LETTER TO THE CHAIRMAN OF THE COMMITTEE
FROM THE ECONOMIC SECRETARY TO THE TREASURY, RUTH KELLY MP
I wrote to the Committee on 31 August with an interim
response to the Interim Report into Equitable Life and the Life
The Government is grateful for the work of the Treasury
Select Committee in producing the Interim Report into Equitable
Life and the life assurance industry. The Government has noted
the recommendations made in this report.
This letter and attachment provide the full Government
response to that report.
GOVERNMENT RESPONSE TO
THE TREASURY COMMITTEE'S TENTH REPORT, SESSION 2000-01: EQUITABLE
LIFE AND THE LIFE ASSURANCE INDUSTRY: AN INTERIM REPORT
It is clear that the situation at Equitable Life
raises important issues for the conduct, administration and regulation
of the life assurance industry. As explained in the memorandum
by HM Treasury to the Committee, the Government is responsible
for the legislative framework of regulation. The FSA is responsible
for regulation, both in terms of prudential supervision and conduct
of business regulation. Until the implementation of the provisions
of the Financial Services and Markets Act, this is under interim
arrangements which have been designed to create the benefits of
the new regime as far as possible under existing legislation.
In the past, the Department of Trade and Industry,
and, in 1998, HM Treasury were directly responsible for the prudential
supervision of insurance companies while the relevant self regulatory
organisations (first the Life Assurance and Unit Trust Regulatory
Organisation, then the Personal Investment Authority) were responsible
for the conduct of business regulation of life business.
I wrote to the Committee on 31 August regarding the
Government announcement of an independent inquiry into Equitable
Life. The terms of reference for the Inquiry, to be conducted
by Lord Penrose, are:
To enquire into the circumstances leading
to the current situation of the Equitable Life Assurance Society,
taking account of relevant life market background; identify any
lessons to be learnt for the conduct, administration and regulation
of life assurance business; and to give a report thereon to Treasury
In addition, the FSA have conducted an internal review
of the discharge by the FSA and the Personal Investment Authority
of their regulatory functions in relation to Equitable Life in
the period from January 1999 to December 2000. The Government
is grateful to the FSA for the work which has gone into completing
the review. The report of the review was passed to the Government
last week and has been presented to Parliament today.
In line with its terms of reference, the report analyses
conduct of business and prudential supervision over this short
period. The report is a helpful contribution to understanding
aspects of the Equitable story. I have today passed a copy of
the report to Lord Penrose as evidence to the Inquiry he is conducting
into the circumstances leading to the current situation at Equitable
By its very nature, the report deals with only two
years out of a story which covers more than forty years in total.
It could not, as it acknowledges, deal with the actions of other
key players; in particular, it could not look at the internal
decision making and actions of the most important of all, namely
Equitable Life itself over the decades. The report is therefore
a significant but necessarily limited part of a much larger picture
of events relating to Equitable Life.
By virtue of its wide ranging remit, the Inquiry
to be conducted by Lord Penrose into the current situation at
Equitable Life will be able to look back as far as necessary to
the origin and development of the problems and look in detail
at the actions of the Society and all of the other key players.
While Lord Penrose cannot be bound by either the
analysis or the conclusions and recommendations of the FSA report,
the Government understands he expects it to be an important piece
of evidence to his independent Inquiry.
The FSA report makes a number of detailed recommendations
about the regulation of life insurance, in particular its call
for improved solvency and disclosure standards.
Some of these recommendations will involve consultation
with the industry and the Government is anxious that the FSA should
take this forward as a matter of urgency. The conclusions of this
consultation will, of course, need to be considered alongside
the work of Lord Penrose's independent Inquiry, but the Government
hopes the FSA can start this work immediately.
The report also makes a number of recommendations
on the 'regulatory approach' - the FSA's culture, processes and
tools - to ensure that it achieves the "role, style and approach"
envisaged for the FSA as a single, integrated regulator. The Government
believes that implementation of these recommendations is crucial
to the delivery of an integrated risk based regulator and to the
objective underlying the creation of the FSA. The Government has
therefore asked the FSA to provide a report by 20 November,
prior to the time at which it adopts its full powers, covering
the actions they have taken, or plan to take, to implement these
The Government Actuary's Department have also been
involved in discussions on the report. Action has already been
taken to address the issues raised in the FSA report and actuaries
covering the insurance sector are now integrated fully into the
In addition, as the Committee is aware, the Government
is making major changes to the structure of financial services
regulation in the UK. As part of the implementation of the Financial
Services and Markets Act 2000, the Government is issuing today
a consultation paper, together with draft regulations, on the
circumstances in which appointed actuaries will be obliged to
inform the FSA of matters that have come to their attention during
the course of their duties.
