A paper prepared by John MacLeod FIA
EQUITABLE LIFE'S MANAGEMENT OF RISK
1. The Equitable's current difficulties
arise from the fact that the recent fall in interest rates has
exposed them not to just ONE but to TWO different sets of liabilities.
2. FIRSTLY there are those that arise from
the fact that they have accepted premiums in the past to which
annuity guarantees were attached. These might be called "known
liabilities". It is the manner in which these liabilities
were managed that gave rise to the recent court proceedings, culminating
in the House of Lords' judgment.
3. SECONDLY there are those that could arise
from the fact that all policies issued pre-July 1988 and which
are still in force allow the policy holder to pay any further
premium up to Inland Revenue limits still at the originally
guaranteed rates. These "latent liabilities", being
open ended, could be even more devastating than the ones above.
4. The distinction between these two sets
of liabilities does not seem properly to have been made in the
public comments made on the Equitable affair. This paper aims
to set out their consequences.
5. With-profit Retirement Annuity Policies
(RAPs) were first marketed by the Equitable in 1970. The law then
was that the office that took premiums had to pay the policyholder
his pension. It was thus inevitable that policy holders should
know what pension their premiums would purchase, so the inclusion
of an "annuity guarantee" was inevitable. What was not
inevitable was the lack of conditions attaching to those guarantees,
particularly in regard to the way they could also be applied to
future premiums (thus giving rise to the "latent" liabilities
referred to above). This made them extremely generous.
6. The introduction of the open-market option
by the 1977 Finance Act permitted policy holders to take their
benefits in cash form to any other annuity provider. This removed
the necessity for annuity rate guarantees to be given on new policies
entered into after that date.
7. However, the Equitable did not take advantage
of the opportunity to do so until mid-1988. All existing policy
holdersthe "GAR policy holders"kept their
guarantees. All new policies taken out subsequently did not, giving
rise to a class of "non-GAR policy holders" when they
created in effect two classes of policy holders.
8. During this time, the Equitable reserved
for their liabilities in respect of past premiums paid (the "known"
liabilities); but only to the extent that annuity rates might
fall to the guaranteed rates. No account was taken of the possibility
that annuity rates might fall even further, thus adding to the
value of the known liabilities as well as kindling the latent
9. At least towards the end of this time,
the Equitable pursued a policy of fully distributing profits.
All assets not set aside for supporting the known liabilities
were intended for eventual distribution as terminal bonus to existing
policyholders. No cushion of assets (known as the "orphan"
estate) was built up to guard against any unforeseen events; and,
since the Equitable was a mutual company, there were no shareholders'
funds to call on either. The terminal bonus fund thus "doubled
up" as a contingency fund.
10. When the fall in interest rates, coupled
with a domestic fall in pensioners' mortality rates, caused annuity
rates to drop below their guaranteed level in 1993, that created
an "unforeseen event"unforeseen only five years
earlier, apparently, since such guarantees were then still being
freely givencausing a call having to be made on the contingency
11. This "double booking" of the
contingency fund with funds intended for future terminal bonuses
led to the Equitable taking the cost of the guarantees out of
that part of the terminal bonus fund that was ear-marked for those
guaranteed policy holders. Such policy holders thought this unfair,
and claimed the cost should be taken from the entire fund.
12. The High Court action; the Appeal against
that action; and the final Hearing before the House of Lords then
followed. The final verdict went against the Equitable and they
finally closed their doors to new business on 8 December 2000.
13. Although the Equitable made no financial
reserves to cover their liabilities in the event of annuity rates
falling below the guaranteed levels, that would seem to be in
accordance with actuarial guide lines current at the time.
14. A Position Statement issued by the Institute
of Actuaries in 1999 states in paragraph 27 that the cost of guarantees
". . . may be met by the specific class of policy itself
in whole or in part, or may be met by other policyholders' bonus,
out of shareholders' fund, or from the [orphan] estate."
