Notes on Penrose Report  Ch 1-3 and 19 by Nicolas Bellord


(Rubrics: chapter/page/para e.g 2/45/55 refers to para 55 on page 45 in Chapter 2 however for the letter and forward it is para/page e.g.  5/i  refers to para 5 on page i.

Quotes are in italics)


Letter to Ruth Kelly


1/i   Terms of reference:


To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society, taking account of relevant life market background; to identify and lessons to be learnt for the conduct, administration and regulation of life assurance business; and to give a report thereon to Treasury Ministers.’


5/i  Tells us also that he has ‘informed the appropriate public prosecution authorities of aspects of the evidence and my emerging findings’


6/ii   Report describes the ‘situation as at 31st August 2001.’


11/ii      The task of regulation must not be allowed to obscure its aim, as appears to me to have happened in this case




vii   Note 3 says Halifax deal discussed in chapter 5.


ix/9 Several former directors refused to co-operate in any way


The production of documents became a long draw-out and stressful process.


     ix/13             Letter from desperate policyholder illustrating human impact.


xi/22       He comments on the Hyman case very briefly – narrowness of issue at the same time as limiting scope for future challenge – ring-fencing and Miss Gloster being unable to run a mutuality argument as previous behaviour of ELAS was inconsistent.  This is dealt with later in Chapter 1.






This chapter deals with the Hyman case.  Although Penrose is supposed not to be second guessing the House of Lords he makes it clear that he supports the decision but points out that the manner in which ELAS ensured that only one policyholder was represented and that only a very narrow issue was decided upon ensured that the Court gave a decision on a narrow issue which took no account of the interests of other policyholders.


1/1/1       Whatever else contributed to the situation at Equitable Life, the annuity guarantees had a part in it.


6/2/1       Prior to 1998 settlements were made with certain GAR policyholders subject to gagging orders.


9/2/1       In 1993 Soundy suggested differential bonus policy was underhand and proposed other methods including ring-fencing but was defeated by Ransom.


16/4/1       September 1998 Headdon tells Board about the problem.  Chapter 2 says the differential bonus policy originated in 1983, was subsequently approved by the Board in about 1990 (but see Chapter 2) but the complaints were reported to the board in September 1998.


20/5/1       Headdon mentions the #1.5 billion cost to executives 7th Sept 1998.


22/6/1       9th Sept 1998 briefing meeting for Directors re 1.5 billion.


25/7/1       Tentative warnings by Dentons simply recorded.


47/14/1       A comment that is relevant in many aspects of this affair e.g. opinions obtained by the current board:  Instructions may, without any positive intent to influence counsel, so present issues for advice that the strengths in the client’s position are exaggerated and possible weaknesses understated.


       He goes on to quote from Counsel’s opinion that the Directors could be regarded as trustees. (one of the bees in my bonnet!).


52/19/1       Counsel  advised against bringing the matter to court unless they were forced to.


57/20/1       On 14th December counsel advised that the Society’s case was solid.

Basically Penrose thinks that ELAS was advised that they had a good case and not much doubt seems to have been expressed by their lawyers.  Penrose thinks they were right to commence this Hyman action.


58/21/1        Grabiner was keen to involve representatives of a wider range of classes.


62/22/1        The advice received from Counsel was uncompromisingly enthusiastic.


63/22/1       There were originally six defendants representing different kinds of policies but NO non-GAR representative.


64/22/1       Counsel advised that it was not necessary to have a representative defendant for those whose policies did not include a GAR: it could lead to unnecessary complication and in any event the Society could put the points to be made in relation to such policyholders.


66/23/1       Reduced to one defendant: Hyman.


70/24/1       The plan was that the issue to be decided was to be a very narrow one but by putting many documents relating to other issues in the bundle of documents they could make use of Issue Estoppel  to prevent these other issues being litigated in the future.


74/26/1       a certain euphoria had become established


75/26/1          Penrose is very critical of the Issue Estoppel possibilities:  To an observer from a different legal system, this appears to confer undue authority on documents prepared with considerable legal input.


82/28/1        Elizabeth Gloster takes over from Grabiner for the House of Lords.  She wanted to found her arguments on the principle of mutuality.


