Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 20-39)



  20. What I really would like to get at is whether you feel that as the head of the FSA such action as has been taken on your bonus is in some way a token gesture for the absence of the ability to impose fines, failure to report to the regulator or almost total immunity of the FSA except in respect of bad faith?
  (Sir Howard Davies) No, I do not believe there is any connection whatsoever but you would have to pursue this with my remuneration committee. That was certainly not a point made to me in any way at all. This is about the management of the Authority.


  21. You did release this information yourself to the world and the nation on the Money Programme.
  (Sir Howard Davies) Chairman, it has been in our annual report for the last two years.

  22. That is why we are here.
  (Sir Howard Davies) It was publicly available information. It was published in our annual report in June. It has recently attracted some attention because I was asked a question about it. It has been in the public domain for some time.

  Chairman: It was freely given by yourself in that programme. We will go on to the next section which is the role of the FSA in the context of Equitable's regulation and I will ask Nick Palmer to lead on that.

Dr Palmer

  23. Sir Howard, you have accepted that there were management errors in this process and you have said that there were legislative or regulatory limitations to what you could do. Just to pin that down more precisely. Would you agree that within the limits of the current regulations the FSA failed to fulfil its entire regulatory responsibilities? Were the management errors sufficient for that or were they really an internal problem?
  (Sir Howard Davies) I do not believe that we failed to fulfil our regulatory responsibilities, no, because I believe that there are arguable points in here and, indeed, at the key decision points the report either accepts that the FSA made the right decision or that it made a reasonable decision, a decision which reasonable people could reasonably make at that time given the information they had at their disposal.

  24. To quote the old saying "if everything is fine why are we so miserable". If the Authority did fulfil the regulatory responsibility it had, is that not a very swingeing indictment of the regulatory powers the FSA have?
  (Sir Howard Davies) I think it is quite a serious indictment of the regime as it has been in that I believe personally it is extraordinary that a company could write so many guaranteed annuity policies and the regulatory returns should include no reference to the liabilities thereby created. I find that extraordinary and I find it extraordinary that was the position we inherited. There was no reference and had been no reference for many years, as I understand it, in the regulatory returns to the liabilities created by these guarantees. I believe that in that one respect the regime, that is the recommendation that there should be stochastic valuation of guarantees, is designed to meet that point. A second is that I think that the use of financial reinsurance and the way in which the companies are allowed to take account of future profits, and the two are rather linked because the financial reinsurance is frequently remunerated by the future profits, is in my view inappropriate and creates a very opaque view of companies' assets and liabilities. Thirdly, I believe that what this story shows is that the reliance placed under the regulatory regime on the role of the appointed actuary as the independent, if you like, advocate of the policyholders within the company has been misplaced in certain circumstances and certainly in this one in that a practice which might have seemed to be giving policyholders a degree of authority, and which was really the underpinning of a regime, could quite easily become something quite different when the appointed actuary held a senior management position, in some cases chief executive, in the company and therefore was clearly operating with severe tension. I believe that in those three respects the regime as it has operated has been inadequate.

  25. We will be coming back to some of these issues. Just one final question from me on this point. To what extent did the FSA accept without question what Equitable told it? There is a perception among lay people that the City has a lot of people who know each other and trust each other. Trust is a good thing but in this case it does not seem to have worked, does it?
  (Sir Howard Davies) No, and I think I would accept the criticism in the report that on occasions we were too inclined to accept the Equitable's interpretation of events and, indeed, forecast of events. I think what you can see from reading the full narrative of the regulation is that that trust was misplaced in that we were frequently not told the full picture.

  26. Would you not call that a regulatory failure?
  (Sir Howard Davies) I think it was unfortunate that we took that reliance but the question of regulatory failure is two things. One is whether it would have been better had we been more sceptical of the Equitable Life, I agree, but did that lack of scepticism result in, was it the cause of the regulatory failure, is not something I think I could accept on the basis of this report.

