Exmination of Witnesses (Questions 320-338)|
TUESDAY 13 NOVEMBER 2001
320. You have these papers, do you not?
(Sir Howard Davies) Which?
321. Prior to January 1999?
(Sir Howard Davies) Yes.
322. Does the Treasury have full access to those
(Sir Howard Davies) Yes.
323. I would like to clarify one answer which
you gave my colleague Mr Laws. You said that the actions taken
with regard to allowing Equitable to continue advertising were
best for policyholders as a whole. Would you also describe the
decision as best for new policyholders?
(Sir Howard Davies) I think that would be a very difficult
question to answer because that would depend on what else the
new policyholders might have done if they had not joined Equitable
Life. I think that would be very difficult to answer.
324. With respect, you did find yourself able
to answer the question for all policy holders. I think there is
a reasonable doubt whether that decision was helpful for new policyholders.
It sustains the view that new policyholders were to some extent
used to rescue the old policy holders.
(Sir Howard Davies) That is certainly not the way
I would see it but, as I say, it is difficult to answer in relation
to new policyholders because it would depend on what they would
have done with the money otherwise.
325. Have you had any complaints from new policyholders?
(Sir Howard Davies) We have had, yes.
326. Do you not have some sympathy for these
complaints, that they basically have been misled by the advertising
to support the business as a whole?
(Sir Howard Davies) Whether they were misled by the
advertising I would not think I could say was definitely the case.
I certainly have sympathy with new policyholders who came into
the Equitable Life during the course of this. I think that they,
like any policyholders, have a reasonable assumption that they
are going into a company which will remain a going concern and
they find themselves policyholders in a closed fund. Closed funds
are not necessarily in the long run particularly bad places to
be but this one is a closed fund which of course is somewhat unstable
at the present time and therefore think that we are at the point
at which there is maximum uncertainty and maximum unhappiness
about the policyholders who came in because they are not quite
sure what the stability of the fund is going to be. That of course
will be considerably clearer, we hope, if a compromise scheme
goes through in the early part of next year but I recognise that
at the moment it is a very unhappy time for those policyholders.
327. In defending policyholders do you feel
you have a duty to try to defend the interests of each group of
policyholders or do you feel that you only have a duty to protect
policyholders of a company as a whole?
(Sir Howard Davies) I think that we would say that
we had a duty to protect policyholders and in certain circumstances,
such as the compromise scheme, it is necessary for us to look
at the position of different groups of policyholders and reach
a view as to whether their interests are being properly represented
and whether they are being treated fairly, so yes, on occasion
we do interpret that as meaning that we have to look at particular
groups of policyholders.
328. But you do not feel that your position
necessarily has to be in the interests of a particular group of
policyholders if it would benefit the collective of policyholders?
(Sir Howard Davies) There are certain absolutes and
there are certain relativities if you like in that clearly if
a group of policyholders has been given guaranteed benefits then
I would say that that is an absolute and we should ensure that
those guaranteed benefits are being met in the way in which the
fund is handling itself. There are of course other circumstances
and the compromise scheme is one where essentially the task that
the company faces and something that we must look at when they
have produced their final version is to produce a scheme which
attempts to take account of conflicting claims by different groups
of policyholders which are extremely difficult to quantify with
any degree of certainty because they rest on legal claims and
the probabilities of success attached to those legal claims. In
those circumstances one has to strike a balance between the interests
of different groups and there is a need to weigh that up.
329. Let me raise the statement made on 16 July
2001 by Equitable Life where they announced the reduced pension
policy values by 16 per cent. Among the reasons for this they
said that the decision could not be delayed because stock markets
have fallen, maturity values exceed the value of the investments
and, "As a mature fund, a large number of policy holders
are currently retiring and taking their benefits." Do you
consider that this is a reason for not delaying the action? Do
you feel that in a fund where a large number of policy holders
were not yet taking the benefits they could have just waited and
hoped for the best?
(Sir Howard Davies) That was a decision for the company
to take. We did feel that they had taken that decision taking
into account the interests of different groups of policyholders
and the difficult position that they found themselves in was that
retiring policy holders were able to take away a significantly
larger sum than represented by their asset share given the way
the markets had moved. Of course retiring policyholders were not
subject to the market value adjuster which had been put in place
by the company and which of course has now been put in place by
many other companies as well to ensure that people who leave the
fund do not take an "unfair" amount of money with them.
That could not be done for retiring investors where there is no
market value adjuster on the amount of the fund. Of course other
companies will do that typically by changing their terminal bonus
rates from year to year and because for most other companies the
terminal bonus represents a much larger proportion of the total
return than it did in the case of Equitable who had a policy,
as the Committee knows, of distributing bonuses along the life
of policies and therefore had much less flexibility at the end.
