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REPORT     
PDF 3062kWORD 2532k
4 June 2007
PE 386.573v05-00 A6-0203/2007

on the crisis of the Equitable Life Assurance Society

(2006/2199(INI))

Committee of Inquiry into the crisis of the Equitable Life Assurance Society

Rapporteur: Diana Wallis

This report was updated on 9.5.2007. It has taken into consideration evidence received up to 20.03.07: in particular, it has analyzed written evidence up to WE 92, WE-File 33 and WE-CONF 32, and oral evidence up to H 11, including WS 2.

We recall the abbreviations used in this report for evidence submitted to the Committee:

H # = oral evidence given at EQUI Hearings

WS # = oral evidence given at EQUI Workshops

WE # = written evidence posted on EQUI website (accessible to the public)

WE-FILE # = written evidence not posted on website

WE-CONF # = confidential written evidence

ES-# = external studies

The Committee of Inquiry into the crisis of the Equitable Life Assurance Society started its work on 2 February 2006 and adopted its final report on 8 May 2007. It met 17 times, held 11 public hearings, organized 2 workshops and sent 2 official delegations to Dublin and London. Its coordinators met 12 times.

It heard oral evidence from 38 witnesses, analyzed 92 pieces of public written evidence, 32 pieces of confidential evidence and 33 pieces of filed evidence, totalling thousands of pages. It also commissioned 3 external expert studies.

The 22 full Members and 15 substitute Members of the committee were:

McGuinness, Mairead : Chairwoman

Medina Ortega, Manuel : Vice-Chairman

Gauzès, Jean-Paul : Vice-Chairman

Sir Atkins, Robert : Member, coordinator

Bloom, Godfrey : Member

Bowles, Sharon : Member

Cashman, Michael : Member

De Rossa, Proinsias : Member, coordinator

Doorn, Bert : Member

Ettel, Harald : Member

Gargani, Giuseppe : Member

Klinz, Wolf : Member

Meyze Pleite, Willy : Member

Mote, Ashley : Member, coordinator

Ó Neachtain, Seán : Member, coordinator

Parish, Neil : Member

Purvis, John : Member

Rühle, Heide : Member, coordinator

Skinner, Peter: Member

Van Lancker, Anne : Member

Wallis, Diana : Member, Rapporteur, coordinator

Wieland, Rainer : Member

Audy, Jean-Pierre : Substitute

Aylward, Liam : Substitute

Beres, Pervenche : Substitute

van Buitenen, Paul : Substitute

Bullmann, Udo : Substitute

van den Burg, Ieke : Substitute

Chichester, Giles : Substitute

Dobolyi, Alexandra : Substitute

Gutiérrez-Cortines, Cristina : Substitute

Hasse Ferreira, Joel : Substitute

Karas,, Othmar : Substitute

Lehne, Klaus-Heiner : Substitute

Mitchell,, Gay : Substitute

Panayotopoulos-Cassiotou, Marie : Substitute

Radwan, Alexander : Substitute

The members of the secretariat were:

Director:Riccardo Ribera d'Alcala

Head of the Secretariat: Miguel Tell Cremades, Secretariat Nadine Froment

Administrator: Miguel Puente Pattison, Secretariat : Silvana Casella

Administrator: Hannes Kugi, Secretariat : Sylvie Renner-Yalcin

Administrator: Claudio Quaranta, Secretariat : Saskia de Rijck

Assistant: Amelia Fernandez Navarro

PART I - INTRODUCTION
 I.         Summary of the mandate
 II.       Lines of action in detail
 III.  Historical background
 IV.      Summary of actions undertaken
 PART II - TRANSPOSITION
 I.         Introduction
 II.  Investigation into the correct transposition into UK law of the 3LD and its application/implementation by UK authorities in relation to the ELAS
 Conclusions PART II, TRANSPOSITION
 PART III - REGULATORY SYSTEM
 I.         Community Law Provisions
 II.       The UK Life Insurance Regulatory System
 III.      Key findings of the Penrose and Baird reports on Insurance Regulators
 IV.      Other Oral and Written Evidence considered by the Committee
 Conclusions PART III - REGULATORY SYSTEM
 PART IV - REMEDIES
 I.         Introduction
 II.       Damages
 III.      Complaints to the UK regulators and official investigations
 IV.      Actions by ELAS in relation to aggrieved policyholders
 V.       Allegations of fraud and the UK Serious Fraud Office
 VI.      Claims against ELAS for mis-selling
 VII.    Claims against the UK regulator
 VIII.   The UK Financial Services Compensation Scheme and the decision not to close ELAS
 IX.      The position of non-UK policyholders
 X        Potential remedies for ELAS victims under EU law
 XI.      The case for a European class action lawsuit
 XII.    The need to compensate Equitable Life victims
 Conclusions PART IV - REMEDIES
 PART V - ROLE OF THE COMMISSION
 I.         Introduction
 II.   The implementation of EU legislation - general background
 III.      The Commission's monitoring of implementation in practice
 IV.  The need to ensure a comprehensive approach to implementation
 Conclusions PART V, ROLE OF THE COMMISSION
 PART VI - ROLE OF COMMITTEES OF INQUIRY
 I.   The Committee of Inquiry: current situation.
 II.       Limitations of the current status
 III.  ANNEX
 Conclusions - PART VI, COMMITTEES OF INQUIRY
 PART VII - RECOMMENDATIONS
 A. RECOMMENDATIONS, PART II AND III - TRANSPOSITION AND REGULATORY SYSTEM
 B. RECOMMENDATIONS, PART IV - REMEDIES
 C. RECOMMENDATIONS, PART V - ROLE OF THE EUROPEAN COMMISSION
 D. RECOMMENDATIONS, PART VI - ROLE OF COMMITTEES OF INQUIRY
 ANNEXES
 ANNEX 1: EQUI TIMELINE
 ANNEX 3: ARCHIVE OF EVIDENCE AND TRANSCRIPTS
 PROCEDURE

PART I - INTRODUCTION

on the mandate and actions of the Committee of Inquiry

INDEX   PART I

I.         Summary of the mandate

II.       Lines of action in detail

III.      Historical background

IV.      Summary of actions undertaken


I.         Summary of the mandate

On 18 January 2006, the European Parliament decided(1) to set up a Committee of Inquiry of 22 members to investigate alleged contraventions or maladministration in the application of Community law in relation to the collapse of the Equitable Life Assurance Society, without prejudice to the jurisdiction of national or Community courts.

The concerns which led to the setting up of the committee had previously been raised via several petitions to the European Parliament.(2) These petitions formed the basis and starting point of the inquiry and have helped focus its direction. It therefore was crucial to acknowledge and maintain input from the petitioners and invite them to the committee's meetings in order to set the scene. The central role of these particular petitions also reflects the general importance of Parliament's Petitions Committee in monitoring the application of Community law.

It is important to bear in mind that the scope of the inquiry is limited by the mandate, by Article 193 of the EC Treaty and by the Decision of the Parliament, Council and Commission on the exercise of the European Parliament's right of inquiry.(3)

According to the mandate, the committee's investigation was to focus on four key issues:

1)  Investigation into alleged contraventions or maladministration in the application of Directive 92/96/EEC by the UK;

2)  Assessment of the UK regulatory regime in respect of Equitable Life;

3)  Status of claims and adequacy of remedies available to policyholders;

4)  Assessment of the Commission's monitoring of implementation.

Finally, the committee was required to "make any proposals that it deems necessary in this matter."

With this scope in mind, the committee adopted on 23 March 2006 a Working Document on the Lines of Action arising from the mandate (ref. 2006/2026(INI)). These lines of action are set out in greater detail below. The approach was to separate the investigations at the Member State-level on the one hand (transposition/implementation, regulation/supervision and redress mechanisms) and to deal with the question of the Commission's role separately.

The four key issues set above were gradually developed through different preliminary draft reports, starting with the present one, which focuses on the mandate and lines of action. In the course of this process, an interim report on the investigation, presented to Parliament in July 2006, in accordance with the Decision setting up the Committee of Inquiry, summarized the work undertaken at that point in time.

It is important to bear in mind that the inquiry has set itself apart from previous and ongoing national investigations by adopting a European perspective. In order to achieve this, the analysis was done in a comparative way, including the UK, Germany, Ireland and at least one other Member State with a well developed financial services industry, such as the Netherlands or Spain.

(1)

Decision of the European Parliament B6-0050/2006 of 18 January 2006, setting up a Committee of Inquiry into the collapse of the Equitable Life Society, publication in OJ pending.

(2)

Petitions 0611/2004 by Arthur White (British) and 0029/2005 by Paul Braithwaite (British), on behalf of the Equitable Members' Action Group (EMAG) and subsequent petitions on the same subject submitted by German and Irish petitioners.

(3)

Decision 95/167/EC, Euratom, ECSC of the European Parliament, the Council and the Commission of 19 April 1995 on the detailed provisions governing the exercise of the European Parliament's right of enquiry, OJ L 113 19/5/1995, p.2.


II.       Lines of action in detail

1)  Investigation into alleged contraventions or maladministration in the application of Directive 92/96/EEC by the UK

One of the core tasks of the committee was to examine whether Directive 92/96/EEC, the Third Life Directive (3LD)(1), was correctly transposed and properly implemented at the national level in the UK by its competent authorities. The main elements of this line of action are covered in Part II of this report.

To do this, the committee was firstly called upon to analyse the overall EU legislative and regulatory framework for the insurance sector and clarify which provisions apply to Equitable Life's situation. In addition to looking at the UK, the committee carried out a comparative analysis, identifying the provisions of national law intended to give effect to the requirements of the Directives, and examined whether these requirements were transposed in a full and timely manner.

Secondly, the committee was called upon to examine whether the application of the Directive by the different UK authorities was in conformity with EU legislation. It tried to clarify the respective responsibilities of the various financial authorities involved in the supervision of Equitable Life during the reference period. Detailed investigations were carried out to establish by whom, when and how Equitable Life's solvency, as well as its accounting and provisioning practices, were supervised and how authorities responded to potential weaknesses.

As far as the period covered is concerned, the mandate mentions that it should begin with the entry into force of the Third Life Directive (3LD), 1 July 1994, and should end with the events that occurred at Equitable Life, i.e., 1999-2001. Nevertheless, for the purposes of the inquiry, it was necessary to analyze events before 1994, both in terms of the First and Second Life Directives (1LD(2) and 2LD(3)) as well as the whole adoption process of the 3LD before 1994.

2)  Assessment of the UK regulatory regime in respect of Equitable Life

The main elements of this line of action are covered in Part IV of the final report.

Although this part of the mandate called for a wide-ranging investigation, the standards of conduct to examine are related to Community law, since otherwise the committee would exceed its limits as fixed by Article 193 EC. Furthermore, it appeared appropriate to compare the UK regime with regulatory approaches in Ireland, Germany and another EU Member States. In short, the committee was called upon to examine how UK regulatory practice in respect of ELS compares when judged against its peers in an EU environment. The Penrose report(4), which overlaps with parts of this investigation, was taken as a starting point and then considered in a wider European context. In addition, the committee needed to take into account the ongoing investigation by the UK Parliamentary and Health Service Ombudsman "to determine whether the relevant domestic regulatory regime was properly administered". The release of that report is expected in mid-2007.

According to the Decision setting up the Committee of Inquiry, the reference period for this line of investigation goes back "at least" to 1989 and is thus wider than the reference period for point 1.

3)  Status of claims and adequacy of remedies available to policyholders

The main elements of this line of action are covered in Part IV of the final report. Firstly, it was necessary to determine the number of non-UK European citizens affected and to clarify the circumstances under which they acquired Equitable Life policies (i.e., when they purchased them, whether they purchased them within or outside the UK, directly or through intermediaries, etc.).

Secondly, information was to be collected as to the magnitude of the financial damage caused to non-UK policyholders and possible actions they might have undertaken to obtain compensation. In addition, the committee was to clarify the potential legal obligations and constraints for the authorities of those Member States in whose territory the policies were sold (e.g. Ireland or Germany), what they did, and to what extent they had any control on the situation. This line of investigation is connected to the principle of "single official authorization" and "home State" control contained in the 3LD.(5)

The committee subsequently examined the system of legal remedies available for those policyholders. Two scenarios were possible depending on the results of the committee's investigations under points 1 and 2. Should the UK regulatory system be found to have been in conformity with EU law, the committee would nevertheless need to look into the possibility of policyholders being able to claim damages under UK law, as well as the possibility of EU citizens from other Member Sates encountering particular difficulties in that regard. If the UK was found to be violating EU law, the committee could also focus on the system of judicial protection under EU law. Member States are obliged to make good loss and damage caused to individuals by breaches of Community law for which they can be held responsible according to criteria developed by the Court of Justice. These questions needed to be further clarified by evaluating whether domestic courts are adequately equipped to protect this right to reparation or whether different remedial standards exist in different Member States.

4.)  Assessment of the Commission's monitoring of implementation

The main elements of this line of action are covered in Part III of the final report. The committee was called upon to examine the way in which the Commission monitored the transposition of the relevant Directives by the UK. Firstly, it was necessary to establish whether the Commission considered the implementing legislation notified to it by the UK authorities to be in compliance with Community law from the outset or whether it had initially identified any shortcomings and subsequently requested further clarifications. In addition, it was necessary to ascertain whether the Commission ever started infringement proceedings or if it investigated any related complaints by citizens.

The Commission's performance in monitoring transposition was to be measured both against its legal obligations under the Treaty and in terms of its political responsibility. If the committee were to find that the UK did not comply with EU legislation, a further task under this part of the mandate would be to assess whether the situation might have been avoided had the Commission fulfilled its obligation to monitor transposition.

Specific actions arising from the list of actions and investigations as adopted by the Committee of Inquiry in its Working Document of 23 March 2006

1)   Hearing of relevant witnesses before the committee:

-    Hearing of petitioners and affected policyholders;

-    Invitation of Lord PENROSE and the UK Parliamentary Ombudsman;

-    Invitation of senior decision-makers from UK Treasury;

-    Invitation of Commissioner McCREEVY and the Director General of DG MARKT;

-    Invitation of the Equitable Life Assurance Society's current management;

-    Invitation of Financial Regulators from the UK, Ireland and Germany;

2) UK market analysis:

-    Overall background analysis of the UK life assurance market, as well as of Equitable Life as a company (history, state-of-play, prospects) and the events surrounding the collapse of Equitable Life;

-    Background analysis of EU legislative and regulatory framework in relation to Equitable Life;

-    Clarification of UK authorities' respective competences with regards to the supervision of Equitable Life;

3) Comparative market analysis:

-    Analysis of the Penrose report in the light of EU requirements and of regulatory standards in other Member States;

-    Comparative analysis of transposition in the UK and other Member States, with regard to the supervision of insurance undertakings, using "table of transposition" (study commissioned through the committee's "Expertise Budget"),

-    Comparative study (in connection with the study on transposition) on regulatory approaches in the UK and other EU Member States;

-    Examination of communication and cooperation between the regulatory bodies in the different Member States, especially the UK, Germany and Ireland;

-    Comparative study of the remedies available under UK and EU law for policyholders from the UK and other Member Sates (external study commissioned under the committee's "Expertise Budget");

4) Investigation:

-    Gather information about the number of affected policyholders from the UK and non-UK Member States and the magnitude of damages suffered;

-    Determine status of policyholders' claims;

-    Fact-finding missions to UK, Ireland and Germany to meet petitioners and representatives of financial authorities, and/or hearing of competent authorities in order to establish if the relevant provisions were properly applied;

-    Request information and documentation from the Commission regarding:

§ the transposition of the relevant Directives and their application by competent authorities during the reference period;

§ actions taken by the Commission with regard to monitoring implementation;

§ the monitoring of the transposition of the Third Directive in the UK, including relevant correspondence with the UK authorities.

Summary of the approach proposed by the Rapporteur

in the Working Document of 23 March 2006

                                                                                                           UK (e.g. Treasury, DTI)

Q: How did you implement? Germany

                                                                                                           Ireland

                                                                                                  Spain /Netherlands

                                             Q: How did you or would you have regulated?               

                                          UK (e.g. FSA, PIA, GAD)                 Germany

                                            Ireland

                                                                                                          Spain/ Netherlands

                                                                                                          Other State?

                                                             

Q: What mechanisms are/were available

to claimants in your country?                                                                           UK

                                                                                                          UK

                                                                                                          Germany

                                                                                                          Ireland                       

                                                                                                          Spain / Netherlands                           Other State?        

Conducting this research will then assist in responding to the related issue concerning the Commission:

(1)

Council Directive 92/96/EEC of 10 November 1992 on the coordination of laws, regulations and administrative provisions relating to direct life assurance and amending Directives 79/267/EEC and 90/619/EEC (third life assurance Directive), OJ L 311 , 14/11/1997, p.34.

(2)

First Council Directive 79/267/EEC of 5 March 1979 on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of direct life assurance, OJ L 063 , 13/03/1979 P. 0001 - 0018; Second Council Directive 90/619/EEC of 8 November 1990 on the coordination of laws, regulations and administrative provisions relating to direct life assurance, laying down provisions to facilitate the effective exercise of freedom to provide services and amending Directive 79/267/EEC, OJ L 330 , 29/11/1990 p.50.

(3)

Second Council Directive 90/619/EEC of 8 November 1990 on the coordination of laws, regulations and administrative provisions relating to direct life assurance, laying down provisions to facilitate the effective exercise of freedom to provide services and amending Directive 79/267/EEC, OJ L 330 , 29/11/1990 p.50.

(4)

The Treasury set up Lord Penrose’s inquiry in August 2001.  The terms of reference were: “To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society, taking account of relevant life market background; to identify any lessons to be learnt for the conduct, administration and regulation of life assurance business; and to give a report thereon to Treasury Ministers.” The report of the Equitable Life inquiry was published on 8 March 2004.

(5)

Recitals 6, 7 and Article 8.


III.  Historical background

History

In 1762, the Equitable Life Assurance Society was created as the first mutual life assurance company and is still the oldest mutual life assurance company in the UK. For the next 200 years, it established itself as a reputable and trusted provider of pension products. Its success is partly based on its reputation, its strategy of paying no commissions to insurance agents or independent advisers and its tactic of always keeping reserves low and returning to its members more money than other companies. During the 1950s, Equitable began selling so-called GAR(1) (“guaranteed annuity rate”) policies alongside its other pension products. GARs guarantee investors a minimum annuity rate when they retire. It can be argued that the company's troubles start here: a guaranteed pension for life means predicting how long people will live and the level of interest rates for up to 40 years into the future. Equitable did not correctly predict the increase in life expectancy of the general population nor the historical fall in interest rates; thus, a time-bomb started ticking the moment GARs were introduced, with the firm consistently under-reserving for the guaranteed annuities throughout the whole period and creating an ever-increasing asset shortfall.

Despite experiencing a period of rapid growth in the 1990's based on the long bull market of that decade, as interest rates begin to fall it became increasingly expensive for ELS to honour its policies. Throughout this period, the ELS management still continued to devise innovative products that continued to attract new policyholders, most notably a new type of with-profits fund, where part of the benefits are guaranteed but the final bonus depends on future market performance. However, as the expansion stopped, the firm realized the extent of its asset shortfall and decided to pay newly retired people less than the guaranteed amount: in 1994, ELS announced plans to cut the size of the final bonuses paid to its 90,000 GAR policyholders, which was immediately challenged in court by some of the policyholders affected. At the same time, the Society's with-profits business came under close scrutiny in the press.

After a long legal battle, with subsequent appeals from both sides, the UK House of Lords ruled in 2000 that the Society's approach was inappropriate and that it must meet its obligations to its GAR policyholders. As a result, the already existing asset shortfall situation worsened (£1.5 billion) and the company decided to put itself up for sale. However, initial potential purchasers withdrew at the last minute. On 8 December 2000 the Society closed its doors to new business and a new Board was appointed. In 2001, the new Board cancelled interim bonuses and cut all (£4 billion) pension policy values by 16% (14% for life policies). Before the end of 2001, the new Board further proposed a compromise scheme to policyholders to change the status of GAR and non-GAR investments, a scheme which was sanctioned by the UK High Court on 8 February 2002.

In the face of all these developments, several investigations at the UK level started one after the other: in March 2001 the House of Commons Treasury Select Committee published its 'Equitable Life and the Life Assurance Industry: an Interim Report'; in August 2001 Lord Penrose started his wide-ranging investigation; in September 2001 the Corley Report into Equitable Life was published; in October 2001 the Baird Report into regulatory handling of Equitable Life was published. In April 2002 the Society tried to sue its former auditor, Ernst & Young, and 15 former directors but the action was ultimately unsuccessful.

In June 2003, the UK parliamentary Ombudsman issued a report finding prudential regulators not guilty of maladministration. In March 2004, the Penrose report was published. It stated in essence that, despite having identified some serious regulatory failings in the way the firm was supervised, the balance of blame lay more with ELS' management than with the regulators. Later the same year, the first petitions on the case reached the European Parliament's Committee on Petitions. The petitioners argued that UK regulators failed to supervise adequately the Society's ability to meet its regulatory financial requirements and that the actions and omissions of the past regulators were in breach of UK rules and the corresponding EU life insurance Directives. On 18 January 2006, Parliament decided to set up the Committee of Inquiry into the Crisis of the Equitable Life Assurance Society (EQUI) committee, which held its constituent meeting on 2 February 2006.

Main figures and policies

At the height of its business in 2001, the number of with-profits policyholders affected by the policy cut was close to one million, mostly in the UK. If non with-profits policyholders are included, up to 1.7 million policyholders were affected, according to some estimates. Today, the with-profits fund, worth £10 billion, still has about 600,000 members. It is estimated that some 15,000 policies had been sold in Germany, the Irish republic and other non-UK Member States by the time of the closure of ELS to new business in 2001. Currently there would appear to be 8,300 with-profits policyholders remaining in Ireland and some 4,000 in Germany.

Types of policies

Before describing what type of products were sold by ELS, it is perhaps useful to clarify for the layman what an annuity is. In essence, it is an insurance product that provides a series of periodic payments that are guaranteed as to amount and payment period. If a person chooses to take the annuity payments over his or her lifetime, the person will have a guaranteed source of income until his death. If he dies before his life expectancy, he will get back from the insurer far less than was paid in. On the other hand, if he outlives his life expectancy, he might get back far more than the cost of the annuity plus earnings. Usually, the earnings that occur during the term of the annuity are tax-deferred (i.e., they are not taxed until they are paid out). The following are different types of annuity products, with an indication of the types of policies sold by the Society and the outstanding amounts(2):

§ Single-Premium Annuities: the investment is made all at once

§ Flexible-Premium Annuities: the annuity is funded with a series of payments

§ Immediate Annuities: it starts payments right after the annuity is funded, usually with a single premium

§ Deferred Annuities: with this type of annuity, payouts begin many years after the annuity contract is issued. Scheduled payments can be received either in a lump sum or as an annuity. They may be funded with a single or flexible premium

§ Fixed Annuities or GAR Annuities: with a fixed annuity contract, the insurance company puts funds into conservative fixed income investments such as bonds, and the principal is guaranteed. The company gives the policyholder an interest rate that is guaranteed for a certain minimum period. This guaranteed annuity rate (GAR) is adjusted upwards or downwards at the end of the guarantee period. ELS still has fixed annuity business of around £5billion

§ Variable Annuities: the variable annuity carries higher risks than the GAR fixed annuity. It gives the purchaser the ability to choose how to allocate his money among several different managed funds. Unlike the fixed annuity, there are no guarantees of principal or interest. Thus, the investment is taken by the annuitant who bears the risk, not the insurance company. ELS sold a type of variable annuity called a with-profit annuity, a policy that received a share of the distributed surplus from the relevant fund by way of bonuses. ELS wrote the bulk of its with-profit annuity contracts in the 1990s when investment returns were high. The Society’s financial problems and the stock market fall of 2000-2003 resulted in a material cut of about one-third of the with-profit annuities. This was also compounded by the matter of the so-called Guaranteed Interest Rate (‘GIR’), an amount by which basic benefits are guaranteed to increase each year before the addition of a declared bonus. It is estimated that GIR probably still applies to about 75% of with-profit policies of ELS. Those policies with GIR benefit from a 3.5% guaranteed annual increase. The overall effect of the GIR is that ELS is locked into investment in government stocks and loans, which can barely produce a 3.5% annual return. This has meant that the Society has not benefited much from the stock market recovery of 2003-2005. The ELS with-profits fund is currently estimated to be worth £10 billion.

The functioning of a with-profits fund in detail

Funds are invested - whether in equities, bonds, gilts and property - depending on the fund and its investment objectives. The intention of with-profits is to give relatively cautious investors a taste of the stock market but without too much risk. In return for monthly premiums, the company promises to pay a lump sum at the end of the policy's term. Investors' premiums are paid into a central fund with those of other "with-profits" investors. A large part of the policy's final value depends on bonuses paid by the firm during the investment period and when the policy matures. To safeguard the funds' strength, financial penalties are also imposed on savers who wish to withdraw their money early. With-profits funds also have an in-built safety mechanism known as "smoothing". This means that in years of good investment growth companies should hold back profits and use them to top up bonuses in years when economic conditions are harsher.

(1)

See Glossary in Annex for explanation of technical terminology.

(2)

For more detail see WE 28.


IV.      Summary of actions undertaken

Actions taken and evidence analysed so far

1. Hearing of relevant witnesses before Committee

During its meetings on 23 March 2006, 25 April 2006, 29 May 2006, 21 June 2006, 11 July 2006, 13 September 2006, 4 October 2006, 23 November 2006, 19 December 2006, 25 January 2007 and 1 February 2007, the Committee of Inquiry heard testimonies of several witnesses, including Equitable Life policyholders, who had previously petitioned the European Parliament, other policyholders from the UK, Ireland and Germany, representatives of the UK, Irish, German and Swiss governments, the European Commission and the current chief executive of Equitable Life. The following witnesses provided oral evidence:

Meeting of 23 March 2006 (oral evidence H1):

-    Tom LAKE, Chairman of the Equitable Members' Action Group

-    Paul BRAITHWAITE, General Secretary of the Equitable Members' Action Group, (petitioner)

-    Elemér TERTÁK, European Commission DG Markt, Director for Financial Institutions

-    Karel VAN HULLE, European Commission, DG Markt, Head of the Insurance and Pensions Unit

-    Alan BEVERLY, European Commission, DG Markt, Insurance and Pensions Unit

Meeting of 25 April 2006 (oral evidence H2):

-    Michael JOSEPHS, Adviser to Investor's Association

-    Beatrice KNOWD, Irish policyholder

-    Patrick KNOWD, Irish policyholder

-    Nicolas BELLORD, policyholder (petitioner)

-    Paul WEIR, Chairman of the Late Contributors Action Group

-    Charles THOMSON, Chief Executive Officer, Equitable Life Assurance Society

Meeting of 29 May 2006 (oral evidence H3):

- Peter SCAWEN, Equitable Life Trapped Annuitants (ELTA) group

- Markus J. WEYER, DAGEV (Deutsche Arbeitsgemeinschaft der Equitable Life Versicherungsnehmer), association representing the interest of policyholders who underwrote Equitable Life policies in Germany

- Martin McELWEE, author of the Leviathan report

Meeting of 21 June 2006 (oral evidence H4):

- Clive MAXWELL, Director for Financial Services Policy at HM Treasury

- David STRACHAN, Director for the insurance sector at the Financial Services Authority (FSA)

- Christopher DAYKIN, Government Actuary, Head of the GAD (Government Actuary's Department)

- Mary O'DEA, Consumer Director, Anne TROY, Head of insurance supervision, at the Irish Financial Services Regulatory Authority (ISFRA), and George TREACY, Head of Consumer Protection Codes at the Irish Financial Services Regulatory Authority (IFSRA)

- Colin SLATER, accountant and partner at Burgess Hodgson.

Meeting of 11 July 2006 (oral evidence H5):

- Richard LLOYD, Equitable Life Assurance Society ex-sales representative

- Stuart BAYLISS, managing director of Annuity Direct

Meeting of 13 September 2006 (oral evidence H6):

- Thomas STEFFEN, First Director for Insurance Supervision of the German Financial Services regulator (BaFin) (Bundesanstalt für Finanzdiensleistungsaufsicht)

- Kurt SCHNEITER, Member of the Board of the Swiss Federal Office of Private Insurance

Meeting of 4 October 2006 (oral evidence H7):

- Mr BJERRE-NIELSEN, Chairman of CEIOPS, the Committee of European Insurance and Occupational Pensions Supervisors

- Liz KWANTES, head of the Equitable Life Members Help Group

- Leslie SEYMOUR, a Brussels-based ELS policyholder

Meeting of 23 November 2006 (oral evidence H8):

- Charles THOMSON, Chief Executive Officer, Equitable Life Assurance Society

- Simon BAIN, journalist from the Glasgow Herald

- Charlie MCREEVY, European Commissioner for the Internal Market

Meeting of 19 December 2006 (oral evidence H9):

- Eric DUCOULOMBIER, representative for FIN-NET

Meeting of 25 January 2007 (oral evidence H10):

- Claire-Françoise DURAND, Deputy Director General of the Legal Service of the European Commission

- Jacqueline MINOR, Director of Directorate B (Horizontal Policy Development) of DG MARKT

- Michel AYRAL, Director of Directorate C (Regulatory Policy) of DG ENTR

- Julio GARCIA-BURGUES, Head of Unit A.2 (Infringements) of DG ENVI

Meeting of 1 February 2007 (oral evidence H11):

- Paul BRAITHWAITE, General Secretary of the Equitable Members' Action Group (petitioner)

- Lord NEILL QC and Matthew MORRISON

2. Witnesses invited to hearings who declined to attend

UK Government and Regulators:

- The Rt Hon Mr. Des BROWNE former Financial Secretary to the UK Treasury

- The Rt Hon Mr. Ed BALLS MP*, current UK Economic Secretary to the UK Treasury (Treasury: regulator 1998-2001)

- Mr. Callum McCARTHY*, Chairman of the Financial Services Authority (FSA) (current regulator, since December 2001)

- Sir Howard DAVIES, ex-FSA Chairman

- Mr. Martin ROBERTS, formerly responsible for the Insurance Directorate at the Department of Trade and Industry, and later at Treasury (DTI: regulator until January 1998)

Other Regulators:

- Michael MARTIN, Irish Minister for Enterprise, Trade and Employment

European Commission:

- Frits BOLKESTEIN, Ex-Internal Market Commissioner

Others:

- John McFall MP*, Chair of the UK House of Commons Treasury Committee

- Tony Wright MP, Chair of the UK House of Commons PA committee

- Lord Penrose

- Ann Abraham*, UK Parliamentary Ombudsman

- Iain Ogilvie*, Head of UK Parliamentary Ombudsman Investigations into ELS

- Walter Merricks*, Financial Services Ombudsman (FOS)

- Stephen Hadrill, Secretary-General of ABI (Association of British Insurers)

- Daniel Schanté, director-general CEA (Comité européen des assureurs)

- David Forfar, former actuary and Head of Finance of a Scottish Life Assurer

- Liz Dolan, journalist at the Sunday Telegraph

- Rupert Jones, journalist at The Guardian

- Roy Ranson and Chris Headdon, Previous Executives of ELS

- Matthias Niesel, former ELAS salesman in NRW

*: Met with EQUI Delegation in London on 16.10.06, see point 8

3. List of accepted written evidence

WE

Reception of evidence was possible until the closing date of 20 March 2007. Documents officially considered as written evidence and posted on the website are the following:

92.  Postscript to EMAG presentation on 1 February

91.  Response by EMAG to FOS submissions

90.  Letter from Chair to the FOS and reply from FOS

89.  Letter by EU Ombudsman to Chair

88.  Letter by Young to Chair

87.  Response by FOS to Neill report

86.  Executive Summary Lord Neill's report

85.  Markus Weyer report

84.  Josh Holmes Opinion on Life Directives

83.  Lord Neill report

82.  Submission to EU Ombudsman by Mr Rankin

81.  Letter by Mr Deppe to Chair

80.  Response by ISFRA

79.  Paper on asset shortfall by Investors' Association

78.  Response H. Davies

77.  Response PASC

76.  Senior Counsel's opinion of 27.07.06, Anthony Boswood QC

75.  Official notes of EMAG's meeting with the FSA on 14.12.05

74.  Exchange of letters between EMAG and McGuinness

73.  Presentation by Commissioner McCreevy on 23.11.06

72.  Presentation by Simon Bain on 23.11.06

71.  Letter Hebert Smith to ELS

70.  Presentation by Mr Thomson on 23.11.06

69.  Further paper on fraud by Investors Association

68.  Letter by Chair to Ms Meade and response on 07.11.06

67. Compromise scheme assessment by FSA

66. Compromise scheme letter by FSA

65. Letter by Ms O'Dea to Chair

64. Letter by Irish permanent representative to the EU

63. Irish cases submitted to Ombudsman

62. Submission by Mr Meade to Dublin delegation

61. Submission by Ms O'Dea to Dublin delegation

60. Treasury Committee: Report by the Committee on European financial services       regulation

59. Evidence to Treasury Committee on Actuarial profession

58. Memo by Cazalet Financial Consulting

57. Submission by Mr McFall to London delegation

56. Submission by Mr Merricks to London delegation

55. Sienna protocol

54. Annex II to evidence by Mr Seymour on 041006, 'La vie d'or' case

53. Annex I to evidence by Mr Seymour on 041006

52. Evidence by Mr Seymour on 041006

51. Evidence by Ms Kwantes on 041006

50. The Corley report

49. Oral evidence by Mr Schneiter on 1309096

48. Correspondence between German policyholders and FSA

47. Response by Mr Thomson, ELS CEO

46. Evidence by Mr Stonebanks

45. Response by Chris Headdon to invitation to be a witness

44. EMAG presentation to Petitions Committee, 13.09.05

43. Letter from Mr Vinall to Chair on FSA

42. Letter fraud Josephs McGuinness

41. Paper by EC on Home/Host issues

40. 2nd submission by Mr Brian Chase Grey

39. Letter European Commission 6.6.6

38. Statement of Consumer Director Ireland, 210606

37. Evidence by FSA on 21.06.06

36. Evidence by Mr Seymour

35. Letter Byrne to McGuinness

34. Burgess Hodgson for meeting 21.06.06

33. Paper by Michael Nassim, update: "Anatomy of a fraud"

32. UK government submission for meeting of 21.06.2006

31. Paper on fraud by the Investors Association

30. Documents from the Treasury Committee of the UK House of Lords:

(10th Report, 2001-02, Equitable Life and the Life Assurance Industry: An Interim Report (March 2001); 6th Special Report, Session 2001-02: Government response to the above (October 2001); Text of the Financial Secretary's (FST) statement to the House on 8 March 2004, and subsequent questioning; Evidence from Lord Penrose and the FST on 16 March 2004; "Restoring Confidence in long-term savings" (8th Report, session 2003-04, July 2004))

29. Paper on current state of the With-Profits Fund of the ELS

28.  Options paper for EMAG

27.  Memorandum from FOS to EQUI

26.  Burgess Hodgson report for EMAG

25.  Letter from Mr Chase Grey to John McFall MEP

24.  Presentation by McElwee on 29.05.2006

23.  Presentation by ELTA on 29.05.2006

22.  Presentation by DAGEV on 29.05.2006

21.  Evidence by BAFin - also summary of BaFin evidence

20.  Wilde Sapte study implementation report, UK

19.  Letter from the European Commission 02.05.2006

18.  Written evidence by Mr Brian Edmonds

17.  The Baird Report

16.  The Penrose Report

15.  Petition 0611/2004 and annex to petition 0611/2004

14.  Petition 0029/2005 and annex to petition 0029/2005

13.  Notice to Members on petitions 0611/2004 and 0029/2005

12.  Memorandum to the EP from the UK Ombudsman

11.  Memorandum of understanding between the FSA and the FOS

10.  Written evidence by Mr Peter Schäfer

9.   Written evidence by Mr Brian Chase Grey

8.   Paper by Michael Nassim: "An equitable assessment of rights and wrongs"

7.   Paper by Michael Nassim: "Equitable Life: Penrose and Beyond - Anatomy of a fraud"

6.   Presentation by Paul Weir of ELCAG on 25.04.2006

5.   Presentation by Charles Thomson on 25.04.2006

4.   Investor's Association contribution on 25.04.2006

3.   Mr O'Brion on the Irish policyholders receiving compensation in the UK

2.   EMAG contribution on 23.03.2006

1.   European Commission contribution on 23.03.2006

WE-File

List of filed written evidence, not posted on the website, WE-File #:

1.  Evidence by Edmonds (letter)

2.  Evidence by Power (letter)

3.  Evidence by O'Brien (letter)

4.  Evidence by Troy (letter)

5.  Evidence by Douglas (letter)

6.  Evidence by Byrne (letter)

7.  Evidence by B.Groves (letter)

8.  Evidence by McGuirk (letter)

9.  Evidence by O'Farrell (letter)

10.  Evidence by Seymour (email) [subsequently put on web as WE 36]

11.  Evidence by Ms K. Noonan (letter)

12.  Evidence by Peter Thornton (letter)

13.  Evidence by Jim Berry (letter)

14.  Evidence by Jack Duggan (letter)

15. Evidence by John Galvin (letter)

16. Evidence by Patrick McCarthy (letter)

17. Evidence by Roy Harding (email)                                                             

18. Evidence by DAGEV (copies of correspondence with FSA; later WE 48)

19. Evidence by Mr. O'Farrell (letter and news article,+ letters Abraham)

20. Evidence by Mr. N.F.Norrish (letter forwarded by Chichester MEP)

21. Evidence by Mr. Krege (petition 508/2006)

22. Evidence by S&P (ELAS credit ratings 1993-2002)

23. Evidence by John Rankin (on complaint to Ombudsman)

24. Evidence on Lloyds, Poole case (1)

25. Evidence on Lloyds, Poole case (2)

26. Evidence by Mr. Golding on Sun Life

27. Evidence by Mr. Deppe on FOS

28. Evidence by Manfred Westphal (FIN-USE) on follow-up questions

29. FSA information to policyholders July 2004

30. High Court Judgement PO/Pensioners case

31. Evidence by Alexander Kern on follow-up questions

32. Ruling by Institute of Actuaries against Ranson, Headdon

33. Responses by 30 Irish policyholders to questionnaire, including annexes (paper copy only)

WE-Conf

There are 32 pieces of confidential written evidence, WE-CONF 1-32.

Other background documents:

- Directives: First Council Directive 79/267/EEC of 5 March 1979 on the coordination of laws, regulations and administrative provisions relating to the taking-up and pursuit of the business of direct life assurance; Second Council Directive 90/619/EEC of 8 November 1990 on the coordination of laws, regulations and administrative provisions relating to direct life assurance, laying down provisions to facilitate the effective exercise of freedom to provide services and amending Directive 79/267/EEC; Third Council Directive 92/96/EEC of 10 November 1992 on the coordination of laws, regulations and administrative provisions relating to direct life assurance and amending Directives 79/267/EEC and 90/619/EEC (Third life assurance Directive); Directive 2002/83/EC of the European Parliament and of the Council of 5 November 2002 concerning life assurance.

- List of files from the European Parliament Petitions Committee on the Equitable Life affair:

1.) Petition 0611/2004 (Arthur White)

- Petition with annexes

- Summary of petition and recommendations from the PETI secretariat (SIR document)

- Commission's response to PETI's request for information (CM)

- Speech given by Mr Nicolas Jerome Bellord on behalf of the petitioner at the PETI meeting of 13 September 2005

- Various letters from the chairman of PETI to the petitioner informing him about the progress made in the treatment of his petition

2.) Petition 0029/2005 (EMAG)

- Petition with annexes

- Petition translated into German

- Summary of petition by the petitioner

- Summary of petition and recommendations from the PETI secretariat (SIR document)

- Addendum to petition dated 15 July 2005 concerning remedies

- Addendum to petition dated 9 November 2005 concerning FSA and FOS

- Commission's response to PETI's request for information (CM) same as above

- Speech given by EMAG representatives at the PETI meeting of 13 September 2005 and PowerPoint slides

- EMAG response of 22 June 2005 to Commission statement

- Various letters from the chairman of PETI to the petitioner informing him about the progress made in the treatment of his petition

- e-mail exchanges between PETI secretariat and petitioners

3.) Petition 0775/2005 (Manfred Bischof)

- Petition

- Summary of petition and recommendations from the PETI secretariat (SIR document)

- Various letters from the chairman of PETI to the petitioner informing him about the progress made in the treatment of his petition

4.) Petition 0067/2006 (Franz-Josef Groemping)

- Petition

- Letter to the petitioner acknowledging receipt of his petition.

5.) Request to set up a Committee of Inquiry

- Background note of PETI secretariat on possible request to set up a Committee of Inquiry

- Various draft versions of mandate

- Letter of PETI chairman to President Borrell requesting the setting-up of a Committee of Inquiry (29. September 2005)

- Reply of President Borrell to the PETI chairman (13 October 2005)

- List of signatures by members supporting the request to set up a Committee of Inquiry

- Opinion of the Legal Service concerning the request (in FR only)

- Conference of Presidents: summary of decisions at meetings of 19 December 2005 and 12 January 2006

- EP decision of 18 January on setting up a Committee of Inquiry into the collapse of the ELAS

6.) Documents relating to investigations in the UK

- Report of the FSA on the review of the Regulation of the ELAS from 1 January 1999 to 8 December 2000 ("Baird Report")

- Treasury Committee Report: Equitable Life and the Life Assurance Industry: An Interim Report Volume I: Report and Proceedings of the Committee (27 March 2001)

- Treasury Committee Report: Equitable Life and the Life Assurance Industry: An Interim Report Volume II: Minutes of Evidence and Appendices (27 March 2001)

- Treasury Committee: Regulation of Equitable Life; Minutes of Evidence (30 October 2001)

- Treasury Committee: Regulation of Equitable Life; Minutes of Evidence (13 November 2001)

- Treasury Committee: Restoring confidence in long-term savings: The Equitable Life Inquiry; Oral Evidence (16 March 2004)

- Report of the Equitable Life Inquiry ("Penrose Report")

- The UK Parliamentary Ombudsman: The prudential regulation of Equitable Life (1st report)

- Memorandum to the Petitions Committee of the EP by the Office of the UK Parliamentary Ombudsman concerning the investigation into the prudential regulation of Equitable Life

7.) Other documents

- Submission by ELAS to PETI concerning possible claims by society and policyholders against regulators

- Various press articles

4. Information exchanges with the European Commission

Information was requested from the European Commission regarding the transposition and implementation of the 3LD in the UK and other Member States. This includes the so-called implementation reports as well as the reviews of those implementation reports. In addition, the European Commission was asked to provide EQUI with a complete list of all documents related to the ELS affair in its possession as well as a list of the infringement procedures that had been opened with Member States other than the UK with regards to the 3LD. The Commission responded by sending the private study commissioned into the implementation of the 3LD, the Wilde Sapte study, as well as nine individual country correlation reports. It also sent a list of relevant infringement proceedings and further information on the review of the study and relevant correspondence.

5. Meeting with members of staff of the UK Parliamentary Ombudsman on 29 March 2006 in London

On 29 March 2006, the rapporteur met with members of staff of the UK Parliamentary Ombudsman, who is currently conducting an inquiry into alleged maladministration by UK authorities in the regulation of Equitable Life. The main purpose of the meeting was to discuss, among other issues, the scope and timing of the respective inquiries and the cooperation between the Committee of Inquiry and the Ombudsman.

On this occasion, the rapporteur pointed out that it would be desirable for the Committee of Inquiry to know the Ombudsman's findings before the committee finalises its work. The Ombudsman's staff confirmed that the final report would be published before the end of 2006, and that a draft report was expected to be ready by July 2006 and would be sent to both a representative of the complainants and the UK Government for comment. However, subsequent events led the Ombudsman to postpone publication of the report until mid-2007. At the time of publication of this report, the timing remains uncertain.

The rapporteur discussed possible ways of organising cooperation between the UK Ombudsman and the committee prior to the publication of the Ombudsman's report. The question was raised as to whether and what kind of information the Ombudsman would be willing to share. For instance, the Ombudsman has already carried out a detailed analysis of the UK regulatory system on life assurance, something which the Committee of Inquiry is also required to do under its mandate. However, the Ombudsman's staff underlined the fact that the Ombudsman is not empowered to disclose any information obtained in the course of her investigation other than through her final report.

6. Tools for Members

A glossary of specialized insurance and ELS-related terms and a timeline of events was produced for the benefit of the committee's Members (see Annex), as well as a background note on the regulatory structure of the UK and a note on the scope and powers of a European Parliament Committee of Inquiry.

Website: A website for the EQUI committee was set up and has been operational since 16 February 2006. Here citizens and Members alike can find all relevant information as well as a number of contact lists, such as the committee secretariat, political group' advisers and other useful information. E-mails were regularly sent to Members with the updates to the website. The Brussels-based press has also been informed of its existence. The purpose of the website was to allow the work of the committee be as transparent as possible for the public, without prejudice to the need to preserve confidentiality when required. The EQUI secretariat kept the website updated to ensure that all relevant documents (oral and written evidence, background documents and agendas) and Working Documents, Draft Reports and other documents were available. Up to 92 pieces of evidence were posted on the website before the closing date of 20 March 2007. Members were also able to contribute to the web by proposing that documents or links be added at their request. The verbatim transcripts of each of the 11 committee public hearings were also posted on the website. The link to website is as follows:

(http://www.europarl.europa.eu/comparl/tempcom/equi/default_en.htm)

7. Studies:

- Study on part 1 of mandate (ES 1): In order to help with the tasks at hand, EQUI requested the advice of external experts. For this purpose, a comparative study was commissioned under the committee's expertise budget. The experts were asked to examine how the provisions on prudential supervision and conduct of business rules of life assurance undertakings as laid down in the relevant EU Directives were transposed into UK law. The study identifies for each of those provisions the matching UK provisions and indicates when they entered into force, by way of a transposition table. The transposition in the UK was then compared with implementing legislation in Ireland, Germany and Spain. The results of the study are included in the findings of the final report.

- Study on part 2 of mandate (ES 2): To advise members on legal and procedural issues related to this part of the mandate, as well as to collect and analyze relevant background material, the Committee of Inquiry commissioned an external study on the UK regulatory arrangements related to both prudential supervision and conduct of business rules of life assurance undertakings, seen in the context of the Equitable Life case. The comparative approach includes financial regulators in Ireland, Germany and Spain and other relevant examples of transposition and regulation in EU Member States. The results of the study are included in the findings of the final report.

- Study on part 3 of the mandate (ES 3): the committee received a comparative study on the adequacy of remedies available under UK and EU law for policyholders from the UK and other Member States in the context of the Equitable Life affair. The study provides a complete list of existing judicial and non-judicial remedy schemes available under UK and EU law and gives a qualitative judgment of their adequacy. The results of the study are included in the findings of the final report.

8.  Delegation visits to Dublin and London

The committee made two fact-finding visits - to Dublin on 6 October 2006 and to London on 16 October 2006 - as part of the evidence-gathering process in preparation for its report.

In Dublin, MEPs met Irish Equitable Life policyholders and financial services regulators as well as the Irish Financial Services Ombudsman and the former Insurance Ombudsman of Ireland. In London, they met British policyholders, Ed Balls, Economic Secretary to the Treasury, the FSA chairman Callum McCarthy, the FOS, Mr Merricks, the Parliamentary Ombudsman, Ms Abraham, and others. Press conferences were held during both visits.