83/28/28       But in a note from Denton she was undermined by the fact that the Society had never acted mutually.  Penrose comments:  Mutuality across the with-profits fund had clearly become problematical in view of the Society’s actual practices in managing the with-profits fund and discriminating between policy groups in relation to bonus allocation.  It is not immaterial, in view of some later criticism of the House of Lords’ decision, that Gloster’s initial intention had been to emphasise mutuality as the core issue in the case.


Basically what Penrose is saying that as ELAS had never acted equitably or fairly in the administration of the WP fund it could not claim to be doing so now.

Ring fencing came to the fore as the last ditch solution; however I find the Report difficult to understand on this issue.  More study is needed of pages 28 to 31.


92/31/1       28th January 1999 Cindy Leslie of Dentons suggested creating a new WP fund for all new business.  The prominence which Penrose gives to this is significant..  If the suggestion had been followed many late joiners would have been protected.  As he says there would have been difficulties introducing this but I suspect the real reason for it being rejected was that the Society would have had to get a Special Resolution and generally come clean with its members which would not be acceptable to the Board.


There follows several pages on contingency planning.


117/38/1  Penrose says he cannot review the House of Lords decision.  However it is interesting just how far he does go in leading us up to the door of the court and narrating the strategy of ELAS.  He says the Court was asked a narrow question and inevitably gave a narrow answer.


118/38/1  He dispels the notion that Hyman was a decision beyond reasonable contemplation.  This demolishes the argument of the PO and the FSA that the decision was a total surprise.  The latter were simply asleep in my view!


122/39/1       Penrose says mutuality could have been a deciding factor but the previous behaviour of ELAS sunk this.  It was just one of the myths promulgated by the Society about itself that have become evident in the course of this inquiry.





This chapter deals with the origins and history of the Annuity Guarantee.  Before there were any non-GARs the extra benefit of the Annuity Guarantee was effectively being paid for in the premium.  However when in 1988 the non-GARs appeared this was no longer the case as non-GAR money was being used to support the contracts with the GARs.


6/42/2       Inland Revenue never required companies to have guaranteed annuity rates in their policies.


14/44/2       Repeats the above point more specifically.


[My interpretation of some of this chapter is that it seems that there are two ways of getting a policyholder to pay for a GAR.  One is by increasing the premium from the start above what is charged for a non-GAR policy.  The other is by adjusting the terminal bonus.  There are two ways of adjusting the final bonus.  One is by having a different terminal bonus for all GAR policies and the other is the differential bonus policy which depended upon the choice made by the policyholder at retirement.  It was this differential policy that was condemned by the House of Lords].


19/45/2       Later assertions that it had ‘always’ been the intention of the Society to recover the cost of guarantees from terminal bonus cannot be true in any absolute sense.


This was because the terminal bonus was only introduced in 1973 AFTER GARs had already been in place since 1956/57.


23/46/23 The Society did charge explicitly for certain guarantees at the time the retirement annuity contract was introduced. 


The Society issued policies to certain groups with GARs and charged extra for the GAR but they did not do so in retirement annuity contracts. 


26/47/2  First retirement annuity contracts issued in 1957.


39/50/2  The Society had other policies which contained clauses which could vary the charge for the GAR every 5 years.  They did not use these clauses in the retirement annuity contracts.


48/52/2       From July 1988 until July 1996 the Society sold personal pension policies with an express guaranteed investment return of 3.5% [GIR]  but without a guaranteed conversion rate in possession [GAR]……

     The inquiry has not uncovered evidence that their [Dentons] advice was sought on any risk of conflict between the interests of the new-type policyholders and the pre-existing retirement annuity class.  [i.e. between GARs and non-GARs].


54/53/2  The inquiry has not uncovered any evidence that the directors sought legal advice on their powers in relation to bonus at any time thereafter [after 1962] until the Society was embroiled in the dispute that resulted in the Hyman case.


58/54/2  At the end of 1982 concern was being expressed about the ability of GARs to top up their policies with large premiums.  Ranson proposed a clause to designed to remove large single premiums from guaranteed terms. 

This never seems to have got any further.  It would have saved ELAS from the unquantifiable liabilities that were to sink the sale of the company  in 2000.


