Examination of Witnesses (Questions 40-59)|
TUESDAY 30 OCTOBER 2001
40. Sir Howard, given your answers to the Chair
and in particular to David Laws, and your frank admission that
you did not actually expect the House of Lords outcome, and your
admission that things were not handled perfectly, it is hard to
see how policyholders could have realised their own expectations.
What do you now see as your role in protecting policyholders,
particularly with their reasonable expectations, given what you
have just said about the guaranteed annuity rate?
(Sir Howard Davies) We must work as quickly as possible
towards a prudential disclosure regime first, which more accurately
reflects the risks and vulnerabilities in each fund. There are
several recommendations in the report which speak to that point
but I think that probably our consideration will not be limited
to those recommendations. We have some other ideas that we want
to pursue as well. We would like first of all to make regulatory
returns more transparent and give the market and individuals but
also those who act for individuals (IFAs etc) a better ability
to understand the safety and soundness of that particular fund.
Secondly, we are working to try to improve the comparative information
available to policyholders so that they can make better informed
decisions. We have begun with our comparative information tables
in which this Committee have shown some interest in the past.
We launched those formally a couple of weeks ago with one set
of products, unit trust ISAs, but we will be expanding that so
that over time people will be able to look to the FSA for objective
comparative information on a range of products that they might
want to buy. In addition to that we are expanding our consumer
education work so that people know how to interpret this information
or can get advice on how to interpret it more easily and more
effectively than they have in the past. We hope that by working
in these two ways, one, increasing the transparency of the funds
themselves, and two, by increasing the consumer friendly nature
of the information available to investors, we can over time improve
the position, but I recognise that this is a long term project.
41. That is fine for future policyholders making
a decision, but what of Equitable Life customers who have already
made losses? I accept that you say that they have not lost everything
because the company is not insolvent, but it is clear they have
made losses where they thought they had guarantees. What is your
response to that?
(Sir Howard Davies) I am not sure about whether they
have made losses where they thought they had guarantees. The Society
would argue that it has not cut any guaranteed bonus rates. There
are interesting arguments about individual types of policies surrounding
that but I am not sure I could at this point say that people had
lost guaranteed policy amounts. The future prospects for Equitable
Life policyholders are very closely bound up with the compromise
scheme which has been published in draft, which proposes a one-off
uplift for guaranteed annuity holders of a substantial amount,
17 per cent, and a smaller one-off uplift for non-guaranteed policy
holders in return for giving away the right to their guarantees.
If that were to happen, if a scheme along those lines were to
be agreed, then the fund should be a reasonably sound fund for
the future bearing in mind that it is a closed fund which always
has some drawbacks, but it should be in a much better position
to guarantee a reasonable return for policyholders going forward.
I think the compromise scheme is the key to that.
42. You did not mention though any definition
of PRE. It has no legal basis at all, does it? Do you think it
(Sir Howard Davies) Policyholders' reasonable expectations,
as this report I think makes clear, has a somewhat chequered history
and is lacking in clarity and definition. The phrase "PRE"
will not be part of the new regime. We have tried to replace that
with the concept of treating customers fairly and we have published
a paper on what we think that means in future in terms of the
information that should be provided to policyholders and the information
particularly about the way in which companies will exercise their
discretion. We are working on that in the context of our review
of with-profits policies and we aim to produce a more comprehensive
definition of what we mean by treating customers fairly in the
spring of next year, but I agree that that concept has beenI
will not go so far as to say unhelpfulnot as clear as it
should have been.
43. So are you saying that it is a concept that
has had its day?
(Sir Howard Davies) Yes, and it has only got a month
44. Sir Howard, if we could now turn to the
approach of the FSA to the legal rulings, as we all know, the
first court, the Chancery Division of the High Court, upheld Equitable's
view that it had sufficient discretion to grant a final bonus
depending on how a policyholder decided to take his or her benefits.
We know that in the Appeal Court, one judge, Lord Justice Morritt,
agreed with the High Court but the other two, Lord Woolf and Lord
Justice Waller, said that the Board could not award differential
bonuses depending on whether the guarantee was taken up, and Lord
Justice Waller spoke of ring-fencing, which was a bit different
from Lord Woolf. However, in the House of Lords all five Law Lords
decided that Equitable was not entitled to award different final
bonuses. The Court of Appeal made its judgment on 21 January 2000.