9. Workshops

Two workshops were organized in the context of the investigation:

WS 1: Presentation of studies, 5 October 2006, 9:00-12:30

§ Study on transposition of EU life insurance directives, presentation by the authors (Taki Tridimas, professor, Sir John Lubbock Chair for Banking Law, Centre for Commercial Law Studies, Queen Mary University of London)

§ Study on regulatory systems, presentation by the authors (Jane Welch, Director, European Financial and Corporate  Law Centre, British Institute of International and Comparative Law)

§ Study on redress mechanisms, presentation by the authors (Taki Tridimas, professor, Sir John Lubbock Chair for Banking law, Centre for Commercial Law Studies, Queen Mary University of London)

WS 2: Transposition issues, 30 November 2006, 14.30-17.30

§ Session 1: General Issues concerning the transposition of EU law into National law (Professor Stefan Vogenauer; Professor Bernard Steunenberg)

§ Session 2: Transposition of Financial Services Directives into National Law (Dr Manfred Westphal. Fin-Use; Dr Kern Alexander; Ms Lieve Lowet)


PART II - TRANSPOSITION

                on the alleged contraventions or maladministration in the application of Directive 92/96/EEC (the "Third Life Directive") by the UK and on its monitoring by the European Commission

INDEX  PART II

I.         Introduction

I.1. The mandate

I.2. The scope

I.3. The directive in brief

I.4. Specific actions

II.       Investigation into the correct transposition into UK law of the 3LD and its application/implementation by UK authorities in relation to the ELAS

II.1. Analysis of transposition in detail in light of the evidence

II.1.1. Key articles of the 3LD: 8, 10, 18, 25, 28, 31

II.1.2. Other articles of the 3LD

II.1.3. Relevant articles from other Directives

II.2. Further evidence on transposition

II.2.1. Evidence by the Commission

II.2.2. Evidence from the implementation study

II.2.3. Other selected written and oral evidence on transposition

Conclusions


I.         Introduction

I.1.      The mandate

This part of the report (Part II) aims to provide the Committee of Inquiry into the Crisis of the Equitable Life Assurance Society (EQUI) with information on whether Directive 92/96/EEC(1) (the Third Life Directive or 3LD) was correctly transposed and properly implemented at the national level in the UK by its competent authorities. The mandate further specifies this section by reproducing Recital 7 of the 3LD relating to "the monitoring of the financial health of insurance undertakings, including their state of solvency, the establishment of adequate technical provisions and the covering of those provisions by matching assets". This analysis of the transposition and implementation of the Directives must be undertaken with regards to the specific circumstances surrounding the Equitable Life Assurance Society (ELAS) as well as from the viewpoint of the whole life insurance sector, particularly with regard to its regulatory regime.

Consequently, the committee needs to identify first of all those provisions of UK national law intended to give effect to the requirements of the Directives, and examine whether these requirements were transposed in a full and timely manner. Secondly, the committee will need to examine if the application by the various UK authorities of those national legal provisions which transposed the Directive has been in conformity not only with UK but also with EU law. For this purpose, it will have to clarify the respective responsibilities of the various financial authorities involved in the supervision of Equitable Life during the reference period. Detailed investigations need to be carried out to establish by whom, when and how Equitable Life's solvency, its accounting and provisioning practices, were supervised and how the authorities responded to possible weaknesses.

This part (Point II.2.1) will also examine in detail how the Commission has monitored the implementation of the 3LD. This section of this part is closely linked to Part V of this report on systematic weaknesses in the Commission.

I.2.      The scope (directive and time)

The directive

The mandate limits EQUI's scope to the 3LD, adopted in 1992, and the directive that codified it (hereafter, the “codified directive”(2) or CD), adopted in 2002. However, it should be pointed out that the earlier directives, which were amended by the 3LD and then subsequently codified by the CD, also need to be examined, i.e. the first(3) (1LD) and second(4) (2LD) life assurance directives, from 1979 and 1990 respectively.

The fact that the 3LD is not the only legal text to be taken into account is crucial. The 3LD complements and reinforces key provisions that were already contained in 1LD and 2LD. Moreover, any other community legislation applicable to the case examined by the EQUI committee will likewise warrant scrutiny. This is particularly true of Directive 2002/12/EC(5), also known as Solvency I, but also of others, which will be listed further on.

For the purposes of this inquiry, all allusions to articles will refer to the 3LD and in some instances, if necessary, the equivalent articles from other directives or from the CD will be mentioned in brackets. If major differences exist between provisions contained in different directives, they will be specified. For the purpose of identifying articles, it is useful to peruse the Table of correspondence in Annex VI of the CD.

The main provisions relevant to the inquiry are to be found in Title III of the 3LD, namely Articles 8-31.

Time period

As far as the period covered by the inquiry is concerned, the mandate specifies that it should commence with the entry into force of the 3LD (1 July 1994) and should end when the main events surrounding the ELAS case occurred, i.e., 1999-2001. Nevertheless, for the purposes of the inquiry, and as has been explained previously, it is necessary to analyze events before 1994, both in terms of the time periods when the 1LD and 2LD were in force and with regards to the whole process of adoption of the 3LD before 1994. Moreover, the mandate also mentions the year 1989 as the starting point for the investigation as far as allegations against UK regulators are concerned. Therefore, in broad terms, the reference period covers 1989-2001.

I.3.      The directives in brief

The importance of the 3LD for this inquiry is paramount. This is clearly illustrated by the mandate itself when it quotes Recital 7 of the Directive, which speaks of "the monitoring of the financial health of insurance undertakings, including their state of solvency, the establishment of adequate technical provisions and the covering of those provisions by matching assets". Hence, these are the key elements that should form the core of the investigation into the issues of correct transposition and supervision.

The 3LD, later complemented and built upon by the 2002 CD, is the basic text governing the single market in life insurance in the EU. The text’s basic tenets are the principles of single authorisation and mutual recognition. The Directive incorporated the main provisions contained in the 1979 1LD (authorisation of life assurance undertakings by a competent authority, constitution of adequate sufficient technical provisions and of a solvency margin) and the 1990 2LD, which allowed life assurance providers to benefit from the freedom to provide services across borders for the first time.

The overall approach pervading the 3LD consisted in bringing about a certain degree of harmonisation, which was considered at the time an essential stepping stone to achieving mutual recognition of authorisations and prudential control systems. The Directive thus made it possible to grant a single authorisation valid throughout the Community and enshrined the principle of supervision by the home Member State. The aim was to promote economic efficiency and market integration by permitting insurers to operate throughout the EU via the opening of offices or via the cross-frontier provision of services. This would give consumers a wider choice of insurer and insurance products, providing them at the same time with the knowledge that all insurers would be subject to comparable minimum standards. The investigation into allegations regarding transposition and implementation must assess whether both the letter and the spirit of the Directive were upheld both by transposed UK law and UK regulatory practice.

With respect to the principle and methods of financial supervision, the Directive significantly modifies the scope of competence of the supervisory authorities of the home and host Member States. It basically provides that the home Member State’s authorities are responsible for the supervision of the “entire business” of the assurance undertakings whose head office is established in their territory and, accordingly, it curtails the supervisory power of the host Member State’s authorities over EC companies operating within their territory.

In order to facilitate the exchange of information necessary for the supervision of undertakings operating in more than one Member State, the Directive introduces various exceptions to the auditor’s duty of secrecy, authorises the exchange of information between competent authorities and imposes on auditors the duty to report facts and decisions that may affect the functioning of the undertaking.

A number of provisions are devoted to providing the necessary harmonisation of the financial guarantees of assurance undertakings. Detailed guidelines and principles are given on technical reserves, the covering assets and the methods for their calculation, determination of investment categories and valuation, matching rules and asset localisation rules. In turn, other articles provide for the coordination of rules relating to solvency margins, the items they may include and the minimum solvency margin that must be implemented for each type of assurance underwritten.

The Directive also includes provisions aimed at the further harmonisation of conduct of business rules, including those governing the information to be provided to policyholders and the minimum cancellation period to which policyholders must be entitled.

The 2002 consolidated Directive (CD)

The aim of the 2002 recast Directive was to consolidate Community provisions on life assurance so as to provide the public with a single, clear and readily understandable text. The majority of the directive's provisions are a restatement of those contained in the 1LD, 2LD and 3LD. The only new provisions relate to: the definition of a regulated market, dates concerning the activities of composite undertakings, calculation of future profits, presentation of a scheme of operations by third country branches to be established in the EU, abolition of derogations, and rights acquired by existing branches.

Other recent legislation

· Directive 95/26/EC reinforcing prudential supervision. This Directive modified several financial services directives, and amongst them the 3LD, with the objective of strengthening the powers of the supervisory authorities to prevent fraud when a financial undertaking forms part of a group. Specifically, this Directive regulates disclosure of group information to competent authorities and defines and clarifies concepts such as "close links". The Directive also requires that an auditor report promptly to the authorities whenever he becomes aware of certain facts which are liable to have a serious effect on the financial situation or the administrative and accounting organization of a financial undertaking.

· Directive 2002/12/EC. Also known as Solvency I, it is aimed at strengthening life assurances’ solvency requirements in order to ensure adequate capital requirements. To this end, the previous solvency margin regime from the 1970s is changed: a limit is set on the possibility of including future profits in the available solvency margin and an obligation to phase them out by 2009 is introduced. Secondly, the existing minimum guarantee fund is increased and is periodically adjusted according to inflation. Finally, early intervention by the regulator to take remedial action is strengthened, when the undertaking’s position is deteriorating and policyholders’ interests are threatened.

· Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate. This Directive constitutes the first initiative in moving away from a sector-specific regulatory approach in order to tackle the challenges raised by financial conglomerates, for example, by requiring the establishment of proper lines of communication between supervisory authorities responsible for different financial industries.

· Directive 2005/1/EC on a new organisational structure for financial services committee (the so-called 'Lamfalussy committees'). Amongst other things, this law sets up CEIOPS, the European Committee of Insurance and Pensions Supervisors. The 'Lamfalussy process' consists of four levels:

- Level 1: The EP and Council adopt legislation in co-decision, determining framework principles and guidelines on implementing powers

- Level 2: Technical implementing measures taking the form of further directives and/or regulations, adopted under powers delegated at level one

- Level 3: Networking between regulators with a view to producing joint interpretative recommendations, consistent guidelines and common standards, peer review, and comparisons between regulatory practice to ensure consistent implementation and application

- Level 4: Monitoring by the European Commission of Member State compliance with EU legislation and enforcement action where necessary.

· Directive 2005/68/EC on reinsurance activities. As reinsurance activities conducted by specialised reinsurance undertakings were not subject to EU law at the time, a specialized directive was adopted, to establish a legal framework for this activity and address the weaknesses in existing provisions, which had resulted in significant differences in the level of supervision of reinsurance undertakings in the EU, in turn creating barriers to the pursuit of reinsurance business.

· The future Solvency II Directive, a second reform of the solvency margins of insurance companies. This project has been in the pipeline for several years and is expected to be presented by the Commission in July 2007. The main elements of the proposal are to harmonise capital adequacy standards and develop more risk-based rules, in an effort to match solvency requirements more closely to the true risk encountered by an insurance undertaking, as well as enhancing the powers of intervention of insurance regulators.

I.4.      Specific actions foreseen/undertaken in the context of Part II

- Hearing of petitioners before the committee (see relevant list);

- Request for information from the Commission regarding:

o the transposition of the relevant Directives and their application by competent authorities during the reference period;

o action taken by the Commission with regard to monitoring implementation;

- Background analysis of EU legislative and regulatory framework in relation to Equitable Life;

- Clarification of the UK authorities' respective competences with regard to the supervision of Equitable Life;

- Hearing of UK Government and regulators: HMT (Her Majesty's Treasury), FSA (Financial Services Authority) and GAD (Government Actuary Department);

- Fact-finding missions to the UK and Ireland and hearing of competent authorities in order to establish whether the relevant provisions were properly applied;

- Comparative analysis of transposition in the UK and other Member States: a comparative study was commissioned under the committee's expertise budget, with experts being asked to examine how the provisions on prudential supervision and conduct of business rules of life assurance undertakings as laid down in the relevant EU Directives were transposed into UK law. The study identified for each of those provisions the matching UK provisions and indicated, by way of a transposition table, when they entered into force. The transposition in the UK was then compared to implementing legislation in Ireland, Germany and Spain. The contents of the study served as input for this working document.

(1)

Council Directive 92/96/EEC of 10 November 1992 on the coordination of laws, regulations and administrative provisions relating to direct life assurance and amending Directives 79/267/EEC and 90/619/EEC (third life assurance Directive), OJ L 311 , 14/11/1997, p.34.

(2)

Directive 2002/83/EC of the European Parliament and of the Council of 5 November 2002 concerning life assurance (OJ L 345, 19.12.2002, p 1). Directive as last amended by Directive 2005/68/EC (OJ L 323, 9.12.2005, p. 1).

(3)

First Council Directive 79/267/EEC of 5 March 1979 on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of direct life assurance, OJ L 063 , 13/03/1979 P. 0001 - 0018; Second Council Directive 90/619/EEC of 8 November 1990 on the coordination of laws, regulations and administrative provisions relating to direct life assurance, laying down provisions to facilitate the effective exercise of freedom to provide services and amending Directive 79/267/EEC, OJ L 330 , 29/11/1990 p.50.

(4)

Second Council Directive 90/619/EEC of 8 November 1990 on the coordination of laws, regulations and administrative provisions relating to direct life assurance, laying down provisions to facilitate the effective exercise of freedom to provide services and amending Directive 79/267/EEC, OJ L 330 , 29/11/1990 p.50.

(5)

Directive 2002/12/EC of the European Parliament and of the Council of 5 March 2002 amending Council Directive 79/267/EEC as regards the solvency margin requirements for life assurance undertakings.


II.  Investigation into the correct transposition into UK law of the 3LD and its application/implementation by UK authorities in relation to the ELAS

Introduction

The first task is to identify clearly those provisions of UK national law intended to give effect to the requirements of the Directive and to evaluate whether they are of the same quality and require the same standards, both in terms of the letter and the ultimate aim of the directive. The fact that the UK implemented the directive in a fragmented way (i.e., the directive was transposed not into one single national law but spread throughout different acts of varying hierarchy) is not helpful from the outset. Determining whether this means of transposition gave rise to difficulties which thwarted effective regulation is one of the objectives of this investigation.

A second objective would be to ascertain whether the responsible regulators indeed fulfilled the requirements of national law and, consequently, of the EU Directive. It might be that the Directive was defectively transposed and that the regulators faithfully applied defective and insufficient national law; on the other hand, it could also be that the directive was faithfully and fully transposed but the regulators did not completely fulfil their responsibilities and did not uphold both the letter and the spirit of both UK and EU law. Conversely, both these scenarios could be wrong, i.e. not only was the EU Directive correctly transposed but the regulators also acted adequately. Finally, there could be a mixed picture (incorrect transposition compounded by incorrect application). The outcome of these investigations will be clearly laid out in the conclusions of this part of the report. Moreover, these conclusions feed into the contents of Part V on systematic weaknesses in the Commission and how they have contributed to the ELAS crisis. In this part, the concept of implementation used as reference throughout the report of the Committee of Inquiry will be also developed.

The methodology followed is: first, to identify one by one the key provisions of the 3LD relevant to the ELAS case, particularly as regards the monitoring of financial health, state of solvency and the establishment of adequate technical provisions; second, to identify and analyze the matching implementing provisions in UK law to ascertain if they fulfil the quality requirements of the directive; third, to evaluate the performance of the regulator taking into account the thresholds, benchmarks and requirements that have been set in those matching implementing provisions as well as in the Directive.

To this end, the main sources of evidence, other than the directive itself and the UK provisions, will be the information received from the European Commission, the implementation study undertaken by the Wilde Sapte firm, the oral evidence obtained during the EQUI hearings and any other written evidence contained in the list of official written evidence.

II.1.     Analysis of transposition in detail in light of the evidence

In order to understand the 3LD, it is pertinent to outline its structure, which falls into four parts:

1.  Definition and scope;

2.  The taking up of the business of life assurance;

3.  Conditions governing the business of life assurance, which include: principles and methods of financial supervision, rules relating to technical provisions, to the solvency margin and to the guarantee fund, rules relating to contract law and conditions of assurance;

4.  Provisions relating to the right of establishment and freedom to provide services.

The following 16 articles (and 1 annex) of the 3LD have been selected on account of their relevance to this inquiry:

§ Articles 8, 9, 10, 12, 13 and 15: financial supervision;

§ Articles 18, 19, 20, 21 and 22: technical provisions;

§ Article 25: solvency margin;

§ Articles 28, 29, 30 and 31: conduct of business rules;

§ Annex II: information for policyholders.

The key articles for the investigation (8, 10, 18, 21, 25, 28 and 31) are dealt with first.

As far as UK law is concerned, the UK notified the Commission of its implementation of the 3LD by letter dated 29 June 1994. The UK letter specified that the following relevant statutory instruments giving effect to the Directive would enter into force on 1 July 1994, the deadline laid down in the Directive:

1.  The Insurance Companies (Third Insurance Directives) Regulations 1994, which amended relevant sections of the Insurance Companies Act (ICA) 1982 and the Financial Services Act 1986 with a view to introducing the principle of home country control for direct insurance as provided by the 3LD and the Non-Life Directives;

2.  The Insurance Companies Regulations 1994, which implemented the 3LD’s rules on technical provisions, matching and localisation of assets, solvency margin and guarantee funds;

3.  The Insurance Companies (Accounts and Statements) (Amendment) Regulations 1994, which implemented the 3LD's rules relating to the form and contents of the annual returns, amending the Insurance Companies (Accounts and Statements) Regulations 1983.

According to official records, the UK respected the deadline for entry into force and correctly notified the Commission, providing copies of the implementing legislation.

As can be seen from the above, and in contrast to the consolidated approach followed by other Member States, the UK opted for a piecemeal and indirect transposition, transposing the Directive by adopting various statutory instruments, which introduced amendments to a number of Acts of Parliament and subordinate legislation. This technique is often used in the UK. In addition, and contrary to best transposition practice(1), the UK implementing measures did not identify which provisions of the Directive were being transposed on an article by article basis. Each implementing measure included a reference to the Directive in the explanatory notes but did not include a table showing the correlation between provisions from national implementing measures and provisions from the Directive.

Moreover, the structure and terminology(2) used by UK implementing legislation does not always and necessarily coincide with that of the Directive.

It can be argued that this indirect transposition lacks clarity and may not be the best way of incorporating EU standards into domestic legislation. However, this lack of clarity does not necessarily equate with failure to meet the requirements of the 3LD(3).

Methodology

Each of the key articles will be analyzed in light of the evidence received and in an analogous fashion, using the following format:

§ Number and title of the article

§ Summary of objectives

§ Text of the article

§ Detailed comments on UK transposition

§ Link to the ELAS case

Equivalent articles in the 1LD, 2LD and CD, where they exist, are referred to after each individual article.

II.1.1.  Key articles of the 3LD: Articles 8, 10, 18, 21, 25, 28 and 31

Article 8 - Competent authorities and supervision (Articles 15 of 1LD and 10 of CD)

Summary of objectives

Article 8 clearly states that financial supervision of an insurance company shall be the sole responsibility of the home Member State. It also adds that the host authorities shall inform the home authorities if they believe the company's activities are affecting its financial situation. Financial supervision includes verification of solvency and the establishment of technical provisions and of the assets covering them. Likewise, the home Member State requires every company to have sound administrative and accounting procedures and adequate internal control mechanisms.

Text of the article

Article 8

Article 15 of Directive 79/267/EEC shall be replaced by the following:

'Article 15

1. The financial supervision of an assurance undertaking, including that of the business it carries on either through branches or under the freedom to provide services, shall be the sole responsibility of the home Member State. If the competent authorities of the Member State of the commitment have reason to consider that the activities of an assurance undertaking might affect its financial soundness, they shall inform the competent authorities of the undertaking's home Member State. The latter authorities shall determine whether the undertaking is complying with the prudential principles laid down in this Directive.

2. That financial supervision shall include verification, with respect to the assurance undertaking's entire business, of its state of solvency, the establishment of technical provisions, including mathematical provisions, and of the assets covering them, in accordance with the rules laid down or practices followed in the home Member State pursuant to the provisions adopted at Community level.

3. The competent authorities of the home Member State shall require every assurance undertaking to have sound administrative and accounting procedures and adequate internal control mechanisms.'

Comments on UK provisions(4)

In order to adjust it to the principle of home country control the scope of application of Part II of the ICA 1982 was amended. The core domestic rules that transposed Article 8 of the 3LD into UK legislation are included in the Insurance Companies (Third Insurance Directives) Regulations 1994 and the Insurance Companies (Amendment) Regulations 1994. The provisions that limit the UK Secretary of State’s supervisory power over EC companies with their head office in a Member State other than the UK who carry on activities in the UK either via the establishment of a branch or through the cross-border provision of services are found in the Insurance Companies (Third Insurance Directives) Regulations 1994. Regulation 13 inserted paragraph 1A into section 15 of the ICA 1982, which basically excludes EC companies from the application of Part II of the Act in so far as those companies are carrying on insurance business through a branch and have complied with the requirements specified in Part I of Schedule 2F to the Act. Regulation 45 inserted Schedule 2F into the ICA 1982.

The Secretary of State has residual power to impose requirements for the protection of policyholders, which includes the right to take “any action as appears to him to be appropriate”. In principle, the Secretary of State can only exercise this power over UK or non-EC companies. However, in certain circumstances it can exercise this power over EC companies operating on UK territory. The conditions for the exercise of this power over EC companies are spelled out in paragraph 15 of Schedule 2F to the Act. In line with the Directive, those conditions establish that the Secretary of State can exercise those powers over EC companies only if the supervisory authority of the company’s home Member State has so requested.

Paragraph 16 of Schedule 2F prescribes what the Secretary of State can do when an EC company fails to comply with any provision of law applicable to its insurance activities in the UK. According to this paragraph, the first step is to notify the supervisory authority in the home Member State (16(2)). If the company persists in contravening the provision in question, paragraph 16(3) allows the Secretary of State, after informing the supervisory authority of the home Member State, to direct the company to cease carrying on insurance business or providing insurance. Finally, paragraph 16(4) allows the Secretary of State to direct the company to cease carrying on insurance business even without informing the supervisory authority of the home Member State, if he considers such measures should be taken as a matter of urgency. The Secretary of State must always inform the company in writing of the reasons for adopting such a measure.

The provisions that expand the Secretary of State’s supervisory power over the entire business (within the Community) of those companies with a head office in the UK are included in the Insurance Companies (Amendment) Regulations 1994. Regulation 4 amends section 15 of the ICA 1982, including “all UK companies which carry on business in a Member State other than the United Kingdom”. The scope of competence of the UK supervisory authorities over insurance undertakings whose head office is in the UK is broad enough, in line with the requirements of the Directive. The Secretary of State has powers to verify the assurance undertaking’s state of solvency, the establishment of technical provisions and the assets covering them with respect to the assurance undertaking’s entire business.

The requirement for assurance undertakings to have “sound administrative and accounting procedures and adequate internal control mechanisms” has been transposed into domestic legislation by Regulation 5 of the Insurance Companies (Third Insurance Directives) Regulations 1994, which amends section 5 of the ICA 1982 on the conditions to be met by the assurance undertaking to obtain an authorisation to operate. Regulation 5 inserts sub section (1A) into section 5 of the Act, which prevents the Secretary of State from issuing an authorisation when it appears to him that the applicant does not or will not fulfil the criteria of “sound and prudent management”. The Regulation also inserts an entire schedule to the Act which develops the meaning of “sound and prudent management”. The schedule specifies that for a company to be regarded as conducting its business in a sound and prudent manner it has to maintain, amongst other things, “adequate accounting and other records of its business” and “adequate systems of controls of its business and records”. It then goes on to specify the meaning of these two standards. Paragraph 6A of Schedule 6 to the Insurance Companies (Accounts and Statements) Regulations 1983, as amended, stipulates that the certificate by Directors required by Regulation 26(a) must also state, by way of a list, any published guidance with which the systems of control established and maintained by the company in respect of its business comply.

Link to the ELAS case

There are three elements of this article linked to the ELAS case. First, the obligation of regulators to supervise the company as a whole, i.e., always to take account of its 'entire business'; secondly, the requirement to have 'sound administrative and accounting procedures and adequate internal control mechanisms'; thirdly, the obligation of the host authorities to inform the home authorities when problems arise.

1. Supervision of the 'entire business' and PRE

It is safe to assume that, when the article states in such simple, clear and unambiguous terms that financial supervision must cover the “assurance undertaking's entire business”, that is precisely what the legislator intended and nothing else. ‘Entire business’ means, it would seem, in all languages and circumstances, the totality of a company’s business, without any exceptions or loopholes.

Having established this, it is pertinent to analyze the numerous pieces of evidence received which claim that the UK authorities (the home Member State) did not correctly supervise the company because they did not sufficiently take into account or simply disregarded the idea of the ‘entire business’. Evidence refuting these claims also needs to be considered.

First of all, Lord Penrose (WE 16)(5) claims that the regulator focused exclusively on solvency margins and took no account of accrued terminal bonuses, which are those non-contractual benefits distributed by the company at its discretion. These bonuses might be considered, according to one interpretation, as an integral part of the company's ‘entire business’ (this is directly linked to the arguments relating to Article 18 on Technical Provisions). The importance of these bonuses and their link to the GAR issue is explained at length in Part I (Introduction) and Part III (Regulatory issues).

UK law includes a reference, not mentioned by the Directive, to pay due regard to the reasonable expectations of policyholders (PRE). The UK regulator claimed that PRE in respect of terminal bonuses was not created by the society's bonus practice. This is what Lord Penrose was told (WE 16)(6). However, unconvinced by these arguments, he refutes them and argues that PRE did indeed arise by reason of the Society's terminal bonus practice (in other words, that policyholders had reasonable expectations that they were entitled or would receive discretionary bonuses in addition to contractual benefits).

Holmes, in WE 84, supports this thesis: "The protection of PRE under UK law was of great importance because of the shift in the 1980's and 90's in the balance of benefits provided by ELAS under its policies away from guaranteed benefits to un-guaranteed terminal (later final) bonus. [...] Whereas guaranteed benefits qualified as 'liabilities' under national an Community law(7), and therefore had to be reserved for, the only protection accorded to unallocated terminal or final bonus under the UK regulatory scheme was the obligation to consider whether to intervene in order to protect the reasonable expectations raised in relation to such bonus" (See also section II.2. ‘Further evidence on transposition’).

From the different ELAS sales materials analyzed and various pieces of evidence (WE 26 Burgess Hodgson, WE 52-54 Seymour, H5 Lloyd), it is possible to infer that terminal bonuses were an integral part of the package offered to policyholders, who had thus been led to expect that these bonuses would be paid depending only on the state of the markets at the time of leaving the Fund. Indeed, the Society used its terminal bonus practice to indicate policy values to members, to make payments on maturity or surrender, and to encourage new policy sales through statements of past performance.

To summarize, some of the evidence received by the committee points to a situation where the regulator always focused exclusively on solvency margins and took little or no account of accrued terminal bonuses in its overall analysis of the financial health of the company. One line of reasoning thus argues that, if it is to be considered that these types of bonuses are an integral part of the company's ‘entire business', the regulatory authorities should have taken them into account during the course of their duties, as required by Article 8. The fact that the UK had the option of not forcing ELAS to reserve for discretionary bonuses did not necessarily exonerate the authorities from doing their utmost to respect the letter and the ultimate aim of the directive, which, as has been said, required that financial supervision cover the “assurance undertaking's entire business”.

2. Sound administrative and accounting procedures and adequate internal control mechanisms: the Appointed Actuary issue

The 3LD lays down a baseline for regulation and, consistent with the nature of a directive as opposed to a regulation, leaves it to Member States to find the most appropriate means to achieve the results required by the Directive’s provisions. One of the means the UK regulators came up with was the figure of the Appointed Actuary (AA), an essential part of the UK national insurance framework and one which does not appear in the Directive. One of the AA’s missions was to act partly as a guardian of policyholders' interests (see also comments on Article 10 of the 3LD).

Several pieces of evidence received claim that at different points in time ELAS might not have had sound administrative and accounting procedures nor adequate internal control mechanisms, because no action was taken to solve a serious problem that arose with the AA of ELAS.

Mr. LAKE explains in H1 how in 1992, "Appointed Actuary Roy Ranson became CEO of ELAS without relinquishing the role of Appointed Actuary, which was clearly prejudicial to the interests of policyholders, but UK legislation did not provide for the removal of Mr Ranson”. According to the evidence, the UK GAD (Government Actuary's Department) explicitly expressed its disapproval of this dual role but no action followed. Clive MAXWELL from HMT, under questioning during H4, rejects this claim, arguing that the 3LD does not mention the figure of the AA and that this is not therefore a matter for the Directive. However, another competing view claims the contrary, viz. that the fact that the Directive itself does not mention the figure of the AA is actually irrelevant because, once in place, the AA figure became part of the UK supervisory system which, as a whole, had to implement fully and correctly the provisions of Article 8 of the 3LD, both in terms of the letter and the aim of the text.

The overall evidence received (see also section II.2. ‘Further evidence on transposition’) suggests that by not taking swift action on this matter, the UK regulator did not fulfil its obligation to require from ELAS sound administrative and accounting procedures and adequate internal control mechanisms, as demanded explicitly by Article 8 of the 3LD.

3. Home/host exchange of information

Another issue is whether other Member States (Ireland, Germany) ever considered that ELAS' activities might have had a negative effect on the company’s financial soundness, in which case they should have informed the UK authorities. Correspondence between regulators to which this committee has had access is examined in detail in Part IV (Redress issues).

Article 10 - Accounting, prudential and statistical information supervisory powers (art. 23 of 1LD and 13 of CD)

Summary of objectives

Article 10 defines the type of information required from companies on their financial situation. They must render the returns and documents necessary for supervision on a periodic basis. Member States need to ensure that the competent authorities have the powers and means necessary for the supervision of assurance undertakings with head offices within their territories, including business carried on outside those territories. These powers and means must allow them to:

a)  make detailed enquiries, for example by gathering information or requiring the submission of documents, or carrying out on-the-spot investigations;

b)  take any measures that are appropriate and necessary to ensure that the business complies with the law and to prevent or remedy any irregularities prejudicial to the interests of the assured persons;

c)  ensure that those measures are carried out, if need be by enforcement, or through judicial channels.

Text of the article

Article 10

Article 23 (2) and (3) of Directive 79/267/EEC shall be replaced by the following:

'2. Member States shall require assurance undertakings with head offices within their territories to render periodically the returns, together with statistical documents, which are necessary for the purposes of supervision. The competent authorities shall provide each other with any documents and information that are useful for the purposes of supervision.

3. Every Member State shall take all steps necessary to ensure that the competent authorities have the powers and means necessary for the supervision of the business of assurance undertakings with head offices within their territories, including business carried on outside those territories, in accordance with the Council directives governing those activities and for the purpose of seeing that they are implemented.

These powers and means must, in particular, enable the competent authorities to:

(a) make detailed enquiries regarding the undertaking's situation and the whole of its business, inter alia by:

- gathering information or requiring the submission of documents concerning its assurance business,

- carrying out on-the-spot investigations at the undertaking's premises;

(b) take any measures, with regard to the undertaking, its directors or managers or the persons who control it, that are appropriate and necessary to ensure that the undertaking's business continues to comply with the laws, regulations and administrative provisions with which the undertaking must comply in each Member State and in particular with the scheme of operations in so far as it remains mandatory, and to prevent or remedy any irregularities prejudicial to the interests of the assured persons;

(c) ensure that those measures are carried out, if need be by enforcement, where appropriate through judicial channels.

Member States may also make provision for the competent authorities to obtain any information regarding contracts which are held by intermediaries.'

Comments on UK transposition

The obligation to produce annual reports and accounts is required by the Companies Act 1985 (statutory returns). The obligation to submit the regulatory returns is required by the ICA 1982, which establishes that every insurance company must submit every year to the prudential regulator, in addition to the statutory returns, the regulatory returns. They are prepared taking into account the valuation of assets and liabilities regulations and thus the net asset figure calculated in the return is very unlikely to be the same as the net asset figure appearing in the company’s published financial statements. The regulatory returns are designed to allow the regulator to monitor the solvency of the insurer. The forms and contents of the regulatory returns were originally regulated by the Insurance Companies (Accounts and Statements) Regulations 1983. Such Regulations were amended on various occasions, including by the Insurance Companies (Accounts and Statements) (Amendment) Regulations 1994 to implement the Third Life and Non-Life Directives to the extent that they affect the form and contents of the annual returns. In 1996, the 1983 Regulations, as amended, were consolidated with modifications by the Insurance Companies (Accounts and Statements) Regulations 1996.

The returns are made up of a balance sheet, a profit and loss account, a revenue account, an abstract of the actuary’s annual valuation report and additional information on general business and on long-term business. Additional information must be submitted in the form of statements which must provide information on, inter alia, major treaty and facultative reinsurers, company’s policy on investment in derivatives and details of all controllers of the company, including their name and the shareholding held. The ICA 1982 establishes three mechanisms to enhance the reliability of the regulatory returns: a) the Act makes it an offence knowingly or recklessly to cause or permit a statement which is false in a material particular to be included in a return; b) the directors of a company are required to certify that the return has been properly prepared and that the solvency requirements have been complied with; c) in the case of a company carrying on long-term business, the appointed actuary must also certify whether, in his opinion, proper provision has been made with respect to its liabilities; d) returns must be audited. Although the annual return is primarily intended to enable the regulator to monitor the solvency of insurers, it is also available on request to policyholders and shareholders and open to public inspection at the appropriate Companies House.

For life assurers, the appointed actuary must produce an annual valuation report to enable the regulator to form an opinion as to whether the minimum standards set out in the appropriate rules are met by the actuarial reserves. The appointed actuary must also prepare a statement of its long-term business at least once every five years.

The requirement in UK legislation that every insurance company appoint an actuary as the actuary of the company is not a requirement of the 3LD. The actuary must possess the prescribed qualifications, i.e. he/she must be a fellow of the Institute of Actuaries or of the Faculty of Actuaries. The appointment of the Actuary must be notified to the Secretary of State and a statement with information on the actuary’s interests in the company (e.g. shares or debentures of the company in which the actuary had an interest, particulars of any pecuniary interest of the actuary in any transaction between the actuary and the company, remuneration and other benefits received by the Actuary, etc.). This information must be provided to the Secretary of State on a yearly basis.

The obligation to provide statistical information is prescribed by Regulations 79 to 83 of the Insurance Companies Regulations 1994. The forms to be used are set out in Schedules 15 and 16 of those Regulations. The statistical information must be submitted on a yearly basis. Default in complying with these obligations is an offence.

Supervisory powers of competent authorities: UK legislation attributes to the Secretary of State a wide range of powers to perform his supervisory duties, equivalent to those required by Article 10 of the 3LD. Sections 37 to 47 of the ICA 1982, as amended, list those powers and stipulate the grounds on which they can be exercised and the formalities that must be observed when exercising them. Under the ICA 1982 the Secretary of State has ample powers to obtain information from and to investigate insurance companies. Under those powers, the Secretary of State may request the appointed actuary to make an investigation into the company’s financial condition or he can appoint a person to investigate whether the criteria of sound and prudent management has been fulfilled. The Secretary of State, or a person authorised by him, may require a company to furnish him with information about specific matters and to produce books, papers or other documents as may be specified. If the Secretary of State considers there are reasonable grounds for believing that documents whose submission has been required and which have not been produced are held on any premises, he may request a justice of the peace to issue a warrant authorising a constable to enter and search the premises.

Powers over the company’s assets: The Secretary of State may require the assets of a company used to cover its liabilities to be maintained in the UK. He can also require the whole or a specified proportion of those assets to be held by a person approved by him as trustee for the company. Finally, he can apply before a court for an injunction to restrict the company’s freedom to dispose of its assets. These powers can only be exercised on the basis of a narrower set of grounds. The exercise of these powers, in particular the power to restrict a company’s freedom to dispose of its assets, is also subject to more stringent formalities.

The Secretary of State may also impose requirements on investments (in so far as the value of its assets does not exceed the amount of its liabilities), limit premium income and require further and earlier information. The list of powers enumerated by the Act closes with a broad residual power which entitles the Secretary of State to require a company to take such action as appears appropriate to him for the purpose of protecting policyholders against the risk that the company may be unable to meet its liabilities or to fulfil the reasonable expectations of policyholders or potential policyholders and for the purpose of ensuring that the company observes sound and prudent management principles.

Failure to comply with a requirement imposed in the exercise of any of the powers mentioned above is an offence. According to the ICA 1982, the Secretary of State is equipped with comprehensive powers to discharge his duties and neither the formalities he has to observe nor the set of grounds that he must invoke may impose severe restrictions on him in exercising those powers. On the contrary, the exercise of most powers (other than the restriction of a company’s freedom to dispose of its assets) is subject to a flexible and vaguely defined threshold, i.e. the protection of the reasonable expectations of policyholders or potential policyholders. Ultimately, the Secretary of State may intervene on almost any occasion he considers desirable (rather than necessary) for the protection of policyholders and not just when specific infringements or shortcomings have been identified.

Link to the ELAS case

Three elements of this article link it to the ELAS case. First, the issue of the "powers and means” of the regulators; secondly, the question of ‘excessive respectful treatment’; thirdly, the obligation of regulators to ensure that ELAS complied with national law, which, as explained previously, includes the concept of PRE.

1.  Powers and means

It is necessary to ask, first of all, whether the UK regulator had the "powers and means necessary" to perform its functions at the time. Numerous pieces of evidence point to weaknesses in terms of ‘means’; on the other hand, the evidence received clearly demonstrates that, as far as ‘powers’ were concerned, the regulators had clearly enough.

1.A. The ‘means’

According to Mr. LAKE in H1, the "insurance regulators were seriously under-resourced throughout the 1990s". He supports his claim by citing the Baird report (WE 17), likewise cited by Mr. HOLMES (WE 84) when referring to the breakdown of staff involved in insurance regulation on 1 January 1999: “... the total number of staff involved in the prudential regulation of approximately 200 insurance companies (…) was less than 135. By way of comparison, there were approximately 135 staff involved in the regulation of 400 authorised UK banks, building societies and UK branches of non-EU institutions” (WE 17, paragraph 2.23.5).

Mr. NASSIM (WE7) similarly claims that "the regulators were not always sufficiently resourced and did not all possess the necessary skills to make an effective contribution to the regulatory process and responsibly exercise discretionary powers as intended by Parliament from 1973 onwards. As a consequence, they did not properly undertake their functions."

The Penrose report (WE 16, par. 158) also states that "the DTI insurance division was ill-equipped to participate in the regulatory process. It had inadequate staff and those involved at line supervisor level in particular were not qualified to make any significant contribution to the process. Insurance division regulators were fundamentally dependent on GAD for advice on the mathematical reserves, implicit items, technical matters generally and PRE and were not individually equipped with specific relevant skills or experience to assess independently the Society's position in these respects (…). For all practical purposes, scrutiny of the actuarial functioning of life offices was in the hands of GAD until the reorganisation under FSA was in place". It adds that "the staffing levels available to the prudential regulators varied but the number of staff with direct responsibility for the Society and their grades within the civil service remained broadly constant ... Increased resources might have improved the chances of identifying problems but... Government required a 'light touch' approach to regulation and allocated resources accordingly "(WE16, par. 39, 158 and159).

Finally, Mr. HOLMES (WE 84) concludes by stating that “even allowing for the discretion which Member States possess in deciding upon an appropriate level of regulatory resources, it must be open to doubt whether the UK provided its competent authorities with the means necessary for supervision, the standard explicitly laid down in the Community legislation since November 1992. On the one hand, it must be asked whether in numerical terms sufficient staff were devoted to the task. On the other hand, it must also be asked whether the personnel that were available were appropriately qualified to provide supervision which was effective.” (See also section II.2. ‘Further evidence on transposition’)

1.B. The ‘powers’

In terms of the powers allocated to the UK regulators, most evidence points to a satisfactory situation where the competent authority had ample, flexible and sufficient powers.

The UK's implementing provisions transposing Article 10 give the Secretary of State very comprehensive powers to perform his supervisory functions, his powers in principle at least equivalent to those required by the Directive. These powers include the possibility to force a company to protect policyholders against the risk that the company may be unable to meet its liabilities or to fulfil policyholders' and potential policyholders' reasonable expectations (PRE)(8) for the purpose of ensuring that the company observes sound and prudent management principles. The question that arises in the ELAS case is not so much whether the Secretary of State had enough powers, which he ostensibly did, but whether he made good use of these extensive powers: Some of the evidence collected so far seems to negate the latter (for detail, see comments on section 3 on PRE). See also section II.2. ‘Further evidence on transposition’.

It can therefore be argued that the UK regulators did indeed have at least the ‘powers’ required by the Directive, if not necessarily the ‘means’.

2.  Respectful treatment and light touch

The second key issue relating to Article 10 is whether the UK regulator made detailed enquiries, by requiring the submission of documents or carrying out on-the-spot investigations. It has been alleged that investigations were indeed carried out but that regulators were always excessively respectful and even fearful of the ELAS management. In WE 51, Mrs KWANTES says: "I think the truth was the regulators were asleep at the wheel. They appeared to stand in awe of Equitable and handled it with kid gloves. If the regulator was aware that Equitable had problems, why didn't they say something? If they were not aware, they were not doing their job of regulation properly."

Referring to the ELAS collapse, Mr. BAYLISS in H5 states that "I do not think there will be another one entirely related to the arrogance of the management and the tolerance of that arrogance. The way in which Equitable behaved and treated the regulator was really quite extraordinary."

Another petitioner, Mr. BELLORD (H2) also insists on the "very cosy relationship between regulators and EL", highlighting some findings by the Penrose Report that suggest that reports available to the GAD dating back to the late 1980s had already hinted at ELAS' dangerous business practices but had remained totally unheeded by the GAD.

More evidence also strongly suggests that the regulator adopted a conscious and deliberate ‘hands-off’ approach with regards to the ELAS case. If this were proven to be the case, it would constitute a breach of the regulators’ obligation to ensure the respect of PRE and therefore a breach of the letter and aim of Article 10 of the 3LD. Both the Baird (WE 17) and Penrose (WE 16) reports contain criticisms of the regulator’s lack of a "pro-active approach".

M. LAKE claims in H1 that an “over-reliance on industry-led agencies and the traditional 'light touch' approach" made the UK reluctant to adopt the aim of the life directives, thus failing in their implementation as well as in their execution.

Some of these allegations, in particular the "lack of challenge to ELAS' senior management by the UK regulators" are emphatically rejected by WE-CONF8. The findings of the First Parliamentary Ombudsman's report also deny these allegations, saying that the FSA (together with GAD) could not be said to have addressed the GAR reserving issue and any misrepresentation of ELAS' financial position "in anything less than a resolute manner", that their approach could not be described as 'passive' and that the "FSA continued to insist throughout that Equitable conform to their full reserving requirements in the face of strong resistance from Equitable".

3. PRE

As was mentioned earlier in the section covering Article 8, UK law gives power to the Secretary of State to force a company to protect policyholders against the risk that the company may be unable to meet its liabilities or to fulfil PRE. The Secretary of State can take any action that appears to him to be appropriate (other than restricting the company’s freedom to dispose of its assets) against the risk that the company may be unable to fulfil those expectations. In this sense, UK law respects the requirements of Article 10 of the 3LD, which requires authorities to take any measures that are appropriate and necessary to ensure that the company's business continues to comply with the laws of the UK and to prevent or remedy any irregularities prejudicial to the interests of the assured persons. To summarize, Article 10 of the 3LD required that UK authorities be given the powers and means to ensure that the PRE were respected.

It has already been established that the means were possibly insufficient but that the powers were adequate. The question that arises in the ELAS case is whether the Secretary of State made good use of these extensive powers: were these powers used to protect PRE? Evidence received(9) claims that there were indeed possible irregularities prejudicial to the interests of the assured persons but that the UK regulator did not take the appropriate measures to correct them. This evidence seems to suggest that for many years the regulators in the UK did not exercise their extensive powers with respect to ELAS, despite having knowledge about the impending catastrophe. A review(10) of the DTI’s annual reports notes that the most common ground on the basis of which the Secretary of State had exercised his powers was that a company was newly authorised (i.e., within the last five years) or that there had been a change of control (again, within the last five years). Only in a handful of cases each year did the Secretary of State exercise his powers on other grounds. This lack of pro-activeness, despite having the adequate powers, was also referred to by Charles THOMSON, current CEO of ELAS, when he declared in H2 that "for many years the Regulators in the UK had very extensive powers to raise questions with companies and considerable powers to intervene in exceptional cases [...]. In short, my view is that the relevant regulators in the UK, both before and after the changes made as a consequence of the consolidated life directive, had sufficient powers to regulate effectively."

Mr. LAKE in H1 also supports this view by claiming that "in UK law the PRE have the protection of the competent authorities" and that the UK "did not implement the legal requirements to enable the authorities to monitor the application of its own law in respect of PRE", despite it being appropriate and necessary, thus possibly breaching the letter and spirit of Article 10.

One specific reason why PRE were not respected is related to the solvency margin (for more detail, see section on Article 25, Solvency margin). The argument goes as follows: the regulator allowed ELAS to fulfil its solvency requirements, despite the dubious financial situation in which the company found itself. This is, in effect, tantamount to hiding the true financial situation of ELAS from policyholders and endangering the company’s future financial viability. Consequently, PRE were put at risk and thus it would follow that UK regulators took measures that were not “appropriate and necessary to prevent or remedy any irregularities prejudicial to the interests of the assured persons” and ensure that the business complied with UK law, i.e., PRE. This raises the possibility of a breach of Article 10 (PRE) via a possible breach of Article 25 (solvency margin).

Article 18 - Establishment of technical provisions (Articles 17 of 1LD and 20 of CD)

Summary of objectives

This article deals with the requirement of every assurance company to establish sufficient technical provisions in respect of its entire business. It also provides for rules for the calculation of the technical reserves, establishing a number of principles, which call for a “prudent prospective actuarial valuation” and for a prudent rate of interest, placing on the home Member State regulator the obligation to fix one or more maximum rates of interest. The bases and methods used in the calculation of technical provisions must be made available to the public. Furthermore, all technical provisions must be covered by matching assets. It also imposes an obligation to localise those assets within the Community.

Text of the article

Article 18

Article 17 of Directive 79/267/EEC shall be replaced by the following:

'Article 17

1. The home Member State shall require every assurance undertaking to establish sufficient technical provisions, including mathematical provisions, in respect of its entire business.

The amount of such technical provisions shall be determined according to the following principles:

A. (i) The amount of the technical life-assurance provisions shall be calculated by a sufficiently prudent prospective actuarial valuation, taking account of all future liabilities as determined by the policy conditions for each existing contract, including:

- all guaranteed benefits, including guaranteed surrender values,

-bonuses to which policy-holders are already either collectively or individually entitled, however those bonuses are described - vested, declared or allotted,

- all options available to the policy-holder under the terms of the contract,

- expenses, including commissions;

-taking credit for future premiums due;

(ii) the use of a retrospective method is allowed, if it can be shown that the resulting technical provisions are not lower than would be required under a sufficiently prudent prospective calculation or if a prospective method cannot be used for the type of contract involved;

(iii) a prudent valuation is not a "best estimate" valuation, but shall include an appropriate margin for adverse deviation of the relevant factors;

(iv) the method of valuation for the technical provisions must not only be prudent in itself, but must also be so having regard to the method of valuation for the assets covering those provisions;

(v) technical provisions shall be calculated separately for each contract. The use of appropriate approximations or generalizations is allowed, however, where they are likely to give approximately the same result as individual calculations. The principle of separate calculation shall in no way prevent the establishment of additional provisions for general risks which are not individualized;

(vi) where the surrender value of a contract is guaranteed, the amount of the mathematical provisions for the contract at any time shall be at least as great as the value guaranteed at that time.

B. The rate of interest used shall be chosen prudently. It shall be determined in accordance with the rules of the competent authority in the home Member State, applying the following principles:

(a) for all contracts, the competent authority of the undertaking's home Member State shall fix one or more maximum rates of interest, in particular in accordance with the following rules:

(i) when contracts contain an interest rate guarantee, the competent authority in the home Member State shall set a single maximum rate of interest. It may differ according to the currency in which the contract is denominated, provided that it is not more than 60 % of the rate on bond issues by the State in whose currency the contract is denominated. In the case of a contract denominated in ecus, this limit shall be set by reference to ecu-denominated issues by the Community institutions.

