EQUITABLE LIFE MEMBERS
Critical Analysis of the Parliamentary Ombudsman’s Report on the
“The Prudential Regulation of Equitable Life”.
Nicolas J. Bellord
1. Scope of the Enquiry.
The first important fact to understand is the extremely limited scope of the Parliamentary Ombudsman’s enquiry. First of all the report covers only a two year period 1st January 1999 to 31st December 2000. The problems of ELAS (Equitable Life Assurance Society) had been building up over more than a decade prior to this period and had certainly come to the attention of the Regulators, as a matter of concern, by 1997 (v. para 49). Further the Regulators were inevitably heavily involved after 31st December 2000 and there remain many outstanding and unresolved question as to what happened thereafter. What was the role of the Regulators in the sale of parts of ELAS to the Halifax and what was their role in the appointment of the new board? No explanation is offered for this time limit except that it was made by her predecessor..
1.2. Bodies covered.
For the over 500 complainants to the PO (Parliamentary Ombudsman) there was something called “the Regulators” whose role was to protect them and whose role needed investigating. Not so for the PO. She claims that she had jurisdiction over only part of the Regulatory system. Even then it is not clear from her report as to where she thinks her jurisdiction lies or indeed whether she has any jurisdiction at all. One has to guess from page 1 of Part II that the Treasury does come within her jurisdiction. However for the two years covered by this report the Treasury had sub-contracted its regulatory function as “Prudential Regulator” to the FSA (Financial Services Authority). The PO seems to think that this means that only the performance of the FSA conducting Prudential Regulation is at issue. The performance of the Treasury as employer of the FSA gets no consideration as if in some way the Treasury had been able to divest itself of any responsibility by sub-contracting to the FSA.
Then there was the GAD (Government Actuary’s Department). We get no explanation as to whom that body is responsible to. Presumably somebody pays their salaries? Is it part of the Treasury or the DTI (Department of Trade and Industry)? We are not told. Or is it some free-floating body answerable to no-one like the FSA or the PIA (Personal Investment Authority) – all apparently created by Parliament and invested with statutory powers but out of control?
1.3. Subjects covered.
The third limitation on the scope of the investigation is the distinction between “Prudential Regulation” (carried out by the FSA on behalf of the Treasury) and “Conduct of Business” (carried out by the FSA on behalf of the PIA). In fact there is considerable overlap between the two functions and they are closely related. For example an insurance company may make a claim about its financial stability and that is a matter for Conduct of Business as to whether the claim is well founded and policyholders and particularly potential policyholders are not being misled. At the same time and on the same facts Prudential Regulation is concerned that the insurance company’s business is being conducted in such a way that reserves are being maintained in a sufficiently prudent manner to fulfil the policyholders reasonable expectations based upon the company's same claim to financial stability. There is a valid distinction between the two functions but clearly there is a very great overlap in that the two are intimately linked. There must be therefore a very close co-operation and exchange of information between the two divisions to ensure they work properly. This was the responsibility of the senior management of the FSA and it failed. So both functions did not happen properly and in the case of PR (Prudential Regulation) this was the ultimate responsibility of the Treasury.
The PO says she is only concerned with “maladministration” and is not concerned with “the merits of a discretionary decision taken without maladministration”. However we are never told what she would consider maladministration to be let alone defines it or gives any example. To put it bluntly: to what level of idiocy and incompetence does a Government department have to descend before the PO regards it as maladministration? In the absence of any explanation by her I would suggest there is maladministration where:
A. A decision is plainly idiotic defying all commonsense.
B. There is a complete absence of administration where there should have been administration.
C. The conduct is unlawful.
All three of these occurred as I will demonstrate later.
In conclusion on the subject of the scope of the enquiry one can see that only a very small part of the story came in for critical analysis by her over a relatively short period and then it is difficult to see what she is looking for anyway.
