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Select Committee on Treasury Appendices to the Minutes of Evidence


APPENDIX 2

Memorandum from the Faculty and Institute of Actuaries

  Actuaries provide commercial, financial and prudential advice on the management of a business's assets and liabilities, especially where long-term management and planning are critical to the success of any business venture. They also provide advice on social and public interest issues.

  Members of the actuarial profession have a statutory role in the supervision of pension funds and life insurance companies. They also have a statutory role to provide actuarial opinions for managing agents at Lloyd's.

  The profession is governed jointly by the Faculty of Actuaries in Edinburgh and the Institute of Actuaries in London. A rigorous examination system supported by a programme of continuous professional development and a professional code of conduct ensures high standards reflecting the significant role of the profession in society.

  The actuarial profession welcomes the opportunity to submit evidence to the Treasury Committee in relation to its examination of the regulatory environment and the management of risk in the life assurance sector following the Equitable Life affair.

  While most of this memorandum deals with the existing regime of supervision and of professional guidance to Appointed Actuaries, it also includes some comments about possible future developments.

SUMMARY

  Insurance contracts provide a significant part of the long-term savings market in the United Kingdom as well as providing protection in the event of early death or longevity in retirement.

  Directors of life insurance companies are seen as having a fiduciary responsibility towards policyholders, because of the nature of the business, whereby premiums are received from members of the public in return for a paper promise.

  Section 19 of the Insurance Companies Act 1982 (the 1982 Act) requires every life insurance company to appoint an actuary to undertake certain duties. The Appointed Actuary has wide responsibilities in relation to monitoring the adequacy of the assets to meet the liabilities on a continual basis including an appropriate allowance for risk.

  The 1982 Act does not seek to regulate insurance companies either in the design of contracts or the determination of premium rates. Rather the emphasis is on continual monitoring by the Appointed Actuary, with a duty to report annually and on a "whistle blowing" basis in the event that the directors fail to act on his recommendations. The Appointed Actuary system is regarded as providing a more effective degree of monitoring than can realistically be expected of the Financial Services Authority (FSA). It has proved highly effective in protecting policyholders in recent years.

  The Appointed Actuary to every life insurance company has to hold a current practising certificate from the profession and to comply with professional guidance notes issued by the actuarial profession. In deciding whether to grant such a certificate, the profession requires several years of relevant experience, an unblemished professional record and compliance with a programme of Continuing Professional Development.

  The professional guidance notes issued by the actuarial profession and the "Dear Appointed Actuary" letters sent by the Government Actuary define an appropriate high level of conservatism for the required annual financial investigation by the Appointed Actuary and the appropriate allowance for risk.

  The FSA has significant powers of intervention for protecting policyholders or potential policyholders of the company against the risk that the company may be unable to meet its liabilities or to fulfil the reasonable expectations of policyholders or potential policyholders.

  Because the 1982 Act does not contain any definition of policyholders' reasonable expectations (PRE), the regulators and the actuarial profession have built up an informal framework over the years to determine what are PRE. The main factors are:

    —  the fair treatment of policyholders vis-a¢-vis any shareholders;

    —  fair treatment amongst different groups and generations of policyholders;

    —  any statements by the company as to its bonus philosophy, charges and the entitlement of policyholders to a share in profits—for example in its articles of association, with-profits guide or other company literature;

    —  the history and past practice of the company; and

    —  general practice within the life insurance industry.

  The House of Lords judgement in the case of the Equitable Life Assurance Society Ltd differed in important respects from what had become the accepted wisdom. For example, it is accepted wisdom that directors have discretion to reduce terminal bonuses, in the case of with-profits policies, to enable them to give policyholders the benefit of investment in a broad range of types of asset whilst protecting them from the full volatility of such investment. It is also accepted practice that groups of participating policies are appropriately and equitably distinguished when making a distribution of bonuses.

  The UK Appointed Actuary system (or variants of it) has been accepted in many other countries as providing a very good way of regulating insurance markets. The implementation of the Third Life Directive triggered this for most countries in the EU. Other countries now using an Appointed Actuary system of regulation include Canada, Australia, South Africa, India, Hong Kong, Malaysia, Singapore and Taiwan and this system is also under active consideration in China. The USA also has an Appointed Actuary system but the role is slightly less all-encompassing than is the case in the UK.

