An Equitable Assessment of Rights and Wrongs
by Dr Michael Nassim
10. Critique of the Society’s own assessment of its damage
Critique of the Society’s own assessment of its damage
has concluded that there is a deficit of £ 3.2 billion pounds in the With
Profits Fund, which estimate is very close to that of independent outside
accountants, such as Burgess Hodgson22,23.
It is now seeking to recover the whole of this sum from former officers,
directors and its erstwhile auditor. The
sums sought from the individuals are punitive, and some face ruin from the legal
costs alone. Having proclaimed the
worst links in its chain, the Society is making them solely and wholly
accountable, which is not inconsistent with the conclusions of the previous
section. Because of its import we
are all obliged to take this exercise at face value, and disregard any public
relations, political or diversionary aspects.
therefore also take the view that the Society should not seek to be judged by
others any less fully than it judges its former self.
On this basis former as well as present members of the Society are
entitled to their share of full compensation pro rata.
It must therefore be a matter of astonishment and regret that the Society
proposes to offer former members less in compensation than it seeks on behalf of
its present ones.
does not end here. The deficit
which Burgess Hodgson has identified, and which the Society alleges that
auditors Ernst and Young overlooked, is the cumulative disparity arising from a
dual standard of reporting non-discounted policy values for members, but
discounted values for its own management and the regulator.
A memorandum from Equitable actuary Catherine Payne addressed to
Christopher Headdon came out in the Ernst & Young case, and it showed that
total with-profits policy values exceeded assets in the years 1995-99 inclusive.
This enabled Burgess Hodgson to firm up previous estimates19,
and to surmise that a similar situation had obtained in the years 1990, 1991,
1992 and 1994. (It is also of interest that footnotes to the Payne memorandum
reveal that the GAR reserve had been kept at £50 million from 1998 into 1999.
This may explain the origins of the misleading estimate of the GAR
liability referred to earlier, which was apparently held constant despite legal
advice by then received. It is also
likely to reflect the approximate size of the absolute solvency gap within the
GAR segment of the fund as computed under Second Order Sophistry Item 5, which
further emphasises the impropriety of maintaining that this was the maximum
liability that the Society would incur if it lost the House of Lords Appeal.)
Ernst and Young case is centred upon the reverses of more recent years, it is
unlikely to allow even partly for an earlier loss of the Society’s estate. This we have previously identified as a crucial question.
Until there is definite knowledge of its fate no attempt can be made to
recover it, but the likelihood is that this will largely be impossible.
Reason enough, perhaps, for the Society not to advertise the matter. Yet as has been seen previously in comparison with other
offices, a preserved estate or its equivalent provides a valuable smoothing and
strengthening buffer, and is part of the inherent characteristics of a healthy
With-Profits Fund. If at the height
of the bubble the total valuation of the With Profits fund was £30 billion, and
it had been backed by a relatively spare estate comprising only 10% of this (15%
is more usual), then we can see that the true loss to the fund is at least 3
billion pounds more than has previously been stated11. And if the
Equitable With Profits Fund is ever again to function as such, this estate must
first be restored. Meanwhile
whatever allowance or recompense for its loss later policyholders should be made
requires formal debate.
As yet the Society has ignored
the effects of a growing tide of complaints about the GIR issue, which though
analogous to the GAR one in many ways, could not by its nature have been laid
off fully in dual accounting standards. This
issue has previously been summarised as Second Order Sophistry item 6. The background to this has been explained in detail by Peter
Scawen12 as part of a more general exposition of how Equitable
With-Profits annuities are calculated. When
the Society stopped policies with the GAR option, from 1988-96 they awarded a
guaranteed interest rate of accumulation of 3.5% per annum (GIR) to policies
until they matured. This was
mentioned in the product particulars, but in practice it could be arranged to
cost the Society little or nothing. In the first place, an initial deduction of
4.5% was taken from each premium, and there was an annual management charge of
0.5%. In the second, although the
accumulation rate was guaranteed, the proportion of this allotted as guaranteed
and un-guaranteed annual bonus was at the Society’s discretion. In retrospect,
the first indication that this might be important came from the bonus statements
for 1997, when both GIR and post July 1st 1996 non-GIR bonus rates
had to be declared, and the guaranteed portion of GIR bonus was 3.5% lower than
for non-GIRs. And what the GIR
product particulars did not state was that, that once a GIR annuity was taken,
the hurdle rate of overall return to ensure it remained level was also raised by
3.5%, such it suffered an automatic below-the-line compound drain rate 3.5% to
4% p.a. on both its guaranteed and un-guaranteed elements12.
As a result, most GIR annuitants had overall rates of return to keep
their annuities level 3.5% higher than they understood them to be.
The situation is further
worsened because, during the successive years of the annuity the proportion of
annual bonus added in guaranteed or un-guaranteed form to the remaining asset
share is also at the Society’s discretion.
As a result, the proportion of a GIR annuity that is in basic guaranteed
form can erode rapidly, as is now the case.
All this amounts to a guarantee that functions more like a penalty, and
one that can be charged for in full twice over; i.e. both before and after the
annuity is taken. Retrospective
perusal of R & H8 sections 3.1.4 –6, which describes the
overall GIR charging structure, and section 3.2, which outlines the discretion
involved in allotting the guaranteed and un-guaranteed bonus elements, is also
useful in understanding the degrees of freedom which allowed this situation to
develop. Even so, the R & H paper was written before non-GIR
policies were introduced, and so does not deal with the further inequities that
resulted from their admixture. As a result the GIR policyholders (i.e. the rump
of the With-Profits Fund) are selectively disadvantaged in comparison with the
both the older GAR policyholders and the newer non-GIR policyholders, because
the GIR annuities erode 3.5% p.a. faster overall. We may also anticipate that
now the fund is closed to new business the Tontine effect will also disadvantage
GIR policyholders selectively versus newer policyholders. This will be further
accentuated if the life expectancy of the newer members is greater than older
ones, a factor that might place additional demands on the remnants of the
With-Profits Fund in any event. Unfortunately, despite the wishes of some, this
issue was not addressed in the Compromise Scheme, which is why further troubles
now threaten. In view of the
outcome of the GAR issue, the Society may additionally be liable for the GIR one
in future, perhaps to the tune of several billion pounds.
basis the Society could be as much as £10 billion short, of which it is
actively seeking to recover 3.2 billion. The
amount recoverable from former directors is likely to be very much smaller.