If a Member State decides, pursuant to the second sentence of the preceding paragraph, to set a maximum rate of interest for contracts denominated in another Member State's currency, it shall first consult the competent authority of the Member State in whose currency the contract is denominated;

(ii) however, when the assets of the undertaking are not valued at their purchase price, a Member State may stipulate that one or more maximum rates may be calculated taking into account the yield on the corresponding assets currently held, minus a prudential margin and, in particular for contracts with periodic premiums, furthermore taking into account the anticipated yield on future assets. The prudential margin and the maximum rate or rates of interest applied to the anticipated yield on future assets shall be fixed by the competent authority of the home Member State;

(b) the establishment of a maximum rate of interest shall not imply that the undertaking is bound to use a rate as high as that;

(c) the home Member State may decide not to apply (a) to the following categories of contracts:

- unit-linked contracts,

- single-premium contracts for a period of up to eight years,

- without-profits contracts, and annuity contracts with no surrender value.

In the cases referred to in the last two indents of the first subparagraph, in choosing a prudent rate of interest, account may be taken of the currency in which the contract is denominated and corresponding assets currently held and where the undertaking's assets are valued at their current value, the anticipated yield on future assets.

Under no circumstances may the rate of interest used be higher than the yield on assets as calculated in accordance with the accounting rules in the home Member State, less an appropriate deduction;

(d) the Member State shall require an undertaking to set aside in its accounts a provision to meet interest-rate commitments vis-à-vis policy-holders if the present or foreseeable yield on the undertaking's assets is insufficient to cover those commitments;

(e) the Commission and the competent authorities of the Member States which so request shall be notified of the maximum rates of interest set under (a).

C. The statistical elements of the valuation and the allowance for expenses used shall be chosen prudently, having regard to the State of the commitment, the type of policy and the administrative costs and commissions expected to be incurred.

D. In the case of participating contracts, the method of calculation for technical provisions may take into account, either implicitly or explicitly, future bonuses of all kinds, in a manner consistent with the other assumptions on future experience and with the current method of distribution of bonuses.

E. Allowance for future expenses may be made implicitly, for instance by the use of future premiums net of management charges. However, the overall allowance, implicit or explicit, shall be not less than a prudent estimate of the relevant future expenses.

F. The method of calculation of technical provisions shall not be subject to discontinuities from year to year arising from arbitrary changes to the method or the bases of calculation and shall be such as to recognize the distribution of profits in an appropriate way over the duration of each policy.

2. Assurance undertakings shall make available to the public the bases and methods used in the calculation of the technical provisions, including provisions for bonuses.

3. The home Member State shall require every assurance undertaking to cover the technical provisions in respect of its entire business by matching assets, in accordance with Article 24 of Directive 92/96/EEC. In respect of business written in the Community, these assets must be localized within the Community. Member States shall not require assurance undertakings to localize their assets in a particular Member State. The home Member State may, however, permit relaxations in the rules on the localization of assets.

4. If the home Member State allows any technical provisions to be covered by claims against reassurers, it shall fix the percentage so allowed. In such case, it may not require the localization of the assets representing such claims.'

Comments on UK transposition

Home/host Member State obligations: the supervisory powers of the competent authorities of the home Member State need to cover the “entire business” of the companies established in their territory. At UK level, the expansion of the supervisory powers of the Secretary of State over companies established in the UK over their entire business – within and outside the UK – was implemented by the Insurance Companies (Amendment) Regulations 1994. Regulation 4 of these regulations amends section 15 of the ICA 1982, which determines the scope of application of Part II – Regulation of Insurance Companies. Regulation 4 prescribes that Part II of the Act applies, amongst other things, to “all UK companies which carry on business in a Member State other than the United Kingdom”. The limitation of the supervisory powers of the Secretary of State was also implemented by the Insurance Companies (Third Insurance Directives) Regulations 1994. Regulation 13 of the Third Insurance Directives inserted paragraph 1A to section 15 of the ICA 1982, which basically excludes EC companies from the application of Part II of the Insurance Companies Act in so far as those companies are carrying on insurance business through a branch and have complied with the requirements specified in Part I of Schedule 2F to the Act. Regulation 45 of the 3LD inserted Schedule 2F to the ICA 1982. This Schedule is the core regulation in terms of the definition of the rights and obligations of the UK supervisory authorities with respect to EC companies that carry out activities in the UK either via a branch or via the provision of cross border services. More specifically, Regulations 15 and 16 modify sections 34 and 35 of the ICA 1982, rightly limiting the Secretary of State’s power to control the value, nature and localisation of the assets of the EC companies operating in their territory.

Rules on the calculation of technical provisions: UK rules on the valuation of long-term liabilities are set out by the Insurance Companies Regulations 1994. The main principles for valuing the amount of the liabilities are set out in Regulation 64, which provides as follows: “The determination of the amount of long-term liabilities (other than liabilities which have fallen due for payment before the valuation date) shall be made on actuarial principles which have due regard to the reasonable expectations of policy holders and shall make proper provision for all liabilities on prudent assumptions that shall include appropriate margins for adverse deviation of the relevant factors. The determination shall take account of all prospective liabilities as determined by the policy conditions for each existing contract, taking credit for premiums payable after the valuation date. (3) Without prejudice to the generality of paragraph (1) above, the amount of the long-term liabilities shall be determined in compliance with each of regulations 65 to 75 below and shall take into account, inter alia, the following factors: all guaranteed benefits, including guaranteed surrender values; vested, declared or allotted bonuses to which policyholders are already either collectively or individually contractually entitled; all options available to the policyholder under the terms of the contract; expenses, including commissions; any rights under contracts of reinsurance in respect of long-term business; discretionary charges and deductions, in so far as they do not exceed the reasonable expectations of policyholders”. The principles referred to in Regulation 64 appear to be in line with those prescribed by the Directive, with an additional reference, not mentioned by the Directive, to pay due regard to the reasonable expectations of policyholders.

The “actuarial principles” are set out in two Guidance Notes prepared by the Faculty and the Institute, GN1 and GN8, which are designated as “practice standard”, meaning they are in effect mandatory for Appointed Actuaries.

Both the Directive and UK legislation explicitly mention that a prudent prospective actuarial valuation of an assurance’s liabilities must take into account all future liabilities as determined by the policy conditions for each existing contract, including guaranteed benefits, bonuses and contractual options for policyholders. In turn, the Directive further specifies that, where the surrender value of a contract is guaranteed, the amount of the mathematical provision for the contract at any time must be as great as the value guaranteed at that time. UK legislation does not replicate this provision but includes a specific Regulation on reserves for policyholders’ options, which provides as follows: “(1) Provision shall be made on prudent assumptions to cover any increase in liabilities caused by policyholders exercising options under their contracts. (2) Where a contract includes an option whereby the policyholder could secure a guaranteed cash payment within twelve months following the valuation date, the provision for that option shall be such as to ensure that the value placed on the contract is not less than the amount required to provide for the payments that would have to be made if the option were exercised.”

Regulations 65 to 75 prescribe more specific criteria on the determination of the amount of liabilities: Regulation 65 prescribes, in line with the 3LD that, in principle, long-term liabilities must be determined separately for each contract by a prospective calculation. The regulation allows the exceptional use of appropriate approximations and generalisation and the use of the retrospective method, subjecting both exceptions to the same conditions as those prescribed by the Directive. The regulation prescribes that, where necessary, additional amounts must be set aside for general risks not individualised and also prescribes that the method of calculation must not be subject to arbitrary changes from year to year. Regulation 69 on rates of interest to be used in calculating the present value of future payments by or to an insurance company sets out prudential standards equivalent to those laid down by the Directive. The same is true of Regulations 68 and 71 on allowances for expenses. In line with the Directive, domestic legislation requires the company to disclose such information to the competent authority as part of the requested information to support an application for an authorisation to operate. Further information on this is found in the actuary’s annual valuation report, which is available on request to policyholders and shareholders and open to public inspection at the appropriate Companies House.

Matching rule obligation: The 3LD prevents Member States from requiring companies to localise their assets in a particular Member State. It also allows the home Member State to permit relaxations of the localisation of assets rules. UK legislation does include regulations which, under particular circumstances, do require assurance undertakings to localise some or all of their assets in a particular place. Firstly, Regulation 31 of the Insurance Companies Regulations 1994 prescribes that the assets that cover liabilities in sterling must be held in the EC and the assets that cover liabilities in any other currency must be held in the EC or in the country of that currency. Secondly, Regulation 33 of the Insurance Companies Regulations 1994 prescribes some asset localisation obligations for non-EC companies, whose head office is not in an EFTA State, in respect of their assets representing a UK margin of solvency maintained under section 32(2)(b) of the Act. Thirdly, sections 39 and 40 of the Act afford the Secretary of State, under certain circumstances, the power to require a UK company to localise in the EC assets equal to the whole or a specified proportion of the amount of its domestic liabilities and to impose some kind of custody over them. According to section 37(3), those powers are not exercisable unless the company has failed to satisfy certain obligations to which it is or was subject, including the failure to determine the value of its liabilities in accordance with the regulations. Regulation 27 prescribes that the company must hold sufficient assets in a particular currency to cover the company’s liabilities in that particular currency only if the company’s liabilities in that particular currency exceed 5% of its total liabilities. According to the Directive, by contrast, there is no 5% leeway before the matching obligation is triggered, but this is not a departure from the Directive’s matching obligation because the Directive itself allows Member States to introduce exceptions to that obligation.

Link to the ELAS case

There are two aspects connecting this article to the ELAS case: first, the ‘entire business’ argument, linked to the optional reserving of discretionary bonuses, and second, the issue of PRE, which appears once again.

1. 'Entire business' argument and optional reserving of discretionary bonuses

Article 18 required the UK to ensure that Equitable Life established sufficient technical provisions, including mathematical provisions, in respect of its entire business, using a sufficiently prudent prospective actuarial valuation (this article therefore reiterates the ‘entire business’ requirement, already mentioned explicitly in Article 8). Neither the Directive nor UK legislation elaborate any further on the meaning of "prudent valuation", which is left for actuarial judgement. This is an important point, given that what ELAS did was to build up reserves for reversionary bonuses(11) (those already declared bonuses which are contractual benefits) but did not reserve for future reversionary bonuses and terminal bonuses, which are given at the discretion of the insurance company. According to some of the evidence received, this lack of reserving was one of the reasons for the company's downfall(12). The importance of these bonuses and their link to the GAR issue is explained at length in Part I (Introduction) and Part III (Regulatory issues).

The Directive only requires that future liabilities include, apart from all guaranteed benefits, bonuses to which policyholders are already either collectively or individually entitled, however those bonuses are described - vested, declared or allotted. Neither UK regulations nor the Directive require the establishment of additional technical reserves especially for future reversionary bonuses and terminal bonuses which are given at the discretion of the insurance company rather than as the result of a contractual obligation. The 3LD leaves open as an option (section 1.D) for the Member State regulator the requirement to reserve for these discretionary future bonuses (reserving of “future bonuses of all kinds”).

Nicholas BELLORD claims that this was deliberate, as he states (H2) that "when it came to the third life directive being drafted, it was found that stricter reserving requirements were being proposed and the UK delegation was supporting these stricter requirements. However, the Treasury, the regulators, realised that, if this directive went ahead as drafted, it might reveal the truth about Equitable and therefore they scotched the idea by making the reserving optional (…). So the option existed to have proper reserving but the UK regulators deliberately did not take advantage of that option."

In addition, another interpretation (WE Conf 11) argues that when the Directive requires sufficient technical provisions in respect of its entire business, that is exactly what it means without any ambiguity, i.e., the technical provisions need to be calculated not only in respect of its contractual benefits but also of its future reversionary bonuses and terminal bonuses. Lord Penrose (WE 16) reinforces this point when he says that the regulator was focused exclusively on solvency margins and took no account of accrued terminal bonus, with the implication that supervision should include verification of a company's entire business and not just its state of solvency (see also similar arguments in the section on Article 8).

According to the various pieces of evidence mentioned above, the line of reasoning goes as follows: it is true that the option contained in section 1.D does not force the regulator to require reserving of “future bonuses of all kinds” (e.g., discretionary bonuses); however, discretionary bonuses are still an integral part of the company's ‘entire business’, viz.: the option exists does not exonerate the UK authorities from doing their utmost to respect the letter and the aim of the directive. Evidence received by the committee suggests that by not taking into account accrued terminal bonuses (discretionary bonuses) in its overall analysis of the financial health of the company and by focusing exclusively on solvency margins, the regulator disregarded the obligatory concept of ‘entire business’ and, possibly, did not respect the letter and the aim of Article 18.

Lord Penrose states clearly (WE 16): the Directive "required prudent reserving for, or some realistic account to be taken of, final bonus. This would have exposed the weakness of the Society at a much earlier stage and would have prompted corrective action. DTI did not take that opportunity (…). The UK regulations implementing the Directive left the position as it had been previously."

2. PRE argument and the reserving of discretionary bonuses

As was mentioned in the sections relating to Articles 8 and 10, UK law goes beyond the Directive by including a reference to pay due regard to the reasonable expectations of policyholders (PRE) when determining the amount of long-term liabilities. In the context of the ELAS case, one line of argument has it that one of aspect of PRE was that they did indeed expect to receive discretionary bonuses in addition to contractual benefits. The reasoning continues by saying that if the UK authorities had followed through with their obligation to ensure the respect of PRE, this would have led to a more conservative estimation of the company’s liabilities and might have avoided the consequences of the ruling of the House of Lords on the Hyman case, which was the event that sparked ELAS’ misfortune, as mentioned previously.

This is expressed in another way by witness Mr. JOSEPHS in H2, who claims that "Equitable insisted on treating all policies alike, whether they were written as ‘defined benefit’ contracts, or in the later form as ‘investment’ contracts." The contracts "were written so as to give their holders the absolute right to share in the investment return of the Society pro rata to net premiums paid." According to his interpretation, Article 18 would have required that this right be reflected in the calculated liabilities for those policies, which, according to Mr. JOSEPHS, was not the case.

Were discretionary and non-contractual bonuses perceived to be included in PRE? As has been explained at length in the section on Article 8, the UK regulators did not believe so. However, from numerous pieces of evidence received by this committee, and starting with the Penrose report (WE 16), it is possible to infer that discretionary and non-contractual bonuses were an integral part of the package offered to policyholders, who had been led to expect that these bonuses would be paid depending only on the state of the markets at the time of exiting (see WE 26 Burgess Hodgson, WE 52-54 Seymour, H5 Lloyd).

To conclude, the argument in terms of Article 18 goes as follows: if the UK authorities were obliged to respect PRE, they should also have made sure that ELAS’ reserves covered discretionary and final bonuses. By not considering discretionary bonuses as an integral part of the company’s ‘entire business’ and not obliging ELAS to provide adequate technical provisions for them, the UK regulators indirectly contributed to ELAS’ downfall at the time of the House of Lords ruling and therefore did not pay due regard to the PRE they were supposed to defend, possibly breaching the letter and spirit of Article 18 of the 3LD.

For further information on this point, see Part III on Regulatory Action.

Article 21 - Assets included/excluded in technical provisions (Article 23 of CD)

Summary of objectives

This article prescribes the type of assets that can be authorised to cover technical provisions (Article 18) and lays down some principles on the valuation of the authorised assets. It also gives power to the regulator to accept other categories of assets as cover for technical provisions in exceptional circumstances and at an assurance undertaking's request. This must be temporary and under a properly reasoned decision.

Text of the article

Article 21

1. The home Member State may not authorize assurance undertakings to cover their technical provisions with any but the following categories of assets:

A. Investments

(a) debt securities, bonds and other money- and capital-market instruments;

(b) loans;

(c) shares and other variable-yield participations;

(d) units in undertakings for collective investment in transferable securities and other investment funds;

(e) land, buildings and immovable property rights;

B. Debts and claims

(f) debts owed by reassurers, including reassurers' shares of technical provisions;

(g) deposits with and debts owed by ceding undertakings;

(h) debts owed by policy-holders and intermediaries arising out of direct and reassurance operations;

(i) advances against policies;

(j) tax recoveries;

(k) claims against guarantee funds;

C. Others

(l) tangible fixed assets, other than land and buildings, valued on the basis of prudent amortization;

(m) cash at bank and in hand, deposits with credit institutions and any other body authorized to receive deposits;

(n) deferred acquisition costs;

(o) accrued interest and rent, other accrued income and prepayments;

(p) reversionary interests.

In the case of the association of underwriters known as Lloyd's, asset categories shall also include guarantees and letters of credit issued by credit institutions within the meaning of Directive 77/780/EEC (¹) or by assurance undertakings, together with verifiable sums arising out of life assurance policies, to the extent that they represent funds belonging to members.

(¹) First Council Directive 77/780/EEC of 12 December 1977 on the coordination of the laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions (OJ No L 322, 17. 12. 1977, p. 30). Directive as last amended by Directive 89/646/EEC (OJ No L 386, 30. 12. 1989, p. 1).

The inclusion of any asset or category of assets listed in the first subparagraph shall not mean that all these assets should automatically be accepted as cover for technical provisions. The home Member State shall lay down more detailed rules fixing the conditions for the use of acceptable assets; in this connection, it may require valuable security or guarantees, particularly in the case of debts owed by reassurers.

In determining and applying the rules which it lays down, the home Member State shall, in particular, ensure that the following principles are complied with:

(i) assets covering technical provisions shall be valued net of any debts arising out of their acquisition;

(ii) all assets must be valued on a prudent basis, allowing for the risk of any amounts not being realizable. In particular, tangible fixed assets other than land and buildings may be accepted as cover for technical provisions only if they are valued on the basis of prudent amortization;

(iii) loans, whether to undertakings, to a State or international organization, to local or regional authorities or to natural persons, may be accepted as cover for technical provisions only if there are sufficient guarantees as to their security, whether these are based on the status of the borrower, mortgages, bank guarantees or guarantees granted by assurance undertakings or other forms of security;

(iv) derivative instruments such as options, futures and swaps in connection with assets covering technical provisions may be used in so far as they contribute to a reduction of investment risks or facilitate efficient portfolio management. They must be valued on a prudent basis and may be taken into account in the valuation of the underlying assets;

(v) transferrable securities which are not dealt in on a regulated market may be accepted as cover for technical provisions only if they can be realized in the short term or if they are holdings in credits institutions, in assurance undertakings, within the limits permitted by Article 8 of Directive 79/267/EEC, or in investment undertakings established in a Member State;

(vi) debts owed by and claims against a third party may be accepted as cover for the technical provisions only after deduction of all amounts owed to the same third party;

(vii) the value of any debts and claims accepted as cover for technical provisions must be calculated on a prudent basis, with due allowance for the risk of any amounts not being realizable. In particular, debts owed by policy-holders and intermediaries arising out of assurance and reassurance operations may be accepted only in so far as they have been outstanding for not more than three months;

(viii) where the assets held include an investment in a subsidiary undertaking which manages all or part of the assurance undertaking's investments on its behalf, the home Member State must, when applying the rules and principles laid down in this

Article, take into account the underlying assets held by the subsidiary undertaking; the home Member State may treat the assets of other subsidiaries in the same way;

(ix) deferred acquisition costs may be accepted as cover for technical provisions only to the extent that this is consistent with the calculation of the mathematical provisions.

2. Notwithstanding paragraph 1, in exceptional circumstances and at an assurance undertaking's request, the home Member State may, temporarily and under a properly reasoned decision, accept other categories of assets as cover for technical provisions, subject to Article 20.

Link to the ELAS case

This article is linked to the case within the terms of paragraph 2, which introduces an escape clause to the closed list of categories of assets enumerated in point 1. According to this provision, “in exceptional circumstances” and “at an assurance undertaking’s request”, the home Member State may “temporarily” and “under a properly reasoned decision” accept other categories of assets as cover for technical provisions.

This needs to be seen in the context of Article 25 on the Solvency margin. The issue at hand is whether UK legislation gives the regulator (the Secretary of State) broader powers than those prescribed by the Directive to waive regulations on the admissibility of assets for regulatory purposes. At UK level, under section 68 of the 1982 ICA, the Secretary of State may, upon request or with the consent from an insurer, waive the application of, amongst other things, valuation of assets regulations to that particular company. The exercise of this power is not constrained by the standards mentioned in the Directive (i.e. “exceptional circumstances”, “temporarily”, “under properly reasoned decision”). The provision stipulates that the Secretary of State’s decision “may be subject to conditions”, clearly attributing to the regulator the discretion to decide whether to impose those conditions or not. These powers seem to be broader than those prescribed by the Directive.

Such powers entail the risk of being exercised in a very lenient way, undermining the application of harmonized standards. This raises some concerns as to the compatibility of section 68 of the ICA 1982 with the 3LD. See further arguments in the section covering Article 25 on the Solvency margin.

Article 25 - Available solvency margin (Articles 18 of 1LD and 27 of CD, also amended by Article 1.4 of Solvency I Directive, 2002/12/EC)

Summary of objectives

This article imposes the obligation to require from every assurance company an adequate available solvency margin in respect of its entire business at all times. The solvency margin is the value of assets over the amount of foreseeable liabilities, less any intangible items. The article also lays down some conditions on the types of assets, which shall include: the paid-up share capital or, in the case of a mutual, the effective initial fund plus any members' accounts which must meet a series of criteria, viz.: one half of the unpaid share capital or initial fund; reserves; profits brought forward; the cumulative preferential share capital and subordinated loan capital, on an optional basis, and only up to 50 % of the margin; securities with no specified maturity date and other instruments.

Text of the article

Article 25

Article 18, second subparagraph, point 1 of Directive 79/267/EEC shall be replaced by the following:

'1. the assets of the undertaking free of any foreseeable liabilities, less any intangible items. In particular the following shall be included:

- the paid-up share capital or, in the case of a mutual assurance undertaking, the effective initial fund plus any members' accounts which meet all the following criteria:

(a) the memorandum and articles of association must stipulate that payments may be made from these accounts to members only in so far as this does not cause the solvency margin to fall below the required level, or, after the dissolution of the undertaking, if all the undertaking's other debts have been settled;

(b) the memorandum and articles of association must stipulate, with respect to any such payments for reasons other than the individual termination of membership, that the competent authorities must be notified at least one month in advance and can prohibit the payment within that period;

(c) the relevant provisions of the memorandum and articles of association may be amended only after the competent authorities have declared that they have no objection to the amendment, without prejudice to the criteria stated in (a) and (b),

- one half of the unpaid share capital or initial fund, once the paid-up part amounts to 25 % of that share capital or fund,

- reserves (statutory reserves and free reserves) not corresponding to underwriting liabilities,

- any profits brought forward,

- cumulative preferential share capital and subordinated loan capital may be included but, if so, only up to 50 % of the margin, no more than 25 % of which shall consist of subordinated loans with a fixed maturity, or fixed-term cumulative preferential share capital, if the following minimum criteria are met:

(a) in the event of the bankruptcy or liquidation of the assurance undertaking, binding agreements must exist under which the subordinated loan capital or preferential share capital ranks after the claims of all other creditors and is not to be repaid until all other debts outstanding at the time have been settled.

Subordinated loan capital must also fulfil the following conditions:

(b) only fully paid-up funds may be taken into account;

(c) for loans with a fixed maturity, the original maturity must be at least five years. No later than one year before the repayment date the assurance undertaking must submit to the competent authorities for their approval a plan showing how the solvency margin will be kept at or brought to the required level at maturity, unless the extent to which the loan may rank as a component of the solvency margin is gradually reduced during at least the last five years before the repayment date. The competent authorities may authorize the early repayment of such loans provided application is made by the issuing assurance undertaking and its solvency margin will not fall below the required level;

(d) loans the maturity of which is not fixed must be repayable only subject to five years' notice unless the loans are no longer considered as a component of the solvency margin or unless the prior consent of the competent authorities is specifically required for early repayment. In the latter event the assurance undertaking must notify the competent authorities at least six months before the date of the proposed repayment, specifying the actual and required solvency margin both before and after that repayment. The competent authorities shall authorize repayment only if the assurance undertaking's solvency margin will not fall below the required level;

(e) the loan agreement must not include any clause providing that in specified circumstances, other than the winding-up of the assurance undertaking, the debt will become repayable before the agreed repayment dates;

(f) the loan agreement may be amended only after the competent authorities have declared that they have no objection to the amendment,

- securities with no specified maturity date and other instruments that fulfil the following conditions, including cumulative preferential shares other than those mentioned in the preceding indent, up to 50 % of the margin for the total of such securities and the subordinated loan capital referred to in the preceding indent:

(a) they may not be repaid on the initiative of the bearer or without the prior consent of the competent authority;

(b) the contract of issue must enable the assurance undertaking to defer the payment of interest on the loan;

(c) the lender's claims on the assurance undertaking must rank entirely after those of all non-subordinated creditors;

(d) the documents governing the issue of the securities must provide for the loss-absorption capacity of the debt and unpaid interest, while enabling the assurance undertaking to continue its business;

(e) only fully paid-up amounts may be taken into account.'

Comments on UK transposition

The solvency margin requirement: at UK level, section 32(1) of the ICA 1982, as amended, requires every insurance company (to which Part II of the Act applies) whose head office is in the UK to “maintain a margin of solvency of such amount as may be prescribed by or determined in accordance with regulations made for the purpose of this section”, known as the Required Minimum Margin (RMM). Section 32(5)(a) of the Act defines the margin of solvency of an insurance company as “the excess of the value of its assets over the amount of its liabilities, that value and amount being determined in accordance with any applicable valuation regulations”. The Act does not stipulate the amount of the RMM nor any provision on its composition, leaving both issues to be specified by statutory instruments.

In line with the Directive, the insurance company is obliged to maintain a margin of solvency at least equal to the RMM at all times and not just at the year end. The RMM of a company carrying on long-term business is the greater of:

§ the Minimum Guaranteed Fund (which, in the case of a mutual life insurer company, is EUR 600,000)

§ the Required Margin of Solvency (RMS).

Composition of the solvency margin: the 3LD prescribes that the solvency margin must be represented by assets free of any foreseeable liabilities, also known as ‘explicit assets’ and, exceptionally, by ‘implicit’ or ‘intangible’ assets, provided an authorization from the competent authority is obtained. Implicit items are assets of a long-term fund which are intangible and result from the underestimation of assets or the overestimation of liabilities. Insurance Companies Regulations 1994 also differentiates between explicit and implicit items. Paragraph (3) of Regulation 22 requires that, of the assets covering a company’s RMM, at least 50% of the Guarantee Fund (or, if greater, 100% of the Minimum Guarantee Fund) be covered by ‘explicit assets’. Explicit assets are all types of assets other than implicit items, which are expressly mentioned by the Regulations. According to Paragraph (1) of Regulation 22, the Guarantee Fund is equivalent to one-third of the RMM. Therefore, the effect of Regulation 22 is that one-sixth of the RMM must be covered by explicit assets, while the remaining five-sixths of the RMM may be covered by implicit items.

Insurance Companies Regulations 1994 do not include a provision that lists the explicit and implicit items the available solvency margin may consist of. However, they do include a number of regulations that prescribe how assets and liabilities must be valued. Any asset not mentioned in the valuation regulations other than cash (e.g. gold or commodities) is treated as having no value and therefore must be excluded from the calculations. Once the assets are valued in accordance with the valuation of assets regulations, each category of assets must then be compared to the admissibility limits prescribed by the regulations, which, in order to spread the risk, limit the value of each category of assets that can be taken into account to cover the company’s liabilities. The value of the assets that exceeds the liabilities that can be taken into account to meet the company’s solvency requirements is subject to further limitations, which are laid down by Regulation 23 of the Insurance Companies Regulations 1994. Regulation 23(2) allows half the amount of unpaid capital to be valued so long as a quarter of the capital is paid up (with analogous provisions for a mutual). Regulation 23(4) allows a mutual carrying on general business to value uncalled contributions, subject to the restrictions in subparagraphs (a) and (b). In line with the Directive, the 1994 Regulations prescribe that subordinated loan capital can count for solvency purposes if the obligation to repay the loan is subordinated to the rights of policyholders and a section 68 Order is obtained. The implicit assets mentioned by the 1994 Regulations are future profits, zillmerising and hidden reserves. In line with the Directive’s requirements, the inclusion of implicit items in the calculation of the margin of solvency is subject to the previous authorisation of the competent authority, as prescribed by section 68 of the ICA. At the time of the implementation of the Third Life Directive, the Secretary of State of the DTI issued a Prudential Guidance providing further specifications on the use of implicit assets for solvency purposes and on the use by the Secretary of State of the discretion granted by section 68 of the Act in relation to this issue. The Guideline stated that while orders in respect of future profits and zillmerising were readily available provided the relevant conditions were met, Orders in respect of hidden reserves were only given as an exceptional measure.

Zillmerising and hidden reserves: zillmerisation is a process whereby an adjustment is made in the actuarial valuation of long-term business to take account of the future recovery of the costs of acquiring new business. The Zillmer adjustment allows for the initial expenses incurred by a company when writing new business to be spread over the lifetime of the policy in proportion to the premiums due. In this way the initial costs are offset against the future income arising from that policy. Zillmer adjustments are applied only to policies where regular premiums are payable.

The rules that prescribe the amount of the required minimum margin and the admissibility of assets are contained in the Insurance Companies Regulations 1994. According to those rules, different margins are required for different type of liabilities, the required minimum margin being the aggregate of all the margins in question. In line with the Directive, Regulation 26 of the 1994 Regulations prescribe that, in so far as they are not of an exceptional nature, hidden reserves resulting from the underestimation of assets and overestimation of liabilities (other than mathematical reserves), may be given full value for solvency purposes.

Link to the ELAS case

Article 25 imposes the obligation on the regulator to require from every assurance company an adequate available solvency margin in respect of its ‘entire business’ at all times. The concept is therefore explicitly reiterated for the third time. The solvency margin must be represented by assets free of any foreseeable liabilities.

Was ELAS solvency margin ‘adequate at all times’? There are two issues to be analyzed: the non-reserving of discretionary bonuses, and the use of future profits and Zillmerisation.

1. Non-reserving of discretionary bonuses, link to Articles 10 and 18

As was explained in detail in the section on Articles 8, 10 and 18, ELAS did not reserve for discretionary bonuses, thereby not computing these liabilities in its solvency margin. There is one line of reasoning that assumes that, by being allowed to do this, ELAS managed by artificial means to meet its solvency requirements, thereby hiding the truth from policyholders and endangering its future financial viability. The argument continues by saying that this would have meant that PRE were put at risk and that regulators took measures that were not “appropriate and necessary to prevent or remedy any irregularities prejudicial to the interests of the assured persons”, as required by Article 10. By not ensuring that the business complied with UK law on PRE, it possibly failed to respect Article 10 (See also section II.2. ‘Further evidence on transposition’).

2. Future profits and Section 68 issue

The second key aspect of the solvency margin issue is the question of future profits, Zillmerising and the powers of the Secretary of State.

At the time of the implementation of the 3LD, the EC legislation in force(13) on future profits prescribed that up to 50% of future profits could be used for meeting the undertaking’s solvency requirements, prior to the authorization of the competent authority and subject to certain conditions. The underlying rationale behind this was to anticipate the likelihood that profits on investments would arise in future and be available to meet future liabilities. To avoid risks, the estimation of future profits was to be carried out on a prudent basis. This possibility was severely restricted with the adoption in 2002 of the Solvency I Directive (see Article 1.4), which totally prohibits their use from 2009 onwards. The linkage with the ELAS case becomes apparent following Baird's (WE 17)(14) assertion that, on several occasions, ELAS requested and successfully obtained authorisation from the regulator on numerous occasions to use future profits, Zillmerising and subordinated loan capital to meet its solvency requirements. According to this evidence, the company was thereby allowed to enhance the external perception of its financial strength. Baird recommended reviewing the exercise of discretion by the regulator relating to authorisations for using future profits to meet solvency requirements.

Therefore, one of the lines of investigation being pursued is whether the discretion exercised by the Secretary of State based on section 68 of the ICA 1982 played a prominent role in the ELAS affair and whether that discretion itself is compatible with the 3LD. The Directive prescribes that Member States must ensure that competent authorities have sufficient powers and means to carry out their supervisory functions (see Article 10 3LD). The Directive, by contrast, allows the competent authority to waive the application of rules only on a limited number of occasions and subject to stringent conditions but it seems that nowhere in the Directive is the competent authority of a Member State entrusted with such waiver powers as those prescribed by section 68 of the ICA 1982. The investigation must ascertain whether such powers entail the risk of being exercised in a lenient or inconsistent way that might have been beneficial to some companies but not to others, thereby possibly undermining the application of harmonised standards. Moreover, the issue is whether the ELAS scandal would have been avoided, had those powers been constrained.

Section 68 of the ICA 1982

Let us look at section 68 more closely. Under section 68 of the Act, the Secretary of State may, upon request or with the consent from an insurer and provided certain conditions are met, waive the application of prudential rules to that particular company. Is this discretion compatible with the 3LD?

Section 68 is entitled “Power to modify Part II in relation to particular companies”. The wording of this section accords the Secretary of State generous powers not to apply to particular companies (or apply with modifications) a substantive number of sections of the ICA and regulations made under those sections. According to paragraph (4), the Secretary of State may decide not to apply the following provisions:

“…sections 16 to 22, 23(1) and 25 to 36 of this Act, the provisions of regulations made for the purposes of any of those sections and the provisions of any valuation regulations. […]”

This broad scope of provisions potentially affects the application of a vast number of prudential regulations, including, amongst other things, regulations on regulatory returns, technical provision requirements and solvency requirements to the Secretary of State’s discretion. The Secretary of State must exercise his discretion not to apply the referred provisions at the request or with the consent of the insurance company concerned and the authorization must take the form of an order. Section 68 goes on to stipulate that the Secretary of State may subject the authorization to specific conditions and may revoke it at any time. No other formalities or standards qualify the exercise by the Secretary of State of the power to decide not to apply relevant provisions to particular insurance companies.

The 3LD prescribes that Member States must ensure that competent authorities have sufficient powers and means to carry out their supervisory functions but allows the competent authority to waive the application of rules only on a limited number of occasions and subject to stringent conditions(15). The broad waiver powers prescribed by section 68 of the ICA 1982 are nowhere to be found in the Directive.

It must be noted that the previous comments do not apply to the UK regime currently in force. The Financial and Services Market Act 2000, which has revoked, amongst other things, the ICA 1982, also authorizes the regulator, now the FSA, to waive the application of prudential regulations to particular companies. The difference between this and section 68 of the ICA 1982 is that current rules include stricter qualifications and much more detailed formalities for the exercise by the FSA of the discretion granted by the Act.

These divergences show an apparent incompatibility between UK law and the requirements of the 3LD, which raises serious concerns as to whether Article 25 of the 3LD was correctly transposed into UK law. Failure to amend the ICA 1982 could be construed as tantamount to defective transposition of the 3LD, given that the Act should have been modified in 1992 to reflect the requirements of the 3LD.

Summary

To conclude as regards Article 25: the evidence quoted beforehand suggests that ELAS used two accounting techniques to achieve solvency margins that satisfied the regulators’ requirements but which did not truly reflect the financial health of the company. According to this evidence, it follows therefore that the regulator did not do its utmost to ensure that ELAS had an adequate solvency margin in respect of its entire business at all times. The regulator:

a) took a very narrow view of solvency margins because it did not take into account accrued terminal bonuses in its analysis. This allowed ELAS legally to avoid having to reserve for discretionary bonuses as liabilities, which were therefore not computed in its solvency margin. By being allowed to meet its solvency requirements artificially, ELAS hid the truth from policyholders and endangered its future financial viability. Therefore, PRE were also put at risk. It follows that UK regulators took measures that were not “appropriate and necessary to prevent or remedy any irregularities prejudicial to the interests of the assured persons” (Article 10) and did not ensure that ELAS complied with UK law, i.e., PRE;

b) authorized too frequently the use of future profits and Zillmerising by ELAS as part of the implicit assets; this diminished the reliability and truthfulness of the solvency margin; it could therefore be argued that Article 25 was not respected because the UK regulators did not fulfil their obligation to require from ELAS an “adequate available solvency margin in respect of its entire business at all times”.

Article 28 - General good (Article 33 of CD)

Summary of objectives

The supervision of so-called "conduct of business" rules (i.e. contractual terms and practices affecting the consumer taking out a policy) is another field of responsibility of regulators appointed by Member States.

This article places on the Member State the commitment to prevent a policyholder from concluding a contract with an assurance company in circumstances that would be contrary to the “general good”. The provision does not define the meaning or scope of the “general good”, leaving its definition to each Member State according to its domestic legislation.

Text of the article

Article 28

The Member State of the commitment shall not prevent a policy-holder from concluding a contract with an assurance undertaking authorized under the conditions of Article 6 of Directive 79/267/EEC, as long as that does not conflict with legal provisions protecting the general good in the Member State of the commitment.

Comments on UK transposition

As with any domestic legal system, the UK legal system includes an open-ended list of provisions aimed at protecting the general good, which varies from time to time and may affect the nature of the assurance products, the contract documents used, the marketing and advertising of those products and, more generally, the conditions under which the insurance business must be carried on in the Member State of the commitment. Of course, to be compatible with Community law, such legislation must be aimed at protecting interests which are not already safeguarded by the rules of the home Member State, it must be applied without discrimination to all undertakings operating in that Member State and must be objectively necessary and in proportion to the objective pursued. The UK advisory authorities did not prepared a list of conditions described as constituting the general good. Instead, they prepared a non-exhaustive list outlining the principal enactments which regulate insurance business in the UK. In comparison with continental legal traditions, UK law tends to rely less on restrictions of the contractual autonomy of the parties as a means to protect the general good. Notwithstanding this approach, the UK does include a large number of provisions aimed at protecting the general good. These are included in Part III of the ICA 1982 on conduct of insurance business including provisions limiting the form and content of insurance advertising and provisions regulating the type of information that insurance companies or intermediaries must provide to policyholders before they enter into an insurance contract.

Link to the ELAS case

The issue here is whether the regulators in the UK, Ireland, Germany and other countries did not fulfil their legal duty to uphold the general good by preventing ELAS from mis-selling its policies. As the issue of home/host responsibilities is mainly one of implementation and concerns the relation between the UK regulators and those from other Member States, it is preferable to refer to Part III on Regulatory Action and Part IV on Redress issues. Obviously, in order to pursue this line of investigation, it is necessary first to prove whether mis-selling did indeed take place, in other words, whether there were any circumstances contrary to the general good under which ELAS policies were sold.

In terms of how conduct of business rules were managed in the UK, Mr. LAKE gives some insight in H1 that the policyholder information required by the 3LD came under the control of the conduct of business regulator, which was separate from the prudential regulator at the time in the UK, and that this legal division of responsibilities between business and prudential was prejudicial to ELAS policyholders. However, David STRACHAN from the FSA refutes this claim in H4, saying that "the Third Life Directive has been implemented in a way that has ensured clarity as to the respective responsibilities of the home and host regulators [...] This avoids an otherwise confusing situation in which policyholders would be subject to different conduct of business protections".

Fundamentally, policyholders have been making two types of allegations against ELAS:

§ mis-selling, by knowingly misrepresenting facts about the company's financial position, especially in relation to the GAR risks;

§ omission (possibly based on deceit), by failing to draw attention to the GAR risks, when that risk was a matter to be disclosed to existing and prospective policyholders.

There are several pieces of evidence that point to this, viz.:

- WE 7 NASSIM

- WE 51, 52

- WE 53 SEYMOUR

- WE 69 JOSEPHS

- WE 72, WE 81 DEPPE

- H5 LLOYD

- H7 KWANTES

- H8 BAIN

- WE-Conf 2

Other allegations include:

§ Allegations of 'churning' policyholders' contracts

§ Claims of communication failure between UK regulators

§ Issues on communications between UK and foreign regulators

§ Claims of misleading advertising on the German and Irish market.

For in-depth detail, see Part III on Regulatory Action and Part IV on Redress issues.

Article 31 - Information for policyholders (Article 36 of CD) and Annex II (Annex III of CD)

Summary of objectives

This article states that the information listed in Annex II of the Directive must be communicated to the policyholder, with the possibility to require companies to give additional information if it is necessary for a proper understanding by the policyholder of the essential elements of the commitment.

Text of the article

Article 31

1. Before the assurance contract is concluded, at least the information listed in point A of Annex II shall be communicated to the policy-holder.

2. The policy-holder shall be kept informed throughout the term of the contract of any change concerning the information listed in point B of Annex II.

3. The Member State of the commitment may require assurance undertakings to furnish information in addition to that listed in Annex II only if it is necessary for a proper understanding by the policy-holder of the essential elements of the commitment.

4. The detailed rules for implementing this Article and Annex II shall be laid down by the Member State of the commitment.

ANNEX II

INFORMATION FOR POLICY-HOLDERS. The following information, which is to be communicated to the policy-holder before the contract is concluded (A) or during the term of the contract (B), must be provided in a clear and accurate manner, in writing, in an official language of the Member State of the commitment.

However, such information may be in another language if the policy-holder so requests and the law of the Member State so permits or the policy-holder is free to choose the law applicable.

A. Before concluding the contract

Information about the assurance undertaking

Information about the commitment

(a) 1. The name of the undertaking and its legal form

(a) 2. The name of the Member State in which the head office and, where appropriate, the agency or branch concluding the contract is situated

(a) 3. The address of the head office and, where appropriate, of the agency or branch concluding the contract

(a) 4. Definition of each benefit and each option

(a) 5. Term of the contract

(a) 6. Means of terminating the contract

(a) 7. Means of payment of premiums and duration of payments

(a) 8. Means of calculation and distribution of bonuses

(a) 9. Indication of surrender and paid-up values and the extent to which they are guaranteed

(a) 10. Information on the premiums for each benefit, both main benefits and supplementary benefits, where appropriate

(a) 11. For unit-linked policies, definition of the units to which the benefits are linked

(a) 12. Indication of the nature of the underlying assets for unit-linked policies

(a) 13. Arrangements for application of the cooling-off period

(a) 14. General information on the tax arrangements applicable to the type of policy

(a) 15. The arrangements for handling complaints concerning contracts by policy-holders, lives assured or beneficiaries under contracts including, where appropriate, the existence of a complaints body, without prejudice to the right to take legal proceedings

(a) 16. Law applicable to the contract where the parties do not have a free choice or, where the parties are free to choose the law applicable, the law the assurer proposes to choose

B. During the term of the contract

In addition to the policy conditions, both general and special, the policy-holder must receive the following information throughout the term of the contract.

Information about the assurance undertaking

Information about the commitment

(b) 1. Any change in the name of the undertaking, its legal form or the address of its head office and, where appropriate, of the agency or branch which concluded the contract

(b) 2. All the information listed in points (a) (4) to (a) (12) of A in the event of a change in the policy conditions or amendment of the law applicable to the contract

(b) 3. Every year, information on the state of bonuses

Comments on UK transposition

The UK transposed Article 31 and Annex II into domestic legislation via the Insurance Companies (Third Insurance Directives) Regulations 1994. Regulation 40 of these regulations inserts section 72A and Schedule 2E – Information for policyholders of UK insurers and EC companies - into the ICA 1982. Paragraphs 1 and 2 of the Schedule prescribe the information to be disclosed before and during contracts of long-term insurance, while paragraphs 3 and 4 prescribe the information to be disclosed before and during contracts of general insurance. The DTI issued a Prudential Guidance Note that offers guidance to insurers as to the methods by which they may best comply with the new disclosure legislation. The preamble to this Guidance clearly states that it cannot be taken as an authoritative statement and that insurers should refer to the Regulations and the relevant Directives.

Pre-contractual disclosure requirements: the scope of application of pre-contractual information requirements for long-term insurance contracts is defined by paragraph (1), sub paragraphs (1) and (2) of the Schedule. According to these provisions, pre-contractual disclosure requirements:

§ Apply to contracts of direct long-term insurance effected by a head office or branch of an insurance company or member of Lloyd’s situated in the UK or situated in a Member State other than the UK where one or more of the other parties to the contract is habitually resident in the UK

§ Do not apply to contracts which constitute “investment business” , as defined by the FSA Act 1986, affected by companies which are authorised persons within the meaning of that Act. These contracts are governed by the SIB/LAUTRO disclosure rules.

Pre-contractual disclosure requirements for long-term insurance as set out by Schedule 2E basically reiterate those included in Annex II with two relevant differences. Firstly, the Schedule requires the disclosure of “any compensation or guarantee arrangements which will be available if the insurer is unable to meet its liabilities under the contract”. This is an additional requirement not listed by Annex II of the Directive. The Prudential Guidance Note stipulates that, as a minimum, the assurance undertaking should provide on request detailed information as to the compensation arrangements that will apply to the contract. However, the Guidance notes that the best practice is to provide a brief description of the compensation arrangements which will apply and that further information is available on request.

Secondly, in respect of the language to be used for disclosure, the Directive requires the disclosure to be in a language of the Member State of the commitment (i.e. where the policyholder is habitually resident) or, if the law of that Member State so permits and the policyholder so requests, it may be provided in the language of another Member State. However, Schedule 2E states that the information shall be furnished in English except when the other party to the contract requests that the information be disclosed in an official language of a Member State other than the UK. This means, for example, that if the policyholder is habitually resident in a Member State other than the UK whose official language is not English, the UK company can comply with the disclosure requirements by furnishing that policyholder with information in English unless the policyholder requests that the information be furnished in his own language. Thus, the UK language rules do not oblige the insurer to provide the information in a language other than English whereas the Directive requires the disclosure to be in the language of the Member State of the commitment (i.e. where the policyholder is habitually resident).

In addition, the Prudential Guidance Note further specifies the disclosure requirements included in the schedule. For instance, with respect to the requirement to disclose the method of calculation and distribution of bonuses, the Guidance Note specifies that the insurer should state:

§ how it distributes profits which are allocated for the payment of bonuses (for example, by an increase in benefits or a decrease in premiums)

§ whether increased benefits resulting from bonuses are only payable (subject to any adjustments) even if the contract is terminated early by either party to the contract

§ where the bonus acts to increase benefits, whether increases are likely to be made each year or only when the policy monies become payable to the policyholder

§ the basis upon which bonuses are allotted to policyholders (for example, sum assured, premiums paid, value of existing bonuses)

§ whether policies share equitably in the distribution of all the profits of the long-term fund or only certain elements of these profits because, for example, certain assets are to be hypothecated to the type of contract concerned so that the bonuses distributed to the policyholder will be restricted to the profits earned on those assets.

The Prudential Guidance Note specifies that all the information must be disclosed in writing before the contract is entered into. It goes on to specify that, as best practice, insurers should disclose the information early in the selling process and whenever a product recommendation is made or a proposal form completed by the policyholder.

Ongoing disclosure requirements: the scope of application of ongoing disclosure requirements for long-term insurance contracts is defined by paragraph (2), sub paragraphs (1) and (2) of the Schedule. According to these provisions, ongoing contractual disclosure requirements apply to contracts of direct long-term insurance entered into by a head office or branch of an insurance company or member of Lloyd’s situated in the UK or situated in a Member State other than the UK where one or more of the other parties to the contract is habitually resident in the UK. Unlike pre-contractual disclosure requirements, ongoing disclosure requirements apply to all kinds of contracts for direct long-term insurance, whether they have an investment component or not.

In line with Annex II of the Directive, ongoing disclosure requirements for long-term insurance, as set out by Schedule 2E, refer to both disclosure of information on contract variations and on the state of bonuses. The extent, form and timing of the ongoing disclosure requirements are further specified by the Prudential Guidance Note, which refers to the SIB/LAUTRO rules. The SIB/LAUTRO rules on disclosure of information relating to contract variations and on the state of bonuses is far more detailed than the succinct reference made by the Directive. SIB/LAUTRO rules stipulate that bonus notices must be issued at least once in every calendar year and that they should take one of the following forms:

§ a client-specific notice that indicates the amount of the bonus allotted to that policyholder, or

§ a client-specific notice which indicates the total value of the investment, including the value of any bonus allotted, and the rate of bonus over the period of time to which the bonus notice relates, or

§ a non client-specific notice that provides sufficient information to enable policyholders to calculate the amount of bonus allotted to them and indicates the method for the calculation. Such a notice could take the form of a table of values for the bonus for given sums assured and years of commencement of the contract or indicate the amount of the bonus as a proportion of the sum assured.

Link to the ELAS case

This article is inseparably linked to Article 28.