  The Equitable Life Assurance Society Ltd was unusual in the way it conducted its financial affairs, as evidenced by discussion (see paras 12.1 and 12.2).

  On 21 December 2000 the actuarial profession announced that it was setting up a Committee of Inquiry to look into the implications of the events surrounding the closure of Equitable Life Assurance Society to new business. The Committee is considering in particular the role of actuaries in the regulatory process to see if the guidance provided by the profession needs to be strengthened.

  Meanwhile, the actuarial profession is considering mandatory peer review of Appointed Actuaries as well as for other statutory roles in the pensions and Lloyd's areas.

1.  BACKGROUND TO LONG-TERM INSURANCE CONTRACTS

  1.1  Insurance contracts provide a significant part of the long-term savings market in the United Kingdom as well as providing protection in the event of early death or longevity in retirement. In 1999, funds invested in long-term insurance contracts with companies and directive friendly societies amounted to £992 billion. Furthermore, of the estimated £1,300 billion of funds invested for provision of retirement benefits, 35 per cent was invested through long-term insurance contracts.

  1.2  Long-term insurance contracts used for savings are unusual in that the policyholder is committed for the long term but the benefits are often to some extent at the discretion of the company or society. The rationale for such discretion, in the case of with-profits policies, is to give policyholders the benefit of investment in a broad range of types of asset whilst protecting them from the full volatility of such investment. This differs from, for example, a building society deposit account where the interest is at the discretion of the society, but the depositor has the option of withdrawing the face value of the deposit at any time.

  1.3  Long-term insurance contracts used for savings divide between with-profits contracts and unit-linked contracts. In 1999 just under 50 per cent of new annual premiums were invested in unit-linked funds.

  1.4  With-profits contracts share profits with shareholders in proprietary companies in a proportion determined by directors, normally constrained by the articles of association to policyholders receiving at least 90 per cent. In mutual insurance companies and friendly societies policyholders receive 100 per cent of distributed profits. Profits in proprietary and mutual companies and societies are allocated to policyholders at the discretion of the directors, after receiving the advice of the Appointed Actuary.

  1.5  Unit-linked contracts have a more direct link between investment profits and policy benefits but the company often has discretion to vary charges for investment, administration, mortality and guarantees.

  1.6  Directors of life insurance companies are seen as having a fiduciary responsibility towards policyholders, because of the nature of the business, whereby premiums are received from members of the public in return for a paper promise. The ability to deliver satisfactorily on that promise, not only in contractual terms, but in accordance with policyholders' reasonable expectations, possibly many years into the future, necessitates sound financial management and is the background to the need for a significant level of regulation of the business.

2.  THE ROLE OF THE APPOINTED ACTUARY

  2.1  The Insurance Companies Act 1982 (the 1982 Act) contains the primary legislation relating to life insurance companies. In many areas the 1982 Act lays down broad principles leaving detailed supervision to be covered by regulations.

  2.2  Section 19 of the 1982 Act requires every life company to appoint an actuary, known as the Appointed Actuary, to undertake certain duties. The Appointed Actuary has wide responsibilities in relation to monitoring the adequacy of the assets to meet the liabilities on a continual basis.

  2.3  The duties of the Appointed Actuary include making an annual investigation into the financial condition of the company and reporting the findings of the investigation to the directors of the company. An abstract of this report is included in the Annual Return which the company is required to submit to the Insurance Directorate of the Financial Services Authority (FSA), which is responsible for the supervision of life insurance companies.

  2.4  Further details are given in the booklet on The Role of the Appointed Actuary enclosed at Appendix 1 [not printed]. There are similar statutory requirements of directive friendly societies, and of the Appropriate Actuaries to such societies.

  2.5  The 1982 Act does not seek to regulate directors either in the design of contracts or in the determination of premium rates. Rather the emphasis is on continual monitoring by the Appointed Actuary, who has a duty to report annually and on a "whistle blowing" basis in the event that the directors fail to act on his recommendations. This is regarded as providing a more effective degree of monitoring that can realistically be expected of the FSA.

