Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 140-162)



  140. That was obviously a substantial difference. Do you not think, looking at the Baird Report, that at various points during 1999 there is a real tension inside the FSA between its role as a prudential regulator wanting to keep the institution going, wanting to see if it could trade out of the position which it was in, and its role as a conduct of business regulator, trying to advise people who were writing to it, complaining to it about a number of aspects of the Equitable's behaviour in that period? Would you agree that there was that tension?
  (Ruth Kelly) What the Baird Report shows clearly is that if there was a tension there should not really have been. The two arms of the regulator needed to take a coherent approach to the problem and if they had done so, they might have spotted earlier the problems which later emerged. The prudential regulator is much more intimately involved with the company, as you rightly say. It has the company's solvency under close scrutiny at all times; whereas the conduct of business regulator takes a much more stand off approach and has relied upon people coming to it with complaints. My reading of the report was that not many people did that, particularly in certain critical periods. One of the rationales behind the creation of the integrated regulator is not just to provide a consistent approach but to introduce a much more risk based approach which will concentrate resources appropriately on key issues, particularly the conduct of business ones which emerged in the actual case and which were not subject to that risk based regime.

  141. If there was a failure of the FSA as a conduct of business regulator, where would the ultimate legal and financial responsibility of that lie?
  (Ruth Kelly) As far as I understand it, the position is that the PIA is still currently a self-regulatory organisation and will remain so until the formal transfer of powers at the end of November, despite the fact that its employees are employed by the FSA and the FSA is responsible for monitoring how it complies with the rules. It is a very odd situation but the PIA would be responsible. What I read from the report is that they did fail to operate in a coherent fashion and that it is essential from now on that these two sides of the regulator liaise in a much more coherent way over particular companies and particular issues.

  142. You do consider the possibility that there was conduct of business regulation failure and, if there was, under the terms of the old Financial Services Act 1986, the responsibility for burying the dead of that particular episode would lie with the life insurance industry itself?
  (Ruth Kelly) I am not saying I think there was a regulation failure on the conduct of business side. I am saying that Baird very clearly shows that there should have been a more consistent and coherent approach to these issues. I am determined to see that that now happens, which is precisely why I have been pressing the FSA on this point. As I understand it, you are right. If there were evidence of failure, it would rest with the PIA and then it would be the industry which would be responsible.

Kali Mountford

  143. Policyholders who are making decisions about their financial future do the best they can with the information they have available to them. In this instance, they found that their reasonable expectations had been built on sand and in the Myners Report there is severe criticism of how transparent the industry is. If there had been a better definition of PRE, do you think that the Equitable Life episode could have been discovered earlier?
  (Ruth Kelly) That is a really interesting question. The nebulous nature of policyholders' reasonable expectations has been a recurrent issue throughout regulation. It is something to which the Baird Report clearly suggests more attention could have been paid over the years for which the FSA was responsible. As I understand it, that concept is going to change when the formal transfer of powers is handed over to one of fair treatment for consumers. The FSA is going to be devoting its efforts to establishing precisely how that can work in the best interests of consumers but policyholders' reasonable expectations have been an issue which has bedevilled the industry for a long time.

  144. While pursuing a similar line of inquiry with Sir Howard, I asked him if the concept had had its day and he agreed it had, with only a month to live. That leaves me with some concerns about existing policyholders not just for Equitable Life but across the insurance sector altogether, given that policyholders still have what they believe are their legitimate reasonable expectations from their policies. Would it be useful at this stage, even now, to properly define their reasonable expectations and have some sort of definition that has a legal bearing?
  (Ruth Kelly) What we would run the risk of doing is precisely to replicate one of the accusations that has been mounted against the issue of insurance guidance to insurance companies and that is to try to second guess how a court might interpret policyholders' reasonable expectations. There is a real danger of doing that—and then the industry and the policy holders place too much weight on how the regulator, which would be the FSA, interprets those legal issues. That is now a matter for the FSA to look at before the end of November. It is probably not the appropriate time to reconsider policyholder's reasonable expectations, as it is devoting a lot of its resources to understanding the new concept of fair treatment of consumers.

  145. I understood completely what both you and Sir Howard said about fair treatment but what I do not see is the transition between one set of concepts and the other and how consumers can have some understanding of what their legal position is, what their consumer rights are in this situation and what applies for them, given that they have policies that they have taken out under one set of suppositions and now they are looking into a whole new future. What protection is there for them?
  (Ruth Kelly) In some respects, that is precisely why the test cases were mounted in Equitable Life's case, to try and understand how a court might interpret policyholders' reasonable expectations and whether Equitable Life's practice was consistent with that interpretation. As it turned out, the House of Lords decided that it was not. Clearly others in the industry will have been following that interpretation closely but I do not think there is a very strong case for use of the regulator now to be advising on how that test case might apply to other parts of the industry, although clearly that is something that you should be putting to Howard Davies.

