Examination of Witnesses (Questions 80
- 99)
WEDNESDAY 5 MAY 2004
Mr Stephen Sklaroff, Ms Sian Lewis, Mr Stephen Richards
and Mr Martyn Parker
Q80 Baroness Howarth of Breckland:
So all other countries in the EU are on the same basis as you,
except for France which is a different kind of marketplace, as
you would say?
Mr Parker: Bearing in mind that we are an insurer
to the insurance companies, and so we are not selling policies
on the high street; but that is how we operate at the current
time.
Mr Sklaroff: Stephen, do you want to say anything
about the annuities market?
Mr Richards: The annuities market in the UK
is unique. It is the largest annuity market in the world, and
certainly in the EU. About £7 or £8 billion of maturing
pension funds buy an annuity each year in the UK. This particular
Directive, while it would affect annuities across the 25 EU Member
States, would have a completely disproportionate impact in the
United Kingdom and Ireland from what it would have in many of
the other Member States, like, for example, France, where annuities
are not a mainstream product.
Q81 Baroness Howarth of Breckland:
Why would sex have an effect in annuities? What is your argument
about that?
Mr Richards: Prudential analyses its own database
of three quarters of a million annuities. We find that, after
age, gender is the most significant rating factor: the most significant
factor for explaining future life expectancy, which is obviously
critical for an annuity. We find that gender is still the most
significant, even after taking into account things like income,
wealth, lifestyle, socio-economic group. Even after taking into
account lifestyle differences, gender is still the second most
important rating factor.
Q82 Baroness Howarth of Breckland:
Do you think that will change if it was put onto an equal basis?
Mr Richards: Do you mean if gender were removed?
Q83 Baroness Howarth of Breckland:
Yes.
Mr Richards: It would still be possible to price
annuities on a basis without gender. However, as Martyn mentioned
earlier, it would change the nature of the annuity market quite
a lot. In particular, as Lord Harrison alluded to earlier, it
would also change behaviour quite a lot. I have said that about
£7 or £8 billion goes into the annuity market each year.
This is small relative to the large market for defined-benefit
pension schemes—final salary pension schemes—variously
estimated at between £600 billion or a trillion pounds. If
we were to price on a unisex basis, from midpoint, we would be
charging men more than the cost of the annuity to us; we would
be charging women less than the true cost. If there were a true
middle rate, then defined-benefit schemes would have the opportunity
to buy out members' benefits at less than the true cost of providing
them. So the behaviour would change in the annuity market and
you would actually see the annuity rate not settling on the midpoint,
but probably going very close to the old female rate—because
behaviour would change so radically.
Chairman: This is a substantive point—and
we will come to this in more detail—about annuities. Can
we proceed a bit more on the extent to which there has been consultation
and research? I know that this is sometimes a little boring, but
I think that for the conduct of the further negotiations in Brussels
it is important that we get the best information we can about
the extent of consultation and research. It may influence whether
proposals go forward or are sent back.
Q84 Lord Howie of Troon: To what
extent have you and your counterparts elsewhere in the European
Union been consulted before the draft was drawn up?
Mr Sklaroff: There was no formal consultation
with the industry before the draft was produced.
Q85 Lord Howie of Troon: There was
not?
Mr Sklaroff: No. We did have one meeting with
the Commissioner, Commissioner Diamantopoulou as it then was,
and the staff. That was a meeting at our request, chaired by the
CEA, the European federation. We asked for that meeting because
we had heard that such a Directive was in preparation.
Q86 Lord Howie of Troon: I was going
to ask you if you thought this was adequate.
Mr Sklaroff: I think that it would be fair to
say that we felt it was inadequate.
Q87 Lord Howie of Troon: After that
somewhat shaky start, if indeed it was a start, is there any consultation
now?
Mr Sklaroff: Because of the nature of the process,
no. What has happened is that, having sent the Commission our
views on the likely results of the Directive, as we understood
it was likely to be, we heard little more from them until the
Directive was published: at which point it went straight into
the decision-making process, which in this case is the Council
of Ministers.
Q88 Lord Howie of Troon: That has
dealt with the Commission. Is the performance of the UK Government
more promising?
Mr Sklaroff: I think that it is a good deal
more promising. We have been very pleased with the discussions
we have had with officials and with ministers in the UK Government,
as the Council of Ministers has continued its deliberations on
the Directive. We have felt that we have had a very fair hearing,
and that we have had an opportunity to explain to various departments
of government what we think the effects of the Directive would
be.
