Examination of Witnesses (Questions 740
- 759)
TUESDAY 27 APRIL 2004
MR TOM
ROSS, MR
JEREMY GOFORD,
MR DAVID
STRACHAN AND
MR PAUL
SHARMA
Q740 Chairman: Yes. Sure.
Mr Goford: When I look at the
life insurance industry, I see an emotionally depressed industry.
That started really, in my mind, when they tried to limit commissions,
back 15-odd years ago, with a thing called RoLAC (Register of
Life Assurance Commissions). That was prevented by the Office
of Fair Trading at the time and I think there was a misunderstanding
then: this was an attempt by the industry to limit commissions
and it was deemed to be anti-competitive. What was not understood
at the time was that competition actually increases commission
in the insurance business.
Q741 Chairman: I am interested in
actuaries. That is why you are here this morning.
Mr Goford: Yes.
Q742 Chairman: Could you give us
a view of how actuaries can help restore confidence and not a
history lesson.
Mr Goford: My point is that actuaries
understand the mechanics of the insurance business. We know what
is going on. We understand, for example, this issue that competition
increases commission and would like to bring that to the attention
of the regulators—because you will understand that we do
not have powers, we only have influence, whereas the regulators
have the powers. It is our job as a profession to understand the
market and report issues that we see to the regulators for them
to act on. Another example in recent times would have been the
issue of precipice bonds, which we saw in the market as a product
which did not satisfy identifiable customers' needs but was launched
as a product to substitute for deposits, for people to take their
money out of deposit and put it into precipice bonds without,
in our view, adequate warnings of what the downside risk on the
capital side was. In that situation actuaries would say, "You
are being offered something that looks like it has guaranteed
income. It says 8%, but actually the rate in the market is 4%,
so someone is giving you 4% more—
Q743 Chairman: If I look at the Institute's
website, would I see a red letter warning against the selling
of precipice bonds?
Mr Goford: No, but you would see
letters to the FSA.
Q744 Chairman: I would not see that
on your website, so, again this is all anecdotal stuff but this
is an evidence session. You mention that actuaries know what is
going on. That is pretty breathtaking when you consider the litany
of scandals that there is. In your submission to us, the first
thing you say is, "To start with, it's time the nation faced
the facts." And then, "Turning it round will take a
long time and will depend on a combination of factors. These will
include: an end to the scandals . . ." Actuaries have been
involved intimately in life insurance companies and elsewhere
for yonks and we have this litany of scandals. Why have we had
these scandals? Why have actuaries not sorted it out?
Mr Goford: The actuaries are advisors
and it is the managers of insurance companies which do the execution.
We have seen, for example—
Q745 Chairman: I am sorry, but on
your website you have it loud and clear: "An actuary is someone
who has a thorough grounding in economics, statistics and the
economics of finance, and who uses these skills to solve business
problems." We have had a mountain of business problems, and,
far from solving them, it seems that actuaries are in the middle
of creating the business problems. Are you able to persuade us
that that is not the case? Where did it all go wrong?
Mr Goford: There are some things
that went wrong and Penrose has highlighted those and we can cover
those, but there are an awful lot of things that went right. There
has been a delivery of very good returns, for example, on with-profit
policies until 1998-99, until the market started to fall out of
bed. All guarantees of insurance policies have been paid—
Q746 Chairman: One of the things
an actuary does is forecast long term. Where were your long-term
forecasts? It is no use telling us that things went well until
1998, because it was based on endowment mortgages when we had
double-digit inflation. A monkey could have predicted what was
going to happen when we had double-digit inflation. When you have
problems and a low inflation environment, that is when the business
skills come out. It seems as if there has been little business
skill applied; it depended on luck.
Mr Goford: Those business skills
have been used as the market fell. If you took a position at 1999
and then you said, "What was the chance of the scenario that
actually happened?"—that is, falling interest rates,
falling markets and increased longevity beyond what we expected—that
scenario in 1999 would have been way off the spectrum of possibility.
Nevertheless, during that market, the business skills of the actuaries
managed the bonus rates and payouts on with-profit policies, for
example, and kept the companies solvent and paid all the guarantees.
So that was the business skills of the actuaries, working in the
background, advising—
Q747 Chairman: So the actuaries did
nothing wrong, there was no problem.
Mr Goford: I am not saying that,
but I am saying they did some things right, too.
Q748 Chairman: We are interested
in what they did wrong, because there is a big mess for consumers
at the moment, we want to sort that out, and that is why you are
here. Where did actuaries go wrong?
Mr Goford: Shall we start with
specific ills?