GOVERNMENT RESPONSE TO
(a) We would like the Financial Services Authority
(FSA), Faculty and Institute of Actuaries (F&IA) and Institute
of Chartered Accountants of England and Wales (ICAEW) to take
on board the points we make in this report in the context of their
own inquiries, so that the Equitable Life Affair can be properly
and fully explained and to help the Committee continue the investigation
The Government notes this recommendation. These reviews
are the responsibility of the organisations conducting them. However,
the Government welcomes the work that the F&IA and ICAEW have
undertaken. As the Committee will be aware, the report of the
inquiry undertaken by the F&IA, the Corley Committee of Inquiry,
was published on Friday 28 September. The Corley Committee made
clear in their report that they took account of the comments made
by the Select Committee.
The ICAEW inquiry is continuing. The Government understands
that they are considering the Treasury Committee's interim report
in the context of their own disciplinary process and that they
have read the Actuary's report with interest.
(c) The F&IA report should consider whether
the actuarial guidance provided by the F&IA was appropriate
at the time, and whether such general advice was suitable. It
should also consider the extent to which the F&IA's opinion
was based on the prudential insurance regulator's view (paragraph
The F&IA report was published on 28 September.
The report made clear that, in as far as relevant to its terms
of reference, the inquiry took account of the comments made by
the Select Committee.
(e) The relationship between firms' Appointed
Actuaries and management boards, and with the body of policyholders,
is in need of review, in the light of the Equitable Life affair
The Government notes this recommendation. As the
Committee is aware, the Government is making major changes to
the structure of financial services regulation in the UK. The
Committee may be interested to know that as part of the implementation
of the Financial Services and Markets Act 2000, the Government
issued a consultation paper and draft regulations on 17 October
2001 covering the circumstances in which appointed actuaries will
be obliged to inform the FSA of matters that have come to their
attention during the course of their duties.
In addition, one of the recommendations in the report
of the FSA review is that appointed actuaries should be subject
to external review. This is on the basis that reliance on an individual
with no external or detailed check, inevitably poses risks. Action
has already been taken to integrate actuaries covering the insurance
sector into the FSA. It is possible that the role of the appointed
actuary may also be the subject of review and recommendation by
Lord Penrose. The Government has asked the FSA to ensure that
the outcome of their work is integrated with that of the Penrose
(f) It is unclear to us why the issue of GAR liabilities
and reserving was not considered by the prudential insurance regulator
at least by 1993, rather than only in 1998. We believe that the
current inquiries should pursue this closely (paragraph 21).
These reviews are the responsibility of the organisations
conducting them. However, the Government welcomes the work that
the FSA, the F&IA and ICAEW have undertaken, and are, in the
case of the ICAEW, still undertaking.
The terms of reference of the Penrose Inquiry will
allow Lord Penrose to pursue this issue.
(g) We ask the FSA to consider whether cash reserves
only need to be accumulated when required by the economic circumstancesor
whether there are other circumstances in which cash reserves may
be required (paragraph 26).
The issue of the prudential framework was considered
by the FSA review which recommended that the current framework
needs to be restructured so that the required minimum capital
reflects all the risks in the business. The FSA will take this
The terms of reference of the Penrose Inquiry
will allow Lord Penrose to pursue this issue further. The Government
has asked the FSA to ensure that the outcome of this work is integrated
with that of the Penrose Inquiry.
(h) We ask the FSA to reconsider whether it was right
to accept the reinsurance contract given its terms, and whether
it was prudent to allow such a contract to have accounted for
half of the Equitable Life's statutory reserves (paragraph 28).
The issue of acceptance of the reinsurance contract
was considered by the FSA review. The report notes that Equitable
Life did not disclose the full terms of its reinsurance contract.
The report goes on to recommend the full disclosure of financial
reinsurance arrangements. The FSA will consult urgently on the
implementation of this recommendation.
This area is one which is open to Lord Penrose
to pursue as part of his independent Inquiry into Equitable Life.
The Government has asked the FSA to ensure that the outcome of
this work is integrated with that of the Penrose Inquiry.
(i) Equitable Life demonstrated that the information
provided to policyholders, through the statutory accounts, and
to the regulator, through the regulatory return, differed substantially
in their treatment of the GAR liabilities and the consequential
reserving that had been undertaken. As a result, policyholders
were not able easily to establish the true position of the company.
We ask both the FSA and the ICAEW to consider whether statutory
accounts and regulatory returns should draw upon the same information
and assumptions wherever possible, in order to improve transparency.
In addition, the FSA should consider whether a life office's reserving
policy should be made clear to policyholders, either in statutory
accounts or in some other way (paragraph 31).
