Select Committee on Treasury Appendices to the Minutes of Evidence


Supplementary memorandum by The Equitable Life Assurance Society

  The Committee raised with The Equitable during its evidence session the relationship between the statutory reserves required as part of the regulatory return, and the effect on policyholders' benefits of the House of Lords' decision. The Committee's concerns were that:

    —  awareness of the nature and extent of the statutory reserves would have provided policyholders with an early indication of the potential impact of the most adverse of a range of possible outcomes from the House of Lords;

    —  the level of the statutory reserves indicates that insufficient provision was made in the company accounts for the possible effects of the House of Lords' decision.

  There appears to be a fundamental misunderstanding on this issue, which we feel is important to correct. There is little or no connection between the statutory reserves and the impact on policyholder benefits of the House of Lords' decision. The misunderstanding may arise from the fact that the figure of £1.5 billion for the statutory reserves (filed in the regulatory return for the period ending 31 December 1998) is the same as the amount The Equitable estimated should be set aside to deal with the consequences of the House of Lords' decision. The fact that the two figures are the same is coincidental. They deal with two quite different sets of circumstances.


  There are two main elements to the benefits under with-profits policies. These are (a) the guaranteed benefits including the annual or reversionary bonus and (b) the final bonus. The statutory reserves are required to ensure that all life companies are able to meet their liabilities to pay the guaranteed benefits in even adverse economic circumstances.

  GAR policyholders have the option of taking their guaranteed benefits in either cash form or as an annuity. In the latter form, the guaranteed annuity rate is applied to the guaranteed cash form benefits to produce a guaranteed minimum income.

  The new regulatory guidance that caused us to set the statutory reserves at £1.5 billion as at 31 December 1998, required us to assume a very high rate of take up amongst GAR policyholders of the annuity option, in preference to the cash option. But even under these new assumptions, the statutory reserves were still only concerned with the guaranteed annuity benefits produced by applying the guaranteed rate to the guaranteed cash form benefits. It did not require The Equitable to assume that the rate should be applied to total benefits including a final bonus or, indeed, to anticipate a final bonus at all.

  For the statutory reserves to be fully called upon would have required there to be not just a significantly adverse set of conditions, but for these conditions to prevail throughout the whole period during which retirement benefits would be drawn. As this was considered unlikely to apply, it was possible for The Equitable to transfer some of the risk via a reassurance policy. The statutory reserves are not, and were never intended to be, a means for providing for the consequences of the eventual decision of the House of Lords.


  The litigation on which The Equitable embarked was designed to establish if it was lawful to pay different final bonuses to GAR policyholders depending on whether or not those holders exercised the right to take their benefits in annuity form at a rate guaranteed by the Society. It related therefore to the treatment of final bonuses, not the guaranteed benefits with which the statutory reserves are concerned.

  The Court of Appeal determined by a majority of 2:1 that it was not lawful to differentiate in this way within the group of GAR holders. A GAR policyholder should receive the same proportionate final bonus irrespective of the form of benefits selected. The Court did not however rule that the society could not differentiate between GAR and non-GAR holders in this respect.

  The House of Lords' ruling took matters one stage beyond this by saying that the Society could not apply a different bonus policy to GAR and non-GAR holders.

  The effect of this ruling was to bring about an economic transfer from non-GAR holders to GAR holders. The with-profits fund is a single pot of money. The House of Lords' judgment affects the way in which the assets in the fund are allocated between different categories of policyholder. Following the House of Lords' decision, this necessary reallocation of assets was assessed at £1.5 billion. The Society could have in theory anticipated the House of Lords' decision earlier and started to make the reallocation sooner. This would have influenced the phasing of the economic transfer, but would not have changed the result. In light of this fact, the legal advice that suggested such a decision was a remote possibility, and the Society's objective—as a mutual—to allocate assets fairly between different groups of its members, the action taken at the time was thought to be reasonable.

  The House of Lords' ruling did not, and has not since, determined the level of The Equitable's statutory reserves. We would still have had to continue to make provision for additional statutory reserves as we did at the end of 1998 and 1999, even if the House of Lords' decision had not gone against us.


  A distinction needs to be made between two forms of guarantee and between two forms of reserving.

  There are the "guaranteed benefits" that apply to all with-profits policyholders and there is the "guaranteed annuity rate" that applies to GAR policyholders choosing to take their benefits in annuity form.

  There are the statutory reserves designed to provide a contingency against falls in asset values, to an extent that the Society would otherwise become unable to meet its liabilities to pay guaranteed benefits when a with-profits policy matures. There is also the separate provision that the Society has had to make to set aside a greater proportion of assets from within the single with-profits fund to re-allocate from non-GAR holders to GAR holders. It is only the latter which was directly affected by the House of Lords' judgment.

19 March 2001

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