Select Committee on Treasury Minutes of Evidence

Exmination of Witnesses (Questions 220-239)



  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 action—I 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.

Kali Mountford

  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 subsequently.

  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 reinsurance?
  (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.

Mr Tyrie

  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 that question.

  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. [2]

  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

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