Select Committee on Treasury Appendices to the Minutes of Evidence


A paper prepared by John MacLeod FIA



  1.  The Equitable's current difficulties arise from the fact that the recent fall in interest rates has exposed them not to just ONE but to TWO different sets of liabilities.

  2.  FIRSTLY there are those that arise from the fact that they have accepted premiums in the past to which annuity guarantees were attached. These might be called "known liabilities". It is the manner in which these liabilities were managed that gave rise to the recent court proceedings, culminating in the House of Lords' judgment.

  3.  SECONDLY there are those that could arise from the fact that all policies issued pre-July 1988 and which are still in force allow the policy holder to pay any further premium up to Inland Revenue limits still at the originally guaranteed rates. These "latent liabilities", being open ended, could be even more devastating than the ones above.

  4.  The distinction between these two sets of liabilities does not seem properly to have been made in the public comments made on the Equitable affair. This paper aims to set out their consequences.


  5.  With-profit Retirement Annuity Policies (RAPs) were first marketed by the Equitable in 1970. The law then was that the office that took premiums had to pay the policyholder his pension. It was thus inevitable that policy holders should know what pension their premiums would purchase, so the inclusion of an "annuity guarantee" was inevitable. What was not inevitable was the lack of conditions attaching to those guarantees, particularly in regard to the way they could also be applied to future premiums (thus giving rise to the "latent" liabilities referred to above). This made them extremely generous.

  6.  The introduction of the open-market option by the 1977 Finance Act permitted policy holders to take their benefits in cash form to any other annuity provider. This removed the necessity for annuity rate guarantees to be given on new policies entered into after that date.

  7.  However, the Equitable did not take advantage of the opportunity to do so until mid-1988. All existing policy holders—the "GAR policy holders"—kept their guarantees. All new policies taken out subsequently did not, giving rise to a class of "non-GAR policy holders" when they created in effect two classes of policy holders.

  8.  During this time, the Equitable reserved for their liabilities in respect of past premiums paid (the "known" liabilities); but only to the extent that annuity rates might fall to the guaranteed rates. No account was taken of the possibility that annuity rates might fall even further, thus adding to the value of the known liabilities as well as kindling the latent ones.

  9.  At least towards the end of this time, the Equitable pursued a policy of fully distributing profits. All assets not set aside for supporting the known liabilities were intended for eventual distribution as terminal bonus to existing policyholders. No cushion of assets (known as the "orphan" estate) was built up to guard against any unforeseen events; and, since the Equitable was a mutual company, there were no shareholders' funds to call on either. The terminal bonus fund thus "doubled up" as a contingency fund.

  10.  When the fall in interest rates, coupled with a domestic fall in pensioners' mortality rates, caused annuity rates to drop below their guaranteed level in 1993, that created an "unforeseen event"—unforeseen only five years earlier, apparently, since such guarantees were then still being freely given—causing a call having to be made on the contingency fund.

  11.  This "double booking" of the contingency fund with funds intended for future terminal bonuses led to the Equitable taking the cost of the guarantees out of that part of the terminal bonus fund that was ear-marked for those guaranteed policy holders. Such policy holders thought this unfair, and claimed the cost should be taken from the entire fund.

  12.  The High Court action; the Appeal against that action; and the final Hearing before the House of Lords then followed. The final verdict went against the Equitable and they finally closed their doors to new business on 8 December 2000.


  13.  Although the Equitable made no financial reserves to cover their liabilities in the event of annuity rates falling below the guaranteed levels, that would seem to be in accordance with actuarial guide lines current at the time.

  14.  A Position Statement issued by the Institute of Actuaries in 1999 states in paragraph 27 that the cost of guarantees ". . . may be met by the specific class of policy itself in whole or in part, or may be met by other policyholders' bonus, out of shareholders' fund, or from the [orphan] estate."

  15.  The fact that the Equitable had no orphan estate, and that it was their policy not to create one was no secret, at any rate within the life assurance world. It was also freely admitted by Mr. Nash in a newspaper article on 27th September last year.