  2.6  The Appointed Actuary system of regulation is regarded as having proved highly effective in protecting policyholders in recent years.

3.  PRACTISING CERTIFICATES

  3.1  Subordinate legislation under the 1982 Act has prescribed that an Appointed Actuary must be a Fellow of the Faculty of Actuaries or Institute of Actuaries (and have attained the age of 30). The Faculty and Institute of Actuaries permit their members to take up a position as Appointed Actuary only if they hold a current practising certificate from the profession. In deciding whether to grant such a certificate, the profession requires several years of relevant experience, an unblemished professional record and compliance with a scheme of Continuing Professional Development. Evidence of a failure to comply with professional conduct standards or standards of practice set out in Guidance Notes could lead the actuarial profession to refuse to renew an actuary's certificate.

4.  PROFESSIONAL GUIDANCE TO APPOINTED ACTUARIES

  4.1  The Appointed Actuary to every life insurance company has to comply with professional guidance notes GN1 and GN8 issued by the Faculty and Institute of Actuaries, the controlling body for actuaries in the United Kingdom. They are practice standard guidance notes, and are thus mandatory on the Appointed Actuary. The Appointed Actuary has to certify whether he has fully complied with practice standard guidance notes in his certificate to the FSA as part of the annual returns which life insurance companies make to the FSA. In this way GN1 and GN8 have a place in the insurance company regulatory framework. GN1 deals with general matters and GN8 deals with interpretation of valuation regulations. Guidance note GN1 is attached as Appendix 2; GN8 is at Appendix 3 [not printed].

  4.2  GN1 makes it clear that continuously monitoring the financial condition of the company involves keeping track of everything that might impinge on financial condition. This includes:

    —  being consulted on the design of new products, the setting of premium rates and marketing plans;

    —  monitoring options and guarantees;

    —  monitoring investment policy to ensure that it is appropriate to the nature and term of liabilities;

    —  current and likely future level of expenses;

    —  reinsurance arrangements; and

    —  the level of free assets.

  4.3  In addition, guidance note GN2, which is recommended practice, sets out the profession's view on the advisability of supplementing the annual investigation into a company's financial condition with a report to the directors on the results of a dynamic financial analysis. This dynamic financial analysis involves testing the company's ability to withstand possible future adverse conditions, making use of cash flow projections on a variety of assumptions. A copy of GN2 is at Appendix 4 [not printed].

5.  INSURANCE COMPANIES ACT 1982 AND SUBORDINATE REGULATIONS

  5.1  Section 37 of the 1982 Act confers on the regulators powers in respect of investments, premium limitation, additional actuarial investigations, acceleration of returns and power to request additional information. These powers are exercisable on the grounds that the regulators consider the exercise of the power to be desirable for protecting policyholders or potential policyholders of the company against the risk that the company may be unable to meet its liabilities or to fulfil the reasonable expectations of policyholders or potential policyholders.

  5.2  Section 45 confers the power to impose further requirements in these circumstances.

  5.3  The power to withdraw authorisation is contained in section 11 of the 1982 Act and requires evidence that a company is failing to satisfy an obligation imposed by the Act.

  5.4  The reserving standard which was intended with the passage of the 1982 Act, and which was subsequently embodied in the Insurance Company Regulations and the actuarial guidance note GN8, incorporated the requirement to make proper provision for all liabilities on prudent assumptions that shall include appropriate margins for adverse deviation of the relevant factors. There is also a requirement to make provision for PRE and not just for contractual liabilities. It was thus much more than a solvency standard for the guaranteed liabilities.

6.  POLICYHOLDERS' REASONABLE EXPECTATIONS (PRE)

  6.1  Although the 1982 Act uses the term "reasonable expectations of policyholders" (PRE), it does not contain any definition of PRE. Because the concept of PRE is not defined in statute, any interpretation is inevitably a matter for the Courts. However, until the recent Equitable Life case, there had been very few cases which have tested the concept, so the industry, and the actuarial profession, have built up an informal framework over the years to determine what are policyholders' reasonable expectations (PRE).

