Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 100-119)



  100. The Treasury must have been quite pleased, from a glance at the Baird Report, to get the regulation of Equitable Life off its hands in 1998/9. When we look at the Treasury report that was prepared and the briefing note that was given to Howard Davies, Equitable Life sounds as if it was in a pretty awful position. The memorandum in October 1998 said, "Meeting the cost of guarantees is putting significant strain on the company's resources. It is feasible the company would have to consider some form of demutualisation." The briefing note that was given to Sir Howard Davies when the FSA were about to take over in late 1998/early 1999 said that the information received to date is unconvincing about Equitable Life's reserves and raises serious questions about the company's solvency. Are you happy that this company continued to take on new business in this transfer period between the Treasury and the FSA?
  (Ruth Kelly) You are asking me specifically about 1998 and how the Treasury handled the regulation in that period. It became clear in the summer of 1998, after the Government Actuary's Department had received its initial responses to a survey of the life assurance industry, that Equitable Life had a very serious exposure to guaranteed annuities. In addition, it had made no provision, no explicit charge and no reserves against those options being exercised. Clearly, that posed a major regulatory challenge to the Treasury and subsequently to the FSA. In the latter half of 1998, I think the report shows that, first of all, the problem was recognised; secondly, that the Government Actuary's Department and insurance regulators attempted to get Equitable Life to reserve in full for these guarantees.

  101. Did the Treasury consider stopping new people from joining Equitable Life at that time?
  (Ruth Kelly) Let me start with a caveat. We no longer retain the documentation for that period at the Treasury. When we decided to contract out the regulation of life insurance and to create a single regulator at the beginning of 1999, not only did we transfer the insurance regulators to the FSA but we also transferred the knowledge and documentation.

  102. You must know whether the Treasury considered contemplating stopping new policyholders at that stage.
  (Ruth Kelly) I am just saying this as a caveat. What I am relying on, from my knowledge of this era, is the Baird Report itself and the statements of fact which are in that. It is clear to me and to Members of the Committee that briefing notes were prepared which suggested this as an option.

  103. Why was that not pursued?
  (Ruth Kelly) As far as I understand it from my recollection of the Baird Report, that was considered very near the end of 1998, just as the transfer of power was already taking place.

  104. It says in the Baird Report, "The note"—from the Treasury officials to Sir Howard—"contemplated closing Equitable Life to new business" but it does not say what the conclusions of that were. One has to draw assumptions. Would that not have been a sensible course, given that this was a company, even on the Treasury's own view, where there were serious questions about its solvency? How could the Treasury and the FSA allow this company to go on trading for another two years with new policyholders joining when it was considered almost to be insolvent?
  (Ruth Kelly) You are asking me whether, within the six month period after we became aware of the exposure to guaranteed annuities, we should have made what I would consider a very bold decision to close Equitable Life to new business on that basis. The potential need for new capital had been recognised. The need to reserve fully for the guaranteed annuities had been recognised. Closing a life insurance company to new business is not a costless option. Another way (apart from reserving) in which you might seek to transfer capital into a life insurance company is to effect a sale of that company. Closing a life insurance company to new business makes a sale far more difficult than it might have been. These are regulatory and professional judgments.

  105. If you joined a month after as a new Equitable Life policyholder, not being in your existing lofty position, and you thought you wanted to put some investment funds aside and you discovered the Treasury was sending these reports out considering closing it to new business, saying that the information received to date about their reserves is unconvincing and raises serious questions about its solvency, and discussing whether it would have to effectively go out of business, would you not feel pretty much aggrieved?
  (Ruth Kelly) It is not up to the regulator to give that sort of financial advice to consumers.

  106. The regulator should not be bothered about a company that is about to become insolvent?
  (Ruth Kelly) Of course it should be bothered. The action through this period shows precisely how concerned we were and the action we were taking.