Q749 Chairman: You tell me. I am
looking for sharp responses to my questions.
Mr Goford: If we look at mortgage
endowments, then typically the rates of illustration which customers
were given would have been laid down by the regulators. Those
illustrations would have shown at the lower growth rates that
there would have been a shortfall on policies to repay mortgages.
When they were sold policies, customers should have been given
alternatives of repayments and endowment mortgages, and the current
clearing up is because of the mis-selling of those products. A
lot of those products were sold by lenders. The motivation of
the lenders in those days was because they made their profit out
of the interest margin: they liked endowment mortgages because
the loan stayed outstanding for the full amount for the full term,
so the total interest receipts were bigger, so the profits were
bigger, and they got commission as well.
Q750 Chairman: The point is that
actuaries are there to advise the company. It is nothing to do
with the salesmen. It is a business model produced by the company
and then you get salesmen to sell that. The product has an integral
role in that.
Mr Goford: There is a misunderstanding
about the appointed actuary role in that situation. The appointed
actuary is there to make sure there are sufficient assets in the
company to fulfil the promises and activities in which the company
indulges. The appointed actuary's role—
Q751 Chairman: That was not the case
with Equitable Life.
Mr Goford:—is post hoc.
Q752 Chairman: Your submission accused
the FSA of "exaggerating" a culture of mistrust of financial
institutions among the public.
Mr Goford: I do not recall that
aspect.
Q753 Chairman: I have read it three
times. Given that is the case, are you suggesting it is wrong
for the regulator to highlight issues such as pension mis-selling,
endowment mortgages mis-selling or the scandals surrounding split
capital trusts and precipice bonds? Are they exaggerating? In
fact, we would accuse the FSA of being slow off the mark.
Mr Goford: It sounds like a history
lesson but the industry first of all, as I say, suffered from
this attempt to put their own house in order 15 years ago and
were blocked. Then the Financial Services Act was enacted in 1985
and I have to say that my observation is that the industry pretty
much ignored that for five years, with phrases like: "This
act is for fringe companies," "It is not for me,"
"We compensate policyholders when they complain," and
so on, until the FSA, quite rightly, in my view, put inspectors
on the ground to check that each and every sale was compliant—that
was the very good effect of what was the PIA then—because
that is really getting at the heart of the sale and the exchange
between the salesman and the customer. That is really where the
value of the FSA was in those days.
Q754 Chairman: But you have not answered
the question. Why do you state that the FSA were "exaggerating"
a culture of mistrust of financial institutions among the public?
Why do you say that?
Mr Goford: I think that is how
it was perceived by the industry because of their depressed state
in the first place. They were continuously being hit with consultative
paper after consultative paper and rule changes after rule changes.
For example, there were many old, very high quality salesmen who
knew their customers extremely well, but the FSA supervisors on
the ground insisted on having a full fact-find, even for customers
which the salesmen had known well, which takes four or five hours
to complete. In our view, it was very depressing for the industry
to have to do that. The policymakers in the FSA, to be fair, said,
"If you know your customer and you can demonstrate it, that
is fine, but the supervisors on the ground—
Q755 Chairman: I would suggest to
you, Mr Goford, that that is a very loose use of language when
you come out and accuse the FSA of exaggerating a culture of mistrust,
because the consumer is seeing that there is not a fair deal at
the moment, that there are back-logs with endowment mortgages.
This Committee has looked at split caps, precipice bonds, whatever,
but it seems that you as an industry are not facing reality and
you are accusing the FSA when, at the end of the day, the fault
is with the industry. We need the industry to turn its attention
to positive solutions. That is why you are here this morning.
Mr Goford: We do not represent
the industry.
Q756 Chairman: You are part of the
industry though.
Mr Goford: We advise the industry
and we are very influential in the industry, I would agree, but
we are not the industry.
Q757 Chairman: That is a surprise
to us. You are an integral part of the industry. I think it is
a bit silly for you to come along here and associate yourself
with the industry.
Mr Goford: I would associate myself
in so far as they make the decisions. No actuaries make decisions
in their actuarial capacity. We have a lot of executives who are
actuaries.
Q758 Chairman: We will look at that
later on.
Mr Goford: May I just finish on
the issue of precipice bonds? In my presidential address two years
ago, I raised precipice bonds, I have spoken to the FSA ever since
to try to get the literature changed to emphasise this loss of
capital—and without result, I have to say.
Q759 Chairman: Maybe this is after
the event. The disaster has occurred.
Mr Goford: But our view is that
the sooner you get—
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