15. The fact that the Equitable had no orphan
estate, and that it was their policy not to create one was no
secret, at any rate within the life assurance world. It was also
freely admitted by Mr. Nash in a newspaper article on 27th September
16. When all guarantees were removed from
policy holders who joined after July 1988 (the "non-GAR"
policy holders) it is just possible to argue that all guarantees
on premiums already paid on existing GAR policies (the "known"
liabilities) could be met out of the GAR policy holders' own reserves,
and that all non-GAR policies would be unaffected.
17. There was however no certainty that payment
of guarantees on future premiums paid by the then existing GAR
policy-holders (the "latent" liabilities) could be met
from GAR policy holders funds alone, even if the Equitable's disputed
policy had been upheld. Indeed it was explained at the Equitable's
1999 AGM that £30 million had to come out of general funds
in this way, updated to £10 million pounds the following
18. Given that an existing GAR policy holder,
whose policy is still in force, can now, depending on his age
and earnings, pay up to £40,000 to purchase an annuity at
25 per cent less than the market rate, even though he might have
paid no more than £150 per year in the past, it follows that
this figure would certainly continue to escalate year by year,
seriously eroding the returns such post-1988 policy holders could
expect to receive.
19. The existence of the annuity guarantees,
either known or contingent, was not revealed to those policy holders.
This surely constitutes a prima facie case of mis-selling.
Other offices could perhaps maintain that it was up to the policy
holder's financial advisers to ascertain this situation, and appeal
to the "Freedom with Publicity" principle on which insurance
business was then conducted.
20. However it was The Equitable's much
vaunted claim that they dispensed with such intermediaries. So
either way, whether as adviser or provider or both, the Equitable
appear to have failed to alert all post-1988 policy holders to
the fact that they were walking into a situation in which they
were liable to pay at least in part for liabilities that were
in place at the time they took out their policies.
21. In the event, they are now being called
upon to shoulder the major part of the cost of those guarantees.
But House of Lords or no House of Lords, they would always have
been liable to pay a significant proportion of those liabilities.
22. No doubt the Equitable have prepared
projections for the future, to which we are not privy nor would
we expect to be.
23. We wonder, however, whether such projections,
assuming realistic assumptions concerning future take-up rates
by policy holders (including the extent to which they are likely
to "top-up" their future premiums and so invoke the
latent liabilities); together with interest rates at current European
levels (which it must be assumed could well apply in five years'
time) result in the Equitable being insolvent at some point in
24. If so, does that not mean that the
Equitable is insolvent now?
25. The Equitable is currently solvent in
that guaranteed benefits are not eroded. But that seems a mere
technicality. Policy holders have always been encouraged to consider
their total benefitsie guaranteed benefits plus full bonuses,
and final bonuses have been severely cut back and this trend is
likely to continue.
26. So what would change if the Equitable
were to be pronounced insolvent now? Obviously GAR policy holders
would not be able to put in further premiums, and to have the
value of those premiums increased by the non-GAR policy holders,
an inevitable and unforeseen, but nonetheless generally considered
undesirable, consequence of the House of Lords decision. Clearly
therefore, the sooner the Equitable can be declared insolvent,
the better it will be for non-GAR policy holders.
27. We find it curious that whereas the
Equitable is closed to new business, existing GAR policy holders
can still elect to pay in further premiums without limit, the
benefits of which can only be paid for by other policy holders;
particularly as it has been reported in the Press that the Scottish
Widows' has managed to restrict this very practice and they are
still a going concern!
28. We wonder if the Equitable have interpreted
the House of Lords judgment correctly. Their lordships found against
distinguishing between policies whose only difference was that
one had a guarantee and the other did not. But does that necessarily
preclude them from distinguishing between policies according to
when they were first taken out?
My involvement with the Equitable is both personal
On the personal side, I have been a policyholder
of the Equitable since 1970, and now derive a substantial proportion
of my retirement income from the Equitable. I attended the High
Court action in July 1999, as well as the last two of the Society's
On the professional side, I am a qualified actuary.
I spent the last 10 years of my working life (the greater part
of which was spent in the computer industry) at the Government
Actuary's Department. These included two years in what was then
the Insurance Supervision Directorate.
I am currently a committee member of the Equitable
Policy Holders Action Group (EPHAG).
1 February 2001