Examination of Witnesses (Questions 1-19)|
TUESDAY 30 OCTOBER 2001
1. Good morning, Sir Howard. Welcome again to
the Committee on this hearing on the regulation of Equitable Life.
For the sake of the shorthand writer would you introduce yourselves,
(Sir Howard Davies) Howard Davies, Chairman of the
Financial Services Authority, and John Tiner, Managing Director
responsible for consumer affairs, investment and insurance.
2. Thank you. Sir Howard, as Chairman of the
FSA Board, did you in any way attempt to modify or change the
Baird Report before it passed to the Treasury?
(Sir Howard Davies) The first six chapters are entirely
as written by the team without any involvement from management
or from the Board. Chapter 7, which contains the recommendations
for future action, was shown to a non executive committee of the
FSA Board in draft because the team thought that the recommendations
were in some way a different character from the analysis. We made
one or two minor comments on the recommendations but not such
as to change them in any substantial way.
3. The Baird Report did not cover the issues
after 8 December 2000. What consideration have you given to these
(Sir Howard Davies) We have been continuing with our
regulation of Equitable Life, of course in the unusual circumstances
as it is a closed fund and one seeking to reconstruct itself through
a compromise scheme. We obviously saw for maxwellisation purposes
the recommendations two or three months ago and we have been taking
into account those recommendations in our continuing work.
4. Are you satisfied now that the steps you
are taking in regard to life assurance regulation will be sufficient?
(Sir Howard Davies) If I could divide that into two,
Chairman. One are the internal steps and two are the external
steps because the recommendations really fall into those two categories,
the things which are about how the Authority is organised in order
to manage the regulation of the life insurance sector and the
regulatory environment within which we operate, by which I mean
the rules, the role of the appointed actuary, etc.. On the former,
the Board has taken a close interest in the way in which we have
responded. I would say that as far as the management structure
of the Authority is concerned, we had in fact already made the
changes indicated by this report and, indeed, we had declared
our intention of doing so over 18 months ago, that we would bring
together the prudential and conduct of business regulation ready
for N2 when we took on our full responsibilities. So those management
restructurings have been undertaken. They were finalised, fully
completed on 1 April this year. The problems to which the report
draws attention in terms of communication between different types
of regulators in the ancestral regime, if you like, all of that
has been dealt with in a structural way and the Board is satisfied
that it has been. The second set of recommendations obviously
relate to the way in which life insurance companies report their
assets and liabilities, the role of the appointed actuary, etc.
Those recommendations are now being carried forward by a team
headed by John Tiner, which is why he is here today, with a team
of a dozen or so people drawn partly from outsiders, from consulting
firms and others, and partly from people seconded from other parts
of the FSA into that team and that work is now under way. Of course
that work requires consultation with the industry and will require
cost benefit analysis etc, subject to the disciplines of the Financial
Services and Markets Act.
5. You did appear in the Money Programme
on 20 October and mentioned to the nation that you had reduced
your salary by £13,900. Subsequent to that in a discussionand
I have looked at the transcriptthe interviewer was pressing
you on why the salary reduction took place and trying to find
out if there was any culpability there on your part. It does seem
to one on the outside if you are losing £13,900 there has
to be some reason for that personally. I notice in the transcript
when you were asked directly if you had taken your eye off the
ball you said "No, I have not taken my eye off the ball".
What you are saying is in effect you did nothing wrong. If you
did nothing wrong, it puzzles me why you have lost £13,900?
(Sir Howard Davies) Perhaps I could explain the way
in which senior executive remuneration at the Authority is determined.
There is a Committee of Non Executive Directors chaired by the
Deputy Chairman, which is our remuneration committee. That remuneration
committee has set a basis on which the remuneration of the senior
executives of the Authority should be determined. That divides
between the basic salary and a performance related bonus. In relation
to the basic salary the remuneration committee takes advice from
salary consultants about movements in the external market using
a range of comparators from other city organisations and other
regulatory organisations. In relation to the bonus entitlement
of the executive members of the Board, the Committee established
a procedure for determining how much bonus the executives should
be entitled to which takes account of, first of all, objective
criteria, for example meeting the budget during that year, meeting
for example the service level agreements that we had in terms
of the programme, and there are various other measures to do with
the speed with which we authorise firms, etc. There are a whole
series of objective measures to do with the running of the Authority.
The remuneration committee also consults the chair of the consumer
panel, the chair of the practitioner panel and the Treasury about
their impressions of how well the Authority is operating and delivering
its strategic objectives and also the reputation of the Authority.
They then take account of all of those factors and reach a determination
on how well they think the senior executives have performed against
these objective factors but also on these reputational factors.
They concluded in the light of that analysis that they would pay
a lower bonus in respect of the year 2000 than in respect of the
year 1999, I think partly because they considered that there had
been reputational damage to the Authority. They did not have the
report in front of them, this decision was made some months ago,
quite unrelated to the Baird Report. The decision was made in
January of this year so the two points were completely unrelated,
as it were, the assessment in the Baird Report and the assessment
of the decision. I feel somewhat uncomfortable in going into detail
about this, Chairman, because I am not responsible for my own
remuneration, that is done by the non-executives.
