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:
"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".
"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".
"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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