Select Committee on Public Administration Second Report

3  The case for compensation

21. During the Ombudsman's investigation, the public bodies invited her to refuse compensation on a variety of public policy grounds, including the cost to the taxpayer and the diversion of scarce public resources, the risk that it might make regulators over-cautious in the future, or that it could set a dangerous and costly precedent. For these reasons, the public bodies urged the Ombudsman to adopt the cautious approach that has traditionally led the courts to "shy away from imposing a duty of care on regulators".[26]

22. The Ombudsman's report carefully addressed and then rejected each of these concerns.[27] The Ombudsman has, however, highlighted being "acutely conscious of the potential scale" of her recommendation for a compensation scheme and invited Parliament to debate the issue.[28] She has accepted that

    it would be appropriate to consider the potential impact on the public purse of any payment of compensation in this case. That one group of taxpayers might have to underwrite the payment of compensation to another group is something that cannot be left out of all account.[29]

23. An Equitable Life annuitant, Anthony Wilson, highlighted some of the dilemmas that face our consideration of the case for compensation:

    I find myself ambivalent how the government should respond to our situation. On the one hand, I did what both Tory and Labour administrations told me to do: save hard… I assumed that regulation was sufficiently effective to protect me… On the other hand, does caveat emptor apply here (though how could I have found out that Equitable was insubstantial)? And people depending on the state pension who are facing rising fuel and food bills must have a higher priority than private investors on the public purse. Would 'compensation' create a precedent which could cause endless problems for years ahead?[30]

24. The Law Commission recently published a consultation paper, Administrative Redress: Public Bodies and the Citizen, to review the availability of legal redress, including compensation, for substandard administrative action by public bodies.[31] Its key objective is "to achieve the correct balance between fairness to aggrieved citizens and appropriate protections to public bodies and the public funds they use."[32] In many ways a similar balance has been proposed by the Government. For instance, the Economic Secretary to the Treasury has stated in relation to the issue of compensation that: "the Government must weigh in the balance the interests of policyholders and taxpayers generally".[33] This section of our Report outlines the many factors that were raised as part of our inquiry, before we offer our own view on the case for compensation.

Factor 1: Burden on taxpayers and regulators vs fairness to policyholders

25. At the heart of this difficult issue is the potential impact on the taxpayer. The potential sums involved remain unclear. EMAG estimates that compensation will cost approximately £4.66 billion, while Equitable Life Trapped Annuitants (ELTA) estimates that compensating the annuitants alone would be around £6 billion.[34] Based on ELTA's figures, the total cost of compensating all policyholders could be £10 billion or more. Neither ELTA's nor EMAG's estimates are endorsed by the Ombudsman, who has told us that she does not possess the necessary information to calculate loss.[35] The board of Equitable Life, who maintain a record of the information that would be needed to make such a calculation, has stated that it will not be possible to provide a meaningful estimate until the principles of a compensation scheme are established.[36] In the meantime, its Chair, Vanni Treves, has stated it would be "irresponsible" to speculate upon the amounts involved.[37] The Economic Secretary stated that there was "not very reliable evidence" about the potential cost of compensation, but was unable to give us any indication of what the likely cost could be.[38] Regrettably, in these circumstances we are unable to assess the accuracy of EMAG's and ELTA's estimates, although we note that EMAG's approach is more closely aligned to the Ombudsman's proposals. What is clear, however, is that the cost of compensation is likely to run into the billions.

26. It is plainly apparent that the public purse is facing intense and conflicting demands in light of the current economic difficulties. The weight that this deserves has been a matter of dispute. For instance, EMAG states that current restraints should be irrelevant in the context of compensating individuals for events taking place eight or more years ago: "the delays are almost entirely of the Treasury's making. That the cupboard is temporarily bare in 2008 is hence not a fair consideration".[39]

27. The former rail regulator, Tom Winsor, has stated that the cost is secondary to the requirements of justice: "in this case it is a lot of money. If it were £10 million and not £10 billion, the Chancellor would probably write a cheque to make the problem go away. The degree is not relevant. The principle is. The State has failed these people and the State should compensate them. Justice requires it."[40]

