Exmination of Witnesses (Questions 220-239)|
TUESDAY 13 NOVEMBER 2001
220. We have a company here that is a one-off
in terms of no reserves, and we have already heard that a Section
68 Order was passed over the telephone. There were no warning
bells; no closer scrutiny because of particular circumstances
of this company. I find it strange on reinsurance that the same
thing happens. The FSA are surprised to find that it is an Irish
company and so it is reinsured in a way they do not support. That
is the first thing. Secondly, the terminal bonuses clause is withheld
from you. It is clear that the FSA did not see it, did not ask
to see it. In view of the background and the uniqueness of the
company, that does seem complacent from the FSA.
(Sir Howard Davies) You draw attention to some aspects
where we could wish that we had been more probing and more sceptical.
One thing that we have learned and that is a very firm recommendation
in the report is that we should be more proactive and in some
cases more sceptical. I think it is fair to say that the supervisors
were aware, as indeed in their assessment quoted in here in relation
to the character of the company, that there were problems with
it but they were surprised during the period to find that there
were things that they were not told which they would normally
have expected and of which they would have had a reasonable expectation,
given the way in which insurance supervision worked, of having
them drawn to their attention in a timely way by the company and
which were not. As for the future, I very much hope that we have
learned that lesson. I would also say, and this is one of the
most encouraging aspects of the story, that I believe the insurance
companies themselves have learned that lesson. As I say, we have
had volunteered to us the view that people can see that they want
a different and better character of relationship. I would not
hide from you the fact that you are right to draw attention to
the fact that there were times when we should perhaps have been
more aggressive in relation to Equitable Life.
221. When did the FSA first find out about the
terminal bonus cost?
(Sir Howard Davies) I am not sure that I can reliably
answer that except as it is in the report.
222. In the Baird Report there is the fact that
Ernst & Young as part of the takeover drew it to your attention
in November 2000. I have never seen anything in the preceding
paragraphs that suggests that you leapt into actionI do
not know whether you knew before but it does not seem as though
anything happened. In the Baird Report in one of the paragraphs
they tell the FSA, and actually specifically mention it to you
in the next paragraph.
(Sir Howard Davies) This is November 2000?
223. Yes. What happened after that? There is
nothing in the report that you immediately notice.
(Sir Howard Davies) At that point the clear focus
was first of all on dealing with the sale of the company and during
that time we were very closely involved in discussions with the
various potential candidates who were aiming to purchase the company.
Of course all of them had to come in and talk to us about their
plans and whether they would meet our regulatory requirements
and so on. At that point, I think it is fair to say that the supervisors'
focus was on seeking to achieve a successful sale of the company
which we actually did think was going to happen until a very few
days before 8 December, in the week before.
224. But, Sir Howard, that is alarming because
you allowed that company to be sold even though you knew the reinsurance
was very doubtful.
(Sir Howard Davies) I am sorry. The reinsurance? I
thought you were talking about the terminal bonus.
225. That is linked to the reinsurance. There
was a clause in there which said if the terminal bonus is changed
the reinsurance falls.
(Sir Howard Davies) No; sorry. We know about that.
I thought you were talking about the issue of the unquantifiable
nature of the liabilities. I am sorry. We knew that that was the
case earlier. We knew that if the bonus policy changed the reinsurance
policy was not valid. The purchasers would not, I believe it is
right to say, have needed or wanted the reinsurance policy because
the reinsurance policy was designed to create a temporary strengthener
if you like for the Equitable's balance sheet which would not
have been needed had it been folded into another company and more
capital had been injected into it, so that would have fallen away.
226. But the reinsurance contract was unsigned,
was it not, in 1998?
(Sir Howard Davies) Yes. The report does point out
that the company told us that the reinsurance policy had been
settled and agreed but that it in fact was not signed for some
time afterwards and that had not been drawn to our attention.
227. Until 1999 in fact.
(Sir Howard Davies) Yes.
228. Why was that allowed to happen?
(Sir Howard Davies) I think that in future we will
certainly ask to see a signed policy but we had seen the negotiation,
we had seen the terms of it, we were told by the company that
it had been done and I suppose we believed them because you tend
to do if you look at a company like the Equitable, if they tell
you that they have agreed and signed a policy. In fact, I do not
think it had huge significance because what was eventually signed
was what we were told was going to be signed.
229. So the FSA is very trusting?
(Sir Howard Davies) Once again, not an accusation
frequently levelled at me. I think "very trusting" would
be wrong as a general statement. Perhaps we were too trusting
in this particular case.
230. Would that level of trust be given to any
other company in similar circumstances?
(Sir Howard Davies) I think it is right to point out,
Ms Mountford, that we do have to rely in many cases on companies
telling us the truth and telling us what is going on and doing
so in good faith, because we do not have the numbers of staff,
the ability, to double-check every document. We have to accept
that companies will tell us that things have been done, tell us
that things are happening and we would normally believe them until
we had some reason to do otherwise. I hope that is not too credulous
on our part but in regulation, as in business, that is just the
basis on which you tend to operate. In this case I do not think
it had a great significance.
231. Signed or unsigned, what was the motive
behind allowing the reinsurance contract to be included at all?
(Sir Howard Davies) The regulations as they stand
allow companies to reinsure their liabilities and that is in many
cases a wholly reasonable thing to do, certainly in the general
insurance market, but it also has a place in the reserving for
life policies. It can be done sometimes in order to take the benefit
of future earnings by seeking to get some capital support for
the current nature of the business, so a business which is growing
quite quickly might perfectly reasonably use reinsurance to strengthen
its balance sheet now, in recognition that the policies that it
is putting on will generate profits in the future. It is a perfectly
reasonable part of the regulatory regime in normal circumstances.
