Attached Summary to Draft Letter

Equitable Life Assurance Society

 And it’s handling of the With-Profits Annuities.

Summary

1)      Loss of Income

The Society appears to have taken substantial sums of money from the present and future income of its WPAs who legally cannot transfer their annuities to another life company or make any other changes and are completely at the whim of whatever the Society decides it is able to do at its own discretion and under the terms of polices that were never intended to cover this type of contingency.

There have been or will be three reductions:

1)      The initial reductions made as a result of the House of Lords ruling and the lowering of the Overall Rate of Return as declared by the Society are costing the WPAs approximately £600 million over the life-time of the annuitants, transferred from their accounts into the funds of the Society.

2)      The Society did not mention and did not make clear that the 20% reduction was in addition to the normal reduction the annuitant has agreed each year as a result of the bonus rate that was chosen at the start of the annuity. On the basis that there are approximately 65,000 WPA’s and that the weighted average reduction in annuity is approximately £31,000 per annuitant, the Society has removed approximately £1.5 billion from the pockets of its annuitants that it was otherwise committed to paying over the lifetime of the annuities presumably to fund its other liabilities.

3)      It is clear from a letter written to an annuitant that next year the Society it intends to remove the remainder of the so called Final Bonus which will result in a further transfer of approximately £350 million from the annuitants.

This total transfer of approximately £2.4 billion is an astonishing sum of money and one that deserves a detailed explanation from the directors and the regulatory bodies involved, one that so far has not been forthcoming.

The Society states that we must all suffer equally, which is at least questionable even within the group of clients called the With-Profits Annuitants, WPAs.

But the fact is that the WPAs are NOT equal to other groups of the Society’s clients.

1.       They are not protected from further losses.

2.       They cannot recover these losses by seeking employment, even if age and infirmity do not preclude such an activity, since employment for people of pensionable age is not easily found.

3.       They cannot transfer their funds to another life office in order to obtain greater stability and certainty of income.

4.       The reductions can never be recovered no matter how well the With-Profits Fund performs in the future as the WPAs capital has been partially wiped out by the actions or inactions of the Society.

It is a superficially appealing argument that, though convenient and easy for the Society to enunciate, is in fact without ethical or logical merit at all.

As for the future, in order to maintain a level annuity the Society has to produce an Overall Rate of Return (ORR) of at least 3.5% but for technical reasons, the majority of annuitants the ORR has to be at least 6.0%. This is quite beyond the current capability of the Society, as according to the Society, the funds are now invested in secure but low interest or low dividend investments. It is probable that the income for all WPAs will gradually decline at a rate that that I estimate to be about 3% per annum. To put that another way, in 10 years time, the probable absolute value of an annuity from the Society have reduced to ⅔ rd of its current value in a period when inflation will have increased costs by approximately 28%. That is, within 10 years the value of the annuity will have been reduced by approximately 50%. This is the complete opposite of the stated intention of the With-Profits annuity and why the failure of the Statutory Regulator needs to be investigated and actions taken to prevent a repetition.

2)      What happened?

Over the last 15 years, there have been many events that taken in isolation might be regarded as of no consequence, chance acts, things that just happen in any organisation that has to operate in changing times managed by people who are at least as prone to error and mis-judgement as everyone else. However, there has been a sustained pattern of events that is set out in detail in the full report.

In the late 1980’s the Society decided to withdraw the GAR product since according to the Burgess Hodgson report, the Society was beginning to encounter financial problems.

At about the same time, the Society introduced an innovative concept under its own title, which was the With-Profits Annuity. The logic was that the annuitant could benefit from increasing stock market values and dividends that otherwise were retained by the annuity provider. This must have been and in some respects still is a very attractive proposition. What was not apparently explained to the purchasers of the Society’s annuity at the time was that whilst their income was higher than it might otherwise have been, much of that income over time was to be classified under the terms of the annuity as “un-guaranteed”.

In effect the Society, intentionally or otherwise, had created a vast source of assets that, whilst apparently assigned to the annuitants as future benefits, in reality could be removed at any time. Such an act would substantially and immediately reduce its future liabilities and the incomes of the annuitants.

It would be interesting to understand how this was recorded in the accounts of the Society, since it is not immediately obvious when an un-guaranteed liability is a commitment to pay in the future unless the Society decides otherwise, becomes a real liability in a true accounting sense. It is understood that no provision appears in the Society's accounts for this un-guaranteed bonus element despite its appearance in the annual statements sent to policy holders and despite it accordingly forming part of Policy Holders Reasonable Expectations under insurance legislation.

