Examination of Witnesses (Questions 100-119)|
MP, MR JON
TUESDAY 30 OCTOBER 2001
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
(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
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
(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.
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
(Ruth Kelly) All of the insurance regulators transferred
to the FSA at that time so we have no in-house expertise in this
(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
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 termmonitors
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
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 professionalsafter
all, regulatory judgments are clearly professional judgmentsrather
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
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