy to write new business in the short run although it does mean you can take a larger future profits item in due course.

Mr Mudie

  334. Can I ask a general question because one of the things that must worry people that put money in long term and two-thirds of the way through a policy they think they know the situation is reversionary bonuses. On every policy that I have had with reversionary bonuses there are words to the effect that once you have earned these they will not be taken away. You understand the terminal bonus can fluctuate and you watch that anxiously but you regard the reversionary bonus as being in the bank. As our guardian, there seems to be leeway for insurance companies even to interfere with reversionary bonuses.
  (Sir Howard Davies) No, I think not because I would put those in the guaranteed box. The life companies would typically operate with such a healthy degree of margin between their guaranteed commitments and the total assets in the fund that I cannot think of a case in recent years where there has been a problem about guaranteeing reversionary bonuses. The problem with the Equitable Life in terms of its presentation of its returns is that the Equitable took the view first that it would pay out bonuses as it went along, but also that it would give people a continued regular update of what they expected the value of the policy to be on maturity. This was regarded by many people of course as a positive thing because it was certainly in many respects more transparent than the return that you typically get, and I congratulate you, Mr Mudie, for understanding your returns on life policy which is not given to everyone. The Equitable typically said, "This is what you will get if your policy now matures". In fact, those were not guaranteed because they included an element of the terminal bonus which the company was forecasting. When the 16 per cent cut occurred in July there were many policyholders who believed, and I have to say not unreasonably believed, that they had lost guaranteed value because that is the number that they had been looking at over time as the number that they expected to get. The company points out also, legally correctly, that those were not guaranteed; they were a reasonable forecast of what they expected to happen. I think that is where the confusion about the status of reversionary and guaranteed and terminal bonuses comes from in relation to Equitable.

Chairman

  335. Sir Howard, the justification for the cut in policy values was that they are materially greater than the underlying asset values. What does this say about the regulatory approach to bonus declarations, some of which must have been over-generous?
  (Sir Howard Davies) Yes. It is the case that companies have considerable discretion and that is built into their policies to pay different bonuses at different times. Indeed, over the last three or four years companies have typically been paying out above asset shares, not just Equitable Life; many companies have been paying out above asset shares. In practice in many cases that has been eating into the inherited estate. That is something which companies are allowed to do and they will amend their bonus policies up or down depending on the state of the market as well as the state of the fund. It is clearly inherent in with-profits policies that there is no precision about whether you get back precisely the asset share or more or less. One of the reasons why Equitable Life policyholders as they look now at what they have got and what other people have been getting, and Equitable's returns have slipped well down the league in the last couple of years, is that many other companies have been paying out more than asset share over the last two or three years, and I would suspect that that is unlikely to continue. The returns therefore between Equitable Life and others may well, depending on the compromise scheme, come closer together over the next few years. That is a little bit hard to forecast.

  336. That could mean that some people in the future get less than asset share?
  (Sir Howard Davies) It certainly could and some indeed in the past have done.

  337. Sir Howard, you wanted to make a statement on behalf of the Board regarding the Baird Report.
  (Sir Howard Davies) Yes, thank you. I can be extremely brief because most of what I wanted to say has been covered. I simply thought it right to say that the Board recognised when it commissioned the review that it could only cover part of the history but it believed that, given that we had continuing and, as of 1 December, more formal responsibility for insurance, that it was very important as a matter of good practice that the Board should assess the performance of the Authority in determining lessons for the future. It did that therefore in advance of the Government's decision to hold a further inquiry by Lord Penrose which would cover a longer period. When it looked at the report, the Board noted that this was a snapshot taken very early in the life of the new regulator. The conduct of business regulators were still working to a service level agreement with the PIA Board and the insurance regulators were working under contracted out provisions from the Treasury. They were therefore still managed separately within the Authority. They noted that the report says that it was explicitly written with the benefit of hindsight and they noted the overall conclusions of the review which we have discussed several times over the last two hearings. The Board acknowledged that the report made at times uncomfortable reading and that it made pertinent criticisms of management and of communication with the Authority, criticisms which required a firm and rapid response. They noted however that many of the management changes needed in response had already been implemented. The conduct of business and prudential regulators were merged on 1 April this year when we had some certainty about the N2 date and responsibility for the nine largest groups, which is about 57 per cent of the life sector, was transferred out of the insurance division into the major financial groups division which is the part of the Authority that supervises large integrated groups which require a particular character of relationship because of their crucial importance in the financial system. Responsibility for prudential policy has been moved into a new Prudential Standards Division which includes former Bank of England staff responsible for prudential policy in banks in order to ensure that we learn the lessons of other types of prudential regulation for insurance and all of these changes have significantly strengthened the resources devoted to insurance regulation and brought new skills and fresh eyes to bear on the problems. The Board is convinced that we do need an increase in the net resources devoted to insurance regulation. We inherited, including the actuaries, about 35 people to regulate the whole of the life insurance sector which, if you compare with what we would do with comparable banks with the size of balance sheets, would be well under half what we inherited from the Bank of England. For the future of the regulatory regime itself the Board have asked John Tiner to carry out a project which we have described. A team of 12 people has been set up, half from outside the Authority, and we will publish a detailed paper on that work before the end of this month. After careful consideration of those changes and the management's response to the Baird Report, the Board confirm their confidence in the management of the Authority to take forward the regulation of insurance, but will closely monitor progress on these initiatives. Of course, since the report was published, the Parliamentary Commissioner for Administration announced a further inquiry into part of our regulation of Equitable Life over the same period and we will co-operate fully with that inquiry and with Lord Penrose.

  338. Thank you very much, Sir Howard. You made the point that the management changes have been made but I think there is an open mind in this Committee about the effectiveness of the management changes and the regulation. We will be keeping in touch with you on that. We look forward to the written submissions that you are making as a result of comments this morning and the opportunity to see you again on this particular issue. Could I end the session by asking a simple question, hopefully non-controversial? It is on Railtrack. On 16 October you appeared before the Committee and you said that you were making certain enquiries into the market in Railtrack plc shares before the company went into railway administration. Could you inform us what progress you have made in those enquires and when you expect to come to a conclusion on the matter?
  (Sir Howard Davies) We wrote to the company to ask the company to supply us with information about, colloquially, what it knew and when and what it said to its shareholders. We received a large amount of documentation from the company last Friday which we are now looking through as a matter of urgency. Our preliminary review of that documentation has caused us to write to the Department of Transport to ask for their responses to certain questions about what they said to the company and what they thought the company knew. This follows the Secretary of State for Transport's statement in the House on 5 November, where he suggested that the company may have failed to give out appropriate information to its shareholders. We sent that request to the Department of Transport only late last night and so we are awaiting that response and we are analysing the company's documentation further before we will be able to say anything about the future course of our enquiries.

  Chairman: Thank you very much for that answer, and thank you and your colleague for appearing before us this morning.





 
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