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Westminster Hall

Wednesday 17 October 2001

[Sir Michael Lord in the Chair]

Equitable Life

Motion made, and Question proposed, That the sitting be now adjourned.—[Angela Smith.]

9.30 am

Richard Ottaway (Croydon, South): It is a matter of profound disappointment that, yet again, Opposition Members must raise the matter of Equitable Life. The only occasion on which the Government have voluntarily made any pronouncement was when they launched their public inquiry, having previously said that they were content with the inquiry being conducted by the Financial Services Authority. The matter concerns not just a few hundred people but millions of policyholders who are suffering trauma and anxiety. The Government's lack of action and leadership is regrettable.

I welcome the FSA's report, but it was published only a little over two hours ago so there has been insufficient time to consider it fully. Why did it take this debate to flush it out? Why could it not have been published earlier? A preliminary flip through it suggests that it raises more questions than it answers. It is a narrow report on a limited period and, rightly, concentrates on improving regulation in the insurance sector. Its conclusions can be summarised by saying that at the end of 1999, when the FSA took over, the die was cast. Interestingly, the FSA was surprised by the outcome of the House of Lords decision that the regulators could have been more proactive.

I first raised the matter on 19 December 2000, and a brief recap may assist hon. Members. During the 1950s, the Equitable started to sell with-profit pensions which gave policyholders a guaranteed annuity rate—more commonly known as a GAR. On retirement, an annuity must be purchased by the policyholder's 75th birthday. During the era of high interest rates in the 1970s and 1980s, GARs gave no cause for concern as the offered annuity rates were well below market rates.

Mr. John Greenway (Ryedale): I am grateful to my hon. Friend for giving way so soon.

I worked for Equitable Life from 1970 to 1972, and it may be helpful to our debate if I explain two aspects of the GAR at that time. First, the potential benefit for policyholders was significantly greater if they did not take the GAR, and very few policies were sold on the GAR figures. Secondly, at that time, Equitable Life lent money for house purchase at interest rates of 13 and 14 per cent. fixed for 25 years. When Lord Penrose examines the history of the problem, he will need to bear in mind the extent to which Equitable Life's ability to fund the GAR in the early days was clear from its own business.

Richard Ottaway : I am grateful for my hon. Friend's intervention, which shows his experience of the matter. I am sure that Lord Penrose will hang on his every word.

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Interest rates were higher in the 1970s and 1980s, but when they fell in the 1990s, the policies became a liability to the Equitable. About 90,000 policyholders were entitled to benefit from a GAR higher than the prevailing rate in the open market. That was an attractive proposition to the GAR policyholders, but not to other Equitable policyholders who had to pay for it.

The mistake that previous Equitable boards made was not to address the issue and not to save reserves for a rainy day. Instead, they took a different course of action. As the GAR policies began to mature, the Equitable offset the extra costs by paying a lower final bonus to policyholders with GARs than to those policyholders without GARs. GAR policyholders were, in effect, given a choice between exercising the right to a GAR—in which case the final bonus would be reduced—or relinquishing the guaranteed growth, purchasing an annuity at current market rates, and receiving the full bonus.

The Equitable was entitled to believe that that was the right approach. On 18 December 1998, the Treasury's director, consumer, investment and insurance directorate published a letter—it is in the FSA report—which it described as a "considered view" that endorsed that strategy. Referring to the guaranteed annuities, the directorate said:

The advice was clear, easy to understand and confirmed the established practice that had sprung up over the past three or four years. Interestingly, if the FSA was surprised by the outcome of the court case, it clearly thought that the practice was acceptable.

The GAR policyholders, however, were not so enthusiastic. A group of them complained to the Personal Investment Authority ombudsman, who agreed to allow the case to be referred to the High Court. The policyholders lost in the High Court, but had a partial success in the Court of Appeal and an emphatic victory in the House or Lords. That has placed the future of the Equitable in a grave position. The Law Lords published their judgment on 20 July 2001. They found that the Equitable's actions had not been valid, and they obliged it to pay a full bonus to the GAR policyholders and to pay the guaranteed annuity on the whole sum.

As a result two different classes of policyholder have been created in the Equitable: those with guaranteed annuities, and those with annuities at market rates. Consequently, the non-GAR policyholders are funding those with GAR policies. The worst-case scenario liability is believed to be about £2.6 billion. To cover that cost, the Equitable froze its bonuses for seven months, which has raised £1.5 billion. It has also entered into an arrangement with the Halifax, whereby the Halifax is paying £500 million for the Equitable's operating assets. The Halifax will pay a further £500 million on two conditions: it will pay £250 million if the Equitable's compromised proposals are passed, and £250 million if the Equitable's sales force, which is transferred to the Halifax, meets certain performance

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targets. That leaves the Treasury with egg on its face, particularly with regard to the guidance document of 18 December 1998.

When prompted, the Treasury has put up what can best be described as the "Treasury defence": its guidance specifically indicates that any "charge" on policyholders needs to be consistent with the terms of the contract and how that contract has been presented to policyholders. That is a perfectly reasonable position, and was the view of the House of Lords, which reached the conclusion that the Equitable's contract did not provide for a reduction in the final bonus to the guaranteed policyholders.

The Treasury comes unstuck at that point. If five Law Lords can reach that conclusion after looking at the documents for a few days, why cannot the Treasury—with its army of advisers and all the time in the world—also reach the same conclusion? The Treasury must have read the contracts. If it did not, that is negligence beyond anyone's imagination. The guidance was suspended within hours of the Law Lords' judgment. Why? The Treasury argued that the guidance was right, and the FSA agreed with it. The Treasury, after reading the contracts, was satisfied with the Equitable's conduct. It is a regulator's role to reach such a conclusion. Unfortunately for the regulator, he or she got it wrong, and it is for that reason that I believe that the Treasury was negligent.

The Chancellor of the Exchequer has indicated that, in his view, the Government are not responsible. What is the point of setting up the Lord Penrose inquiry if the right hon. Gentleman has already prejudged the issue? The Treasury has argued in answer to questions tabled by me and by others that compensation is available only when a firm becomes insolvent. That is disingenuous; a cynic might say that it was a holding argument for the course of the general election.