(j) We do not believe that the auditing arrangements
for the statutory accounts and, in particular, the regulatory
returns of life offices were adequate. In their memorandum to
us, Ernst and Young set out the judgments that they made concerning
disclosure. We ask the FSA to consider the justification for the
auditors' judgments and whether there are implications for future
reporting practices by auditors generally (paragraph 32).
The Government notes these recommendations. The
FSA review considered the framework of the regulatory returns
required from life offices and made a number of recommendations
regarding both content and format. The FSA are taking forward
(k) Equitable Life failed to explain to their policyholders
the full implication of Lord Woolf's judgment. The FSA should
therefore consider whether the assessment made by Equitable Life,
and indeed by themselves, of whether the eventual House of Lords
ruling could have been predicted, was justified, especially given
Lord Woolf's judgment (paragraph 37).
The FSA review considered the early assessment
made by the regulator of the potential outcome prior to the judgement
of the House of Lords. The report of the review concluded that
the regulator should have placed less reliance on statements made
by Equitable Life and should have prepared an alternative plan
of action. It goes on to conclude that if the regulator had done
this, it would have been in a better position to act when the
judgement was made. The report recommends a more pro-active approach
by the FSA. The Government has asked the FSA to pursue this recommendation
vigorously and to provide a full report, by 20 November, covering
the action the FSA Board has taken, and intend to take, to implement
(l) We welcome the FSA's review of Equitable Life's
selling practices after the Court of Appeal decision and we ask
the FSA to review the Equitable Life's practices when pension
policyholders gave up rights to guaranteed annuity rates (paragraph
The Government notes this recommendation. Any
review of the practices of Equitable Life when pension policyholders
gave up rights to guaranteed annuity rates is a primarily a matter
for the FSA. However, this area is one which is open to Lord Penrose
to pursue as part of his independent Inquiry into Equitable Life.
(m) We welcome the announcement of an FSA review
of management discretion in the with-profits business. We recommend
that the FSA analyse the extent to which financial services, in
particular life assurance, rely on managerial absolute discretion
The extent of discretion available to managers
of with-profits funds, and how that discretion is exercised, are
issues which are being addressed by the FSA's review of with-profits
business. In addition, these sorts of issues will be addressed
more widely by the Sandler review of retail investment.
The Sandler review was announced in the Government's
statement "Enterprise for all - the challenge for the next
Parliament" on 18 June 2001. Its terms of reference, for
the markets for long-term retail savings, were:
"to identify the competitive forces and
incentives that drive the industries concerned, in particular
in relation to their approaches to investment, and, where necessary,
to suggest policy responses to ensure that consumers are well
(n) It is important that the role of regulator since
1993, when Equitable Life began to operate a policy of terminal
bonus differentiation, should be analysed in order for the regulatory
lessons to be properly learnt for policyholders to fully understand
the history of the affair and for Parliament to undertake its
scrutiny of this topic properly and fully. The Committee will
await the FSA's report. It will want to examine what it has to
say on the regulatory background to the Equitable Life affair
between 1993 and 1999, and then decide how to proceed (paragraph
As the Committee is aware, the Government has
announced an independent inquiry into Equitable. The Inquiry,
headed by Lord Penrose, will be free to look at past events as
necessary. In the same way, Lord Penrose will also be able to
look at more recent events.
(o) We welcome the announcement that the FSA inquiry
will have access to Government Actuary's Department (GAD) files
and personnel. In our recent report on GAD, we recommended that
GAD should publish a regular report to Parliament on the life
assurance sector, so that public attention can be drawn to trends
and issues of concern. We recommend that the FSA inquiry make
suggestions as to how this could best be achieved and how better
public information about the condition of individual life assurers
can be published, on the basis of the actuarial advice received
by the FSA (paragraph 53).
The Government notes this recommendation. The recommendations
made by the FSA review are a matter for the FSA review team. However,
the Committee will note that GAD actuaries dealing with life assurance
have now been integrated within the FSA. Under the Financial Services
and Markets Act 2000, one of the responsibilities of the FSA is
to make reports to the Treasury at least once a year on the discharge
of its functions. These reports will cover the FSA's responsibilities
in connection with the life assurance industry and will be laid
This issue was considered by the FSA review which
recommended that the FSA consider the feasibility of producing,
on a regular basis, a review of issues and trends that may pose
a regulatory risk to the industry. The FSA will take forward this
2 Not reported. Back
of the Financial Services Authority on the Review of the Regulation
of the Equitable Life Assurance Society from 1 January 1999 to
8 December 2000, which Her Majesty's Government is Submitting
as Evidence to the Inquiry Conducted by Lord Penrose, HC (2001-02)