The Errors and Who Was to Blame

Last Updated: Friday, February 13, 2004 07:47 PM

The Equitable Life Assurance Society:  The errors and who was to blame.


            The Society was effectively ruined by the House of Lords decision on 20th July 2000.    As a result of the judgment the Society was forced to make provision for the payment of annuities at above market rates to about 90,000 policyholders with guarantees (GARs).  This produced an immediate liability for a large unquantifiable extra cost on the Society’s with profits fund.  The judgement of Solomon had been carried out but in this case each mother was left with part of a dead child.


            As the Society had always paid out a high proportion of its profits in the form of bonuses there were only small reserves in the fund available for meeting the guaranteed annuities and most of the cost of the guarantees would have to be found by reducing the bonuses of all the policyholders including the non-GARs.  As there were at that time 290,000 non-GARs to 90,000 GARS this solution was theoretically possible by reducing the bonus payments to all policyholders, but in practice as soon as the judgment was announced all non-GARs were very upset to hear that their funds would be used to meet the cost of guarantees of which they knew nothing when they took out their policies.  Many non-GARS cut their losses and left the Society and the Society had to close to new members and try to sell out to a stronger company.  The Society, already battered by legal costs and a falling stock market, was effectively ruined.  The Directors were forced to resign.


            It has been argued that the Society should have set funds aside at an early date to meet the cost of the guarantees, but they could only do so by reducing bonuses, as there is and never was any other source of funds apart from the premiums paid by all the policyholders, and the fund belonged entirely to the policyholders in proportion to their asset shares.  In logic and in equity the Society should never have offered guarantees of any kind to some policyholders, which were not offered to all.  They might have legally done so if they had made clear to all potential customers before they started making contributions that there were substantial numbers of policyholders who were entitled to a larger share in the common fund than their asset share.  Clearly no potential customer of the Society would have entered the fund if they knew of such conditions.


            The Vice-Chancellor’s judgment in the High Court in finding for the Society, used the following words: “He (a policyholder taking an annuity at the guaranteed rate) is being allotted a lesser final bonus because a lesser final bonus is all that is needed to bring the value of the benefits he receives up to his asset share.” If this succinct and wise judgment had been followed a major financial disaster would have been avoided.


            In the Court of Appeal Lord Woolf M.R. found against the Society, taking the view that the Society had a duty to honour the guarantees.  Waller L.J. agreed with Lord Woolf but included in his judgment a passage, which acknowledged that it was legitimate for the Society to try to give all policyholders their notional asset share, and in effect countered his own judgment.  Morritt L.J.  dissented.  He felt that the Society had the powers to reduce final bonus payments to the GARs and that the directors of the Society acted in good faith.


            The Society was given leave to appeal to the House of Lords who gave judgment on the 20th July 2000 when all five Lords found against the Society.  Lord Steyn gave most of the judgment.  He concentrated on whether the Society had the right to act as they did under article 65 of the articles of association of the Society.  He found that on the strict terms of article 65 the directors had the right to reduce bonus payments for the GARs in order to remove the advantage they would have gained by exercising their guarantees.  However he went on to say that there was an implied condition in article 65 which prohibited the directors exercising their discretion to override or undermine guaranteed annuity rates. 


            The “implied condition” in article 65 gave legal force to Lord Steyn’s judgment.  He gave no other justification apart from an implied certainty that the Society should have paid the GARs their full guaranteed annuity rates on the same bonus rates as were enjoyed by the non-GARS.  He seemed to give little, if any, weight to the argument that asset share should be the basis for dividing the benefits of the fund equally between all policyholders. 


            Lord Cooke of Thorndon in giving judgment against the Society uses the words:  “The Vice-Chancellor’s description introduces the concept of asset share, which is nowhere mentioned in the policy but dominates the approach of the directors”.


The concept of asset share should not have been ignored, as it is central to the idea of a mutual society.  One can fully agree with the Lords that the Society was acting improperly in negating the benefits of the guaranteed annuity rates by devious and underhand methods but one must insist that the Society had no practical alternative.  The truth of this statement is amply illustrated by what happened when the Society was forced to honour the guarantees to the letter.  Not only the Society as an entity suffered heavily but also nearly all of the policyholders.  The Lords made a serious mistake in not considering more than the narrow legality of the case.


The remaining three Lords simply agreed with Lord Steyn and Lord Cooke of Thorndon in finding against the Society.