The issue in this instance is whether ELAS properly informed policyholders, in addition to the initial pre-contractual information, of changes to their policy conditions, for example concerning updates on the state of their bonuses. To pursue this line of investigation, it is necessary to verify if ELAS did indeed adequately fulfil these obligations and, if it did not, what action, if any, was taken by the conduct of business regulator in each case (UK, Ireland, Germany, etc.).

The Directive itself requires only that the policyholder must be informed, inter alia, of “the definition of each benefit and each option” and “the means of calculation and distribution of bonuses”. These requirements are not sufficiently specific. There is powerful evidence to suggest that, from 1998 onwards, ELAS did not adequately disclose the risk posed by guaranteed annuity rates to prospective policyholders with non-guaranteed rates. It is difficult to make the case that this was a breach of the Directive but easy to make the case that there is a need to enhance disclosure requirements for the benefit of policyholders.

For in-depth detail, see Part III on Regulatory Action and Part IV on Redress issues.

II.1.2.  Other articles of the 3LD

Article 9 - Supervision of branches established in another Member State (Articles 16 of 1LD and 11 of CD)

Summary of objectives

This article entitles the home Member State to carry on on-the-spot supervision of branches established in another Member State and previous notification to the competent authorities of the host Member State.

Text of the article

Article 9

Article 16

of Directive 79/267/EEC shall be replaced by the following:

'Article 16

The Member State of the branch shall provide that, where an assurance undertaking authorized in another Member State carries on business through a branch, the competent authorities of the home Member State may, after having first informed the competent authorities of the Member State of the branch, carry out themselves, or through the intermediary of persons they appoint for that purpose, on-the-spot verification of the information necessary to ensure the financial supervision of the undertaking. The authorities of the Member State of the branch may participate in that verification'.

Comments on UK transposition

This provision has been transposed into UK legislation by Regulation 45 of the Insurance Companies (Third Insurance Directives) Regulations 1994, which inserts Schedule 2F to the ICA 1982. Paragraphs 13 and 14 of Schedule 2F modify the power of the Secretary of State to obtain information from insurance companies conferred by section 44 of the ICA 1982, when that power is exercised in respect of an EC company. Section 44 of the Act confers the Secretary of State two types of power: subsection (1) refers to the power to require a company to furnish the Secretary of State with information about specified matters; subsections (2)(a), (2)(b) and (4)(a) refer to the power to require a company to produce books or papers as may be specified. With respect to the power to require information about specified matters, paragraph 13(1) provides that the Secretary of State may exercise this power in respect of an EC company either if the supervisory authority of the home Member State has requested him to do so or if the Secretary of State considers that the information to be acquired is necessary to enable him to perform his supervisory functions. In the latter circumstance, the Secretary of State enjoys some discretion in using this power, which is not subjected to a request from the competent authority of the home Member State. With respect to the power to require a company to produce books or papers, in line with the Directive, paragraph 13(2) provides that the Secretary of State shall not exercise this power in respect of an EC company unless the supervisory authority in the company’s home State has requested him – in writing – to obtain information from that company. Thus, the UK implementing measure is more restrictive than the Directive in that it requires the home Member State not only to notify the host Member State authority but also to submit this notification in writing.

Finally, in accordance with the Directive, paragraph 14(2) provides that an officer or agent of the Secretary of State may accompany the person authorised by the competent authorities of the home Member State while he is exercising the power to obtain information.

Link to the ELAS case

According to the evidence analyzed so far, no on-the-spot visits were performed by UK supervisors in other Member State regarding ELAS, nor have any previous notifications to the host Member State been found on this matter.

Article 12 - Difficulties to comply with financial guarantees (Articles 24 of 1LD and 37 of CD)

Summary of objectives

This article lists the actions to be taken by the competent authority of the home Member State to protect policyholders’ rights when assurance companies are facing difficulties in complying with their financial guarantees. It specifies the circumstances under which such actions may be taken, the formalities that are to be observed and the circumstances under which the home Member State may prohibit the company's free disposal of assets.

Text of the article

Article 12

1. Article 24 of Directive 79/267/EEC shall be replaced by the following:

'Article 24

1. If an undertaking does not comply with Article 17, the competent authority of its home Member State may prohibit the free disposal of its assets after having communicated its intention to the competent authorities of the Member States of commitment.

2. For the purposes of restoring the financial situation of an undertaking the solvency margin of which has fallen below the minimum required under Article 19, the competent authority of the home Member State shall require that a plan for the restoration of a sound financial position be submitted for its approval.

In exceptional circumstances, if the competent authority is of the opinion that the financial situation of the undertaking will further deteriorate, it may also restrict or prohibit the free disposal of the undertaking's assets. It shall inform the authorities of other Member States within the territories of which the undertaking carries on business of any measures it has taken and the latter shall, at the request of the former, take the same measures.

3. If the solvency margin falls below the guarantee fund as defined in Article 20, the competent authority of the home Member State shall require the undertaking to submit a short-term finance scheme for its approval.

It may also restrict or prohibit the free disposal of the undertaking's assets. It shall inform the authorities of other Member States within the territories of which the undertaking carries on business accordingly and the latter shall, at the request of the former, take the same measures.

4. The competent authorities may further take all measures necessary to safeguard the interests of the assured persons in the cases provided for in paragraphs 1, 2 and 3.

5. Each Member State shall take the measures necessary to be able in accordance with its national law to prohibit the free disposal of assets located within its territory at the request, in the cases provided for in paragraphs 1, 2 and 3, of the undertaking's home Member State, which shall designate the assets to be covered by such measures.'

Comments on UK transposition

Failure to establish sufficient technical provisions: the ICA 1982 grants the Secretary of State the power to restrict a company’s freedom to dispose of its assets, if it appears to him that the company has failed to cover its liabilities by assets of appropriate safety, yield and marketability. Unlike the Directive, domestic legislation does not require the Secretary of State to communicate its decision to restrict a company’s freedom to dispose of its assets to the competent authorities of other Member States.

Failure to maintain the required solvency margin: at UK level, section 32(4) of the ICA 1982, as amended, prescribes that when an insurance company fails to maintain the required margin of solvency it must, at the request of the Secretary of State, submit to him a plan for the restoration of a sound financial position. If the Secretary of State considers the plan inadequate, the company must propose modifications to it. Once the Secretary of State accepts the plan, the company must give effect to it. The Directive clearly prescribes that, should this irregularity occur, the competent authority of the home Member State must request the restoration plan. By contrast, the domestic provision stipulates that the company must “… at the request of the Secretary of State…” submit a restoration plan. The domestic provision can thus be construed as conferring a prerogative to the Secretary of State to request the submission of the restoration plan, rather than imposing an obligation on him to request it.

Failure to prevent the solvency margin from falling below the guarantee fund: at UK level, section 33 of the ICA, as amended, prescribes that when the margin of solvency of an insurance company falls below the guarantee fund (one-third of a required margin of solvency), the company must, at the request of the Secretary of State, submit to him a short-term financial scheme. If the Secretary of State considers the scheme inadequate, the company must propose modifications to it. Once the Secretary of State accepts the scheme, the company must give effect to it. The Act places the emphasis on the insurance company’s obligation to submit the short-term financial scheme but does not impose an obligation on the Secretary of State to request it.

Duties of the Member States where the assets are located: UK legislation does envisage the possibility that the Secretary of State may restrict an EC company’s freedom to dispose of its assets at the request of the supervisory authority of the company’s home State.

The power of the competent authority to prohibit the free disposal of assets: under UK legislation, the ICA 1982 confers on the Secretary of State the power to restrict a company’s freedom to dispose of its assets. Sections 37, 40(A) and 45 of the ICA 1982 govern the grounds for the exercise of this power and the formalities to be observed. Section 37(3) of the Act lays down the following grounds on the basis of which the Secretary of State may restrict a company’s freedom to dispose of its assets: where the Secretary of State has given (and not revoked) a direction withdrawing (section 11) or suspending (section 12(A)) a company’s authorisation to carry on insurance business; on the grounds that it appears to the Secretary of State that the company has failed to satisfy its obligation to maintain a minimum solvency margin (section 32) or has failed to comply with the obligations relating to the localisation and currency of the assets (section 35); on the grounds that it appears to the Secretary of State that the company’s liabilities have not been determined in accordance with valuation regulations or generally accepted accounting methods; on the grounds that it appears to the Secretary of State that the company has failed to cover its liabilities by assets of appropriate safety, yield and marketability (section 35A).

Section 45 of the Act, as amended by the Insurance Companies (Third Insurance Directives) Regulations 1994, confers on the Secretary of State a residual power “to take such action as appears to him to be appropriate for the purpose of protecting policyholders or potential policyholders of the company against the risk that the company may be unable to meet its liabilities or, in the case of long-term business, to fulfil the reasonable expectations of policyholders or potential policyholders”. Such residual power, which can only be exercised when the Secretary of State considers that those purposes cannot be appropriately achieved by the exercise of the powers expressly mentioned by the Act in sections 38 to 44, includes the Secretary of State’s power to restrict the company’s freedom to dispose of its assets. Paragraph 2 of section 45 basically reiterates the grounds enumerated by section 37(3) on the basis of which the Secretary of State may restrict the company’s freedom to dispose of its assets.

With respect to the formalities to be observed, the Act prescribes that when exercising any of the powers conferred by the Act, the Secretary of State must “state the ground on which he is exercising it”. To restrict a company’s freedom to dispose of its assets, the Secretary of State must apply to the Court for an injunction. Section 40A prescribes the conditions under which the Court may, on the application of the Secretary of State, grant the requested injunction. Such restriction is limited to the value of the company’s “EC liabilities”. It stems from the provisions cited above that the power of the Secretary of State to freeze a company’s assets under UK legislation is broader than that conferred by the Directive to Member State’s competent authorities. In other words, the Secretary of State can restrict a company’s freedom to dispose of its assets in more circumstances than those exceptionally envisaged by the Directive. The exercise by the Secretary of State of his power to freeze a company’s assets is subject, however, to the observance of special formalities - including the need to apply before a court for an injunction – which are not prescribed by the Directive.

Link to the ELAS case

The applicability of Article 12 to the Equitable Life crisis is unclear. The UK regulator claimed that this article was not relevant and justified its lack of intervention in the 1990’s by stating that, "Equitable has always been solvent and in its regulatory returns it has always reported that it is currently meeting its regulatory solvency requirements" (David STRACHAN, as stated in H4). Given that the solvency margin was always formally respected by ELAS, paragraph 3 of the article was never activated. For further information on this point, see the section on Article 25 on the Solvency margin and Part III on Regulatory Action.

Divergences between the 3LD and implementing provisions: UK legislation confers to the Secretary of State the power, in line with the 3LD, to intervene in the case of assurance undertakings facing financial difficulties. However, contrary to the Directive, the Secretary of State may request the submission of a restoration plan or a short finance scheme. In addition, the Secretary of State may restrict the company’s freedom to dispose of its assets in more circumstances than those envisaged by the 3LD.

Article 13 - Withdrawal of authorisation (Articles 26 of 1LD and 39 of CD)

Summary of objectives

This article harmonises the grounds for withdrawal of authorisation in respect of an assurance company by the competent authority of the home Member State. In addition, this provision places some obligations on the home Member State and on the host Member State in the event of withdrawal. It also deals with some procedural formalities that must be observed.

Text of the article

Article 13

Article 26

of Directive 79/267/EEC shall be replaced by the following:

'Article 26

1. Authorization granted to an assurance undertaking by the competent authority of its home Member State may be withdrawn by that authority if that undertaking:

(a) does not make use of the authorization within 12 months, expressly renounces it or ceases to carry on business for more than six months, unless the Member State concerned has made provision for authorization to lapse in such cases;

(b) no longer fulfils the conditions for admission;

(c) has been unable, within the time allowed, to take the measures specified in the restoration plan or finance scheme referred to in Article 24;

(d) fails seriously in its obligations under the regulations to which it is subject.

In the event of the withdrawal or lapse of the authorization, the competent authority of the home Member State shall notify the competent authorities of the other Member States accordingly and they shall take appropriate measures to prevent the undertaking from commencing new operations within their territories, under either the freedom of establishment or the freedom to provide services. The home Member State's competent authority shall, in conjunction with those authorities, take all necessary measures to safeguard the interests of the assured persons and shall restrict, in particular, the free disposal of the assets of the undertaking in accordance with Article 24 (1), (2), second subparagraph, or (3), second subparagraph.

2. Any decision to withdraw an authorization shall be supported by precise reasons and notified to the undertaking in question.

Comments on UK transposition

Several grounds for withdrawing an authorisation already existed in UK legislation before the adoption of the 3LD (e.g. the undertaking does not make use of the authorisation within twelve months; the undertaking expressly renounces; failure to fulfil the conditions for admission). In cases where the undertaking ceases to carry on business for more than six months, the UK provision allows the Secretary of State to withdraw the authorisation if the undertaking “ceases to carry on insurance business or insurance business of any class” but does not qualify the Secretary of State’s right of withdrawal to the observance of a minimum period of six months. Regarding failure to adopt the measures prescribed by the restoration plan, UK legislation confers on the Secretary of State ample margin to withdraw an authorisation if it appears to him that a company has failed to satisfy any kind of obligation to which it is subject by virtue of the ICA Act or the Financial Services Act 1986.

Serious” failure to comply with the obligations it is subject to: this qualification is not included in UK legislation and the Secretary of State may withdraw an undertaking’s authorisation for failure to comply with the obligations it is subject to, even if that failure is not “serious”. He may withdraw the authorisation if it appears to him that any of the criteria of sound and prudent management is or has not been fulfilled, or may not be or may not have been fulfilled, in respect of the company.

UK obligations as home Member State in the event of withdrawal of authorisation of a UK company operating in Member States other than the UK: the Directive prescribes that the home Member State must take all necessary measures to safeguard the interests of assured persons and shall restrict, in particular, the free disposal of assets of the assurance undertaking. Under UK legislation, the Secretary of State has the power to restrict the company’s freedom to dispose of its assets not only when he has given (and not revoked) a direction withdrawing a company’s authorisation to carry on business but also when he has given a direction suspending such authorisation.

Link to the ELAS case

This provision would have required the UK regulator to withdraw authorisation granted to ELAS inter alia if the latter had failed "seriously in its obligations under the regulations to which it is subject". Several pieces of evidence (WE 2, 4, 6-8, 14-17, 22-23, 31, 33-34, 36, 44, 51-54, 69, 72, 79 and 84) claim that Equitable did indeed fail seriously in this respect. However, the regulator never considered that the conditions for activating this article were met. For further details, see section II.2. ‘Further evidence on transposition’.

Divergences between the 3LD and implementing provisions: the Directive provides that the home Member State must notify the competent authorities of the other Member States. The national implementing measure does not stipulate that the Secretary of State must inform the competent authority of other Member States.

Article 15 - Professional secrecy (Article 16 of CD)

Summary of objectives

This article establishes a duty of professional secrecy aimed at protecting the confidentiality of information and then introduces a number of exceptions to that obligation. It describes the purposes for which competent authorities can use confidential information and lists the circumstances and conditions under which the exchange of confidential information between the competent authorities of Member States or with other bodies such as other supervisory authorities, independent actuaries, central banks and other departments can take place.

Text of the article

Article 15

1. The Member States shall provide that all persons working or who have worked for the competent authorities, as well as auditors or experts acting on behalf of the competent authorities, shall be bound by the obligation of professional secrecy. This means that no confidential information which they may receive in the course of their duties may be divulged to any person or authority whatsoever, except in summary or aggregate form, such that individual assurance undertakings cannot be identified, without prejudice to cases covered by criminal law.

Nevertheless, where an assurance undertaking has been declared bankrupt or is being compulsorily wound up, confidential information which does not concern third parties involved in attempts to rescue that undertaking may be divulged in civil or commercial proceedings.

2. Paragraph 1 shall not prevent the competent authorities of the different Member States from exchanging information in accordance with the directives applicable to assurance undertakings. That information shall be subject to the conditions of professional secrecy indicated in paragraph 1.

3. Member States may conclude cooperation agreements, providing for exchanges of information, with the competent authorities of third countries only if the information disclosed is subject to guarantees of professional secrecy at least equivalent to those referred to in this Article.

4. Competent authorities receiving confidential information under paragraphs 1 or 2 may use it only in the course of their duties:

- to check that the conditions governing the taking-up of the business of assurance are met and to facilitate monitoring of the conduct of such business, especially with regard to the monitoring of technical provisions, solvency margins, administrative and accounting procedures and internal control mechanisms, or

- to impose sanctions, or

- in administrative appeals against decisions of the competent authority, or

- in court proceedings initiated pursuant to Article 50 or under special provisions provided for in the directives adopted in the field of assurance undertakings.

5. Paragraphs 1 and 4 shall not preclude the exchange of information within a Member State, where there are two or more competent authorities in the same Member State, or, between Member States, between competent authorities and:

- authorities responsible for the official supervision of credit institutions and other financial organizations and the authorities responsible for the supervision of financial markets,

- bodies involved in the liquidation and bankruptcy of assurance undertakings and in other similar procedures, and

- persons responsible for carrying out statutory audits of the accounts of assurance undertakings and other financial institutions,

in the discharge of their supervisory functions, and the disclosure, to bodies which administer (compulsory) winding-up proceedings or guarantee funds, of information necessary to the performance of their duties. The information received by these authorities, bodies and persons shall be subject to the obligation of professional secrecy laid down in paragraph 1.

6. In addition, notwithstanding paragraphs 1 and 4, Member States may, under provisions laid down by law, authorize the disclosure of certain information to other departments of their central government administrations responsible for legislation on the supervision of credit institutions, financial institutions, investment services and assurance undertakings and to inspectors acting on behalf of those departments.

However, such disclosures may be made only where necessary for reasons of prudential control.

However, Member States shall provide that information received under paragraphs 2 and 5 and that obtained by means of the on-the-spot verification referred to in Article 16 of Directive 79/267/EEC may never be disclosed in the cases referred to in this paragraph except with the express consent of the competent authorities which disclosed the information or of the competent authorities of the Member State in which on-the-spot verification was carried out.

Comments on UK transposition

Under UK legislation, restrictions on disclosure of information are governed by section 41A and schedule 2B of the ICA 1982, inserted by Regulation 26 of the Insurance Companies (Third Insurance Directives) Regulations 1994 implementing the Third Life Directive, as amended by Regulation 20 of the Financial Institutions (Prudential Supervision) Regulations 1996, implementing Directive 95/96/EC.

The professional secrecy obligation: at domestic level, the professional secrecy obligation is governed by paragraph 1 of Schedule 2B of the Act. In terms of its scope of application, the obligation binds “any person” who discloses “restricted information” in contravention to paragraph 1. “Restricted information” refers to information obtained by the Secretary of State for the purposes of, or in the discharge of, functions under the Act or any rules or regulations made under the Act, which relates to the business or other affairs of “relevant persons”, namely, “any UK, EC or non-EC company and any controller, manager, chief executive, general representative, agent or employee of such a company”. Paragraph 5 extends the obligation not to disclose confidential information to information which has been supplied to the Secretary of State for the purposes of its functions under the Act by a supervisory authority in a Member State other than the UK or has been obtained for those purposes by the Secretary of State or by a person acting on his behalf, in another Member State. It can be said that the scope of application of the obligation prescribed by the national provision is even broader than that prescribed by the Directive because it binds “any person” (not only persons working, or who have worked, for the competent authority). In addition, the national provision expressly specifies that “restricted information” covers not only information relating to the assurance undertakings themselves but also to information relating to executives and employees of those companies. Finally, the national provision goes further than the Directive by prescribing a penalty for those who breach the obligation not to disclose information in contravention to the conditions laid down by paragraph 1.

Exchange of information between the competent authority of a Member State and other competent authorities or relevant bodies: at UK level, paragraph 3 of Schedule 2B refers to authorisations for the Secretary of State to disclose information aimed at facilitating discharge of functions by other regulatory authorities and paragraph 4 refers to other authorised disclosures aimed at facilitating discharge of functions by other relevant bodies. In line with the Directive, all authorised disclosures are to supervisory authorities, regulatory authorities or other relevant bodies expressly identified by the national legislation and in all cases the purpose of the authorisation is to allow those bodies to discharge their functions. Furthermore, national rules expressly prescribe that disclosed information shall not be used otherwise than for the expressly mentioned purposes and imposes criminal penalties for persons who use the information in contravention of the rules.

Link to the ELAS case

The article is relevant with regards to the exchanges (or lack thereof) of correspondence between the UK regulator and the Irish and German regulators. For further information on this point, see Part III on Regulatory Action and Part IV on Redress. WE-Conf 9 contains a list of confidential correspondence between regulators on the ELAS case.

With regard to the duties of auditors, see the reference to Article 17 of the CD. Questions have been raised as to the actions of ELAS' auditors throughout the affair. However, the mandate of the EQUI committee does not explicitly cover this area. A case was brought against ELAS' previous auditors (Ernst&Young) by the new management in 2001 but was ultimately dismissed.

Divergences between the 3LD and implementing provisions: the UK provision establishes that information is not “restricted information” if “it is information in the form of a summary or is "information so framed as not to enable information relating to any particular person to be ascertained from it". As it stands, the UK provision contradicts the Directive because it allows a further exception to the obligation of professional secrecy, namely, that the dissemination of information about the company “in the form of a summary” is sufficient. In contrast, what the Directive allows is the dissemination of information “in the form of a summary [or aggregate form] such that individual assurance undertakings cannot be identified.”

Article 19 - Premiums for new business (Article 21 of CD)

Summary of objectives

This article provides for some general guidelines on the adequacy of the premiums for new business, viz.: they must be sufficient on reasonable actuarial terms to enable the company to meet its commitments and to establish adequate technical provisions. For this purpose, the only inputs to be taken into account in order to respect the solvency margin are those coming from premiums and other systematic and permanent income sources.

Text of the article

Article 19

Premiums for new business shall be sufficient, on reasonable actuarial assumptions, to enable assurance undertakings to meet all their commitments and, in particular, to establish adequate technical provisions.

For this purpose, all aspects of the financial situation of an assurance undertaking may be taken into account, without the input from resources other than premiums and income earned thereon being systematic and permanent in such a way that it may jeopardize the undertaking's solvency in the long term.

Comments on UK transposition

These standards were transposed into UK legislation by the Insurance Companies (Third Insurance Directives) Regulations 1994. Regulation 18 of these regulations inserted section 35B into the ICA 1982, which rightly transposes the Directive’s provision, including all its guidelines on the adequacy of the premiums. UK legislation goes beyond the Directive and requires that the appointed actuary of a company carrying long-term business certify that premiums for contracts entered into during the financial year and the income earned thereon comply with these standards.

Link to the ELAS case

There is no clear link to the case. For further information on this point, see Part III on Regulatory Action.

Divergences between the 3LD and implementing provisions: none found.

Article 20 - Assets covering matching provisions (Article 22 of CD)

Summary of objectives

This article provides for some general guidelines on the investment standards the assets covering technical provisions must aim to meet: they must secure the safety, yield and marketability of its investments and must be diversified and adequately spread.

Text of the article

Article 20

The assets covering the technical provisions shall take account of the type of business carried on by an undertaking in such a way as to secure the safety, yield and marketability of its investments, which the undertaking shall ensure are diversified and adequately spread.

Comments on UK transposition

These standards were transposed into UK legislation by the Insurance Companies (Third Insurance Directives) Regulations 1994.

Link to the ELAS case

There is no clear link to the case. It would be necessary to review the investment strategy of ELAS over a number of years and even decades to ascertain whether the assets covering the technical provisions were secure and diversified. In any case, the main contentious point in the case is not so much the investment standard of the assets covering technical provisions but rather the possible lack of sufficient reserving. For further information on this point, see Part III on Regulatory Action.

Divergences between the 3LD and implementing provisions: none found.

Article 22 - Rules for investment diversification

Summary of objectives

This article refers to the rules and principles that Member States must observe when regulating on assurance undertakings’ investments. It covers, on the one hand, investment limits on specific assets and, on the other hand, general investment principles for admissible assets.

Text of the article

Article 22

1. As regards the assets covering technical provisions, the home Member State shall require every assurance undertaking to invest no more than:

(a) 10 % of its total gross technical provisions in any one piece of land or building, or a number of pieces of land or buildings close enough to each other to be considered effectively as one investment;

(b) 5 % of its total gross technical provisions in shares and other negotiable securities treated as shares, bonds, debt securities and other money- and capital-market instruments from the same undertaking, or in loans granted to the same borrower, taken together, the loans being loans other than those granted to a State, regional or local authority or to an international organization of which one or more Member States are members. This limit may be raised to 10 % if an undertaking invests not more than 40 % of its gross technical provisions in the loans or securities of issuing bodies and borrowers in each of which it invests more than 5 % of its assets;

(c) 5 % of its total gross technical provisions in unsecured loans, including 1 % for any single unsecured loan, other than loans granted to credit institutions, assurance undertakings - in so far as Article 8 of Directive 79/267/EEC allows it - and investment undertakings established in a Member State. The limits may be raised to 8 and 2 % respectively by a decision taken on a case-by-case basis by the competent authority of the home Member State;

(d) 3 % of its total gross technical provisions in the form of cash in hand;

(e) 10 % of its total gross technical provisions in shares, other securities treated as shares and debt securities which are not dealt in on a regulated market.

2. The absence of a limit in paragraph 1 on investment in any particular category does not imply that assets in that category should be accepted as cover for technical provisions without limit. The home Member State shall lay down more detailed rules fixing the conditions for the use of acceptable assets. In particular it shall ensure, in the determination and the application of those rules, that the following principles are complied with:

(i) assets covering technical provisions must be diversified and spread in such a way as to ensure that there is no excessive reliance on any particular category of asset, investment market or investment;

(ii) investment in particular types of asset which show high levels of risk, whether because of the nature of the asset or the quality of the issuer, must be restricted to prudent levels;

(iii) limitations on particular categories of asset must take account of the treatment of reassurance in the calculation of technical provisions;

(iv) where the assets held include an investment in a subsidiary undertaking which manages all or part of the assurance undertaking's investments on its behalf, the home Member State must, when applying the rules and principles laid down in this

Article, take into account the underlying assets held by the subsidiary undertaking; the home Member State may treat the assets of other subsidiaries in the same way;

(v) the percentage of assets covering technical provisions which are the subject of non-liquid investments must be kept to a prudent level;

(vi) where the assets held include loans to or debt securities issued by certain credit institutions, the home Member State may, when applying the rules and principles contained in this Article, take into account the underlying assets held by such credit institutions. This treatment may be applied only where the credit institution has its head office in a Member State, is entirely owned by that Member State and/or that State's local authorities and its business, according to its memorandum and articles of association, consists of extending, through its intermediaries, loans to, or guaranteed by, States or local authorities or of loans to bodies closely linked to the State or to local authorities.

3. In the context of the detailed rules laying down the conditions for the use of acceptable assets, the Member State shall give more limitative treatment to:

- any loan unaccompanied by a bank guarantee, a guarantee issued by an assurance undertaking, a mortgage or any other form of security, as compared with loans accompanied by such collateral,

- UCITS not coordinated within the meaning of Directive 85/611/EEC (¹) and other investment funds, as compared with UCITS coordinated within the meaning of that Directive,

- securities which are not dealt in on a regulated market, as compared with those which are,

- bonds, debt securities and other money- and capital-market instruments not issued by States, local or regional authorities or undertakings belonging to Zone A as defined in Directive 89/647/EEC (²), or the issuers of which are international organizations not numbering at least one Community Member State among their members, as compared with the same financial instruments issued by such bodies.

4. Member States may raise the limit laid down in paragraph 1 (b) to 40 % in the case of certain debt (¹) Council Directive 85/611/EEC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (OJ No L 375, 31. 12. 1985, p. 3). Directive as amended by Directive 88/220/EEC (OJ No L 100, 19. 4. 1988, p. 31).

(²) Council Directive 89/647/EEC of 18 December 1989 on a solvency ratio for credit institutions (OJ No L 386, 30. 12. 1989, p. 14).

securities when these are issued by a credit institution which has its head office in a Member State and is subject by law to special official supervision designed to protect the holders of those debt securities. In particular, sums deriving from the issue of such debt securities must be invested in accordance with the law in assets which, during the whole period of validity of the debt securities, are capable of covering claims attaching to debt securities and which, in the event of failure of the issuer, would be used on a priority basis for the reimbursement of the principal and payment of the accrued interest.

5. Member States shall not require assurance undertakings to invest in particular categories of assets.

6. Notwithstanding paragraph 1, in exceptional circumstances and at the assurance undertaking's request, the home Member State may, temporarily and under a properly reasoned decision, allow exceptions to the rules laid down in paragraph 1 (a) to (e), subject to Article 20.

Comments on UK transposition

UK legislation does not impose direct restrictions on a company’s choice of investments. However, valuation of assets regulations exert a significant indirect influence over a company’s investment policies. Either by providing that certain type of assets are inadmissible or by limiting the value of those assets that can be taken into account for regulatory purposes, valuation of assets regulations encourage companies to hold a prudent spread of relatively low-risk assets, which are in line with the Directive’s prescriptions for investment diversification.

Investment limits on specific assets: the Directive prescribes some investment limits on certain type of assets expressed in terms of percentages of total gross technical provisions. For instance, no more than 10% can be invested in any piece of land, no more than 3% in the form of cash in hand, and so forth. Similarly, UK legislation includes rules that impose a limit on the maximum admissible value of each type of asset that can be taken into account for regulatory purposes.

Regulation 57 provides that, where the aggregate exposure of the company to assets of any one description exceeds the “maximum admissible value” for assets of that description, “there shall be left out of account assets equal in value to the excess”. Regulation 57 goes on to define “maximum admissible value” for a company carrying on long-term business as an amount equal to the percentage of the “long-term business amount” specified in Schedule 12, Part I.

Unlike the Directive, UK legislation imposes the percentage restrictions by reference not to technical provisions but with regard to “long-term business amount”. The DTI argued that it was not necessary to introduce any changes because UK rules are, in the majority of cases, more prudent than the rules set out in the Directive. (16)

For instance, the maximum admissible value for cash is 3% of the long-term business amount. The UK rule does not expressly prescribe that assurance undertakings cannot invest more than 3% on cash; what the UK rule does prescribe is that, if the company does invest more than 3% on cash, the excess will not be counted for the valuation of that particular asset.

In some cases the national aggregate exposure limits are more prudent than the Directive’s investment limits. For instance, the Directive limits investments in any piece of land to up to 10% of the company’s total gross technical provisions, while the national measure limits the company’s aggregate exposure to a piece of land to up to 5% of the undertaking’s long-term business amount. In other cases the limits are the same, for instance for unlisted shares (10%) and cash (3%). UK regulation goes on to prescribe some limits not prescribed by the Directive, for example, 5% on holdings in authorised unit trust schemes, 5% on computer equipment and 2.5% on office machinery.

Link to the ELAS case

This article is linked to the case within the terms of paragraph 6, which introduces an escape clause to the requirements contained in the rest of the article. According to this provision, "in exceptional circumstances” and “at an assurance undertaking’s request”, the home Member State may “temporarily” and “under a properly reasoned decision" allow exceptions to the rules laid down in paragraph 1.

This needs to be seen in the context of Article 25 on the Solvency margin and Article 21 on assets allowed to cover technical provisions. The issue at hand is whether UK legislation gives the regulator (the Secretary of State) broader powers than those prescribed by the Directive to waive regulations on prudential supervision. At UK level, under section 68 of the 1982 ICA, the Secretary of State may, upon request or with the consent from an insurer, waive the application of prudential supervision rules. The exercise of this power is not constrained by the standards mentioned in the Directive (i.e. “exceptional circumstances”, “temporarily”, “under properly reasoned decision”). The provision stipulates that the Secretary of State’s decision “may be subject to conditions”, clearly attributing to the regulator discretion to decide whether to impose those conditions or not. These seem to be broader powers than those prescribed by the Directive.

Such powers entail the risk of being exercised in a very lenient way, undermining the application of harmonized standards. This raises some concerns as to the compatibility of section 68 of the ICA 1982 with the 3LD. See further arguments in the section covering Article 25 on the Solvency margin.

Article 29 - Conditions of assurance and premiums (Article 34 of CD)

Summary of objectives

The aim of this article is to encourage Member States to adopt less trade restrictive practices. It prevents Member States requiring the prior approval of policy conditions, scales of premiums, technical bases used for calculating scales of premiums and technical provisions and other printed documents the insurer may use in its dealing with policyholders.

Text of the article

Article 29

Member States shall not adopt provisions requiring the prior approval or systematic notification of general and special policy conditions, scales of premiums, technical bases used in particular for calculating scales of premiums and technical provisions or forms and other printed documents which an assurance undertaking intends to use in its dealings with policy-holders.

Notwithstanding the first subparagraph, for the sole purpose of verifying compliance with national provisions concerning actuarial principles, the Member State of origin may require systematic communication of the technical Bases used in particular for calculating scales of premiums and technical provisions, without that requirement constituting a prior condition for an undertaking to carry on its business.

Not later than five years after the date of application of this Directive, the Commission shall submit a report to the Council on the implementation of those provisions.

Comments on UK transposition

The Directive’s provision was transposed into UK legislation by Regulation 4 and Schedule 1, paragraph 11 of the Insurance Companies Regulations 1994. According to those rules, applicants are no longer required to submit information on the general and special policy or treaty conditions which the company proposes to use. This information was required by the Insurance Companies Regulations 1981 but since the Insurance Companies Regulations 1994 came into force the applicant only needs to provide information on “the nature of the commitments which the company proposes to cover” but not on the issues mentioned above.

Link to the ELAS case

Unclear. For further information on this point, see Part III on Regulatory Action.

Divergences between the 3LD and implementing provisions: none found.

Article 30 - Cancellation period (Articles 15 of 2LD and 35 of CD)

Summary of objectives

This article requires Member States to have a cancellation period for policyholders of between 14 and 30 days from the time when he/she is informed that the contract has been concluded.

Text of the article

Article 30

1. In the first subparagraph of Article 15 (1) of Directive 90/619/EEC the words 'in one of the cases referred to in Title III' shall be deleted.

2. Article 15 (2) of Directive 90/619/EEC shall be replaced by the following:

'2. The Member States need not apply paragraph 1 to contracts of six months' duration or less, nor where, because of the status of the policy-holder or the circumstances in which the contract is concluded, the policy-holder does not need this special protection. Member States shall specify in their rules where paragraph 1 is not applied.'

Comments on UK transposition

In its original version, this provision allowed Member States not to provide for a cancellation period only in the case of contracts of six months’ duration or less. Article 30 of the 3LD introduces a second exception, allowing Member States not to provide for a cancellation period when, according to the status of the policyholder or the circumstances in which the contract is concluded, there is no need for this special protection. The provision leaves it up to each Member State to specify the rules stating where, according to the prescribed guidelines, the cancellation period is not applied. The UK transposed this Article into UK legislation via the Insurance Companies (Cancellation) Regulations 1993 and the Insurance Companies (Cancellation No 2) Regulations 1993 subsequently replaced by the Insurance Companies Regulations 1994. Regulation 2 of the Insurance Companies (Cancellation) Regulations 1993 amends section 75 (Statutory notice by insurer in relation to long-term policy) and section 76 (Right to withdraw from transaction in respect of long-term policy) of the ICA 1982.

Link to the ELAS case

Unclear. For further information on this point, see Part III on Regulatory Action.

Divergences between the 3LD and implementing provisions: none found.

II.1.3.  Relevant articles from other Directives

· First Life Directive (1LD), 1979/267/EC

Article 18.3 on use of future profits (which became Article 27.4 of the CD) [See also the context of Article 18 3LD on technical provisions, Article 21 3LD on inclusion of assets in technical provisions and Article 25 3LD on solvency.]

Upon application, with supporting evidence, by the undertaking to the supervisory authority of the member state in the territory of which its head office is situated and with the agreement of that authority :

( a ) an amount equal to 50 % of the undertaking's future profits ; the amount of the future profits shall be obtained by multiplying the estimated annual profit by a factor which represents the average period left to run on policies ; the factor used may not exceed 10 ; the estimated annual profit shall be the arithmetical average of the profits made over the last five years in the activities listed in article 1 .

the bases for calculating the factor by which the estimated annual profit is to be multiplied and the items comprising the profits made shall be defined by common agreement by the competent authorities of the member states in collaboration with the commission . pending such agreement , those items shall be determined in accordance with the laws of the member state in the territory of which the undertaking ( head office , agency or branch ) carries on its activities .

when the competent authorities have defined the concept of profits made , the commission shall submit proposals for the harmonization of this concept by means of a directive on the harmonization of the annual accounts of insurance undertakings and providing for the coordination set out in article 1 ( 2 ) of directive 78/660/eec ( 7 ) ;

( b ) where zillmerizing is not practised or where , if practised , it is less than the loading for acquisition costs included in the premium , the difference between a non-zillmerized or partially zillmerized mathematical reserve and a mathematical reserve zillmerized at a rate equal to the loading for acquisition costs included in the premium ; this figure may not , however , exceed 3,5 % of the sum of the differences between the relevant capital sums of life assurance activities and the mathematical reserves for all policies for which zillmerizing is possible ; the difference shall be reduced by the amount of any undepreciated acquisition costs entered as an asset ;

( c ) where approval is given by the supervisory authorities of the member states concerned in which the undertaking is carrying on its activities any hidden reserves resulting from the under-estimation of assets and over-estimation of liabilities other than mathematical reserves in so far as such hidden reserves are not of an exceptional nature.

· Consolidated Directive (CD), 2002/83/EC

Article 17, duties of auditors (originally Article 5 of Directive 95/26/EC) [See also the context of Article 15 of 3LD on professional secrecy.]

1. Member States shall provide at least that:

(a) any person authorised within the meaning of Council Directive 84/253/EEC (1), performing in an assurance undertaking the task described in Article 51 of Council Directive 78/660/EEC (2), Article 37 of Directive 83/349/EEC or Article 31 of Council Directive 85/611/EEC (3) or any other statutory task, shall have a duty to report promptly to the competent authorities any fact or decision concerning that undertaking of which he/she has become aware while carrying out that task which is liable to:

— constitute a material breach of the laws, regulations or administrative provisions which lay down the conditions governing authorisation or which specifically govern pursuit of the activities of assurance undertakings,

or

— affect the continuous functioning of the assurance undertaking or

— lead to refusal to certify the accounts or to the expression of reservations;

(b) that person shall likewise have a duty to report any facts and decisions of which he/she becomes aware in the course of carrying out a task as described in (a) in an undertaking having close links resulting from a control relationship with the assurance undertaking within which he/she is carrying out the abovementioned task.

2. The disclosure in good faith to the competent authorities, by persons authorised within the meaning of Directive 84/253/EEC, of any fact or decision referred to in paragraph 1 shall not constitute a breach of any restriction on disclosure of information imposed by contract or by any legislative, regulatory or administrative provision and shall not involve such persons in liability of any kind.

· Directive 2002/12/EC, Solvency I

Article 1.4 on use of future profits (originally Article 18.3 of 1LD) [See the section on Article 25 of the 3LD.]

4. Upon application, with supporting evidence, by the undertaking to the competent authority of the home Member State and with the agreement of that competent authority, the available solvency margin may also consist of:

(a) until 31 December 2009 an amount equal to 50 % of the undertaking's future profits, but not exceeding 25 % of the lesser of the available solvency margin and the required solvency margin. The amount of the future profits shall be obtained by multiplying the estimated annual profit by a factor which represents the average period left to run on policies. The factor used may not exceed 6. The estimated annual profit shall not exceed the arithmetical average of the profits made over the last five financial years in the activities listed in point 1 of Article 1.

Competent authorities may only agree to include such an amount for the available solvency margin:

(i) when an actuarial report is submitted to the competent authorities substantiating the likelihood of emergence of these profits in the future; and

(ii) in so far as that part of future profits emerging from hidden net reserves referred to in point (c) has not already been taken into account;

(b) where zillmerising is not practised or where, if practised, it is less than the loading for acquisition costs included in the premium, the difference between a non-zillmerised or partially zillmerised mathematical provision and a mathematical provision zillmerised at a rate equal to the loading for acquisition costs included in the premium. This figure may not, however, exceed 3,5 % of the sum of the differences between the relevant capital sums of life assurance activities and the mathematical provisions for all policies for which zillmerising is possible. The difference shall be reduced by the amount of any undepreciated acquisition costs entered as an asset;

(c) any hidden net reserves arising out of the valuation of assets, in so far as such hidden net reserves are not of an exceptional nature;

(d) one half of the unpaid share capital or initial fund, once the paid-up part amounts to 25 % of that share capital or fund, up to 50 % of the lesser of the available and required solvency margin.

· Directive 2005/1/EC on a new organisational structure for financial services committees

Articles 5 to 8 establishing EIOPC

Article 5

Directive 91/675/EEC

Directive 91/675/EEC is hereby amended as follows:

1. in the title, the words "Insurance Committee" shall be replaced by the words "European Insurance and Occupational Pensions Committee";

2. "Article 1

1. The Commission shall be assisted by the European Insurance and Occupational Pensions Committee established by Commission Decision 2004/9/EC of 5 November 2003 [23] (hereinafter the Committee).

2. The chairperson of the Committee of European Insurance and Occupational Pensions Supervisors established by Commission Decision 2004/6/EC [24] shall participate at the meetings of the Committee as an observer.

3. The Committee may invite experts and observers to attend its meetings.

4. The secretariat of the Committee shall be provided by the Commission.

3. "Article 2

1. The period laid down in Article 5(6) of Decision 1999/468/EC shall be set at three months.

2. The Committee shall adopt its rules of procedure.

4. Articles 3 and 4 shall be deleted.

Article 6

Directive 92/49/EEC

In the first sentence of Article 40(10) of Directive 92/49/EEC, the words "submit to the Insurance Committee set up by Directive 91/675/EEC a report summarising" shall be replaced by the words "inform the European Insurance and Occupational Pensions Committee of".

Article 7

Directive 98/78/EC

Directive 98/78/EC is hereby amended as follows:

1. Article 10a(3) shall be replaced by the following:

"3. Without prejudice to Article 300(1) and (2) of the Treaty, the Commission shall, with the assistance of the European Insurance and Occupational Pensions Committee, examine the outcome of the negotiations referred to in paragraph 1 and the resulting situation.";

2. Article 11(5) shall be replaced by the following:

"5. Not later than 1 January 2006 the Commission shall issue a report on the application of this Directive and, if necessary, on the need for further harmonisation.".

Article 8

Directive 2002/83/EC

Directive 2002/83/EC is hereby amended as follows:

1. in the first sentence of Article 46(9), the words "the Commission shall submit to the Insurance Committee a report summarising" shall be replaced by the words "the Commission shall inform the European Insurance and Occupational Pensions Committee of";

2. Article 58 shall be replaced by the following:

"Article 58

Information from Member States to the Commission

(a) of any authorisation of a direct or indirect subsidiary, one or more of whose parent undertakings are governed by the laws of a third country;

(b) whenever such a parent undertaking acquires a holding in a Community assurance undertaking which would turn the latter into its subsidiary.

When the authorisation referred to in point (a) is granted to the direct or indirect subsidiary of one or more parent undertakings governed by the law of third countries, the structure of the group shall be specified in the notification which the competent authorities shall address to the Commission and to the other competent authorities.";

3. Article 65(1) shall be replaced by the following:

"1. The Commission shall be assisted by the European Insurance and Occupational Pensions Committee established by Commission Decision 2004/9/EC [26].

II.2.  Further evidence on transposition

II.2.1. Evidence by the Commission

As an introduction, it is useful to recall first of all what are the precise responsibilities of the Commission in terms of the transposition of EU law(17). Article 211 of the EC Treaty states that the Commission is charged with monitoring the application of Community law, which entails:

1) verifying if Member States have adopted implementing national measures and communicated them to the Commission within the prescribed time limit;

2) verifying the conformity of national transposition measures with Community legislation;

3) ensuring the actual respect of the provisions by private and public entities, bodies and authorities (enforcement).

It is with these benchmarks in mind that the EQUI Committee took evidence from the Commission. Firstly, the Commission, represented by Insurance unit Director Elmer TERTAK, attended the EQUI hearing of 23 March 2006 (oral evidence H1). Further written exchanges also took place. Secondly, the Internal Market Commissioner, Charlie McCREEVY, gave evidence on 23 November 2006 (oral evidence H8). During all these exchanges, the Commission responded to questions asked by Members and presented evidence requested from it on the transposition of the relevant Directives and their application by competent authorities during the reference period, as well as on action taken by the Commission with regard to monitoring implementation. This evidence includes the implementation study on the 3LD by the UK law firm Wilde Sapte (WE 20), a list of infringement procedures (WE 19) and a list of all documents related to ELAS in the Commission's possession, including letters, e-mails and other miscellaneous documents (WE 39). A paper on home/host issues was also prepared by the Commission (WE 41). Further information was received in WE Conf-11: the review of the implementation study, information on the identity of officials in charge at the time, information on responsible people at the Wilde Sapte firm, and other issues.

Summary of themes arising from oral and written evidence

1. Correct and timely implementation of 3LD

Mr. Elmér TERTAK, Director for Financial Institutions in the Internal Market and Services Directorate-General of the Commission, claims that, according to the evidence in his possession, "the UK implemented the 3LD in time and correctly" (H1). This was proven by the fact that that Member State "notified the Secretary-General of the Commission of its implementation of the 3LD by letter dated 29 June 1994.” In this letter the UK specified that the implementing provisions “would enter into force on 1 July 1994, the deadline laid down in the Directive. The UK thus respected the deadline for entry into force laid down in the Directive, and followed the correct practice in its notification and provided copies of the implementing legislation.” The Commission checked Member States' compliance in conjunction with outside consultants who produced an implementation report and detailed correlation table. The study covering the transposition of both the 3LD and the non-life Directives was carried out by the law firm Wilde Sapte. Greece and Spain were not included. Mr TERTAK claims that the report and the Commission services' examination of it and of the UK implementing legislation "did not point to any major gaps or problems as regards UK implementation" (H1).

Commissioner McCREEVY in H8 reiterates that "our conclusion was that the UK had correctly transposed the Third Life Assurance Directive into its national legislation."

2. Role of the Commission

Mr TERTAK clarified that the Commission "has no direct role in the supervision of individual insurance undertakings in Member States and that EU insurance directives do not confer specific supervisory powers upon the Commission, nor does the Commission authorise and supervise undertakings wishing to write insurance business, and that it falls to the responsibility of each Member State to organise and effect this national supervisory responsibility" (H1). The task of the Commission is to ensure that, in exercising these supervisory powers, Member States respect their obligations under the relevant EC directives and do not hinder the proper functioning of the internal market. Only where there is a failure to fulfil these obligations under the Treaty is the Commission allowed to open formal infringement proceedings.

Commissioner McCREEVY describes the difficulties the Commission faces sometimes (H8): "Checking Member States’ implementation of Community legislation is a difficult exercise. It is time and resource-intensive. There are linguistic problems. Translations are not always available. Member States frequently implement our directives by amending multiple pieces of existing legislation and often fail to provide transposition tables." He then goes on to add: "I must stress, however, that the Commission is not responsible for the supervision of individual insurance undertakings. That is the job of the national authorities. Nor can we stand behind the national supervisors to make sure they are doing their job properly. As I and my officials have stated before, the Commission is not and cannot be the supervisor of the supervisors."

3. Infringement procedures: minor ones were launched but are now closed

Mr. TERTAK claims in H1 that at the present time, the Commission is not aware of any infringement of the EU insurance directives in connection with ELAS and that they are not in a position to take a definitive view on whether there might have been an infringement in the practical application of the directive in the case of ELAS and, even if they were able to take such a view and were convinced that there had been an infringement in practice, it would not be able to take infringement proceedings before the Court, on account of the Commission's role and of the nature of infringement proceedings under the Treaty as interpreted by the Court of Justice. Mr TERTAK expanded by saying "that most of infringements at DG Markt level, to my best knowledge are there because (…) those who believe that something is derailing from the line are coming to the Commission, bringing to our knowledge that something is going wrong. Of course, the minute we do get evidence and a clarification that there indeed there is a breach of the rules, we are taking actions; but on the other hand we are not entitled to be a police and we do have the limitation I quoted from the Court and within that boundaries we have to act."