6. I understand. From our point of view, we
are interested in the issue of culpability. We are looking here
to see if anyone was responsible for the situation in Equitable
Life. In your own case you were at a meeting on 5th December 1998
in the Treasury and in the Baird Reportand I refer to the
Baird Report4.19.2 mentions a briefing memorandum. It would
appear from the Baird Report you had prior warning of the potential
prudential problems at the Society and the fact that this was
the only insurance company whose problems were the subject of
a specific pre handover note issued on 15th November 1998 by the
Treasury to the FSA might have raised alarms with you regarding
(Sir Howard Davies) It certainly did and Equitable
Life received a disproportionate amount, well disproportionate
is the wrong word, received an unusual amount of senior management
attention in relation to other insurance companies during the
subsequent period. I would point out that that meeting predated
the Equitable's decision to go to court to seek to resolve its
bonus issue and, therefore, the position relating to the company
and the relationship that we had with it and the flexibility that
regulators had to deal with it changed very substantially immediately
after that meeting. The Equitable decided to go to court without
consulting or informing the regulators and from that point on
there was a court process which led to the House of Lords' decision
which has been at the root of the company's difficulties. Things
changed very quickly after that meeting. I would say certainly
that we were aware of the problems in Equitable Life and you will
see from the report that there were extensive exchanges with the
company, particularly on the question of reserving for guaranteed
annuities and we pursued, as the report says, a resolute approach
to getting the company to increase its reserving.
7. If I could go through the Baird Report and
pick out one or two issues. For example, the failure to integrate
adequately the prudential regulation of insurance with the conduct
of business insurance regulation, paragraph 6.23.4, and that is
relating to FSA representatives. A failure to follow up some of
the issues which arose from earlier regulatory interventions including,
for example, requiring proper disclosure in the regulatory returns
of non contingent risks in terms of key financial re-insurers
or the risk of a legal challenge to Equitable's bonus policy,
paragraph 6.8.2. A failure by the FSA to enquire on a reserving
basis of GAO policyholders' entitlement to top up their existing
policies or to appreciate the consequences of this entitlement.
Insufficient preparatory work by FSA carried out without evident
need of its policyholders' reasonable expectations. The FSA inadequately
prepared for the decision in the House of Lords, paragraph 6.15.1,
and also the FSA should have been better prepared in the event
Equitable Life would be unable to find a buyer, paragraph 6.16.3.
Is that not quite a catalogue of events for the FSA to have overlooked?
(Sir Howard Davies) You quote accurately from the
report, Chairman, but what you do not quote is that the report
says quite explicitly that these criticisms are made with the
benefit of hindsight and, furthermore, the report says that when
we took over the regulation of the Society there was nothing which
could have been done by the FSA to alter substantially the eventual
8. I will put it to you, Sir Howard, that you
were at a meeting on 5th December 1998 when you were taking over
this issue, these have followed since then so rather than the
die being cast at a particular time, rather than hindsight being
proffered by yourself as a reason, is it not the case that the
FSA should have got involved in that straight away and the warning
signs with the meeting at the Treasury were there for you and
everyone else to see? It should have been the primary consideration
of the FSA?
(Sir Howard Davies) The FSA did get involved directly.
We did pursue a resolute approach with the company in spite of
the fact that the company resisted our attentions. The company
went ahead with a court case without consulting us. The company
resisted us at every turn, complained to ministers, threatened
judicial review. We pursued a resolute approach to dealing with
the company's prudential problems. I accept that the report suggests
that there were ways in which this could have been handled differently,
more effectively, but it does say that the eventual outcome would
not have been changed. I am afraid here, Chairman, we were dealing
with a company which had an arrogant superiority, also that is
quoted in the report, did not deal with the regulator in the way
we would expect. Quite out of character with the relationship
that we have with most firms, certainly with most banks and, indeed,
increasingly with most insurance firms. These were difficult issues
to deal with and also against a changing legal background where,
as we have accepted in previous hearings before this Committee,
we did not expect the House of Lords' outcome, we have acknowledged
that. Against that very difficult legal background, we considered
that we wrestled with these prudential issues, sought to do what
we could to strengthen the balance sheet of the society during
that period, but against a background which was extremely difficult
and where the changing legal circumstances made that work somewhat
9. So I can take it from that, Sir Howard, you
are saying "it ain't to do with us. It is because it is an
arrogant company, Equitable Life, and we could do absolutely nothing
about it". That is the distillation of your comments to me
(Sir Howard Davies) I think that would be an unfair
characterisation of what I am saying, Chairman. The Authority,
my Board, has acknowledged that the report made pertinent criticisms
of the way we managed ourselves during this period. We have published
this report because we believe that it is in the public interest
to do so. My Board commissioned this report and supplied it to
the Treasury of its own volition because it considered that we
should be an open and accountable regulator and that it is better
to set out what we have done and what we have not done even if
that creates uncomfortable publicity for us because it demonstrates
things were not handled perfectly. Your question is whether that
amounts to a finding that we have fundamentally failed the policyholders.