3. The Complaint
3.1. Reading the PO’s report you soon forget that there was actually a complaint. In fact there were over 500 but she chose to consider but one. A Mr P complained about the annuity he purchased in June 2000. Mr P was never told that it was his case that was being investigated . He was never interviewed. He was never asked to clarify or provide better particulars of his complaint. He was not asked to comment on the case against his complaint. He was not able to cross-examine any of the witnesses (mostly civil servants) that gave evidence to the PO. The identity of the witnesses has been anonymised. Mr P’s identity was leaked to the press without his permission. Is this the kind of standard we can expect from the PO in conducting an investigation? Does this have any relation to natural justice?
3.2. Indeed it is hard in the acres of print in this report of over 104,000 words to find any mention of his complaint at all. And when one does at paras 1 and 236 it seems clear that the PO has misunderstood the nature of his complaint. At para 1 it is stated that Mr P bought his annuity in June 2000 “and was unable to transfer it to another insurer without penalty”. Surely the PO must have been aware that Mr P could not transfer his annuity to another insurer at all with or without penalty. Secondly in para 236 the PO says Mr P should have taken separate advice given “all the publicity surrounding Equitable’s high profile court case and their subsequent decision to put the company up for sale”. The decision to put the company up for sale was not made until July 2000 so he could not have known about it in June 2000. As for the publicity the FSA had allowed ELAS to give a false view of the company for several years and in June 2000 in view of “all the publicity” the FSA were doing absolutely nothing, as they were doing in May 2000, April 2000 and March 2000. Except of course for warning IFAs (Independent Financial Advisors) to be very careful about giving any advice which would lead to a transfer away from ELAS prior to buying an annuity. For IFAs worried about their professional indemnity insurance this was a coded message: DO NOT GIVE ADVICE.
3.3. However whatever treatment Mr P’s complaint received, can we rest assured that the other 500 plus complaints were identical i.e. they bought annuities in June 2000? Of course not. The circumstances would have varied widely as would matters complained of. The PO has not even bothered to mention this obvious fact. The other complaints have just been dismissed as if unread.
Freedom with disclosure
4.1. At para 35 we are told that the style of prudential regulation was “passive” (do nothing?), “light touch” and “like negative vetting” (which gave us Burgess, MacLean and Philby). ‘This approach was generally characterised as “freedom with disclosure”’. According to para 140 this meant “detailed public disclosure of financial information”. This is a key to the whole matter. The companies were to be allowed to operate in this light touch regulatory environment doing what they liked “coupled with full disclosure by them of relevant information”. But this is just what everybody has been complaining that they did not do. ELAS did not disclose relevant information in the form of its true financial situation; it misrepresented it. The regulatory authorities knew of the financial situation but made no attempt to force ELAS to disclose the true situation and indeed the regulatory authorities eventually connived in agreeing that it was better that the situation be not disclosed as it might upset a sale of the company. ELAS was eventually fraudulently misrepresenting its situation to potential policyholders and the FSA was not just doing nothing but instead actively conspiring in this course of action. See for example on page 94 recording 13th November 2000 “An internal note recorded that FSA had successfully encouraged journalists …no disaster in the making … the FSA had spoken to them and they were withdrawing their campaign”. Just days later the bottom fell out of ELAS.
4.2. At para 42 we are told “The lack of shareholders as a possible source of additional capital and the absence of any estate meant that, although sound, Equitable were – by design – not particularly strong financially. All of this information was in the public domain….”. One immediately asks why if it was sound it went under - well of course we now know it was not sound but would the average potential policyholder have understood what this meant? Would he have understood what was meant by the “absence of any estate” when in fact he was being told by the salesmen that the fund was being smoothed i.e. there were reserves to cover any downturn in the market – that is to say they claimed there was an estate when there was not? Well of course what the salesmen said verbally and in writing (evidence is available) comes under Conduct of Business and not Prudential Regulation so the PO can ignore it. How convenient! Is this not just sleight of hand or what our juniors call “spin”?