Mr Beard

  146. The only reason that anyone would have a motive for a guaranteed annuity arrangement would be to protect themselves against the position where the interest rate went down at some point in the future so that they had a certain base for their expectations of a pension. That is the basis upon which these policyholders that we are talking about were asked to invest and yet, at the time when the interest rate did fall and they were in need of this sort of guarantee, it was removed from them in such a way that this terminal bonus arrangement left them in no better position than someone who had not opted for this to begin with. It must be plain that that is not a reasonable expectation of a policyholder. It is a situation almost amounting to fraud or deception.
  (Ruth Kelly) The interpretation which the House of Lords put on Equitable's course of action was that it was not consistent with policyholders' reasonable expectations. There were other views prevalent at that time and other legal opinions, including that sought by Equitable Life itself, which couched these issues in much more vague terms than were subsequently arrived at by the House of Lords. There were different attitudes as to how consistent that policy practice would be for policyholders.

  147. It seems to me it is worse than that because the last time we had a session on Equitable, when we raised this sort of question, we were told this practice was common throughout the life insurance industry.
  (Ruth Kelly) As far as we understand it, Equitable is rather unique in that it neither imposed an explicit charge for its premiums, nor built up any concrete fund to meet those guarantees. As I understand it, it was fairly unique, if not entirely unique in the industry, for acting as it did. Other options were pursued by different insurance companies when these issues first emerged in the late 1980s.

  148. The government actuary said to us that the process of virtually abrogating GAR and putting it into a terminal bonus was prevalent throughout the industry. In addition to that, we have the rest of the Baird Report that tells us about an appointed actuary also acting as a chief executive. We have the whole question about the adequacy of reserves. We have the question of different figures given to the regulator compared with the figures put into the accounts and then we have this strange reinsurance policy added in. This is on behalf of Equitable, a company which was the oldest life insurance company and the gold standard of the life insurance sector. Does it not make you worried about what is going on in all these other cases if that is the best one behaving in this sort of way? Should not the Penrose Inquiry really be investigating the life insurance sector beyond Equitable, not just the issues arising from Equitable? There is a tendency—and there has been this morning—for us to be pursuing the regulators but they are a decoy. These are the people that we ought to be pursuing in the inquiry. Can you assure us that the Penrose Inquiry will indeed be pursuing this type of question right through the life insurance sector, not just with Equitable?
  (Ruth Kelly) I think there are two responses to that. The first is I thought it important that the lessons of Equitable be learned and to see what lessons could be learned from that particular experience for the whole of the life insurance industry. His terms of reference are clearly set out to enable him to pursue his agenda and I very much hope that he will interpret them to the full. The second is that there is a separate study being conducted by Ron Sandler which looks at the incentives behind the long term retail savings industry, which will also be able to consider some of these largely fundamental questions for the life insurance industry.

  149. The other danger is that the Baird Report and other means have revealed quite a lot already which implies that there is something rotten in the state of Denmark. Are we to wait until the Penrose Inquiry has reported before any of those issues are tackled or can we expect those issues to be tackled in the meantime, despite waiting for Penrose?
  (Ruth Kelly) Not only can we expect them to be tackled; I am absolutely determined to see that they are tackled, which is precisely why, on publishing the report, I wrote to Howard Davies asking him to report back to the Treasury on the actions which had been taken to implement those lessons and recommendations by 20 November. I am expecting a fairly substantive document outlining how the FSA intends to take that forward. What Penrose cannot do and what I cannot suggest is that the Penrose Inquiry will somehow be bound by the conclusions which emanate from this report. Penrose has a much wider remit. He is able to look back at history; he is able to look at other key participants; he is able to look across the market place at prevailing practice. He wrote to me to say that he cannot feel bound by the conclusions of the report. However, he accepts, I accept and the FSA accepts that it is important for them to make progress immediately, particularly on aspects which involve consultation with the market place, for instance, and reviews of their activities, and for the Penrose review to feed into that, to try and gain the best of both worlds.

Mr Fallon

  150. Could I declare an interest as an Equitable Life policyholder? Why did the Chancellor tell this Committee in March that there should not be an inquiry until the Baird Report had come out?
  (Ruth Kelly) I have not seen the proceedings of that Committee. The nature of the problem has changed significantly over the latest period. The reasoning behind the launch of the Baird Report in December 2000 was that the FSA should learn immediate lessons for the way it conducted its own stewardship of the Equitable Life and the industry over its period; that it should learn the lessons as it set up its own structure before the formal transfer of powers. On top of that, it became very clear to me over the summer that policyholder concern and concern from Parliament and indeed the Treasury Select Committee itself was very great on these issues; that the issues were not something that we could in any sense choose to ignore; that there might be wider implications for the industry and that the issues themselves on their merits deserved a full, independent inquiry. That is why I decided to go down that route.

