Exmination of Witnesses (Questions 200-219)|
TUESDAY 13 NOVEMBER 2001
200. Sir Howard, when you were answering the
Chairman's question, you said that the FSA liked to act in an
anticipatory problem-solving way. Later on you said: "We
need to be in problem-solving mode". Further on you said
that Equitable attracted a great deal of attention because of
your alarm scale; it was scoring more highly than others. In the
Baird Report in paragraph 4.39.2 it says here: "The IFSD
have told us that it did not consider it necessary to quantify
in numerical terms [and I am not sure what other terms you quantify
things in] the financial implications for Equitable Life in the
event that it lost the case", the case in the House of Lords
as it turned out. Further on in paragraph 4.60.1 the Baird Report
says, "There is no documentary evidence that the FSA analysed
the consequences at this stage during the bidding process for
Equitable which took place after the House of Lords ruling of
the Equitable Life failing. They did not assess the consequence
of Equitable Life failing to find a buyer or request any information
from Equitable Life on this worst case scenario". Sir Howard,
why did the FSA not assess the worst case scenario both regarding
the House of Lords' ruling and the absence of a buyer for Equitable?
(Sir Howard Davies) Certainly part of my response
to the Baird Inquiry and my Board's response is that in future
we should do more of that; and that in future we should be game
planning the outcomes of circumstances of this kind. I have to
say, we fondly hope that we would not find repeat circumstances
of this kind; but if we do find difficulties developing then it
is certainly one of the conclusions I draw from the Baird Report
that we should do more anticipatory work. That is the culture
we are trying to build into the Authority at present. I do not,
therefore, seek to deny to the Committee that I wish we had done
that. I would, however, say that it is not wholly clear in the
circumstancesand given the fact that the court case began
before we took over and developed in a way that we could not influencewhat
we would have done with that scenario planning in the event. It
is not clear what regulatory actions we could have taken. Indeed,
the Report, although it criticises us for not doing that kind
of scenario planning (I believe rightly, because I believe in
future circumstances we should do that), it does not find that
in the circumstances there would be anything we could have done
usefully on the basis of it.
201. Has the FSA made any assessment of what
will happen or made any preparation if the policyholders fail
to agree the compromise deal which is now before them?
(Sir Howard Davies) Yes, we certainly have looked
very carefully already at what the consequences of that might
be, and what the company would need to do and what our response
to it needs to be, certainly.
202. Sir Howard, just to follow up something
Mr Fallon mentioned in the implicit future profits item and it
is regarding the contract, the reinsurance agreement, which Equitable
entered into with the Irish European Reinsurance Company. Under
the terms of that the IERC would recover in instalments from Equitable
Life any payments that it made so reducing the profits of the
life assurer. Firstly, were the Insurance Supervisory Committee
informed that the future profits implicit item may be adversely
affected by any claim made by Equitable Life on their reinsurance
contract? Secondly, was the interdependence between the reinsurance
contract and the future profits implicit item properly considered
by the FSA?
(Sir Howard Davies) Yes, I believe that on those two
points the Government Actuaries Department, who assessed this
contract, were aware of that interdependence, and were aware of
the relationship with the future profits item. I should say two
things on this point, Mr Chairman: one, that in the Authority
we are by no means happy about the nature of these reinsurance
contracts. I described them last time as sometimes being in the
nature of "window dressing". One central part of Mr
Tiner's review will be to look very carefully at the nature of
the rules surrounding reinsurance contracts with a view to assessing
whether they can be tightened up. That is something which is very
much on our agenda. I would also like to add one other point in
relation to this contract. Some information about the contract,
of which we were not aware at the time and of which the review
team were not aware, has more recently come to light. That is
currently the subject of commercial negotiations, and I would
be grateful if the Committee will allow me to send them a note
on the subject, rather than go into it any further.
203. Thank you. I will not ask any more questions.
It gives us a little bit of concern when you tell us you are not
happy with the reinsurance contract. I think it is something we
will come back to as well.
(Sir Howard Davies) I would be very happy for you
to do so. I would certainly be happy to give a longer explanation
in a letter to you, Mr Chairman.