In truth, Governments are liable to compensate those adversely affected by their negligent advice. No one else was in the position to, or was expected to, give that advice. The public look to the regulator to protect their interests, and in this instance there was a woeful failure. The Government got it wrong. Investors relied on their advice, and the Government must accept responsibility for that.

A number of bodies have conducted inquiries into the matter—so many that we will suffer inquiry fatigue by the time that they have all finished. They include the Institute of Actuaries, the Institute of Chartered Accountants, the Office of Fair Trading, the Treasury Committee, the FSA and Lord Penrose. Two ombudsmen have decided not to conduct inquiries.

I welcome any inquiry that sheds light on the failure of the regulatory authorities. The Treasury Select Committee rightly identified some of the key questions for Lord Penrose, especially the risky decision not to establish reserves in 1993. It wishes to ask why the insurance regulator did not address that point. The Minister has had the report from the FSA—which succeeded the Treasury as regulator in January 2000—on her desk for some time. In my view, the FSA has questions to answer. In a preliminary flip through the report this morning, I think I saw that it acknowledges that.

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The Equitable welcomed the deal that was made with the Halifax in February 2001, stating that the Equitable's prime objective was

Where was the FSA when that statement was made? Did it have any idea that the statement was ludicrous? Did it know that the reserves were so inadequate that a fall in the stock market could affect the situation? Only five months later, the Equitable slashed 16 per cent. off pension fund values.

If the FSA knew that the reserves were inadequate, why did it not speak up? If it did not know, why not? I have the answer. At Treasury questions on 19 July, I raised the point. The Chancellor ducked the issue, and left a junior Minister to answer; the Minister may find that she often experiences that. The managing director of the FSA's insurance section, Mr. John Tiner, wrote to me subsequently to say that he was satisfied with the Equitable's decisions. He wrote:

In other words, the FSA will not act unless it thinks that it can make things better. I call that the passive approach to regulation. I have news for Mr. Tiner and the FSA. I am unsure whether the Equitable has acted with due regard for some time. The same test was applied in the 1990s, when regulators could have intervened to make things better. The regulator—be it the Department of Trade and Industry, the Treasury or the FSA—is guilty as charged.

How do we make the charges stick, and how do we bring the Government to book? I hope that the inquiries will provide an answer. I am pleased to say that the FSA has concluded this morning that the regulatory approach is to be strengthened. I am interested to note that the Minister agrees with that, and I welcome her letter in which she says that she encourages the bringing forward of proposals by the end of November.

How does Parliament find out what happened? We have the parliamentary ombudsman, whose role is to decide whether there has been maladministration in government activity. However, he seems reluctant to carry out his duties in this instance. When I referred a complaint from a constituent of mine about Equitable Life, the ombudsman said that he would defer making a final decision until the FSA report became available. This summer, when the Government announced the Lord Penrose inquiry, the ombudsman announced that he had decided to await the outcome of that inquiry, and to consider further at that stage whether he might usefully intervene. That seems to be an example of bobbing, weaving and ducking the punches like a prize fighter at a boxing match.

Sir Gordon Downey, a former Parliamentary Commissioner on Standards, pointed out in a letter to The Times:

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The parliamentary ombudsman must recognise the essential distinction between the Executive and the legislature before Parliament concludes that he is too close to the Executive. He may well argue that there is a precedent in the Barlow Clowes affair. In my opinion, that was wrong as well. The issue is huge—as big as it gets—and the ombudsman must address it without delay.

The concept of saving for retirement is put into question by the Equitable Life situation, particularly the obligation to buy an annuity. In response to questions from myself and others, the Government have made it clear that they do not intend to change the present regime. In the last Budget, they recognised the anxiety that the issue has created but indicated that many of the ideas for reform would incur substantial costs running into hundreds of millions of pounds. In my view, if we can resolve the annuity issue for hundreds of millions of pounds, that is a small price to pay.

The recommendations of Dr. Oonagh McDonald's report deserve closer scrutiny by the Government than they have obviously had so far. There is much unrest concerning this matter, and it seems fair to point out that the Equitable situation would be largely alleviated if there were no obligation to buy an annuity and people had a wider freedom to choose how best to use their lifetime savings.

We have to question how much risk individuals can be expected to take in a pensions system that depends on fluctuating capital markets and income rates. The issue highlights the failure of the private sector to protect individuals against such risk and clearly demonstrates the need for a reappraisal of pensions policy. The Government's stakeholder pensions are simply a way of encouraging lower and middle income groups to begin making contributions to privately funded pension schemes. However, they carry the same market risks as those of the Equitable. If the retirement prospects of the knowledgeable professionals who took out Equitable Life policies could be damaged so unexpectedly, how reasonable is it to expect lower income groups to accept a similar degree of market risk? Investors will need unusually visionary minds when planning for their retirement. That is the exact opposite of what was intended, and will simply put people off making decisions about their retirement.

I conclude by addressing the position of the Equitable. I am extremely grateful for the advice and guidance that I received from policyholders throughout the country and from constituents. It would be an understatement to say that there is a wide range of views and opinions as to the way out. However, it seems that one or two essential principles have already become clearly established. The first is that the past management of the Equitable has been woeful. What on earth did senior managers and directors think that they were doing in guaranteeing a rate of return when they had no idea of what the future held? No one in their right mind would guarantee high rates of return but, having done so, why did they not adopt an investment strategy to back it up? A prudent company would create reserves to back up the situation.

It is my opinion that pointing the finger at those who made those bad decisions is a fruitless exercise. I read reports in the newspapers that legal action may be commenced against past directors, but I believe that that

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is a complete waste of time. Even if, after years of litigation, such a course of action is successful, where does it get us? They are not rich people, and a few thousand pounds here or there will not make any difference whatever. Some say, "Let us sue the Equitable", but it is for the policyholders themselves to do that, and that would also be a pointless exercise.

There is now a new board. If the previous board did us any favours at all, it was by going quietly and ensuring a smooth transition to the present board under the chairmanship of Mr. Treeves. I must confess that I have never met Mr. Treeves, but I spoke to him on the telephone, when he had the courtesy to warn me of the 16 per cent. cut in policy values. Nevertheless, he seems to be determined to draw a line under the past and to push through the compromise agreement. All policyholders have now received a copy of the proposed compromise and details of the consultation exercise that is being carried out. Yet again, that has produced a plethora of comment and opinion, which leads to the second principle that I think is becoming accepted: that it is not a perfect world.