61/55/2       I consider that it has been established that a differential guaranteed annuity terminal bonus policy was conceived at the latest in 1983.


62/55/2  However Headdon does not seem to have told the staff about this new policy.


75/58/2  Nor were these policy decisions made public


76/58/2  Indeed it looks as though the Board did not know about them until 22nd December 1993


78/59/2 29th November 1993 Headdon wrote to Ranson:  The disadvantage is that presumably we will not be updating any literature in respect of a change to final bonus rates and so clients might feel that had been a bit underhand in ‘sneaking in’ this change.  Whatever we do, however, there is quite a fine balance to strike between being open and not drawing attention to the existence of the GARs.


82/60/2  In the light of the decisions taken, it would hardly qualify for plaudits for frankness.


105/66/2  Another significant issue thrown up by the annuity guarantee issue and, in particular, the failure of the ring-fencing proposal arose from the Society’s consistent practice of publishing financial information with reference to a single undifferentiated with-profits fund.


It is this inconsistent treatment of the WP fund bonuses that Penrose says in Chapter 1 led to ELAS not being able to run the mutuality argument initially proposed by Miss Gloster.  He goes on to mention that Warren & Lowe said that a separate fund could have been created.


106/66/2  But it would have required a special resolution of the company pursuant to [F] in the Memorandum and Article 57.  It seems the Board never even considered this.  The notional hypothecation of the fund into sub-funds circumvented the provisions of the articles by treating the matter as a management issue.


This is a point raised by many in EMAG and myself in the past.  One wonders whether the failure to create a separate fund does not mean that the right to a GAR is in fact invalid.


Conclusions by Lord Penrose:


111/67/2  Management decided to carry on with the old fund, not creating a new one.  The Board never even considered it.


112/67/2 Management managed the whole thing without any intervention by the Board who mostly did not know about it until the Autumn of 1998.


113/67/2  Why should a shortfall of 1.5 billion or 5%  have brought down the company? 


I seem to remember EMAG asking that precise question some years ago and then going on to find out why – the second black hole.

Notes on Penrose Report:





This is a crucial chapter detailing the growth of the company from the 1960s to 1988 when non-GAR policies were introduced.  Previously we had known about the second black hole thanks to the intuition of Michael Josephs and the research by Burgess Hodgson but it was not know how far back it went.  Michael Nassim said the company traditionally was very conservative and always had reserves but somewhere along the line they had been lost possibly in the 1974 oil crisis.  This chapter is able to confirm these surmises with the full detail of what became a reckless scramble for growth achieved by quite unjustified bonuses for which there were no proper reserves.  It shows just how far back the problems went and it is a surprise for most of us.  Has ELAS been anything but a Ponzi scheme for the last 30 years?


This chapter shows clearly the over-bonussing that went on and Penrose demolishes the idea that smoothing ever took place.  They claimed they were smoothing but in fact had no policy for smoothing.


1/69/3       Benefited from equity growth in the 1960s.  End of 1972 there were reserves of #52 million on a fund value of #143 million.


7/70/3       The fund grew in value from #39 million in 1960 to #34 billion in 2000


15/72/3      Because of the adverse investment climate in 1973 a new scheme for allocating surpluses had to be abandoned: the prudent second call reserve for future reversionary bonus was abandoned, and the available balance was held for terminal bonus.


16/72/3  It was said: if bonus had had to be reduced the effect on new business at a critical time would have been catastrophic.


19/73/3  Sustained growth But the Society’s capital position was not maintained.

1973 and 1974 were disaster years for equities.


24/74/3 A further way to increase the surplus is to increase the rate of interest used in valuing liabilities.


29/75/3  The decisions on interim bonus levels for 1974 and 1975 involved serious risk.


To put it simply all this looks like too rapid expansion with continual eroding of the capital base such as it was.  The bonuses seem to be market rather than results driven.


37/78/3 But at this stage the pursuit of  growth and the preservation of capital strength were not treated as  incompatible  objectives. Although  it  resolved on  a course that weakened the capital  base,  the  Board’s objective was to maintain adequate reserves. However, in the short term the pursuit of growth was sustained at a considerable price. 