4.3. ELAS’s promotion of a false reputation can be documented at length from many sources that have since come to light. But one need go no further than the PO’s account: For ELAS telling the truth was “impractical without serious implications for public relations” (para 53); Treasury in 1998 says “… publication of such a low solvency position was likely severely to undermine their reputation and could threaten their independent survival” (para 54). FSA in November 1999: “whether the acceptance of payments into non-GAR policies (which might then have been used to subsidise GAR policy payments) might be viewed as mis-selling… the conduct of business division said not if an appropriate warning had been given”. No such warning was given and Prudential Regulation knew this but that is Conduct of Business. Again how very convenient! After the House of Lords ruling Officer A is surprised at para 105 at what ELAS is saying but nothing is done.
4.4. The FSA connived at this false reputation by doing nothing before the House of Lords judgment to inform policyholders or potential policyholders. After the judgment they actively conspired in a Benthamite/Faustian pact to defraud potential policyholders. When the sale falls through at Para 147 Officer J says: “A balance had to be struck between the interests of new and existing policyholders, and the prudential regulator had taken the view that the balance was overwhelmingly in favour of allowing Equitable to continue writing new business. …. Furthermore, new policyholders could be compensated if they sustained loss as a result of joining on the basis of misleading information (under the conduct of business rules)”. So in the interests of the greater good some could be swindled out of their life savings. Of course that was conduct of business so nothing to do with the PO although patently planned by Prudential Regulation. This indorsement of conspiracy to defraud is repeated again at para 207. Again compensation for those defrauded is mentioned but not recommended. Why not? Has the FSA taken any steps to put this matter right? We are not told.
4.5. At para 218 we are told that “Equitable had assured them that the sales force had been adequately briefed and instructed to advise potential policyholders of the Society’s circumstances prior to sale”. And yet “them”- the Prudential Division - was fully aware of the complaints that were being received about non-disclosure. Further the FOS (Financial Ombudsman Service) has now ruled that the briefings to the sales force contained material misrepresentations i.e. were fraudulent. Should not the FSA have inquired about that? Should not the PO have taken note of the FOS’s rulings? Should not the PO have asked Mr P what he was told by the salesman? Perhaps though we just never look at anything that a mere policyholder says or ask them any questions.
4.6. One could go on illustrating the false public image of ELAS. It is now known from the court action by ELAS against their former auditors Ernst & Young that throughout the 1990s they had a deficit of around a billion pounds instead of the smoothing fund they claimed to have. This was quite apart from the GAR problem.
4.7. ELAS published a false image of their financial stability. The Regulators knew about it and did nothing. ELAS slowly slid into misrepresentation and eventually fraud. The FSA, after the House of Lords judgment, connived at this fraud. This was at the very least unlawful.
Idiotic decisions are maladministration
5.1. I have suggested above
that one of the tests of maladministration is idiotic decisions.
In the strange world of accounting in insurance companies there are
two techniques which would have brought warmth to the heart of Mr Micawber:
allowances for future profits and Zillmerisation. Prudential Regulation must surely be based upon common sense
and whilst custom regulation and tradition might permit something where
that something is plainly idiotic and inappropriate in the circumstances
then to allow that something is not merely imprudent but maladministration.
5.2. Allowing for Future Profits
5.2.1. This is described at para 28 on page 5. Effectively in calculating whether the company was solvent it was allowed “to anticipate the likelihood that profits on investments would arise in future and be available to meet future liabilities”.
other piece of advice, Copperfield,' said Mr. Micawber, 'you know. Annual
income twenty pounds, annual expenditure nineteen nineteen and six, result
happiness. Annual income twenty pounds, annual expenditure twenty pounds
ought and six, result misery. The blossom is blighted, the leaf is
withered, the god of day goes down upon the dreary scene, and - and in
short you are for ever floored. As I am!'
If only Mr Micawber had been allowed to account for future profits!