There are those who want to push the balance of the compromise this way or that, and to point the finger of blame at one group of people or another. Some want to delay while various opinions are sought, and so it continues. Even the legal opinions that have been obtained disagree with one another. The hard, cold, unrelenting truth is that, if the compromise does not go through, the policyholders' position will be much diminished. There is no doubt that the present board will resign, and that the sort of people whom we need to lead us out of the mire will not come forward. It is no surprise that a number of action groups have already recommended a yes vote. Whether or not the Government ultimately chip into the pot is irrelevant, as that would affect only the size of the pot and not its distribution. The lawyers will have a field day and everything will spiral downwards. I leave it to individuals to make their own choice, but no one should be unaware of the consequences of a no vote.

I regret the lack of leadership from the Government. Many people whom they employ, from civil servants to judges, are affected, including staff and employees of the House. It is the Government's approved pension scheme. Many staff in the House are policyholders, and it would be helpful if the Minister were to agree to meet their representatives to alleviate their concerns. If the Government can produce a solution to the Railtrack problem in a matter of weeks, why cannot they act in this case? The country is crying out for the Government to say something, and I mean no disrespect to the Minister when I say that it should be the Chancellor who is replying to this debate and not her. This is a profoundly serious matter that goes to the heart of our financial system and the security that it should be providing for all those who have served their nation well and are entitled to a peaceful retirement.

9.53 am

Mr. Barry Gardiner (Brent, North): I congratulate the hon. Member for Croydon, South (Richard Ottaway) on securing this extremely important debate. I was concerned by his somewhat partisan opening remarks, and trust that he will agree that hon. Members on both sides of the House have been most assiduous in

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questioning Ministers on the matter. He may also care to reflect that his remarks about the culpability of the Government as regulator, however true, reflect damningly not on this Government qua regulator alone, as he seemed to suggest, but on successive Governments who failed to spot or control one central problem with Equitable over the past two decades and more.

Today's Financial Services Authority report on Equitable is extremely candid, and I welcome it. It has been impossible in the two hours that have been available to read the report in its entirety, but I would like to draw attention to one section in the report, which is extremely pertinent to our debate, and which strikes at the nub of the problem that existed with Equitable Life. Paragraph 6.1.2 of the report refers to

That applies to any insurance company in a position such as that of Equitable. The paragraph continues:

The report adds:

That clearly explains, in three brief paragraphs, one of the fundamental problems that lay behind what went wrong at Equitable Life. For that reason, I want to discuss what the Government and regulators may be able to do in future to ensure that such situations do not recur.

The solvency margins that are required by the European Union are universally regarded within the financial community as a complete joke. If one considers the Independent Insurance Company and its recent collapse, it would have met the EU solvency margins four times over at the point of collapse. I recently had the opportunity to discuss solvency margins with Herr Kaulbach, the deputy financial services regulator in Germany, who also said that EU solvency margins were far too low. I found that surprising given that his boss as regulator in Bonn is Dr Müller, who wrote the famous Müller report, which stated that solvency margins were adequate in principle and in practice. However, the Government and the regulators must look again at the solvency margins applied within the EU, and change dramatically the way in which we regard the solvency of a company.

If we consider the north American model, actuaries in Canada adopt a dynamic capital adequacy testing model. That is a risk-based assessment of future trends and parameters, which is far better able to capture the

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risk exposure of a company and to ensure that its solvency margins are adequate to meet potential risks. When regulators in the United States introduced new risk-based assessment requirements in 1993-94, the histogram showed a dramatic fall in the number of insolvencies—the number was reduced by more than half in the years following the introduction of those models. I therefore urge the Government to consider extremely carefully how this aspect of financial services is regulated in this country and elsewhere in Europe. The FSA is moving in the right direction and is beginning to lead the change towards risk-based assessment, but I fear that in the rest of Europe it will not be able to take many people with it in the immediate future. Other countries are even further back in this respect than we are in the United Kingdom.

Moving on to the current circumstances at Equitable, I was most intrigued to hear the hon. Member for Croydon, South say that Mr. Treeves had had the courtesy to warn him ahead of time of the 16 per cent. cut in the value of funds. When I spoke recently to Mr. Treeves and the new chairman of the company, Mr. Charles Townsend, I challenged him about how some representatives of Equitable Life had, after the application of the market value adjuster to stop people flying from the company, said that no further penalty would be applied to members and that they had to be absolutely secret in company discussions about the 16 per cent. drop. I find it staggering that the directors of Equitable Life gave advance warning—

Richard Ottaway : Before the hon. Gentleman gets too carried away, it was done simultaneously, as the news was announced.

Mr. Gardiner : I am extremely glad to hear that the courtesy did not extend, as the hon. Gentleman suggested earlier, to prior warning of what had happened.

I shall pursue the point about the circumstances at the time. Representatives of Equitable Life Assurance company had suggested to members of the public that no further penalties would be applied to their fund. In such circumstances, there has been neglect on the part of the new board of Equitable Life, which must bear responsibility for misinformation being given to members of the public at the time. Although I appreciate the difficulty of negotiating a way forward for policyholders, I do not believe it acceptable for members of the public to be given misinformation by the company about the security of their position at a time when the company intended to slash 16 per cent. off policyholders' funds.

In my debate with Mr. Treeves and Mr. Townsend, I was further troubled by their acceptance that, because of the constraints on Equitable Life at the moment and being unable to take on new business, its future performance would be sub-optimal. We are discussing a company that accepts that its performance relative to the rest of the life assurance market will be substandard in future. It recognises that its performance will be substandard, and a huge question mark hangs over the company and its capacity to weather the storm and secure the agreement that is required. The directors have been clear that they are far from sure that the compromise will be accepted. It would be inconceivable

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that an independent financial adviser would advise an existing policyholder not to withdraw their funds now and place them elsewhere to avoid the sub-optimal performance that they admit will take place and the potential confusion and further claims on the company that may arise if the compromise deal does not go ahead.

I am sure that many other hon. Members want to participate in the debate. I could bring many more problems to the attention of the House, but I am sure that the issue will be revisited. On that note, I shall allow others to speak.