Mr. BEVERLY from the Commission clarifies that infringement "is not a simply wrongdoing, but if this wrongdoing is really related to breach of Community law and this is however again something which needs evidence. To summarize, we did not have any evidence to my best knowledge at that time, that we could have started any infringement procedures and we didn't receive any complaints, again to our best of knowledge at that time, which would have initiated that any infringements procedures should have been started against the UK for not complying in relation with Equitable Life with the prescription of the Third Life Directive."

However, the Commission sent the committee a list of the infringement procedures (WE 19) that had been opened with Member States with regards to the 3LD. This list states that "proceedings for incorrect application were launched against a number of Member States, including the UK, with regard to specific aspects of their national measures. In the case of the UK, for example, the problem related to the exchange of statistical information between supervisors." WE 19 clarifies that "all these cases have now been closed" and that "none of them appear to relate to the core prudential requirements of the directive."

4. Absence of complaints to the Commission before 2001 - The Commission cannot act against alleged past infringements that have been corrected

Mr. TERTAK, under questioning, clarified that when facts are not brought to the Commission's attention in due time, formally they do not exist. This applies to the ELAS case, where, at the time, no-one notified the Commission. However, it should be borne in mind that the Commission can obtain information in other ways.

On the issue of correspondence on ELAS in the Commission's possession, Mr TERTAK claims in H1 that "the earliest correspondence that appears on the Commission's files dates from early 2001, with letters from Mr James Elles MEP and Mr Roy Perry MEP. Mr Perry wrote again to Commissioner Bolkestein in July 2001 following the collapse of the Independent Insurance Company and following Equitable Life's decision to cut pension policy values by 16%. Mr Perry asked the Commission whether it was satisfied that the European directives had been adhered to in these matters." Mr. TERTAK then went on to say that the Commission will continue to search in its historical archives for exchanges prior to that date. Commissioner McCREEVY, in H8, reiterates these facts: "The Commission did not become aware of the problems of Equitable Life until early 2001, when Members of this Parliament began to contact us on behalf of their constituents who were Equitable policyholders. We have provided you with a full list of all our documents on Equitable Life. The UK authorities reacted quickly following the Society’s crisis and closure to new business. On the basis of the Baird Report and the Tiner Reforms, the United Kingdom has radically changed its rules on life assurance in general, on with-profits policies in particular, on mutuals and on the role of the actuary. I think one can safely say that the regime that applied prior to the crisis at Equitable Life no longer exists."

With regard to the issue of Commission involvement, Clive MAXWELL in H4 states that on the issue of "the involvement of the Commission in the follow-up to Equitable Life, I have no details in front of me of any involvement of the European Commission in taking up individual cases".

On a related point, the Commission insisted that it could not express an opinion or investigate infringements that have been remedied by the Member State concerned. This was due to the nature of infringement proceedings, whose objective was merely to ensure compliance with EU law. Victims of past infringements could still test the compatibility of the Member State's conduct through national courts. Members expressed astonishment that there is no way to reopen infringement cases or investigate past infringements, especially when the detrimental effect of those infringements is only revealed at a later stage.

Finally, Alan BEVERLY from the Commission, in H7, defends his institution's actions, reiterating Mr TERTAK's views, by saying that the "the role of the Commission is not to be a supervisor of the supervisors. It is not our mandate and we cannot possibly do that. We have said to you before that, having checked that implementation has been carried out in Member States, we are then virtually dependent on complaints or letters from citizens to have an idea of whether something is going wrong. Again, as we have informed you, we were not informed of any problems before the earliest letters we received, which were sent in 2001, after the closure to new business [...] Why did we not hear anything before 2001? It was probably because in the 1990s people leaving Equitable Life left with generous payments and had no reason whatsoever to complain".

5. Implementation reports done by UK firm

At the request of committee members, the Commission provided the so-called implementation reports of the 3LD. The report was produced by a UK private law firm called Wilde Sapte. The report includes an overall summary as well as nine individual country correlation reports. The Commission states that the Directive was implemented too late in two countries to be caught by the report. Mr. VAN HULLE from the Commission, explained that the usual public tender was followed in order to select the firm, and that it was selected to do a study on the whole of the EU, which also includes the UK; it is unfortunate that there was such a linkage, but at the time that the study was carried out the ELAS affair had not arisen. The Commission "tries to select usually a firm which has contacts in all the Members States" (H1), a difficult endeavour.

Commissioner MCCREEVY (H8) also explained how "how we checked the implementation of the third generation of insurance directives back in 1994-95 using in part a study commissioned from a well-known law firm. We have made available to you the study reports and our own internal papers which show clearly the problems encountered. Those papers also show the considerable efforts of Commission officials to achieve value for money and obtain the best possible result."

6. Transposition: Commission can only view a 'snapshot'

Mr. TERTAK, under questioning, admitted that when analysing the transposition of a directive "you can just get a snapshot of any given time which not automatically covers what will happen afterwards (…). We should not forget that above all institutions, especially those which do have supervisory powers, the National Parliaments are also exercising a certain supervision, and one would expect the democratic Parliament is sufficient to overview institutional acting in their boundaries, and whether they are fulfilling that law, since the directives are being transposed by their national laws." In WE-Conf 11, the lack of resources for the Commission in the area of transposition (especially linguistic capabilities, as the implementing legislation received is not even translated) becomes apparent, reinforcing the impression that the Commission can only perform adequate monitoring of transposition if it has more means at its disposal.

On the issue of resources, Commissioner McCREEVY alludes in H8 "to some of the difficulties in checking the transposition record and the problems that there are and the problems there have been in the past. Since the new Barroso Commission and since my tenure, better regulation has been the theme of the Barroso Commission. One of the things it means is better regulation coming from Europe. Therefore, logically, there should be more people available in the whole system to police the transposition of directives, the implementation, infringement proceedings, etc."

7. Transposition has elements of box-ticking

Under questioning from Members, Mr. TERTAK admitted that, as regards the functioning of the single market aspects, it could only be that the creation, adoption and implementation of new life insurance directives was a box-ticking exercise "because we were creating something new, making it easier for the European companies to offer freedom of services, in particular, across frontiers. So we carried out the examination of implementation fairly soon after the deadline for implementation. So, almost by definition, there was no experience of the practical application of the new measures at that stage (...). So, there is an element of box-ticking but there is much more to it as well".

During the different debates, Members have raised the idea that transposition is currently a static and short-sighted exercise which needs to become more forward-looking, for example, by evaluating the quality of a piece of legislation across the first few years of its application and not just at the outset. Reference was made to this by Commissioner McCREEVY in H8: "It is our job to make sure that the rules are applied. So how can we best achieve our objective? With the resources at our disposal, we can hardly send out teams of officials looking for cases of incorrect application in our 25 – soon to be 27 – Member States. But what we can do, and are already doing, is to encourage the Member States’ regulators and supervisors to work more and more closely together. As their cooperation becomes increasingly close and regular, as they carry out peer reviews, adopt protocols or memorandums of understanding for the coordinated application of specific directives and generally pursue a policy of supervisory convergence, we will find that problems of incorrect application of Community legislation will be picked up and solved at an earlier stage."

8. Quality of the implementation reports and review

The issue of whether lessons should be sought by the Commission from this particular case was raised by Members. They also asked during H1 whether a review of the review of the implementation studies had been done. Under questioning, the Commission admitted it was "not satisfied with the conduct of the study in respect to certain countries" (H1). It will undertake to compile a full dossier from the historical archives, in order to inform the committee as to where and on what points and in relation to which countries they were not satisfied with the study (WE-Conf 11). Mr. BEVERLY claims that a review of the study was undertaken. He said that "at the time the study was carefully reviewed, because we certainly raised problems with the consultant at that time" (H1).

However, this evidence seems to contradict what is said in WE 19, where the Commission states that "it is clear from the papers and from our contacts with a retired official that major problems were encountered in the course of the execution of the study. The final outcome was that an improved version of the interim report became the final report and the final budget was reduced by 50%." The Commission concludes that "no written review of the study was carried out" but it claims that it can confirm that "the officials then responsible for the study, while not checking all the work of the consultants in all the individual Member States, nevertheless played an active role in monitoring the production of the study". Also in WE 19, the Commission states that "it is clear that the UK coverage of the report is one of the sounder aspects of the study". These assertions would seem to be corroborated in WE Conf-11.

9. No comitology provisions

Under questioning, the Commission stated that the 3LD did not foresee any comitology procedure for implementation of technical details. The Directive was implemented straight as it came from the Parliament and the Council of Ministers and there was no comitology process for technical details.

10. Solvency II is a major overhaul

The Commission believes (H1) that “we should recall that the Insurance Directives contain mostly minimum rules, and that is the reason why Member States sometimes want to add on to those rules (…). We are preparing "Solvency II" which is a major overhaul of the solvencies requirements for insurance companies. We have been working on that for some time now, ... , and the reason why we do that is based on experiences such as Equitable Life." According to the Commission, the Solvency II directive "will have a system which is more risk-sensitive, so that everybody concerned, the supervisors as the companies themselves, will be forced to look into the risks of the products they put on the market; such as the capital-market risk that was a major issue also in this case of Equitable Life."

Commissioner McCREEVY in H8 comments on Solvency II: "Our current top insurance priority is the Solvency II project. The ambition is nothing less than to bring about a fundamental revision of insurance regulation and supervision in the European Union. The current solvency regime, like many of us, regrettably, is showing its age! Solvency margin requirements for insurers were first introduced at EU level over 30 years ago and the method of calculation has remained essentially unchanged since then. They were designed for an insurance industry and a world that no longer exist. Insurance directives set out minimum standards that can be and are supplemented in a variety of ways by additional rules at national level. We thus have no real common basis."

Speaking of the issue of using more regulations instead of directives, McCREEVY then goes on to say that "in the Solvency II directive we intend to have as much harmonisation as possible and not have all these derogations, etc. However, as these directives go through the process of the Council Ministers and the European Parliament, inevitably things get added on and we do not have correct harmonisation. Let us be very honest about it: not many Member States are jumping up and down asking for the Commission to be given more direct power in those areas and not to have these derogations. It is not happening in any area, least of all the financial services. Let us be brutally frank about it. Even in the most pro-European countries I do not see any of the ministers, whatever their political persuasion – centre, right or left – wanting that. There are very good reasons from their perspective as to why they would not want to go in that direction, so it is a difficult argument altogether."

11. Improved financial information, parallelisms with ENRON

On the issue of the lack of information provided to investors, Mr TERTAK (H1) retorts that "presently financial information requirements and transparency requirements have tremendously increased and improved over the last years. [...] We haven't made an analysis yet, whether or not the practice in the UK was at that time the best practice, or at least not very far from the European level. But one thing is sure: do not compare early regulations with the present ones because the present regulations always contain all the lessons which have been acquired in the course of time. Surely also Enron has brought a lesson, as nobody was aware, but somebody turned out and it happened that a lot of regulations concerning reporting requirements, auditors' duties, all this has been changed in the US and similarly some changes will come also in Europe."

12. Philosophy of 3LD: minimum harmonisation, mutual recognition and home country control but host country can apply general good rules

Alan BEVERLY, in H3, summarizes the overall philosophy underpinning the 3LD. According to him “the impression has been created (…) that the host country, the country of the branch, has no possible role whatsoever. That is not strictly accurate. It is quite true that the directives and, in particular, the third directives, set out a minimum basis of harmonisation, that is the minimum harmonisation of insurance law across the Member States”. This minimum harmonisation is the “basis for mutual recognition and home country control – that is the European Passport system.” As far as branches are concerned, the undertaking wishing to create a branch in another country can be subjected to “the obligatory rules that are to be applied in the country where the branch is situated on the basis of the general good. That is a political choice up to the country hosting the branch, but it is not completely eliminated from the picture, it is able to tell the insurance undertaking establishing the branch what the local rules are that must be respected.” This concept of the general good is dealt with in Article 40(4) of the codified life directive. According to it, the country of the branch has considerable control over the selling arrangements and the way in which information must be provided to policyholders.

In a subsequent paper on home/host issues prepared by the Commission (WE 41), these issues are expanded: "the home Member State is responsible for financial supervision. But it also bears a more general responsibility for the conduct of the insurers it authorises and is ultimately responsible for ensuring compliance by the insurer with the provisions relating to the general good existing in the various host Member States in which it carries on its business. The Member State where a branch is established or into which cross-frontier services are provided also has a role to play, particularly as regards checking compliance with local provisions applicable to insurance contracts which aim to protect the general good. It is not deprived of all means of monitoring the insurance business carried out by insurers from other Member States and can require the application of its own conduct of business rules justified by the general good. The Directive can only work smoothly if there is good co-operation between home and host State authorities. It is not a satisfactory situation where aggrieved policyholders are referred by the host State authority to the home State authority and are then sent back by the home to the host authority, and thus find themselves unable to have their case examined by either."

II.2.2.  Evidence from implementation study (WE 20)

The study covering the transposition by the Member States of both the 3LD and the third non-life directive was carried out by the UK law firm Wilde Sapte. The final report was presented to the Commission services on 14 November 1995. The study did not cover all the then 12 Member States as Greece and Spain were late with implementation.

The study is divided into three parts: one detailed analysis under 7 specific headings specified by the Commission, another one on specific divergences between the directive and UK implementing legislation, and a third section with practical issues arising in relation to implementation.

Summary of themes arising from the study

In general it can be argued that the implementation study does not say much about the quality of transposition. Firstly, the text itself is quite short, vague and imprecise. Secondly, as the implementing provisions transposing the 3LD are spread out in 3 different UK implementing acts, it is difficult to obtain a coherent picture. Additionally, the study shows how some of the directive’s provisions were simply not transposed as they were considered by the UK authorities as being covered already by existent UK law, complicating matters still further.

The study was accompanied by a detailed correlation table(18) (up to 300 pages), simply specifying for each article of the directive the matching article in the UK implementing provisions. In order to verify the level of coherence and quality of UK transposition, it has been necessary to check each and every one of the UK implementing provisions. This task has been performed with the help of the experts’ study on transposition (ES 1) commissioned by the EQUI Committee. This study, financed from the committee’s expertise budget, not only focuses on UK transposition but also tries to make a comparison with other Member States’ transposition of the 3LD (See Part II.1 ‘Transposition in detail’ for a more precise article-by-article analysis of UK transposition).

Overall, no clear-cut conclusion emerges from the Wilde Sapte study and the accompanying correlation table as to whether there is a lack of adequate transposition. As discussed below, the Commission seemed satisfied with the results of the study and with transposition in general.

1.  Conditions on obtaining authorisation: sound and prudent management; notifiable persons; disclosure of information;

According to the study, and in compliance with articles 7 and 14 of the 3LD "companies must be managed in accordance with the principles of sound and prudent management". The study argues that the UK implementing provisions "place new requirements on directors which require the maintenance of a system of control." It concludes by stating the obvious, i.e., that "the DTI has powers to take regulatory actions if insurance companies are not soundly and prudently managed".

On notifiable persons the study does not add much other than describing the articles from the UK implementing provisions. On disclosure of information, the study claims that the UK implementing provisions respect the higher information requirements contained in the 3LD. The provisions are sparsely implemented throughout different Acts.

2.  Technical provisions, detailed analysis

The study finds no divergences with the 3LD of the UK implementing provisions, other than Article 22(1). See below, 'divergences'.

3.  Establishment of branches

The study goes into detail on authorization and notification procedures and on how the DTI intended to fulfil the requirements in this regard. It is not clear from the text whether there is a lack of adequate transposition and the Commission seemed satisfied with the explanations given.

4.  Rules protecting the general good

The study describes how the UK advisory authorities did not prepare a list of conditions described as constituting the general good. Instead, they prepared a non-exhaustive list outlining the principal enactments which regulate insurance business in the UK and which may apply to foreign insurers writing business in the UK. This includes, amongst other things, rules on advertising, disclosure of links by intermediaries, misleading information, cessation of cover (no specific rules), issues of language, choice of law (free in the UK) and cancellation rights (there are none in UK law).

5.  Specific divergences:

§ Article 12

"The UK implementing provisions do not specifically require the Secretary of State to inform the competent authority of the Member State of the commitment which the risk is situated in the relevant circumstances." The DTI felt this was unnecessary as the Secretary of State already had to the power to exchange information with other competent authorities under existing UK legislation.

§ Article 13

"The UK implementing provision does not state that the UK supervisory authority must inform the competent authority of the other Member States" in the event of the withdrawal of authorisation of another Member State, as is required by the Directive.

§ Article 14(2)

"The UK supervisory authority felt that, since it has no power to object to a disposal, it was irrelevant whether notification took place before the disposal or seven days after." Therefore, this article was not transposed.

§ Article 21(1)

This article provides that assets covering technical provisions shall be valued net of any debts arising out of their acquisition. This provision was not fully implemented. The study says that it received information from the DTI saying that UK legislation already provides for liabilities to be properly covered by assets.

§ Article 22(1)

This article provides that assets covering technical provisions should be invested to no more than a specified percentage in specified assets. The UK implementing legislation imposes the percentage restrictions by reference not to technical provisions but to long-term business amounts. The study says "the competent authority felt that it was not necessary to change this approach because the UK rules are, in the majority of cases, more prudent than the rules set out in the Directives."

6. Practical issues relating to implementation

The study points out that implementation was "achieved wholly by subordinate legislation". It argues that "the framework in the Directives largely followed the existing UK regulatory system. Consequently, there has been no need for substantial changes in the style of UK supervision."

The study says that, at the time, "no concern has been expressed by ABI, Royal or Lloyd's with regard to the technical divergences between the Directive and the UK implementing provisions." The only concerns raised were in respect of how to ascertain what the 'general good' provisions are.

It subsequently explains that "from the perspective of the UK it seems that, purely for commercial reasons, the implementation of the Directives has not substantially altered existing patters of, or increased, cross-border trade by UK insurance companies."

Another issue is that "UK companies are also deterred from expanding into other Member States because they are concerned that they may encounter legal problems in view of the non-harmonisation of contract law and the need in to long term business to provide contracts which will be subject to the local law of the host country."

7. Review of the study

The Commission claims (H1) that "the report and the Commission services' examination of it and of the UK implementing legislation did not point to any major gaps or problems as regards the UK implementation of the third life directive." However, in WE 19, the Commission states that "it is clear from the papers and from our contacts with a retired official that major problems were encountered in the course of the execution of the study. The final outcome was that an improved version of the interim report became the final report and the final budget was reduced by 50%." The Commission concludes that "no written review of the study was carried out" but it claims that it can confirm that "the officials then responsible for the study, while not checking all the work the consultants did in all the individual Member States, nevertheless played an active role in monitoring the production of the study". Also in WE 19, the Commission states that "it is clear that the UK coverage of the report is one of the sounder aspects of the study". In H8, Commissioner MCCREEVY explains how the Commission has made available to the EQUI committee the study reports and the Commission’s internal papers “which show clearly the problems encountered. Those papers also show the considerable efforts of Commission officials to achieve value for money and obtain the best possible result."

In WE-Conf 11, we find possible proof of the overall poor quality of the Wilde Sapte study and the fact that the Commission tried its best to obtain changes and improvements to the text. This raises the question of the general quality and management of the Commission's procurement procedures for these kinds of external studies at the time and whether these practices have improved since then.

II.2.3.  Other selected written and oral evidence on transposition

From other written and oral evidence, it is surprising to note how few times the directives and the issue of correct/incorrect transposition is mentioned. Witnesses and other experts (Penrose, Baird) understandably always make reference to UK law and UK regulatory practice. It is therefore difficult to separate what is clearly an issue purely related to transposition from matters relating to supervision and regulation of ELAS. The emphasis on the latter is dealt with in much more detail in Part III on regulatory practice. In order to structure the investigation, the different pieces of evidence are placed - where possible - under headings which list each of the key articles of the 3LD. If no specific link is found to an article, the evidence is placed under a ‘general themes’ heading:

· General themes

· Article 8 - Prudential supervision

· Article 10 – Supervisory powers & accounting returns

· Article 18 – Technical provisions

· Article 25 – Solvency margin

· Article 28 – General good

· Article 31 – Information to policyholders

General themes

1. The unsatisfactory implementation and execution of the 2LD and the 3LD gave rise directly to the weakness of regulation of ELAS

Mr. Tom LAKE, from the Equitable Members' Action Group (EMAG), claims that "the implementation and execution of the 2LD and the 3LD was unsatisfactory and that this directly affected the quality of the regulatory oversight of ELAS" (H1). He argues that the aim of these directives - the adequate protection of policyholders - was not achieved by UK regulation of ELAS.

2. Grave doubts that any of the 3 EC life directives were successfully transposed

Mr. JOSEPHS, in H2, declares that he and his association (Investors Association) "have grave doubts as to whether any of the three EC life directives could have been successfully transposed into the UK regulatory environment, given the differences of philosophy between the Commission's intentions and the way in which the UK system actually worked."

Ms KNOWD, a policyholder, also claims in H2 that "Equitable was non-compliant with EU-regulations over a sustained period of time".

3. The Commission should have been more proactive

In H3, Peter SCAWEN from ELTA, believes that, in terms of the role of the Commission in policing the implementation of EU law, it "is to be proactive. I think the failure in the UK was that it was a passive department waiting on events, hoping, fingers crossed, that things might get better. I think that is what took place. I believe they were very well aware but had no idea what to do about it." It seems that Mr SCAWEN is referring to the UK authorities and not the Commission.

4. 3LD was correctly implemented and UK law already complied with most of it

Mr MCELWEE in H3 is of the view that the UK “implemented the directive correctly. I have not yet seen anything that suggests to me that there was any egregious manner in which it was not properly implemented”. Clive MAXWELL, from HMT, claims in H4 that "the Third Life Directive and its predecessors were correctly transposed into UK domestic law. In fact, the pre-existing UK law already complied to a large extent with the provisions required by the directive". Mr MAXWELL then listed the pieces of legislation through which the 3LD was transposed into UK law, that is, the Insurance Companies (Third Insurance Directives) Regulations of 1994, the Insurance Companies Regulations of 1994 and the Insurance Companies (Accounts and Statements) Regulations of 1994. In addition, during H4, David STRACHAN of the FSA claimed that "the UK consistently went beyond the formal requirements of the Third Life Directive in implementing successive investor compensation and ombudsman schemes".

5. The UK Government responsible for transposition

Mr MAXWELL, in H4, clarified that "the UK Government is responsible as a matter of law for the correct transposition of directives in the UK. [...] With respect to the correct transposition of European directives in the UK, it is ultimately for the Member State to be responsible for that as a matter of European law."

6. Fragmented transposition does not affect the quality of transposition

Responding to a Member's question (H4) on whether if transposition into different acts and regulations has any legal or other significance as to the seriousness with which the Directive and other directives were transposed into UK law, Clive MAXWELL responded with a clear no: "the law is the law: it does not matter whether something is covered in an act of parliament or in a regulation of parliament or, for that matter, the FSA’s rule book. It still has legal force and it is still a very valid way of transposing the directive.[...] I think that many Member States have a system of transposing directives into a range of different legislative instruments depending on their national arrangements. [...] It depends, of course, on their national arrangements and traditions and how they regulate."

7. The directives are just a baseline

Martin McELWEE, in H3, takes a contrary view to other witnesses and states that "the directives necessarily laid down a baseline for regulation and, consistent with the nature of a directive as opposed to a regulation, they leave it to Member States to find the most appropriate means to achieve the results required by the directive’s provisions. Directives are necessarily less prescriptive than regulations, which is why doubts as to their correct implementation sometimes arise.

This view was reinforced by Clive MAXWELL from HMT in H4: "The Third Life Directive, like its predecessors, was a minimum harmonisation directive. [...] Member States were required to implement in domestic legislation the minimum standards the directive contained but could do so within the context of their domestic policy approach. It was not the intention that Member States create identical domestic regimes."

8. Directives do not require a zero-failure regime

In H3, Mr MCELWEE also dispels the myth that the directives require, or even imply, a zero-failure regime: “It would be difficult to construct such a regime but I suspect that it could be done, at least in theory. It would require a level of regulation that would, in my own view, be contrary to the consumer’s ultimate interest. (…) There is nothing in the directives that signals the intention to create such a regime.” Likewise, Clive Maxwell from HMT states that "the regime did not, and still does not, seek to prevent all failures of or problems with regulated firms" (H4).

9. Freedom with publicity, designed to stimulate innovation

In H4, Clive MAXWELL from HMT adds to the previous point by trying to explain how the UK's approach to "prudential supervision was characterised as being one of ‘freedom with publicity’. Insurance companies were given freedom within the applicable legislation to determine their policies and make their own decisions, provided that certain information was disclosed to the public. The approach was deliberately designed to avoid undue interference in the affairs of companies, since this was thought likely to inhibit innovation and entrepreneurial behaviour, which would have been to the detriment of policyholders and consumer choice."

10. The regulators applied the law

Responding to a question from a Member as to whether the UK Government was satisfied that the regulators, in relation to the entry into force of the 3LD, faithfully applied the implementing provisions as well as the spirit of the directive, Mr MAXWELL states in H4 that regarding "the application of the law in practice, the regulators have applied the law."

11. Ultimate responsibility of the crisis lies in hands of ELAS management

In H3, Mr MCELWEE also says that “the ultimate reason why Equitable Life found itself in this crisis lies squarely in the hands of the management, which was variously venal or ignorant.” This is also one of the partial conclusions of the Penrose report (WE 16). However, Brian CHASE GREY (WE 9) claims that the British Government is responsible for the collapse of ELAS. He denounces collusion with ELAS over a 6-year period to suppress evidence of the true cause of the collapse, a conspiracy that, according to him, at every stage was inspired, sourced, and supported by HM Treasury. He supports these allegations by referring to the Penrose Report (WE 16), the Burgess Hodgson report (WE 26) and the Reports of Dr. Michael Nassim (WE 8, 7 and 33).

On the issue of responsibility, WE Conf 3 claims that ELAS repeatedly lied concerning the state of the company and the successes that they were enjoying. They were negligent in not putting aside gains from stock market growth for ‘with profit’ policyholders nor making provision for future payments of GAR policyholders. It also claims that management paid itself large salaries, large bonuses and large pension benefits. It also contains claims against the auditors, Ernst & Young, for not conducting a proper audit of Equitable Life’s Accounts and ascertaining that there was not enough money to cover GAR policyholders' funds.

12. The regime must evolve, and the answer is Solvency II

In H4, Clive MAXWELL from HMT says that "no system of supervision can stand still in ever-changing markets. It is important that the European framework for the supervision of life insurance companies continues to evolve to secure an appropriate level of protection for policyholders. The UK Government, therefore, supports the European Commission’s Solvency II project".

Article 8 - Prudential supervision

13. Article 8 of the 3LD not respected

Article 15(3) of the 1LD as amended by the 3LD (Article 8) provides that the competent authorities of the home Member State shall require every assurance undertaking to have sound administrative and accounting procedures and adequate internal control mechanisms. Again, this provision was not correctly followed, argues Mr. LAKE in H1. His argument is as follows: an essential part of the UK national insurance framework is the qualified Appointed Actuary whom insurers appoint to advise on reserving, bonuses, expectations etc. and who should act partly as a guardian of policy-holders' interests. Mr. LAKE claims that the fact that in 1992 "Appointed Actuary Roy Ranson became CEO of ELAS without relinquishing the role of Appointed Actuary was clearly prejudicial to the interests of policy-holders but that UK legislation did not provide for the removal of Mr Ranson" (H1). It follows, according to Mr. LAKE, that faulty implementation rendered the UK authorities powerless. The UK GAD explicitly expressed its disapproval of Mr Ranson's dual role but did nothing.

Mr. HOLMES (WE 84) also goes into detail on the issue of lack of sound administrative and accounting procedures and adequate internal control mechanisms, namely the Appointed Actuary issue problem, quoting at length Penrose (WE 16) and repeating the allegations contained therein.

However, Clive MAXWELL from HMT, under questioning during H4, rejects this claim, arguing that "the Third Life Directive does not refer to an individual called an Appointed Actuary. The question of whether an Appointed Actuary could take on that particular role is therefore not a matter for that Third Life Directive. It was a common arrangement with a number of other life insurance companies that the Appointed Actuary played that sort of role within the UK system."

14. Penrose detects general failings as regard prudential supervision of ELAS

The Penrose report (WE 16) detects general failings as regard prudential supervision of ELAS: "Regulation, and GAD's advice, were focused exclusively on the solvency margin over contractual liabilities and took no account of accrued terminal or final bonus, notwithstanding that at the date of the 1989 report exposure to falling markets was real and was known to GAD and the regulators."(Ch.16-16). "The Society... was too venerable to be of real concern, and lack of information provided grounds for inaction ... Regulators had been given an insight into the Society's practice that might reasonably have alerted them to a need for monitoring of current and future practice. No special steps were taken to put in place a suitable system." (Ch.16-21)

Supporting these ideas, WE Conf 3 claims UK regulators did not deal with ELAS' problems when serious difficulties within the organisation were known before 1997 and possibly even as early as 1991. They did not realise that there were insufficient funds to cover policyholders with GARs.

15. PRE protected by UK law

Mr. LAKE in H1 claims that "in UK law the 'reasonable expectations of the policyholders or potential policyholders' (PRE) have the protection of the competent authorities".

Mr HOLMES's (WE 84) evidence supports this thesis: "The protection of PRE under UK law was of great importance because of the shift in the 1980's and 1990's in the balance of benefits provided by ELAS under its policies away from guaranteed benefits to un-guaranteed terminal (later final) bonus. [...] Whereas guaranteed benefits qualified as 'liabilities' under national an Community law, and therefore had to be reserved for, the only protection accorded to unallocated terminal or final bonus under the UK regulatory scheme was the obligation to consider whether to intervene in order to protect the reasonable expectations raised in relation to such bonus".

16. PRE were created by ELAS' practice

On the issue of PRE, Penrose (WE 16) states that he was told by the UK regulators that PRE in respect of terminal bonuses were not created by the society's bonus practice. Instead he argues in the opposite direction, stating that PRE did arise by reason of the Society's terminal bonus practice (in other words, that policyholders had reasonably expectations that they were entitled or would receive discretionary bonuses in addition to contractual benefits). Paragraph 220, chapter 18, WE 16, states: "GAD and the Treasury have told the inquiry that the relevance of terminal bonus was always recognised by GAD and the regulators, but that PRE in respect of terminal bonus was not created by the Society's bonus practice. They point to the notes that stated that terminal bonus was not guaranteed. However, GAD and the Treasury also recognise that PRE was not restricted to guaranteed benefits. It is not necessary to conclude that policyholders would have reasonable expectations of receiving a precise amount of bonus to take the view that reasonable expectations would still have been created. The point is highlighted in GAD's own representations: “It was generally accepted in the life insurance market that past levels of terminal bonus did not create reasonable expectations for the future, as they would be entirely dependent on market conditions, subject to a degree of smoothing, which varied considerably from company to company.” The reasonable expectation would not be that the precise policy value quoted would be payable, regardless of market conditions or smoothing, but that any reduction would reflect adverse market conditions. A position where the Society could not afford to honour the policy values without rising market values or inter-generational transfers would not have been understood by the Society's policyholders on the information provided to them, and would not have informed their reasonable expectations."

17. Effective control in the hands of the life assurance industry

"The Investors' association concludes that the UK prudential system was designed to give the appearance of proper regulation but it left effective control in the hands of the life assurance industry", is the conclusion drawn by Mr JOSEPHS in H2. He asked EQUI to examine "whether such a consistent pattern of concealment and misdirection is or should be compatible with the regulatory regime implicit in the EC Life Directives."

18. FSA not industry-led

Referring to allegations that the FSA is ‘industry-led’ as well as industry-funded and that the FSA is ‘facing the way of the industry’, Mr. McELWEE in H3 believes that this is not a fair characterisation. According to him, “the FSA has got four statutory objectives: market confidence, public awareness, consumer protection and the reduction of financial crime. Under statute, the FSA must, as far as possible, act in a way that is compatible with those objectives. Of these at least three appear to me to be consumer-facing and one, the maintenance of market confidence, at least neutral as between consumer and practitioner. At a higher level, of course, even this is ultimately to the benefit of consumers, to the extent that it benefits market participants. Those benefits are also ultimately passed on to consumers.”

The same message was put across by David STRACHAN from the FSA in H4, explaining that "the FSA is independent of the UK Government. Nor is it funded through general taxation. Rather, we are funded entirely through our power to levy fees on the firms we regulate or which use the UK’s stock markets and exchanges. [...] We are a statutory regulator established by Parliament; we are not a self regulatory body or a trade association with voluntary membership. [...] Regulated firms across all financial sectors must pay for the costs of regulation."

Article 10 – Supervisory powers & accounting returns

19. ELAS became a Ponzi fund

Mr. LAKE also believes that "the failures by the UK Government and regulatory authorities allowed ELAS' with-profits fund to become a “Ponzi fund” in which attractive payouts were subsidised from growing investments by new and existing policyholders" (H1). He claims that retention of funds to meet expected payouts was protected by law but UK authorities failed in their duty to enforce the law.

Mr SEYMOUR in H7 is of the same view: "the UK regulator could easily have determined the existence of a pyramid scheme, together with the absence of reserves – as did Penrose and Burgess and Hodgson – and taken remedial action as required by the Directive. This was essential, particularly as the declared presence of a reserve fund was a key selling point throughout the Community."

20. Over-reliance on 'light touch' approach

M. LAKE claims in H1 that those implementation failures cover the powers to deal with prejudices to policy-holders, inadequacy of regulatory returns, inadequate resources, unworkable divisions of responsibility in respect of regulation of consumer information "and over-reliance on industry-led agencies and the traditional “light touch” approach". He claims that this approach made the UK reluctant to adopt the aim of the life directives and thus failed in their implementation as well as in their execution.

Mr SEYMOUR in H7 corroborates this view: on the Directives’ requirement for supervision, "the word ‘shall’ is mentioned all over the place. It is not ‘may’, but ‘shall’. The only interpretation that has been quoted for UK regulation is ‘light touch’ – which I call ‘head in the sand’ regulation." He recalls the numerous unregulated practices within ELAS, including "such horrors as a reinsurance contract which on examination was worthless, and a company actuary who was engaged to represent policyholders’ rights while he was in fact the chief executive of the company’s business". Nevertheless, he states that he does not believe in heavy regulation but "that a policyholder should be given clear and accurate information regarding their policy. It is in the directives; it is totally reasonable. It is also totally reasonable that the regulator who has to supervise and know thoroughly what was happening to an insurance business, whose head office was in his territory, does just that, and makes sure that people are not given wrong information and that the company is not able to run its business contrary to its sales material."

21. The Society's returns did not meet the directive's requirements

On the accounting returns, Penrose (WE 16) says that "so long as there is a regulatory solvency test prescribed under European Directives, there will be a need for financial statements that meet the regulatory requirements developed for that purpose. Under the historic regime these statements have been impenetrably mysterious, over-complex, over-wordy, and detailed to the point that overall substantial effect has been buried. The Society's returns were so convoluted that material information escaped notice of regulators and their advisers in GAD."

This lack of clarity of the returns could contravene the requirements of Article 10, which requires of the UK regulator that it make detailed enquiries and require the submission of documents or carry out on-the-spot investigations. Other evidence seems to suggest that the regulators were always excessively respectful and even fearful of the ELAS management.

Penrose has more to say on returns: "The scrutiny reports on Equitable's regulatory returns from the mid to late 1980s were relatively brief, terse documents, normally running to a page or a page and a half. They were prepared by GAD ... The scrutiny reports would record a few headline figures, the amount of new business written, the movement in mathematical reserves and the cover for the required minimum margin (RMM) of assets over liabilities." (Ch.16-1.) The Society's cover for the RMM was clearly a key index ... dropping through the mid to late 1980s, from 8.5x in 1984 to 3.8x in the 1988 returns. In the absence of the correspondence files, it is not possible to say exactly what doubts may have existed over the returns, or how the downwards trend in cover for RMM was regarded, but it would not appear to have been an issue of any great concern to regulators." (Ch.16-3). "There are no DTI correspondence files dealing with Equitable for the period prior to 1991. A group of earlier files was destroyed ... in 1998 while the regulatory return files were still available (1987 and 1988 missing) back to 1981." (Ch.15-46,47,53).

22. Article 10 of the 3LD not respected: under-resourcing and non-respect of PRE

Mr. LAKE in H1 claims that the "insurance regulators were seriously under-resourced throughout the 1990s", contravening Article 23(3) of the 1LD as amended by the 3LD (Article 10). He then goes onto argue that Article 23(3)(b) of the 1LD as amended by the 3LD (Article 10) requires that the powers and means be sufficient to allow the competent authorities to be able to prevent or remedy any irregularities prejudicial to the interests of the policyholders, which was not done in this case.

The Baird Report (WE 17) also gives support to the idea that insurance regulators were under-resourced during the crucial years when the ELAS crisis developed. It refers to the breakdown of staff involved in the insurance regulation on 1 January 1999: “...the total number of staff involved in the prudential regulation of approximately 200 insurance companies (…) was less than 135. By way of comparison, there were approximately 135 staff involved in the regulation of 400 authorised UK banks, building societies and UK branches of non-EU institutions” (paragraph 2.23.5).

Mr. HOLMES (WE 84) also gives credence to the Baird report when criticizing the lack of means available to regulators during the 1990’s. In addition, he states that “even allowing for the discretion which Member States possess in deciding upon an appropriate level of regulatory resources, it must be open to doubt whether the UK provided its competent authorities with the means necessary for supervision, the standard explicitly laid down in the Community legislation since November 1992. On the one hand, it must be asked whether in numerical terms sufficient staff were devoted to the task. On the other hand, it must also be asked whether the personnel that were available were appropriately qualified to provide supervision which was effective.”

Mr. LAKE, also in H1, argues that Articles 23(1), 23(2) and 23(3) of the 1LD as amended by the 3LD (Article 10) require annual accounts and the periodical returns, together with statistical documents, necessary for the purposes of supervision, which must enable the competent authorities to take any measures that are appropriate and necessary to ensure that the undertaking's business continues to comply with the laws in each Member State, including the home Member State. Mr. LAKE also claims that the UK simply did not implement the legal requirements to enable the authorities to monitor the application of its own law in respect of PRE, despite its being appropriate and necessary, and thus breaching Community law.

23. Adequacy of UK regulatory regime, differing views

Contrary to other witnesses, Charles THOMSON, current CEO of ELAS states in H2 that "for many years the Regulators in the UK had very extensive powers to raise questions with companies and considerable powers to intervene in exceptional cases. Specifically, the Secretary of State had the power to intervene if the reasonable expectations of policyholders or prospective policyholders were not being met. In short, my view is that the relevant regulators in the UK both before and after the changes made as a consequence of the consolidated life directive had sufficient powers to regulate effectively."

Mr Clive MAXWELL from HMT in H4 acknowledges the fact that there were "problems with the regulatory system in place at the time. It is not that individual directives – the Third Life Directive, for example – were not transposed properly; rather, with the benefit of hindsight, the system in place was not modernised: it was not necessarily the optimum system to be in place."

24. Under-resourcing of regulators not necessarily means UK approach was inappropriate

Article 10 of the 3LD states that competent authorities must have ‘the power and the means to take any measures to prevent or remedy any irregularities prejudicial to the interests of the assured persons’. Mr MCELWEE believes, referring to Lord Penrose’s findings, that UK “regulators were not (…) in some periods well-funded.” Therefore they did not have the ‘means’ to fully fulfil their duties. “As a result, I think the committee would do well perhaps to be cautious in reaching a conclusion that, because a different approach was taken in different Member States, that the UK’s approach was not appropriate.” This view was supported by Clive MAXWELL in H4, who, when commenting on resourcing issues of the regulators, says that "in his report, Lord Penrose draws attention to some issues such as the resourcing of certain aspects of the regulatory system in place at various points in time. However, I think it is fair to say that his comments were made with the benefit of hindsight and in many ways reflected his own views about the need for a stronger form of regulation. [...] So those sorts of comments about resourcing need to be seen in that light".

Article 18 – Technical provisions; Article 25 – Solvency margin

25. UK system not respecting intention of the Directive

Mr JOSEPHS (H2) believes that the intention of the Directive was that contracts of insurance should be very carefully valued to compute the liabilities. This should be based on the precise wording of each class of contract. Mr JOSEPHS believes that "the UK system was not doing that at all, judging by the evidence of the amount of time given to various things - i.e., what the regulator's staff saw, what they did and so on".

26. Articles 18 and 25 of 3LD not respected? Different ways to calculate solvency

Mr. JOSEPHS, in H2, also reinforces this view by claiming that Article 18 of the 3LD on technical provisions was not respected given that "Equitable insisted on treating all policies alike, whether they were written as ‘defined benefit’ contracts, or in the later form as ‘investment’ contracts." The contracts "were written so as to give their holders the absolute right to share in the investment return of the Society pro rata to net premiums paid." Article 18 makes it an obligation that this right be reflected in the calculated liabilities for those policies, which, according to Mr. JOSEPHS, was not the case. He concludes that it "enabled the continued transfer of assets from holders of the newer policies to the favoured cohorts."

However, Christopher DAYKIN, Government Actuary, Head of GAD, claims in H4 that "as regards the reserving basis, Equitable Life adopted a gross premium reserving approach, which was different to the approach used by most other companies but it had to demonstrate the equivalence of what it was doing to the net premium reserve requirement. It always succeeded in doing that satisfactorily. So its reserves – at least up until 1998 – were always in line with the requirements of the regulations."

Article 25 on the minimum solvency requirement requires a company to have an excess of assets over liabilities, at least equivalent to the solvency margin requirement. However, it seems there are different ways of calculating solvency. David STRACHAN, FSA tries to clarify the issue in H4 by saying that "Equitable has always been solvent and in its regulatory returns it has always reported that it is currently meeting its regulatory solvency requirements. There are, in fact, at least three different bases that are used: the approach Chris Daykin has described which characterised the regime for much of the 1990s and was consistent with the Third Life Directive; there is a basis of calculation which was produced by Lord Penrose in his report that was based on figures produced by Equitable for its own purposes – those figures were not provided to the regulator; the third basis, which is the current basis, is the FSA’s new realistic solvency requirements".

However, answering a Member's question during H5, Stuart BAYLISS, Managing Director of Annuity Direct, says that the UK regulators "had been buying Equitable’s story on solvency margins for a very long time. It goes back to that illustration on new sales: as long as you are generating new sales to cope with it, then you are OK. If your new business is big enough, you can backfill the hole. That is what they were doing and, to a certain extent, some of the regulators presumably must have seen that. I cannot imagine that they could not have done, because it was something that the growth pattern of the company required them to keep growing".

Alan BEVERLY, from the Commission, also builds on this point in H6, with reference to insurance guarantee schemes: "the point on the Equitable Life case is that Equitable Life did not become insolvent, it did not fail. Therefore, even the existing compensation scheme – the insurance guarantee scheme in the UK – did not come into play in the case of Equitable Life. [...] Therefore, even if there had been a directive at European level setting up a harmonised insurance guarantee scheme system, it is far from clear that would have been relevant in the case of Equitable Life because there was no insolvency or failure as such".

27. Persistent asset shortfall due to poor reserving

On the issue of Article 18 on Technical provisions, WE 79 (Paper by Investors Association on asset shortfall) gives useful insight into what it claims were the causes for ELAS' situation. The paper states that "the key weakness in the prudential regime as operated in the UK was that it made no provision for paying future investment returns to the people who were entitled to those returns, namely the policyholders of ‘investment policies’. The rules were deliberately left vague with the decision on provision for future bonuses left at the whim of the Actuary. However the consequences of not making such provisions were not vague at all, since in the absence of those provisions the with-profits fund would almost certainly fail."

The report is of the opinion that the overarching problem at ELAS was a massive shortage of assets, as measured against the realistic liabilities. This asset shortage persisted from 1985 at the latest, up until the point when Equitable closed to new business at the end of 2000. It was made up of the following elements:

"A) Failure to allow properly for future guaranteed bonuses to which holders of investment policies were contractually entitled;

B) Failure to make proper provision for guarantees in the contracts (such as the notorious GARs);

C) Failure to make any visible provision for non-guaranteed bonuses already allotted;

D) An excessively liberal and self-serving interpretation of the Statutory Rules (and possibly the Professional Guidance)."

The report concludes that, throughout the period 1990 to 2000, there was a persistent asset shortage ranging from around £5 billion to around £7 billion excluding "any provision for the ‘Final Bonuses’, which it was claimed were ‘non-guaranteed’, despite the fact that policyholders had been led to expect that those bonuses would also be paid, depending only on the state of the markets at the time of leaving the Fund. In effect, the whole of final bonus was uncovered by any assets throughout the period in question. [...] The sums in question were substantial, and we estimate them to have increased from around £3 billion in 1990 to £11 billion in 2000, averaging about 45% of assets over the 11 years in question."

28. No reserves for terminal bonuses: choice of option in UK law was detrimental

Nicholas BELLORD states in H2 that "when it came to the third life directive being drafted, it was found that stricter reserving requirements were being proposed, and the UK delegation was supporting these stricter requirements. However, the Treasury, the regulators, realised that if this directive went ahead as drafted, it might reveal the truth about Equitable and therefore they scotched the idea by making the reserving optional (…). So the option existed to have proper reserving but the UK regulators deliberately did not take advantage of that option."

In this regard, WE Conf 11 also claims that the 3LD, as adopted, had a major flaw, namely the abovementioned fact that allowance of future bonuses was made optional in the final version of the text (see also the section on Article 18 of the 3LD). WE Conf-11 claims this was done under pressure from the UK throughout the negotiations to adopt the directive. As has been explained elsewhere, the UK did indeed subsequently opt out of this provision. WE-Conf 11 explains how this in turn made it legal for ELAS not to make allowances for terminal bonuses, which was one of the reasons why the company did not have enough assets when the House of Lords forced them to pay GAR policyholders their promised bonuses.

WE 26 (Burgess Hodgson report for EMAG) also explains how no reserves were put aside for terminal bonuses and the consequences thereof. It explains how the accounting figures supplied to the Regulator by ELAS did not include any provision for terminal bonuses. The figures were enough to cover the required minimum margin for statutory reporting purposes (from 1994 to 1999, the margin averaged around 7%). However, the report claims that "it must have been clear to the Regulator, as an actuarial expert, that it could not possibly be enough to cover terminal bonuses. He might reasonably have estimated that for this purpose the margin would need to be nearer 20%. In short, the Regulator must be asked whether he knew (or should have known) that Equitable Life’s assets did not cover the Director’s bonus declarations in any year after 1993. The Regulator would have known that terminal bonuses were used: a) to indicate policy values to members; b) to make payments on maturity or surrender; c) to encourage new policy sales through statements of past performance. Whilst he would be aware that from 1998 onwards the contractual liabilities included a provision for GAR cost, he would also have known that its effect was greatly reduced by the rather uncertain value of the reassurance policy with Irish European Reinsurance Company Limited."

Penrose (WE 16) also supports the idea that prudent reserving would have exposed ELAS' weaknesses. He claims that the UK Regulator was focused exclusively on solvency margins and took no account of accrued terminal bonus, possibly breaching Article 18, which requires that supervision include verification of a company's entire business and not just its state of solvency.

Penrose says that the directive "required prudent reserving for, or some realistic account to be taken of, final bonus. This would have exposed the weakness of the Society at a much earlier stage and would have prompted corrective action. DTI did not take that opportunity, taking the view instead that “some appropriate allowance should be made implicitly in the parameters of the system”. The UK regulations implementing the directive left the position as it had been previously." Penrose also criticises the regulator’s lack of a "pro-active approach".

29. Use of future profits to fulfil solvency margin not in line with Article 25

Mr. SEYMOUR claims in H7 that when the UK Regulator saw the extent of the problems at ELAS and discussions on the use of the insurance rescue fund started, the UK Regulator panicked (as this would have entailed a tax or levy on all other insurance companies to compensate ELAS policyholders) and to avoid this situation it "then approved a system of including five years of theoretical future profits to balance the books of a closed company – ELAS, thus rendering impossible access to the compensation fund." He says this "makes nonsense of the whole concept of solvency".

In WE 54 (‘La Vie d’Or’, Case 98/2863 at the District Court of The Hague, date of pronouncement 13 June 2001), Mr. SEYMOUR (H7) explains how the plaintiff claims that "the inclusion of future profits in the balance sheet did not give a true picture of the assurance company’s solvency and was therefore contrary to the EU Life Directives. [...] It is important to note that the issue of the legality of future profits in terms of the EU Life Directives was raised."