  6.2  There are a number of references to PRE in actuarial guidance note GN1, for example:

    Paragraph 1.1

    "It is incumbent on all Appointed Actuaries to ensure, so far as it is within their authority, that the long-term business is operated on sound financial lines and with regard to its policyholders' reasonable expectations".

    Paragraph 3.3

    "It is part of the Appointed Actuary's continuing responsibility to advise the company of the Appointed Actuary's interpretation of its policyholders' reasonable expectations. In general terms this interpretation should have regard to the broad nature of the company and its approach to the treatment of policyholders both individually and (where appropriate) collectively as a group vis-a"-vis shareholders".

    Paragraph 8.3.4 of GN1 is concerned with the Appointed Actuary justifying recommendations regarding the allocation of bonuses. In so doing, the Appointed Actuary must take account of his interpretation of PRE. It is stated in paragraph 8.3.4 of GN1 that PRE is influenced by policy literature and by other publicly available information. The Appointed Actuary: "should assume that among the conditions for the fulfilment of those expectations are:

    that, in the recognition and allocation of profits in accordance with the company's terms of participation and its policy in respect of [the nature and timing of allocations of profits to policyholders], groups of participating policies are appropriately and equitably distinguished having regard inter alia to the terms of policies, their duration and their relevant pooled experience; and that the company conducts its affairs, including its new business and investment strategies, with due regard for its financial resources".

    Paragraph 4.1.2

    "The Appointed Actuary must take all reasonable steps to ensure that the company's constitution or authorised procedures are or will be such that it will not make or undertake to make a specific allocation of profit in a long-term fund (whether to policyholders, shareholders or both) before the directors have obtained from the Appointed Actuary and duly considered a written report containing the Appointed Actuary's observations and recommendations on the subject."

  6.3  On 24 February 1995, Mr Jonathan Evans, President of the Board of Trade, stated in response to a Parliamentary Question on "Orphan assets" that:

    "The Department considers that policyholders' reasonable expectations in respect of attribution of surplus are influenced by a range of factors, notably:

      —  the fair treatment of policyholders vis-a¢-vis shareholders;

      —  any statements by the company as to its bonus philosophy and the entitlement of policyholders to a share in profit, for example, in its articles of association or in company literature;

      —  the history and past practice of the company; and

      —  general practice within the life insurance industry."

  6.4  The actuarial profession agrees that these are the relevant factors to consider in determining PRE and in the wider context of distribution of bonuses would add:

    —  fair treatment amongst different groups and generations of policyholders.

  6.5  It is worth noting at this point that the House of Lords judgement differed in important respects from what had become the accepted wisdom (see Section 12 below).

7.  ACTUARIAL WORKING PARTY ON PRE

  7.1  Recognising the difficulty for actuaries in advising on PRE, the actuarial profession set up a working party which first reported in 1990. No formal guidance resulted.

  7.2  In relation to a series of interviews conducted with Appointed Actuaries, the first report of the working party stated:

    "In almost every interview the point emerged as to what level of sophistication it was relevant to attribute to the policyholders in PRE. The point was repeatedly made that the policyholder himself generally had little understanding of the kinds of technical issue raised by PRE. Generally the view emerged that the expression should be interpreted in the context of professional advisers acting on behalf of policyholders, the courts, the press and similarly well informed observers of the life insurance industry".

  7.3  In paragraph 3.2 of the same report, it was stated in relation to policies which have a discretionary element.

    "The holders of such contracts may reasonably expect that life offices will behave fairly and responsibly in exercising the discretion which is available to them. They may also expect a reasonable degree of continuity in an office's approach to determining variable charges or benefits".

  7.4  The working party also concluded that:

    "in the normal day-to-day actuarial management of a life office PRE is virtually synonymous with equity and the almost universal method for measuring its asset-share calculations . . ."

  7.5  Asset shares are the accumulation of premiums less expenses incurred allowing for the investment return earned for a group of similar policies. In making the calculations the asset share would normally be charged for the cost of accruing guarantees.

  7.6  The asset share is a guideline or benchmark rather than an absolute constraint. In practice there may be good reasons why a particular group of policyholders should be entitled to more than just asset shares, or in some circumstances less, for example because of the effect of smoothing of investment returns.