Several hon. Members rose—

Mr. Frank Cook (in the Chair): Order. This is a vexed subject, which requires careful consideration and, in the Chair's view, a fair response from the Government. At the moment, three hon. Members are seeking my eye. I advise that we start wind-up speeches at 10.25 am, which gives us only 20 minutes. I ask hon. Members to bear that in mind and to make their comments clear and concise.

10.6 am

Mr. Michael Weir (Angus): The hon. Member for Croydon, South (Richard Ottaway) has given a succinct resumé of the history of Equitable Life. I do not propose to go into that, other than to say that the plethora of different regulators in the insurance industry over the past few years seems to be part of the problem. Equitable Life policyholders are being asked to consider the compromise proposal without having the full information about the regulator's role before them. They are entitled to that information before being asked to vote on the proposal.

The Government's lack of leadership and openness has led to great deal of suspicion—justified or otherwise—that there is something to hide. That is making Equitable Life policyholders reluctant to deal with the compromise proposal before all the information is in the public arena. The policyholders are entitled to that information. How many hon. Members have heard the remark, "Why should I bother with a pension if this is going to happen?" The situation at Equitable Life is leading to difficulties throughout the pension industry. There is a loss of confidence in pensions. That is a serious problem, especially when the Government are trying to promote stakeholder pensions.

I ask the Government to take on board a particular point. The hon. Member for Croydon, South mentioned briefly the Government's own employees. That matter was first brought to my attention not because of the guaranteed annuity rates but because of worries expressed by constituents within the NHS pension scheme. As the Minister will be aware, in Scotland—I presume that the same applies in England—many people in the NHS pension scheme paid additional voluntary contributions. The Government, through the NHS, were advising people in that scheme to invest AVCs within Equitable Life, and continued to do so even when the difficulties were apparent to them—at least they should have been apparent to them through the regulator.

A constituent told me that, in 1999, he attended a sales presentation given by representatives of Equitable Life that was organised by the NHS on its premises that

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encouraged NHS employees to purchase AVCs through Equitable Life. The Government, as regulator and as an employer, have difficulties. I appreciate that dual roles cause a difficulty for them, but many of their employees, particularly those in the NHS, are finding that their ultimate pensions will be worth a great deal less than they first believed. The Government must seriously examine the problem. It has been suggested that meetings should be held with representatives of pension schemes within the House, but the problem goes much further than that. Action must be taken to deal with the pensions of those who work in the NHS.

I reiterate the point that the matter goes far beyond Equitable Life. It has caused a drop in confidence in the other life assurance companies that are very important to the Scottish and United Kingdom economies. If the matter is not dealt with, that lack of confidence will have serious long-term effects for all of us who are looking for pensions, as it will on the Government at a time when they seek to establish stakeholder pensions. The issue is not going down well with the general public and a great deal of cynicism exists about pension provisions. Serious consequences will follow in future unless the issue is dealt with.

10.10 am

Mr. Jim Cousins (Newcastle upon Tyne, Central): I will take your advice to be brief, Mr. Cook. I have only two points to make.

Mr. Frank Cook (in the Chair): Order. Please also accept my advice to speak up.

Mr. Cousins : I am always happy to accept your advice.

At the heart of the issue is the question of reserving policy. If we were to read the financial press for coverage of insurance companies, the question that arises time and again throughout the 1980s and 1990s is that of so-called orphan assets or free assets.

When the House deals with this issue, it should bear in mind that the issue of reserving policy, which caught the public eye and the attention of the press and the media during that period, was not lack of reserves but excess of reserves. That point must be borne clearly in mind when criticising the events of the past. When the technical issue of reserving policy ever caught public attention, the emphasis was always that life insurance providers were carrying excessive reserves.

Equitable Life's strong marketing point was precisely that it was pursuing a policy of not carrying excessive reserves. That is why so many people signed up for policies with the company. In talking about these issues, it is wise not to be too clever after the event. We now see that the central failure of Equitable Life was at the heart of its marketing strategy. Nobody could say that they were not aware of that.

However, it brings into question the issue—and I hope that the Government will address it in due course—of whether the Insurance Companies Act 1982, which established the role of appointed actuary within with-profits funds, did enough to strengthen the powers of the actuaries. It also brings into question whether some of those who had the responsibility of being

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appointed as actuaries were carrying out their duties in the best interests of policyholders. I hope that that serious underlying issue will not be overlooked.

I am a member of the Treasury Select Committee. As part of our inquiry, we were told that the Government Actuary's advice to the regulators, who were within government, was not to be made available to us. We were told that we could not cross-question the Government Actuary about the advice that he may have given to the regulators about Equitable Life's reserving policy. I hope, in the course of Lord Penrose's inquiry, that that advice will be made public. That would allow us to see what was the advice of the Government Actuary on the issue. I also hope that exposing better the advice of actuaries will be one of the main benefits that will flow out of this unfortunate affair.

The hon. Member for Angus (Mr. Weir) said that a great number of regulators were involved and, in form, that was the case. Fortunately or unfortunately, in all cases they were the same two people. There was continuity of personnel, even though the regulators switched institutions, and that will enable a proper examination to be made.

I want to emphasise the point made by the hon. Member for Angus that 40,000 people in the NHS pension scheme have additional voluntary contributions with Equitable Life and that the problem is very serious for them. Half of those people are in the with-profits fund and half are not. Half of the 40,000 went to Equitable Life as a result of transfers back into the NHS scheme, which was a product of mis-selling further on. The problem is serious and it must be addressed outside the terms of Lord Penrose's inquiry. I hope that the Government do not intend to overlook the problem by using the Penrose inquiry as an excuse.

Many people in the civil service pension scheme—for whom the Treasury was the source of advice on superannuation—also have AVCs with Equitable Life. I hope that the Minister will assure us that the issue of AVC policyholders, whether in the public sector, the Government sector or otherwise, will be addressed alongside the Penrose inquiry.

The hon. Member for Croydon, South (Richard Ottaway) said that the previous board of Equitable Life went quietly. One board member sought quietness on the board of Halifax, but I think that history will show that that was an odd place to seek it.