38/78/3       By 1976, the  Board had used almost the whole of the Society’s inherited  unrealised  capital appreciation and the hidden reserves in liabilities to maintain  competitive levels of declared and interim bonus at a time of market volatility. It had  done so without applying the prudent reserving policy that it had accepted in 1973. 


69/87/3   Each year principles were set out; good intentions were asserted but each year these intentions were not fulfilled:


Pragmatism had overtaken  principle once  more, with  an  explicit acknowledgment  that capital appreciation was required to sustain distribution policy. 


95/94/3       The policy of deciding on bonuses by setting them above those of  other companies rather than on real results continued into the 1980s:


Objectively, the period from the end of 1982 through to  early 1984 saw a momentous change in the  Board’s policy, largely for competitive  reasons, that laid the  basis for the Society’s subsequent weakening. But this was  not apparent from published information.


98/95/3  And yet in 1985:  Following a review of the market, Ranson said that he had “felt it necessary to advise  the  Board that a less  cautious approach to  determining terminal bonuses was  desirable.” A rate based on 35% was represented as “fair”.  The actuary reported that  his calculations  showed that the  rate  could  be  maintained  even if there were no  further capital appreciation over the  coming  year.


And some maintain this was NOT a Ponzi scheme?   The chapter goes on with Ranson finding more and more incredible reasons for increasing the terminal bonus rates. 


In 1986 Professor Sir Roland Smith took over as Chairman of the Board.  More sensible policies with emphasis on earning money rather than going for growth were adopted?  Well, actually, NO:


10/71/3  However,  Professor  Roland  Smith  returned  to  positive  presentation  of  marketing objectives in 1986. He expressed the “guiding intent” of the Society as:  “To achieve growth in the Society’s  business, being the provision of life 

assurance,  retirement  benefits  and complementary investment facilities, by 

offering,  without  payment  of  commission,  an  appropriate  range  of  products 

and services of consistently good quality.”


11/71/3.  The pursuit of growth continued to be a policy objective throughout Professor  Smith’s presidency. In 1988, he commented on  the growth  targets  the Society had  pursued and on the success achieved in exceeding those targets, and looked forward  to pursuing further growth in  1989. Targets were abandoned in  1989: a fresh  approach had been adopted that would provide a greater incentive and challenge to  staff to produce growth. In 1992 Smith commented: 

“A mutual society such as The Equitable is a self-financing organisation and 

by encouraging more policyholders to join, in other words by growing, bigger 

benefits can be  brought to the larger group and unit costs driven down still 

further. The carrying of The Equitable concept into Europe begins to build the 

Society for further growth by the turn of the century and beyond.” 


A self-financing organization?  Or a Pyramid selling scheme?


138/109/3  The introduction of the Personal Pension Policy in 1988 was an opportunity to create a new fund that was missed.


139/109/3  .  In relation to bonus policy, this was a momentous, and ultimately disastrous,  decision. ……… The Society might have avoided the  Hyman problem at the outset.


161/116/3         Smoothing and averaging were said to be necessary. The managed fund concept  would have been the equivalent of a unit-linked operation without those elements. In  fact, the Society’s practice had involved over-distribution:


“For  the  past  three  years  or  so  we  have  adopted  a  deliberate  policy  of 

supporting policy  proceeds above their natural levels for durations round 

about ten years or so.. There are limits to the amount of averaging which is 

possible and fair.” 


In  my view, a smoothing policy would have  defined those limits as a guide to 

decision making. The analysis  of the Society’s  practice from  1982 does not 

demonstrate ‘averaging’ in any sense: it demonstrates progressive ‘support’ of levels  of bonus, first from previously accumulated reserves, and then from current capital.  One would understand that there had to be limits to that process. But it could not  be described as ‘averaging’. 


The above puts paid to the idea that there was ever any kind of smoothing.  And just in case you have not got the message about smoothing:


169/118/3   Over  this  period  there  were  references  to  smoothing  as  an  inherent  characteristic of with-profits business. There was at no time a statement of the  Society’s smoothing policy. There was no specification of smoothing parameters, as  regards a target line of equilibrium, deviation above or below any such line, target  durations of any smoothing cycle or any other factor. The description of the position  in the late 1980s as a point on the smoothing cycle appears to have had no basis in  reality. It would have been possible to consider the restoration of reserves between  1976 and 1982 as part of a smoothing process if the parameters had been defined.  From 1982 until the end of the decade the Society had progressively weakened its  reserves  until  a  negative  position  had  become  established  where  policy  values  intimated in illustrations and on  pay-out  exceeded  available assets.  If there had  been a smoothing cycle, it was without defined limits of value, and it was without  defined limits of time. 