8.  THE ROLE OF THE GOVERNMENT ACTUARY'S DEPARTMENT IN RELATION TO LIFE INSURANCE SUPERVISION

  8.1  An important part of the role of the Government Actuary's Department (GAD) has been to assist in the relevant authority (DTI, succeeded by HMT and then the FSA) in the supervision of life assurance companies. Most obviously, this has been done through the delegation to GAD of the process of examining the Annual Returns submitted by those companies. With the transfer by HMT to within FSA itself of the supervisory responsibility under the Financial Services and Markets Act 2000, the relevant advisory function is to be transferred from GAD to FSA. The actuarial profession has commented on this development in its memorandum of 19 January 2001 submitted to the Treasury Sub-Committee in relation to its inquiry into GAD.[1]

  8.2  From time to time the Government Actuary sends "Dear Appointed Actuary" letters (DAA letters) reinforcing what GAD see as existing good practice within the profession. In practice, these have set a minimum acceptable standard for Appointed Actuaries in determining provisions for particular risks in the valuation of liabilities.

  8.3  The Committee may find it useful to receive a copy of a paper on The Regulatory Role of the Actuary by C D Daykin (the Government Actuary) which was published by the actuarial profession in February 1999 and which offers an overview relevant to the subject-matter of the Committee's Inquiry. A copy is enclosed as Appendix 5 [not printed].

9.  OVERSEAS EXPERIENCE AND INFLUENCE OF THE APPOINTED ACTUARY MODEL

  9.1  The UK Appointed Actuary system (or variants of it) has been accepted as providing a very good way of regulating insurance markets when rigorous prior approval of policies and premium rates and mandating of reserving standards are removed. The implementation of the Third Life Directive triggered this for most countries in the EU. Other countries, such as Canada, Australia, and South Africa were already going down this route, with regulatory traditions not unlike the UK.

  9.2  The same route has now been followed in many other countries, eg India, Hong Kong, Malaysia, Singapore, Taiwan and is under active consideration in China. The USA has an Appointed Actuary role but this is less all-encompassing that the equivalent UK position reflecting the greater control exercised over policy conditions and reserving bases.

10.  GUARANTEED ANNUITY OPTIONS

  10.1  The interpretation of PRE for policies with guaranteed annuity options (GAOs) is made by boards of directors, acting on the advice of their Appointed Actuary within the above framework. Directors are bound by the terms of contracts and declared bonus policy, and may be specifically restricted by Articles of Association or Board resolutions. A number of different interpretations were made.

    10.2  On 18 December 1998, Mr Martin Roberts (Director, Insurance) wrote on behalf of HM Treasury to all managing directors of insurance companies to clarify HM Treasury interpretation. The following extracts are taken from that letter:

    "The nature of the guarantees offered by companies varied widely, but one issue that needed to be addressed by all companies was how the concept of policyholders' reasonable expectations (PRE) should be interpreted in the context of guaranteed annuity options."

    "In the case of participating policies, any charge could be deemed to be met out of each premium received (or the investment return to be credited by way of bonus), and hence would impact on the assessment of bonuses, including in particular any final bonus that would normally be payable to the policyholders. Generally we consider that it would be appropriate for the level of the charge deemed to be payable by participating policyholders for their guarantee (or annuity option) to reflect the perceived value of that guarantee (or option) over the duration of the contract. This could be achieved in some cases through some reduction in the final bonus that would be payable if there were no such guarantee (or option) attached to the policy. However, the selected treatment by each office would need to depend on the wording of the contract involved and how it had been presented to policyholders.

    "Under the majority of participating policies which have been written it appears that any guarantee or annuity option is applicable to at least the guaranteed initial benefit under the policy and any attaching declared bonuses. As a consequence of this, we would expect that for most companies the present guaranteed cash benefits (including declared bonuses) would be converted, as a contractual minimum, to the annuity on the guaranteed terms. However, as indicated above, it would appear possible, depending on the particular circumstances relating to the contract, that any final bonus added at maturity may be somewhat lower than for contracts without such options or guarantees, and that this final bonus could in some cases be applied at current annuity rates".