  107. You did nothing until the House of Lords and Equitable Life brought the whole thing to a conclusion.
  (Ruth Kelly) The requirement on the regulator is to ensure that the life insurance company is being managed in a sound and prudent fashion, and to make sure that it meets its solvency requirements. As the note set out, that was the position.
  (Mr Cunliffe) If I could pick up the point about doing nothing, throughout this period what the regulator was trying to do was to get the company to increase its reserving and that is what happened. The regulator's response to the company whose solvency was threatened was to try and improve that solvency position.

  108. When I say "do nothing", I mean that you did nothing and the FSA did nothing for two years, to give advice to people like potentially the Minister who might have been joining as new policyholders that this was a company that was almost insolvent.
  (Ruth Kelly) It is an extraordinary position that you are suggesting, that we should in some sense, when a company goes through a difficult period, advise people that they should not be investing in it, when the correct way through this is to try and encourage the company to improve its solvency requirements.

  Mr Laws: It is not me who is saying it. If you read the Baird Report you will see criticisms of the fact that the FSA did not pick up on the advertised information and did not take any steps to ensure that new investors had any information about this.

Mr Tyrie

  109. You said a moment ago in response to the question about gross regulatory failure that it would be open to policyholders to sue the regulator. As you well know, you must be aware that the FSA is immune from judicial review, except in cases of bad faith. Indeed, against advice from many quarters, the government pressed ahead with putting that on the statute book when the Financial Services Bill went through the House. Do you not realise, Minister, that the idea that redress may be obtainable through the courts by policyholders who have lost out against the regulator would be greeted with a hollow laugh by them?
  (Ruth Kelly) The options remain open for people to pursue this through the courts.

  110. There are no options.
  (Ruth Kelly) I do not understand the position you are putting forward to be the case pre N2 when all the formal transfer of powers takes place at the end of November and formal transfer of authority goes to the FSA but, to be absolutely certain for the record, that is something we shall come back to you on.

Mr Plaskitt

  111. At the time you came to the service level agreement with the FSA and handed over the supervisory and regulatory role to them, uniquely amongst all the cases you passed over there was a warning flag attached to the Equitable Life file. At that time, did you give the FSA any advice as to what they should do about that case, that company and that file?
  (Ruth Kelly) We no longer retain the information in-house or the supporting documentation or advice that may have been there at that time, so it is very difficult for me as Minister now to form a view of the surrounding debate. I am entirely reliant upon what the Baird Report says. That is one reason why I thought it important to set up the Penrose Inquiry, as Penrose himself will be able to gain access to all the documents, not just in the post 1 January 1999 period, but also in 1998 and indeed going right back further into the history of the affair and he will also be able to ask other key players such as Equitable Life themselves how they related to the regulator over this period.

  112. It was not that long ago. Are you telling us that no one in the Treasury can remember whether any advice was given to the FSA as to what they should do about Equitable Life?
  (Ruth Kelly) All of the insurance regulators transferred to the FSA at that time so we have no in-house expertise in this area.
  (Mr Fellgett) Shall I run through the way in which the insurance supervision function moved? This was the function of a division within the DTI up to the first few days of 1998. It then transferred into the Treasury and it was essentially the same people with the same knowledge and the same papers, doing the same job, sitting in the same building, still the DTI building in Victoria Street, not the Treasury building. They worked alongside my part of the Treasury for a period of a year. The function never came into my area, the continuing Treasury responsibility. They are essentially the same people, with the same papers, the same knowledge etc., who moved to the FSA at the beginning of 1999 and indeed moved offices to Canary Wharf. As the Economic Secretary has explained, the history does not lie in the Treasury; the history, for very good reasons, lies in Canary Wharf.

  113. There was a period when there was Treasury responsibility. What does "responsibility" mean? How is that defined?
  (Mr Fellgett) In this context, the responsibilities of any Department of State are set out in the Insurance Companies Act of 1982, which was essentially to regulate in terms of the solvency of the company and the fitness and properness of the management.