This chapter shows that from 1972 to 1988 there was a policy of achieving growth at all costs. Barry Sherlock had taken over from Maurice Ogborn and had Ranson as his deputy but it seems that Ranson ran the show.  Reserves and smoothing were sacrificed in favour of paying bonus rates dictated by the desire to be seen to be doing better than other insurance companies thereby attracting more policyholders and more growth.


119/101/3  In 1986 Barry Sherlock became a regulator as Chairman of LAUTRO.  Apparently  setting  up and running the organisation  absorbed a considerable  proportion  of his mental energies.   His association with Ranson must surely have been of great mutual advantage to them.  Regulation must have got off to a brilliant start.

Notes on Penrose Report:


Rubrics: chapter/page/para e.g 2/45/55 refers to para 55 on page 45 in Chapter 2


Quotes are in italics






1/683/19       This chapter summarises the story detailed in the earlier Chapters and discusses role of Board, executives, auditors and regulators.


5/683/19       Society started to expand in a new way from late 1960s.


7/684/19         Mutual – therefore no access to outside capital.  A theory was developed that each new generation of policyholders provided money for the previous one – a Ponzi scheme?  Penrose says:

The mechanism by which the reward was returned was not explicit, and the theory of capitalisation for growth from policyholders’ contributions was controversial.


Penrose sees Maurice Ogborn, who introduced the with-profits retirement annuity with guaranteed annuity rates, as having done a good job.  The cost of the GAR was charged in the premiums:


13/685/19       Despite subsequent claims to the contrary, there is persuasive evidence that the cost of the annuity guarantee was incorporated into the RAP premium bases4.



21/686/19  When Personal Pensions came in 1988 Crucially the Society did not open a new bonus class that might have distinguished the pensions business sold before and after 1 July 1988 according to their respective benefits provisions, but, for marketing reasons, presented the new business as effectively a continuation of the old.

Earlier I believe Penrose describes this as a disastrous decision.  Previously however in about 1983 Ranson had made the decision to pay for the cost of the GAR by adjusting terminal bonuses.  This latter decision was not communicated to the Board until 1993 and to policyholders until 1996:


24/687/19  . Failure to disclose this intention must be regarded as a serious omission in communication to policyholders of relevant information about their prospective interests from at least 1988, and arguably from the time in the early 1980s that management first took that decision.


The WP PPP supplemented by the WP annuity and the WP managed drawdown were all designed to reduce guarantees in a way only an expert could detect:


28/687/19  . Although these developments, and other parallel product developments, were intended to withdraw policy guarantees progressively, the Society continued to base its products on the fundamental ideas of premium flexibility, flexibility as to maturity date, and the availability of recurrent single premium terms.

29/687/19  Overall the Society developed an impressive range of products that appealed to the relatively sophisticated market sector that it targeted. The changes in the underlying assumptions within the developing forms of business would not, however, have been apparent except to financial analysts familiar with actuarial methods.

After Ogborn’s departure in 1972 Ranson and Sherlock took over and changed the policy of ELAS from having an inherited estate to a new ‘three-call’ system which was prudent provided it was adhered to.  However in fact the bonus distribution was dominated by the need to compete with other companies by having high bonuses.  In 1982 the second call of the three-call system which provided for the building of reserves was abandoned formally but it really had not been used since the market crash of 1973/74. 


38/689/19  However, from the early 1980s the Board’s bonus policy became increasingly driven by the pursuit of growth in new business. It was understood that the Society was falling behind in competitive terms, and in particular that its terminal bonus levels were not matching those of its principal competitors. A highly competitive market dictated the level of bonus allocation. The surplus published by the Society became a function of the desired level of bonus.

By 1987 the reserves of the Society were exhausted and Ranson attempted to justify this in his paper ‘With Profits Without Mystery’. 