10.16 am

Mr. John Greenway (Ryedale): I do not want to detain hon. Members for long. It is fair to say that everyone who has had an association with Equitable Life in a professional or employment capacity is hugely disappointed by the way in which events have turned out. As I said in my intervention on my hon. Friend the Member for Croydon, South (Richard Ottaway), I worked for Equitable Life at its Epsom office for about two years in the early 1970s. I suspect that many colleagues are policyholders with Equitable Life, particularly Surrey Members who were serviced by the Epsom office at that time and subsequently. In those days, very few life offices wrote that type of business, and the two leading companies were Equitable Life and

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National Provident. I was headhunted by National Provident from Equitable Life, and subsequent to that I became an insurance broker.

Lord Penrose is right to go back to the early days, but I do not believe that the problems arose then, because at that time the guaranteed annuity rate, which is the cause of all the difficulties, was not considered to be particularly attractive. As I indicated in my intervention, it was common for people to be happy to borrow money for mortgages at a fixed interest rate of 13 per cent. or 14 per cent. for 25 years. There was a high interest rate policy for some time and under successive Governments. The guaranteed annuity rate was significantly less than that—I would guess that it was about 60 per cent. or 65 per cent.—so the open-market option was much more attractive.

Conditions changed in two ways. First, many other insurance companies entered the market and in the late 1970s and early 1980s successive Governments made investment in personal pensions much more attractive by increasing the amount of money that could be put into a policy. The hon. Member for Newcastle upon Tyne, Central (Mr. Cousins), who is an active member of the all-party group on insurance and financial services of which I am the chairman, knows that the group takes a close interest in the matter. He is exactly right to say that Equitable Life pursued a different policy on reserving from other companies.

Many companies have had huge orphan fund problems. For example, Equity and Law recently made an arrangement with its policyholders, of which I am one, to make a payment whereby some of the orphan funds would go to the company. However, Equitable Life was always supposed to be ahead of the game. It was the top and most attractive company, and the one in which everyone ought to be recommended to place their business. I suspect that there were considerable pressures in Equitable Life to maintain that position. I also suspect that the inquiry will find that the slip into not making adequate reserves for a potential downturn in interest rates started about 20 to 25 years ago.

For now, I will merely address two simple points, because it will take a long time to absorb all of the contents of the report. We should have regard for the expectations of the policyholders. They were encouraged to join the mutual society by almost every financial journalist—and public sector workers were encouraged to join to take out various types of investment—and they had a right to expect that the company was properly managed. They also had a right to expect that supervision of the company was satisfactory. That point goes to the heart of the matter. My first reading of the document confirms to me what many hon. Members have suspected; under the prudential supervision of the Department of Trade and Industry and subsequently the Treasury—long before the Financial Services Authority was formed—that supervision was inadequate. The Government must address that issue now.

As my hon. Friend the Member for Croydon, South has stated, policyholders must now make a choice; as the hon. Member for Brent, North (Mr. Gardiner) said, they have been let down once with regard to the 16 per cent., and they cannot afford to be misled again. I suspect that they have no choice but to accept the offer, which has, I believe, been made in good faith. It would

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help them to come to that conclusion if, as several hon. Members have suggested, the Government were to indicate early on that if the inquiry by Lord Penrose pins some of the blame on regulatory failure by the Government, they will do the honourable thing by providing funds. That would reassure the policyholders that their policies will continue to provide the returns to which they are entitled.

10.21 am

Angela Watkinson (Upminster): I will not repeat the many valid points raised in the debate, but I wish to refer to a comment made by the hon. Member for Brent, North (Mr. Gardiner) about the advisability of policyholders withdrawing their funds and transferring them elsewhere if the compromise scheme is unsatisfactory to them. That option is not available to many of my constituents who have contacted me with regard to the matter, as they are nearing retirement. Moreover, the transfer of funds by policyholders who are able to do that would exacerbate the problem for those who have no option but to remain in the scheme.

Mr. Gardiner : I accept that point; a policyholder who has less than about 10 years to go until retirement would be in an invidious position.

Angela Watkinson : These constituents of mine, some of whom are due to retire in less than five years, are facing a very different retirement from that which they had planned and paid for, and they are entirely dependent on the compromise scheme. It has been stated that legal opinion about that scheme is varied, and I urge the Government to clarify the position swiftly. That would alleviate the stress on the many people of ordinary means who have tried to provide for their retirement.

10.32 am

Dr. Vincent Cable (Twickenham): I congratulate the hon. Member for Croydon, South (Richard Ottaway) on focusing on the essential problem, which is the issue of government regulatory failure. It is not the job of hon. Members to be financial advisers to our constituents, or to look over the shoulder of the new management and to tell it how to run the company. However, it is our job to scrutinise the Government's actions and to examine the possibility of regulatory failure.

I will make two brief comments about the company and its current situation. I, like other hon. Members, have constituents coming to me with problems with regard to the situation, and it is important to point out to them that their losses can be separated into three different elements: first, the losses associated with the guaranteed annuity rate liabilities, although it is still unclear how open-ended they are—a figure of £6 million has been mooted, but it could be more than that—secondly, the losses that they are experiencing, along with everyone else in the life insurance industry, because of the falling value of the stock exchange; and, thirdly, the losses that they would incur if they chose to withdraw from the society—which are optional losses, as they could choose to participate in the conference rather than to withdraw from the society.

As for the conduct of the company, the hon. Member for Croydon, South was correct to stress that there would not be any great advantage in different groups of

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policyholders fighting one another in a mutual society. That is the road to mutual ruin and the enrichment of lawyers. However, there is certainly one category that merits detailed attention—that of the auditors' conduct. I find it impossible to understand why Ernst and Young gave the company a completely clean bill of health in 1999, after all the discussion that took place in the City during 1998-99. The regulators were discussing the matter and the memorandum that I produced before a debate in the House in June 1998, when the Department of Trade and Industry was advising about insolvency, also dealt with it. That action was utterly incomprehensible. If there were any possibility for litigation, I would have thought that it lies in that direction.

I return to the key issue, which is the role of the Government. The Government's prime responsibility in the matter now, whatever may have happened in the past, is to ensure that there is a transparent and expeditious process for examining whether there has been a regulatory failure. I agree with the hon. Member for Croydon, South that the present position is a mess. First, there is the Baird report, which appeared at 7.30 am—some of us have had a chance to glance at it. The Baird report was structurally flawed from the outset, because it was a report by the FSA about the FSA, and even if Mr. Baird is a man of enormous integrity, and I am sure that he is, the credibility of this report is bound to be questioned and it will have limited value.