Q89 Lord Howie of Troon: Do you think
that the Government are moving in your direction?
Mr Sklaroff: We believe that the Government
have taken account of the industry's concerns in discussions which
have taken place in the Council of Ministers' Working Group.
Q90 Earl of Dundee: What do we know
about the research upon which the Commission has based its proposals?
Have you seen it, and is it publicly available?
Mr Sklaroff: We have seen it and it is publicly
available. The Directive, when it was published, alluded to some
studies which the Commission argued supported much of the argumentation
in the preamble to the Directive. It did not, however, cite those
studies. We therefore requested information from the Commission
about what those studies were, and did not receive a reply. There
was then a question put down in the European Parliament, which
elicited the information we had requested. We now know that there
were five scientific studies, dating from the last two to five
years: two of them concerning the United States; three of them
concerning Europe. They are publicly available; they are academic
papers and have been published. We can make them available to
the Committee, if that would be helpful.
Q91 Earl of Dundee: Have they just
come to you or did they come to you some while ago and you have
studied them?
Mr Sklaroff: We have had a chance to look at
the papers and I might ask some of my colleagues perhaps to comment
on what they made of them.
Mr Parker: Especially there is a part of the
paper which is called the "Sex mortality differential".
This was directly stimulated for us by sight of the studies that
the Commission had used. More correctly, stimulated by the evidence
the Commission had recorded in the Directive—the impact
assessment from the studies. We felt that it rather picked out
the pieces that supported this argument and left some other important
information behind. Swiss Re therefore set about the collection
of independent research, offering our comments to the Committee
to consider. We started it as an open-minded piece of research
and we said that we wanted to contribute to the debate, but we
did not have a preset mind. We collected data from a variety of
sources. The academics will debate that there is biological difference
and maybe there is a lifestyle difference; it is very hard to
separate out both elements. However, our study, the research we
produced, shows that there is a consistent link across almost
every measure, across almost every country—a difference
in the life expectancy of males and females, with ladies living
longer. A country-by-country analysis.
Mr Richards: In every single Member State of
the European Union women outlive men. That varies by country.
The biggest difference is in Estonia, where women outlive men
by 12 years; the smallest difference is Cyprus—three and
a half years. Most European Union nations have a difference between
male and female life expectancy at birth of around six years.
The European Commission was fairly selective with its use of statistics
and, in some cases, factually incorrect. Most researchers do accept
that there are both behavioural and biological reasons why male
mortality is so much higher than female mortality. Nobody disputes
that there are both biological and lifestyle differences. Within
Prudential, we do our own mortality studies. We take account of
behavioural differences where possible, and we still find that
gender is the second most important rating factor for explaining
mortality differences.
Q92 Earl of Dundee: Your written
evidence refers to the assessment of the Chairman of the Financial
Services Authority. He thinks that the possible consequence of
the Directive is an additional capital provision of £1 billion.
Do you agree with that estimate, and have you been consulted?
Mr Sklaroff: The FSA is in the best position
to come up with such an estimate, because they are the authority
which sets capital requirements for the industry and they are
in possession of a complete set of data from all the companies
in the market. We are therefore entirely content with their estimate.
It seems to us a perfectly reasonable one.
Mr Parker: The FSA have also published expected
changes to the premium rates for females for life assurance, as
an example. Stephen may then want to come in on the annuity side.
Swiss Re have independently done some calculations and can confirm
that they are very close to the FSA's findings. We do not know
the FSA's methodologies; we do not know their assumptions; but
we worked independently and came up with differences in price
changes very approximately the same as the FSA.
Q93 Earl of Dundee: It goes without
saying, from what you have just explained, that you have your
own methodologies, you deployed these and came up with the same
figure as the FSA did—although you do not know what their
methodologies happen to be.
Mr Parker: That is right.
Q94 Earl of Dundee: Anyway, you are
both singing from the same hymn sheet.
Mr Parker: Indeed.
Q95 Lord Colwyn: I took something
out of the Sunday Times a couple of weeks ago on this statement
by Mr McCarthy. His final quote was that ". . . good social
objectives will override the realities of life expectancy and
actual behaviour . . . it is not surprising that such a policy
will have unintended consequences for both men and women".
Is that not going against what you have just been talking about?
Mr Parker: No, we would support that comment.