As it appears that the With-Profits Annuities were structured to enable the Society to remove entirely a very large portion of the annuity that is “un-guaranteed” in order to meet other obligations, then it would appear that this crisis was not entirely un-anticipated by the Society and one which should have been known to the FSA, or its predecessors.

But no action appears to have been taken and this has left one section of the Society’s clients, the With-Profits Annuitants, exposed to, what has been felicitously phrased, Institutional Exploitation with substantially reduced incomes and without the possibility of recovery.

It would appear that not only has the Society had some very clear financial objectives since the late 1980’s and early 1990's and that this process appears to be both exploited and continuing with the new board and under the supposedly close supervision of the regulatory authorities.

3)      Regulatory Failures

There are many areas where arguably the Society failed to inform its members of the full implications of their product offerings and where as a consequence the Statutory Regulator failed in its duty to the community.

A) The Society made a presentation made by to the Institute of Actuaries on 20^th March 1989 and titled ‘With Profits Without Mystery’ (Journal of the Institute of Actuaries, v.116 1989) The document and review is 30 pages long, but as it happens members of the Institute of Actuaries expressed deep reservations about the paper as potentially exposing the Society to failure and collapse, a forecast that turned out to be remarkably prescient.

Of course, it is very difficult to be sure what was meant by something said 15 years ago, but one interpretation is that the financial strategy of the Society was to create a With-Profits fund where “strength” could be achieved by establishing a Final Bonus that could be removed at the Society’s discretion and that Policyholders would not be concerned (i.e. since they would not understand?) how the proceeds (i.e. the annuity?) is made up. The Society’s “Estate” (i.e. its reserves?) could be used for other purposes presumably in the promotion of the Society as a successful Life and Pensions company.

The Government employs actuaries in its service in the FSA today, DTI at the time, who presumably are professionally qualified, are members of the Institute of Actuaries and receive the Institute’s periodicals. It follows that it is inconceivable that the regulatory authorities were unaware of the Society’s strategy as presented by its Chief Executive and of the concerns expressed by the members of the Institute about the paper and the implied strategy and yet no action was taken then or since.

Whatever, the motivations of the individuals, separately or collectively, might have been at the time and arguably continue to the present day, whether it was some grand conspiracy or just a mixture of bad luck and incompetence, can be guessed at, but probably never truthfully exposed. In some respects, it doesn’t matter, since the impact on the With-Profits Annuitants of the Equitable Life Assurance Society is the same.

The Society appears to have structured the With-Profits Annuities in a manner that enabled it to present them as producing very good benefits, but without explaining the downside risks. These risks were identified in 1989 at a meeting of the Society of the Institute of Actuaries when the original paper “With Profits Without Mystery” was presented by the Society, before the initial offering of this new type of annuity. The members of the institute were quite severe in their criticism of the paper but, so far as can be assessed this was broadly ignored by the Society and the Statutory Regulator.

B) The Compromise Deal was proposed by the Society as the way forward to resolve the outstanding difficulties facing it and by implication and amongst others, the WPAs. As an inducement to accept the deal, the WPAs were offered two uplifts to different elements of their annuity, but my analysis shows that one uplift had no effect on the amount of money paid and the other uplift which would have had an effect was more than offset by a reduction in the Overall Rate of Return declared by the Society in that year.

It is arguable that the Compromise Deal would not stand up to legal challenge on the following grounds:

a)      The full state of the Society's finances, in so far as they were disclosed, was in fact NOT as they were disclosed.

b)      The Compromise deal did not increase the total income of the WPAs’ despite the implication in the Society’s literature that it would.

The With-Profits Annuitants have gained nothing from the deal save perhaps to ensure the Society did not go into receivership, giving up their rights to sue over mis-selling and a minor increase in the guaranteed element of their annuity, which has no effect on their total income.

So this poses the question, would the annuitants have accepted the offer had we known what we know now? The answer is surely not since, apart from the above, there are facts that the Society knew, but had not disclosed - see the EMAG web site for hidden losses etc. (www.emag.org.uk)

C) Complexity and Obfuscation

The annuity paid each year is determined solely by a complex relationship between the Anticipated Bonus Rate and the Overall Rate of Return. But there is one other “bonus rate” and in effect 5 elements that make up the annuity, some “guaranteed” and others “not guaranteed”. (It is worth noting here that ‘guaranteed does NOT mean that the amount of money is constant only that it is guaranteed to decline at a fixed rate each year!)