Another basic problem with the Baird report lies in the way in which it has interpreted its own terms of reference. I read the original terms of reference, which state clearly that the report will describe the background and events leading up to the FSA's assumption of responsibility for the prudential regulation of Equitable Life on 1 January 1999. In fact, it has not done that. It seems to have interpreted its brief, in an extremely narrow way, to refer to the FSA's management of the affair after 1999. The report could have gone into the early history, but the FSA chose not to do so.

That responsibility has now fallen to the Penrose inquiry, which we hope will be definitive. It will certainly be very long—we understand that it will take until next summer. It is not clear that it will be entirely in the public domain; I hope the Minister will answer questions about that.

The big problem with the process—the hon. Member for Croydon, South dealt with this very well, but I will reinforce the point—is the way in which it has paralysed the parliamentary ombudsman. I have been writing to the ombudsman to ask him why he cannot get on with the job that Parliament has given him to do. The answer that he gives, in a letter written yesterday, is clear. He states:

Why are two bodies conducting overlapping investigations? The answer is that the Government asked them to do so. The parliamentary ombudsman cannot get on with his job because of the structure of the process that the Government have set in train. That is unsatisfactory.

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What can we already say about the evidence of regulatory failure? There are three elements. First, there is the early history, covering the period of the early 1990s, when guaranteed annuities were being written extensively by Equitable Life. One could say that we are wise with hindsight about that practice, but other Members who are knowledgeable about the industry, such as the hon. Member for Ryedale (Mr. Greenway), know that the Equitable Life was unique in going so far out on a limb in writing guaranteed annuities on such a scale. It was already becoming apparent that a period of low inflation and low interest rates was upon us. Indeed, the Government of the day adopted the Maastricht targets, which precisely embodied that.

There must surely have been, at some point, an intervention from the Government Actuary advising on the structural soundness of that type of financing. It is important that the evidence of the exchanges between the Department of Trade and Industry, the Treasury and the Government Actuary is publicly revealed, so that we understand at what point it was clear to the financial community that the policies that Equitable Life were writing were unsustainable. That is one of the key elements in the story that has not yet been revealed.

Secondly, there is the Baird report itself. Obviously, I have not had an opportunity to read it in the few minutes that we have had access to it, but it is already clear in the conclusions that it reaches. Although it is put politely, there are some damning comments on the FSA's role. Section 6.6.1 of the report states:

Section 6.6.2 continues:

The report goes on to describe poor levels of communication and co-ordination between the two arms of regulation. It is for the parliamentary ombudsman to judge whether there has been a regulatory failure, but prima facie, even the Baird report, with its restrictive mandate, seems to find serious faults.

I conclude by suggesting what should be the Government's role in future. The problem, as in the old Irish saying, is that we should probably have started from somewhere else, but I hope that the Minister will give us an assurance that the inquiry will proceed quickly and with the full co-operation of the Government. There should be no attempt to conceal documentation, which should be transparent and in the public domain so that the parliamentary ombudsman can get on with the job.

The hon. Members for Newcastle upon Tyne, Central (Mr. Cousins) and for Angus (Mr. Weir) and others raised the worrying matter of what the episode tells us about the state of the long-term private savings and pensions industry. For far too long in Britain there has

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been a conceit that whereas the benighted continentals have the problem of unfunded pensions, we do not because we have brilliant financial institutions that look after everyone's private occupational pensions. That illusion and conceit is crumbling rapidly, for several reasons: first, the compulsory annuity problem, which may be resolved as there are solutions available; secondly, the growing problem—it could even be called a crisis—in the with-profits sector. We are probably entering a long-term bear market in equities and many of the assumptions that underlie the growth of bonuses may prove to be fallacious. The confidence that previously existed in private pension provision has been further undermined by chronic and endemic mis-selling, which is undermining the entire structure. The Government must give us a clear lead on the matter of stakeholder pensions and on the future of private and occupational pensions in an environment where confidence has been severely damaged.

10.32 am

Mr. Christopher Chope (Christchurch): I warmly congratulate my hon. Friend the Member for Croydon, South (Mr. Ottaway) on securing the debate and on showing such a command of the complex issues that are involved. I hope that the Minister will answer his questions and those asked by other hon. Members in this important debate.

When my hon. Friend raised the issue on 19 December 2000, he secured from the Minister who responded a guarantee that there would be an inquiry; today he has initiated the debate and forced the Government to produce their FSA report. To judge by the Minister's body language and the words used in August when the Penrose inquiry reported, it was clear that the Government were toying with the idea of delaying publication of the FSA report until after Penrose. I am glad that they have now come clean and produced the report.

It is disappointing that we were given only two-and-a-half hours notice that the FSA report was being produced. If the Government could produce a report at 7 o'clock in the morning, why could they not do so at 7 o'clock the previous evening, so that people had a chance to read it? I was amazed to discover from representatives of Equitable Life yesterday evening that they were told only at 5.30 pm that the report would be published this morning, and that they could look at it on a website at that time. That is thoroughly unsatisfactory; we are grateful to have the report, but it is a pity that the Minister did not make a greater effort to produce it a few hours earlier so that we had more time to read it.

I hope that the Government will be prepared to use their time to allow a fuller debate of the issues raised by the report. It is no good saying that we will not have a further debate until Penrose has reported. Policyholders must decide in the next few weeks whether to accept the compromise, and they are entitled to the benefit of a Government response on the subject. I am pleased that the Minister is attending the Treasury Committee on 30 October, but that is not enough, and the Government should provide us with a proper debate.

Much of the debate has been about possible regulatory failure. The first question is whether there has been such a failure? The report, especially chapters 5 and

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6, suggests strongly that there has. The second question is that if there was a failure, was it caused by the negligence of one or more of the regulators? The parliamentary ombudsman should be getting to grips with that issue straight away. If a regulator was negligent, will policyholders who suffered loss as a result receive compensation? The Minister seems to have answered that question already in a written answer to the hon. Member for Brent, North (Mr. Gardiner) on 15 October. He asked if the Government

The Minister replied:

I am sure that I am not alone in finding that answer contemptible and an insult to policyholders. If a regulator has been negligent, it—or, in other words, the Government—should be open and forthcoming in meeting claims for compensation flowing from that negligence.