Mr Laws

  27. Sir Howard, obviously you would accept that in your aims and objectives it says that one of those is to regulate the insurance industry so that policyholders can have confidence in the ability of UK insurers to meet their liabilities and fulfil policyholders' reasonable expectations. Can I now take you back, using the recent FSA report, to the events when you took over the regulation of Equitable Life. In 4.15 in the report, page 82, we get some idea of the nightmare that is about to descend on you in regulating Equitable Life in a memorandum from the Treasury to the Economic Secretary on 19th October. It says "Meeting the cost of the guarantees is putting a significant strain on the company's resources . . .". Going further down "It is feasible that the company could have to consider some form of demutualisation, for instance through merger with another company, depending on how serious the financial situation proves to be". In 4.15.11, referring to another meeting, it says that the Treasury's insurance directorate thought there was ". . .at least the possibility that dissident policyholders might win a case in Court that they should be paid a guaranteed annuity on unadjusted terminal bonus." When you came to take over the regulation of this company you must have been worried about this? You must have thought when you got the briefing, which was referred to in 4.19.3 from the Treasury, about what you were about to inherit that this was a real nightmare in the offing. Was that your view?
  (Sir Howard Davies) If I could just clarify that, yes, these were people who at that time were Treasury Insurance Division, but of course they transferred en bloc to me, so the views that they held then they brought with them for good or ill.

  28. Very pessimistic views.
  (Sir Howard Davies) They had pessimistic views at that point and were concerned about the eventual outcome for the company. What had happened of course, by the time we took over formal responsibility under our delegated authority on 1 January, was that a key event had occurred which post-dates these two references, and that was the decision that the Equitable Life itself took to seek to resolve its uncertainties by means of a court case, again, as the report points out, not something which they consulted us about or even informed us about at all, which I find extraordinary, but they went ahead and decided that they would seek to resolve these uncertainties in the law. That of course significantly constrained the regulator's room for manoeuvre because the company was able to say, "Look; we have very good legal advice that suggests that our interpretation of all these things is correct and anyway that is going to be determined."

  29. Just to clarify this, when you had the briefing with Michael Foot in anticipation of the transfer of responsibilities you were given a briefing about the situation in relation to Equitable Life which must have been pretty gloomy. As the Chairman explained earlier on, this was the only company, I think, that was singled out as a particular problem, and indeed, in the covering memorandum to you referred to in 4.19.2, Treasury officials expressed concern about Equitable's ability to reserve adequately, and I quote: "The information received to date is unconvincing, and raises serious questions about the company's solvency", so this was a pretty gloomy position, was it not?
  (Sir Howard Davies) It was indeed. As a result we needed to pursue some fairly robust lines of enquiry with the company about its reserving. I was consulted about that. I looked carefully at the arguments because it was clear that we were heading for a serious row with a company which, as you know, was in very high standing in general in the market place at that time, a 240-year old company with a long and distinguished record, and we were running into a serious battle with them. Therefore I sought to satisfy myself that our arguments for pressing our views on reserving with them were robust.

  30. When you left that meeting with HMT officials and Michael Foot, when they briefed you about what this company looked like, would you have been happy at that point to put any of your own personal financial resources into Equitable Life?
  (Sir Howard Davies) I have a small unit linked Equitable Life policy which I have not done anything with.

  31. Would you have been willing to put any new money into Equitable Life after that meeting?
  (Sir Howard Davies) I do find that a slightly odd question. I am not quite sure why my own personal finances, which we have discussed at some length already—

  32. I am trying to get a view of your opinion about the safety and security of putting money into Equitable Life two years before the company was closed to new business.
  (Sir Howard Davies) No, I did not think that, Mr Laws, because it seemed to me at the time that we were going to end up trying to impose our will on Equitable in terms of reserving for these guarantees, that life insurance business is usually a very long term business, as is explained in the early part of the report, that while it might be necessary for the company to increase its reserves and probably to reduce its bonus payouts in order to strengthen its position (depending of course on the eventual outcome of the court case), none-the-less it looked at that point as though there was a way through.

  33. You would have been happy to recommend to a good friend putting more money into Equitable Life after you had had that briefing?
  (Sir Howard Davies) I am not approved by the Financial Services Authority to give advice.

  34. Do you not find it astonishing, given the briefing that was given about the position of the company, that two years later this company was still taking on board new policyholders?
  (Sir Howard Davies) No, I do not find that extraordinary given the story as it was set out here.