  10.3  This letter confirmed HM Treasury's view at that time (expressed as without prejudice to any decision of the costs which might affect it) that, in appropriate circumstances, any final bonus added at maturity for contracts containing Guaranteed Annuity Rates might be lower than for contracts which did not contain Guaranteed Annuity Rates.

  10.4  It should be recognised that a guarantee on a with-profits policy can be charged for either by imposing a higher premium or making deductions from asset shares and thereby ultimately from bonuses, or by some combination of the two, but the guarantee should be charged for in one way or another.

  10.5  It is the view of the actuarial profession that prudent reserves should be held for all guarantees on a conservative basis with regard to the likelihood of their being called and their cost (covered under guidance note GN8). The general requirement for a prudent valuation and the specific requirement of the regulations made under the 1982 Act regarding options and guarantees meant that actuaries were reserving prudently for GAOs. "Dear Appointed Actuary" letters DAA11 and DAA13 were issued by the Government Actuary to reinforce what GAD saw as existing good practice within the profession with regard to reserving for GAOs. These letters did not break new ground. Copies of DAA11 and DAA13 are attached as Appendix 6 [not printed].

11.  ACTUARIAL BRIEFING STATEMENT ON GUARANTEED ANNUITY OPTIONS

  11.1  The Public Relations Committee of the Faculty and Institute of Actuaries, in association with the profession's Boards, produces from time to time various briefing statements to enable its officers, members of its Council and senior members of staff to respond to questions from the profession, the public and the media about important topical issues and developments. These statements are not formal guidance, neither are they necessarily a definitive expression of the views of the profession as a whole on the subject.

  11.2  In March 1999 the actuarial profession issued a statement on annuity guarantees which is shown at Appendix 7 [not printed]. The statement was publicly available on the Internet.

  11.3  The statement recognises that there are various acceptable approaches to the determination of bonus for policies containing GAOs. The following is an extract:

    " . . . In this case the policyholder is likely to receive the full value for the funds built up to support the policy, regardless of whether they take a cash option or pension option under their policy. The final bonus rates for individual policies will be set so that the accumulated fund equals the cost of the annuity provided. The "guarantee" may seem to be lost, but the position is no different from the position of the past under older policies with a guaranteed conversion the other way—from pension to cash. The guarantee will still bite if final bonus rates fall to zero".

  This statement was amended in October 2000.

12.  EQUITABLE LIFE ASSURANCE SOCIETY

  12.1  Equitable Life Assurance Company was unusual, some would say unique, in the way it conducted its financial affairs. The Equitable approach was sufficiently different to be described in a paper to the Institute of Actuaries which was discussed on 20 March 1989. The following extracts from that paper give an indication of the Equitable approach.

    "The essence of the concept is that we regard with-profits policyholders as participating in a `managed fund'. The premiums they pay, after meeting expenses and the cost of life cover and other benefits and options, are invested in the managed fund. The benefits a policyholder ultimately receives will reflect the value of the assets in the fund attributable to his policy, ie that policyholder's asset share."

    "It may be instructive to consider briefly how the concept has developed. In many ways it is the explicit expression of an attitude which has prevailed in the office for many years. Put simply, that is that the business belongs to the current generation of with-profits policyholders. Those policyholders participate in a pooled fund and, when they leave, should take `full value' from the fund. The fund is continually open to new members. In particular, we do not believe in the concept of an `estate' in the sense of a body of assets passed from generation to generation and which belongs to no-one."

    "Once expressed, the managed-fund concept has proved a natural, and valuable, way of looking at the with-profits business. In our view it aids clear thinking in a number of areas and has gained currency within the office as a way of thinking about the way we operate. In particular, we find quite alien the concept of adding a `bonus loading' to non-profit premium scales in order to participate in the `profits' of the office. That concept carries the implication that the policyholder could have paid a different, lower, premium for guaranteed benefits. That is simply not an appropriate view for many modern contracts as can, perhaps, most easily be seen by considering unitised with-profits business. Providing cover on a non-profit basis is a quite separate activity and we do not find parallels between, say, non-profit and with-profits endowment assurances relevant. The concept of joining a managed fund on appropriate premium rates to share in the experience of that fund is fundamentally different from that of paying additional premium charges to earn a share of the profits of the office.

