Examination of witnesses (Questions 1
THURSDAY 15 FEBRUARY 2001
SCLATER, CVO, MR
1. As you know, the Treasury Committee is holding
an inquiry with the following terms of reference: to examine the
regulatory environment and the management of risk in the life
assurance sector, following the Equitable Life affair. Of course,
there are three other inquiries going on but this is the first
to be held in public and it is being carried out by the representatives
of the people. I am sorry that this room is so large. I think,
Mr Sclater, you want to make an initial statement.
(Mr Sclater) Mr Chairman, briefly, may
I introduce myself? I am the Chairman of the Board of the Equitable;
on my right is Peter Martin, who is Vice Chairman and a lawyer
by profession; on my left is Chris Headdon, who is the Chief Executive,
recently appointed, previously the appointed actuary. I would
like to say, first of allI have said this before and I
will repeat itthat we are profoundly sorry for what has
happened at the Equitable. We deeply regret it. I am conscious
of the fact that it touches the lives of very many people and
I could not be more sorry about that. In recent months, we have
focused our energies on trying to realise as much value as we
can for the Society and for the members. In that context, I am
very pleased that we have sold successfully The Permanent Insurance
Company for £150 million and we have now concluded a deal
with the Halifax which, all being well, should produce another
£1 billion for the members. The most important task now is
to secure a compromise between those who do and those who do not
have guaranteed annuities in their policies. In that context,
I am very pleased that it was possible yesterday for the Society
to announce that Mr Vanni Treves will take over shortly from me
as Chairman and I am sure that he and the new board will do their
very best to take things forward in a good way.
2. Thank you. Could I start with two general
questions? Why did the crisis in the Equitable happen and what
does the future hold for the Equitable policyholders, following
the deal with Halifax Bank?
(Mr Sclater) In terms of why the crisis happened,
I think there was a series of probably unique circumstances that
combined together to produce what eventually happened, and I would
like to ask Mr Headdon to elaborate on those, if I may.
(Mr Headdon) This issue has essentially been about
how the assets of a mutual organisation are divided up between
the different groups of members. The board followed an approach
which they believed was fairly attributing the assets in a particular
way. The House of Lords decision rendered that approach inappropriate
and the assets had to be divided up in a different way, which
produced more of the assets going to the guaranteed annuity rate
policyholders and less to the remainder. The reason why it had
a particular effect on the Equitable Life is really due to three
factors. Firstly, over the years we have been predominantly a
pensions office, so we have a larger proportion of this sort of
business in our portfolio than many other offices. Secondly, we
offered a very flexible type of contract and a guarantee that
applied at a wide range of ages, not just at one specific retirement
age chosen at the outset. In that sense, it was a more widely
applicable guarantee than had been the case for other organisations.
Thirdly, as a mutual, we had a well-known policy of trying to
distribute earnings as fully to members over the years as we possibly
could. Consequently, we had no shareholders' funds and no, what
are commonly called, orphan assets in order to meet this unexpected
liability that arose from the House of Lords decision. As for
the future, as Mr Sclater said in his introductory remarks, the
focus since July has been on trying to achieve the best possible
future for members, and a number of steps have been put in place
in recent months. When the Halifax transaction becomes fully effective,
I believe we will have secured a considerable new cash injection
into the fund. The compromise between the guaranteed and non-guaranteed
rate policyholders, which is an intrinsic part of the deal, will
strengthen the fund in the financial sense and give greater investment
freedom going forward. The deal has also secured cost-effective
administration for the members on an ongoing basis and access
to a first-class investment team. I think those measures taken
together should lead to a considerably better future after the
period of uncertainty that we have seen over recent months.
3. We will be looking later at the deal. The
way you have described what happened is that it is a sort of process
of events which you could not really have been expected to do
anything about. Am I right in describing the way you have just
explained your case?
(Mr Headdon) I do not think I would put it in quite
that way. Clearly there has been a succession of events over the
4. Do you think mistakes have been made?
(Mr Headdon) Clearly, with hindsight, one would have
done some things differently.
(Mr Headdon) In the 1980s the board looked ahead to
the prospect of an environment of much lower interest rates than
had been experienced during the 1970s and 1980s when these policies
were being sold. The course of action that was determined to cope
with that was to have a different final bonus rate to reflect
the different value of the guarantees on the policy. That was
consistent with the type of bonus approach that we have described
to our members. It was consistent with normal actuarial practice,
where one has different bonus levels where contracts contain different
guarantees. When those circumstances actually emerged at the end
of 1993, that was the approach that was then implemented. Clearly,
one mistake was that we did not do enough at that time to make
members aware of that bonus system and the rationale for it. We
thought that we had but in 1998 it clearly emerged that some members
were not content and therefore, by definition, we had failed to
explain the rationale for the approach and the reasons for it
properly in the early 1990s.
6. So that was your only mistake?
(Mr Headdon) I think that was a significant mistake.
It is the result of a whole chain of history. With hindsight,
one can pick out individual things where anyone would wish that
a different course of action had been taken. If one goes right
back to the beginning, one might say that perhaps it would have
been better if the policies had not been sold in the first place.
It is a combination of circumstances. It is quite difficult to
isolate one particular event and say that was a key turning point.
7. Did you expect the House of Lords decision?
(Mr Headdon) No, we did not.