What are the functions of all the other elements of the annuity? Why is it necessary to have a Basic Guaranteed Annuity (BGA), a Declared Bonus Annuity (DBA) and a Final Bonus Annuity (FBA)? Why is it necessary to have a “Guaranteed” and “non-Guaranteed” elements in the annuity at all? There does not appear to be an obvious reason. If the results are poor, then the society can reduce the ORR and the annuity declines or if results are good, then the annuity increases. What could be easier?

There is one possible explanation and which is stated quite clearly in the presentation to the Institute of Actuaries in 1989. It is very convenient to have an unnecessarily complex and, so far as is known, unique structure of the With-Profits Annuity of the Society where a large amount of money allocated in theory for future payments to annuitants but which can be removed at a stroke.

The method used by the Society for deriving the inter-relationships between the various elements of the annuity is extremely subtle and quite beyond everyone who has not done (or might be capable of doing) this type of analysis. And even then it is only obvious with hindsight and gained by comparing annuities, something that was not feasible in the early 1990's before the widespread availability of the Internet.

It was surely not unreasonable to expect that the documentation included all the information that needed to be known, but it was not. The information that was necessary was simply not presented. It is doubtful if the sales force knew, could have known or even understood what they were offering.

It follows that the typical annuitant could not have understood the likely future consequences of his or her decision to purchase an annuity from the Society, a condition that was almost precisely tailor made for the FSA to investigate using its expertise and powers of enquiry not available to the ordinary members of the public.

Summary

It is arguable that the whole concept of the With-Profits Annuity is open to a charge of mis-selling since the investment of their savings of future and current annuitants was in a financial vehicle not that dissimilar from any other investment that is linked to Stock Market performance, with investments in high return, but high risk equities, and bonds. This is NOT the right strategy for a financial vehicle that is meant to provide stable income for pensioners. It is perfectly feasible to provide a With-Profits Fund, that permits the annuitants to benefit from both capital growth and dividends in good years and smoothed over bad year, without resorting to a high-risk strategy.

Anecdotally, an investment banker expressed the opinion that the function of the Society was to meet its liabilities with respect to pensioners and those building up retirement funds AND NO MORE. It was not the function of the Society to make risk investments that are more appropriate for other savings vehicles, such as PEP's, ISAs and the like. In his opinion, the Society took a very high risk investment strategy for reasons that are not relevant here and that not least was one cause of their problems.

One of the implied themes of the analysis and report is that the Society has been taking situations as they arise and developing policies to counter or minimize the effects and/or damage as the board perceived the problem. In a commercial organisation driven by profits, this is not only to be expected, but also demanded by its owners. But the Society is not a commercial organisation. It is in fact a mutual Society which is supposed be driven to meet the reasonable needs and expectations of all of its members. That it has failed in its primary function is hardly a matter of debate.

The key question and which remains unanswered is why such a deeply flawed scheme was ever allowed to come into existence. How is it that the actuaries employed by the FSA, then the DTI, were unaware of such misgivings and took no action after the Society presented the concept to the Institute of Actuaries in 1989?

The With-Profits annuity system as devised by the Society is, so far as is known, unnecessarily and uniquely complex. Thus for nearly all annuitants, the method used by the Society to derive its annual payments was completely obscure. A situation that the Society maintained by refusing to explain to its members how it worked, an extraordinary situation given that it was a Mutual Society set up for the interests of its members.

My report clearly demonstrates, not only how the system works, but also why it was set up in this unique fashion and asks why the FSA has failed so far to take the appropriate action for the last 15 years and still takes no action.

I am aware that former directors and auditors are being sued, but there has been a massive failure of administration by the regulatory authorities, which begs for a thorough investigation and exposure. It is not enough to just to sue and reduce even more people to penury.

Punishment is not a solution unless it is accompanied by recognition that there has been an endemic failure and that steps are put in place to ensure that such a situation does not re-occur. As a society we need to provide pensions for ourselves so that our financial future is secure but unless the government is able to demonstrate that it has learnt from its past mistakes and that steps have been taken then nothing has been or will be achieved.

The FSA and its predecessors have clearly failed in their statutory duty to the public and those members of the Society – the With-Profits Annuitants, who are now expected to carry the costs of their administrative failure, have the right to and deserve recompense.

The full report can be found at:                     www.elta.org.uk