Chairman: On the role of the Appointed
Actuary, I will ask Mr Plaskitt to ask you some questions.
204. Sir Howard, can you just remind us what
is the responsibility of the Appointed Actuary?
(Mr Tiner) I think the responsibility of the Appointed
Actuary is towards the policyholders to ensure that the reasonable
expectations of the policyholders are met by the insurance firm.
205. In the case of Equitable Life between 1991
and 2000, who were the Appointed Actuaries, can you remind us?
(Sir Howard Davies) The current Appointed Actuary
is Peter Nowell; the Appointed Actuary was Mr Christopher Headdon
who took over from Mr Roy Ranson. I cannot recall instantly the
precise dates on which one took over from the other.
206. The last two names you mentioned, they
covered the period of 1991 to 2000. While they were the Appointed
Actuaries of the firm did they have any other responsibilities
in the firm?
(Sir Howard Davies) Yes, at various times they were
also Managing Director of the firm.
207. Does that not create a conflict?
(Sir Howard Davies) It is a practice which has grown
up in the insurance industryI am not happy with it.
208. You did in fact in evidence to us two weeks
ago refer to that as "operated with severe tension".
Would you stand by that?
(Sir Howard Davies) Yes.
209. Given that they were the Appointed Actuaries
and there was that tension, do you think it was rigorous enough
for you to rely, without any independent assessment, on what the
Appointed Actuaries were telling you about what was the state
of play inside Equitable Life?
(Sir Howard Davies) We had no basis on which to believe
that we were not being given an accurate picture and, therefore,
I think we were reasonable in placing reliance on that. The principle
on which insurance regulation has operated for many years has
been that the Appointed Actuary is the policyholders' frontline
defender, if you like. We did, however, of course have access
to advice from the Government Actuaries Department, which reviews
the returns on our behalf. Until quite recently that was managed
outside the Authority. Now those actuaries have been transferred
within. I think we did feel we could reasonably place reliance
on the Government Actuaries' assessment of what the Appointed
210. Can it really be that the frontline defender
of the policyholders are also the Chief Executive of the company?
(Sir Howard Davies) In my view it is not satisfactory.
It is a position I inherited in this company and a number of others,
and I have said as clearly as I can that I do not like it. It
is something we are reviewing in an attempt to change those rules.
211. Yet when Equitable Life was transferred
over to you, albeit the same people coming over with their files,
it had this red light flashing on it; and still, also knowing
about the severe tension and now feeling that it is inadequate,
it seems that no independent effort was made to check what the
actuary was telling you about the state of the company with regard
to reinsurance or reserving requirements?
(Sir Howard Davies) No, I would not accept that. The
Government's Actuaries department did carefully review the reinsurance
contract on the basis of the information that they were given
about it. We believed we could place reliance on that.
212. The Baird Report tells us that "the
regulator may intervene if it considers the Appointed Actuary's
decision here in relation to reserving or reinsurance is a breach
of the criteria to sound and prudent management". Do you
not consider it so?
(Sir Howard Davies) We did not consider that the criteria
of sound and prudent management had been breached, no, otherwise
we would have intervened.
213. Looking back, do you wish that some independent
investigation had taken place for you to judge what the Actuary
was telling you?
(Sir Howard Davies) As I look back at the period from
1 January 1999 I am not sure that that would have yielded a particularly
useful result from a regulatory point of view. I think that the
line we were taking in pressing the company to increase its reserves
was an appropriate one in the circumstances; but that, given over
a long period of time the company had run with guaranteed annuity
policies without any reserves, it is not clear to me what an independent
assessment would have delivered in terms of consequences for the
policyholders. As the Report points out in paragraph 6.2.3 where
Baird says: "It is important to recognise that, once the
GAR took effect . . ., there were no quick solutions or cures
for a company in the position of Equitable Life, a mutual with-profits
insurer which had limited free assets. In the event of such a
contingent liability crystallising (which was the effect of the
House of Lords' judgment), the only viable option open to it was
to raise external additional capital by putting itself up for
sale". I think that the only consequence of an external review
would have been to reveal perhaps more starkly than had been revealed
before that that was the position. I do not think it could have
led us to take any steps that we did not take which would have
had a useful outcome from the policyholder point of view.