  16.  When all guarantees were removed from policy holders who joined after July 1988 (the "non-GAR" policy holders) it is just possible to argue that all guarantees on premiums already paid on existing GAR policies (the "known" liabilities) could be met out of the GAR policy holders' own reserves, and that all non-GAR policies would be unaffected.

  17. There was however no certainty that payment of guarantees on future premiums paid by the then existing GAR policy-holders (the "latent" liabilities) could be met from GAR policy holders funds alone, even if the Equitable's disputed policy had been upheld. Indeed it was explained at the Equitable's 1999 AGM that £30 million had to come out of general funds in this way, updated to £10 million pounds the following year.

  18.  Given that an existing GAR policy holder, whose policy is still in force, can now, depending on his age and earnings, pay up to £40,000 to purchase an annuity at 25 per cent less than the market rate, even though he might have paid no more than £150 per year in the past, it follows that this figure would certainly continue to escalate year by year, seriously eroding the returns such post-1988 policy holders could expect to receive.

  19.  The existence of the annuity guarantees, either known or contingent, was not revealed to those policy holders. This surely constitutes a prima facie case of mis-selling. Other offices could perhaps maintain that it was up to the policy holder's financial advisers to ascertain this situation, and appeal to the "Freedom with Publicity" principle on which insurance business was then conducted.

  20.  However it was The Equitable's much vaunted claim that they dispensed with such intermediaries. So either way, whether as adviser or provider or both, the Equitable appear to have failed to alert all post-1988 policy holders to the fact that they were walking into a situation in which they were liable to pay at least in part for liabilities that were in place at the time they took out their policies.

  21.  In the event, they are now being called upon to shoulder the major part of the cost of those guarantees. But House of Lords or no House of Lords, they would always have been liable to pay a significant proportion of those liabilities.


  22.  No doubt the Equitable have prepared projections for the future, to which we are not privy nor would we expect to be.

  23.  We wonder, however, whether such projections, assuming realistic assumptions concerning future take-up rates by policy holders (including the extent to which they are likely to "top-up" their future premiums and so invoke the latent liabilities); together with interest rates at current European levels (which it must be assumed could well apply in five years' time) result in the Equitable being insolvent at some point in the future?

  24.   If so, does that not mean that the Equitable is insolvent now?

  25.  The Equitable is currently solvent in that guaranteed benefits are not eroded. But that seems a mere technicality. Policy holders have always been encouraged to consider their total benefits—ie guaranteed benefits plus full bonuses, and final bonuses have been severely cut back and this trend is likely to continue.

  26.  So what would change if the Equitable were to be pronounced insolvent now? Obviously GAR policy holders would not be able to put in further premiums, and to have the value of those premiums increased by the non-GAR policy holders, an inevitable and unforeseen, but nonetheless generally considered undesirable, consequence of the House of Lords decision. Clearly therefore, the sooner the Equitable can be declared insolvent, the better it will be for non-GAR policy holders.


  27.  We find it curious that whereas the Equitable is closed to new business, existing GAR policy holders can still elect to pay in further premiums without limit, the benefits of which can only be paid for by other policy holders; particularly as it has been reported in the Press that the Scottish Widows' has managed to restrict this very practice and they are still a going concern!

  28.  We wonder if the Equitable have interpreted the House of Lords judgment correctly. Their lordships found against distinguishing between policies whose only difference was that one had a guarantee and the other did not. But does that necessarily preclude them from distinguishing between policies according to when they were first taken out?


  My involvement with the Equitable is both personal and professional.

  On the personal side, I have been a policyholder of the Equitable since 1970, and now derive a substantial proportion of my retirement income from the Equitable. I attended the High Court action in July 1999, as well as the last two of the Society's AGMs.

  On the professional side, I am a qualified actuary. I spent the last 10 years of my working life (the greater part of which was spent in the computer industry) at the Government Actuary's Department. These included two years in what was then the Insurance Supervision Directorate.

  I am currently a committee member of the Equitable Policy Holders Action Group (EPHAG).

1 February 2001

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