40/689/19  Over the 1980s the Society maintained competitive levels of bonus allocation by cutting back on its general reserves until, by 1987 it had over-allocated bonus so that its aggregate policy values on a realistic basis exceeded available assets. Ranson and actuarial colleagues in the Society published in With Profits Without Mystery7 a robust defence of the Society’s policies and approach, putting the actuarial profession on public notice of the policies it intended to pursue. The mixed response included polite expressions of disagreement and disquiet.


In 1990 when markets fell the Society declared a surplus by fiddling the valuation of liabilities and whilst keeping the overall bonus high started reducing the guaranteed element and increasing the non-guaranteed element – a policy that continued thereafter.


41/689/19  1990 was a disastrous year for the industry. Equitable suffered a serious loss of value on its equity holdings. The Society’s response was pragmatic. It reverted to the practice of 1974 and, despite what was objectively a loss of capital value, generated an apparent surplus for allocation by maximising the interest to market value ratio used in valuing liabilities (see below). The Society also reduced declared bonus relative to total allocations, so that the proportion of the total allocation that was reflected in its liabilities valuation fell progressively. The trend in that direction had begun in the 1980s and continued throughout the 1990s.


Penrose uses the word ‘pragmatic’ where sometimes I would use the word ‘fraudulent’.  Certainly there was no positive smoothing fund:

48/690/19  . In 1990 the aggregate policy values intimated to policyholders were significantly higher than the assets available as a result of the allocations of that year. Thereafter the with-profits assets of the Society were never in excess of or equal to aggregate with-profits policy values including accrued terminal bonus9.


What he calls ‘quasi-zillmer adjustment’  gets rubbished:


52/691/19  . This was not consistent with sound and prudent actuarial practice. The practice generated surplus that was not properly available for distribution.


Zillmerisation has, of course, been essential, and still is, to the Society’s solvency.  Where is that solvency now?


All of this led to the July 2001 16% cut.


56/691/19  Cumulatively these factors contributed to a position of significant over­allocation of bonus that culminated in a weak liability position that was a major contributory factor to the weakness that required a substantial reduction in policy values in July 200111.


Further it added up to the Second Black Hole #3 billion in addition to the #1.5 billion created by losing Hyman:


58/692/19  The excess of policy values over assets increased until, at 31 December 2000, the un-funded portion of aggregate policy values was about £3 billion, of which £1.8 billion had crystallised and had been lost to the fund through claims. The decision in Hyman, and the additional liability of £1.5 billion on top of that erosion of fund value through over-allocation and over-payment made future independence impossible.


Penrose goes on to rubbish the idea there was any smoothing:


62/692/19  Various representations have sought to suggest that the pattern of policy values observed by the inquiry was consistent with the Society’s smoothing policy. Apart from the absence of a consistently expressed and coherently followed smoothing policy (of which more below), it is hard to reconcile what the inquiry has found with any credible approach to smoothing.


I would query his assertion that the July 2001 cut was partly due to stock market falls: 63/693/19.


Penrose says Policyholders Reasonable Expectations (PRE) does not include just guaranteed bonuses at 76/695/19.  There is a particularly important assertion:


78/695/19  . Indeed policyholders (and the Society’s Board and the profession through With Profits Without Mystery) were told in the 1990s that the bonus mix was irrelevant: only the final proceeds mattered to them. That representation was consistent only with a bona fide intention to pay a final bonus according to current market conditions and the stage in the Society’s current smoothing cycle, if there were a relevant smoothing policy.


Should not then the final bonus have been reserved for in some way as suggested by Oliver Parsons?  Penrose seems to suggest in the affirmative:


81/696/19   These general factors provide the background to an assessment of the impact of the Hyman decision, and the need to make provision for annuity guarantee liabilities. The necessary provision was, in absolute terms, a material sum.


Penrose seems to let the Board off rather lightly on the grounds that they were not informed of all the relevant facts.  But why did they not insist on knowing the relevant facts?  Did they never ask any questions?


He says it is not his role to judge the non-executives.  This is not letting them off.  See 91-94/698/19.  Why did they never get the vital actuarial calculations and advice independently checked rather than relying on one man?