  35. What did you do to warn potential new policyholders about the risks that were set out in the Treasury note? What did you do as a regulatory authority to make sure that anybody who was about to put new money into that company was aware of just what type of risks they were taking?
  (Sir Howard Davies) This raises an interesting question, but I think that the reality is that you are either authorised to carry out insurance business or you are not. I do not interpret our rules as giving us the ability to say, "Company A is authorised and I, the Chairman of the FSA, would be delighted to put my money in it. Company B is authorised but if I were you I would watch out." We do not have that ability to make those distinctions. We would be in serious difficulty were we to seek to do so. We are able to satisfy ourselves that a company is solvent and, if we are satisfied that it is solvent, then it may carry on taking on business unless it does not meet the criteria—

  36. Is it not reasonable of you to ensure that those people who are sold new policies are aware of some of those risks? To have given the information on which they could form that judgement, what action did you take to make sure that the information given to new people who entered Equitable Life after that period of time was adjusted to reflect the risks?
  (Sir Howard Davies) The company needs to disclose its financial position. I have explained in my answers to Dr Palmer that I believe that those disclosures in the regulatory returns are not adequate. I think that is a lesson that we can learn from this. I really do not think it is open to the Authority to reach impressionistic judgements about the probabilities of difficulties in companies and to require companies to say something about those to policy holders. That is not the way I interpret our responsibilities in the regime.

Mr Tyrie

  37. Do you think that confidence in the market, including those people who wish to buy life assurance, has been dented as a consequence of the Equitable Life affair?
  (Sir Howard Davies) That is a very interesting question. Many have asserted that it has. I can only say that the evidence of the market place would not provide any solid grounds for that assertion. John, I think you have looked more recently at the latest sales figures.
  (Mr Tiner) Yes. A number of the very large life houses have recently published results showing substantial increases in new business over the last year. That implies that at least to a certain extent long term savers and investors are still putting their money into the life assurance industry.

  38. Do you think that by not promising a zero failure regime, something which I support in principle your decision upon (and some of us do as I think you know from earlier exchanges between us, orally and in writing), you are simply seeking to reduce expectations and therefore blame when a company does fail?
  (Sir Howard Davies) No. I have been grateful for your support and that of others in the past on that. I do not think so. I think that the regime that we have, which was very extensively debated in Parliament during the passage of the Financial Services and Markets Act, made it very clear that the Authority should pursue two objectives in its consumer protection area. One is promoting public understanding of the financial system and the second is protecting consumers but bearing in mind their own responsibilities. We interpret that as meaning that as far as possible we should operate on the basis of disclosure and regulate in a way which promotes competition because healthy competition in the market is in the long run the best guarantee of a good deal for consumers, but a healthy and competitive market place is one in which not all can have prizes. There were bound to be relative winners and relative losers. I would emphasise that the Equitable Life has not in fact failed and is not an insolvent company. The returns to policyholders have been somewhat lower than those policyholders had hoped, so it is not a failure in that absolute sense. However, although it can be uncomfortable and we are sometimes caricatured for having said that we cannot run zero failure regimes, my own strong view is that to attempt to do the opposite would in the long run be extremely damaging. It would be possible for us to reduce further the probability of failure in the life insurance industry. That would be something which I could easily achieve. I would do so by requiring all life companies to hold 100 per cent of their assets in five pound notes or in short dated gilts perhaps, which would be more realistic, and there would be a very solid life company. The returns over a 25-year period would of course be very poor indeed. At the moment they would be four per cent returns. Over the long run equities yield, as you know, Mr Tyrie, an equity premium (although we may argue that it may have changed recently) of, let us say, four per cent. The risk that you have to bear if you want to have a life insurance sector which is heavily invested in equities, which in the long run has been rather good for policyholders, is that that creates a sector which is more vulnerable to downturns and to uncertainties. That is, I am afraid, the price that we pay. One of the debates that we will have to have as we pursue the recommendations in this report, which will be an interesting debate, is where do we want to set this line? I would like to be quite clear to the Committee. It would be possible to set this line somewhere else. It would be possible to have lower solvency requirements. It would be possible to have higher solvency requirements, but there is a fairly straightforward trade-off there in the long run between risk and return.

  39. And you are going to stick to your risk based approach to regulation which you set out in those discussion papers a year and a half ago?
  (Sir Howard Davies) We believe that that is the right approach, and indeed I think there is support for that in the report. Indeed, in so far as the report is critical of our management approach, it is that we did not adopt early enough the approach that we have set out as the approach that the new Authority will take.

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