An Equitable Assessment of Rights and Wrongs

by Dr Michael Nassim

5.  Awarenesses, Apprehensions and Inhibitions

5.  Awarenesses, Apprehensions and Inhibitions

Paragraph 3.2.10 of the Ranson-Headdon paper implies that the various changes summarised above were being implemented at the end of 1982 (i.e. the year of the Insurance Companies Act, to which there may be a connection), and so they may have been well established before 1988 when the decision was taken to stop offering GAR policies.  If so, they may have been accompanied by a growing awareness which culminated in the conscious realisation that a crisis point was approaching, or was indeed already inevitable.  We should thus also consider the extent to which the Ranson-Headdon paper was an attempt to stem potential rumours to this effect.  However, the contemporary “climate of disclosure” alluded to by H.W. Froggatt (Appendix I Section I) may also have been influential. In 1986 Marshall Field delivered a philosophical Presidential Address to the Faculty and Institute of Actuaries, which was entitled “ Risk and Expectation”¹³.  He sought to open up debate on the shift from basic insurance towards investment and the difficulties that this posed, particularly during periods of inflation, and indeed the reverse when interest rates were low and taxation high.  He discussed the emergence of the concept of policyholders’ reasonable expectations, attitudes to risk and strength, more stringent requirements for disclosure of material information and regulation, and fairness in distributing surpluses with particular reference to the early experiences of the Equitable Life Assurance Society. C.S.S. Lyon followed this up more practically in 1997 and 1998 in a paper entitled “ The Financial Management of a With-Profit Long Term Fund- Some questions of disclosure.”¹⁴ Lyon was also motivated by the impending requirement, stemming from the Financial Services Act 1986, to give an investment client, including the holder or prospective holder of an insurance savings contract, what is described as “best advice”. Both Lyon and Field were interested in the fact that, because of the investment aspect, terminal and reversionary bonuses were becoming an increasing proportion of with-profits policy values.  In section 1.2.3 of his paper Lyon wrote:  “Future terminal bonus on existing policies can represent a major moral charge on the excess of assets over published liabilities, but the extent of this charge is not quantified in the returns.”  Now in that the Equitable’s declared position was to pay full policy value at maturity or surrender such that there was effectively no difference between the guaranteed and unconsolidated portions (i.e. First Order Sophistry Item 7), this moral charge was made a real one.  And in the discussion none other than Roy Ranson said (p403): “I support the author’s suggestion that the, to use his words, “moral charge” which existing terminal bonus has on the free assets might be reported.  If the free assets remaining after such an exercise were used as a sign of so-called “strength”, such a disclosure would need to be supported by a note about the office’s approach to with-profits business.”  Lyon’s assertion and Ranson’s reply reach the very heart of the tragedy that was to follow.

Mr. R.C. Wilkinson was the last discussant of Lyon’s paper, and so it is curious that his short statement may now be viewed as its epitaph.  It reads:  “There has been much discussion about the solvency margin shown in Form 9 of the DTI Returns and the lack of any specific comment about a reserve for accumulated terminal bonus.  A more fundamental point has to be addressed which relates to the proportion of reversionary bonus which is actually allowed for in the published valuation basis.

The size of the free reserve demonstrated in Form 9 for larger companies runs not into hundreds of millions, but billions, and in some cases represents a figure well over 25% of total assets.  If a comparison is made of the with-profit valuation basis between these offices there is a significant difference and I would contend that in some cases only a partial allowance is being made implicitly for future reversionary bonuses.  This is despite Guidance note 8, §2.1.3 which states:  “Actuarial principles require the actuary to pay due regard in his valuation to the future interests of with-profit policyholders notwithstanding the fact that Regulations 55-64 do not specify the point.

A comment needs to be made when reporting to the GAD and the DTI on what proportion of reversionary bonus has been allowed for in the statutory valuation basis.  This figure would be very significant and should be published to give some guidance to intermediaries when they are looking at assessing the problem of best advice.  This situation also impinges on policyholders’ expectations and if the appointed actuary is only loading for a proportion of the current reversionary bonus rate he is not having total regard to this point.”   Again the underscoring and italicising in this statement are the present writer’s; readers are invited to reconsider the import of Roy Ranson’s own words and Second Order Sophistry Item 3 in relation to any loopholes afforded by the contemporary regulations.