Maybe I have not been clear. Our expectation is that, for some
classes of product, ladies will see a modest decrease in their
policy charges; for others they will see an increase. Overall,
however, if you add up the contributions of all the men and all
the women in future generations of policyholders, as a result
of this Directive, if it is carried, the consumer will pay more.
That is the unintended consequence.
Q96 Lord Howie of Troon: I am wondering
if Ms Lewis has a slightly different view on this or not. That
is a highly sexist and male chauvinistic comment, for which I
apologise!
Ms Lewis: I can only speak for the motor market
in particular, where we see the cost of claims coming from the
young male driver being at least 60 per cent more than a female
young driver of a similar age. We would say why should they pay
the same premium when the risk is clearly very different.
Q97 Lord Howie of Troon: And you
look at it purely objectively?
Ms Lewis: Yes.
Chairman: We have a couple of questions
before we come on in a little more detail to motor insurance and
Ms Lewis will be able to give us quite a lot of information then.
There are two more points on annuities and pensions specifically.
One is on adverse selection, which is an important point because
it is a major part of your argument. The other is on the implementation
period, because there is a specific proposal on that. I will ask
Baroness Greengross and Baroness Howarth to deal with those points,
and then Lord Harrison can have a field day on motor insurance!
Q98 Baroness Greengross: You have
talked about adverse selection but I think that it would be very
helpful to us if you clarified exactly how that works and what
it would mean.
Mr Parker: I would be very happy to. As an industry,
we need to be very careful about jargon and proceeding on the
assumption that everybody understands this. "Adverse selection"
is an industry term. It is important for an insurer to defend
its financial viability from adverse selection. It is a very important
feature. What we are saying we need to do is guard against a policyholder
effecting cover when he or she knows that the price is below the
risk that they bring to the pool. It is not the activity of one
individual that we concern ourselves with; it is the activity
of a number of individuals, which could tip the balance of our
financial results. If we have unisex rates for life assurance,
effectively what would happen is that the male premium would be,
to an order, subsidised by the female premium, and adverse selection
would take place if men said, "This is a great deal. Let's
all go and buy lots of life assurance cover at this new, cheaper
rate than we used to be able to buy it at". In terms of annuities,
if we had unisex rates of annuities, females would get it at a
rate subsidised by males, because females live longer, males live
shorter lives, and so females would be getting a better deal.
The female population could then start buying more policies than
they would have done in the past—larger policies perhaps—and
the subsidy by the males would actually encourage adverse selection.
This comes back to our earlier point about the unpredictability
of the business mix, and the fact that you may get more of a particular
class of life coming to you—at a risk premium cheaper than
the premium they would otherwise pay without the gender Directive.
So we would have to price prudently and we would have to prudently
provide capital. It comes back to the two points we have made.
As an example of when adverse selection can take place, in the
1980s one of the high street names in life assurance put out an
insurance product into the marketplace which had no underwriting—no
selection questions at all, no health questions—if your
policy was being taken alongside a mortgage loan. The theory of
the pilot was to say to ourselves, "If people are buying
a 10-year mortgage, life assurance is incidental". What actually
happened with that book of experience was that it was seriously
adverse to the expected experience. Many more, in terms of payments,
coming out of the organisation; many more paying claims than premiums
collected by some margin. It showed that human behaviour is such
that you can see an opportunity and you can adversely select to
buy from that company rather than a different company that takes
your medical history. The less healthy lives were buying cover
and getting claims and having benefits under the policies. Adverse
selection, with that example, is a real phenomenon that changes
people's behaviour.
Q99 Baroness Howarth of Breckland:
The point you have just raised leads to the next question I was
going to ask. It demonstrates that behavioural predictions are
notoriously difficult over the longer term. The Commission's proposals
include the possibility of an extended implementation period of
eight years. Would that not give enough time for the insurance
business to adjust? And why should consumers suffer?
Mr Sklaroff: I think that the short answer to
this is that the length of the transition period is to some extent
irrelevant to the adverse consequences that we are describing
for our customers. So whether it takes one year or eight years
to get to a point at which prices are higher, it seems to us that
our customers would still suffer. Of course, it is true that the
longer the transition period the easier it is, or the more time
companies have, to adapt to the new system; but that does not
in any way undermine what we are saying about the effects on our
customers—which would be the same anyway. We therefore think
that the issue of the transition period is a bit of a red herring.
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