2 Developments since our last Report |
7. There has been uncertainty surrounding whether
the current Government accepted all the Ombudsman's ten findings
of maladministration. During our evidence session we sought clarity
from the Financial Secretary on this point. We
welcome the fact the Financial Secretary to the Treasury made
clear that the Government accepts all findings of maladministration
made by the Ombudsman.
Ombudsman's report v Chadwick
8. The Financial Secretary, in his statement of 22
July said that the Government was committed to implementing the
Parliamentary Ombudsman's recommendation to pay compensation,
made two years ago. At the same time he said that the Chadwick
Report would contribute to the process of establishing a scheme
that is fair both to policyholders and to taxpayers. He added
that it would be one of the "building blocks"
in resolving what is a complex matter.
9. However, there
is a fundamental incompatibility between the position of the Ombudsman
and Sir John Chadwick's approach. Sir John's remit does not reflect
all ten of the Ombudsman's findings. Sir John and the Ombudsman
may have reached different answers because they addressed different
questions. In a letter to all MPs, in
July, the Ombudsman stated categorically that Sir John Chadwick's
advice was an "unsafe and unsound" basis on which to
proceed. In her evidence, she elaborated on the reasons why she
took this view. She explained that:
a) Sir John's terms of reference required him
to start from a different place, i.e. the previous Government's
response to her report, rather than the report itself. His report
is not based on all the findings of maladministration and injustice
that she had made, only on those findings accepted by the previous
b) Sir John's advice is predicated on a rejection
of her central recommendation for redress. She recommended compensation
to all policyholders who had suffered relative loss as a consequence
of regulatory failure. Sir John was asked to propose limited compensation
only for those people 'disproportionately affected' by
the maladministration the previous Government accepted had occurred.
c) Sir John took a different view to her about
what would have happened if maladministration had not occurred.
Her recommendation for redress was based on the view that, if
the regulators had been doing their job properly, and information
about the real state of Equitable Life had been in the public
domain as it should have been, people would not have decided to
invest, or add to their existing investments. Sir John thought
10. In his evidence, Sir John recognises this incompatibly.
He confirms the principal reasons why he and the Ombudsman have
taken different views. They are the consequence of his terms of
reference. First, the terms of reference required him to disregard
those findings of maladministration and injustice which the Government
did not accept. "The effect of that requirement was that
the Ombudsman reached her conclusions on the basis of findings
of maladministration which were more extensive than those on which
I based my advice".
Second, unlike the Ombudsman, his remit required him to consider
what steps the Equitable Life would have taken in response to
the concerns that would have been raised by the Government Actuary
Department (GAD) and the prudential regulators, had maladministration
11. He also takes a fundamentally different view
from the Ombudsman about the behaviour of investors. In her letter
to him of 20 August 2009, she explains that, "in essence"
absent serial maladministration, no reasonable investor would
have invested in or remained in Equitable Life. Sir John finds
it impossible to accept this view. He points out that the Ombudsman's
report does not expressly say what she "in essence".
12. At the heart of this difference is the fact that
the Ombudsman's jurisdiction and Sir John Chadwick's terms of
reference are fundamentally different. Added to this they took
radically different views about how investors would have behaved
had there been no maladministration. Sir John also went on to
consider how Equitable Life would have reacted to regulatory actions,
which the Ombudsman did not. It is these key differences in approach
which then led Sir John to advise that relative losses should
be reduced by around 75-80%. As the Financial Secretary recognised
in his evidence, to us the controversy arises because "these
are the steps influenced by Sir John's restricted terms of reference
and are most based on subjective judgment [...]".
13. We asked Sir John if his conclusions would have
been different had is terms of reference been compatible with
the Ombudsman's findings. He said he was unable to say with certainly
that this would have led him to reach a different conclusion.
However, conclusions naturally followed from terms of reference.
A change in one was likely to result in a change in the other.
14. We asked the Financial Secretary whether he had
actually asked Sir John, back in May, whether he was prepared
to amend his terms of reference and how long it would take him
to do the work. He told us he had not. Sir John said it would
not take long to amend the instruction to Towers Watson, but the
actuarial work would probably take a few months.
15. We regret
that despite the Government's commitment to meet the Ombudsman's
recommendations that it did not properly explore the possibility
of amending Sir John's terms of reference back in May. Had this
change been made then it would not have significantly altered
the timescale for delivering compensation.
16. We therefore recommend that
the Government re-engages Sir John Chadwick to establish what
conclusions he would reach under terms of reference which reflect
all ten of the Ombudsman's findings. We believe this work can
be done in parallel with the Independent Commission's work to
design a compensation scheme. We think that this need not delay
payment to policyholders. It would however leave open the extent
of the Government's liability in the spending review, but the
timetable for the CSR should not be the driving factor. Alternatively
the Government must find some other way of resolving the incompatibility
between the Ombudsman's findings and Sir John Chadwick's existing
terms of reference. If the Government's proposals remain based
on Sir John's existing terms of reference, we concur with the
Ombudsman that they are, in principle, an "unsafe and unsound"
basis on which to proceed.