It appears from the Baird Report that there was little communication
between the FSA and Equitable Life on this particular issue, and
indeed Equitable Life had laid out a scenario for their lawyers
as to how the court case would go. There were six elements to
that. The first was complete success on the part of Equitable
Life. The second was success but some adverse comment in the judgment.
The third was that directors have discretion but have incorrectly
executed it on technical grounds. The fourth was that directors
have discretion but have not given sufficient weight to or considered
the right PRE etc. The fifth was that the Society's approach was
invalid and that final bonus rates on cash and annuity benefits
must be equal, and the sixth was that the Society's approach was
invalid. The lawyers discounted the latter four and said that
the only ones worthy of consideration were the first two, ie complete
success by Equitable Life or success but some adverse comment
in the judgment. In the Court of Appeal case verdict on 21 January
2000 the Master of the Rolls, the most distinguished judge, the
most senior judge, Lord Woolf, made his comments known, and if
we look to the Baird Report appendix it says very clearly that
Lord Woolf's judgment was a declaration that a differential final
bonus was not a permissible exercise of the discretion conferred
by Article 65 of the Society's Articles. Why then did the FSA
in essence discount the reasoning of the Court of Appeal judgment
and in particular the judgment of the lead judge, the Master of
the Rolls, Lord Woolf?
(Sir Howard Davies) I am not sure that we did discount
that judgment. This is of course a case where (and after the first
case when we had the Vice Chancellor's very firm judgment) at
one point we felt we had a firm position based on Sir Richard
Scott's judgment. However, I think the key was that the Court
of Appeal judgment was addressing the question of whether it was
possible to award differential bonuses depending on whether or
not you took up the guarantee. That was the point you made at
the beginning of your question, Chairman. That did not mean as
we understood it that the Society would need to award exactly
the same bonus to all of the guaranteed and the non-guaranteed
policyholders but it would be possible to use that judgment to
award some differential bonuses, albeit you could not within the
class of guaranteed policyholders award differential bonuses there.
Therefore it would not have the serious effects on the Society's
financial position that the House of Lords' judgment had, which
was different. Therefore we did think that if the Court of Appeal
judgment was upheld that was a position which the Society could
manage within its resources. It was the House of Lords judgment
which went further than that and said there was no possibility
at all of differential bonuses that was not something that was
45. Can I remind you, Sir Howard, that Lord
Justice Woolf on the 21 January was very clear when he said, and
I repeat it, that the declaration of a differential final bonus
was not a permissible exercise. If I refer you to the Baird Report,
page 140, paragraph 4.53.5, that says that from the documents
seen by the Review Team [the Baird team], there was no communication
between the Insurance Financial Services Division of the FSA and
Equitable Life between mid January 2000 when the Court of Appeal
decision was published and late May 2000 relating to the court
(Sir Howard Davies) Yes.
46. That five months' inactivity seems staggeringly
complacent and it would indicate that really not much cognisance
was given to Lord Justice Woolf's comments. Incidentally, all
five Law Lords agreed with Lord Justice Woolf. Here was a train
coming down the line at 120 miles an hour and people walked away
from the station for five months and did not communicate. It seems
inexplicable, Sir Howard.
(Sir Howard Davies) I hoped we were not going to talk
about the railways today.
47. We will come on to that.
(Sir Howard Davies) The judgment in 4.53.3, which
was reported to our Board, was that if the appeal judgment was
upheld Equitable would need to revise its bonus policy but potentially
the new approach need not lead to significant additional costs.
That was because our interpretation of the Court of Appeal judgment
was that it would not be possible for them to have differential
bonuses for people who took up the guarantee or did not take up
the guarantee, but it would not be absolutely necessary to have
exactly the same bonus for the guaranteed and non-guaranteed policyholders.
Therefore, the House of Lords judgment went further. The position
that we were looking at during that period was whether or not
the Court of Appeal judgment would be upheld, and we thought that
on the basis of the argumentation in 4.53.3 it would be possible
for the company to go on if the Court of Appeal judgment was upheld.
48. With all due respect, Sir Howard, I did
not read out the rest of Lord Woolf's judgment for the sake of
time, but I think I will read it out now. It says: "The powers
contained in that provision [Article 65] were not conferred for
the purpose of treating a policyholder differently depending on
the manner in which he sought to exercise his rights under the
policy. Yet that was precisely the result of the policy adopted
by the society and that was a collateral purpose designed to negative
a benefit to which the policyholder would otherwise have been
entitled." So, rather than the Court of Appeal and Lord Justice
Woolf going beyond the House of Lords judgement, it was the clarity
with which Lord Justice Woolf expressed that which was taken up
by the Law Lords, and therefore it was the same implication that
was made, so I would suggest that it is wrong to imply that it
went further. Indeed Lord Justice Woolf hit the nail on the head
on the 21 January 2000 and it seemed that nobody took that on.