Indeed the Fleet prison might have been emptied over night!
The calculation of the allowance for future profits was based on “the
average annual profit achieved over the preceding five years” (grandly
entitled the retrospective calculation).
Now if there is one certainty about the stock market and
investments it is that the market goes up and down.
During the 1990s it had been going up in one of the longest bull
markets on record. The
profits earned during that five year period were to be taken as a measure
of the profits to be earned on investments over a maximum of ten years in
the future. Surely it was
obvious by the end of the 1990s that a downturn in the market was long
overdue. Predicting when this
would happen was not of course at all easy but nobody was required to do
that. However to assume that
it would not happen within the next ten years was totally IDIOTIC.
ELAS’s future was under threat from the GAR problem, it had
no free estate and yet it was allowed to assume that not only it would
continue to trade but that it would continue to earn the exceptional
profits on investments earned in the 1990s.
The FSA was allowing the counting of future profits throughout the
period and even after the House of Lords ruling which crystallized the GAR
problem. That was idiotic; that
was maladministration. The
excuse given at para 177 was that not to allow this “would almost
inevitably drive them close to regulatory insolvency”.
This is nonsense. What was driving them to insolvency was the mistakes of the
management. “Not to allow
this” would have shown the true position.
This is the other side of the coin. Mr Micawber is entitled to pretend that his annual expenditure twenty pounds ought and six was really only nineteen nineteen and six as the extra shilling expenditure could be ignored and spread over future years. For the same reasons (i.e. the doubtful future facing ELAS) to allow this was idiotic and maladministration.
Failure to administer equals maladminstration
6.1. To do nothing when something should be done is surely maladministration. Inaction may arise from a decision not to take action – you have taken steps to look at the problem but decided to do nothing. However failure to even look at the problem is a failure of duty and maladministration. This is what happened in the period from 21st January 2000 when the Court of Appeal ruled against ELAS to a matter of days before the House of Lords confirmed that decision in July 2000.
6.2. One needs to read paras 77 and 78 in full to realise just how wrong the FSA and the GAD got it. Although ELAS had lost comprehensively in the Court of Appeal. The suggestion about ring-fencing was merely a remark – obiter dicta – upon which no reliance could be put. (If any reliance could have been put on it, it would not have been necessary for ELAS to appeal to the House of Lords). “The prudential division told their conduct of business colleagues that the judgment gave no cause for panic”. “The extra costs to Equitable might be fairly marginal”. How on earth could they have come to those conclusions? Why was no proper legal advice sought on the judgment? It was not that difficult to interpret – it actually starts by saying that Mr Hyman’s appeal was to be allowed. Should not alarm bells have been ringing at that point?
6.3. The PO herself says:
there we have it; there would have been no “impact on subsequent
events”. This is surely a
breathtaking statement. If
the FSA had done these things which it should have done they could have
intervened in the House of Lords case in the public interest so that the
crucial point of ring-fencing could have been dealt with properly.
The idea that ring-fencing was not permissible has had an enormous
impact on the industry as a whole and surely the stability of the industry
was obviously going to be greatly affected by the decision that was taken
by the House of Lords. The
House of Lords would undoubtedly have come to a different decision on this
issue if it’s impact and particularly the impact on the non-GARs had
been properly put to it. But
the FSA did nothing. That was
6.5. There is a significant contradiction in the PO’s account of this period between the Court of Appeal and the House of Lords judgements. At para 78 we are told:
6.7. Nobody was asking or expecting the FSA to predict the result of the case. Indeed no-one was asking what was probable. It was surely the duty of the FSA to consider and make plans for all possible eventual outcomes. As far as the House of Lords was concerned if they upheld the Court of Appeal then ring-fencing was either valid or not valid and surely it was a gross dereliction by the FSA not to consider both possible outcomes. They just sat on their hands. That was maladministration. The PO makes no further comment in her conclusions on this.
