Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 200 - 219)



  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 ask—possibly require—Equitable 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 damage?
  (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 the risk?
  (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.

Mr Davey

  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 mistake?
  (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.

Mr Davey

  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.[4]

  Mr Davey: I think we would be grateful for that.


  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, Mr Davey?
  (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.

Mr Davey

  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 whom for.

Mr Beard

  219. You said a moment ago to the Chairman, Sir Howard, that you were surprised by the House of Lords judgment—those were roughly your words—one 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 Equitable?
  (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

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