Examination of witnesses (Questions 200
THURSDAY 15 FEBRUARY 2001
200. Do you think you should have gone further
though? Having seen what has transpired and the damage it has
done to many savers up and down the country, did you not think
you should have gone further to askpossibly requireEquitable
Life to make further provision in case the House of Lords ruling
went against them, given you were in detailed discussions looking
at that particular contingency?
(Sir Howard Davies) No, I do not think I would agree
with that. I am not sure they could have gone further. They passed
up all the bonus that was available not to be distributed, if
you like, those first seven months of the year. As the company
have explained, they did not run with a large inherited estate
which they could use for this purpose so the only way they could
generate additional reserves would be by not paying out bonus.
What they decided to do, however, was reasonable. It is not for
us to determine precisely what a company should do; it is for
us to say, "Is what the company proposes consistent with
its regulatory obligations, the rules and the solvency requirements
and, therefore, does it allow us to allow it to continue to trade?",
and what they did was adequate for that purpose.
201. Did you make any judgment or comment on
what they were proposing to do?
(Sir Howard Davies) Yes, we did. We said, "It
is consistent with the regulations; it is adequate; and if that
is what the outcome is you had better do it and do it quickly",
but the way these things work is for the company to propose a
solution within our regulatory requirements and for us to determine
whether it meets our regulatory requirements.
202. So you are totally satisfied with the action
Equitable Life took looking ahead to that contingency? You do
not think it could have taken any other action to minimise the
(Sir Howard Davies) We are talking I think about the
period between the Court of Appeal and the House of Lords; that
was where your line of questioning started. I think what I am
saying is there were not very many options open to the company
at that stage to do anything other than pass up its bonuses, which
was the only means it had of generating the additional reserves
that it needed to cope with the House of Lords judgment. I am
not sure that it would have been in a better position if it had
done anything very different from what it did.
203. Going back a little in time, and you said
you did this in a very robust way, you required them to take out
something like a reinsurance policy to make sure they were going
to be solvent. When you were looking at that with them and seeing
whether that met your regulatory requirements, did you look at
the legal risks?
(Sir Howard Davies) Yes. We did think about the legal
risks but at that time we took the view on our legal advice that
companies including the Equitable were entitled and were likely
to continue to be entitled to make adjustments in their terminal
bonuses. This was a practice which was followed by a number of
companies. In that respect, the Equitable was not an unusual/unique
company. It was in terms of its longstanding policy on reserving
but, in respect of dealing with guaranteed annuities, other companies
were adjusting bonuses; the Institute of Actuaries had accepted
that approach, so I am afraid we were operating within the consensus
wisdom at the time and that is the advice that we had that was
available to us.
204. With hindsight, do you think you miscalculated
(Sir Howard Davies) I do not think we miscalculated
the legal risk; I think we were wrong rather than that we miscalculated.
We thought an outcome would come out one way and it came out another.
205. That sounds very much like a miscalculation.
Clearly the public and savers look to the regulatory authorities
to check that the risks have been minimised as much as possible
and they hope they are not going to make such a miscalculation,
so you are admitting to the Committee that the FSA did make a
(Sir Howard Davies) No, I am sorry, I did not do that.
I thought what you were asking me was whether we were right about
what the law was. We were not right about what the law was and
I think that is on the record and is clear and there is no way
in which I can escape from that. We thought that the Equitable's
view that it could adjust bonuses practice was consistent with
the law at the time and consistent with the advice we had as to
what the courts would rule in that case. Now you can then say,
"Well should we have, in spite of that, required the company
to do more to reserve against the possibility that they were wrong?"
I think that is somewhat difficult and I am not sure we could
have required them to do more. It would have been slightly odd
for us to say, "We think the law is as it is but we require
you to put in reserves in case you, we, the Vice Chancellor and
everybody else are all wrong". That is not what we would
normally do. We would not, in insurance supervision or in banking
regulation or in any other financial supervision, require people
explicitly to provide for legal risk.
206. It just seems to me, though, speaking as
a layman, that everyone who is giving evidence to this Committee
commenting on this is saying that their legal advisers said their
course of action was OK, so all these legal advisers, whoever
they are, have been proved to be wrong. You can imagine if you
are a policyholder you are rather fed up with these legal advisers.
(Sir Howard Davies) I can understand that point of
view, Mr Davey. All I can say is that the House of Lords did overturn
what had been regarded as quite a fundamental principle of the
way in which with-profits funds and the assets shares of with-profits
funds were calculated, and the way in which returns were distributed.
207. Are you saying that in no circumstances
is it sensible practice to take account of legal risks? Surely
companies do this on a daily basis?
(Sir Howard Davies) I am not saying it is not in any
circumstances impractical to do so but in this particular circumstance,
in 1999 and 2000, I am not sure that we could have done anything
differently that would have put the company in a significantly
different position to cope with this unexpected judgment.
208. I am still not very clear about this because
the company felt it had to stimulate the court case; therefore,
it was before the courts and, therefore, a judgment could have
gone against them, and you were having discussions with them and
you were discussing with them the fact that this outcome might
happen, but you did not choose at any time over this period to
suggest they should make a proper contingency?