28. The undoubtedly high cost of compensation is also mirrored by the high impact of falling pension payments on Equitable Life's members, particularly (but not exclusively) the "trapped" annuitants who had already retired by the time that Equitable Life closed to new business. We have received evidence from many such individuals who emphasise the anxiety and hardship that has been caused by cuts of up to 50% or more in their retirement income.[41]

Factor 2: Degree of regulatory failure

29. Another important factor is the degree of regulatory failure involved. Sir Howard Davies, who chaired the FSA at the relevant time, emphasised that regulators are faced with a difficult task:

On this basis he argued that compensation should only be paid in the event of fraud by a regulator, but not where the regulator makes the wrong judgment or fails to prevent "financial imprudence" on the part of a company's directors.[43] John Kay of the Financial Times stated similarly that compensation should be restricted to cases of "egregious failure" or "conspicuous hardship" and that the present case "rather weakly" fell within these grounds.[44]

30. In contrast, the Ombudsman has stated that she is "acutely aware that those exercising regulatory functions are often placed in very difficult situations in which they have to exercise judgment in relation to complex matters which require the balancing of a range of often competing pressures and interests".[45] It was for this reason that the Ombudsman deliberately applied "a standard that was grounded in the reality of the relevant regulatory regime as it existed at the relevant time and not in my own opinion as to what such a regime should have looked like".[46]

31. In others words, the Ombudsman set the bar very high before concluding that there had been maladministration: "I have approached this in a way which is not simply saying that the regulator made a few errors, there was one set of returns that was not very good and therefore we are automatically into maladministration and injustice and redress. I think the report sets the bar very high in terms of what constitutes maladministration."[47] Tom Winsor agreed: "This is, as I understand it, a case of regulators neglecting their duty, looking the other way in some respects, and not understanding their powers. Those are not judgmental errors; they are culpable errors. The distinction needs to be made."[48]

Factor 3: Public policy

32. A public policy consideration that has been raised by a number of commentators is whether the payment of compensation would make regulators over-cautious in the future. For instance, Jeremy Warner of the Independent has stated that routine payment of compensation "would lead to such oppressive 'safety first' regulation… that it would stifle innovation, enterprise and activity. Far from making people feel safer about saving, it would so diminish returns that they would give up saving altogether."[49] The Ombudsman turned this argument on its head:

    I would like to think it would have the opposite effect. At one point in this investigation when we were thinking about what we would call this report we had a working title of The Reluctant Regulator and at the end of the day that seemed a bit flippant…. However, it seems to me that actually what this report argues for—if it argues for anything—is more effective, stronger regulation which actually means that regulators know and understand their duties, know and understand their powers, know when they should consider using those powers and use them when it is appropriate to do so.[50]

33. Ian Cowie of the Telegraph re-iterated the potential impact of failing to pay compensation on the incentive to save for pensions in the future:

    the costs of compensating the victims of Equitable Life need to be seen in the context of what amounts to a savers' strike that has been underway in this country for many years now… People have looked at Equitable Life and formed their own conclusions: Saving does not pay. Unless the Government takes decisive action here… more people will decide that saving does not pay…. There are tens of thousands of effectively negative salesmen out their in the country now saying to people, 'Whatever you do, don't put any money in a pension. I did. It was a waste of time.'[51]

34. A slightly different argument has been raised by EMAG, which states that compensation is required to restore confidence in the FSA.[52] Its Chair, Paul Braithwaite, had drawn an analogy between "having quite a powerful car which has got seat belts and the seat belts give you a sense of security but unfortunately those seat belts, the regulator, were not anchored. They gave you a false sense of security. If it had been caveat emptor that would have been fine, I would have understood it."[53] Others, such as Tom Winsor, re-iterated that the main issue should be about the principle of justice:

    The regulators are emanations of the State. They are the creations of Parliament. They are the custodians and stewards of a precious public interest. They are part of the apparatus of government. They are given functions and duties and they must adhere to standards, high standards - standards which in this case have been found to have been woefully neglected. There is a considerable degree of public interest, public trust, public confidence, public reliance, in the regulators doing their job properly. If regulatory failure is the direct and proximate cause of people sustaining loss, then my view is the State should pay financial compensation…. Justice requires it.[54]