(Sir Howard Davies) With respect, Chairman, that was
not our interpretation. Indeed, the additional bit of the judgment
which you read out really speaks to the question of whether it
was possible to do what the Equitable had been doing, which was
to award a different bonus rate whether or not the guaranteed
annuity policyholder had taken up the guarantee or not. That was
certainly outlawed. If I could refer you to 4.55.8 on page 142,
at that point (this was on 4 July) a third scenario which is described
as "this new third scenario" was now in play: "A
ruling that did not allow the Society to alter the rate of bonus
for policies that contain GARsthe Society would need to
declare a rate of bonus as if the policies did not contain GARs.
This would mean that the Equitable would have to pay a GA [guaranteed
annuity] on top of unadjusted asset share; the directors of the
Society would not be able to adjust bonus rates downward because
GAR benefits gave an additional benefit to the policyholder."
We had thought in the light of the Court of Appeal judgment that
that would still be possible based on the view that had been taken
right at the outset, which is referred to as a Government Actuary's
Department view, which was that it was reasonable, and that was
in the Treasury's letter of December 1998, that it was reasonable
for a company to extract some charge for the guarantee. The House
of Lords judgment was a different scenario as we saw it from the
Lord Woolf judgment. The Lord Woolf judgment did not appear to
us to have catastrophic effects for the finances of the Society.
49. It seems to me as a non-lawyer that in very
plain English Lord Justice Woolf is saying that the powers were
not conferred for treating a policyholder differently.
(Sir Howard Davies) Depending on what choice he made.
That is quite right. I agree with that, but we are talking about
GARs as a group and non-GARs as a group.
50. I understand.
(Sir Howard Davies) He is saying that within the GARs
as a group you may not differentiate between those who choose
to take the guaranteed annuity and those who do not.
51. Can you explain why there was no communication
for five months after the Court of Appeal judgment?
(Sir Howard Davies) It was simply because the case
was being prepared for reviewing and nothing new had happened.
Nothing new happened until the House of Lords hearing actually
52. Continuing this line of questions, Baird
makes clear that you placed too much reliance on obiter dicta
in the Court of Appeal from Lord Justice Waller regarding ring
fencing. Why did you do that? It is page 216, paragraph 6.15.5.
(Sir Howard Davies) I think this is the same point.
53. No, with respect it is not. It is developing
the point. Can you answer the question? The obiter dicta
point has not been touched on by the Chairman so it is a fresh
point on that question. What is the answer? Why did you place
so much reliance on obiter dicta which did not form part
of the proper decision?
(Sir Howard Davies) We would not accept that we placed
too much reliance on it. We were seeking to interpret the appeal
judgment and how the company could operate within it. I think
that we believed that the combination of the Lord Woolf judgment
and the Lord Justice Waller judgment would allow the company to
have differential bonuses for GARs as a whole. We took those two
54. Yes, and you came to the dud conclusion,
did you not?
(Sir Howard Davies) I do not see how you can possibly
say it was a dud conclusion, Mr Ruffley, because that is not the
position that we ended up at. The House of Lords took a different
view. If the House of Lords had taken the Court of Appeal's view
we think that it would have been possible for the Equitable to
have taken that different approach.
55. With respect, it was dud in the sense that
the House of Lords came to the conclusion that you and your lawyers
did not counsel it. You got it wrong.
(Sir Howard Davies) You have changed your accusation
there, Mr Ruffley, in the course of that. You said to me that
that was a dud conclusion that we interpreted the Court of Appeal
judgment in the way we did. That was not the case. We believed
that interpretation was correct. The judgment then changed.
56. Falsified by the decision of the House of
(Sir Howard Davies) The judgment was a different one
in the House of Lords.
57. In what sense?
(Sir Howard Davies) It was different because it said,
as I pointed out, on 4.55.3, that you could not I think
it was 4.55.3
58. Your decision about what was going to happen
after the Court of Appeal was wrong. You did not see the House
of Lords ruling coming. You were coming to dud conclusions after
the Court of Appeal by definition because you did not call it
right from the House of Lords, did you, Sir Howard?
(Sir Howard Davies) That is right. We did not call
the House of Lords right. I agree with that, but that is a different
59. That is what I am saying.
(Sir Howard Davies) That is a different point.