  151. Originally, the Treasury's position was that an independent inquiry might prejudice the policyholders' decisions on the compromise deal.
  (Ruth Kelly) Once it became clear to me that an independent inquiry was to be launched or should be launched, I had a choice as to whether to await the Baird Report, which was to arrive at some time undefined, and to announce an independent inquiry as a response to Baird, or to act quickly and to set up the independent inquiry as soon as it was practicable to do so. I had a balance of issues to consider when making that judgment. One, as is very clear, is the speed with which Lord Penrose could get down to the work and the speed at which the report could finally be completed and the lessons learned both for Equitable Life itself and the rest of the industry. Another issue which was quite high on my agenda at that time was a desire to totally separate this independent report, as far as possible, from very delicate decisions which are being taken by Equitable Life policyholders as we speak. They are in the process of considering the compromise offer. I wanted to make absolutely clear, first of all, that I did not see this inquiry as in any way relating to the issues on the table of the compromise deal and therefore the earlier the announcement the better. Secondly, I wanted to use the opportunity to say very clearly—and not to mislead people—that I did not see at that time a role for public money to support in any sense a lifeboat for the Equitable Life Society, as I was being counselled that that was a view that was currently being held by certain policyholders. I used the opportunity to do both things, to separate the announcement of the inquiry from the compromise deal and to set straight the record on the Treasury view of an injection of public money.

  152. Returning for a moment to the section 68 order and the solvency for which you had responsibility, the section 68 order on 11 September that rejigged the Equitable balance sheet to the tune of £1.1 billion, was the Treasury aware that that order was passed on the advice of the government actuary's department that pre-dated the House of Lords decision?
  (Ruth Kelly) I do not think this was ever brought to the attention of ministers and we relied very heavily on the advice of the FSA for these orders. It is clear from Baird that a full assessment in the round was not presented together with the section 68 order.

  153. The answer is yes; you were not aware. Is that right?
  (Ruth Kelly) I do not think we were given the full picture of events.

  154. You were not aware that the advice was flawed because it was the advice of your own department, the Government Actuary's Department, given before the judgment that was relied on of 11 September?
  (Ruth Kelly) As far as I understand it, the FSA presented this to the Treasury as a routine regulatory issue, together with their advice that it should be granted.

  155. Can I ask you to comment on Sir Howard's admission this morning that there were management failures? You defended the single regulator structure. Do you agree that there were management failures at the FSA?
  (Ruth Kelly) Baird clearly shows that things could have been done in a different way.

  156. Do you agree?
  (Ruth Kelly) This report was never intended to lay the blame at any particular person's or institution's door. That is clearly set out at the beginning of the report. It is clearly written with the benefit of hindsight and the lessons which it draws are based on that assessment. Having said that, I do think there are issues which come out in this report which are of public interest and which Lord Penrose himself will want to take into account in his report. If anything, I think this report shows that a single regulator is the way forward, that what we want to do is to see the benefits flow as quickly as possible from the joint approach.

  157. The single regulator has admitted to management failure. Do you agree with that?
  (Ruth Kelly) I did not actually hear the earlier hearing.

  158. Do you think there has been management failure or not?
  (Ruth Kelly) The report itself says, although I stand to be corrected, that senior management could have taken a closer interest in some of these issues. To that extent, with the benefit of hindsight, it is clear that it would have been very helpful had senior personnel of the FSA taken a closer interest in events earlier.

  Chairman: Following Mr Fallon's statement about declaring an interest, a number of us discussed that earlier this morning and, given that we were looking at Equitable Life itself rather than legislation I ought to declare that I have an interest and maybe some other Members have.

  Mr Ruffley: I have.

  Mr Plaskitt: I have.

Dr Palmer

  159. I too. Why was no target date set for Lord Penrose to report? There are an awful lot of people out there who are very anxious to get a result quickly.
  (Ruth Kelly) Lord Penrose is probably the single most appropriate person to conduct this inquiry in that he is a very senior commercial judge but he is also an accountant by a previous profession. He is eminently qualified to carry out this inquiry. What he made clear to us in accepting his responsibilities was that he first of all wanted to familiarise himself with all of the particular issues surround Equitable Life; that he was not in a position to say exactly how he thought his inquiry would proceed, what evidence he would need to see etc., but he still had to become familiar with all of the issues involved. I thought, under those circumstances, it was better for him just to get stuck in and to make progress as quickly as possible. I remain of the view that he is an incredibly determined man who wants to get on top of this as quickly as possible and to report back to us as soon as he is able to.

  160. Do you think it is possible that he might not even be able to report back during this Parliament? The BCCI investigation has been going on for ten years, I believe.
  (Ruth Kelly) I am absolutely sure that what he wants to do is to make progress as quickly as he can. It would be ridiculous however for me to speculate on how his inquiry is going. I have no day to day contact with him and it is up to him what courses of action he chooses to pursue. Clearly, the routes which he chooses to go down will very much determine how quickly he reports, but that will be up to him.

  161. I do understand that we have to leave it to him but can you express an opinion from your position on whether it would be welcome in the interests of the large number of people out there who are waiting for the results if he were able to complete his investigation within this Parliament?
  (Ruth Kelly) I think Lord Penrose understands the urgency of this inquiry and is determined to get on top of the issues as quickly as he can.

Mr Laws

  162. Would you be disappointed if we did not have a report from Lord Penrose by the end of next year?
  (Ruth Kelly) I think it is unlikely that we will not have a report, given his determination to pursue the issues.

  Chairman: Can I thank you very much, Minister? You have not experienced that side of the counter before as a Treasury Committee member. I hope the experience the other side was novel for you. Can we thank you and your officials for your attendance this morning?

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