Projected investment returns and
the role of actuaries
15. While the share of the mortgage market taken
by endowments declined through much of the 1990s as tax relief
was progressively withdrawn, the Table above indicates a particularly
abrupt fall in just five years from 34% in 1998 to just 5% in
2002. Many major companies ceased selling endowment policies over
this period. A variety of factors seem to have conspired to undermine
endowment mortgage sales, but one major problem was that a slide
in likely investment returns exposed the risks for all to see
that were always inherent in endowment mortgages. Major insurance
companies told us that they, alongside the Institute of Actuaries,
began to review the likely returns on endowment policies in the
late 1990s in the face of the changing economic environment, with
the Institute of Actuaries panel reporting on the issue in 1999.[22]
Thus when asked what was the first point at which the appointed
actuary raised the issue, Prudential plc told us "that it
was late 1999, [as] part of the discussion we were having about
asset allocation, which was also linked with future expected yields
on investments, which is really the key part of it, together with
changes on the interest side that led to consideration of the
balance between an endowment mortgage and a repayment mortgage
and the economic effects of them."[23]
In the wake of those discussions the company stopped selling endowment
mortgages from 2000.[24]
16. The period in which endowment mortgage sales
collapsed also coincided with intense regulatory activity on a
variety of fronts. Looking at potential investment returns, the
investment landscape had changed fundamentally through the 1990s.
Base rates fell from 14% in late 1990 to levels that were less
than half that through most of the mid-1990s. The risk free rate
of return expressed by long-bond yields, widely used as a benchmark
in gauging likely returns across a range of financial assets,
had also fallen from 11.8% at the end of 1990 to just over 7%
at the end of 1997, before falling below 6% in 1998. It was against
this background that the PIA embarked in October 1998 on a formal
consultation exercise on the need to reduce the illustrative investment
returns used in marketing material. They were subsequently reduced
from 5%, 7.5% and 10% to 4%, 6% and 8% in July 1999.[25]
17. The industry's slow switch to a more realistic
internal assessment of the likely investment returns underpinning
endowment products as the investment environment changed through
the 1990s may have reflected a desire to maintain the apparent
competitiveness of endowment mortgages relative to repayment mortgages.
The industry's failure to respond quickly to the sharp fall in
bond yields and inflation rates nevertheless raises significant
questions about the effectiveness with which the appointed actuaries
within insurance companies fulfilled their roles. Legal &
General, for example, told us that throughout this period the
appointed actuary had not issued a warning about likely investment
returns"not formally, informally or in any other way"[26]
and the evidence the Committee heard from other major insurance
companies[27] confirmed
that the appointed actuaries had generally failed to provide the
warnings that might have been expected about the changing investment
climate. As well as providing an earlier alert to everyone of
the potential problems building on endowment mortgages, if the
actuaries had raised such warnings on investment returns in a
more timely fashion the industry may have entered the bear market
in equities from 2000 onwards with rather more robust investment
portfolios.
18. The FSA has launched a major reform of the actuarial
function within life insurance companies, prompted partly by the
events surrounding Equitable Life. The evidence the Committee
has heard about the role the actuarial profession played, or failed
to play, in advising companies and their customers on the unfolding
problems in endowment mortgages confirms the urgent need for change.
The FSA's proposals, contained in consultation paper CP167 "include
discontinuing the role currently fulfilled by the appointed actuary.
Responsibility for actuarial aspects of the insurance business
would then clearly rest with the board and senior management,
rather than the appointed actuary."[28]
A new actuarial role is also being introduced for with-profits
business, in the shape of a with-profits actuary who will be barred
from sitting on the board and "will play an important continuous
role in protecting consumers."[29]
In addition the FSA is also requiring auditors to seek independent
actuarial advice, but the issue of the appropriate role for actuarial
advice is an important one which the Committee intends to return
to later in the course of our broad inquiry into restoring confidence
in long-term savings. The events surrounding Equitable Life
raised questions about the effectiveness of the pre-existing actuarial
regime, but the insurance industry's approach to endowment mortgages
through the late 1990s also demonstrates an inadequate approach
to investment issues by appointed actuaries. The Committee considers
it important that the FSA's proposed reforms of the actuarial
process within insurance companies are effective in providing
warnings and a more proactive and independently minded actuarial
advice.
Conclusions
19. The evidence the Committee has received has shown
that there are a range of issues surrounding the basic nature
of the endowment mortgage as a product. First and foremost, despite
their great popularity in the 1980s and 1990s (in part because
they sometimes enabled the borrower to take out a larger mortgage),
there must be a question as to whether it was ever appropriate
for consumers to be sold a complex savings product with potentially
volatile returns as a means of paying off a fixed debt without
a clear explanation of the risks they were taking. There are,
however, wider issues which raise concerns about long-term savings
generally. These include the 'with-profits' model, the role of
actuaries and the part played by the tax system. These are issues
which will form an important part of our wider long-term savings
inquiry, but it seems clear to the Committee from its review
of endowment mortgages that generally more needs to be done to
ensure that financial products and the tax system surrounding
them are simplified as much as possible, that officials whose
role is in part to protect and re-assure the consumer actually
discharge that function effectively and, above all, that when
complex financial products are sold to consumers they accurately
fit the purpose for which they are bought.
4 Ev 3, Table 1 (HC 275) Back
5
How Many Endowments Fall Short? Cazalet Consulting 27 January
2004 Back
6
PIA Regulatory Update Number 72, December 1999 Back
7
Q 109 Back
8
ibid Back
9
Medium and Long-Terms Retail Savings in the UK, A Review,
HM Treasury, July 2002 Back
10
Q 319 Back
11
Ev 186 paragraph 29 (HC 275) Back
12
Ev 162 paragraph 42 (HC 275) Back
13
Q 299 Back
14
Q 27 Back
15
Q 36 Back
16
Q 273 Back
17
Ev 154 paragraph 7.2 (HC 275) Back
18
Q 103 Back
19
Medium and Long-Terms Retail Savings in the UK, A Review,
HM Treasury, July 2002, page 16, paragraph 90 Back
20
Q 556 Back
21
Medium and Long-Terms Retail Savings in the UK, A Review,
HM Treasury, July 2002, page 16, paragraph 92 Back
22
Q 526 Back
23
Q 539 Back
24
Q 537 Back
25
Progress Report on Mortgage Endowments FSA, October 2000,
page 8 Back
26
Q 536 Back
27
Q 534 Back
28
FSA Press release on CP167, 23 January 2003 Back
29
With-profits governance and the role of actuaries in life insurers,
FSA, June 2003, page 6 Back