Select Committee on Treasury Appendices to the Minutes of Evidence



Memorandum by the Annuity Bureau Ltd

"To examine the regulatory environment and the management of risk in the life assurance sector following the Equitable Life affair"

  (This memorandum has been prepared by David Marlow of The Annuity Bureau for the Treasury Committee investigation.)


  1.1  The Annuity Bureau, together with its associated company, The Income Drawdown Advisory Bureau, is a specialist Independent Financial Adviser company focused on the provision of retirement advice.

  1.2  The Annuity Bureau concentrates on annuity business, providing services to those with Open Market Options and those wanting to provide income from non-pension funds. The Income Drawdown Advisory Bureau concentrates on Phased Retirement and Income Drawdown pension arrangements.

  1.3  The Annuity Bureau was established in 1990 and both companies are directly regulated by the Personal Investment Authority.

  1.4  The specialism of our companies means we understand the issues surrounding the Guaranteed Annuity Rate contracts offered by Equitable Life. We are a small firm of approximately 30 staff, but we have a broad spread of industry experience and expertise.


  2.1  Some pension contracts provided the right to a guaranteed annuity rate (GAR), ie a guaranteed rate at which the capital value of a pension contract could be converted into income, via an annuity.

  2.2  The guarantees on these contracts extend many years into the future.

  2.3  The cost of providing these guarantees varies, depending on three key variables:

    (a)  Investment performance. The capital value to be applied to the GAR depends on the investment performance during the term to retirement age. (Some contracts applied the GAR to a known value, thereby removing this variable);

    (b)  the "normal" annuity rates applying at the maturity date of each contract. At times when the normal rates available from the provider are as high as or higher than the GAR, the GAR costs nothing. But, in times when rates available are lower than the GAR, the cost is relative to the difference of the two. In practice, through the use of open market options, the guarantees may not cost anything providing a higher rate is available on the open market;

    Annex 1 highlights this point. Based on estimated figures, it shows that the GARs provided by Equitable Life started to become valuable to annuitants (ie started to cost Equitable Life something) during 1993. Clearly, if the OMO amount of income falls further in future, so does the cost of providing GARs; and

    (c)  the number of people exercising their right to a GAR. High take-up is likely when the rate is attractive, but, as the GAR only applies to annuities bought on a particular basis, it is not suitable for all retirees. However, even in these instances, it is usually beneficial for the retiree to exercise their GAR on at least part of their pension fund.

  2.4  So, providers of such contracts carry a risk, the exact extent of which is unknown.

  2.5  This risk is usually managed by setting reserves aside to meet the potential costs and or reassuring part of the expected liabilities.

  2.6  This risk is similar to that inherent in Final Salary pension schemes, whereby the employer is taking the risk. Here, instead of investment performance being a variable factor on the future value of the liabilities, it is the projected growth in salaries. (Good investment performance in this instance benefiting the employer through potentially lower contributions to the scheme.) This similarity is mentioned as the ongoing debate around the Minimum Funding Requirements for such schemes could provide some further insights to the issues associated with Equitable Life.


  Pensions with GARs were sold in large volume.

  The company chose to distribute high levels of with profit fund returns, thus leading to a low free asset ratio, ie insufficient reserves were set aside to meet the liabilities arising from GAR policies.


3.1  Whether such factors could affect other firms?

  Yes, as the same factors affect other companies who sold GAR pensions. But, the scale of the problem is unlikely to be repeated as other companies have generally been more conservative in the distribution of with profit fund returns, ie they have higher reserves.

3.2  Consequences for investor confidence

  Bad. The Equitable life's closure to new business, their withholding of bonuses to some members, the increased Financial Adjustment of 10 per cent to those transferring and the company's perceived or actual arrogance (demonstrated by their continuing to actively promote themselves after the High Court ruling) have all contributed to lower investor confidence.

  Many will no doubt feel that similar mismanagement could apply to other companies, regardless of the facts of this.

3.3  Role of the regulators

  Regulatory monitoring should ensure that companies have adequate risk management controls (in particular, prudent reserves).

  Regulatory monitoring should ensure that companies cannot trade when their own stability is in doubt.

  Clearly, both these safeguards have not happened in relation to the Equitable Life.

3.4  Solutions

  Whilst we do not believe there is a simple solution to ensure that this damaging affair cannot re-occur, we mention below aspects of concern for consideration. Overriding any concerns listed is the need to protect consumers and to ensure that the necessary incentives for people to save for their own retirement are not damaged further.

  3.4.1  The current wide discretionary powers of Appointed Actuaries.

  3.4.2  Lack of true transparency in contract design.

  3.4.3  The inequality of corporate governance requirements between mutual and proprietary companies.

  3.4.4  The lack of accounting monitoring (which allowed the company to promote financial strength, based on flawed assumptions. Namely, that it would win the court case).

2 February 2001

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