    "Although the concept has been used internally for a number of years, it is only relatively recently that we have attempted to use it as a way of describing with-profits business to policyholders. The results have been pleasing, in that clients generally seem to find the idea understandable and helpful. We believe that other benefits can ensue from emphasising the investment nature of the business and the parallels between linked and with-profits contracts. For example, a client who appreciates the concept is, we feel, less likely to find changes in declared bonus rates in the fact of changing investment conditions surprising. By this means we have tried to take some of the mystery and mystique out of with-profits business."

    "A natural extension of the managed fund concept is to regard each with-profits policyholder as having a specific stake in that fund. The well-known approach of looking at `asset shares' is, thus, wholly consistent with the managed fund concept. However, we look at the `asset share' as part of the accumulated pooled fund (subject to averaging), not as the product of a mechanistic model at the individual policy level assuming, for example, a changing mix of fixed interest and equity holdings over a contract's term, which, we understand, is used by some offices. Such an approach represents a quite different philosophical standpoint and can be expected to produce different results. In our view it suffers from complexity in practical application and does not give due prominence to the mutual insurance of investment risk, which we regard as a key feature of the business. That is a concept developed more fully in the following paragraph."

    "The managed fund's holding of fixed-interest stocks broadly matches the guaranteed liabilities. However, that fixed-interest holding can be considered to match the guaranteed liabilities in aggregate. That is, the members of the fund are regarded as mutually insuring the investment risk amongst themselves so that the same investment mix applies to each asset share irrespective of duration in force or outstanding term. In that context it is worth noting that new business is desirable for the existing members because it helps maintain the proportion of guaranteed benefits on the business as a whole at a level that does not unduly constrain investment freedom. The key consideration for bonus distribution policy is the most appropriate way of passing on their "asset shares" to policyholders leaving the fund. It should be noted that this approach to bonus policy is quite general. Although the recurrent single premium form of contract is well suited to the asset share approach, it is possible to look at most other, more conventional, types of product in a similar way and, indeed we do."

  12.2  The approach to operating without an estate or free assets did attract criticism from some actuaries as is evident from the following extracts from the discussion:

    "Mr H H Scurfield—The authors' office is different from many others, not only in its distribution system, but also in its product mix. We are told that most of their with-profits business is recurring single premiums. This requires less financing than the traditional annual premium business and perhaps explains why they exist very successfully without any estate. In that respect they are unusual."

    "Mr H W Froggatt—The simplicity described in the paper has its price; and existing and new policyholders . . . ought, in the present climate of disclosure, to be made aware of what these might be."

    "Mr P N S Clark—I believe it is in consideration of the improbable that some of us retain what we would unashamedly call an estate."

    "Mr A B Bamford—An advantage of strength, despite what the authors say, is that the office has freedom of manoeuvre. If it is not felt to be desirable that the office with large reserves has freedom of manoeuvre, then there is no case for the policyholder entrusting his savings to that office in the first place."

    "Mr R S Skerman—An insurer risks facing competitive difficulties sooner or later if it holds an estate significantly less than that held by competitors. When assessing an insurer, from the point of view of a financial adviser to potential policyholders, bonus performance and strength combined should be taken into account."

    "Mr I J Kenna—In the final analysis, policyholders will judge whether security should be sacrificed in return for the claim to give the investor better service and value for money."

  12.3  Prior to the House of Lords ruling, the Equitable Life Assurance Society was interpreting PRE in the context of the HM Treasury letter of 18 December 1998 and actuarial profession's briefing statement of March 1999.

  12.4  The requirement that the Appointed Actuary ensures that the company conducts its affairs, including its new business and investment strategies, with due regard for its financial resources contained in GN1 was also relevant to Equitable, since it is evident from the above and was shown in the High Court that the resources of the company were limited.

  12.5  The House of Lords' judgement took account of the particular circumstances of Equitable Life and differed in important respects from what had become the accepted wisdom on PRE.