New, to my knowledge previously unknown, ‘fiddles’ in valuing liabilities are mentioned:


102/700/19  . Surplus apparently available for distribution was supported by actuarial techniques that reduced liability values:

i.             Quasi-zillmerisation in respect of recurrent single premium business;


         ii. Between 1990 and 1996, different interest rates were used for projecting gross bonus rates and for discounting liabilities, with the result that the liabilities in respect of recurrent single premium business were valued at less than face value.


iii. Delayed up-dating of mortality assumptions15.


The last one strikes me as particularly serious if deliberate.  It is certainly gross negligence and perhaps a new ground of complaint.


Damnation of Ranson:


117/703/19  At interview, I found Ranson to be highly intelligent and articulate, but manipulative. I was not persuaded that his memory was as inconsistent as he asserted, nor that he had put the Society’s affairs so completely behind him at his retirement that he could not comment on some of the matters that were put to him.


Failure to reserve for non-guaranteed bonuses is criticized:


120/704/19  . In advising on bonus mix, and on the ability of the Society to manage payments on maturities and other claims, Ranson persistently emphasised that there was no need to reserve for accrued terminal bonus in regulatory returns, or to provide for emerging liabilities in the Companies Act financial statements. That was technically correct, but the prudence of recognising in financial statements the accrued value of terminal bonus intimated to policyholders, in and after 1989 in particular, was not the subject of advice. Typically that would have been done by holding investment reserve or fund for future appropriation balances against all or some specified part of the accrued terminal bonus.

125/705/19  Ranson never advised the Board to have a policy for smoothing so there was no smoothing.

In dealing with Nash it is curious that Penrose does not mention the infamous Nash letter after the Court of Appeal judgment in January 2000: 136-7/707/19.

In judging Ernst & Young there are problems because of the Court case  but Penrose is able to say:

145/708/19 145. Assuming, however, that Ernst & Young’s position is acceptable, on which I express no view whatsoever, my conclusions are:

i. There has been a comprehensive failure by industry and by standard­ setting bodies over a long period of time to formulate and put into effect accounting standards for the preparation and presentation of financial statements relating to long-term business that reflect the realistic financial position of life offices.

ii. Without adequate accounting standards relating to liabilities, including contingent liabilities, audit has been inhibited from effective reporting on life offices’ financial statements as a whole.

iii. In particular, failure to provide adequate accounting standards for disclosure and valuation of future terminal bonus payments has resulted published financial statements that failed adequately to reflect the realistic financial position of companies reported on.

          Could the standard setting bodies be liable to the policyholders?

          However Penrose is surely ciriticizing E&Y as how can the accounts be showing a true and fair view in the light of:


147/709/19  . In the case of the Companies Act accounts there was a failure to identify and to quantify in an intelligible way differences arising from changes in assumptions, and a failure to relate the consequences to PRE. In particular, between 1990 and 1997 the Society’s published financial statements failed to inform policyholders of the analysis of the movements in value resulting from the changes in actuarial assumptions, and failed to draw attention to resulting discrepancies between the policy values intimated to them and the relative liabilities reflected in the accounts.


The Regulatory Regime

Need to scrutinize regulatory returns and also PRE: 151/709/19.

‘Light touch’ is mentioned as being alleged Government policy at 161/711/19 but at 163/712/19 Penrose say this misses the point:

 However, the observations appear to me to miss the point. If regulators had identified the need to amend the regulatory system, for example to require realistic accounting in the way now proposed by FSA, and Ministers had failed or refused to pursue proposals for change, the ground for criticism of the department would have remained the same. The balance of individual responsibility would have changed. But no relevant proposals for change were made, and the ground for criticism of the department remains the same. Whether that affects individual responsibility depends on one’s assessment of Ministers’ general policies. But my concern, in terms of the remit, has to do with identification of any deficiencies I have found and with appropriate recommendations for future change. Allocation of responsibility as between Ministers and officials, while an interesting diversion, is not of the essence of the exercise.