6.8. It was during this period that ELAS issued a letter on 1st February 2000 saying that the Court of Appeal judgement would have minimal impact on ELAS. This letter was a fraudulent misrepresentation of the Society’s financial position as FSA well knew. Neither Prudential Regulation nor Conduct of Business did anything. The PO just accepts the FSA’s statement at para 143: “it would be difficult to say that it was actually wrong”. Yet the FOS have since ruled that the letter was a material misrepresentation. Can the PO now please explain why she thinks differently? She says at para 196 that Prudential Regulation failed to inform Conduct of Business about this letter. Further that withdrawal or correction would have been destabilising for Equitable. Evidently telling the truth is just not on.
7.1. We then come to the period after the House of Lords judgment when the fraudulent misrepresentations of their position by ELAS increased by a further magnitude and the FSA connived and assisted in this fraud.
7.2. After the House of Lords judgment the FSA came to the conclusion that ELAS was saleable – indeed a 99.9% certainty para 84. To be fair they thought it was close to that figure – one wonders which way! However it was obvious to anyone familiar with ELAS’s financial situation (hidden from the policyholders actual and potential but well-known to the FSA) that in no way was it saleable as the GAR liability was unquantifiable. The GARs had the right to add extra premiums to their policies without limit thereby qualifying for the costly GAR on the new premiums. This meant there were unquantifiable liabilities to GAR policyholders. No outsider would buy the company with unquantifiable liabilities and no outsider did. The GAR top-up option, as it was known, was a killer as far as any sale of ELAS was concerned. The PO tries to deny that this was a killer by a very disingenuous argument. Basically she waffles as in para 234. Elsewhere she claims that the suitors felt they could not offer enough money for the company to fulfil the expectations of the members. However the reason for not being able to offer enough or any money was the unquantifiable liabilities and nothing else! She notes in para 212 that the Director of the FSA felt the liabilities were unquantifiable rather than unlimited!
7.3. From the House of Lords onwards, from July 2000, ELAS was a basket-case. The idea of selling it was a chimera. Yet it was allowed to continue to trade and pull in new policyholders and take more money from existing policyholders on the basis of misrepresenting its financial position. This was a fraudulent and criminal conspiracy to obtain money by deception. Yet the FSA not only did not stop this happening but concurred in it.
7.4. The attitude of the FSA is explained in para 207:
7.6. The PO goes on to say:
7.7. What point is she
making? We know full well
that ELAS was not making the risks explicit yet she talks as if they did
and seems to suggest it was the policyholders responsibility if he bought
a policy from ELAS at that time. Just what is she trying to say?
7.8. Certainly we are not told whether the FSA made any attempt to ensure that those new policyholders or late joiners were compensated in any way.
7.9. However we now know from the entry of 26th July 2000 (p.86) that ELAS’s appointed actuary accepted that “the company´s position would be unacceptably weak on a continuing basis”. The company was heading for insolvency in that the reinsurance treaty was due to run out 3 months after the House of Lords judgment unless it could be renegotiated. Apparently it was renegotiated but quite how valuable this treaty was remains a subject of some doubt as there was a mysterious side-letter which was not disclosed to the FSA until much later. The status and value of the treaty remains a mystery. Further the company could not pass the new second resilience test which looked at the position if there was a fall in the stock market. This was confirmed again to the Prudential Division of FSA on 11th August 2000 (p.87).