Factor 4: Precedents

35. The Treasury has reportedly received legal advice stating that any decision to create a compensation scheme might set a difficult precedent for the future.[55] Some commentators have questioned whether the case of Barlow Clowes already provides a direct precedent.[56] Others question whether ex gratia payments to the retail depositors of Icesave represents a recent and less deserving illustration of public funds being used.[57] The Chancellor, Rt Hon Alistair Darling MP, has dismissed analogies to Icesave and to the banking sector more generally:

    That is a different problem to the problem we are dealing with just now. Equitable Life is not a bank. It has problems which, as you know, go back for 15 or 20 years. There was an inquiry by Lord Penrose six or seven years ago… Lord Penrose found that the company, as he put it, was substantially the author of its own misfortunes.[58]

36. EMAG has, in contrast, re-iterated that Icesave's retail depositors were neither "guaranteed anything" by a UK regulator nor do they benefit from a finding of maladministration.[59] Ian Cowie of the Telegraph told us:

    Equitable was not some fund that attracted reckless investment from people seeking the highest possible returns. It was not a company that had recently been set up on the internet, as I say, based in Iceland or wherever, offering the highest rates of return. It was a company that had been around for more than 300 years. It appeared to be offering low risk investments. It was regulated, it was authorised, and it turned into a disaster.[60]

37. Lord Norton of Louth, however, highlighted the need to treat the case for compensating Equitable Life's members on its own merits: "the Ombudsman has made rather a powerful indictment in this particular case. As you have said, she has set the bar high, and therefore I see this as a case that has to be looked at on its individual merits."[61]

Factor 5: Turning regulators into guarantors

38. Howard Davies has previously stated that the FSA must not be tasked with running a "no failure" regime: "Failure is an inherent part of a flexible, competitive, innovative capitalist system. We should not aim to oversee a race in which all shall win prizes".[62] He elaborated that this should not be used as an excuse for regulatory failure, but simply that "It is not our job to stop some [companies] failing. We will take proper regulatory risk assessments and so on but it is not our job to underpin the system, to offer any kind of guarantee."[63] John Kay has written that expecting the taxpayer to take responsibility for regulatory failure in this kind of case amounts to "nationalisation".[64]

39. The Ombudsman has rejected the suggestion that paying compensation would turn regulators (or ultimately the taxpayer) into an effective guarantor of failed businesses, stating that compensation is appropriate to remedy regulatory failure rather than to meet a guarantee against company failure:

    I do not think the regulator is there to guarantee anything… I think, as a member of the public and a potential policy holder investor, I or indeed my financial advisor, ought to be able to rely on the information that goes into the public domain, having been looked at by the regulator and verified by the regulator. They did not do that… there were some fundamentals which, without saying that this is regulated by DTI or the Treasury or FSA therefore all my money is guaranteed, I do not think any reasonable citizen could take that away but actually there were very specific tasks which the regulator was charged to do which the report shows they did not do.[65]

Factor 6: Mismanagement

40. The public bodies have previously argued that paying compensation would "obscure the fact that the immediate and material cause of the loss in this case was Equitable itself."[66] This reflects the numerous occasions on which Ministers have referred to Lord Penrose's conclusion that Equitable Life was "principally … the author of its own misfortunes" as a material factor in relation to compensation. The current board of Equitable Life and many others have acknowledged the legitimacy of Lord Penrose's conclusion; few people dispute that its former management were primarily to blame.

41. The Ombudsman has, however, highlighted the full conclusion of Lord Penrose, in which he went on to state that: "the practices of the Society's management could not have been sustained over a material part of the 1990s had there been in place an appropriate regulatory structure adapted to the requirements of a changing industry that happened to manifest themselves in an extreme form in the case of Equitable Life."[67] The Ombudsman continued: "whether or not Lord Penrose was saying that Equitable's management were the villains here, I think he was also saying that if the police—in this case the regulators— had been doing their job properly they would have been caught a lot earlier."[68] It is also apparent that Lord Penrose was unable to consider these issues: "The jurisdiction to adjudicate on regulatory failure in duty is not mine. Even less is it for me to comment on how government should respond if it were to acknowledge that there had been regulatory failure."[69]