Penrose goes on to say that in regulation solvency is not the only issue 165/712/19.  He identifies six items that they should have been looking at in 166/712/19 – the various fiddles:

(i) the interest rate differential (between the bonus rate projected forward and the rate of return used to discount liabilities back to present values) between 1990 and 1997;

(ii) the quasi-zillmer adjustment (through which acquisition costs for recurrent single premium business were annuitised) from the early 1990s;

(iii) implicit items for future profits employed in and after 1994;

 (iv) the subordinated debt;

(v) the GAR liability valuation, and

(vi) the financial reinsurance treaty.


In respect of (i) the interest rate differential at 171/714/19 Penrose points out that this fiddle turned a loss in 1990 into a release of surplus of #557 million.  He says the regulators still do not seem to understand this.

On (ii) the GAD actuary has refused to complete the interview process – 173/714/29.  This is particular shocking.

Penrose comments:

174/714/29 I cannot accept the representation during the maxwellisation process that GAD was not aware of the practice and therefore did not notify DTI of it. This seems to me to be a clear example of the system failing to follow up information that was relevant to financial regulation.


On (iii) Future profits Penrose says:

178/715/19 . The approval of an implicit future profits item in September 2000 after the Society had lost the Hyman case and was in the course of a sale process highlights the artificiality of the regulatory requirements. By that time it was known that the Society itself would not continue in business: it would either be sold or closed to new business. Even in the event of a successful sale, the Society would be a new entity that required assessment of its current business according to its altered financial position. But in the event that the Society had to close to new business, as in fact it did, there would be no basis on which it could have been assumed to have a future future maintainable flow of surplus from in-force business, whatever the margins in the valuation at 31 December 1999. Investment policy would have been constrained by solvency requirements. The quantum and incidence of expenses would have altered.


On (iv) Subordinated debt: Penrose says individual members could be liable for this. 185/716/19.  AND HAS NOT THE NEW BOARD PASSED A RESOLUTION LAST YEAR TO ALLOW THE COMPANY TO BORROW EVEN MORE?

190/717/19  It has been represented to me in the course of maxwellisation that for all practical purposes DTI and GAD had no knowledge of the existence of the annuity guarantees, or of the Society’s treatment of them by means of the differential terminal bonus policy, until 1998.


The reason for this is that the regulators believe there was an industry wide conspiracy to hide GARs from the Regulators.  Penrose rejects this: 191/717/19.


On (vi) the reinsurance treaty Penrose says it does not qualify as such: 194/718/19 and was of no value.

[Just as an aside most of this confirms my criticism of the PO ‘s report.  Should there not be a new word in the language to describe this treatment of accounts: Micawberisation?]

197-209/720-721/19 shows the regulators total failure to deal with the Terminal Bonus.  Our Government implements EU regulations on using the metric system with ferocity – e.g.selling fruit by the pound is a capital offence.  However the third life directive was ignored – 206/720/19.

Regulators failed on PRE as well.  The position of potential policyholders is well summarized in:

214/721/19   Thus, potential policyholders contemplating investment in a with-profits policy with the Society would have been entitled at any time during the 1990s, having regard to the Society’s publications, to expect a return at maturity that reflected the earnings on his contributions over the duration of the policy, subject to some smoothing. The Society’s regulatory solvency position would not have discouraged that view. However, the Society’s realistic position would have indicated that there would be, for the indefinite future, a prior charge on the investment returns on that policyholder’s contributions to compensate the with-profits fund for prior over­allocation of returns on with-profits business. In the context of a well-defined smoothing policy that risk might have been acceptable. Regulators were never in a position to form a view on the issue, and therefore could not form a view whether the conduct of the Society’s business was such that policyholders’ reasonable expectations were likely to be fulfilled.


The Scrutiny Process: 

221/723/19  No problem was considered so serious that it could not be left until next time.


That says it all about the regulators.  There is further criticism concerning Personality issues – the appointment of Ranson as both Chief Executive and appointed actuary – the lack of qualifications in the non-executives etc.


There is comment on the failure of both Prudential and  Conduct of Business Regulation at 229-231/724/19. 

Penrose criticizes the Regulators for not doing more to protect late joiners and particularly those who joined after the decision to sell. – 233/725/19.  His criticism of this episode, which I regard as connivance in fraud, is mild but perhaps this is an aspect which he is leaving to the SFO.

Further criticisms are made of the Regulators and finally there is a list of 11 key findings.  5 of these or nearly half are findings against the Regulators.