(Sir Howard Davies) The contingency that they would
have made, had we taken this view that you must provide for the
possibility that you lose, would have been the same as the one
they actually made. So it is possible to argue they should have
provided for losing the case, but they would have provided for
it six months earlier and they would not have paid any bonus,
but they did not pay the bonus out anyway. I can understand your
frustration on this point, Mr Davey, but I am not sure the outcome
would have been any different actually.
209. The Equitable has been regulated by a number
of government-regulatory bodies over a period of years, not just
yourselves but going back to the Treasury and the DTI. What the
policyholders who have been investing over this period of time
want to know is why did someone not look at this and see this
particular risk, so that action could have been taken perhaps
a lot earlier and we would not be here today and they would not
be seeing their savings going down the drain. The question is,
it seems to me you have been very forthright and very frank to
the Committee, and maybe there have been regulatory mistakes.
If there have been regulatory mistakes, you know as well as I
do there may well be a case for compensation. If you go back,
the logic of what you have been saying to the Committee today
is that at some stage over the last, maybe, decade the regulators
could have anticipated this legal risk and could have asked Equitable
Life to take action?
(Sir Howard Davies) I am not sure I would say that
at all. Indeed, if I may say so, Mr Davey, the premise of your
question has slightly shifted on the way through. If the company
had decided that this was uncertain because of the prospect of
ombudsman hearings and because of complaints from policyholders,
that it had to go to the House of Lords or had to go to court
to get certainty, then you must say there was some significant
legal doubt and therefore perhaps some reserving should have been
done. My answer to that is by that time, it was really too late
because all you would have done in fact is what was eventually
done and the outcome would really not have been very different.
You could have passed the bonus marginally earlier or announced
that you were not going to pay a bonus, but in fact you eventually
did not pay a bonus. You then shifted that to say why was the
decision not taken much earlier. Well, much earlier there was
not this legal doubt. Other companies were doing this and they
were doing this on a similar basis.
210. I think we heard from Equitable Life there
had been challenges to the ombudsman over a period of time from
concerned policyholders and therefore the seeds of legal doubt
were sown quite a long time before, so therefore people could
have taken decisions, people were aware there was some concern
in this area
(Sir Howard Davies) In the autumn of 1998.
211. It was not until then?
(Sir Howard Davies) That is as I understand it.
(Mr Roberts) That is what I believe.
212. Are you saying to the Committee there were
no referrals by Equitable Life policyholders to an ombudsman or
to any other regulator about this legal point?
(Sir Howard Davies) I could not give you that assurance
but I can certainly write to you on that point.
Mr Davey: I think we would be grateful
213. Can I turn the question on its head, are
you really saying that in your view, or in the view of your legal
advisers, the House of Lords appeal decision is a perverse one?
(Sir Howard Davies) I would not wish to say that.
I am saying it was
(Sir Howard Davies) It was unexpected and it overturned
the quite fundamental principle of the way in which returns were
allocated. Everybody is now having to live with it, and not just
Equitable Life, other companies too, and it is having redistributional
consequences in other parts of the market and we have to live
with those. It is creating a different position from what we thought
was the case.
215. On a question of fact on compensation,
could you confirm the conditions in which compensation is paid
to the policyholders, because the issue was raised by my colleague,
(Sir Howard Davies) The Policyholder Protection Board
would kick in if the company were insolvent.
216. That is when it happens, is it?
(Sir Howard Davies) Yes. The Policyholder Protection
Board does not pay slightly higher returns if contracts do not
turn out to be as rewarding as people had thought. That only kicks
in if the company is insolvent.
(Mr Foot) Compensation under the Ombudsman Scheme
of course is an entirely separate strand.
217. Could you tell us about that?
(Mr Foot) In the case of potential misselling of policies,
for example, that is the normal appeal process, and it is quite
separate from the PPB which has been described earlier.
218. If the FSA review of itself found that
it or previous regulators had not really performed their job well,
do you think there would be a case for compensation?
(Sir Howard Davies) I am highly reluctant to go into
a hypothetical question of that nature, Mr Davey, but I think
you would have to ask yourself very hard just what you were compensating
219. You said a moment ago to the Chairman,
Sir Howard, that you were surprised by the House of Lords judgmentthose
were roughly your wordsone reading of Lord Woolf's judgment
in the Court of Appeal is the same as the House of Lords decision,
he did not say that ring-fencing was all right. Did no one take
that into account in these discussions you were having with the
(Sir Howard Davies) Yes, I think the different possible
interpretations of the Court of Appeal judgment were considered,
but overall our assessment of what the consequences of the Court
of Appeal judgment would have been, I think I am right in saying,
was rather the same as the Equitable Life's assessment of it.
In other words, it would have required the same bonus approach
to be taken as towards guaranteed and non-guaranteed, but those
overall could all have been reduced to take account of the cost
of the guarantee but that could not have been done differentially.
So it would have had some distributional consequences within the
Equitable fund, and other people's funds, but would not have created
the overall reserving and soundness problem that the Equitable
had as a result of the House of Lords decision.
4 See p. 45. Back