Factor 7: Equitable members' personal circumstances

42. A general objection that has been raised by some witnesses and commentators is that Equitable Life's members are somehow undeserving. For instance, Patrick Collinson of the Guardian has stated: "The beneficiaries will be lawyers, doctors, dentists, and dare I say journalists and media types… That may explain why you hear so much bleating about it."[70] John Kay has written along similar lines in the Financial Times: "this is not the most deprived group of people who may have suffered from ineptitude of government policy of one kind or another."[71]

43. In contrast, EMAG has been keen to emphasise that the majority of Equitable Life's policyholders had modest sized pensions and were not "fat cats" who "risked their money to get above average returns."[72] In particular, the average investment of the half million individual policyholders amounted to £45,000 each, which in today's money would buy a pension paying around £75 per week according to EMAG.[73] Ian Cowie has commented: "In some ways, the fact that many of Equitable Life's policyholders are professional, middleclass people has worked against them."[74]

Factor 8: General market performance

44. The poor performance of many other pension providers besides Equitable Life has also been a factor that is sometimes raised in opposition to compensation. As Jeremy Warner states, there are "other life funds which have also turned out to be dogs," but he carries on to emphasise that "the distinguishing feature was that Equitable contractually agreed bonus and guaranteed annuity rates which it didn't have the capital to pay when investment conditions turned against it. Other life funds which have performed equally badly or worse were able to find the capital from reserves or parent companies".[75]

45. As we address below, the Ombudsman has accepted that market wide underperformance must be taken into account when assessing compensation, but she did not view it as a reason to refuse payments all together: "Other companies faced difficult market conditions and reduced the proceeds paid to policyholders… What made the Society different was that the methods available to it were constrained by the nature of the financial position in which the new Board found itself."[76] Paul Braithwaite has also emphasised that a simplistic comparison to the performance of other funds would unduly take account of the investors who benefited from Equitable Life's good years (and would not, therefore, be eligible for compensation) while masking the individuals who suffered the most.[77]

46. In this respect, we underscore the Ombudsman's declaration that she was "very far from concluding" that all of Equitable Life's policyholders suffered a financial loss.[78] Her Inquiry Manager, Iain Ogilvie, estimated the number of individuals that might fall within a scheme as between 300,000 to 1,000,000: "Clearly how many people would apply and how many cases would have to be looked at would depend on the nature of a scheme… So we are not talking about the whole population that has ever had an involvement with the company but there is no real way of knowing the exact numbers at this stage."[79]

Our view: the case for compensation

47. We strongly support the Ombudsman's recommendation for the creation of a compensation scheme to pay for the loss that has been suffered by Equitable Life's members as a result of maladministration. Where regulators have been shown to fail so thoroughly, compensation should be a duty, not a matter of choice. However, like the Ombudsman, we are acutely aware of the substantial sums of money involved. This calls for a careful balance to be struck between the interests of the taxpayer, on the one hand, against the competing need to be fair to the large number of policyholders affected, on the other. We take full account of the current and extreme pressure on the public purse. But at the same time the regulators were installed to promote confidence in us all to save for retirement. They were given extensive powers to carry out their task. Not only did the regulators fail, but they failed over a prolonged period and at a fundamental level. The impact has been severe for many of those who were worst affected; it would be unacceptable for current financial pressure to override failings which took place seven or more years ago.

48. We fear that a failure to compensate could further undermine the incentive to save for retirement and could weaken trust in the regulators. While we acknowledge concerns that the threat of compensation may make regulators over-cautious in the future, we do not accept this will happen. The payment of compensation should, if anything, sharpen minds and encourage the effective use of their powers. Neither do we accept that compensation would set a difficult precedent. Each case must be decided on its merits, just as happened in the case of Barlow Clowes and the Ombudsman's many other previous investigations.

49. It would also be wrong for the Government to refuse compensation on the basis of Lord Penrose's conclusion that Equitable Life was "principally … the author of its own misfortunes". This often quoted phrase must not mask Lord Penrose's further conclusion that it was regulatory failure which permitted Equitable Life's management to carry on undermining the interests of its members for so long. We also take into account that Lord Penrose was not tasked with determining issues of regulatory failure or, more particularly, the case for compensation. This was the task of the Ombudsman and we stand behind her well-considered views.