8. That is another possible mistake?
(Mr Headdon) We had certainly planned for the possibility
of it arising but, on all the advice that we had been given, we
considered it to be a very remote possibility.
9. That is why you did not take enough precautions
to guard yourselves against a decision which you thought was unlikely.
Is that right?
(Mr Headdon) I think that is a very interesting question
because, from the vantage point of 1998, the question is: what
could have been done? As I said earlier, this whole case is essentially
about how the funds of the Society are divided up between different
classes of members. Really, the only thing one could have done
in 1998 to anticipate the House of Lords outcome was to make the
change in bonuses between the different groups of policyholders,
which was in fact implemented in July 2000, at an earlier date.
That would have been a very curious course of action because,
firstly, it would have been effectively anticipating what was
thought to be a very unlikely outcome; and, secondly, we were
embarked on a course of action designed to confirm the correctness
and fairness of the approach that was being taken. It would have
been extremely odd then simultaneously to have implemented a completely
different bonus system that was inconsistent with that.
Sir Michael Spicer
10. I need to declare first that my wife is
an Equitable Life policyholder. The question I want to ask is:
is there any possibility, however remote, of Equitable Life now
(Mr Sclater) The Equitable is solvent and has always
been solvent. I am not an actuary but I think I am correct in
saying that if interest rates were to fall sufficiently and if
equities were also to fall in value greatly, in other words you
had an unusual set of circumstances in the market where equities
were collapsing while gilt yields were falling, I think I am correct
in saying that under those circumstances, it would, in an extreme
case, be possible for the liabilities to exceed the assets. Can
I ask my friend, who is an actuary, to confirm whether I have
got that right?
(Mr Headdon) I think there is an important distinction
to be drawn here between true insolvency, which I take "going
bust" to mean in the sense of being unable to meet the guaranteed
liabilities, and technical insolvency under the insurance company
regulations, where those regulations contain a number of layers
of protection to cope with really a quite significant variation
in economic circumstances. In many ways that gives an early-warning
system that one may be moving on a path towards true insolvency,
but technical insolvency in the sense of being unable to meet
the statutory solvency margin laid down in regulations typically
happens at a much earlier stage.
11. If we take two examples in a moment, would
that not occur perhaps if there was to be a run, for instance,
of with-profits policyholders from the company?
(Mr Headdon) That should not happen because these
are long-term contracts and a run normally implies that people
are terminating contracts early and life offices typically have
some control over the level of values that they pay in those circumstances.
Those values will be set in a way that protects the interests
of the continuing members of the fund.
12. You are saying that the penalties would
be sufficient in your view to prevent people leaving the fund?
(Mr Headdon) I believe all life offices normally have
enough freedom to set surrender terms such that those surrendering
do not damage the interests of the continuing policyholders.
13. But it might be the case that people were
willing to pay the penalties to leave?
(Mr Headdon) Yes, but if the values they take away
do not leave the people who stay behind in a worse position, that
is a financially neutral position for continuing policyholders.
14. You are confident that in a true sense there
will not be disintegration?
(Mr Headdon) I think it is a very remote possibility,
as it is for all life companies.
15. One of the things which no doubt my colleagues
will be exploring later is the question of your fallibility on
these matters. You got the £1.5 billion wrong and you got
the reserves associated with that wrong: might you not be getting
these answers wrong in respect of insolvency?
(Mr Headdon) To the extent that the regulatory system
provides a standard framework for life offices to report their
positions, we are fully compliant with the regulations and guidance
that goes around that, and are maintaining the statutory margin
16. I do not have any policies with Equitable
Life. To check the basic facts, typically people talk about 90,000
holders of the guaranteed annuity rates policies and 370,000 or
so with profits non-GAR policyholders and some of those groups
schemes with over one million people affected. Are those statistics
(Mr Headdon) Broadly, yes.
17. As far as your policy of distributing the
full asset share and not maintaining great reserves that can cover
all the funds for the future, would you describe your company
as unique in doing it that way?
(Mr Headdon) I am not sure "unique" would
be correct but I think we were probably fairly unusual in running
such a distribution policy, yes.
18. In that specific respect, the Faculty of
Actuaries, who have written to us, say that Equitable Life Assurance
Company was unusual, some would say unique, in the way it conducted
its financial affairs. How many more companies do you know that
distributed as fully as you do?
(Mr Headdon) I think that is difficult to answer because
companies typically do not broadcast the level of their orphan
assets around the industry, unless the company has set out in
its public documents what its distribution philosophy is. We were
probably fairly unusual in doing that through the Eighties and
Nineties. It is actually difficult to tell from other offices'
statements quite what their distribution policy is.
19. I will come back to that in a moment. The
end of the GAR policies was 1988, so that is nothing to do with
worries about future liabilities but it is to do with changes
in the tax regime and new policy developments. Is that correct?
(Mr Headdon) It was mainly driven by the introduction
of the personal pensions legislation, which was much more focused
on building up a cash fund benefit and they were called portable
pensions. The idea was that you accumulated a fund of money which
you took around from job to job and then bought a pension with
that at the time you retired. So the whole ethos of that contract
was on a cash-orientated product. It seemed a natural point to
us to stop selling contracts that provided a guaranteed minimum
level of income.