7.10. This failure to pass the second resilience test was of crucial importance. In the PO’s report at 14th August 2000 a meeting is mentioned between representatives of ELAS and EMAG (Equitable Members Action Group). The representatives of ELAS at that meeting were Mr Alistair Dunbar (then Senior Manager – Public Relations now Head of Communications at ELAS) and Mr Vic Otter (ELAS Senior Manager - Customer Liaison Department). The minutes records as follows:
8. Government regulations require ELAS to be reasonably certain of meeting this increased amount of guaranteed liabilities, regardless of likely variations in the values of its investments. There are two tests. The first is a simple solvency calculation to show that the current value of assets is at least equal to the total of liabilities. The second test is to show the resilience of the Society's financial position, i.e. whether solvency would still be maintained if adverse conditions in the financial and property markets reduced the value of its assets. Hence, it would not be permissible to hold any equities, which are volatile, unless the current value of assets was so much greater than liabilities that the Society would still be solvent even if the equity market declined by 25%. With its present range of assets, ELAS cannot pass the resilience test. The only sure way of covering ELAS's liabilities in the long term is to invest entirely in gilts and thereby immunise holders of guaranteed policies against market risk. Over a period of many years, returns on gilts have been far less than on equities. Hence, the more conservative investment policy forced on ELAS would reduce the eventual returns to holders of with profits policies and place the Society in a weak competitive position compared to other life offices.
7.11. What this
meant is that the With Profits fund would in future only be able to invest
in Gilts. With the GAR liabilities and the obligation to pay a GIR or
Guaranteed Interest Rate of 3.5% to about three quarters of the
policyholders there were going to be no more profits ever.
The With Profits Fund had to be turned into a fund entirely
invested in guaranteed gilt-edge with no possibility of any profits.
Coupled with the unquantifiable liabilities in respect of the ability of
GARs to top up their policies the company was itself no longer
commercially viable and could only be turned into a closed fund.
The fact that no other company would buy it is surely proof that it
was not a commercial concern. Although
technically solvent at that time and even though it has remained
technically solvent it should have been regarded as a closed fund in
administration with no future. Were
the public at large made aware of this?
Was any warning given to potential policyholders?
7.12. One should mention that in the
PO’s report she mentions that ELAS has cast some doubt upon this
reported meeting with EMAG: “Equitable subsequently told my staff
through their solicitors that, if such a meeting took place, none of the
relevant Equitable officers were still with the Society.
The current appointed actuary had confirmed that it seemed unlikely
that such officers would have made such a statement and indeed, current
officers had no reason to believe that Equitable would not then have been
able to meet the new resilience test 2 in the form in which it had been
Dunbar is still with ELAS as he has written to me saying that in his view
the minutes were inaccurate and misleading but he has not provided me with
what he would regard as a better version despite being asked. The essential point is that the minutes seem to make clear
that the representatives of ELAS said ELAS was not able to pass the second
resilience test. As,
according to the PO’s report, they had told this to the FSA three days
previously it would suggest that the minutes are more likely to be
accurate on this point than not.
A final point about this report is the way in which officials were allowed to rewrite history. After the sale charade finally came to grief in December 2000 there was a Treasury Briefing which said “Does this event show up a deep-seated oversight on the part of the regulator? Probably”. Apparently there are now differing views on what this meant – the official himself is not quoted as to what he meant. Possibly he refers to his wife as the regulator and it was her failure to put mustard in his sandwiches that caused him to write it.
9.1. The PO took so narrow a view of her remit that one wonders what was the point of this presumably very expensive exercise.
handling of this one complaint out of over 500 had no relation to natural
justice and the report fails to show it has dealt with all the complaints
PO talks of freedom with disclosure.
At no time did ELAS make any attempt to disclose the true position
of its finances and the Prudential Regulator did nothing effective to
encourage such disclosure.
was maladministration in:
Allowing the use of
future profits and Zilmerisation which was idiotic in the circumstances of
ELAS. They might have a place
in a business plan but not in any financial statement about solvency.
Failing to take any action at all between the Court of Appeal and
the House of Lords judgments when an effective intervention in the public
interest and that of the insurance industry on the subject of ring-fencing
would have been of the greatest importance.
Conniving at ELAS’s
fraudulent misrepresentation after the House of Lords decision – such
connivance being unlawful at the very least.
report is entirely one-sided with the Treasury and the FSA being
allowed to rewrite history.
in all the role and performance of the PO are called into question and one
wonders whether she serves any useful purpose.