An Equitable Assessment of Rights and Wrongs

by Dr Michael Nassim

4.  Illogical Consequences, or Sophistries of the Second Order 

4.  Illogical Consequences, or Sophistries of the Second Order

For a mutual office only the first two of the numbered statements in the preceding section have any axiomatic force.  The remaining six and their conclusions remain propositions. As the foregoing account has demonstrated, they have not been proven and might even then have been discredited.  It is thus doubly inappropriate to enshrine them as premises, and use them to support a second tier of argument. And yet this is in effect what was done.  The more notable second order fallacies are:

1. The Society has disbursed, or is in the process of disbursing, the majority of the asset and liability estates to current members whose policies have matured or are about to do so.  This is analogous to a return of capital to shareholders, for which there is ample precedent.
2. Thereafter a smaller masse de manoeuvre, or strategic investment reserve that can be used for business development or short term smoothing will be retained, but no other working capital is needed.  The With Profits Fund will then move from a predominantly asset-financed to a leaner occasional liability-sharing insurance model.
3. If the unguaranteed portion of members’ stated total policy values is being used to cover a (we hope temporary) technical solvency gap while total policy values are being paid out at maturity as they arise, it is permissible to show undiscounted policy values to individual members, but to use discounted values for determining the absolute solvency margin when making operational decisions at Board level and below.  Likewise, it is only the absolute solvency margin that is of legitimate regulatory concern.  Under these circumstances it would surely be undiplomatic to reveal the size of the discount to individual policyholders, since this represents a liability and they are trustfully expecting continued profit.  It would be similarly inconvenient to draw the regulator’s attention to the size of the technical solvency gap by calculating the total current liability as measured by the aggregate of undiscounted total policy values.
4. When the technical solvency gap has taken up most of the unconsolidated and unguaranteed portion of the fund, it will become necessary to deduct the value of any optional guarantee (if exercised) from total policy values at maturity in order to maintain absolute solvency (rationale underlying the Dec 22^nd 1993 GAR Differential Terminal Bonus Policy Board Resolution).
5. In more extreme circumstances the value of the optional guarantee (if exercised) could come to exceed the total discounted policy value at maturity. If this difference were to be deducted from the guaranteed portion itself, then a) the guarantee would be breached and b) the fund would be de facto officially insolvent. Hence when this point is reached it should not be indicated, and a sum in excess of the policyholder’s discounted asset share must be paid out, which can only come from the Fund’s other pooled assets (rationale behind the 1993 GAR Board Resolution amendment).
6. Regardless of whether later economic circumstances will make them worthwhile, at least the full value of non-optional guarantees will be clawed back. In the case of guaranteed interest rate annuities, the annual rate of return that ensures a level annuity is guaranteed by 3.5% p.a.  This safety feature is a selling point, and will become part of the policyholders’ reasonable expectation.  On the other hand, policyholders might be displeased to find out that the necessary rate of return to keep the annuity level will be increased annually by the same amount as the interest rate level portion that is guaranteed, i.e. 3.5%.  As a result both the guaranteed and un-guaranteed portion of the annuity will progressively diminish by 3.5% p.a. regardless of whether the fund earns less than that amount per year for any length of time¹².  This will help the Society by extending the technical solvency margin of the With Profits Fund.  Hence this aspect of the guarantee should not have any prominence in sales details or product particulars.  (Cf. Section 10 below; R & H sections 3.1.4-6, 3.2 & 3.3.2).

Any forensic terrier worth its keep might now dispatch these six rats in short order: viz- assuming this is what happened, (1) is inconsistent with the concept of ongoing mutuality, and hence fundamentally improper. (2) undermines the fundamental concept of a “with profits” fund, and so over and above requirements for regulatory financial strength it must be fully disclosed and not covered up as in 3). (4) makes the optional guarantee worthless, and (5) makes others underwrite that guarantee if exercised. Non-optional guarantees that are eroded at full value regardless of whether they are needed as in (6) are no guarantees at all at best, and automatic penalties at worst; they are also a two edged sword because of the established custom of paying policy values in full. Hence they merely transfer the Society’s obligations from the guaranteed portion to the “moral charge”, of which more anon.

It is therefore hardly surprising that these points remain matters for the courts, the Financial Services Ombudsman and the regulators. The details are, however, beyond the remit of this article, the main purpose of which has been to reveal the coherence, consistency and duration of the structure of which they as wrongs form a part, and to demonstrate their individual places in it.  Nevertheless this objective is an essential prerequisite for the assessment of any underlying element of fraud, and there is otherwise the danger of its being overlooked in piecemeal wrangles over the separate issues.