They were faced with having to do this in a rather stark way in
the way that other companies were able to do by adjusting the
levels of terminal bonus which of course have come down in the
last year or two quite significantly from what they were in the
330. I do take the point. However, the point
that I was asking you about is whether you feel that it was relevant
that a large number of policy holders were coming up to retirement
imminently. Do you not feel that any assurance company should
be taking an actuarial view of the balance of benefits and assets
and not hoping that the situation will correct itself if there
is an imbalance of the kind that you describe?
(Sir Howard Davies) I think in taking the decision
in July the company was taking the view that it could not just
hope that this balance would be corrected and that it had to take
some action to deal with it. I would emphasise that the particular
action they took was a decision for the company. We do not make
those decisions. We have to satisfy ourselves that they are decisions
which a sound and prudent management could reasonably take.
331. How does your regulation of closed funds
differ from that of open funds? Do you have different requirements
for reserves or about the value of investments compared with the
value of the policies?
(Sir Howard Davies) Yes. There are certain differences.
Of course there is little in the way of conduct of business regulation
because they are not selling. In the case of the reserving etc
there are obviously things like future profits items which have
to be looked at very differently because you are not taking on
new business and generating future profits and also of course,
as the fund matures and pay-outs increase, there is typically
a shift away from equities to gilts to reflect the maturing nature
of the fund, so we have a special team that looks at closed funds,
of which there a large number, many dozens of them, which takes
account of those particular features in setting their reserving
332. Would you feel that closed businesses need
to take greater account of the value of maturing policies compared
with the value of investments or do you feel that this is something
which is equally important to open funds?
(Sir Howard Davies) It is important to every fund
although it might present itself slightly differently in the case
of closed funds. I think every fund has to satisfy itself that
it is not getting into a position where it is robbing Peter to
pay Paul too much.
333. But in their statement of July 16 Equitable
Life sought to draw a distinction. They said: "However, because
it is closed to new business the Board must take greater account
of the value of maturing policies compared to the value of investments
underlying those policies", which appears to mean that if
it had been an open fund they would have encouraged new investors
to underwrite the gap for the existing investors. Would you agree
(Sir Howard Davies) I would not have drawn that conclusion.
I think that the greater account could refer to a number of things.
Because of the particular position of the Equitable Life and its
bonusing policy they were particularly affected by this movement,
but there is inherent in all life funds a set of redistributions
if you like through the fund. Immediately normally the writing
of new business imposes a strain on the fund. The writing of new
business is not a way of solving a fund's problems which is perhaps
part of the background to why I do not think it is right to characterise
us as using the new policies to bail out the old because in the
normal way if you put on a new policy you have to reserve for
that to start with. It does not help your reserving policy to
write new business in the short run although it does mean you
can take a larger future profits item in due course.
334. Can I ask a general question because one
of the things that must worry people that put money in long term
and two-thirds of the way through a policy they think they know
the situation is reversionary bonuses. On every policy that I
have had with reversionary bonuses there are words to the effect
that once you have earned these they will not be taken away. You
understand the terminal bonus can fluctuate and you watch that
anxiously but you regard the reversionary bonus as being in the
bank. As our guardian, there seems to be leeway for insurance
companies even to interfere with reversionary bonuses.
(Sir Howard Davies) No, I think not because I would
put those in the guaranteed box. The life companies would typically
operate with such a healthy degree of margin between their guaranteed
commitments and the total assets in the fund that I cannot think
of a case in recent years where there has been a problem about
guaranteeing reversionary bonuses. The problem with the Equitable
Life in terms of its presentation of its returns is that the Equitable
took the view first that it would pay out bonuses as it went along,
but also that it would give people a continued regular update
of what they expected the value of the policy to be on maturity.
This was regarded by many people of course as a positive thing
because it was certainly in many respects more transparent than
the return that you typically get, and I congratulate you, Mr
Mudie, for understanding your returns on life policy which is
not given to everyone. The Equitable typically said, "This
is what you will get if your policy now matures". In fact,
those were not guaranteed because they included an element of
the terminal bonus which the company was forecasting. When the
16 per cent cut occurred in July there were many policyholders
who believed, and I have to say not unreasonably believed, that
they had lost guaranteed value because that is the number that
they had been looking at over time as the number that they expected
to get. The company points out also, legally correctly, that those
were not guaranteed; they were a reasonable forecast of what they
expected to happen. I think that is where the confusion about
the status of reversionary and guaranteed and terminal bonuses
comes from in relation to Equitable.
335. Sir Howard, the justification for the cut
in policy values was that they are materially greater than the
underlying asset values. What does this say about the regulatory
approach to bonus declarations, some of which must have been over-generous?