The Baird report's (WE 17) investigation into the issue of future profits also deserves close scrutiny. Quoting exchanges with the GAD, it says that "EU directives and UK legislation permit a value to be placed on the future profits of an insurance company. This is referred to as a “future profits implicit item”. (...) GAD explained to us the background to such items: “The background legislation…stems from the European Directives, particularly the First Life Directive going back to 1979. This says that at the discretion of the supervisory authority, the company may be allowed to count such items against 5/6ths of its margin of solvency, to its future profits calculation. The future profits calculation is then specified in the same Directive as being, in effect, 50% of the average profits earned over the last five years multiplied by the expected duration of the policy in force. The Directive just said that the supervisor could exercise their discretion, and it may be allowed as a solvency margin."

This optionality was severely restricted with the adoption in 2002 of the Solvency I Directive (Article 1(4)), which totally prohibits this practice from 2009 onwards. Baird explains how ELAS requested and successfully obtained authorisation from the regulator on numerous occasions to use future profits to meet its solvency requirements. The regulator used his prerogatives under section 68 of the ICA 1982 to grant the repeated authorizations. This, according to Baird, allowed the company to enhance the external perception of its financial strength. Baird recommended reviewing the exercise of discretion by the regulator in relation to authorisations for using future profits to meet solvency requirements.

This is closely linked to one of the lines of investigation being pursued in terms of correct transposition of the 3LD. The issue is whether the discretion exercised by the Secretary of State based on section 68 of the ICA 1982 played a prominent role in the ELAS affair, as is claimed by Baird. What needs to be evaluated in this context is whether the discretion itself is compatible with the 3LD. The Directive prescribes that Member States must ensure that competent authorities have sufficient powers and means to carry out their supervisory functions (see Article 10 3LD). The Directive, by contrast, allows the competent authority to waive the application of rules only on a limited number of occasions and subject to stringent conditions (see Articles 21(2) 3LD and 22(6) 3LD) but it seems that nowhere in the Directive is the competent authority of a Member State entrusted with waiver powers as those prescribed by section 68 of the ICA 1982. It seems that such powers entail the risk of being exercised in a lenient way, or in an inconsistent way that might have been beneficial to some companies but not to others, thereby possibly undermining the application of harmonised standards. It is possible that, if those powers had been somehow constrained, the ELAS collapse would have been avoided or at least minimized.

Article 28 – General good; Article 31 – Information to policyholders

30. C.O.B/prudential separation was prejudicial

On issues regarding communication with the policyholder, Mr. LAKE says (H1) that the policyholder information required by the 3LD came under the control of the conduct of business regulator which was separate from the prudential regulator, and that this legal division of responsibilities between prudential was prejudicial to ELAS policyholders. Finally, on implementation cases brought to UK court proceedings he says that he knows of none which relate to non-implementation of the EU Law.

However, David STRACHAN from the FSA presented a different view in H4, claiming that "the Third Life Directive has been implemented in a way that has ensured clarity as to the respective responsibilities of the home and host regulators [...]. Consistent with the Third Life Directive, it falls to the regulator of those branches – the host regulator in this case – to apply its own rules. This avoids an otherwise confusing situation in which policyholders would be subject to different conduct of business protections depending on whether they were doing business with a domestic institution or a branch of an EEA institution."

31. Annex II not respected

Leslie SEYMOUR in H7 provides written evidence (WE 53) claiming that Annex II of the 3LD – renumbered Annex IV in the CD –, which requires that the policyholder be given information regarding his policy ‘clearly’ and ‘accurately’, was not respected. WE 53 shows ELAS sales documents explaining the superior performance of ELAS pension funds and claiming that ELAS was able to provide superior performance due to its lower running costs. It also claimed to have superior investment management. Another document explains how ELAS proceeded with 'smoothing', by holding reserves, and that each year the policyholder would receive a bonus, with a certain amount of money that the company had made being retained to cover any future downturns in the stock markets or in the investments they had. Mr SEYMOUR claims that all these promises were false and therefore the information was not clear and accurate.

Mr SEYMOUR says that "the Directive requires that policyholders receive regular, clear and accurate information about the insurance undertaking. The regulator did nothing to ensure that this vital part of the Directive was put into effect."

 

(1)

See Recommendation from the Commission of 12 July 2004 on the transposition into national law of Directives affecting the internal market [Official Journal L 98 of 16.04.05].

(2)

For instance, UK legislation uses the terms ‘long-term business’ and ‘general business’ instead of the Directive’s ‘Life insurance’ and ‘Non-Life insurance’.

(3)

It would be a breach of Community law only if it ran counter to legal certainty or left individuals and economic actors in a state of uncertainty as to their rights and obligations emanating from the Directive. The case law of the ECJ lays down a number of specific requirements: (a) it is essential for national law to guarantee that the national authorities will effectively apply the Directive in full; (b) the legal position under national law should be sufficiently precise and clear; and (c) individuals must be made fully aware of all their rights and, where appropriate, be able to rely on them before the national courts.

(4)

All sections entitled 'Comments on UK provisions' use as their primary source ES 1.

(5)

"...the forms and statements required in the annual reporting process were not designed at any time to elicit information relevant to regulatory intervention, except in respect of solvency. In particular, the forms and statements at no time sought to elicit information necessary to enable regulators to form a view on whether the reasonable expectations of policyholders and potential policyholders would be likely to be met or frustrated." (par. 210, chapter 19, WE 16)

(6)

"GAD and the Treasury have told the inquiry that the relevance of terminal bonus was always recognised by GAD and the regulators but that PRE in respect of terminal bonus was not created by the Society's bonus practice. They point to the notes which stated that a terminal bonus was not guaranteed. However, GAD and the Treasury also recognise that PRE was not restricted to guaranteed benefits. It is not necessary to conclude that policyholders would have reasonable expectations of receiving a precise amount of bonus to take the view that reasonable expectations would still have been created. The point is highlighted in GAD's own representations: “It was generally accepted in the life insurance market that past levels of terminal bonus did not create reasonable expectations for the future, as they would be entirely dependent on market conditions, subject to a degree of smoothing, which varied considerably from company to company.” The reasonable expectation would not be that the precise policy value quoted would be payable, regardless of market conditions or smoothing, but that any reduction would reflect adverse market conditions. A position where the Society could not afford to honour the policy values without rising market values or inter-generational transfers would not have been understood by the Society's policyholders on the information provided to them, and would not have informed their reasonable expectations." (par. 220, chapter 18, WE 16).

(7)

The fact that ELAS did not have to reserve for un-guaranteed bonuses is explained in the section on Article 18, Technical Provisions. The 3LD made this reserving optional, and thus the UK did not force companies to reserve for these liabilities.

(8)

As has been mentioned in the section covering article 8, in UK law includes the concept of policy-holders reasonable expectations (PRE).

(9)

WE 84, 72, 69, 51-54, 42, 36, 33, 26

(10)

ES 1, Study on transposition commissioned by the EQUI committee.

(11)

WE 79 claims that ELAS did not even reserve prudently enough for future guaranteed bonuses to which holders of investment policies were contractually entitled nor did they make proper provision for guarantees in the contracts (such as GARs).

(12)

The ruling of the House of Lords on the Hyman case (Equitable Life Assurance Society v. Hyman [2000] 3 WLR 529.) was the event that sparked ELAS’ misfortune. The House of Lords ruled that ELAS did not have discretion under its articles of association to adopt a differential bonus policy according to whether a policy holder with a guaranteed annuity rate option (GAR) decided to take benefits at guaranteed rates rather than current rates. This meant that ELAS could not reduce the size of the final bonuses paid to its GAR policyholders and had to pay them what had been promised. But ELAS had no money to do so: it had not properly reserved for final bonuses and GAR liabilities throughout the years, creating an ever-growing asset shortfall. Proper reserving might have avoided or reduced the extent of the catastrophe.

(13)

Article 18(3)(A) Directive 79/267/EEC, the 1LD. For full text of the article, see section II.1.3, 'Relevant articles from other directives'.

(14)

See Baird Report WE 17, para 7.2.2. at p. 228.

(15)

Apart from article 25 3LD itself, see Article 21 3LD relating to the authorisation of other categories of assets as cover for technical provisions, and Article 22 3LD relating to the authorisation to introduce exceptions to the rules on investment diversification. Regarding Article 22, at UK level, according to section 68 of the ICA 1982, the Secretary of State has the power to waive the application of valuation of assets regulations to particular companies, although the exercise of that power is not qualified by the same standards prescribed by the Directive.

(16)

See comments on article 21.1 in WE 20, Wilde Sapte Report, 'Section II.2.2' of this Part.

(17)

The nature of the responsibilities of the European Commission is dealt with in extenso in Part V of the report.

(18)

Available to interested parties on demand (available in paper version only).


Conclusions PART II, TRANSPOSITION

PART II - TRANSPOSITION

Transposition of the Third Life Directive (3LD)

1.   Despite having identified some discrepancies between specific domestic UK regulations and articles of the 3LD(1), the committee considers that the nature and number of such discrepancies is not important enough to characterize what may be termed as the formal transposition process as defective.

2.   The committee makes one exception, nevertheless, as regards the ample powers domestic UK legislation bestows on the Secretary of State (as prescribed by Section 68 of the ICA 1982) to waive the application of prudential regulations. These powers appear to be incompatible with the letter and the aim of the Directive and were used inappropriately(2) (particularly when granting authorization on numerous occasions to include future profits in the solvency margin), and that therefore, in this particular instance, there are serious concerns that the 3LD was not correctly transposed in full.

3.   The committee believes that the transposition of the 3LD by the UK, was not carried out in a way which allowed the effective fulfilment of its underlying objectives. The committee believes that the UK technique of implementing the Directive in a piecemeal fashion (i.e., the directive was transposed not into one single national law but spread throughout different acts of varying hierarchy) lacks clarity and does not seem to be the best way of incorporating EC principles and standards into domestic legislation.

Application of the 3LD

4.   The committee considers it clear that the obligations imposed by Directives on Member States do not only concern their legislative competences but extend also to their administrative and judicial competences. Furthermore, the adoption of national measures implementing a Directive does not exhaust its effects. Full application of a Directive is only secured when national implementing measures are actually being applied in such a way as to achieve the result sought by it. Indeed, divergences in the application of Directives would otherwise have a negative effect on uniformity and equivalence within the Community legal order.

5.   The committee is of the opinion that the application of the 3LD by the UK in respect of the ELAS case was deficient and that UK regulators and authorities did not adequately respect the ultimate purpose of the Directive. The committee believes that, in the present case, the combination of a formalistic transposition with an application which was defective in several respects leads to the conclusion that the implementation process as a whole was flawed.

Specific issues regarding application

The concept of financial supervision of the entire business

6.   The committee recalls that the Directive states that financial supervision must cover the “assurance undertaking's entire business”.(3) The committee stresses as a legislator that such simple terminology is unambiguous and must be given a wide and proper interpretation.

7.   The committee believes that UK authorities’ supervision of ELAS disregarded or misinterpreted the concept of "financial supervision of the entire business" contrary to Articles 8(4), 18(5) and 25(6) of the 3LD.

8.   The committee believes that the option contained in paragraph 1.D of Article 18 of the 3LD does not exclude future discretionary or non-contractual bonuses from being an integral part of the company's ‘entire business’ and does not exonerate Member State authorities from doing their utmost to respect the letter and the aim of the Directive. Furthermore, it appears from the material available to the committee(7) that one of the main reasons for ELAS’ financial downfall was the fact that, throughout the years, it did not properly reserve for future discretionary or non-contractual bonuses.

9.   It has been argued that ELAS was not obliged to reserve for future discretionary or non-contractual bonuses because this was optional under the Directive, and the UK regulator decided not to avail itself of this option. The committee believes that the fact of making the reserving of discretionary bonuses optional undermined the strength and internal coherence of the Directive. Although the UK regulatory authorities were entitled to introduce such an option, it could be argued that this was inconsistent with the overall aim of the Directive.

10. Submissions made to the committee(8) suggest that the regulator tended to focus on solvency margins in a narrow sense and took little or no account of future discretionary and non-contractual bonuses in its overall analysis of the financial health of the company. The committee believes therefore that it is likely that the regulator did not manage to guarantee that ELAS had an adequate solvency margin in respect of its entire business at all times.

Lack of sound administrative and accounting procedures and adequate internal control mechanisms

11. There are clear indications that the UK regulators knowingly failed to challenge the dual, and therefore conflicting, role of the Appointed Actuary of ELAS, who for six years also held a leading management post in the Society as its Chief Executive. The committee believes that this duality of roles created a conflict of interests detrimental to policyholders' interests which should have been challenged by regulators as an instance of bad corporate governance. Furthermore, the committee believes that, by not taking swift action on the issue of the double role of the Appointed Actuary, the UK regulator did not fulfil its obligation to require from ELAS "sound administrative and accounting procedures and adequate internal control mechanisms" as required explicitly by the 3LD, and contrary to Article 8.(9) The committee insists that the role of the Appointed Actuary was central to the UK supervisory system, and that a failure to guarantee the effectiveness of such a figure undermined the whole system of supervision, in particular rendering any internal controls completely inadequate. The committee considers that, once in place and irrespective of whether the concept was required under Community law, the Appointed Actuary became part of the UK regulatory and supervisory system which, as a whole, was subject to the 3LD. Furthermore, certain statements(10) lead the committee to believe that this failure formed part of a wider administrative practice which undermined the effectiveness of the safeguards contained in Community legislation.

Failure to respect policyholders’ reasonable expectations (PRE)

12. According to some statements made to the committee(11), the concept of PRE included the fact that policyholders expected to receive discretionary bonuses in addition to contractual benefits. If UK authorities were obliged to respect PRE as part of their obligations under Community law, the committee considers that they should have also made sure that reserves covered discretionary bonuses. The committee believes that, by not considering discretionary bonuses as an integral part of the company’s entire business and not obliging ELAS to provide adequate technical provisions for them, the UK regulators did not pay due regard to PRE and thereby appear to have breached the letter and aim of Article 18 of the 3LD.

13. The committee recalls that Article 10 of the 3LD required that UK authorities be given the powers and means to ensure that PRE were respected and that any appropriate and necessary measures were taken to ensure that ELAS' business continued to comply with UK law(12), in order to prevent or remedy any irregularities prejudicial to the interests of the assured persons.

14. Statements made to the committee(13) suggest that, during the 1990s, the regulators in the UK did not exercise their extensive powers with respect to ELAS, despite having sufficient indication of the impending crisis. Some accounts(14) indicate that the regulator adopted a conscious and deliberate hands-off approach with regards to the ELAS case. The committee believes that this may have constituted a breach of the regulators’ obligation to ensure respect of PRE and therefore was in breach of the letter and aim of Article 10 of the 3LD.

UK regulators' excessive leniency on solvency margin

15. Several statements(15) support the conclusion that ELAS artificially enhanced the external perception of its financial strength and managed to meet its solvency requirements by successfully obtaining numerous authorisations from the regulator to include future profits and zillmerising as part of its implicit assets. These authorisations were granted on the basis of the waiver powers of the Secretary of State contained in Section 68 of the ICA 1982, whose compatibility with the letter and the purpose of the 3LD remain doubtful to the committee. The UK regulators' excessive leniency in this regard appears to have been in breach of Articles 10 and 25 of the 3LD.

16. The committee believes that by being allowed to artificially meet its solvency requirements, ELAS hid the truth from policyholders and endangered its future financial viability. It therefore follows that PRE were put at risk and that UK regulators allegedly took measures that were not “appropriate and necessary to prevent or remedy any irregularities prejudicial to the interests of the assured persons(16).

17. The committee believes that excessive use of future profits and zillmerising rendered the solvency margin relatively misleading as an indicator of the financial health of ELAS and that as a result the UK regulators did not fulfil their obligation to require from ELAS an “adequate available solvency margin in respect of its entire business at all times”.

18. A large quantity of material(17) indicates that, particularly in the early 1990s, the UK supervisory and regulatory bodies were not adequately equipped with appropriate means, either by way of competent staff or sufficient resources, to fulfil their supervisory and regulatory duties, contrary to the standard set out in Article 10 paragraph 3 of the 3LD. Such necessary powers and means and the consequent possibility of effective supervision are all the more important since, with the coming into force of the 3LD, the home Member State retains the sole responsibility for the financial supervision of life assurance undertakings.

Information requirements

19.  Material available to the committee(18) raises concerns as to whether the disclosure requirements laid down in the 3LD were properly implemented by the UK and whether they were breached in the case of Equitable Life.

(1)

See Part II, sections II.2.1, Part II, section II.2.2; Part II, section II.2.3; and WE 20.

(2)

See Part II, Section II.1.1. on Art.25 3LD; see also WE 17, para. 7.2.2 at p. 228.

(3)

Article 8 3LD.

(4)

See Part II, Sections II.1.1 and Part II, section II.2.3; see also WE 16 (Ch. 16; ch. 19, para. 210; ch. 18, para.220; ch. 21) and WE Conf 3.

(5)

See Part II Section II.1.1 and Part II Section II.2.3; see also WE Conf 11, WE 16, WE 26 and WE 79.

(6)

See Part II Section II.1.1 and Part II Section II.2.3; see also WE 17.

(7)

See Part Section II.2.3, see also WE 16, WE 26 and WE 79.

(8)

See WE 16, ch. 19, para 210.

(9)

See Part II Section II.1.1 and Part II Section II.2.3.

(10)

See Baird Report (WE 17), paragraph 2.13.6.

(11)

See Part II Section II.1.1; see also Part II Section II.2.3; see also WE 16, ch.18, para 220, and WE 26, WE 52-54 and LLOYD in H5.

(12)

See Part II Section II.1.1.

(13)

See Part II Sections II.1.1 and Part II Section II.2.3; see also WE 17.

(14)

See Part II Section II.2.3 and WE 16.

(15)

See Part II Section II.1.1 and Part II Section II.2.3; see also WE 17, para 7.2.2, p 228.

(16)

Article 10 3LD.

(17)

See for instance: Baird Report (WE 17), at paragraph 2.23.5; Penrose Report (WE 16), Chapter 19, at paragraphs 158 and 160.

(18)

See Section IV.


PART III - REGULATORY SYSTEM

on the Assessment of the UK regulatory regime in respect of Equitable Life

INDEX  PART III

I.         Community Law Provisions

            1. Applicability of Third Life Directive provisions

            2. Prudential supervision responsibility

            3. Conduct of Business supervision responsibility

            4. Assessment of companies' financial situation

            5. Implementation of supervisory measures

            6. Supervision of foreign-based companies

            7. Supervision of accounting and financial situation

            8. Supervision of companies in difficulty

 9. The European Commission and the Equitable Life case

10. CEIOPS and the Siena Protocol

11. The Solvency II project

12. Questions to be answered

II.        The UK Life Insurance Regulatory System

1. Application of Third Life Directive provisions

2. Prudential supervision          

                       a) Period 1982-1998

                       b) Period 1998-2001

                       c) Period post-2001    

            3. Conduct of business regulation

            4. The Appointed Actuary

5. Regulators' Intervention Powers

6. Regulators' Liability

III.      Key findings of the Penrose and Baird reports on Life Insurance Regulators

1. The Baird Report (October 2001)

            2. The Penrose Report (March 2004)

                       2.1 Definition of prudential supervision

                       2.2 Intervention powers by regulators

                       2.3 Interaction of regulators

                       2.4 The unchallenged double role of Mr. Ranson

                       2.5 Alleged regulator shortcomings in general

                                  a) Lack of knowledge and/or weak monitoring

                                  b) Complacency or "easy hand" policy by regulators

                                  c) Negligence by regulators

                       2.6 Timeline of acknowledgement by regulators of concerns about EL

                       2.7 The Penrose Report's conclusions

IV.      Other Oral and Written Evidence considered by the Committee

            1. Alleged negligence in prudential regulation and supervision

                       a) Claims of operational shortcomings by UK regulators

                       b) Alleged obstruction by UK regulators and collusion with EL

c) Claims of Regulators' industry bias

d) Claims of Regulators' 'light touch' regulatory policy

e) Claims of Regulators' excessive 'deference' to EL

                       f) Claims of Regulators' drive to avoid EL's insolvency

                       g) Double role of EL Chief Executive and Appointed Actuary

h) Adequacy of resources available to regulators

2. The GAR Problem

           a) Timeline

b) Background information

c) Claims of regulators' incompetence in failing to recognize GAR risk

3. Alleged Unfairness in the 2001 'Compromise Scheme'

           a) Timeline

                       b) The independent actuary's report

                       c) The Compromise terms in detail

d) FSA's role in 'Compromise Scheme'

           e) Complaints by policyholders

           f) Claims of EL management not qualifying as 'fit and proper'

4. Alleged negligence in Conduct of Business (CoB) supervision

                       a) Allegations of mis-selling and misrepresentation in the UK

                       b) Allegations of mis-selling in other Member States

c) Allegations of 'churning' policyholders' contracts

                       d) Claims of communication failure between UK regulators

e) Communications between UK and foreign regulators

f) Misleading advertising on the German and Irish market

Conclusions

Introduction

Responding to indent 3 of the mandate, the Committee of Inquiry proceeded to analyse the role and effectiveness of the Insurance Regulators in the UK and other Member States concerned, endeavouring to assess whether or not there has been consistent regulatory failure in the supervision of the life assurance sector in general and in the supervision of Equitable Life's business practices and financial standing in particular. The committee also analyzed allegations of regulatory failure in the protection of policyholders and consumers due to incorrect implementation of the Third Life Directive(1), assessing in particular how the UK regulatory system compared when judged against its peers in an EU environment.

The findings of the Penrose report(2) and the Baird report(3), whose investigations overlap with parts of the committee's mandate, were taken as a starting point but considered in a wider European context(4).

(1)

Directive 92/96/EEC of 10 November 1992, in OJ L 360 of 9.12.1992.

(2)

The Treasury set up Lord Penrose’s inquiry in August 2001. The terms of reference were: “To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society, taking account of relevant life market background; to identify any lessons to be learnt for the conduct, administration and regulation of life assurance business; and to give a report thereon to Treasury Ministers.” The Penrose report was published on 8 March 2004.

(3)

The Baird Report, "The Regulation of Equitable Life: an independent report" prepared by Ronnie Baird, Director, Quality Assurance and Internal Audit, FSA, assisted by Norton Rose and PricewaterhouseCoopers, was published by the Treasury on 17 October 2001.

(4)

An ongoing investigation by the UK Parliamentary and Health Service Ombudsman (PO) should also determine whether the relevant UK regulatory regime was properly administered. The first report by the UK Parliamentary Ombudsman, published in June 2003, did not find prudential regulators guilty of maladministration in the period 1999-2000 and ruled that no compensation was due to investors. The second report extended the time period covered by the investigation and included the GAD in its scope. The publication of the 2nd UK Parliamentary Ombudsman's report on Equitable Life, originally due for autumn 2006, has been delayed until May 2007 and its findings could therefore not be included in this report. In her letter to MPs on 16 October 2006 (coincidently, the same day of the EQUI delegation visit to London), the Ombudsman wrote: 'it became clear that evidence that appeared to be of potential relevance to the matters under investigation had not been disclosed to us... We received this evidence in July and August 2006' (Annex to WE-FILE19). Mr. BRAITHWAITE (H11) deplored that this "'truck load' of new written evidence from 2001 which had previously been concealed from the Penrose inquiry... seems to have succeeded in ensuring that the EQUI report will not be able to quote from the PO's investigation.


I.         Community Law Provisions

The role and responsibility of life insurance regulators with regard to the supervision of assurance undertakings is codified in Articles 8 to 10 of the Third Life Directive (3LD)(1) amending Articles 15, 16 and 23 of the First Life Directive (1LD)(2).

Rules relating to technical provisions and their representation by assurance undertakings (including solvency margins) are codified in Articles 18 to 27 of 3LD amending Articles 17 to 21 of 1LD(3).

Provisions affecting the Conduct of Business rules (COB), including contract law, conditions of assurance etc., are codified in Articles 28 to 31 and Annex II of 3LD in addition to provisions of Articles 4 and 15 of the Second Life Directive (2LD)(4).

Finally, provisions applying to assurance undertakings in difficulty were codified in Article 24 paragraphs 2 to 4 (1LD)(5).

The Third Life Directive thus provides for the creation of a single market in the EU/EEA for insurance products, based on the rule that the prudential regime in each Member State is recognized as equivalent by other Member States, and an insurance company regulated in one Member State and selling its products across the internal market, can be deemed by host regulatory authorities to have sufficient solvency to sell its products into other Member States, without having to meet there any additional solvency requirements.

1.         Applicability of Third Life Directive provisions

By contrast to regulations, directives are binding as to the result to be achieved but leave to the national authorities the choice of form and methods for their implementation(6). The Third Life Directive had to be transposed by Member States by 31 December 1993 and applied at the latest by 1 July 1994. The formal notification by the UK authorities to the Commission having transposed the 3LD into UK law was on 29 June 1994, confirming its entry into force on 1st July 1994(7).

This deadline is important when considering the role of UK regulators in the Equitable Life case, as their action in the years 1989-1993 (scrutiny of actuarial reports, prudential supervision) was accordingly ruled by provisions of the First Life Directive (79/267/EEC).

European Court of Justice (ECJ) rulings have repeatedly placed particular emphasis on the purpose of a directive.(8) Accordingly, the crucial issue is whether a Member State has adopted all the necessary measures to ensure the full effectiveness of the directive in accordance with the objective which the latter pursues. As stressed by the ECJ "Member States are under an obligation to ensure the full and effective application of a directive, meaning that a Member State is not discharged of its transposition obligations merely by adopting the necessary implementing measures. Member States remain bound to ensure full application of the directive even after the adoption of those implementing measures and individuals are therefore entitled to rely before national courts against the State whenever the full application of the directive is not in fact secured. That is to say, not only where the directive has not been implemented or has been implemented incorrectly but also where the national measures correctly implementing the directive are not being applied in such a way as to achieve the result sought by it. Further, the ECJ has repeatedly held that directives are binding on all the authorities of the Member States: not only the legislature but also the administrative agencies responsible for the day-to-day application and enforcement of the law... are bound." (ES-1, par.7-8)

2.         Prudential supervision responsibility

Articles 8 and 9 of 3LD clearly define the remit and extent of the Member States' supervising responsibility, including cases where the assurance company operates in other Member States, stating that "financial supervision shall include verification, with respect to the assurance undertaking's entire business, of its state of solvency, the establishment of technical provisions, including mathematical provisions, and of the assets covering them, in accordance with the rules laid down or practices followed in the home Member State pursuant to the provisions adopted at Community level."

In the case of a company having established an operational branch in another Member State, "the competent authorities of the home Member State shall require every assurance undertaking to have sound administrative and accounting procedures and adequate internal control mechanisms." For control purposes, "the Member State of the branch shall provide that... the competent authorities of the home Member State may... carry out themselves, or through the intermediary of persons they appoint... on-the-spot verification of the information necessary to ensure the financial supervision of the undertaking. The authorities of the Member State of the branch may participate in that verification." The home Member State may require systematic communication of technical provisions for prudential supervision, but only for the purpose of "verifying compliance with national provisions concerning actuarial principles, without that requirement constituting a prior condition for an assurance undertaking to carry on its business."

3.         Conduct of Business supervision responsibility

The supervision of so-called "Conduct of Business" rules (i.e. contractual terms and practices affecting the consumer taking out a policy) is another field of responsibility of regulators appointed by Member States. Article 4 of 2LD rules that "the law applicable to contracts... shall be the law of the Member State of the commitment... Member States shall apply to the assurance contracts their general rules of private international law concerning contractual obligations." The obligation for the host country regulator to intervene is hence limited to cases conflicting "with legal provisions protecting the general good(9) in the Member State of the commitment."

As a measure of consumer protection, policy subscribers must be allowed a cancellation period of "between 14 and 30 days from the time when he/she had been informed that the contract had been concluded." (Article 15, 2LD). Furthermore, at least the information listed in Annex II of 3LD must be communicated to the policyholder, with the possibility to "require assurance undertakings to furnish information in addition to that ... only if it is necessary for a proper understanding by the policy holder of the essential elements of the commitment. The detailed rules for implementing this Article and Annex II shall be laid down by the Member State of the commitment." (Article 31 3LD)

4.         Assessment of companies' financial situation

Article10(2) of 3LD defines the type of information required from assurance undertakings, stating that "Member States shall require assurance undertakings with head offices within their territories to render periodically the returns, together with statistical documents, which are necessary for the purpose of supervision. The competent authorities shall provide each other with any documents and information that are useful for the purposes of supervision."

5.         Implementation of supervisory measures

Article 10(3) of 3LD defines the instruments Member States have to adopt to enable them to implement these supervisory measures, stating that "every Member State shall take all steps necessary to ensure that the competent authorities have the powers and means necessary for the supervision of the business of assurance undertakings with head offices within their territories, including business carried on outside those territories, in accordance with the Council directives governing those activities and for the purpose of seeing that they are implemented."

Article10(3) further specifies that "These powers and means must, in particular, enable the competent authorities to:

(a) make detailed enquiries regarding the assurance undertaking's situation and the whole of its business, inter alia, by gathering information or requiring the submission of documents concerning its assurance business, carrying out on-the-spot investigations at the assurance undertaking's premises;

(b) take any measures, with regard to the assurance undertaking, its directors or managers or the persons who control it, that are appropriate and necessary to ensure that the undertaking's business continues to comply with the laws, regulations and administrative provisions with which the undertaking must comply in each Member State and in particular with the scheme of operations in so far as it remains mandatory, and to prevent or remedy any irregularities prejudicial to the interests of the assured persons;

(c) ensure that those measures are carried out, if need be by enforcement, where appropriate through judicial channels."

6.         Supervision of foreign-based companies

The question of prudential supervision of foreign-based companies is governed by Article 8 of 3LD, stating clearly that "the financial supervision of an assurance undertaking, including that of the business it carries on either through branches or under the freedom to provide services, shall be the sole responsibility of the home Member State." It adds that "if the competent authorities of the Member State of the commitment have reason to consider that the activities of an assurance undertaking might affect its financial soundness, they shall inform the competent authorities of the undertaking's home Member State."

7.         Supervision of accounting and financial situation

Article 18 of 3LD states that "the Home Member State shall require every assurance undertaking to establish sufficient technical provisions, including mathematical provisions, in respect of its entire business" to be determined according to well defined principles(10). In particular, Article 20 of 3LD stipulates that "the assets covering the technical provisions shall the account of the type of business carried on by an undertaking in such a way as to secure the safety, yield and marketability of its investments."

It was suggested, however, that the calculation of bonuses in insurance contracts and its 'smoothing effect' on policies - a key factor when assessing EL's operations - was "not deriving from EU law, but had to be considered rather a matter of private contract law"(11).

8.         Supervision of companies in difficulty

Article 24, paragraphs 2 to 4 of 1LD state that "for the purposes of restoring the financial situation of an undertaking... the supervisory authority of the head-office Member State shall require a plan for the restoration of a sound financial position be submitted for its approval. If the solvency margin falls below the guarantee fund ... the supervising authority of the head-office Member State shall require the undertaking to submit a short-term finance scheme for its approval... It shall inform the authorities of other Member States in whose territories the undertaking is authorized of any measures and the latter shall, at the request of the former, take the same measures. The competent supervising authorities may further take all measures necessary to safeguard the policy-holders' interests..."

9.        The Commission and the Equitable Life case

As documented by evidence sighted and confirmed by EU Commissioner Charlie McCREEVY (H8), the earliest correspondence received by the Commission on the Equitable Life case dates to February 2001(12), i.e. when the case had already been widely debated in the UK press, well after the House of Lords rulings and after Equitable Life had closed to new business. In its first replies, the Commission stated it would "wait for the outcome of the Penrose report before determining what actions, if any, should be taken."(13)

In March 2004, the complaints received were still not registered as formal complaints by the Commission Secretariat General, which asserted that the objective of Community infringement proceedings is to "restore or establish the compatibility of national law with Community law and not to rule on the alleged incompatibility of a past regulatory or supervisory regime", adding that "any claims for alleged damages must be pursued before national courts." In substance, the Commission - citing "strong legal advice based on Court jurisprudence"(14) - persistently claimed that it did not need to take a decision on the alleged past incompatibility with EC law of UK regulators' prudential supervision over Equitable Life, as long as the current compatibility of the regulatory regime was ascertained.

In H8 Commissioner Mr. McCREEVY confirmed that it is "the Commission's key job of making sure that Community legislation is properly implemented", adding that "checking Member States' implementation of Community legislation is a difficult exercise. It is time and resource-intensive. There are linguistic problems. Translations are not always available. Member States frequently implement our directives by amending multiple pieces of existing legislation and often fail to provide transposition tables".

His clear message was that "the Commission is not responsible for the supervision of individual insurance undertakings. That is the job of the national authorities.... the Commission is not and cannot be the supervisor of the supervisors." Assessing in particular the Equitable Life case, Commissioner McCREEVY concluded by saying that "the UK authorities reacted quickly following the Society's crisis and closure to new business ... I think one can safely say that the regime that applied prior to the crisis of Equitable Life no longer exists." (WE73)

10.       CEIOPS and the 'Siena Protocol'

The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS(15)) - previously called 'European Conference of Insurance Supervisors' - was established pursuant to Decision 2004/6/EC of 5 November 2003 and began its operations on 28 May 2004. CEIOPS is composed of high-level representatives from the insurance and occupational pensions' supervisory authorities of the EU Member States(16).


In application of the "Lamfalussy Process"(17) to the banking and capital markets sectors, CEIOPS has been performing the functions of 'Level 3 Committee' for the insurance, re-insurance and occupational pensions sectors. This role involves providing advice to the Commission on the drafting of implementation measures for framework directives (for example on 'Solvency II', its core undertaking at present(18)) and advising on insurance and occupational pensions' regulations as well as the establishing of supervisory standards. Its recommendations and guidelines aim at enhancing the convergence and effective application of the regulations, thus facilitating cooperation between national supervisors and upgrading the 1997 'Siena Protocol'. However, concerning its specific implementing powers, CEIOPS has to be seen as a 'mediation mechanism where national regulators are subject to peer pressure, not to cogent enforcement.'(19)

The 'Siena Protocol', signed on 30 October 1997, relates to the collaboration of the supervisory authorities of the EU Member States in the application of the Directives on life and non-life insurance. It considered that "the adoption of the 3LD insurance and life assurance framework Directives, which set up single authorisation and single supervision, particularly financial supervision exercised only by the competent authorities of the home Member State, makes necessary a deepening of their co-operation, which is already covered by protocols applying the First and Second Directives." It was intended to "uphold practical collaboration between national administrative services for the purpose of facilitating the supervision of direct insurance within the European Union and of examining any difficulties which might arise in the application of the Directives." (WE55)

The supervisory authorities declared that "the analysis of the situation of undertakings in their respective countries calls for a variety of supervisory methods and practices and for a collection of different accounting documents and statistics. The standardisation of supervision would be improved by means of a common language of analysis and harmonisation of insurance accounting documentation and statistics. The supervisory authorities confirm that they must have a standard document allowing them to verify the state of the solvency margin, since this is not immediately apparent from an examination of an undertaking's accounts."(20)

Referring to cooperation and professional secrecy, the supervising authorities agreed to "exchange confidential information whenever possible, within the limits of the rules laid down in the Third Directives...) in order to improve the effectiveness of insurance supervision in the European Community" adding that "the rules for collaboration set out in the protocol may show themselves to be inadequate when faced with actual cases and agree that as a result they will be expanded as the need arises."(21)

11.      The Solvency II project

Referring to the ongoing work on the main regulatory project for the insurance business(22), Commissioner McCREEVY (H8) stated that the Solvency II project "has already created a new climate of supervisory cooperation at EU level", confirming that it was the Commission's "current top insurance priority" with the ambitious aim of bringing about "nothing less than a fundamental revision of insurance regulation and supervision in the EU. The current solvency regime... is showing its age! Solvency margin requirements for insurers were first introduced at EU level over thirty years ago and the method of calculation has remained essentially unchanged since then. They were designed for an insurance industry and a world that no longer exist... Solvency II has the challenging job of achieving a balance between the expectations of consumers, supervisors and insurers. It is crucial that the industry should not lose its appetite for risk because of excessive supervisory obligations. But it is also important that companies are fully aware of the risks they are taking on and accept the corresponding consequences. Within the Solvency II framework, solvency requirements will be based on the company’s risk-profile. An insurer that better controls its risks may then be permitted to hold less capital." (WE73)

In brief: the aim of Solvency II is not to increase overall levels of capital requirements but rather to ensure a high standard of risk assessment and efficient capital allocation. This would contribute to increased market transparency and help developing a level playing field across Europe, as a key step in the implementation of a true single market in financial services. In fact, as the capital currently required from insurance companies under Solvency I appears to be inadequately allocated, it led to the strengthening of regulations in a number of Member States, thus creating a patchwork of solvency rules. The new common solvency framework should therefore be based on clear economic principles for the measurement of assets and liabilities, with risk measured on the basis of consistent principles and capital requirements based directly on these measurements.(23)

Thus, if implemented correctly, the Solvency II framework would have a positive impact on policyholders, giving them better protection by ensuring companies improve their risk management practices and hold appropriate levels of capital. At the same time, it would lead to a more efficient capital allocation across the industry, a lower risk of company failure and, consequently, greater confidence in the insurance business and its financial stability.

12.       Questions to be answered

Analyzing the EC law provisions as defined by the Third Life Directive in the context of this part of the mandate, the committee had to find answers to the following questions:

1. Were UK supervisory and regulatory bodies effectively created and adequately equipped with staff and resources to fulfil the duties detailed in Article10(3) of 3LD ?

2. What - and when - could the UK regulatory bodies have reasonably been expected to discover in the Equitable Life case, if they had correctly exercised their supervisory and regulatory powers on prudential regulation following provisions detailed in Articles 10 and 13 of 3LD ?

3. Did UK regulators react in a timely and correct manner once problems with Equitable Life became known to them, in particular on spotting and highlighting the risks inherent in GARs, as requested by Article 13(3) of 3LD ?

4. Did the UK regulators and regulators in other Member States concerned correctly supervise the application of conduct of business rules on their territory? Did they assist policyholders addressing complaints to regulators?

5. Was there an appropriate flow of information and concerted action between UK regulators and regulators of other Member States in relation to EL's activities on their territory?

(1)

see also art.10-13 of the Codified Life Directive 2002/83/EC (CLD), OJ L 345 of 19.12.2002.

(2)

Directive 79/267/EEC of 5 March 1979, OJ L 63 of 13.3.1979.

(3)

see also art.20-31 CLD.

(4)

Directive 90/619/EEC of 8.11.1990, OJ L 330 of 29.11.1990, see also art.32-36 and Annex III CLD.

(5)

see also art. 37 CLD.

(6)

see art.249 EC Treaty.

(7)

ES-1 stated that "the UK opted for a piecemeal and indirect approach aimed at adjusting its already complex and sophisticated regulatory system with the principles and standards of the directives. By contrast, Spain and Ireland opted for a more mechanical and consolidated path based on the importation of the Directive into the domestic legal system through the adoption of a single legislative act, which basically reproduced the structure and text of the Directive. In principle... such different forms of transposition are compatible with Community law, (but) the freedom of choice on the methods and forms does not exempt Member States from the binding effects of a directive “as to the results to be achieved”.

(8)

see cases C-14/83 von Colson and Kaman, para.15 and C-62/00 Marks & Spencer v Customs & Excise, para.27.

(9)

see WE-CONF-26: "The concept of 'General Good' is an exception to the fundamental principles of the Treaty with regard to free movement... The 3LD does not explicitly spell out what the General Good is supposed to be... but gives various hints at the motives." (par. 3.4).

(10)

cfr. art. 18-16 3LD, with art. 25-26 referring to solvency margins.

(11)

cfr. Prof. Tridimas (WS1), who also stated that "the Hyman case ruling as such did not touch EU law".

(12)

letter from MEP to Commissioner Frits Bolkestein, 27.02.2001, followed by 5 letters from other MEPs, 2 EP written questions and 7 complaints from individual citizens.

(13)

see WE-CONF11 and WE 73, page 4.

(14)

see oral evidence in H1 and H7.

(15)

for further information consult www.ceiops.org.

(16)

The authorities of the European Economic Area Member States (Norway, Iceland and Liechtenstein) and EU candidate countries, as well as the European Commission, participate in CEIOPS as observers.

(17)

The 'Lamfalussy process' is an approach to the development of financial services industry regulation adopted by the EU (named after the chair of the EU advisory committee that devised it), consisting of four levels:

· Level 1: The EP and Council adopt legislation in co-decision, determining framework principles and guidelines on implementing powers.

· Level 2: Technical implementing measures taking the form of further directives and/or regulations, adopted under powers delegated at level one.

· Level 3: Networking between regulators with a view to producing joint interpretative recommendations, consistent guidelines and common standards, peer review, and comparisons between regulatory practice to ensure consistent implementation and application.

· Level 4: Monitoring by the European Commission of MS compliance with EU legislation and enforcement action where necessary

(18)

see H7, Mr. Bjerre-Nielsen, and the following chapter 11.

(19)

see H7, Mr. Bjerre-Nielsen.

(20)

see WE55, part I, point 1.3.

(21)

see WE55, part I, points 1.4-1.6.

(22)

The proposal for a new solvency framework for the insurance sector (Solvency II) should be adopted by the Commission in the second half of 2007, aiming at entry into force in 2010.

(23)

see also 'Solvency II Introductory Guide', CEA 2006 and WE-CONF18 for more specific details


II.       The UK Life Insurance Regulatory System

UK insurance companies have been required to make detailed accounting and actuarial returns(1) to enable the monitoring of their state of solvency since the adoption of the "Life Assurance Companies Act" of 1870. A more formal authorisation regime backed by regulatory powers was consequently introduced in 1967 and later strengthened by the introduction of the concept of "policyholders' reasonable expectations" (PRE)(2) and the statutory role of "Appointed Actuaries" in 1974(3).

It appears that UK prudential supervision of life insurance companies had been traditionally inspired by a doctrine of “freedom with publicity” defined as "life insurance companies would make their affairs public through financial information being placed in the public domain." Accordingly, it was desirable to have "some prudential supervision of life insurance business to safeguard policyholders’ interests but it was also desirable not to restrict commercial freedom ... as excessively intrusive prudential supervision could have an inhibiting effect on the development of an innovative and competitive life insurance market ... At its heart, the supervisory regime remained one based on insurance companies’ freedom of action rather than on prescriptive rules."(4) However, academics suggest that EU financial services legislation has improved the UK legal framework governing financial services provision: "In most areas of UK financial regulation, ranging from market abuse/insider dealing, capital adequacy, insolvency ratios for insurers, and capital market regulation, the UK legal regime has benefited immensely and has been reformed by EU legislation. The implementation of EU financial services law into UK law has not undermined the UK’s ‘soft touch’ principles-based system of financial regulation."(5)

Over the past two decades, the regulatory and supervisory framework of life insurance companies in the UK has evolved in different steps, leading to the creation of the single Financial Supervising Authority (FSA), which gained its full regulatory powers only in December 2001. Until then, UK insurance companies that sold long-term investment products were regulated from within two UK Government departments: the Department of Trade and Industry (DTI) from 1989-1997, and later HM Treasury (HMT) from 1998 to 2001(6), with the technical assistance of the Government's Actuary Department (GAD)(7) responsible for the actuarial analysis of company returns and operations, according to a specific mandate ("service level agreements"(8)) and which is supposed to signal to the regulator any elements of concern their analysis might have uncovered. It appears, however, that part of the staff responsible for 'day-to-day' prudential supervision of insurance companies migrated from DTI to HMT and later to the FSA, thus providing a measure of continuity in regulatory action and responsibility.

1.         Application of Third Life Directive provisions

Relating to the practical implementation of prudential and conduct of business supervision by UK regulatory authorities, ES-1 has identified "three different categories of discrepancies between specific domestic regulations and articles of the 3LD, although the nature and number of such discrepancies does not provide conclusive evidence to suggest that UK legislation has violated the letter or the spirit of EC legislation on life assurance undertaking."(9)

Under Article 10 of the EC Treaty, Member States and their administrative agencies have to act in 'sincere cooperation', in this context specifically imposing on competent national regulatory authorities a duty to exercise supervisory functions with due diligence, although the provisions of 3LD awarded them "considerable discretion as to the appropriate course of action in any given case, i.e. as to when and by what means to intervene in order to prevent or terminate irregularities" (ES-1, para.28)

2.        Prudential Supervision

Prudential supervision in the life assurance business can be defined as:

· Ensuring that companies who are not fit and proper, not appropriately resourced and soundly managed, do not carry on life insurance business

· Protecting policyholders against the risk of life assurance companies being unable to pay valid claims or being unable to meet policyholders' reasonable expectations

The prudential requirements for corporate governance and financial management(10) to be enforced by UK regulators appeared broadly equivalent to prudential requirements in other Member States, except for the addition of UK-specific features such as the concept of 'policyholders' reasonable expectations' (PRE), the GAD and the Company Actuary (Appointed Actuary).

2a)      Period 1982 - 1998

Under the Insurance Companies Act 1982, which had incorporated provisions required by the implementation of the 1LD, the Department of Trade and Industry (DTI) was responsible for prudential supervision of insurance companies (including Equitable Life) as well as for policy and legislation in this sector. Until 4 January 1998, the DTI department known as the "Insurance Directorate" had immediate responsibility for prudential insurance regulation (i.e. ensuring firms were solvent), with the assistance of the Government Actuary's Department (GAD).

"GAD began to provide actuarial advice on insurance matters to the prudentially competent authority in the 1960s. This included advice on individual companies, on new applications for authorisation to write life insurance business and on policy issues, either of a general nature or relating to the affairs of particular companies... GAD acted solely as an adviser to the prudential competent authority. All powers under the statute were retained by the prudential competent authority, with GAD having no authority to instruct a company or its Appointed Actuary to take any actions, but only to provide advice to the prudential competent authority to assist it in the fulfilment of its supervisory responsibilities. In practice in later years of the period GAD corresponded with companies directly on technical matters." (WE32)(11)

Institutionally, the GAD reported to the Chancellor of the Exchequer and its Department Minister is the Financial Secretary to the Treasury. In practice, "it was the responsibility of GAD to monitor the financial position of each life insurance company, including examination of annual regulatory returns, quarterly regulatory returns ... and other information, to discuss matters with the company, and in particular with the Appointed Actuary, to clear up any uncertainties and, if possible, to resolve any disagreements. GAD would then report to DTI ... GAD developed its own working rules to define what was acceptable ... issued as guidance to Appointed Actuaries in the form of letters ..." (WE32)(12). The main output of GAD's monitoring of an insurance company was a "Detailed Scrutiny Report" for the prudential supervision authority.

At the start of the period under review, "there was no doubt that GAD was the dominant partner in the supervision of life insurance companies. GAD had more resources and technical expertise than the officials in the insurance division of the DTI. But the balance of power had shifted more to the staff involved in supervision by the time responsibility for supervision transferred from the DTI to the Treasury in 1997, partly as a result of increased numbers and better quality of supervision staff".(13)

In May 1997, the UK Government announced the creation of a single industry regulator (the future FSA), independent from government, which was to take over the roles of nine existing self-regulating bodies.

2b)      Period 1998 - 2001

While the FSA was being created, HM Treasury assumed (from 5 January 1998 until 1 January 1999) "full responsibility as prudential competent authority, answerable for DTI's past actions in that capacity" (WE32)(14). As part of the transitional phase, the DTI Insurance Directorate staff was transferred temporarily to the Treasury, pending transfer to the FSA. The Treasury was therefore directly responsible for the prudential regulation of insurance companies such as Equitable Life. From 1 January 1999, as part of a transitional arrangement, the Treasury outsourced the day-to-day supervision of insurance companies to the FSA, remaining ultimately in charge and retaining its regulatory role until the FSA was given full statutory powers by the Financial Services and Markets Act 2000 (FSMA).