  114. We ought to ask you questions about what you did while you held that responsibility and yet, when I ask the question, you have not got the files.
  (Ruth Kelly) It is very difficult for us. That is exactly why I thought it was important for Penrose to have an independent inquiry which covers this particular area and to form his own conclusions on the basis of that. No doubt in due course you may want us back again to discuss those issues or you may want to ask Lord Penrose what his assessment of that period is.

  115. We have not managed to discover what advice you handed over when the FSA took over. What about subsequent monitoring? Once they had taken over and assumed responsibility, did you in any respect monitor what they were doing with respect to Equitable Life or did you cease to have any interest?
  (Ruth Kelly) There is a fairly clear mechanism of accountability laid out for the FSA which was extensively debated at the time that the Act was debated in Parliament. One of the ways in which the Treasury gets involved with the running of the FSA—"gets involved" is much too strong a term—monitors what is going on is they hold quarterly meetings on the insurance side with the insurance regulators to discuss issues of significance. In addition to that, there are extensive bilateral meetings between both sides.

  116. Can we take it that Equitable Life is on the agenda at all of those meetings?
  (Ruth Kelly) I do not know whether it was on the agenda at all of those meetings but it clearly featured in those meetings.

  117. You were doing the monitoring. Were you satisfied that the FSA was doing all you expected it to do in relation to Equitable Life?
  (Ruth Kelly) I think there is a real question of principle here about what you consider the appropriate role of ministers and the Treasury to be in the regulation of the insurance industry and indeed in regulation per se, because what we made clear at the time of the contracting out order, when the powers were first contracted out to the FSA to do insurance regulation on our behalf, was that we wanted to take advantage as quickly as possible of the benefits of a single, independent regulator. The judgment behind those decisions was that, in the long run, it is actually better for a consistent approach to be taken across different sectors and for this to be carried out by professionals—after all, regulatory judgments are clearly professional judgments—rather than to be second guessed or somehow managed by Treasury officials or ministers. We set that out very clearly in the debates at that time. That was the policy intention behind the transfer of powers and that intention also lay behind the decision to transfer the insurance division within the Treasury in its entirety to the FSA. What you are suggesting by your question is whether that was an appropriate model to follow. My answer is yes, I do think that was the appropriate model to follow. Of course there will be particular instances in which we have a direct interest, but in the long run it is better that those regulatory issues are dealt with by professionals with the appropriate expertise rather than by ministers and Treasury officials.

  118. Monitoring went a bit further than just receiving reports back?
  (Ruth Kelly) That is right. There was quite a lot of discussion between the Treasury and the FSA but, in the end, they are the ones who have to take the decisions and they are the ones who have to be held accountable for the decisions which they make.

Mr Ruffley

  119. Minister, you have talked about the contracting out but the Treasury are not quite off the hook, are they, post January 1999 because you have a responsibility, do you not, for monitoring the service level agreement? One of the requirements of the service level agreement that the FSA has to discharge is to carry out the regulation of insurance companies efficiently and effectively which is in schedule one. Can you really say to us today that you think this agreement with the FSA has been adequately carried out in the light of the Baird Report efficiently and effectively?
  (Ruth Kelly) It is very difficult to draw distinct lines between one regime being in place and another regime coming into being. It is very difficult to say from one day to the next that everything must change. Clearly, regulation is an evolving process where lessons are learned etc. What was clear to us in 1997 when we came to government was that what was needed was a much more consistent and coherent approach to regulation across the different sectors. It is clear that sectoral boundaries are much more blurred, for instance, between the large insurance companies and between the large banks than they were. Those sectoral boundaries no longer exist in the way they used to. What we needed was a new regulatory approach. I think what the Baird Report does very clearly is reinforce the view not just for a consistent approach but for better coordination between the different arms of the regulatory system such as the conduct of business regulation of the PIA and the prudential regulation of the industry which had been carried out by the Treasury previously to that and by the DTI. It reinforces that message. Yes, we had set the system going, we had set it off in the right direction. But it takes time to bring that into effect and, in the case of the Equitable, Baird speaks for itself. Had these benefits been realised earlier—

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