An Equitable Assessment of Rights and Wrongs
by Dr Michael Nassim
6. From Pyramids to Ponzi via Lloyd’s, or A Bubble is born
From Pyramids to Ponzi via Lloyd’s, or A Bubble is born
Ogborn11 and Marshall Field13 relate that the disputed
surpluses of 1816 had accumulated mainly because stiffer premiums for a higher
mortality (conservatively based on mortality tables from Northampton) had been
charged than were applicable to the better social conditions of the Society’s
members. The origin of surpluses in the 1970’s and 80’s was more
general, and different. Those with
a prior interest in the modern primacy of energy in the creation of goods and
the implementation of aims foresaw that, when the price of oil rose abruptly by
threefold in 1973, a wave of inflation and monetary devaluation would begin, and
not work its way out of the system until wages and prices had risen by at least
the same proportion. This duly happened, and in the ensuing inflationary period
there was a scramble out of money and fixed interest securities and into
possessions and assets with intrinsic and durable value.
This included equities once the immediate crisis of confidence had
subsided, and it led into the longest bull market in history.
The market was also drip-fed by underlying real economic progress over
the next two decades, of which the digital electronic revolution is the
outstanding example. It was also
helped by the easing of political tensions as the Cold War came to an end.
with large equity holdings experienced gratifying increases in their monetary
value, and this was further sustained when, once the inflationary wave had been
absorbed and dissipated, the unprecedented compensatory rise in interest rates
also began to subside. These were heady days for pension funds, and many showed
surpluses. Unless a Maxwell asked
it their distribution became a legitimate question, and many firms and schemes
enjoyed breaks from making contributions in order to take up the slack, or took
the opportunity to let older and more expensive staff go on preferential terms.
The shareholders of publicly owned life offices must have benefited, but
mutuals like the Equitable may have had a more subtle quandary over their
burgeoning asset estates. In such cases, growing the business and declaring big bonuses
for the existing members would help take care of it, but so too alas would
diversions into unwise or inappropriate investments. Meanwhile, the investment aspects of modern life assurance
would have made it seem uncompetitive and unprofitable to hold much in the form
of what C.S.S. Lyon14 had called a mismatching reserve, let alone
more conventional fixed interest securities in the liability estate, even if
this denoted a reduction in safety margin.
took a long time, there should have been no surprise that more normal conditions
would eventually return. The rise
in stock values abated and then fell as their earnings capability once again
assumed its longer-term importance, both in its own right and for valuing stocks
themselves. At the same time interest rates fell to historically low levels and
the price of fixed interest securities hardened.
There was now a squeeze on income, during which premium flows from new
business became increasingly desirable. And
by the same token the GAR annuity option became of real value to Equitable’s
maturing policyholders, who took it up in growing numbers. At the same time the cost of providing those annuities was
escalating. This was about the
worst time in history for the Chancellor of the Exchequer to have abruptly
withdrawn tax relief from pension fund earnings, but that is what happened next,
and in the ensuing crisis he has been obliviously unrelenting.
The combination of successive
guarantees on annuity and interest accumulation rates, a paradoxical but
deliberate paring down of smoothing surpluses, and the erosion of the
Society’s estate were now to prove fatal.
The situation had been compounded by tacit pressure to keep paying out
inappropriately highly rated surrender values and bonuses in full15,
such that the Fund’s reputation for superior performance was sustained and an
increasing tide of new premiums flowed in.
At the same time new business strain was further eroding safety margins.
Sooner or later the resulting bubble threatened to collapse or burst. Although the Guaranteed Annuity Rate issue and House of Lords
decision pricked it first, an estimate of the overall cumulative deficit has
subsequently indicated that the Society was already greatly endangered15.
The wonder is that a succession of qualified actuaries devised and
implemented this process when they of all people should have known better.
What asbestos had earlier and slowly done for Lloyds, the 1973 oil crisis
and the loss of its estate may finally have accomplished for the Equitable.
Contrast this now with Appendix
II, which is a further extract from
Maurice Ogborn11 (p206-7), and ask whether most of the elements in
this situation were not already well known lessons from the Equitable’s own
history. The extract also shows
that Ogborn was an advocate of the estate concept in 1962, and it follows that a
critical change must have occurred during the transition from his stewardship to
that of Roy Ranson. Ogborn chapters
11 and 12 give much more of the Society’s history in the same vein.
How all this could have been neglected is indeed bewildering.
At its height the size of the
With Profits Fund bubble was truly impressive.
Between 1957 and 1988 the Equitable had acquired 170,000 members who held
GAR rights. By contrast a further
930,000 members without GAR rights were recruited in the succeeding 12 years,
which is more like exponential than linear growth16. Given that the
United Kingdom has some 60 million citizens who may not vote until attaining 18
years of age, this represents a good 2% of the electorate.
Put this way, the government’s silence on the matter is strangely
inappropriate, because it could tip the balance at the next election.
The Lloyds bubble was in
numerical terms much more modest. Lloyd’s
inner circle had continued to conceal their knowledge of massive impending
losses while intensifying the aggressive recruitment of more and more external
“Names” through members’ and managing agents in what became known as the
“recruit to dilute” campaign. There
were about 6,000 Names in 1970, whereas by 1990 nearly 31,000 new Names had been
added. During this process two
thirds of the old Names withdrew from the risk, such that the total involved
reached 33,000. Meanwhile, in
their own version of dual accounting, the syndicates continued to under-reserve
and/or inadequately insure for incurred but not reported losses, thus hiding the
coming losses and maintaining an illusion of prosperity17.
Prior to the Lloyd’s and
Equitable fiascos the most infamous (and hence eponymous) pyramid selling scheme
was that hit upon by a nefarious US immigrant named Carlo “Charles” Ponzi, a
native of Parma, Italy. In 1920 he
sought to capitalise on the fact that he could purchase postal credits abroad
for considerably less than their encashment value in the US.
Even though the larger scale exploitation of this was impossible, his
friends and acquaintances thought it such a good idea that they advanced him
money. On this he paid them
advantageous rates of interest, which elicited an increasing influx of
subscriptions. When it finally
emerged that the original idea was unworkable, people demanded their money back
and the edifice collapsed, but not before 40,000 people had lost much of their
Not surprisingly, disaffected
Lloyd’s Names have highlighted the parallels between their situation and
Ponzi’s victims18. Professor David Blake of the Pensions Institute19
came to a similar conclusion when investigating the Equitable’s predicament
prior to the Compromise in 2001. He made the point that, because the Equitable
had to attract sufficient non-GAR policyholders to help it bail out the GAR
policyholders if equity performance was inadequate, the With Profits Fund began
to take on the characteristics of a Ponzi scheme when GAR policies ceased to be
offered after 1988. He listed the characteristics of Ponzi schemes as follows:
Professor Blake had no reason
to divine that the situation was already both more serious and advanced than
this by 1988, and Mr Ponzi’s ghost must now surrender his crown to the
Equitable as the new champion in his field.
Mr Ponzi, though, has a cult following on the Internet for his chutzpah. In this the Equitable is unlikely to be as successful.