Quantum of relative loss
17. There seems to be a convergence of views around
the quantum figure for relative loss. The Chadwick process identified
what he termed an 'external relative loss' element?the difference
between the payout which would have been received had the policyholders
invested in comparable product offered by an alternative provider
and the payout which has actually been received (or will be received)
in respect of the Equitable Life policy. A provisional figure
of £4-4.8 billion has been calculated by Towers Watson, the
actuaries appointed by the Treasury to assist Sir John.
18. The Ombudsman agrees that this figure is broadly
consistent with the amounts claimed by those who complained to
her while she was finalising her July 2008 report. "On
that basis it appears to me to be a credible estimate".
Equitable Life thinks this figure "[...] seems
to match most closely the relative loss described by the Parliamentary
Ombudsman's description of relative loss".
Equitable Life Trapped Annuitants (ELTA) say, "This is
the only worthwhile figure provided".
19. Only EMAG dispute it. While they concede that
it is the main element worth saving from the Chadwick process,
they contend that it still considerably understates the final
relative loss by not factoring in three large items: the first
18 months losses; removal of exit penalties and provisions for
those already invested at July 1991. This leads them to conclude
the quantum of relative loss to be well in excess of £5 billion.
20. We welcome
the broad consensus on the quantum of relative loss around the
provisional figures produced by Towers Watson of between £4
and 4.8 billion. EMAG are of the view that this is still a considerable
understatement. The only way this disagreement can be resolved
is if Towers Watson are instructed to recalculate their estimate
in line with the Ombudsman's findings.
Burden on the taxpayer
21. One of the more difficult questions with regard
to compensation is how to ensure the package is fair to both the
policyholders and the taxpayer.
22. Unusually, the Ombudsman qualified her recommendation
by accepting that any compensation package should take account
of the potential impact it would have on the taxpayer. This is
echoed in the Financial Secretary's view that it is "important,
particularly in these times when difficult decisions need to be
made with respect to the country's finances, that we carefully
balance, in the Ombudsman's words 'fairness both to those affected
and to taxpayers generally.'"
23. In assessing relative loss Sir John first assessed
absolute loss, that is the loss actually suffered by policyholders.
Sir John has proposed that external relative loss should be capped
at the absolute loss. "The principle behind this is to
ensure fairness for taxpayers".
In his view it would be unfair to the taxpayer to be paid more
through redress than they would actually have lost.
24. Both EMAG and Equitable Life accept the need
for some reduction in compensation. In EMAG's proposals a reduction
of 20% reflecting the anticipated average cuts across the public
sector. In addition
they suggest phased stage payments over the life of the Parliament.
25. There is no dispute that the
burden on the public purse must be taken into account in assessing
the level of compensation. It follows that there must be some
reduction of the compensation awarded. The reduction must strike
an appropriate balance between the interests of taxpayers and
the interest of policyholders.
26. In his evidence the Minister notes the scheme
will be a significant spending commitment for this Government.
As such, he felt that it would be best to consider the amount
affordable as part of the Spending Review.
He has undertaken to set out the final loss figure when the Spending
Review is announced on 20 October, alongside the funding available
for the scheme.
27. We recognise that affordability will be a factor
in the Government's final decision about the level of compensation.
The Ombudsman was explicit that she would not object to a heavily
reduced compensation sum (up to as much as 70%), so long as the
Government clearly distinguished between the final loss suffered
by policyholders and the amount the Government was able to pay
given the current financial situation. The
Ombudsman's objection was to the challenge posed to her idea of
injustice, not to the level of compensation that the Government
finds to be affordable. The
fact the Government may not be able to afford to compensate fully
for relative loss is a separate issue from the how relative loss
28. The Government
should be open with Parliament and the policyholders. It must
explain the basis for the final loss figure. It must also set
out how it has determined what is affordable.
Government should provide an early opportunity for Parliament
to debate the announcement, and quantum, in government time.
The Chadwick Advice
30. Sir John proposed a five stage process for calculating
compensation that is due to policyholders. This began with a calculation
of absolute loss, which is the loss that policyholders actually
suffered. Then Sir John identified what he called external relative
loss - which is the difference between the returns that policyholders
actually received from their Equitable Life policies and the returns
they would have received if they had invested in a comparable
product in an alternative life assurance company.
31. For some policyholders, their external relative
loss is greater than their absolute loss. This is because of the
strong performance of comparable companies. Sir John therefore
proposed that external relative loss should be capped at the absolute
loss. He believed this would deliver fairness for the taxpayer.
