Examination of Witnesses (Questions 20-39)|
TUESDAY 30 OCTOBER 2001
20. What I really would like to get at is whether
you feel that as the head of the FSA such action as has been taken
on your bonus is in some way a token gesture for the absence of
the ability to impose fines, failure to report to the regulator
or almost total immunity of the FSA except in respect of bad faith?
(Sir Howard Davies) No, I do not believe there is
any connection whatsoever but you would have to pursue this with
my remuneration committee. That was certainly not a point made
to me in any way at all. This is about the management of the Authority.
21. You did release this information yourself
to the world and the nation on the Money Programme.
(Sir Howard Davies) Chairman, it has been in our
annual report for the last two years.
22. That is why we are here.
(Sir Howard Davies) It was publicly available information.
It was published in our annual report in June. It has recently
attracted some attention because I was asked a question about
it. It has been in the public domain for some time.
Chairman: It was freely given by yourself
in that programme. We will go on to the next section which is
the role of the FSA in the context of Equitable's regulation and
I will ask Nick Palmer to lead on that.
23. Sir Howard, you have accepted that there
were management errors in this process and you have said that
there were legislative or regulatory limitations to what you could
do. Just to pin that down more precisely. Would you agree that
within the limits of the current regulations the FSA failed to
fulfil its entire regulatory responsibilities? Were the management
errors sufficient for that or were they really an internal problem?
(Sir Howard Davies) I do not believe that we failed
to fulfil our regulatory responsibilities, no, because I believe
that there are arguable points in here and, indeed, at the key
decision points the report either accepts that the FSA made the
right decision or that it made a reasonable decision, a decision
which reasonable people could reasonably make at that time given
the information they had at their disposal.
24. To quote the old saying "if everything
is fine why are we so miserable". If the Authority did fulfil
the regulatory responsibility it had, is that not a very swingeing
indictment of the regulatory powers the FSA have?
(Sir Howard Davies) I think it is quite a serious
indictment of the regime as it has been in that I believe personally
it is extraordinary that a company could write so many guaranteed
annuity policies and the regulatory returns should include no
reference to the liabilities thereby created. I find that extraordinary
and I find it extraordinary that was the position we inherited.
There was no reference and had been no reference for many years,
as I understand it, in the regulatory returns to the liabilities
created by these guarantees. I believe that in that one respect
the regime, that is the recommendation that there should be stochastic
valuation of guarantees, is designed to meet that point. A second
is that I think that the use of financial reinsurance and the
way in which the companies are allowed to take account of future
profits, and the two are rather linked because the financial reinsurance
is frequently remunerated by the future profits, is in my view
inappropriate and creates a very opaque view of companies' assets
and liabilities. Thirdly, I believe that what this story shows
is that the reliance placed under the regulatory regime on the
role of the appointed actuary as the independent, if you like,
advocate of the policyholders within the company has been misplaced
in certain circumstances and certainly in this one in that a practice
which might have seemed to be giving policyholders a degree of
authority, and which was really the underpinning of a regime,
could quite easily become something quite different when the appointed
actuary held a senior management position, in some cases chief
executive, in the company and therefore was clearly operating
with severe tension. I believe that in those three respects the
regime as it has operated has been inadequate.
25. We will be coming back to some of these
issues. Just one final question from me on this point. To what
extent did the FSA accept without question what Equitable told
it? There is a perception among lay people that the City has a
lot of people who know each other and trust each other. Trust
is a good thing but in this case it does not seem to have worked,
(Sir Howard Davies) No, and I think I would accept
the criticism in the report that on occasions we were too inclined
to accept the Equitable's interpretation of events and, indeed,
forecast of events. I think what you can see from reading the
full narrative of the regulation is that that trust was misplaced
in that we were frequently not told the full picture.
26. Would you not call that a regulatory failure?
(Sir Howard Davies) I think it was unfortunate that
we took that reliance but the question of regulatory failure is
two things. One is whether it would have been better had we been
more sceptical of the Equitable Life, I agree, but did that lack
of scepticism result in, was it the cause of the regulatory failure,
is not something I think I could accept on the basis of this report.