I do not believe that it amounts to such a finding. I do not believe
you can find that conclusion in the report so I am perfectly happy
to sit here and acknowledge that things could have been better
handled. I wish they had been better handled. I think some of
the recommendations that the report makes as to how we could deal
with these kind of cases are very pertinent and, indeed, as I
read the report I did frequently think I wish I had acted differently
in those circumstances. However, I do not think that amounts to
an admission that our own inadequacies produced the problems that
the company is currently in.
10. There is a teeny weeny bit of culpability
on the FSA's part?
(Sir Howard Davies) There is a failing of management
in the FSA which we acknowledge but there is also a significant
problem with the regulatory regime because I have to point out
to the Committee that the company met its regulatory requirements
during this period. It was not insolvent. Its reinsurance was
consistent with the rules and the European rules in place. Its
reserving was consistent with the rules. Therefore, what we are
saying also in this report, or what this report is saying, is
that there is a problem with the regime in that you can have a
company which meets all the existing requirements but still ends
up in serious trouble. So I really do think you have to look at
both of these things together, at what the Authority and the regulators
did and did not do and also at the legal regime and the regulatory
regime within which they were operating. We accept in this report
that we could have done better in terms of our management but
we also accept that there are problems with the regime itself
which need to be addressed.
11. I think you leave me more alarmed at the
end than at the beginning of my questions. What you are saying
now is there are significant problems with the regulatory regime,
companies can comply with that but they can still get into a bit
of trouble. That being the case I think we will see a lot of each
other as a Committee and yourself until we get this regulatory
(Sir Howard Davies) Chairman, if I could respond briefly
to that. That is something we would very much welcome because
the changes that are recommended in Chapter 7 of this report are
serious and fundamental changes which will in some cases change
the practices of this industry in quite a fundamental way. For
example, in relation to reinsurance, there is legitimate reinsurance
going on in the insurance industry but there is also financial
reinsurance which we regard now, having looked at this case in
some depth, as little better than window dressing. Companies will
have to change their practices and this will impose some costs
and it will alter what is going on in the life insurance industry
and we will need support for that, I fear, because I suspect we
will get some resistence.
12. I can assume you have robustly produced
comments in evidence to Ministers on that particular issue?
(Sir Howard Davies) The position is that most of these
changes will be for us to make post N2 under the Financial Services
and Markets Act. We are not at this point looking for Ministers
to change the regime for the next four weeks. We are looking to
put in place after N2 a regime which better meets the needs of
policyholders for the future.
13. I would just like to clear up one point
about the reduction in your bonus, Sir Howard. You did say that
you thought there was some culpability of the management.
(Sir Howard Davies) No, I do not think I used the
word culpability at all actually, I think I rather resisted that
word, I am afraid. I said that there were management failings.
Culpability implies some crime at the end of them.
14. Was the bonus cut in any way connected to
the discovery of those management failings?
(Sir Howard Davies) No, it was not, because as I have
pointed out that decision was made in January of this year in
relation to the overall performance of the Authority and the overall
reputation of the Authority in the previous 12 months. Therefore,
at that point the Baird Report had barely begun.
15. So you are saying that the reputational
damage to the FSA had already been done, or some had been done,
even before the Equitable Life issue came into the public domain?
(Sir Howard Davies) No, I am not saying that at all.
The Equitable Life issue came into the public domain through the
16. Is there any connection at all between the
Equitable Life issue and the bonus?
(Sir Howard Davies) Yes.
17. Right. How much? Can you explain the connection?
(Sir Howard Davies) I do find this very difficult,
I have to say, Mr Tyrie, because I am not responsible for determining
my own bonus. I can say that the remuneration committee determined
a lower bonus rate for the executive directors in recognition
of the difficulties that the Authority had experienced during
the year 2000. They felt that since that had caused questions
about the effectiveness of the Authority in relation to Equitable
Life in particular that it would not be understood in the public
domain if they were prepared to ignore all of that and pay the
same bonus as they had in the previous year. They believed that
the Authority should recognise that reasonable questions had been
raised about its effectiveness and its management and that it
should recognise those in determining its overall bonus judgment.
That was an overall bonus judgment, as I understood it, and not
related to any specific events or failings. That really is not
the way a remuneration committee would normally operate. If you
wish to pursue the details of this point I will have to refer
you to the Chairman of the remuneration committee.
18. I realise that you might feel some difficulty
in discussing it and I realise that some of this may upset you
but what I want to get at is at the moment the FSA is exempt from
fines, the FSA is exempt from all forms of actions virtually.
(Sir Howard Davies) No, that is not really the case,
Mr Tyrie. We have a statutory immunity but we are certainly not
exempt from actions taken in bad faith.
19. Except in cases of bad faith.
(Sir Howard Davies) I should have known you knew this.