(Sir Howard Davies) Yes. It is the case that companies
have considerable discretion and that is built into their policies
to pay different bonuses at different times. Indeed, over the
last three or four years companies have typically been paying
out above asset shares, not just Equitable Life; many companies
have been paying out above asset shares. In practice in many cases
that has been eating into the inherited estate. That is something
which companies are allowed to do and they will amend their bonus
policies up or down depending on the state of the market as well
as the state of the fund. It is clearly inherent in with-profits
policies that there is no precision about whether you get back
precisely the asset share or more or less. One of the reasons
why Equitable Life policyholders as they look now at what they
have got and what other people have been getting, and Equitable's
returns have slipped well down the league in the last couple of
years, is that many other companies have been paying out more
than asset share over the last two or three years, and I would
suspect that that is unlikely to continue. The returns therefore
between Equitable Life and others may well, depending on the compromise
scheme, come closer together over the next few years. That is
a little bit hard to forecast.
336. That could mean that some people in the
future get less than asset share?
(Sir Howard Davies) It certainly could and some indeed
in the past have done.
337. Sir Howard, you wanted to make a statement
on behalf of the Board regarding the Baird Report.
(Sir Howard Davies) Yes, thank you. I can be extremely
brief because most of what I wanted to say has been covered. I
simply thought it right to say that the Board recognised when
it commissioned the review that it could only cover part of the
history but it believed that, given that we had continuing and,
as of 1 December, more formal responsibility for insurance, that
it was very important as a matter of good practice that the Board
should assess the performance of the Authority in determining
lessons for the future. It did that therefore in advance of the
Government's decision to hold a further inquiry by Lord Penrose
which would cover a longer period. When it looked at the report,
the Board noted that this was a snapshot taken very early in the
life of the new regulator. The conduct of business regulators
were still working to a service level agreement with the PIA Board
and the insurance regulators were working under contracted out
provisions from the Treasury. They were therefore still managed
separately within the Authority. They noted that the report says
that it was explicitly written with the benefit of hindsight and
they noted the overall conclusions of the review which we have
discussed several times over the last two hearings. The Board
acknowledged that the report made at times uncomfortable reading
and that it made pertinent criticisms of management and of communication
with the Authority, criticisms which required a firm and rapid
response. They noted however that many of the management changes
needed in response had already been implemented. The conduct of
business and prudential regulators were merged on 1 April this
year when we had some certainty about the N2 date and responsibility
for the nine largest groups, which is about 57 per cent of the
life sector, was transferred out of the insurance division into
the major financial groups division which is the part of the Authority
that supervises large integrated groups which require a particular
character of relationship because of their crucial importance
in the financial system. Responsibility for prudential policy
has been moved into a new Prudential Standards Division which
includes former Bank of England staff responsible for prudential
policy in banks in order to ensure that we learn the lessons of
other types of prudential regulation for insurance and all of
these changes have significantly strengthened the resources devoted
to insurance regulation and brought new skills and fresh eyes
to bear on the problems. The Board is convinced that we do need
an increase in the net resources devoted to insurance regulation.
We inherited, including the actuaries, about 35 people to regulate
the whole of the life insurance sector which, if you compare with
what we would do with comparable banks with the size of balance
sheets, would be well under half what we inherited from the Bank
of England. For the future of the regulatory regime itself the
Board have asked John Tiner to carry out a project which we have
described. A team of 12 people has been set up, half from outside
the Authority, and we will publish a detailed paper on that work
before the end of this month. After careful consideration of those
changes and the management's response to the Baird Report, the
Board confirm their confidence in the management of the Authority
to take forward the regulation of insurance, but will closely
monitor progress on these initiatives. Of course, since the report
was published, the Parliamentary Commissioner for Administration
announced a further inquiry into part of our regulation of Equitable
Life over the same period and we will co-operate fully with that
inquiry and with Lord Penrose.
338. Thank you very much, Sir Howard. You made
the point that the management changes have been made but I think
there is an open mind in this Committee about the effectiveness
of the management changes and the regulation. We will be keeping
in touch with you on that. We look forward to the written submissions
that you are making as a result of comments this morning and the
opportunity to see you again on this particular issue. Could I
end the session by asking a simple question, hopefully non-controversial?
It is on Railtrack. On 16 October you appeared before the Committee
and you said that you were making certain enquiries into the market
in Railtrack plc shares before the company went into railway administration.
Could you inform us what progress you have made in those enquires
and when you expect to come to a conclusion on the matter?
(Sir Howard Davies) We wrote to the company to ask
the company to supply us with information about, colloquially,
what it knew and when and what it said to its shareholders. We
received a large amount of documentation from the company last
Friday which we are now looking through as a matter of urgency.
Our preliminary review of that documentation has caused us to
write to the Department of Transport to ask for their responses
to certain questions about what they said to the company and what
they thought the company knew. This follows the Secretary of State
for Transport's statement in the House on 5 November, where he
suggested that the company may have failed to give out appropriate
information to its shareholders. We sent that request to the Department
of Transport only late last night and so we are awaiting that
response and we are analysing the company's documentation further
before we will be able to say anything about the future course
of our enquiries.
Chairman: Thank you very much for that
answer, and thank you and your colleague for appearing before
us this morning.