Select Committee on Treasury Minutes of Evidence

Exmination of Witnesses (Questions 200-219)



  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 circumstances—and given the fact that the court case began before we took over and developed in a way that we could not influence—what 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.

Mr Plaskitt

  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 industry—I 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 Actuary said.

  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.

Mr Mudie

  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 company—in 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 there.
  (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 that recommendation.

  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 company—an 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.

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