2c)      Period post-2001

Today the FSA is an independent non-governmental body, a company limited by guarantee and financed by the financial services industry.  The Treasury appoints the FSA Board, currently consisting of a Chairman, a Chief Executive Officer, three Managing Directors, and 10 non-executive directors. The Board sets out overall policy, with day-to-day management being the responsibility of the Executive. As sole financial regulator, the FSA is accountable to the Treasury, and through it to the UK Parliament.

The FSA gained full regulatory powers on 1 December 2001 and currently has, out of nine sector teams, one specifically dedicated to the supervision of the insurance sector. Its key functions are risk-identification (identify emerging insurance risks and coordinate ways to mitigate these), managing contacts with a wide range of external stakeholders for the insurance sector, keeping under review the coherence of FSA requirements and policies as they bear on the insurance sector and, if needed, interpreting new rules and requirements. Every year, each insurer authorized by the FSA must send it an insurance return containing audited financial information and auditors' reports.

3.        Conduct of Business (CoB) Regulation

The purpose of the Conduct of Business rules in the life assurance business can be defined as ensuring that:

· retail insurance products offered on the market are suitable to investors

· investors understand all risks involved in the policy they take out

· advertisements for insurance products are fair, clear and not misleading in their message

· performance forecasts are based on adequate justifications.

In the late 1980s, the Conduct of Business (CoB) regulation was governed by the "Financial Services Act" of 1986, which had replaced the "Prevention of Fraud Investments Act" of 1958 and established a regulatory regime for the carrying on of retail investment business.

Operators had either to obtain authorisation from the Securities & Investments Board (SIB), the core of the later Financial Services Authority, or to become a member of a Self-regulating Organisation (SRO) which supervised members by reference to their own rule books. Thus, SROs derived their power from their contractual relationship with their members and regulated independent financial advisers or other subjects related to the marketing of retail investment products to the general public. SRO dealt also with complaints about mis-selling. However, "if an SRO were to expel a life office from membership, the effect would not be to deprive it of its authorisation to carry on insurance business or to sell its policies but merely to transfer the life office to the care of the SIB." (ES-2)

The Financial Services Act of 1986 had designated two particular SRO for Conduct of Business supervision(15):

- LAUTRO (Life Assurance and Unit Trust Regulatory Organisation)

- FIMBRA (Financial Intermediaries Manager and Broker Regulatory Association)

In 1994 these were merged into the PIA(16) (Personal Investment Authority) which from 1998 onwards, contracted out its functions to the FSA, in anticipation of the latter becoming the sole prudential and conduct of business supervising authority.

The relationship of the prudential supervisor with the conduct of business supervisor was critical in the UK, while close cooperation and information-sharing was vital to ensuring proper supervision of insurance companies. As a condition for recognition as an SRO, PIA had to be “able and willing to promote and maintain high standards of integrity and fair dealing in the carrying of investment business and to co-operate, by the sharing of information and otherwise, with the Secretary of State and any other authority, body or person having responsibility for the supervision or regulation of investment business or other financial services.”(17) While CoB concerns could be symptomatic of spotting a wider malaise in the company, which needed to be pursued by the prudential supervisor, the CoB regulators also had an interest in any prudential problems affecting a life office, since such problems could indicate a need to scrutinise marketing materials more closely, to ensure that they were not misleading.

Before 1 January 1999, when FSA took over the day-to-day monitoring of compliance with PIA’s conduct of business rules together with the prudential supervision of life offices, the two regulators operated under separate legislation in different locations with little formal contact and did not set up any regular information-sharing procedures. From 1999 onwards, the staff responsible for the day-to-day supervision of life offices under the two services level agreements were located in the same building in FSA but decision-making powers remained with the PIA Board for CoB rules and with HMT for prudential matters until FSMA came into force at the end of 2001. It took some time for each side to acquire a better understanding of the objectives and preoccupations of the other and to learn how to work together.

On 1 December 2001 (when the FSMA came into force) the SRO were dissolved and the FSA became, in addition to being the prudential supervisor, the sole Conduct of Business regulatory authority for life insurance companies.

4.        The Appointed Actuary (AA)

The concept of Appointed Actuary (AA) was introduced by the "Insurance Companies Act" of 1974 and has been for decades a critical feature of the UK regulatory system. The idea was to "designate a specific professional person within the company who could be relied on by the prudential competent authority to monitor the financial position of the company on a continuous basis ... It was regarded as the professional responsibility of the AA to monitor the overall financial position of the company. Having the AA at the heart of the company (with full right of access to the Board) ... was intended to provide protection for policyholder interests, as well as a strong internal system of financial control and risk management." (WE32)(18) He was normally "the first point of contact for GAD within each life office." (ES-2)

The AA "had to hold 'prescribed qualifications', which included a requirement that the actuary must have attained the age of 30 and be a Fellow of the Institute of Actuaries or the Faculty of Actuaries; subsequently it became a requirement ... to hold a “practising certificate” from the Faculty and Institute of Actuaries" (WE32)(19)

In practical terms, the AA was there "to make sure there were sufficient assets in the company to fulfil the promises and activities in which the company indulges." (WE59)(20) The AA had specific duties to report to the board on the financial condition of the company, to advise it on bonus distribution and possibly on the interpretation of Policyholders' Reasonable Expectations (PRE). He had to make an annual report on the company’s financial condition, presented to the board and included in abstract in the company’s regulatory returns, which were sent to GAD.

Appointed actuaries therefore had no regulatory functions as such but were supposed to report to the regulatory authority if the board did not heed their advice on certain key matters, possibly triggering regulatory action. They were also required to certify the section of the regulatory returns showing the company's liability valuation, inducing a possible closer scrutiny of the returns by regulators. The status of the Appointed Actuary varied considerably between life assurance companies.

The FSA reform of insurance regulation, taking full effect on 1 January 2005, abolished the role of the Appointed Actuary in favour of requiring company boards and senior management to take responsibility for actuarial issues and bringing these issues within the scope of the company's external audit. (WE37)(21) (22)

The Actuarial Profession was the first to set up an independent committee of inquiry (December 2000) into the events surrounding the closure of Equitable Life to new business and its implications. The Corley Report(23), published in September 2001, led a review of the adequacy of the professional guidance issued to Appointed Actuaries, to see whether there had been any contributory factors to the problems at Equitable Life. It concluded in broad terms that guidance had been adequate but recommended that the profession should require the work of Appointed Actuaries to be subject to 'peer review' (WE50).(24)

5.        Regulators' Intervention Powers

The major focus of prudential supervision in the UK was on the company's financial resources. In order to assess their adequacy, regulators had to verify the assurance companies' technical reserves, solvency margins and minimum guaranteed funds, with powers to obtain information and the production of documents needed for the assessment. The prudential supervision was based on the disclosure and monitoring of the regulatory returns submitted by the companies, designed to show not only the company's current solvency position but also, through the resilience tests, their sensitivity to future adverse changes. The regulatory returns were also published, so that information about the financial position of the life office was readily available to financial advisers, financial journalists and competitors.

Based on the Insurance Companies Act 1982, any formal intervention by UK regulators had to issue from the prudential supervisor (DTI, HMT or FSA, not the GAD) whenever a company was not meeting the established criteria of sound and prudent management or when a company was found in breach of specific ICA requirement. For instance, failure to maintain the minimum solvency margin could lead to a request from the prudential supervisor under Section 33 of the ICA to submit a short-term financial scheme to bring the company back into compliance(25). The regulator could also impose a number of penalties, such as ordering the company to deliver its regulatory returns early, limiting the maximum aggregate premium income, transferring company assets to a trustee and ultimately the withdrawal of the company's trading authorization, as detailed by ICA 82, Sections 38-44.

Section 45(26) of ICA 82 provided the Secretary of State power "to require a company to take such action as appears to him to be appropriate for the purpose of protecting policy holders or potential policy holders of the company against the risk that the company may be unable to meet its liabilities or ... to fulfil the reasonable expectations of policyholders or potential policyholders.” Recourse to Section 45 was however limited to cases when the purpose of policyholder protection was considered not achievable by the exercise of powers under Sections 38-44 and to preclude "restricting the company's freedom to dispose of its assets."(27)

Amendments to ICA 82 introduced with the implementation of 3LD and taking effect from 1st July 1994 "introduced new criteria for 'sound and prudent management' set out in a new Schedule 2C to the Act, and added to the grounds on which, under section 11, the Secretary of State could direct that an insurance company should cease writing new business, that any of the criteria of sound and prudent management were not being, might not be, or might not have been fulfilled in respect of the company."(28)

In an international comparison, ES-1 considers that UK supervisors "preferred to avoid the use of formal statutory powers wherever possible". Thus while the UK and Irish supervisors had similar enforcement powers, the German insurance supervisor's powers were "more extensive and specific and would support a more interventionist approach ... The German system contemplated a more intrusive system of monitoring and inspection than in other Member States, allowing representatives of the supervisory authority to attend supervisory board meetings, providing for ad hoc inspections without the need to show due cause, up to the replacing of members of management and of the supervisory board."

Referring to enforcement of CoB rules, the use of intervention powers by PIA in relation to life insurers (such as restrictions on dealing with assets or a requirement to maintain certain assets) could be exercised only by the prudential supervisor (DTI/HMT) and were outside the PIA’s powers. The proposed use of intervention powers by the PIA/SIB had to be notified in advance to the DTI/HMT, which had a power of veto over the proposed intervention action.(29)

6.        Regulators' Liability (30)

As far as Regulators' liability is concerned, it may be worth noting that under Common Law a supervisory authority may be held liable only for the tort of 'misfeasance in public office'. This would require a proven element of 'bad faith', with liability limited to losses that could have been foreseen by the authority as a likely consequence of its action/omission(31).

Self-regulating Organisations (SRO) and their officers were not liable in damages for actions or omissions in their functions, unless the act or omission was proved to have been done in 'bad faith'(32).

Under EC law, supervisory liability is limited to 'serious breaches' in the implementation of EC law but only if the infringement has affected individual rights and there is a direct causal link with the damage sustained by the injured party. Recent ECJ rulings appear to have further weakened supervisory liability, asserting supervisory authorities' responsibility to act 'only in the public interest', meaning that supervising functions are to be fulfilled to protect a plurality of interests rather than the interests of any particular group of investors(33).

Following the publication of the Penrose Report in 2004, a legal study(34) assessed the chances of claims by EL or by its individual policyholders against UK regulators, based on their regulatory failings, as highlighted in Chapter 19 of the Report. The conclusions were not encouraging as far as possible legal action is concerned, stating quite clearly that "the Society has no realistic claims against the regulators". Claims of 'common law negligence' or 'breach of statutory duty' by the prudential regulators were considered too weak, as "it cannot be said that the regulator failed to consider whether to exercise its powers of intervention under the ICA 1982 or that no rational prudential regulator could have acted in the way it did; and further, the ICA 1982 does not confer private law remedies on the Society." As to potential claims of 'misfeasance in public office', it concluded that "there is nothing... to suggest that any one or more of the individuals employed by the prudential regulators exercised power unlawfully, specifically intending to injure the Society, or with reckless indifference to the possibility of such injury. There does not appear to be any realistic prospect of such evidence emerging." Finally, no arguments were found supporting legal action by policyholders against the CoB regulators, claiming 'breach of human rights' or 'bad faith'.

An outsider chance was seen only for a "potentially arguable claim on the part of policyholders for breach of the Third Life Directive, in respect of the arguably excessive value ascribed to the reinsurance treaty in the Society’s technical provisions", however highlighting the "uncertainty regarding the merits of a novel claim of this sort" and concluding that there would likely be "numerous complex causation and loss issues, a lengthy and costly litigation, leaving it unclear as to what extent the Society might ever benefit financially from such a claim." (WE71)

(1)

The Insurance Companies Act 1982 required life insurance companies to submit the abstract of the 'Appointed Actuary's valuation report', the 'Annual report' and the company's 'Annual Accounts' required under the Companies Acts. Secondary legislation further specified the content of prescribed regulatory returns which - in the late 1990s - could run to several hundred pages. (compare. WE32, para.44)

(2)

As specified in WE32, para.30-31, the concept of 'policyholders' reasonable expectations' has never been specifically defined and did not have its origin in EC legislation, i.e. EC legislation never created an equivalent legal requirement to PRE. It was unique to the UK but although this standard should have lead to a conservative estimation of a company's liabilities, it clearly did not prove helpful in the EL case.

(3)

see Insurance Companies Act 1974, section 2 (15).

(4)

WE32, para.23.a,b,d.

(5)

see Prof. Kern Alexander, WE-FILE 31, point 4 (1).

(6)

HMT contracted out the day-to-day supervision of insurance companies to the FSA, but remained solely competent to exercise the statutory powers under ICA82.

(7)

The GAD, created in 1919, had no equivalent in other Member States, where actuarial advice was provided to the regulators by either employed or independent actuaries.

(8)

The service level agreements were revised in 1995 and 1998.

(9)

Discrepancies mentioned include cases where a) requirements of domestic law went beyond those of the Directive (e.g. the Appointed Actuary); b) requirements which might have infringed provisions relating to the home country control principle (e.g. UK legislation not requiring the Secretary of State to inform the competent authorities of other MS of a decision withdrawing authorisation or restricting a company's freedom to dispose of its assets); c) requirements in relation to the powers of the regulator (e.g. UK legislation permitting the Secretary of State to waive the application of prudential regulations). For further details see ES-1, para.26 and Annex II, table 9.

(10)

Prudential requirements include i.e. for directors, managers and controlling shareholders to be 'fit and proper', the principle of 'sound and prudent management', minimum solvency margins, minimum guaranteed funds etc..

(11)

WE32, para.8-9.

(12)

WE32, para.10,14.

(13)

see ES-2, Chapter 4.1.

(14)

WE32, para.7.ii).

(15)

The UK and Ireland were "the only MS to have CoB regulators who operated separately from the prudential supervisors; their powers were strictly limited and they were regarded as the junior partner in supervision" (ES-1, page 6).

(16)

Equitable Life was a member of LAUTRO, joining PIA in July 1994.

(17)

see ES-2, chapter 9.

(18)

WE32, para.26,28,29.

(19)

WE32, para.41,42.

(20)

on role and responsibilities of actuaries, see also the Q&A at the House of Commons Treasury Select Committee, minutes of the 24 April 2004 session (WE59).

(21)

WE37, para.25 d).

(22)

Switzerland appears to have introduced the figure of 'Appointed Actuary' in the Swiss financial supervisory system based on the British model, as reported by the representative of the Swiss Office of Private Insurance (H6).

(23)

'Corley Report' named after its author, Roger Corley, President of the Institute of Actuaries.

(24)

see WE50, para.82: "... The logic of (EL's) unusual bonus philosophy is clear and did not appear at the time to have contravened regulations. But it received only limited support from other actuaries ...".

see WE50, para.89: "On the question of whether the guidance was adequate, we conclude that most of the matters we have identified for which guidance was relevant were covered by the Guidance Notes in some form, even if the wording on some points was general rather than specific ...".

see WE50, para.90: "We have not found evidence to suggest that any Appointed Actuary of the Equitable failed to take account of the guidance that was current at the time the various decisions were made. We do not know what conclusions any Appointed Actuary at the Equitable reached when considering how the published Guidance Notes affected his decisions, nor what advice he gave to the management or the Board. We also cannot tell whether the decisions of the Board were in accordance with that advice. We have seen no evidence to indicate that any Appointed Actuary at the Equitable was at any time so concerned about the nature of those decisions that he felt it necessary to 'blow the whistle' to the regulator."

(25)

see ES-2, Chapter 3.2.1.

(26)

ICA 82(45): 'Residual power to impose requirements for protection of policyholders".

(27)

ICA 82(45)(2).

(28)

see WE-CONF25, para.4-5.

(29)

see ES-2, chapter 6 and 7.

(30)

The subject of regulators' liability has been elaborated in more detail in Part V of this report

(31)

see also the conclusions of WE71.

(32)

Financial Services Act 1986, section 187(1).

(33)

see ECJ ruling in case C-222/02 Peter Paul et al. v Germany, 12 October 2004.

(34)

see WE71: the legal advice was given by UK law firm Herbert Smith in a letter to the directors of EL on 14.4.2004, and considered potential claims against prudential regulators (based on ICA 82) and against CoB regulators (based on FSA 86), including claims in respect of the breach of 'enforceable private rights' arising from the 3 EC Life Directives.


III.      Key findings of the Penrose and Baird reports on Insurance Regulators

1.         The Baird Report (October 2001)

The Baird Report was an internal audit commissioned by the FSA and therefore focuses mainly on its own specific role in the assessment of the Equitable Life case. However, it contains findings that can shed some light on the role of financial regulators in general and on this case in particular(1).

In general terms, the report defines the role of the prudential regulator as having "... to exercise judgements so that it is confident that the company will remain solvent and meet the reasonable expectations of policyholders, without intruding unreasonably into the management of the company" (par. 6.1.5). But at the same time it recalls that the FSA remit included a consensus view that "it is neither realistic nor necessarily desirable in a climate which seeks to encourage competition, innovation and consumer choice, to seek to achieve 100% success in avoiding company failure."

Concerning the adequacy of the regulator's available resources, the report recalls how "the FSA has finite resources and, as a consequence, is continually exercising its judgement of risks to determine how to deploy its resources to best effect" (par. 6.3.3). While conceding that "the crude comparator of 'staff resources deployed per institution regulated' shows banks and building societies having more than double the resources of those that are deployed on life insurance companies" (par. 7.9), it reports not seeing at FSA "lack of resources as an issue in the prudential regulation of Equitable Life, ... but rather a better application of resources" (par. 6.3.4).

Concerning the question of the FSA reaction in the Equitable Life case, it concedes that "when responsibility for the prudential regulation of Equitable Life was transferred to the FSA, Equitable Life ... was already a high profile, “live” issue and was the subject of discussions which had been initiated by HMT-ID" (Treasury's Insurance Department) (par. 6.2.2.). However, it comes to the conclusion that "by 1 January 1999, the “die was cast” and we have seen nothing which the FSA could have done thereafter which would have mitigated, in any material way, the impact of the outcome of the Court case as far as existing policyholders were concerned, or made any material beneficial difference to the final outcome so far as Equitable Life was concerned." (par. 6.2.4.).

Nonetheless, the report admits there were "a number of things which the FSA could have done better ... occasions when both the prudential and the conduct of business regulators did not spot issues to be addressed or, having spotted them, did not follow them up", citing as the main reason "the poor level of communication and coordination between the two arms of regulation, prudential and conduct of business." (par. 6.2.5)

In Chapter 7 ("Lessons to be Learned") the report finally makes a number of technical recommendations(2) on the future FSA regulatory structure to prevent similar shortcomings.

2.         The Penrose Report (March 2004)(3)

The Penrose Report deals in great detail with the role of regulators, describing and commenting on the regulators' scrutiny of Equitable Life's regulatory returns since the late 1980s. The report was however "explicitly precluded from allocating blame or addressing compensation."(4) In Part 6 (Chapters 15 to 18), Lord Penrose relates how the financial strength of the Society was perceived by the prudential regulators and how they approached their supervisory tasks, how they regarded the relationship between prudential and conduct of business regulation and how they responded as the crisis unfolded.

2.1       Definition of prudential supervision

Chapter 15, par.7 and 8 define the focus of prudential supervision as "the financial soundness of the insurer and its ability to handle the risks to which it is exposed and meet its liabilities. Thus, as defined in a 1995 service level agreement between DTI and GAD:

· To regulate the insurance industry effectively (within the duties and powers set out in the [1982] Act) so that policyholders could have confidence in the ability of UK insurers to meet their liabilities and fulfil policyholders' reasonable expectations.”

· To protect consumers by ensuring persons or companies who are not fit and proper, appropriately resourced or soundly managed do not carry on insurance business in the UK.

· To protect policyholders against the risk of companies being unable to pay valid claims. In the case of life insurance companies, this includes the risk that they will be unable to meet policyholders' reasonable expectations.”

Or to put it briefly: "The main purpose of insurance supervisory legislation is to protect the public from loss through the insolvency, dishonesty or incompetence of an insurer."

Lord Penrose further recalls that "besides informing the regulators at DTI and their advisers at GAD, regulatory returns were public documents and this transparency was relied upon to impose additional discipline on life companies by exposing details of their financial position to critical analysis by informed commentators ..." (par. 9)

2.2       Intervention powers by regulators

Under the Insurance Companies Act 1982 and on specific grounds, the prudential regulators had the power to issue a direction withdrawing a company's authorisation to conduct new business and the power to intervene in a number of circumstances. In addition, a "residual power" enabled the prudential regulator to take any action needed to protect policyholders or potential policyholders against the risk that the company might be unable to meet its liabilities or fulfil the policyholders' PRE(5).

In his report, Lord Penrose specifies that "the regulatory role of DTI was underpinned by various powers of the Secretary of State under the Act, including powers to require information, to withhold approval for new controllers, and to intervene in the running of the business in various ways, ultimately including withdrawal of authorisation to write new business..." (par.10)

Considering the incorporation of PRE as a trigger for intervention in 1973 "the regulator was bound to consider not only whether the concerns about PRE were sufficient to justify its exercise, but also how it might be exercised in a manner that was appropriate to the purpose ... The regulator would have to balance a number of competing interests, for instance the expectations of several groups of policyholders, or the interests of actual and potential policyholders." (par. 11)

A differing interpretation had been presented to the Penrose inquiry by GAD, stating that "intervention would only be exercised where it was “obvious” that reasonable expectations were not going to be fulfilled, and that this would “stop well short” of seeking to ensure value for money or a particular level of bonus regardless of the surplus revealed by the periodic valuation." (par.12)

2.3       Interaction of regulators

Defining "initial scrutiny" as the regulator being "specifically directed ... to consider whether the documents are accurate and complete, and is required to communicate with the insurance company “with a view to the correction of any such inaccuracies and the supply of deficiencies” (par.13)

In 1984, the respective responsibilities of DTI and GAD for the regulation of insurance companies were formalised in a "service level agreement" (reviewed in 1995), detailing that "DTI retained responsibility for taking formal action on behalf of the Secretary of State, and ... remained the primary interface with the company but GAD were responsible for the examination of returns and were given discretion to pursue questions directly with the insurance companies ... though they were not permitted to approach auditors directly, nor were they to contact appointed actuaries ". (par.34)

The agreement set out a scheme of priority ratings (1-4) to be assigned by GAD on the basis of their initial scrutiny of returns (1=top priority, 4=low priority). A further agreement was drawn up in October 1998 for the transfer of functions from the DTI to Treasury. "The staffing levels available to the prudential regulators varied, but the number of staff with direct responsibility for the Society and their grades within the civil service remained broadly constant." (par. 39)

"Interaction between prudential and CoB regulatory bodies ... (partly viewed as 'tick-box' regulators) seems to have been relatively limited in the 1980s. From 1992 there was some additional formalisation of the interaction through the mechanism known as a 'college of regulators': regular meetings between various financial services regulatory bodies, hosted and chaired by the body perceived as the lead regulator for a certain type of firm: for life insurers, this was DT." (par.26 and 29).

2.4       The unchallenged double role of Mr. RANSON

Under the 1982 Insurance Companies Act the DTI was also assigned the task of considering whether an insurance company and its management (i.e. directors, appointed actuary and significant shareholders) were 'fit and proper' to assume their role.

An issue of particular concern appears the role of Mr. Roy RANSON, Appointed Actuary of Equitable Life since 1982, who on 30 June 1991 became Chief Executive of the Society without relinquishing his former post. This raised the question of a possible conflict of interest negatively affecting the policyholders' interests - a problem addressed by regulators on several occasions but without any formal action being taken by them.

The report details how "GAD was consulted. The Government Actuary, Christopher Daykin, advised on 17 April 1991 that he wished to discourage Ranson from holding both positions, other than on a very temporary basis ... The Society was informed by DTI on 26 April that it was considered undesirable for the same person to hold both positions ... Ranson said that the Society's in-house actuaries needed a further 12 months or so of senior management experience before assuming the role of appointed actuary. It was preferred that he should remain the appointed actuary for 12-18 months until an in-house replacement was appointed ... Daykin agreed that the temporary situation could be accepted and Burt informed DTI on 13 May that GAD were content on the basis that it was intended to be for a limited period." (Ch.16-35 and 36).

In reality, Mr. RANSON was allowed to overstay in his double role far beyond the initially allocated "transition period" of 12-18 months, finally staying on for over 6 years until his retirement in July 1997.

2.5       Alleged Regulators' shortcomings in general

The Penrose report cites a number of shortcomings by UK regulators in the accomplishment of their regulatory and supervision duties which are here summarized for easier comprehension in three groups according to severity. Again, a reference to the time-frame related to the application of the First (1LD) or Third (3LD) Life Directives (i.e. before/after July 1994) should be taken into account to correctly assess the report's findings.

a) Lack of knowledge and/or weak monitoring

"The scrutiny reports on Equitable's regulatory returns from the mid to late 1980s were relatively brief, terse documents, normally running to a page or a page and a half. They were prepared by GAD ... The scrutiny reports would record a few headline figures, the amount of new business written, the movement in mathematical reserves and the cover for the required minimum margin (RMM) of assets over liabilities." (Ch.16-1.) The Society's cover for the RMM was clearly a key index ... dropping through the mid to late 1980s, from 8.5x in 1984 to 3.8x in the 1988 returns. In the absence of the correspondence files, it is not possible to say exactly what doubts may have existed over the returns, or how the downwards trend in cover for RMM was regarded, but it would not appear to have been an issue of any great concern to regulators." (Ch.16-3)

"There are no DTI correspondence files dealing with Equitable for the period prior to 1991. A group of earlier files was destroyed ... in 1998 while the regulatory return files were still available (1987 and 1988 missing) back to 1981." (Ch.15-46, 47 and 53)

"The scrutiny of the 1989 returns was completed on 5 December 1990. The report was only a page." (Ch.16-14)

Pickford (GAD actuary) observed that in 1991 “our remit was mostly concerned with solvency, rather than bonus declarations. Asset share techniques were only just being developed at this time. We did not monitor a company's bonus smoothing process, therefore, focusing instead on compliance with the regulations, especially on the valuation of liabilities and solvency margins ... as a result the system as a whole was open to exploitation by un-regulated decisions on bonus mix." (Ch.16-53)

Lord Penrose comments having discussed "the formulation of the bonus notice in the context of PRE. ... but no-one at GAD or DTI appears to have taken note of the change in format at the time. Neither organisation made it their practice to look at bonus statements. Indeed, the Society's approach to bonuses, which I understand was unique, was not mentioned by the regulators until March 1993." (Ch.16-57)

"Line supervisors and senior line supervisors were not equipped by qualification or experience to form an independent view on the significance of such issues." (Ch.16-81)

In the analysis of the 1991 returns it went unnoticed that "there appeared to be “little or no margin” in the valuation rates used in 1991. In order to pay the bonuses declared in 1989 and 1991 the company needed to earn 11¼% per annum. In fact the company earned +3% over the two years instead of the required 23%." (Ch.16-83)

"GAD was not expected to “give a great deal of emphasis to bonus declaration issues, except in cases where PRE was a source of dispute”. The service level agreement did not provide for GAD proactively to pursue bonus policy issues with companies." (Ch.16-120)

"The scrutiny report on the 1993 returns ... ran to some 17 pages. This was the first new style scrutiny and contained not only much more information about the company but also sections which highlighted 'Key Features' and 'Action Points'. The new style reports, later formalised in the 1995 agreement between DTI and GAD, were a vast improvement in the quantity and quality of information supplied to DTI." (Ch.16-142)

"So far as regulators were concerned, it appears that the liability of members of the Society for the loan debt was of low priority. The risk may not have been understood by regulators. On 9 December 1997, the line supervisor wrote to her German counterparts in response to a query about the Society's position: “Equitable is a mutual insurance company. This means that it is owned by its policyholders and there are no shareholders. Being a member does not involve any obligations other than the obligation to pay the premiums.” I cannot endorse this view. Equitable was and is an unlimited liability company". (Ch.16-215)

b) Complacency or "easy hand" policy by Regulators

"Regulation, and GAD's advice, were focused exclusively on the solvency margin over contractual liabilities and took no account of accrued terminal or final bonus, notwithstanding that, at the date of the 1989 report, exposure to falling markets was real and was known to GAD and the regulators." (Ch.16-16)

"The Society ... was too venerable to be of real concern, and lack of information provided grounds for inaction ... Regulators had been given an insight into the Society's practice that might reasonably have alerted them to a need for monitoring of current and future practice. No special steps were taken to put in place a suitable system." (Ch.16-21)

On 19 May 1992, there was a meeting between Equitable Life and the regulators, "the meeting was part of a programme of three-yearly visits by DTI and GAD to companies and was the first visit to the Society under the programme, and the first meeting between GAD and the Society since November 1990 ... The senior DTI line supervisor for the Society from 1986 to 1991 has told the inquiry that he had never met anyone from the Society face to face. This state of affairs was explained on this basis: “As ELAS were perceived to be well run and sound there would have been no reasons to seek a meeting.” (Ch.16-58)

"Pickford (GAD) said that it had not gone as expected and that he had come away quite angry and frustrated that they had not been able to see and assess any other of the Society's managers." (Ch.16-70)

"The perception of the Society's uniqueness was echoed in a number of the regulators' statements taken by the inquiry. It is unfortunate that appreciation that the Society was unique did not provoke a keener interest in the implications for policyholders." (Ch.16-71)

"While the scrutiny (of the 1991 returns) was in progress, advice was submitted ... to the Secretary of State regarding an invitation to lunch received from the Society. It does not appear from the files that GAD had passed to the DTI the revised figures as per Ranson's 15 June letter and the brief was probably prepared on the basis of the earlier figures." (Ch.16-74)

"The meeting on 19 May 1992 was ... an important opportunity to get what further information was available and to face the Society's problems head on. Regrettably it seems that although some issues were raised with the company, little if anything was resolved." (Ch.16-99)

"Possibly due to the changes of staff at GAD and the DTI after the 1991 scrutiny report, it appears that the general concern about the Society and the specific questions raised ... were allowed to evaporate. The process was lengthy. The quality of GAD's response to queries was poor, and the letters uninformative. The decision to ask no further questions but instead to look ahead to the next year, reflected previous practice. But it resulted in failure to obtain a full account of the Society's position." (Ch.16-103)

"The labelling of the Society as unique appears frequently within the regulatory papers, but what is absent is any analysis of the extent to which this might prove a barrier to effective regulation and, if so, what changes to the current regulatory system might be needed ... Despite terminal bonuses, the valuation basis and new business strain, none of these issues was effectively dealt with or resolved by GAD or DTI. The scrutiny process for the 1991 returns indicates that, without explicit guidance from GAD, the regulators did not have the depth of knowledge about the Society that would have enabled them to make a more accurate assessment of the Society's financial strength. GAD did not provide detailed explanations of many of the issues raised." (Ch.16-104)

"There was no immediate regulatory response to the Society's return to the GAD survey (on bonus distribution). It is not possible to say what was made of the enigmatic first point, that "regard was had ... to projected trends in asset shares." (Ch.16-106)

"In late 1993, the company received an AA rating from Standard & Poor's for its excellent claims paying ability.” (Ch.16-123)

"The Society's return to the bonus survey called for analytical review. It was not self-explanatory and the reference to future trends in asset shares clearly required investigation. The information provided ... could not be reconciled with the replies on asset share methodology and the smoothing cycle, except on the basis that the period had not been normal. The nature and extent of the abnormalities required further investigation. None was undertaken." (Ch.16-131)

"The failure to respond to the information tendered about annuity guarantees and the proposed solution was a serious error. The bonus survey replies showed that no specific information was given to policyholders on the likely frequency of changes to final bonus rates. ... Failure to relate the problem of low interest rates and the increase in final bonus at this stage and to explore Ranson's description of the Society's approach, however garbled and obscure, resulted in regulators having no insight into the annuity guarantee issue until it was disclosed publicly in 1998." (Ch.16-132)

"It appears that DTI did not have sufficient sources of information, internal or external to the Society, to respond to the information that such annuity guarantees existed and were becoming valuable. DTI did not receive a copy of the December Board paper until late 1998 well after the GAR issue had emerged ... Casual acceptance of the Society's position on guarantees as a selling issue, and not one raising prudential issues, reflects complacency for which there could be no justification on information available to the prudential regulator and GAD." (Ch.16-134 and135)

The meeting held on 9 December 1994 "was the first meeting attended by anyone from the Society other than Ranson ... and Ranson announced that he would continue with his dual role until the spring of 1996" (Ch.16-153)

"If GAD did not raise it as an area of concern, DTI would not be concerned" (Ch.16-166)

"The papers prepared for the December 1994 meeting had reflected some concern about the Society in that year; the weakness of the liability valuation, reliance on 'aspirational' assets, vulnerability to shocks, the risk of distribution policies generating policyholders' reasonable expectations, over-distribution and the need for particular vigilance in supervision. The issues had not been debated fully or resolved. The declaration of a growth rate of 10% as against a negative investment return of 4.2% combined with the weakness of the valuation should have caused the regulators to dig deeper into the Society's financial health. Once again, other than to note that the Society was vulnerable, the regulators seemed complacent about its position (reflected in ... being reduced to a rating of 4, which meant that there would be no requirement for scrutiny to be completed earlier than within 9 months)". (Ch.16-191 and192)

"On 17 November 1997, the National Health Service executive wrote to DTI asking about the suitability of the Society to be their AVC provider. An internal memo about the request noted that the Society's RMM cover for the 1996 returns was 2.53x and 2.07x without the implicit item. In a handwritten note ... the line supervisor noted that they had referred to the strong solvency cover of another well-known company in reply to a similar recent request but that the Society's cover “isn't that hot”. Having considered the appropriate response, the reply to the NHS, dated 26 November 1997, stated that, based upon the 1996 returns: “we would say that the company is financially sound. There are no outstanding issues of a material nature pertaining to the DTI's regulation of [the Society or its subsidiaries].” There is no reason to view this statement as other than honest and it is clear that some consideration was given to the reply but as an honest assessment it reflected the poor understanding of the realistic financial position of the Society that DTI had at November 1997." (Ch.16-226)

"The 1996 scrutiny report suggested, for the first time in a scrutiny report, that it would be “desirable” for the Society to hold back more of its emerging surplus by declaring lower guaranteed bonuses, while keeping up generous final bonus payouts, as long as expectations were not raised. The picture that emerges is of a very incomplete understanding of the statutory requirement and a narrow approach to the assessment of PRE. This was the first scrutiny report to have a specific heading entitled PRE (within the bonus section). Despite this, there seems still to have been no system in place (nor any in contemplation) by which PRE might have been actively assessed. The correspondence which followed the scrutiny ... appears ... to show that whilst GAD were becoming increasingly concerned about the Society's vulnerability, bonus notices and PRE ... they viewed their remit in this area as limited to one in which they sought and received reassurance from the Society that they were alive to the problems." (Ch.16-247 and 248)

In January 1999 "there appears to have been a lack of enthusiasm for positive intervention, and preference for advice and warning of the possibility of action failing remedial steps by the Society. The briefing note for the 15 December 1998 meeting had painted a picture of a company that could not afford to declare a bonus and it had been concluded at the meeting itself that there was power under the sound and prudent management umbrella to prevent such a declaration. With intervention as a last resort ... passing a bonus was "probably necessary for the prudent management of the Society”. In any case, FSA did not insist." (Ch.17-110)

"(EL) Headdon's self-indulgent interpretation of “a few % points” was disregarded by all but the more junior of the actuaries involved. GAD considered that no effective action could be taken." (Ch.17-111)

"Due to the explosion of the annuity guarantee issue there had been no scrutiny report on the 1997 returns and therefore the regulators had not had the benefit of such a report since the 1996 scrutiny report in December 1997. GAD completed the initial scrutiny of the 1998 return on 9 April 1999 ... The FSA still lacked the further information about solvency projections and contingency plans requested ... on 1 February 1999. They chased the Society for these (and a copy of the finalised reinsurance treaty) on 15 April. The full scrutiny report, dated 20 May 1999, ran to some 23 pages and headlined the Society's priority rating as 2. It combined statements on both 1997 and 1998" (Ch.17-128,133 and139)

"The relative complacency of the1998 report reflects the extent of the reliance being placed upon the reinsurance treaty by both GAD and FSA, and the concentration of attention on regulatory solvency rather than any realistic view of the Society's long-term position." (Ch.17-146)

"In August 1999, while the outcome of the (High Court) case was awaited, FSA prepared an “initial risk assessment” of the Society as part of a pilot project for a new risk-based approached to supervision. In it the Society was classified as a “high financial risk” because of the level of guaranteed benefits, low free asset position and the difficulty of raising external finance. Under the heading 'Management' the Society's cultural attitude was described as having: “A tendency toward arrogant superiority regarding the efficiency of their operations and the high priority given to the interests of policyholders. This can blind them to the financial risks that can arise as a result of guaranteeing high benefit levels. However they are open with the regulator and there are no particular concerns about the level of cooperation that has been shown in the past.” The assessment acknowledged that there was little evidence available about corporate governance." (Ch.18-22)

"On 13 September 1999 the FSA senior line supervisor suggested to Headdon that there should be a general company visit in early December (the last such visit had been in November 1996)." (Ch.18-25)

c) Negligence by Regulators

"No scrutiny report has been found in either DTI or GAD files for 1987 or 1988, and the inquiry has been told by the then principal actuary ... that it is possible that no detailed scrutiny report was prepared because GAD were involved in a recruitment drive ... to fill various vacancies." But "these years were crucial as 1987 was a poor year for the Society in the markets... and the Society's available assets were insufficient to cover total policy values at the end of each year." (Ch.16-7)

"Burt (principal actuary at GAD) ended with a surprising conclusion ... “At present we do not have enough information about the society to be more specific and indeed, unless the society makes more signals, we do not suggest that further information should be sought. The society is our longest established life company and is well respected in the market". Yet "examination of ... the Society's practice would have revealed that, despite a total allocation well below the investment return in 1989 ... policy values accounted for 104% of available assets, which in turn might have revealed a substantial deficit brought forward from 1987 or before. But this information was not required as part of the returns, nor was the Society asked to provide it otherwise at this stage." (in 1990 - Ch.16-21 and 28)

Scrutinizing the 1990 returns, GAD failed to realize that "the Society had allotted a notional total growth rate of 12%, despite a net investment return of minus 10.4%, the first negative return for the Society since 1974 ... Pickford (GAD) had been put in possession of critical information that disclosed the Society's precarious position and the extreme nature of the steps taken to maintain bonus allocation in a year of severe losses." But "it would appear that Pickford respected Ranson's request not to pass the papers to DTI. In an undated note to Burt about the letter and its contents, Pickford concluded that: “I don't think we need to show these to the DTI unless the situation in due course warrants it.” (Ch.16-40 and 43)

Negligent behaviour appears evident when "on 26 July, not long after the receipt by DTI of the 1990 returns, Pickford (GAD) wrote to Ranson thanking him for the papers, referring to discussions at the upcoming meeting about issues “in this general area” and assuring him that they would get "an extremely restricted circulation". ... Later Pickford acknowledged he was in error in allowing a private understanding with Ranson to cloud his duties to regulators.” (Ch.16-43 and 44)

On this issue Lord Penrose concludes saying that "GAD have told the inquiry that it was established practice for information that was “primarily technical and actuarial in nature and had been provided to GAD” not to be routinely passed to DTI, and that the papers in question revealed nothing of immediate concern as regards the Society's solvency position. GAD also appears to reject my view that the papers disclosed important changes to the Society's bonus system ... I do not accept GAD's view of the papers' contents or their significance, or the basis upon which they were withheld from the regulators. The 1990 scrutiny report was sent to DTI on 20 November 1991. At a page and a half it was typical of the period, but given the concerns existing at the time, it appears totally inadequate ... The papers which Ranson passed to Pickford disclosed an approach to the 1990 bonus allotment that should have raised serious questions amongst the regulators. Having received them, Pickford appears to have made little of them ... He did not pass them to DTI." (Ch.16-46, 47 and 52)

"Roberts (DTI) commented on 4 November 1992: “This paints a worrying picture. Over-distribution by a company with a (deliberately) short coverage of its RMM and a (continuing) policy of high equity exposure. I think we should ask GAD for a better assessment of the position and of the options available to the company in the event of a significant further downturn in the market ... How long could it continue with present bonuses in the face of a zero yield?” These comments do not seem to have been passed on to John Rathbone, who had taken over from Burt as principal actuary, until 14 January 1993." (Ch.16-86)

"The priority rating for the Society' regulatory returns for 1992 had again been 3. The scrutiny report for 1992 was not completed until 28 March 1994 and ran to only two pages. In general the points were favourable." (Ch.16-124)

"The regulators failed to respond to the existence of the guaranteed annuity rates and the Society's proposed solution, as revealed (albeit opaquely) in the returns and at the November 1993 meeting. Nowhere in the scrutiny report for 1993 was anything said about the annuity guarantee issue ... There has been no explanation of the failure of those involved to note the importance of this issue ... The regulators also missed an opportunity to make a full assessment of the Society's increased use and presentation of final bonus." (Ch.16-163 and 164)

"Each year from 1987... to 2000 aggregate policy values exceeded available assets at market value (albeit by varying amounts and percentages) on a fund basis. The figures for the post-1991 period that would have demonstrated this were never in the possession of the regulators and, until the end of 1997, never requested by them." (Ch.16-173)

"Whatever GAD was told about the position as at November 1996, information which would have shown the duration and full extent of the excess seems not to have been requested from the Society. Thus on two important issues (terminal bonus and the excess policy values position) there seems to have been a failure by the regulators to ask for and analyse such further figures or documents as would have enabled them to make a proper assessment of problems that were then being discussed with the company." (Ch.16-206)

"Whatever level of concern was developing within GAD (in May 1998) and being expressed on these various issues, the documents available do not reflect any corresponding concern on the part of the Treasury, or appreciation that GAD may have been communicating concern to the regulator. The Treasury remained wholly passive, depending on GAD to initiate any action required." (Ch.16-251)

"Concern was growing, but remained low level. HM Treasury appear to have been content to allow GAD to conduct the dialogue with the Society without active Treasury participation ... consistent with the service level agreement (a revised agreement was concluded in December 1998). However, reading the service level agreement only deepens the impression that any broader regulatory view that might have been formed was being subordinated to ongoing technical discussions on a purely actuarial basis. It was a transitional phase in the development of regulation. It is difficult to avoid the view that regulation was falling between two stools, the major player in discussions having no regulatory power, and the empowered regulator having little part in the processes that would have instructed regulatory action." (Ch.16-252)

"The High Court hearing was due to commence on 5 July 1999. On about 8 June the senior line supervisor circulated a paper entitled 'Equitable Life Court Case-Possible Scenarios'. So far as the inquiry has discovered, this was the first document prepared by GAD or FSA which recorded any substantive consideration of the court case. ... The formulation of the consequences of the worst-case scenario was focused on immediate or short-term administrative problems. It did not identify any longer term considerations relating to the Society's future." (Ch.18-1 and 6)

"The first meeting with the Society about the court case took place on 29 June 1999 (a few days before the hearing was due to commence and over six months since the Society had notified HMT of their intention to raise proceedings)." (Ch.18-17)

"On 22 May 2000 the senior line supervisor offered the opinion that “[The Society] are not the strongest life office you will find but nor is there an immediate prospect of them going broke (even if they lose in the House of Lords)”. In short, the adverse judgment was not seen as affecting materially the Society's financial position, and very little was done by FSA in relation to the court case between the Court of Appeal judgment in January and whispers of the possible outcome in June and July of the House of Lords' hearing. There was no updating of the earlier scenario document (prepared for the High Court hearing) until the day before the House of Lords' judgment." (Ch.18-47)

2.6       Timeline of acknowledgement by Regulators of concerns about Equitable Life

14.11.1990: "Burt (principal actuary at GAD) expressed concern about the position of the Society, particularly if the market were to fall any further or even remain at its present level. Ranson acknowledged that if the market fell by a further 20% they would “have problems and he would have to consider what action should be taken. Although there were clear concerns, the implication of the memos from both GAD actuaries was that no further action was required."(Ch.16-11, 23) However, "having been concerned about the position of the Society in 1990 (as reflected in the 14 November 1990 meeting and the correspondence which followed), neither GAD nor DTI appear to have sustained this level of interest in the Society during 1991." (Ch.16-51)

14.05.1992: "In the margins of the Burt (GAD) memo, one of the supervisory team at DTI noted, in addition, that “Paul Burt thinks they have been paying too much in bonuses." ... And under weaknesses it listed: ... Mr Ranson's position as Principal Executive and Actuary may create problems because there is nobody to blow the whistle when things go wrong ... Pickford (GAD) noted that he liked the Society's philosophy for its policyholders, but felt that its solvency strength was arguable ... and stated that he would be concerned about the Society's performance if there were dramatic falls in the market. There the matter appears to have rested.”(Ch.16-66 and 68)

15.09.1992: "On 10 September Ranson sent some background information to Burt (GAD). This information ... laid bare the current reality of the excess of aggregate policy values (defined in the letter as “present values of guaranteed benefits plus final/terminal bonuses at the rates then current”) over asset shares as follows:

1989: 104%; 1990: 124%, 1991: 120%

This was information that would not have been available in the returns. At some stage this letter was passed on to DTI." (Ch.16-77).