The Ombudsman does not accept this.
32. From his detailed analysis and the expert actuarial
support he has received, Sir John concludes that the majority
of policyholders would have made the same investment decision,
even if Equitable Life had been properly regulated. The Ombudsman
contests this as a legitimate premise for compensation, but on
this basis, he proposes that policyholders should receive 20-25%
of their capped external relative loss.
33. Finally, Sir John looked at the returns which
those policyholders who would have stayed with Equitable Life
would have received if it had been properly regulated. He called
this internal relative loss.
Again, the Ombudsman does not recognise the legitimacy of such
34. Sir John Chadwick's advice has proved controversial
because of the much lower level of compensation it entails. Nonetheless,
we acknowledge his efforts and commitment to meet the terms of
reference he was given by the previous Government.
35. However, as the Financial Secretary notes, those
steps in Sir John's advice which reduce relative loss calculations
by around 75-80% are those most influenced by his restricted terms
of reference and involve the greatest amount of subjective judgment.
36. This Government came to office with the promise
of early resolution to the vexed question of compensation. In
its Programme for Government the new Coalition Government stated
that it would:
[...] implement the Parliamentary and Health Service
Ombudsman's recommendation to make fair and transparent payments
to Equitable Life policyholders, through an independent payment
scheme, for their relative loss as a consequence of regulatory
37. Since then ministerial pronouncements that a
compensation scheme would be based on the outcome of the Chadwick
process have given rise to ambiguity.
In particular Mark Hoban's reference to Chadwick in his July statement
as a "building block" has caused great concern
38. There is a political obligation which also extends
to Parliament. At the time of the last election campaign a number
of Members made the following pledge:
that if I am elected to Parliament at the next general
election, I will support and vote for proper compensation for
victims of the Equitable Life scandal and I will support and vote
to set up a swift, simple, transparent and fair payment scheme-
independent of governmentas recommended by the Parliamentary
If the public is to have trust in
its elected representatives, we must keep our promises. Expectations
have been raised by many of those seeking election. The coalition
should focus on how to meet the political commitment it has made.
39. Given the circumstance of this
case, and that legislative changes mean that the FSA no longer
falls within the Ombudsman's jurisdiction, it is important to
note that the decisions the Government makes cannot set a precedent
for future cases.
The Independent Commission and
design of the compensation scheme
40. One of the main areas of contention between Sir
John and the Ombudsman is around the nature of the compensation
scheme. For him "[...] a payment scheme based on the need
to establish, on an individual basis, that a policyholder relied
on the Society's regulatory returns must be seen as unacceptable
in practice", because of the impossibility of knowing
what individuals would have done under a different situation 15
years ago. He judged
that only 20% of policyholders would have left Equitable Life
if maladministration had not occurred. Given the impossibility
of identifying this group he decided to share their compensation
between all the policyholders. In this way each policyholder should
receive a proportion of the compensation regardless of whether
they relied on the information or not. He says the potential unfairness
of this approach, as between policyholders, is the price to be
paid for finality and certainty.
41. The Ombudsman strongly refutes Sir John's understanding
of the approach she took. She does not agree that her approach
was based on an assessment of each individual transaction and
that eligibility should be restricted to those who could show
they had relied on regulatory returns. She argues that in fact
she left open the actual design of the scheme and recommended
that an independent commission should adjudicate on the matter.
42. The Government has now established an independent
commission to design a compensation scheme. Its role is to:
- Recommend how best to fairly allocate funds provided
for the Equitable Life Payments Scheme as part of the Autumn 2010
Spending Review to those persons found to have suffered relative
losses as a result of accepted government maladministration; and
- Advise on any groups or classes
of persons that should be paid as a priority.
43. In providing its advice, the Commission shall
have regard to the practicalities of delivering the payment scheme
and to the work undertaken by Sir John Chadwick on the methodology
for calculating relative loss and base its allocation to policyholders
on the relative loss figures provided to HM Treasury by Towers
44. In addition, in the interests of speed and of
the public purse, the Commission should ensure that it does not
unnecessarily replicate existing analysis determining relative
loss. It will also have regard to, but need not be bound by findings
on disproportionate impact carried out by Sir John Chadwick.
45. We welcome the appointment of
the Independent Commission and endorse the Government's intention
that it should work quickly and make the first payments in the
early part of next year. We seek an assurance from the Government
that the cost of administering the scheme should not come out
of the total compensation sum.
- We endorse the principles that
it should be transparent, fair, and independent as well as swift.
We encourage the Commission to design a payment scheme which allocates
compensation as fairly as possible and strikes a balance between
speed and proper compensation to individual policyholders for
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