50. The decision to compensate must not, however, be the equivalent of signing a blank cheque on taxpayers' behalf. It is essential that the public purse benefits from an appropriate measure of protection. In particular, the emphasis must be upon compensating individuals only for that loss that is fairly attributable to regulatory failure. The impact of internal mismanagement must be taken into account. It is on this basis that we reject the suggestion that compensation would be the equivalent of turning the State into the guarantor of a failed business; in contrast it would be a case of the State making good its own serious failure. We also highlight the Ombudsman's conclusion that not all policyholders suffered loss; this should not be a case of compensation for all.

26   Ombudsman's report, Part 1, Chapter 14, paras 55 to 67 Back

27   Ombudsman's report, Part 1, Chapter 14, paras 68 to 133 Back

28   Ombudsman's report, Part 1, Chapter 14, paras 68 and 152; Q6. Back

29   Ombudsman's report, Part 1, Chapter 14. para 113 Back

30   EQL 08 Back

31   Law Commission Consultation Paper, Administrative Redress: Public Bodies and the Citizen, July 2008, available at Back

32   Law Commission press release, 3 July 2008, available at Back

33   HC Deb, Col 212WH, 25 November 2008 (Ian Pearson MP) Back

34   EQL 04; EQL 05; EQL 28 Back

35   Q42 Back

36   Q149 (Vanni Treves); Q159 (Charles Thomson) Back

37   Q152 Back

38   Oral evidence taken before the Committee from Ian Pearson MP on 9 December 2008, transcript due to be published as HC 41-i (2008-09) Back

39   EQL 04 Back

40   Q238 Back

41   Q57 (Peter Scawen); Q117 (Ann Berry) Back

42   Q246 Back

43   Qq236, 277 Back

44   Q231 Back

45   Ombudsman's report, Foreword, Vol 1, p. viii-ix Back

46   Ombudsman's report, Foreword, Vol 1, p. viii-ix Back

47   Q7  Back

48   Q247 Back

49   Now there's a surprise. Government is being forced to suspend its fiscal rules, Jeremy Warner, The Independent, 19 July 2008 Back

50   Q17 Back

51   Q233 Back

52   Q133; Q104 Back

53   Q130 Back

54   Q238 Back

55   Pensions: Darling faces Equitable Life payout of £4.5bn, Rupert Jones and David Hencke, The Guardian, 17 July 2008 Back

56   Ghost from 1980s returns to No 10, George Parker, Financial Times, 17 July 2008; the Ombudsman has also drawn parallels between Equitable Life and Barlow Clowes: Ombudsman's report, Foreword, p v.  Back

57   It's an Inequitable Life: Icesave v Equitable, Retirement & Pensions, 13 October 2008, Malcolm Wheatley, available at  Back

58   Uncorrected transcript of evidence taken before the Treasury Committee, 3 November 2008, HC 1167-i (2007-08), Qq18-19. See also HC Deb, 8 October 2008, Col 287.  Back

59   Qq 56, 57, 107 Back

60   Q234 Back

61   Q235 Back

62   CASS/IEA Lecture, 26 February 2003, available at Back

63   Q259 Back

64   Financial Times, 5 November 2008 Back

65   Q37 Back

66   Ombudsman's report, Part 1, Chapter 14, para 57 Back

67   Report of the Equitable Life Enquiry by the Rt Hon Lord Penrose, HC 290 (2003-04), p 746 Back

68   Q16 Back

69   Penrose Report, p 746 Back

70   Equitable ruling will tax us all, The Guardian Money, 12 July 2008 Back

71   Q231 Back

72   EQL 04 Back

73   Q50 Back

74   Q241 Back

75   Now there's a surprise: Government is being forced to suspend its fiscal rules, The Independent, Jeremy Warner, 19 July 2008 Back

76   Ombudsman's report, Part 1, Chapter 12, para 184 Back

77   Enough is Enough, Daily Telegraph, Paul Braithwaite, 28 July 2008 Back

78   Ombudsman's report, Summary, para 9.8 Back

79   Q26 Back

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