I tried to find out whether Lord Penrose would investigate allegations of maladministration by the regulators, but the Minister, in response to a specific question, merely referred me to the terms of reference of the Penrose inquiry, adding:

That makes me rather suspicious. Many hon. Members have referred cases from constituents to the parliamentary ombudsman, and he should now investigate those issues. As has already been mentioned, he has written to a number of hon. Members during the past few weeks to explain why he should not investigate at the moment. I hope that he will reconsider in the light of today's report, which shows a prima facie case of maladministration. Indeed, he said in February that it would be helpful to read the Financial Services Authority report. He said that it

He was right; the FSA report indicates areas that warrant further scrutiny, which I hope that he will get on with straight away.

The problems of Equitable Life affect millions of people, and I must declare as an interest that my wife is a policyholder, although I am not. The former commissioner, Sir Gordon Downey, has argued that the ombudsman should undertake an inquiry now, and his arguments are persuasive. The Penrose inquiry will investigate matters going back 30 or 40 years, or perhaps even longer; the parliamentary ombudsman can investigate only issues that do not fall foul of the 12-month time bar. He could concentrate on the most recent events, which are highlighted in the report before us today.

There is insufficient time to deal with all the issues that have been raised by policyholders, but I hope that the Minister will bring pressure to bear through the regulator to ensure that policyholders receive proper information to enable them to assess whether the compromise proposals are in their interests. They are still waiting to see the financial results up to 30 June, but they should have much more up-to-date information, particularly in light of the dramatic reduction in values that was announced on 16 July.

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The Minister will know that her predecessor said in the debate last December:

There are many policyholders who, in the light of that advice, did not rush to sell their policies. They now find that, as the new chairman of Equitable Life has admitted, those who withdrew their money before 16 July took a disproportionately larger share of the fund than they were entitled to. Policyholders must not be let down again. They need proper information on which to base their judgment. That should come from the regulator to the individual investment advisers. It is not for us as Members to give that advice, but we can legitimately ask that the framework to make that advice available be established quickly.

I should like now to refer briefly to one or two parts of the report. The Treasury is trying to suggest, and the Minister may be party to this, that it is a "not me guv" situation and that the Treasury was not involved. The report makes it plain that in January 1998 the Treasury took responsibility from the Department of Trade and Industry for the prudent regulation of insurance companies, and from 1 January 1999 it contracted out that role to the FSA but did not surrender or abandon it. That is why the comments in the report about what the Treasury knew and the action that it should have taken but did not take are particularly pertinent.

Those who have had a chance to read the report will know that in August 1998 there was widespread awareness of the problems facing Equitable Life policyholders and memorandums were flying round the Treasury and other parties. Presciently paragraph 5.6.2 states that one of the Treasury memorandums noted that that was

That was in autumn 1998. If the Treasury had followed its own advice, I doubt whether policyholders, particularly those who joined after that, would have been in their current mess.

There are a number of other damning indictments of Treasury involvement. It is clear from paragraph 5.7 and the following paragraphs that the Treasury was aware that the policies being issued by Equitable Life and the related advertising were not accurate. It knew that back in 1998 although nothing was done about it. Indeed, when the matter was raised in 1999 there seemed to be some doubt as to how anyone found out about it originally.

The suggestion running throughout the report is that the Treasury was slow on the uptake and that it did not investigate and take a hands-on approach when it should have done. As a result, policyholders have been let down. There is clear evidence that the Treasury needs to allow the parliamentary ombudsman to investigate these issues on an independent basis. I hope that it will not stand in the way of that. I look forward to hearing what the Minister has to say.

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10.43 am

The Economic Secretary to the Treasury (Ruth Kelly): I congratulate the hon. Member for Croydon, South (Richard Ottaway) on securing this debate. He set out the background to these events clearly and I do not intend to repeat them. I express at the outset my deepest sympathy for all those Equitable Life policyholders, including those who have taken out additional voluntary contributions, who have been affected by recent events. I fully understand the distress and anger that they feel. I should also like to say at the outset that it is not the Treasury that advises people in the public sector about what policies they should take out. It would be inappropriate for the people who provide policy advice on financial services to do so. It is their employers who take that responsibility.

The House will know that I announced on 30 August that the Government had established an independent inquiry under Lord Penrose into events at Equitable Life. Equitable Life indeed raises important issues, many of which have been raised today. The issues deserve full consideration by an independent inquiry, which will consider what lessons can be drawn for the conduct, administration and regulation of life assurance business.

Lord Penrose's terms of reference are:

Those terms of reference will enable Lord Penrose to consider events at Equitable Life from all angles. By virtue of its wide-ranging remit, Lord Penrose's inquiry will be able to look back as far as necessary to establish the origin and development of problems. It can look in detail at the actions not only of the Financial Services Authority but of the society and all other key players. He can investigate issues that have a bearing on the subject, regardless of where and when they arose. It is important that all the lessons are learned from what has happened. The inquiry will allow us to achieve that.

I have written to Lord Penrose today, enclosing a copy of the FSA report into Equitable Life, published by the Treasury this morning. I have taken the opportunity to publish that report as early as possible and in time for Members to consider the information in front of them before our debate.

In line with its terms of reference, the FSA's report analyses the conduct of business and prudential supervision from January 1999 until the society closed to new business in December 2000. The report provides a helpful contribution to investigating problems at Equitable Life, but it is not—and could not have been—a full picture of events. I would like to thank Mr. Baird, who conducted the inquiry, for his report and all the useful research that it contains. The review could not look back more than two years out of a total of more than 40. Nor could it investigate the roles of all involved, the deep-rooted nature of the problems or the actions of Equitable Life itself. Mr. Ronnie Baird and his team at the FSA had no access to documents held by Equitable Life or its advisers. Nor could the inquiry conduct interviews with any of the board members, staff or professional advisers. As such, it was unable to examine events as they unfolded.

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Problems at Equitable Life clearly date back many years. As the report makes clear, the seeds were sown as far back as the 1950s when the first guaranteed annuity policies were sold. A full explanation will have to wait for Lord Penrose's review and report. In my letter to Lord Penrose, I made it clear that the Government recognise that the FSA report will provide a valuable input to his inquiry, but he cannot, of course, be bound by it or its recommendations. He will wish to form his own views on the basis of the evidence that he gathers.