            There was no correct solution to the dilemma faced by the Society.  The simple truth is that the directors were wrong to give guarantees to some policyholders that undermined the interests of other policyholders.  They stopped giving these guarantees in 1988, presumably because they then realised that it could put them in an impossible position if interest rates fell much further.  At this point the Society should have asked all GARs to consider their position and pointed out that if the Society were to put aside funds to honour their guarantees it would reduce the bonuses paid out.  It would have meant admitting that the original guarantees were simply a sales ploy and could never have worked to the GARs advantage without diverting funds from non-GARS.  An alternative would have been to create two completely separate funds, one for GARs and one for non-Gars.   If two funds had been created it would soon have become clear that the GAR fund was not performing as well as the non-GAR fund because of the need to set funds aside to meet above market annuity rates.  The end result of separating the funds would have been the same as that obtained by the Society through the use of different final bonuses but it would have been honest and clear from the start.


            The course of action actually adopted by the Society was illegal from the moment they offered guarantees to some policyholders and not to others.  This principle holds good for any other guarantees of minimum annual or final bonuses given only to some of the policyholders.  The House of Lords were asked the wrong question so it is perhaps not surprising that they gave the wrong answer.  The proper question was how best to rectify the folly of the Society in making promises it could not legally fulfil.  The answer to this question is that the folly could not be rectified, as the funds of the non-GARS should have been untouchable and the only other resources were the personal assets of the directors, which were completely inadequate. 


            It was not in the brief of the Lords to go further than a narrow legal solution to the question put to them, although one might have expected them to look more closely at the results that would certainly flow from their judgement.  The defence put forward by the Society was weak and ineffective, probably because they knew their actions could not be defended except by admitting to almost criminal carelessness in granting guarantees to some but not all policyholders.


 The Regulatory Authorities are at least as much to blame as the Society, in that at all stages over the years leading up to the disaster they failed to find and correct the illegal, highly misleading, and contradictory terms of the policies sold by the Society.  Even when the dispute reached the Courts the Regulatory Authorities failed to recognise the scale of impending disaster.  They should have stepped in to protect the interests of all the policy holders of the Society.  We can only hope that some good may come of this affair if pension fund accounts are made completely transparent.  The funds should be far closer to unit trusts and the mythical protection given by “smoothing” abandoned.


The actions of the GARs in seeking what they saw as their rights triggered the final melt down.  They would have been encouraged in their actions by the feeble defence put up by the Society.  Feeble because the Society knew they had misled the GARs, but by not coming clean allowed the GARs to believe they could both have their cake and a large part of non-GAR cake as well.  Moreover, as the case progressed one might have expected at least some of the GARS to realise that they were pushing the Society towards a total disaster that would engulf them and all members.  The Lawyers acting for the GARs should also have realised what the consequences of their victory would be.


            For very many years the Equitable Life could proudly advertise the highest returns in the industry.  In more recent years their fund management lost its touch and they started spending too much on advertising, the cost of which reduced the fund performance significantly.  Their accounts began to look as though they depended on an ever increasing flow of deposits.  The Society also fell victim to the general tendency in the industry to keep their reserves in equities and too little in less volatile assets.  This has produced severe falls in the value of most pension funds, even those considered very sound indeed.  In this matter also the Financial Regulator has been remiss, as equities have always been the most dangerous way of holding financial assets and are not suitable for use as a store of value in such a critical situation as pension funds.


            The final and possibly the most culpable influence in this matter is the Treasury.  Tax incentives forced us to use intermediaries to hold our personal pension funds thus laying us all open to high management and selling costs.  Many pension funds still have ridiculously high initial charges and do their utmost to lock policyholders into badly performing funds.  Ironically the Equitable Life was far less guilty of such practices than many other Companies.  When, finally, having accumulated a fund and  retired, the Treasury force us to buy an annuity with most of our matured funds thus exposing ourselves to the end of our days to further management charges, lack of flexibility and the effects of inflation on a fixed income.


            It would help to resolve the situation if the fund was unitised so that all members could see exactly where they stand.  This might be painful but it would be a great relief to see what is left and it would bring the smoke and mirrors act by which we have all been misled to an end.  It would be difficult to allocate the units but this is a task that has to be undertaken in some way or other before the case can be finally put to rest.  When it has been carried out we will all see exactly how much we have lost


            It would now be counter productive for any group of policyholders to seek redress from the Society, it is barely solvent and any gain by one group can only be at the expense of the others.   The policyholders can look only to the Government for compensation for losses largely caused by the actions or inactions of Government bodies.  There must be an attempt to estimate the losses to the Society caused directly by the decision of the House of Lords separately from the losses that would have occurred in any case because of falls in the stock market.  All members are entitled to expect compensation for losses caused by Government.


            T W R Davies.