214. But that leaves you relying on what you
have been told by the Appointed Actuary whom, you now yourself
accept, operates under severe tension in a situation that is inadequate.
That cannot go on.
(Sir Howard Davies) Yes, I believe that should not
go on. That is an issue about the nature of the regime which,
I have made clear to the Committee, I have a number of unhappinesses
about. I think that is a different point from saying that if we
had independent review we would have done anything different.
It is not clear to me that we would have done.
215. You have said you are not happy about it.
Baird just says that he should be covered by an external actuary.
Are you going further than that?
(Sir Howard Davies) We are looking at two issues.
Perhaps Mr Tiner can explain what we are doing now.
(Mr Tiner) There are two issues we are looking at.
The first one is the extent to which the Appointed Actuary should
be able to hold officer positions in a companyin other
words, Managing Director or, indeed, any other role on the Board;
or whether the Appointed Actuary should simply be an employee
of the company, and not have a direct responsibility to the shareholders.
The other issue is whether, as proposed by the Corley Committee,
set up by the Institute of Actuaries, there should in addition
to that be an independent actuarial review of the findings of
the Appointed Actuary to find another level of protection; in
the same way that external auditors review the financial statements
of companies. There are two distinct issues we are looking at
(Sir Howard Davies) The Baird Review does say at 7.3:
"We recommend that Appointed Actuaries should be subject
to independent external review. This may be carried out by the
FSA or by independent firms . . .." So we are looking at
216. No, I said that is what he did, but were
you going further? It sounds as though you might go further?
(Sir Howard Davies) We are going further, I think,
in relation to looking at the role of the Appointed Actuary, where
the Baird Report does not, in fact, recommend that the Appointed
Actuary should not hold an executive position.
217. You would be content if they were still
in that companyan employee of that company?
(Sir Howard Davies) Interestingly, you put your finger
on an area where I actually have to say I personally wish in this
area that the Baird Committee had been more aggressive. I personally
am not happy with the twin-hatted roles; although I recognise
that there are those in the industry who say that particularly
in a mutual it is perfectly appropriate, because in a mutual there
is no distinction between a shareholder and a policyholder and,
therefore, clearly the potential tension arises less in the case
of the mutual. They also argue that, if you want to have a high
quality of actuaries and you want to develop actuaries and get
the best possible people, sometimes it is appropriate to also
give them senior management positions as well. I recognise that
there are some arguments that may be advanced on the other side.
My personal view, and this will have to be debated because to
make such a change we will need to consult on it and look at the
costs and benefits of doing so, is that I would prefer this to
be a cleaner separation, and for it to be very clear on whose
behalf the Appointed Actuary is working.
218. That is good for the future and that is
encouraging, but let us take the past. I thought you were a bit
gentle with the way the Appointed Actuary behaved over the years.
He misled you at the FSA; he misled the Government Actuary; he
led the FSA to agree the Section 68 Order that gave them the margins
and therefore stopped you coming in and taking action. He did
all that but there seems to be no criticism, apart from a general
future position that we might want to separate this. If I were
a policyholder losing thousands of pounds and this fellow behaved
in this way, I would be expecting you to be somewhat angrier,
and Baird to be somewhat angrier about it?
(Sir Howard Davies) I shall treasure the description
of me as "gentle", which is not something I hear a whole
lot in the City.
219. I am mindful you are a Manchester City
supporter and you need all the support you can get!
(Sir Howard Davies) "Simple" is perhaps
a better description. I think the reason why you do not find that
criticism is because of the nature of the Baird Report. The nature
of the Baird Report was to look at the actions of the FSA itself.
It only looked at what Equitable did in order to illuminate what
the regulator did. It is, therefore, a partial view of the responsibilities
of the various players in this unhappy game for the position we
are now in. Undoubtedly, the Lord Penrose Inquiry will look at
the actions of the company, its management and its advisors over
a longer period; and that is something we very much welcome.