  12.6  For example, it has been accepted wisdom that directors have discretion to reduce terminal bonuses, in the case of with-profits policies, to enable them to give policyholders the benefit of investment in a broad range of types of asset whilst protecting them from the full volatility of such investment. It is also a requirement of actuarial guidance note GN1 that groups of participating policies are appropriately and equitably distinguished having regard inter alia to the terms of the policies, their duration and their relevant pooled experience, to achieve fair treatment amongst different groups and generations of policyholders, where the measure of fair treatment is almost invariably the asset share.

13.  FINANCIAL SERVICES AND MARKETS ACT 2000

  13.1  Under the Financial Services and Markets Act 2000, the FSA is charged with a number of statutory objectives including maintaining confidence in the financial system, promoting public awareness of the financial system and securing the appropriate degree of protection for consumers.

  13.2  The FSA has been given a range of powers and functions to enable it to pursue these objectives. These produce a framework of regulatory requirements which set standards for firms or individuals seeking authorisation or approval and, for those who do gain authorisation or approval, for the conduct by them of regulated activities.

  13.3  The proportionate and effective use of these powers will play an important part in securing public confidence in the industry.

14.  PEER REVIEW TO STRENGTHEN SUPERVISION OF APPOINTED ACTUARIES

  14.1  In December 2000, the Faculty and the Institute of Actuaries both held meetings to consider recommendations from its Professional Affairs Board working party which included mandatory peer review of Appointed Actuaries (as well as peer review for the other areas where actuaries have statutory duties). The introduction of, and the scope of work covered by, compulsory peer review would be decided by the profession's Life Board. Sanctions for non-compliance with the requirement to introduce an appropriate peer review system might include the non-renewal of a Practising Certificate.

  14.2  The Professional Affairs Board will consider members' views expressed at these meetings, before bringing recommendations to the Councils of the Faculty of Actuaries and of the Institute of Actuaries.

15.  FACULTY AND INSTITUTE OF ACTUARIES COMMITTEE OF INQUIRY

  15.1  On 21 December 2000 the Actuarial Profession announced that it was setting up a Committee of Inquiry to look into the implications of the events surrounding the closure of Equitable Life Assurance Society to new business.

  15.2  The particular focus of the Inquiry is the key issue of professional guidance. The Committee's present intention is to report its findings to the Presidents of the Faculty of Actuaries and Institute of Actuaries by spring 2001.

  15.3  The Inquiry is chaired by Roger Corley, a Past President of the Institute of Actuaries. The other actuary members of the Committee are Malcolm Murray, a Past President of the Faculty of Actuaries, and Bill Abbott, Group Actuary of Legal and General. Two non-actuaries have also agreed to serve on the Committee: Sir John Caines, former Permanent Secretary of the Department of Education and currently Deputy Chairman of the Investors' Compensation Scheme; and Keith Woodley, Deputy Chairman of the Abbey National and a Past President of the Institute of Chartered Accountants.

  15.4  The terms of reference for the inquiry are to:

    —  review the adequacy of the professional guidance in relation to the events leading to the closure of Equitable Life to new business;

    —  consider whether there are any implications from those events of relevance for the roles of Appointed Actuaries and other actuaries who are directors or senior employees of long-term insurance companies; and

    —  make recommendations to the Presidents of the Faculty of Actuaries and Institute of Actuaries.

  15.5  The actuarial profession is looking at the situation with the interest of the public in mind. In particular it is considering the actuaries in the regulatory process to see if the guidance provided by the Profession needs to be strengthened.

February 2001

ANNEXED (NOT PRINTED)

  1.   The Role of the Appointed Actuary—actuarial profession booklet (May 2000).

  2.  Actuarial guidance note GN1.

  3.  Actuarial guidance note GN8.

  4.  Actuarial guidance note GN2.

  5.   The Regulatory Role of the Actuary by C D Daykin (February 1999).

  6.  The Government Actuary's letters to Appointed Actuaries on 13 January and 22 December 1999 (DAA11 and DAA13).

  7.  The Faculty and Institute of Actuaries' briefing statement on annuity guarantees, issued in March 1999.


1   See Seventh Report (Session 2000-01) Government Actuary's Department (HC 236) Appendix 6. Back


 
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