27. Sir Howard, obviously you would accept that
in your aims and objectives it says that one of those is to regulate
the insurance industry so that policyholders can have confidence
in the ability of UK insurers to meet their liabilities and fulfil
policyholders' reasonable expectations. Can I now take you back,
using the recent FSA report, to the events when you took over
the regulation of Equitable Life. In 4.15 in the report, page
82, we get some idea of the nightmare that is about to descend
on you in regulating Equitable Life in a memorandum from the Treasury
to the Economic Secretary on 19th October. It says "Meeting
the cost of the guarantees is putting a significant strain on
the company's resources . . .". Going further down "It
is feasible that the company could have to consider some form
of demutualisation, for instance through merger with another company,
depending on how serious the financial situation proves to be".
In 4.15.11, referring to another meeting, it says that the Treasury's
insurance directorate thought there was ". . .at least the
possibility that dissident policyholders might win a case in Court
that they should be paid a guaranteed annuity on unadjusted terminal
bonus." When you came to take over the regulation of this
company you must have been worried about this? You must have thought
when you got the briefing, which was referred to in 4.19.3 from
the Treasury, about what you were about to inherit that this was
a real nightmare in the offing. Was that your view?
(Sir Howard Davies) If I could just clarify that,
yes, these were people who at that time were Treasury Insurance
Division, but of course they transferred en bloc to me, so the
views that they held then they brought with them for good or ill.
28. Very pessimistic views.
(Sir Howard Davies) They had pessimistic views at
that point and were concerned about the eventual outcome for the
company. What had happened of course, by the time we took over
formal responsibility under our delegated authority on 1 January,
was that a key event had occurred which post-dates these two references,
and that was the decision that the Equitable Life itself took
to seek to resolve its uncertainties by means of a court case,
again, as the report points out, not something which they consulted
us about or even informed us about at all, which I find extraordinary,
but they went ahead and decided that they would seek to resolve
these uncertainties in the law. That of course significantly constrained
the regulator's room for manoeuvre because the company was able
to say, "Look; we have very good legal advice that suggests
that our interpretation of all these things is correct and anyway
that is going to be determined."
29. Just to clarify this, when you had the briefing
with Michael Foot in anticipation of the transfer of responsibilities
you were given a briefing about the situation in relation to Equitable
Life which must have been pretty gloomy. As the Chairman explained
earlier on, this was the only company, I think, that was singled
out as a particular problem, and indeed, in the covering memorandum
to you referred to in 4.19.2, Treasury officials expressed concern
about Equitable's ability to reserve adequately, and I quote:
"The information received to date is unconvincing, and raises
serious questions about the company's solvency", so this
was a pretty gloomy position, was it not?
(Sir Howard Davies) It was indeed. As a result we
needed to pursue some fairly robust lines of enquiry with the
company about its reserving. I was consulted about that. I looked
carefully at the arguments because it was clear that we were heading
for a serious row with a company which, as you know, was in very
high standing in general in the market place at that time, a 240-year
old company with a long and distinguished record, and we were
running into a serious battle with them. Therefore I sought to
satisfy myself that our arguments for pressing our views on reserving
with them were robust.
30. When you left that meeting with HMT officials
and Michael Foot, when they briefed you about what this company
looked like, would you have been happy at that point to put any
of your own personal financial resources into Equitable Life?
(Sir Howard Davies) I have a small unit linked Equitable
Life policy which I have not done anything with.
31. Would you have been willing to put any new
money into Equitable Life after that meeting?
(Sir Howard Davies) I do find that a slightly odd
question. I am not quite sure why my own personal finances, which
we have discussed at some length already
32. I am trying to get a view of your opinion
about the safety and security of putting money into Equitable
Life two years before the company was closed to new business.
(Sir Howard Davies) No, I did not think that, Mr Laws,
because it seemed to me at the time that we were going to end
up trying to impose our will on Equitable in terms of reserving
for these guarantees, that life insurance business is usually
a very long term business, as is explained in the early part of
the report, that while it might be necessary for the company to
increase its reserves and probably to reduce its bonus payouts
in order to strengthen its position (depending of course on the
eventual outcome of the court case), none-the-less it looked at
that point as though there was a way through.
33. You would have been happy to recommend to
a good friend putting more money into Equitable Life after you
had had that briefing?
(Sir Howard Davies) I am not approved by the Financial
Services Authority to give advice.
34. Do you not find it astonishing, given the
briefing that was given about the position of the company, that
two years later this company was still taking on board new policyholders?
(Sir Howard Davies) No, I do not find that extraordinary
given the story as it was set out here.
35. What did you do to warn potential new policyholders
about the risks that were set out in the Treasury note? What did
you do as a regulatory authority to make sure that anybody who
was about to put new money into that company was aware of just
what type of risks they were taking?