Although we expect that Lord Penrose will wish to investigate events of recent years, including those that took place after Equitable Life closed to new business—a period that the FSA report was not asked to cover—he will also be free to go back as far as he thinks necessary.

In his reply to my letter, Lord Penrose says of the FSA report:

He continues:

The Penrose inquiry will look into the circumstances leading to the current situation at the Equitable. It will not comment or offer advice on the merits of any compromise deal proposed to Equitable Life policyholders and nor will it review past judicial decisions in relation to Equitable, or pre-judge future decisions which will be rightly taken by the courts. I very much hope that interested parties will co-operate fully with Lord Penrose's inquiry in its current non-statutory form, but I have made it clear that if Lord Penrose considers that there is a failure of co-operation, I will not hesitate to put the report on to a statutory footing.

Lord Penrose began to work full time on his inquiry as soon as it was announced at the end of August. He is determined to complete his report as soon as possible. Hon. Members have made clear today the importance of that. I agree with them. Lord Penrose will be able to consider some of the detailed issues that have been raised today, including the role of the appointed actuary. I shall today also issue a consultation paper setting out proposals for the situation where an appointed actuary will have to report information to the FSA. This will form part of any potential review of the role of the appointed actuary, which is also considered in the Baird report.

The FSA report makes several recommendations about the regulation of life insurance. In particular, it has called for improved solvency and disclosure standards to ensure the prudential framework for life assurance adequately reflects the nature, direction or scale of business. Under the new regime—which will come into force at the end of November—created by the Financial Services and Markets Act 2000, that will be the responsibility of the FSA. Some of the recommendations will necessarily involve consultation with the industry and I am anxious that the FSA should take it forward as a matter of urgency.

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The report also makes several extremely important recommendations on strengthening the regulatory approach—the culture, processes and tools of the FSA—to ensure that it achieves the "role, style and approach" envisaged for the FSA as a single integrated regulator. In particular, it recommends that the FSA should take a more proactive approach to regulating the insurance industry to ensure that the interests of customers are properly protected; that it should take action to break down all remaining barriers to internal communication and co-ordination, to achieve the full benefits envisaged when the FSA was established; and that it should improve its use of risk-assessment techniques. My hon. Friend the Member for Brent, North (Mr. Gardiner) pointed out some reforms that will be taken forward in this area. I am sure that he is aware that the FSA is considering insolvency standards in that area.

The proposals are core ones. The Government expected that, for example, brigading conduct of business regulation and prudential supervision into one organisation would create opportunities for an integrated approach, even in advance of the enactment and implementation of the Financial Services and Markets Act. From N2—the end of November this year—the Act will be implemented in full. The transition period will be over and we expect all the benefits to exist. The FSA report is clear that the benefits of an integrated proactive, risk-based regulator will be substantial. Accordingly, I have today written to the chairman of the FSA, Howard Davies, asking him to pursue vigorously the recommendations contained in the report, particularly those relating to the problems of poor communication.

Given the importance of those issues to delivering the benefits of the new approach, I have asked him to provide me with a full report by 20 November, covering the action taken to implement the recommendations. That does not mean that we were wrong to establish the Financial Services Authority. On the contrary, the FSA's report shows that the Government were right to make reform of the existing framework of financial regulation a priority on taking office, and that the situation at Equitable would have been worse without a single regulator in place over the past two years.

The FSA report that we published today is only a partial picture. We set up the Penrose inquiry to provide us with a far wider perspective, not to apportion blame but to learn lessons and ensure that the mistakes of the past are not repeated.

Mr. Chope : If the report will not apportion blame and is only partial, how can the Minister already have pre-judged whether the Treasury will in any circumstances pay compensation to policyholders?

Ruth Kelly : I have looked at some issues with regard to the use of public money. In particular, when I announced the public inquiry by Lord Penrose, I said that we had considered the use of public money to inject funds into a lifeboat for Equitable Life and had specifically ruled that out as an option. We do not think that that is the appropriate way forward; rather, we should learn all the lessons from the Equitable Life

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situation to minimise the risk of such a scenario happening again. That is how the terms of the Penrose inquiry were drawn up.

I will not stand here today and prejudge the outcome of Lord Penrose's review. Several hon. Members have questioned the independence of Lord Penrose, but I wish to underline that the reason why we cannot say specifically what he is looking at or how the review is developing is precisely the independence of that review.

Richard Ottaway : If Lord Penrose finds that there has been a regulatory failure, the Government must be liable. Is not the right approach for the Government to say that they have an open mind on whether compensation should be paid, rather than to rule it out at this stage?

Ruth Kelly : I certainly would not pre-judge any recommendations that Lord Penrose will make. It is open to him to pursue the lines of inquiry that he sees fit.

Mr. Gardiner : I am grateful to the Minister for her comments, because I believe that we can take some solace from her words. It would be imprudent to set any course or to put in words anything that might influence the inquiry to reach one conclusion or another. However, I listened to the Minister's words carefully and think that they are well judged.

Ruth Kelly : I thank my hon. Friend for those comments. It is absolutely clear that an independent report was necessary in the public interest, and that is exactly why we decided to set up the Penrose inquiry. I expect Lord Penrose to report as soon as he thinks that he is able to, which I hope will be some time next year.

Mr. Cousins : I welcome what the Minister said about strengthening the role of the appointed actuary; that is a fundamental point. However, will Lord Penrose be able to review the role of the Government Actuary in the advice that was given on the Equitable Life situation?

Ruth Kelly : Action has already been taken as regards the Government Actuary's department, and actuaries responsible for life insurance have been fully incorporated into the FSA. Clearly, it is a benefit of a seamless and integrated regulator that they should be. Lord Penrose will be able to review any actions that he wishes to within his terms of reference. Of course, that could include the role of the actuaries.

Given the importance of the issues, I stand ready to brief the House as events unfold. I have offered to appear before the Treasury Committee and shall do so shortly.

Mr. Frank Cook (in the Chair): This has been a splendid debate, displaying exemplary standards of preparation, delivery, candour, regard and mutual respect. However, we are compelled by the rules to move on to the next topic for consideration, which is the London Underground. I ask right hon. and hon. Members to leave the Chamber quietly so that we can get on with our business.

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