232. But when we last met you said that it creates
an opaque view of the company's assets and liabilities. When did
you come to that view?
(Sir Howard Davies) It can do if the terms of it are
not fully disclosed and the Baird Report makes one pointed criticism
here, which we accept, which is that the disclosure of the reinsurance
policy did not make it clear that it would be subject to change
if the bonus policy that the company had was ruled unlawful by
the House of Lords. We knew that. We understood the purpose of
the policy but I think it would have been better had the terms
of that been disclosed because it has created some misunderstanding
233. We have covered a lot of that ground previously
so I can only hope that when we look at your note on negotiations
we can take some of these issues forward, but would it not be
fair to say that there are a lot of lessons to be learned about
(Mr Tiner) Yes. In fact in the review that I am taking
forward we are going to look at the whole area of financial engineering
that insurance companies have been engaged in and that falls into
three parts. Two we talked about this morning: the implicit profits,
as has been raised, the whole area of financial reinsurance and
the type of financial reinsurance that falls into the window dressing
category. The third is the role of subordinated lending and contingent
loans which all can have the same impact economically. We are
just going to have a look at that whole area to see what needs
to be done to tighten it up in the future.
234. Given your answer just now, Sir Howard,
are you confident that whatever new regulatory regime you want
to introduce you are capable of delivering it?
(Sir Howard Davies) I very much hope we are.
235. I wanted to clarify one thing, which is
your view of Equitable Life. You have said I think that they have
been lying to you categorically, that you rely on firms to tell
you the truth, that they did not tell you the truth about signing
this contract. You said that you rely on people to act in good
faith and so by implication that Equitable Life were not acting
in good faith. The only alternative to good faith is bad faith.
Am I correct in taking your judgement to be that they acted in
bad faith and that they lied?
(Sir Howard Davies) No, I do not think I have said
that they lied and I do not think I could support that. What I
have said, and I have quoted the assessment which appears in the
Baird Report of the culture of the company's dealings, and that
was an assessment made by the supervisors at the time, and the
Baird Report does draw attention to a number of areas where the
company took a somewhat difficult line with us. I would not wish
to suggest that that was true at all points. We had perfectly
civil relationships with the senior management on many occasions,
many discussions which were perfectly helpful, but the report
does draw attention to one or two examples of where the information
flow from the company to us was not what we would have liked,
was somewhat partial. I do not think it is fair to say that that
is lying because I do not think that the company ever said to
us, "We have signed the policy" at a point at which
they had not. They said, "The policy has been agreed"
and I think we perhaps took it to mean that that policy had been
signed. It had not been but it subsequently was.
236. Did you feel misled?
(Sir Howard Davies) I would not be able personally
to say whether we were misled because I am not quite sure of the
terms under which the communication about the reinsurance policy
was made to our people. I am not sure I could personally answer
237. I have to say that on the one hand you
are saying that you rely on firms to act in good faith; you have
told us you rely on them to tell you the truth. On the other hand,
when asked specifically in this case (and you raised those points
in response to questions as to why you had not followed up some
of these issues) you are saying by implication that because you
were not supplied with the information by the firm that you were
not able to do so, and yet when you are pressed to say whether
you felt that they acted in bad faith or that they had not told
you the truth or whether they had misled you, you are only prepared
to say that the information they supplied to you was "somewhat
partial" and that dealing with the firm was "somewhat
difficult". There is a credibility gap there it seems to
me between your description of what they said to you and what
you, when pressed, described as their behaviour.
(Sir Howard Davies) I hope there is not a gap. I have
tried not to engage in colourful language in relation to the company
because I seek to look at this in an objective way. I have quoted
the language that our supervisors produced when they were asked
to describe the company and the way in which they dealt with us.
What I noticed throughout the story, and the Baird Report sets
this out, is a situation in which the company (and I do not think
I am pointing to things which they deliberately concealed and
in the report I do not think it points to that) was not particularly
forthcoming and clearly did not think that the regulator could
be a useful contributor to resolving the Society's difficulties.
Indeed for a long period the Society did not think it had any
difficulties. In the normal way, and this might be difficult to
explain, most of the companies with which we deal operate on the
basis that they want to stay within the rules, that they want
to operate in a way that is sound and prudent etc, and they will
typically come to us very frequently for comfort that that is
what they are doing and they will typically want to talk to us
about solving problems as they arise. That is not always the case
and we always have a list of firms who are perhaps less co-operative
and that shows up on our risk assessment. Normally that is the
approach in relation to prudential regulation. In this jurisdiction,
Mr Tyrie, over many years it has not been a confrontational business
for the most part on the prudential side. What this story shows
is that the normal way in which you would expect that relationship
to work did not work in this case. The company did not come in
and say, "We think we are getting into a difficulty with
the PIA Ombudsman and we think we may have to resolve the legal
position and we are thinking that perhaps we might want to take
a case. Could we talk about how that might be managed and whether
you would want to be in the case", etc, etc. There was none
of that. The company made its decisions and let us know what they
were. That is different from characterising them as bad faith,
which I do not think I would be prepared to do.
238. Is it your view that Equitable Life were
acting in good faith when they told you that they had agreed the
contract but did not tell you that they had not signed it?
(Sir Howard Davies) I would find it very difficult
to answer that question. On this matter of the circumstances of
the reinsurance contract, as I have said, I would like to write
to the Chairman. 
239. You have said that most firms want to stay
within the rules. In your dealings with Equitable Life did you
think that Equitable Life wanted to stay within the rules?
(Sir Howard Davies) Yes, I think they did.
2 See p. 55. Back