(Sir Howard Davies) This raises an interesting question,
but I think that the reality is that you are either authorised
to carry out insurance business or you are not. I do not interpret
our rules as giving us the ability to say, "Company A is
authorised and I, the Chairman of the FSA, would be delighted
to put my money in it. Company B is authorised but if I were you
I would watch out." We do not have that ability to make those
distinctions. We would be in serious difficulty were we to seek
to do so. We are able to satisfy ourselves that a company is solvent
and, if we are satisfied that it is solvent, then it may carry
on taking on business unless it does not meet the criteria
36. Is it not reasonable of you to ensure that
those people who are sold new policies are aware of some of those
risks? To have given the information on which they could form
that judgement, what action did you take to make sure that the
information given to new people who entered Equitable Life after
that period of time was adjusted to reflect the risks?
(Sir Howard Davies) The company needs to disclose
its financial position. I have explained in my answers to Dr Palmer
that I believe that those disclosures in the regulatory returns
are not adequate. I think that is a lesson that we can learn from
this. I really do not think it is open to the Authority to reach
impressionistic judgements about the probabilities of difficulties
in companies and to require companies to say something about those
to policy holders. That is not the way I interpret our responsibilities
in the regime.
37. Do you think that confidence in the market,
including those people who wish to buy life assurance, has been
dented as a consequence of the Equitable Life affair?
(Sir Howard Davies) That is a very interesting question.
Many have asserted that it has. I can only say that the evidence
of the market place would not provide any solid grounds for that
assertion. John, I think you have looked more recently at the
latest sales figures.
(Mr Tiner) Yes. A number of the very large life houses
have recently published results showing substantial increases
in new business over the last year. That implies that at least
to a certain extent long term savers and investors are still putting
their money into the life assurance industry.
38. Do you think that by not promising a zero
failure regime, something which I support in principle your decision
upon (and some of us do as I think you know from earlier exchanges
between us, orally and in writing), you are simply seeking to
reduce expectations and therefore blame when a company does fail?
(Sir Howard Davies) No. I have been grateful for your
support and that of others in the past on that. I do not think
so. I think that the regime that we have, which was very extensively
debated in Parliament during the passage of the Financial Services
and Markets Act, made it very clear that the Authority should
pursue two objectives in its consumer protection area. One is
promoting public understanding of the financial system and the
second is protecting consumers but bearing in mind their own responsibilities.
We interpret that as meaning that as far as possible we should
operate on the basis of disclosure and regulate in a way which
promotes competition because healthy competition in the market
is in the long run the best guarantee of a good deal for consumers,
but a healthy and competitive market place is one in which not
all can have prizes. There were bound to be relative winners and
relative losers. I would emphasise that the Equitable Life has
not in fact failed and is not an insolvent company. The returns
to policyholders have been somewhat lower than those policyholders
had hoped, so it is not a failure in that absolute sense. However,
although it can be uncomfortable and we are sometimes caricatured
for having said that we cannot run zero failure regimes, my own
strong view is that to attempt to do the opposite would in the
long run be extremely damaging. It would be possible for us to
reduce further the probability of failure in the life insurance
industry. That would be something which I could easily achieve.
I would do so by requiring all life companies to hold 100 per
cent of their assets in five pound notes or in short dated gilts
perhaps, which would be more realistic, and there would be a very
solid life company. The returns over a 25-year period would of
course be very poor indeed. At the moment they would be four per
cent returns. Over the long run equities yield, as you know, Mr
Tyrie, an equity premium (although we may argue that it may have
changed recently) of, let us say, four per cent. The risk that
you have to bear if you want to have a life insurance sector which
is heavily invested in equities, which in the long run has been
rather good for policyholders, is that that creates a sector which
is more vulnerable to downturns and to uncertainties. That is,
I am afraid, the price that we pay. One of the debates that we
will have to have as we pursue the recommendations in this report,
which will be an interesting debate, is where do we want to set
this line? I would like to be quite clear to the Committee. It
would be possible to set this line somewhere else. It would be
possible to have lower solvency requirements. It would be possible
to have higher solvency requirements, but there is a fairly straightforward
trade-off there in the long run between risk and return.
39. And you are going to stick to your risk
based approach to regulation which you set out in those discussion
papers a year and a half ago?
(Sir Howard Davies) We believe that that is the right
approach, and indeed I think there is support for that in the
report. Indeed, in so far as the report is critical of our management
approach, it is that we did not adopt early enough the approach
that we have set out as the approach that the new Authority will