Meanwhile, in that the Equitable’s position and practice were to say the least out of line with the tenor of these opinions, some justification of its stance must have seemed sensible.  From the previous section it is clear that the central ground to be defended was the absence of an inherited estate.  So, was the Society compelled to make a virtue out of necessity, because the estate had already disappeared?  How large had it been?  Where and when did it go?  The implication is that it had been or was in the process of being distributed to former and matured policyholders, but if that is not entirely correct it is under these circumstances important to establish what else happened.   Here note that Marshall Field had also alluded to the Society’s further difficulties over the equitable distribution of surpluses in the early 19^th century and, as we shall see, this holds further pertinent ironies for us in our effort to understand how surpluses may transform into liabilities.

What aggregate awareness of the overall situation was there in the Society itself?  It is almost a commonplace that a state of affairs will become obvious to one or several people almost simultaneously, such that it becomes an informal if as yet unvoiced collective preoccupation, which nevertheless influences the stance of the group.  Not to raise it may appear tactful or sensible, but sooner or later a conflict with personal integrity becomes inevitable in most cases.  Beyond that point continued silence is dishonest, and this is compounded if the situation becomes more actively concealed.  By definition there will be no written record of this state of mind, and often for some time after it has arisen, but it can reasonably be inferred from the record of presences and actions under the prevailing circumstances. Yet once this Rubicon had been crossed, one or more of the officers and Board of Directors had clear duties of information and care (some of which are statutory) to established and prospective members of their Society and to the regulators, however embarrassing and uncomfortable those might have been.  It may also reasonably be inferred that, had the duties of information earlier and publicly identified by the discussants in Appendix 1 and even Roy Ranson himself been complied with, there would have been much less initial inhibition to break through, and that this might have saved or ameliorated the situation.  But given that the Society’s motivation was as earlier conjectured, there was never much likelihood of this happening, and in any case it may already have been too late.  

Initial inhibitions of this kind are often greatly reinforced by the fact that the sub-units of society, such as the family and many hierarchies, are essentially feudal rather than democratic.  The latter notably include management structures in the many public companies, organisations and institutions.  If so, it can be allegiance and subservience to the hierarchy rather than ethically inspired competence that determine preferment and reward, and this risks going too far when those at the top see themselves more as masters rather than dutifully faithful stewards.  In times when head stewards are deemed weak if they do not look for more than their due, they had better seek the assistance of like-minded lieutenants and courtiers.  These worldly recruits know they will profit by openly endorsing and praising the hierarchy, obeying almost any order or supporting and implementing any received policy, even when they see that these will fail, or that a succession of them will ultimately wither and kill the organisation itself.  Conversely, others realise that under these circumstances it is unwise to argue the case, since this is doomed to failure and they risk ostracism or punishment. At this point a material element of fear and repression has entered the equation that few are prepared to resist, such that the organisation has become compromised.  This situation has recurred many times in history, and been distilled into biblical parables and children’s tales.  It is moreover a highly topical issue in the governance and regulation of large businesses throughout the world.  Conversely but unsurprisingly this is also a taboo subject in the many managerial textbooks which exude an aura of enlightened management superiority, to which their ambitious readers aspire.  All the more reason, then, to ask whether elements of it apply here.

The tips of these feudal pyramids are in theory answerable to surrounding clouds of owners or shareholders through elected representatives on the Board. Much therefore depends upon how the Board views its duties and functions.  Though the executive members of the Board are part of the pyramid and must tend their feudal allegiances, they as well as non-executive chairs and directors can have wider and more Olympian affiliations that notably include the larger owners, members of what Anthony Sampson termed The Establishment, and the administrators of group participatory schemes. Some big clouds may thus cling more closely to the top of the pyramid than later and lesser wisps.  Almost imperceptibly, therefore, such institutional edifices may come to resemble private clubs, the privileges of which are annexed by an entrenched minority.  Best then that any surplus charge accumulating at the tip be leaked into the immediate clouds with unobtrusive efficiency, lest the furies of the previous 1816 lightning storm be repeated.  So, could the Equitable have been run to some extent as Lloyd’s was for the benefit of older “names”, and the burden increasingly laid upon newer members when things began to go wrong?