04.11.1992: "Meanwhile the scrutiny report had caused some disquiet at DTI. Roberts commented in manuscript on the report...: “This paints a worrying picture. Overdistribution by a company with a (deliberately) short coverage of its RMM and a (continuing) policy of high equity exposure. I think we should ask GAD for a better assessment of the position and of the options available to the company in the event of a significant further downturn in the market... How long could it continue with present bonuses in the face of a zero yield??" (Ch.16-86)

11.01.1993: "the Society had applied for and been granted a Section 68(6) order for a future profits implicit item of £360m." (and again for increasing amounts in the following years). The GAD memo concluded: "Overall I suspect that Equitable could survive a short-term fall in market levels, even a substantial one, as well as most companies. Their portfolio, however, must leave room for concern, were there to be a prolonged period of depressed share value. Their recent shift towards fixed interest securities will ease the difficulties, although they argue at the expense of the expected ultimate benefit to policyholders.” (Ch.16-93)

30.11.1993: At this meeting between regulators and the Society "the existence of the annuity guarantees and Ranson's proposed solution were apparently disclosed to both GAD and DTI ... However it was not followed up and did not receive another mention in the regulatory papers until after the issue had been exposed in 1998. Thus GAD had uncovered a GAR issue..." (Ch.16-117)

09.12.1994: "A GAD briefing note dated 6 December prepared for the meeting listed recent issues ... applications for certain section 68 orders in relation to investment holdings, the Society's classification of critical illness and major medical expenses plans, and Ranson's dual role. The list of concerns was narrowly focused. It omitted reference to either the annuity guarantee or the bonus issue ... It was the first meeting attended by anyone from the Society other than Ranson." (Ch.16-152 and 153)

05.11.1995: An article appeared in a Sunday newspaper reporting that Equitable Life had a low free asset ratio and suggested that independent financial advisers were not recommending the Society's products. "On 6 November 1995 DTI received a telephone call from a policyholder who wanted to know what they were going to do about the poor financial position of Equitable as reported in the press article. An internal note dated 8 November drew the article to the attention of the senior line supervisor. It noted that: EL has a different way of calculating their reserves than most [companies] but surely their financial strength can be ascertained from the DTI returns, albeit not necessarily from Form 9. Otherwise how [would] S+P(7) be able to give them such a good rating?” (Ch.16-177)

08.11.1996: "The scrutinising actuary noted that the Society had to be very careful about their bonus statements to ensure that customers were not misled about the benefits. There appears to have been no follow-up on this point, as the notes moved to another issue, the strength of the valuation. Ranson ... intended to stay on "until the changes had been consolidated."" (Ch.16-203 and 204)

13.01.1998: "The scrutinising actuary asked whether it was correct that total current asset shares exceeded total current admissible assets and requested a figure for the accumulated asset shares for all in-force accumulating with profits contracts at the end of 1996. Headdon responded ... that he had some difficulty in understanding the question about assets shares, but confirmed that the total face value of the policies including final bonus was in excess of the attributable assets." (Ch.16-234 and 235)

27.02.1998: "GAD responded ... while offering the reassurance that no consideration was being given to outlawing the Society's bonus notices ... that: “it would become a matter of concern if any holders of accumulating with-profits contracts were ever to feel that they had been misled.” Further GAD stated: "The manner in which Equitable operates as a mutual, giving the best possible returns to each generation of policyholders, with the consequent lack of any substantial unitised free estate, does mean that you do not have much of a cushion to enable you to protect holders of such contracts from the natural effects of future falls in the market value of assets. We remain confident that your company is fully aware of this.” This correspondence was passed to insurance division, now transferred to the Treasury." (Ch.16-238)

06.12.1999: "The meeting was attended by the two FSA line supervisors, the principal and scrutinising actuaries and Nash, Headdon, Thomas (the investment director) and the general manager, sales and marketing, from the Society ... The supervisors intended “to fill in some of the gaps in its knowledge about the Society” at the visit ... The issue of GAR reserving was taken up and the senior line supervisor announced that the Government Actuary would be writing to all companies to clarify his January guidance, which could mean that Equitable would need to increase its reserves. It had thus taken nearly 10 months for GAD and the FSA to decide to clarify the reserving guidance, leaving the possibility that the 1998 returns (as well as the 1997 returns) showed reserves for the annuity guarantees which were thought by the regulators to be inadequate." (Ch.18-38)

2.7       The Penrose Report's conclusions

The Report dedicates a substantial part of its conclusions (Chapter 19, paragraphs 149-163) to the UK regulatory regime. It highlights how "prudential regulation of life insurance companies focused on a system of returns ... and in the case of the Society, supplemented in and after 1991 by visits to life offices. (Equitable was among the first offices to be visited.) The returns required information relating to the long-term business of the Society in response to specific questions." However, regarding the implementation of supervision, he finds that "it was considered that it was not a proper function of regulation to substitute the regulator's judgement of what was optimal from a regulatory standpoint for the judgement of the management." (par.150) While stating that "scrutiny of the returns to ensure conformity with the current regulations ... did not exhaust the scope of regulation", he specifies that "the financial information required of offices in the returns of long-term business was focused on the contractual liabilities of the office."(par.149 and 151)

Lord Penrose further explains how the GAD had told his inquiry that it was “the overriding principle of regulation and of supervisory monitoring that reliance should principally be placed on the appointed actuary, who was close to the company and had a professional responsibility to monitor its financial position on a day-to-day basis and to establish technical provisions.” Similarly, and referring to the disputed double role of Mr. RANSON as Equitable Life CEO and Appointed Actuary, those responding on behalf of the Treasury told his inquiry that "unless the actuary was acting in some way contrary to the regulations, it was not the task of the regulator (or its actuarial advisers) to substitute its judgement for that of the appointed actuary in areas where the appointed actuary had a clear professional responsibility.” (par.154)

While not disputing that there "had been an advantage in not seeking to prescribe a fixed actuarial approach", Lord Penrose states that in the mid-70s "the system placed too great a reliance on the appointed actuary", a fact apparently "recognised by FSA in their proposals for reform of this role." (par.155). However, he highlights that the annual returns to the regulators contained various "practices of dubious actuarial merit" and that "there was a heavy responsibility on the regulators to monitor, or to procure the monitoring of, the valuation of the mathematical reserves and the quantification and treatment of implicit items in order effectively to assess the solvency position of the Society in terms of the valuation regulations" (par.156)

Regarding the question of structures and resources of the UK insurance regulators, Lord Penrose states very clearly that "the DTI insurance division was ill-equipped to participate in the regulatory process. It had inadequate staff, and those involved at line supervisor level in particular were not qualified to make any significant contribution to the process. Insurance division regulators were fundamentally dependent on GAD for advice on the mathematical reserves, implicit items, technical matters generally, and PRE, and were not individually equipped with specific relevant skills or experience to assess independently the Society's position in these respects. Given the volumes of work to be handled, which extended far beyond the regular scrutiny of returns, higher-grade officers had little opportunity to become involved in routine regulation", adding that "a need for greater regulatory resource had been identified at that time". He concludes saying that "for all practical purposes, scrutiny of the actuarial functioning of life offices was in the hands of GAD until the reorganisation under FSA was in place." (par.158)

Although Lord Penrose confirms that "GAD actuaries were held in high regard by the regulators" he says that "they were often inhibited by their understanding of what was acceptable within broad and ill-defined standards of practice", suggesting that "Government required a 'light touch' approach to regulation, and allocated resources accordingly." He further suggests that "increased resources ... might have improved the chances of identifying problems", and hints at the UK political climate prevailing for most of the 1990s, when the Government's objective "was to deregulate, to reduce regulatory burdens on business, to avoid interference in private companies, and to let market forces prevail." (par.159, 160 and 161)

Finally, he states that "reforms were introduced, within the legislative framework that existed, but that Ministers had repeatedly ruled out primary legislation in this area" as there had been a general perception that " life insurance supervision was a success, as there had been only one insignificant life company failure in twenty years." Partly for this reason "virtually no primary legislation in the regulatory area for which DTI was responsible was taken forward by Ministers", adding that he saw no "wish list of legislative amendments that identified fundamental structural reform as a possible subject for legislation." (par.162)

In his conclusion, Lord Penrose argues that "principally, the Society was author of its own misfortunes. Regulatory system failures were secondary factors" (Ch.20, par.84) indicating however the following points as 'key findings'(8) of his inquiry in relation to the role of the UK insurance regulators:

a) UK regulation was based on an over-reliance on the Appointed Actuary, who in the case of the Society was also the chief executive over the critical period from 1991 to 1997, despite recognition of the potential for conflict of interest inherent in this position; (par. 240.7)

b) The regulatory returns and measures of solvency applied by the regulators did not keep pace with developments in the industry ... Thus regulatory solvency became an increasingly irrelevant measure of the realistic financial position of the Society; (par. 240.8)

c) The significance of policyholders' reasonable expectations (PRE) under the legislation was understood by the regulators ... There was, however, no consistent or persistent attempt to establish how PRE should affect the acknowledged liabilities of the Society; (par. 240.9)

d) The regulators failed to give sufficient consideration to the fact that a number of the various measures used to bolster the Society's solvency position were predicated on the emergence of future surplus; (par. 240.10)

e) There was a general failure on the part of the regulators and GAD to follow up issues that arose in the course of their regulation of the Society, and to mount an effective challenge of the management. (par. 240.11).

Lord Penrose concluded by stating that "the picture that emerges is of a Society that had deep-seated financial and management problems that pre-dated the emergence of the GAR problem ... The judgement of the House of Lords in Hyman precipitated a crisis, but was not solely responsible for it. The lessons that emerge are broad, and relate to the responsibilities of all main parties concerned, directors, management, auditors and regulators." (WS2)

(1)

As recalled by Mr. BRAITHWAITE (H11), the Baird report was precluded from looking at the period of primary negligence, from 1990-98 and it covered only the 23 months prior to closure, for which the FSA was responsible.

(2)

Recommendations were made in particular in relation to: tightening of solvency standards; disclosure of financial reinsurance; introduction of multiple control levels; independent review of AA; content and frequency of regulatory returns; improvement of proactive regulatory culture; improvement of communication and coordination within FSA, along with the improvement of risk-assessment processes, in order to ensure "consistency of interpretation and application across the regulatory process".

(3)

Underlining in this section was added by the rapporteur.

(4)

Mr. BRAITHWAITE (H11).

(5)

see ICA 82, Sections 11,37,38,45.

(6)

Section 68 of the Insurance Companies Act 1982.

(7)

Standard & Poor's.

(8)

Chapter 19, page 726.


IV.      Other Oral and Written Evidence considered by the Committee

In order better to assess the life insurance regulators' compliance with the Community law provisions in the UK and the other Member States concerned, the Committee of Inquiry invited a number of experts and witnesses to present the committee with oral and written evidence on the Equitable Life case(1). Witnesses invited included individual policyholders and representatives of policyholder associations, government representatives, senior officers of present and past life insurance regulators in the UK, Ireland and Germany, representatives of the Commission, actuaries and experts in life insurances, annuities and forensic accounting, as well as other experts or stakeholders, including the current management of Equitable Life.

According to data provided by Mr. THOMSON, current Chief Executive of Equitable Life, in 2001 "roughly 1.5 million people had an interest in the Society's with-profits fund; this included about 8.000 with-profits policyholders in Ireland and about 4.000 with-profits policyholders in Germany. In addition there were approximately 6.500 international policies sold through the Society's Guernsey office to individuals resident throughout the world, some of whom will be in Europe"(WE47).

Regarding Equitable Life's international policyholders, Mr. SEYMOUR (WE53) offered more precise data, stating that the Society had in the late 90s "13.405 policyholders outside the UK, residing in 13 different EU Member States.(2)"

The evidence presented by other witnesses focused on a number of key issues which can be grouped as follows:

1.         Negligence in prudential regulation and supervision

Converging views were expressed by witnesses (petitioners, affected policyholders or representatives of policyholders' action groups) in highlighting a number of wide-ranging concerns and complaints against the UK insurance regulators, as well as regulators in other Member States concerned.

On this specific issue, oral and written evidence considered by the Committee of Inquiry were submitted by Tom LAKE, John NEWMAN and Paul BRAITHWAITE on behalf of EMAG(3) (H1, H11, WE2, WE14, WE26, WE28, WE29, WE44, WE58, WE74, WE75, WE76, WE-CONF 22-34); Michael JOSEPHS (H2, WE4, WE31, WE42, WE79), Beatrice and Pat KNOWD (WE4), Nicholas BELLORD (H2), Paul WEIR (H2, WE6); Peter SCAWEN (H3, WE23), Markus WEYER (H3, WE22); Liz KWANTES (H7, WE51); Leslie SEYMOUR (H7, WE36, WE52); Joseph O'BROIN (WE3); Michael NASSIM (WE7, WE8, WE33); John VINALL (WE43); Onagh O'BRIEN (WE-FILE3); Frank TROY (WE-FILE4); K.NOONAN (WE-FILE11); Fred McGUIRK (WE-FILE8); Peter THORNTON (WE-FILE12); Jim BERRY (WE-FILE13); Jack DUGGAN (WE-FILE14); Brian EDMONDS (WE-FILE1); Peter SCHÄFER; Patrick O'FARRELL (WE-FILE9, WE-FILE19); Barry and Susan GROVES (WE-FILE7); Albert DOUGLAS (WE-FILE5); Dermot BYRNE (WE-FILE6); John GALVIN (WE-FILE15); Patrick McCARTHY (WE-FILE16); Roy HARDING (WE-FILE17); David STONEBANKS (WE46); N.F.NORRISH (WE-FILE20); W. DEPPE (WE81); Richard LLOYD (H5); Seamus POWER (WE-FILE2), Simon BAIN (H8, WE72).

In their statements they have - to different degrees - accused the UK regulators of failing to exercise properly their regulatory functions in respect of Equitable Life and of negligently failing, over a number of years, to recognize, and to react to, a number of clear warning signs in the prudential supervision of Equitable Life.

In H7, Mr. SEYMOUR claimed that "Article 23 of the Third Life Directive requires that the regulator had to supervise and know thoroughly what was happening to an assurance business whose head office was in his territory – I stress both 'in' his territory as well as the business carried out 'outside' that territory. It also states that the supervisor had to “remedy any irregularities prejudicial to the interests of the assured persons”.

Representing a policyholders' support group, Ms. KWANTES (H7) claimed that "the UK government was one of the main backers of the Third Life Directive in the early 1990s and were very insistent on robust regulation of the Life Industry. A decade later we are told that the regulation was only 'light touch', whatever that means. In my opinion you either regulate or you don't regulate, there is no half-way house."

In WE7 Mr. NASSIM claimed that "the regulators spent over-much time debating the circumstances under which they might use their discretionary powers and in the event never used them when the overall situation required them to do so. As a result they did not recognise or react to any of the important successive stages in the development of that position."

In H8 Mr. BAIN claimed that "lack of supervision allowed Equitable Life to believe it could do whatever it liked, because it was operating in a regulation-free zone."

Referring to Equitable Life's communication culture, which should have allowed an attentive Regulator to eventually spot its potential financial weaknesses, a memorandum supplied to the House of Commons Treasury Committee in January 2001(4) highlighted how "Equitable historically did not shy away from revealing its relatively thin solvency cover but, instead, promoted it as the desirable outcome of what it viewed as its virtuous approach to returning to policyholders as high as possible a proportion of the returns earned on their premiums. Given the wide reporting of this in the media, we think it likely that many persons who became policyholders during the past two decades ... would have been aware of EL's philosophy on not accruing and maintaining substantial excess solvency. The point about EL's relatively thin solvency cover is that it always was going to be more exposed than most other life offices to financial adversity, whether in the form of bad news on the asset side in the event of poor investment market conditions, or on the liability side in the event of unplanned liability inflation brought on by issues such as regulatory intervention".

The former Equitable Life sales representative Mr. LLOYD (H5) felt that even the Equitable's sales force were all "let down by the board of Equitable Life ... It had the duty to tell the policyholders and the sales staff about the risks associated with adding further sums to the existing with-profits fund, and those risks should have been known by 1998, and possibly sooner ... I also feel we were failed by the regulators; no-one in the company outside the board had access to all of the information available, but the regulators most certainly should have had this."

Replying to these allegations, the FSA representative Mr. STRACHAN(5) (H4) considered the complaints "reflect a misunderstanding of what the regulators could or should have achieved in a case such as Equitable Life." He equally recalled that FSA's "risk based supervision accepts that a regulatory system neither can nor should aim at avoiding all failures ... We are not seeking to operate a regime in which firm failures do not occur, since we recognise that such a regime is neither desirable nor possible to achieve in a free market economy. This key principle characterises both the UK's current and former approach to insurance regulation."

This position was echoed by the UK Treasury representative Mr. MAXWELL(6) (H4) who stated that "regulation was not static. There was evolution at both the legislative and regulatory policy level as the market evolved, but the regime did not, and still does not, seek to prevent all failures of or problems with regulated firms ... When it became clear in 1998 that Equitable Life had made no explicit provision for annuity guarantees when setting its reserves, the Treasury reacted swiftly and firmly."

A similar note had been struck by Mr. McELWEE (H3) when stating that from a technical point of view "market failure is not inconsistent with a good supervisory regime" and by Mr. BJERRE-NIELSEN (H7) saying "I do not think that we as regulators or supervisors are able to guarantee that there will never be any kind of crisis, collapse, failures or complaints."

The Commission representative Mr. TERTÁK (H1), director for financial services, declined to comment on any appreciation of the effectiveness or possible shortcomings of former or current UK financial regulators, highlighting instead its role in the supervision of national implementations of the relevant EU Directives. However, as emphasised by Commission representative Mr. BEVERLY in H7 and repeated by Commissioner McCREEVY in H8, the Commission "could not - and had no means to - be the regulator of regulators".

Declining the committee's invitation to appear at one of the hearings, the former Equitable Life Chief Executive (and Appointed Actuary) Christopher HEADDON in WE45 aired his "concerns about the objectivity of the committee members and the way in which evidence is tested (or, more accurately, not tested). It appears that there is a presumption of huge failing in the management of Equitable Life in the 20 years or so prior to its closure to new business in December 2000 ... Commentators fail to recognise the influence of the long bear market in equities in 2000-2003, which saw the policy results for all life offices reduce significantly. The committee members’ apparent presumption of huge failing, as described above, would seem to suffer from the same failure. Policyholders cannot easily distinguish between a reduction in policy values caused by the particular events at the Society and the general reduction which affected the whole industry. Many of them appear to be complaining of reduced expectations rather than any actual loss relative to the market. However, with-profits policyholders across the industry have had their expectations sharply reduced due to investment conditions." In his conclusion, he conceded that it was "entirely understandable that an individual policyholder should not be able to disentangle those two things" but claimed that Lord Penrose's report was "deeply flawed because he made no attempt to do so either, despite having an explicit reference to market comparisons in his terms of reference." (WE45)

1a)       Claims of operational shortcomings by UK regulators

As reported in WS2, academic studies have come to the conclusion that the pre-2001 UK financial regulatory system was "clearly inadequate and lacking coherence, which undermined its effectiveness, as proven by a number of major bank failures and financial scandals in the 1980s and 1990s which rocked the UK financial industry."(7) These cases suggest that an inherent weakness existed in the UK banking and insurance supervising system throughout the 1980s and 1990s, prompting the regulatory reform as defined in the Financial Services and Market Act (FSMA) 2000.

In WE7, Mr. Michael NASSIM detailed allegations of operational failure by the UK regulators, stating that "the Regulators did not intervene in any effective way, although they should have known that such over-bonusing would have inevitable effects. In other words, the Regulator, by inaction, allowed the Society to be put in grave solvency peril, both in immediate terms and in constructive terms. The claimants’ losses flowed primarily from reckless behaviour by the Society’s management which over the period 1973-1987 had critical consequences. This behaviour was of a kind which fell squarely within the scope of the Regulator’s duties and powers to monitor, warn and compel retraction. The Regulator took no action or no effective action and allowed actuarial etiquette to guide its conduct instead of statutory duty. As a result the Prudential Regulator became equally responsible for the losses in question."

Mr. NASSIM also claimed that "the regulators failed to question why the Society inappropriately extended its chronic over-allocation by using inappropriate adjustments and subordinated loans which anticipated future premium income and impacted adversely upon future profits. As a result they failed to digest the prudential and PRE implications. The regulators could not detect the reinsurance arrangements made to cover the Hyman position and did not examine ELAS’ public statement in February 2000 that losing Hyman would cost members no more than £50 million, when reinsurance to the tune of £800 million was nominally being sought to cover the same situation."

He concludes saying "if the Regulator had insisted on truly prudent action at that time or earlier, all final (i.e. discretionary) bonuses would have been suspended indefinitely until the financial condition of the Society could be fully established. In sum, therefore, there is sufficient evidence to maintain that operational regulatory failure was total over an extended period, and that in the later stages it was deliberate, such that it had the effect of extinguishing many just claims without opportunity of recompense. Had the regulators halted this progression, an eventually fraudulent position would have been averted, which effectively they condoned by allowing the Compromise Scheme to take place ... Total operational failure of this ultimate kind can only be due to an overall deficiency in ethically responsible attitude. Others have wished further to maintain that, over and above organisational and operational deficiencies, regulatory failure must also have been collusive."

The memo WE-CONF6 claimed that "it is inescapable that the more someone knew about conventional assurance methods, the less likely he was to be misled by what Equitable did, and the more likely to be suspicious about what was really happening to the premiums. Yet the regulators, who should have been the most expert of all, turned a blind eye to the whole matter."

In his testimony (H4) Mr. Colin SLATER, chartered accountant and expert in forensic accounting, highlighted some accounting weaknesses in Equitable Life's operations which the Regulators could and should have noticed and reacted to. In particular, he reminded how "in July 2000 the Hyman case loss was estimated to cost the Society £1,500m ... Information emerged subsequently has shown that the loss of the GAR case was by no means the only factor contributing to the Society’s downfall ... From the late 1980s Equitable Life tried to combine the benefits of with-profits smoothing with the transparency of managed fund valuations, but without maintaining any estate.(8) The Equitable Life approach was set out in the paper ‘With Profits Without Mystery’ prepared by Roy Ranson and presented to the Institute of Actuaries on 20 March 1989. The concept did not meet with unqualified approval. One commentator was Mr. Clark, later President of the Institute of Actuaries (2000-2002) saying ‘the authors state their belief, that the assets are owned by the current generations of policyholders'. I believe that the implication the authors draw from this is that, ignoring smoothing, the sum of individual asset shares for individual policies equals the market value of the fund. This means that smoothing must be a totally balanced concept that any over-payment to one group of policyholders must be equally and oppositely balanced by an under-payment to another group. Failure to achieve this must inevitably lead to insolvency in the long run if the rest of the theory is left intact."

Countering accusations of regulators' operational shortcomings, the UK Government detailed in WE32(9) why, in their opinion, all requirements of 3LD were correctly implemented in practice and that in the supervision of Equitable Life all prudential standards required by the Directive had been applied. In particular they stated that 3LD "required the calculation of the technical reserves of a life insurance company to be based on actuarial principles, common to all member states, and as recommended by the 'Groupe Consultatif des Associations d’Actuaires dans les Pays des Communautés Européennes'. These principles included limiting the rates of interest that could be used in the valuation, but did not prescribe the valuation method to be used, the choice of which was left open to member states to decide(10). The Directive introduced a requirement for “admissibility limits” in relation to assets but prevented member states from requiring companies to invest in particular assets. It amended the asset matching and localisation rules introduced by the First Life Directive so that these applied across all member states(11). It also permitted the required solvency margin to be covered ... by subordinated loan capital for the first time(12). This was not subject to the consent of the prudential competent authority under the Directive but such consent was nonetheless made a requirement in the UK, again implemented by means of the issuance by the prudential competent authority of an order under section 68 of the Insurance Companies Act 1982."

The UK authorities further explained in WE32 that 3LD "prohibited the prior approval by the prudential competent authority of products or premium rates(13), instead relying on the required solvency margin, the rules concerning the technical reserves and the valuation of assets.... to afford adequate protection to policyholders... Whilst the Third Life Directive permitted Member states to impose explicit reserving requirements for terminal bonus, it did not require this.(14)"

In WE43 policyholder Mr. VINALL claimed that "the regulator failed in his duty and then compounded the problem by giving policyholders misleading information." He recalls in large detail his frustrating experience in contacting the FSA in 2001, following the increasing number of reports on Equitable Life, in order to obtain some reliable information and to establish the truth about the Company's financial position. After allegedly having been told by a member of the FSA Equitable supervisory team that in relation to the solvency and reserve levels of Equitable "they could see no cause for concern", Mr. VINALL reported that the FSA staff would not take his questions seriously and had even hung up on him. Written complaints were answered concluding that he had no grounds to claim the FSA had acted unprofessionally, a finding repeated by the FSA Complaints Commissioner. In his view, the FSA's refusal to provide accurate information to the policyholder led him to stay with the company longer than he should have, with the consequence of having to pay a 20% penalty when leaving the company.

In an e-mail of 7 June 2006 (annex to WE43) the Office of the UK Parliamentary Ombudsman confirms to Mr. VINALL they were "aware of the complaints having been made by many individuals ... that they had been reassured by the FSA that there was no reason to be alarmed as to the solvency of the Society."

Among a number of allegations that UK regulators (in particular HM Treasury and FSA) knew already in 1998 of a potential GAR problem at Equitable but took no action, an article in SAGA magazine(15) (September 2001) cited a leaked memo from a civil servant to the FSA managing director, dated 5 November 1998: it expressed concern "about whether Equitable had the reserves to pay its guaranteed annuities. The information received to date is unconvincing and raises serious questions about the company's solvency(16)."

In WE-FILE17, Mr. HARDING specifically points out alleged regulatory failure subsequent to the House of Lords ruling (20 July 2000), as "it may have been too late to save the Equitable in the absence of a cash injection from the Government, (but) it was not too late to ensure that the rights of non-GARs were also considered before transferring wealth from one policyholder to another."

Commenting on the controversial policy cuts in 2000/2001, WE-CONF8 states that "the decision on the policy cuts, and how these were to be distributed, was one for the Society's board to make. The FSA would only have grounds to intervene if the proposed cuts breached either the contractual rights or the reasonable expectations of policyholders in general or any class of policyholder ... But the 'policy value' EL made available to its policyholders were a combination of the contractual value and the (discretionary) final bonus ... In this case the cuts reflected the poor investment returns over 2000 and 2001 and were broadly in line with the falls in that period that occurred in the major investment markets."

Referring to allegations of untimely assessment of possible consequences of the Hyman litigation, WE-CONF8 states that "the FSA considered the decision to seek judgement on a test case in the courts was reasonable, given that EL was faced with an increasing number of complaints from GAR policyholders. Rather than dealing with these complaints individually, EL wanted the certainty of a precedent", recalling how Lord Penrose had also found "no reasons to criticize the Society's board or executive management for taking steps to test the legal issues that had arisen(17)" It concluded saying that the EL board had "carried out contingency planning for a wide range of possible outcomes, identifying that in the worst case it would have to seek a buyer for the business."

Finally, alleging regulatory failure by UK Regulators, WE-CONF25 claims, with the support of detailed legal arguments, that the UK regulators "could and should have intervened, both before and after July 1994, resorting to powers provided under Section 45 of ICA 82", to rectify the serious deficiencies in EL's conduct of business due to over-bonusing and provision of GARs.

In particular, after 1 July 1994, they could have "taken the view that the deficiencies in the conduct of the Society’s business were so grave as to justify the giving of a direction under section 11 of the Act (as amended), on the ground of the absence of sound and prudent management. Having done this, the regulator could ... have made use of the power conferred by section 45(2)(a) to prevent or restrict the payment of final bonuses. The giving of a section 11 direction to Equitable would have been a very drastic step; but it is one the regulators might well have considered taking, on the basis that ... Equitable was voting and paying bonuses well in excess of assets (that is, outgoing policyholders were being paid more than the proportion of the assets properly attributable to them), relying on “goodwill” and/or the expected generation of future cash-flows to bridge the gap ... As there seems to be no doubt that GARs gave rise to a legal liability on the part of Equitable, they would therefore have had to be taken into account in any consideration by the regulators of section 45(2)(d) and section 35A ... The most obvious action which the regulators could have required Equitable to take, not involving the prohibition in sub-section 45(2), would have been to require the Society to put a stop to the very practice that was producing the reasonable expectations on the part of policyholders."(18)

WE-CONF25 concludes by stating that "such a requirement would clearly have fallen

within the scope of the powers and duties of the prudential regulator, as deriving from the need to have regard to the reasonable expectations of policyholders and the Society’s ability to fulfil them ... All in all, it seems to me that had the regulators, in recognition of a serious problem of over-bonusing, waved a big stick at the Equitable board it is very unlikely indeed that nothing would or could have been done about the problem."

1b)      Alleged obstruction by UK regulators and collusion with EL

An even tougher stance was taken by policyholders Mr. CHASE GREY (WE9) and Mr. WEIR (WE6), arguing that, in their opinion, there was collusion and obstruction by the regulators to conceal their regulatory failure and responsibilities.

In particular, Mr. CHASE GREY (WE9) claimed that "the introduction of the non-guaranteed with-profits policy in 1987constituted a conspiracy to defraud, as defined by English Common Law. The deficient capital position of ELAS and the conspiracy to defraud were discoverable by the Treasury and/or FSA by reasonable inquiry. The British Government ... has consistently acted by obfuscation and obstruction to conceal its failure of regulation."

WE-CONF6 claimed that "over a period of approximately 15 years (1987-2001) both the Society and the regulatory organisations set over it, consistently acted in ways designed to confuse and deceive policyholders, whether actual or prospective."

Mr. NASSIM (WE7) specified that "having turned a blind eye to gross solvency risks in 1990-92, the Regulator adopted thereafter a self-protective policy of denial, to conceal the maladministration that had taken place in previous years, and to absolve itself of responsibility when the collapse of the WP Fund eventually manifested itself. It colluded throughout the period 1996-2002 in attributing the circumstances leading to the closure of the WP Fund to problems with Annuity Guarantees, rather than the earlier and far more serious over-bonusing of 1982-87."

In WE8 Mr. NASSIM concluded that "when the GAR crisis was precipitated by the House of Lords judgement, there was widespread consternation among the many parties with an interested responsibility in the matter. Naturally enough, none of them can have wished to be held any more accountable for the situation than the emergent facts might ultimately dictate. The overall pattern of events strongly suggests that their first instincts were to review and cover their respective positions, such that their obligations to manage the situation positively may have taken second place. In the case of the Government, Treasury and the regulators this was particularly unfortunate ...".

Additional allegations of incompetence and/or collusion were made by Mr. JOSEPHS (WE69) claiming a "multiple deliberate frauds on the part of Equitable Life against its customers, over a period of approximately 15 years. Since the key information pointing to those frauds was available in the Regulatory Returns over an extended period of years, we must also conclude that the Regulators were guilty of gross regulatory failure, in failing to draw Ministers’ attention to what was happening and in failing to use their extensive powers to correct the situation."

Thus, fraud was allegedly permitted to happen by regulators either "due to sheer incompetence, flowing from the dysfunctional organisation structure under which the regulators were required to work, combined with inadequate training and supervision, or due to collusion, most probably in the form of an informal and inadequately considered Ministerial instruction to afford Equitable Life some temporary exemption from the strict application of the prudential regulations ... The fact that such an instruction would have been unlawful might explain why it was never rescinded!"

WE69 continued claiming that "Equitable introduced the ill-defined with-profits annuity in 1987 and represented that it was a low risk product, despite the immediate and ongoing risks to the WP Fund: a competent and energetic regulator would have discovered what Equitable were really doing and would have acted by 1990 at the latest to protect the solvency of the Society and to address the serious threats to Policyholders’ Reasonable Expectations. One of those expectations was simply that Directors should run the business honestly and in such a way as to deal fairly between various types and generations of policyholders". In conclusion, Mr. JOSEPHS asked how "the regulatory departments, containing actuaries and other insurance experts, failed for 15 years to detect the strong stench of fraud which surrounded Equitable’s activities, or if they did detect it, how they avoided any effective action going after the source of that stench."

In H11, Mr. BRAITHWAITE stated that he had no doubt that "the depth of potential catastrophe was recognized (in 1998 by the UK Treasury). I believe that since then the over-arching plan has been to deny culpability, avoid compensation and to cause delay after delay ..." He further claimed that "immediately following the Penrose report's publication, the FSA granted consecutive waivers to Equitable to ignore complaints, whilst an orchestrated response was being planned behind closed doors to see off potential claims arising from Penrose", and subsequently "refused to publish its post-evaluation on the Penrose report and merely announced in July 2004 its conclusion that 'Penrose-related claims were unlikely to succeed'." He added that collusion between the Treasury, the FSA, EL and the FOS(19) "has just been categorically confirmed by two damning UK Treasury e-mails with dates in June 2004 obtained under a Freedom of Information request."(20)

Finally, WE-CONF16 questioned the FSA's "highly selective interpretation of 'confidentiality' in the EL case", preventing it from informing policyholders whether a requested investigation on the EL case had been set up or not , while at the same time the FSA website gives access to press releases disclosing FSA investigations being conducted as well as their progress.

Countering these allegations, WE-CONF8 emphatically dismissed any claim or allegation of 'collusion' between the regulators and EL, describing such accusations as "very serious". However, "not being aware of any evidence that would support such a claim, there is no question of any collusion having occurred." Referring to allegations of collusion presented by policyholder groups, the current Equitable Life Chief Executive Mr. THOMSON squarely dismissed any "intriguing picture of conspiracy. In the absence of any verifiable evidence this should remain one man's view of events."(21)

1c)       Claims of Regulators' industry bias

A number of witnesses (Mr. LAKE (H1), Mr. BRAITHWAITE (H1, H11), Mr. BELLORD (H2), Mr. JOSEPHS (H2), Mrs. KWANTES (H7), Mr. SCAWEN (H3); Mr. SEYMOUR (H7)) repeatedly claimed a strong industry-bias of the, supposedly independent, UK life insurance regulators. In their view, this factor has prevented, or at least affected, their impartial assessment of Equitable Life's operations and timely action to prevent its downfall.

In his oral testimony, Mr. JOSEPHS (H2) asserted that, starting from the 1980s, the UK prudential regulatory system "left effective control in the hands of the industry, in spite of giving the appearance of proper regulations". This would have lead to a weak regulatory environment that proved unable to provide investors with effective protection.

Confirming statements were presented by Mr. LAKE (H1) and Mr. BRAITHWAITE (H1, H11), who considered UK regulators to be "too industry-oriented and not sufficiently consumer-oriented" and claiming that "the FSA perceives its customers as being industry firms."

Allegations of being industry-biased were firmly rejected by the FSA representative Mr. STRACHAN (H4) calling "entirely misplaced such concerns, that the FSA would somehow be 'in the pocket' of the firms it regulates: we are a statutory regulator established by Parliament."(22)

1d)      Claims of Regulators' 'light touch' regulatory policy

In order better to specify the 'light touch' nature of the UK regulatory regime, policyholder Mr. SEYMOUR (H7) quoted the UK Treasury(23) commenting on the bill creating the new FSA: "There will be a light touch where possible ... The Bill avoids over-burdensome regulation that would serve only to stifle innovation and to increase consumer costs. Instead the FSA will be under a duty to demonstrate that the burdens that it seeks to impose are proportionate to the benefits that will result."

Another petitioner, Mr. BELLORD (H2), also insisted on the "very cosy relationship between regulators and EL", highlighting some findings by the Penrose Report that suggest that reports available to the Government Actuary's Department (GAD) dating back to the late 1980s had already hinted at Equitable Life's dangerous business practices but had remained totally unheeded by the GAD(24).

A 'light touch attitude' exudes from a letter of January 2001, i.e. just weeks after the mass resignation of the EL board and its closure to new business, to the German regulator BAV. In this letter, the FSA reiterated the point that "EL remains solvent, existing policies remain valid and it is able to meet its contractual obligations to policyholders." It even claimed that "many of the press reports in relation to EL have been inaccurate and speculative" and added peremptorily that the FSA "will not be requiring the company to provide a new valuation."

Or, as summed up by policyholders' representative Ms. KWANTES (H7): "I think the truth was the regulators were asleep at the wheel. They appeared to stand in awe of Equitable and handled it with kid gloves ... If the regulator was aware that Equitable had problems why didn't they say something? If they were not aware, they were not doing their job of regulation properly."

These allegations, in particular the "lack of challenge to EL's senior management by the UK regulators" were emphatically rejected by WE-CONF8, which referred directly to the findings of the First Parliamentary Ombudsman's report(25). It equally dismissed any claims of inaction in investigating the responsibilities of EL's auditors Ernst & Young, an issue considered to be "a matter for the professional bodies". Equally dismissed were claims of not preventing EL management from engaging in legal action against its auditors, on the grounds that "EL had a discrete set of legal and fiduciary obligations to its policyholders and was entirely responsible for its own decisions."

1e)       Claims of Regulators' excessive 'deference' to EL

In H5, Mr. BAYLISS described how an attitude of deference by the regulators towards Equitable Life existed at the time, due "to the fact that Roy Ranson instilled – and it was him principally as an individual – the huge belief that Equitable could do no wrong. It oversold to itself and to its 300 salesmen. It was not criminal until the end, but it was mismanagement and it was not halted by the regulator as it should have been ... This was down to Equitable’s stature and the value it was perceived to have in the marketplace. It was supposedly the ‘good company’, and better than the others, so much better than the rest ... I do not think we have finished the learning curve ..." Not excluding financial sector company failures in the future, Mr. BAYLISS concluded saying that "I do not think there will be another one entirely related to the arrogance of the management and the tolerance of that arrogance. The way in which Equitable behaved and treated the regulator was really quite extraordinary."

Concerns that the FSA might have been 'intimidated' by the name and authority of Equitable Life were partly upheld by EL salesman Mr. LLOYD (H5) when stating that "I am absolutely of the view that the strength of the board’s position and its authority when it came to discussing Equitable’s affairs with the regulators and our own auditors, probably did, to some extent, intimidate the regulators into agreeing with this long-established mutual life office, which had invented the term ‘actuary’ and possibly knew more about it than they did ... Looking back now, I think somebody should have been sitting on Mr Ranson’s shoulders ... and saying, ‘No, we are not accepting your word for things, we want a full explanation, we want to understand how this works’. I cannot understand now why nobody – regulators, auditors or the board – could sit down and work out what eventually happened ... I cannot imagine how they were allowed to operate without that sort of analysis and somebody saying, ‘Wait a minute, this could go badly wrong’. I cannot understand how we, the sales force, were allowed to go on promoting the with-profits fund from 1997-1998 when the board had already had conflicting legal advice that implied that it might not actually win the case, it might have to honour the GARs, etc., etc. We should have all been warned at that point."

However, Mr. LLOYD's competence to issue the latter statement has been questioned and challenged by the EL executives(26) on the grounds that, being a simple sales representative, he would have lacked any first-hand knowledge or experience of Equitable Life's contacts with regulators.

Referring to the controversial sale of 'managed pensions' by EL, Mr. BAIN quoted in WE72 an English IFA as saying “the quality of advice the FSA seemed to require from Equitable was different from what they required elsewhere." This point was confirmed by Mr. JOSEPHS (WE69) stating that "Investors Association has heard from more than one insurance executive that other companies, usually non-mutuals, were regulated far more strictly than Equitable Life".

Another clear hint of 'deference' to EL is found in a letter of 7 August 2000, where the FSA replies to the German regulator BAV asking for an update on EL after the House of Lords ruling. BAV was informed that EL "remained solvent", adding in very optimistic terms that "the company is putting itself up for sale and ... there are not expected to be any shortage of companies interested in acquiring Equitable Life, because of its strong reputation in the UK industry for efficiency ... The management of the company appear to be handling the situation effectively and we are satisfied that in doing so they are seeking to act in the best interests of policyholders." (WE-CONF9)(27)

Finally, WE75 related of a complaint against the FSA's ratification of Mr. Treves' appointment as chairman of EL in 2001: Mr. Treves is described as "having far too many competing chairmanships and being over retirement age, having no experience in life companies ... and having presided over massively expensive failed legal actions." The FSA is reported taking note of these concerns but without giving any further justification.(28)

1f)       Claims of Regulators' drive to avoid EL's insolvency

While Equitable Life appears to have deliberately exploited a possible systemic weakness of the UK regulatory system, the question arises if regulators should or could have recognised this intention but did nothing to prevent its crisis, and then - when it was too late - opted for a solution avoiding the Society's insolvency. This choice, possibly not in the interest of the industry or the financial marketplace as such as insolvency might have burdened the existing financial compensation schemes and hurt confidence in the UK financial market as a whole, might have negatively affected policyholders, otherwise falling under such a scheme.

In his testimony, Mr. WEIR (H2), representing a policyholder action group, claimed a collective effort by the "UK Government to keep Equitable Life afloat, concealing any culpability on the part of UK regulators and avoiding insolvency at any price". He also accused regulators of collusion with the board of Equitable Life to "ensure that the losses ... are borne by investors. This meant avoiding any costs to the Financial Services Compensation Scheme (FSCS), to the rest of the financial services industry (and) to the Treasury." Mr. JOSEPHS (H2) added that "powerful external forces, not least the Treasury and the FSA, were in favour of continuing with the existing strategy."

Referring to this issue and to the general question of Equitable Life's alleged technical insolvency, the UK Treasury representative Mr. MAXWELL (H4) made a point to clarify that "Equitable Life decided to close to new business: the society did not go insolvent." The FSA representative Mr. STRACHAN (H4) dismissed "any misperception that Equitable Life has in some sense 'collapsed' or 'failed' in solvency terms. This is not the case: at all times the company has remained solvent. At no time has Equitable defaulted on any contractual or guaranteed liability to its policyholders. In addition, in each of its regulatory returns it has reported that it is currently meeting its regulatory solvency margins."

In fact, in November 2002, after Equitable Life had warned it may be unable to meet the FSA's required minimum capital margins, the FSA had rejected a call to liquidate Equitable Life on the grounds that policyholders would be worse off, without giving more specific arguments.

In H8, the EL CEO Mr. THOMSON claimed that "the option for the Society to become insolvent was dealt with in the documentation for the Compromise Scheme in 2001, where it was obvious then, and remains so now, that liquidation would have produced a much less satisfactory outcome for policyholders", but again without specifying any further the arguments supporting his position.(29)

1g)       Double role of Equitable Life CEO and Appointed Actuary

The generally accepted definition of 'prudential supervision' in the UK included "ensuring that the directors and major shareholders of a life office were fit and proper."(30)

On this point, it has been established that Mr. Ranson had become Chief Executive of Equitable Life in 1991 without relinquishing his role of Appointed Actuary until his retirement in 1997. EMAG representatives and a large number of policyholders' complaints have referred to it, claiming that this fact, as well as the regulators' inaction and refusal to challenge Mr. Ranson's double role, had been prejudicial to their interests. A similar allegation was presented by Mr. CHASE GREY (WE9), who accused the FSA on this issue of gross negligence and failure in their regulatory duty.

WE-CONF25 equally blamed UK Regulators for not intervening on this matter by using powers provided to them by Section 45 of ICA82. In particular, it stated that "alternative steps which the regulators could have taken under section 45 include, for example, requiring Equitable to strengthen its management, and/or requiring it to split the roles of Chief Executive and Appointed Actuary, both of which were occupied by Mr. Ranson in the early 1990s."

Mr. NASSIM (WE7) confirms that "the regulators and GAD allowed successive chief executives/managing directors of ELAS also to hold the post of Appointed Actuary(31), despite a recognition of the potential for conflict of interest in this position, and the fact that it completely undermined the basis of the regulatory process which was founded on the separation of powers between the AA and the rest of the Executive."

Countering these allegations, Treasury representative Mr. MAXWELL (H4) pointed out that the figure of the Appointed Actuary did not derive from, nor was it foreseen in, any part of EC legislation. "The Third Life Directive does not refer to an individual called an 'Appointed Actuary'. The question of whether an Appointed Actuary could take on that particular role is therefore not a matter for the Third Life Directive. It was a common arrangement with a number of other life insurance companies that the Appointed Actuary played that sort of role within the UK system ... Things move on, but within the terms of the Third Life Directive, there was no particular reference to the role of an Appointed Actuary. Indeed, the tests the regulator could apply as to who was fit and proper to carry out the role of a Chief Executive – to be managing, to be a director – of an insurance company did not include a reference to their role as an actuary."

Following Mr. Headdon's decision to leave Equitable Life on 1 March 2001 the FSA has "discouraged the suggestion that (the new CEO) Mr. Thomson should combine the two roles, and that view was accepted by Equitable." Changes to the regulatory regime since then have included "abolishing the role of the Appointed Actuary in favour of requiring boards and senior management to take responsibility for actuarial issues and bringing these issues within the scope of the firm's external audit." (WE-CONF8)

Asked on this issue as an independent expert, Mr. SCHNEITER (H6) reported that Swiss law would currently not forbid the double role of CEO and AA. He added however that the Swiss regulator would consider such an issue as a clear case of "bad corporate governance", leading to a potential conflict of interest, and that it would have to be addressed accordingly. In any case, the fact that a chief executive covered the roles of CEO/AA in the same company would immediately trigger a detailed scrutiny of the company's overall policies by the Swiss insurance regulator. A final judgement on the compatibility of the double role would then, however, be dealt on a case-by-case basis.

1h)       Adequacy of resources available to regulators

On the subject of structures and resources available to the UK insurance regulators, Lord Penrose found that "the DTI insurance division was ill-equipped to participate in the regulatory process. It had inadequate staff, and those involved at line supervisor level in particular were not qualified to make any significant contribution to the process. Insurance division regulators were fundamentally dependent on GAD for advice on the mathematical reserves, implicit items, technical matters generally, and PRE, and were not individually equipped with specific relevant skills or experience to assess independently the Society's position in these respects".

He added that "the staffing levels available to the prudential regulators varied, but the number of staff with direct responsibility for the Society and their grades within the civil service remained broadly constant ... Increased resources might have improved the chances of identifying problems, but ... Government required a 'light touch' approach to regulation, and allocated resources accordingly. "(WE16, par. 39, 158 and 159)

Mr. NASSIM (WE7) claimed that "the regulators were not always sufficiently resourced, and did not all possess the necessary skills, to make an effective contribution to the regulatory process and responsibly exercise discretionary powers as intended by Parliament from 1973 onwards. As a consequence they did not properly undertake their functions."

Referring to evidence in the Baird report, Mr. LAKE (H1) also claimed that the insurance regulators were seriously under-resourced throughout the 1990s and accused the UK Government of contravening Articles 15(3) and 23(3) of the 1LD as amended by the 3LD, which required that "the powers and means be sufficient to allow the competent authorities to be able to prevent or remedy any irregularities prejudicial to the interests of the policy-holders, which was not done in this case." Likewise, "resources provided had to enable that the competent authorities of the home Member State shall require every assurance undertaking to have sound administrative and accounting procedures and adequate internal control mechanisms. Again, this provision was not correctly followed."

2.         The GAR Problem

The handling of the problem related to Guaranteed Annuity Rates (GAR) appears at the core of evidence and complaints put forward to this Committee of Inquiry by petitioners and policyholders, in particular regarding the alleged failure by regulators to recognize the GAR risk potential for EL's solvency and their subsequent failure to adequately inform and/or warn prospective policyholders about this risk exposure.

2a)      GAR Timeline

1957                Equitable Life began selling with-profits pension annuities with 'guaranteed rates' (GARs) fixed to specific assumptions as to interest rates and life expectancy. GAR policies were sold until 1988; with-profits policies offering 'guaranteed interest rates' (GIRs) were sold until 1996

1970-1982      UK high-inflation years (retail inflation rate 10-22% p.a.)

1990               UK inflation drops significantly, with long-term gilt yields falling accordingly. Insurers with large books of GAR policies saw their liabilities increase dramatically: EL, holding minimum reserves and giving maximum payouts, was to be particularly badly hit(32)

1993               Market current annuity rates fell below the GAR annuity rates promised by ELAS, thereby raising substantially the cost to ELAS of providing GAR pensions; Differential Bonus Policy (DBP) applied

7.9.1998         EL writes to Denton Hall, the Society's solicitors, seeking legal advice on the GAR and Differential Bonus Policy;

GAR formally becomes an issue

Jan.1999        Hyman litigation is launched in the UK High Court

S&P downgrades EL's credit rating from AA to A+/watch negative(33)

20.7.2000       House of Lords ruling ended the Hyman litigation(34)

2b)     Background information

For a better understanding of the GAR issue, it may be useful to identify different groups of policyholders involved:

- GAR policyholders, i.e. those having a guaranteed annuity option on their policy

- non-GAR policyholders, i.e. those holding policies lacking this option

- Late-Joiners (LJ), i.e. policyholders who bought EL policies after 30 September 1998

The market forces leading to the GAR problem have been extensively researched and clearly identified: they mainly relate to the rapid and unexpected fall in UK interest rates in the early 1990s. WE29 recalls how "in late 1993 and in 1995, open market rates fell below GARS and have remained below ever since. In addition, the assumptions concerning life expectancy used to determine the size of the GAR pension payments were not revised in the light of improvements in mortality that had taken place since they had been set, further raising the cost of the pensions. The Board at the time did not take these extra costs into account when it awarded annual bonuses and all members’ policy values (both GAR and non-GAR) increased at the same rate."

In an effort to correct this adverse market movement, "the Board corrected for the extra cost of the GARs through a ‘differential final bonus policy’ first introduced in 1993, which it considered was within the discretion it had(35). The intention was to declare final bonuses that made the value of total benefits broadly equal to each policyholder’s notional share of the with-profits fund ... Those policyholders who elected to take the GAR option from ELAS received a lower final bonus than those policyholders who, despite having a GAR option, elected to take their pension benefits in a different form ... but at the lower market rate ruling at the time. The Board thought that this strategy was legal; the Institute of Actuaries and Treasury Insurance Directorate agreed." (WE29)

As a result of complaints from policyholders, who argued that the differential bonus policy rendered the GAR option valueless, EL initiated a legal ‘representative action’ in the High Court to resolve the issue, which became known as the 'Hyman litigation', ending with the final House of Lords ruling of 20 July 2000. "The case ended up in the House of Lords, which ruled that ELAS could not apply a differential bonus policy to any class of policyholder, whether GAR or non-GAR. Those GAR policyholders who had exercised their GAR option between January 1994 and 20 July 2000 had to be given the same final bonus as the GAR policyholders who had not taken the GAR option and then the GAR had to be applied to the revised terminal policy value. Crucially the House of Lords also ruled that the cost of meeting the GAR liabilities could not be ‘ring fenced’ within the class of GAR policyholders." (WE29)

Following this ruling, the total cost to EL was estimated to be 25% of GAR policy values, or £1.5 billion(36). This sum had to be taken from the single with-profits fund that invested both GAR and non-GAR premiums. "On 20 July 2000 25% of the with-profits fund represented GAR policyholders’ claims and 75% non-GAR policyholders’ claims. So the House of Lords ruling meant that an ‘economic transfer’ of claims of £1.1 bn (75% of £1.5bn) from non-GAR to GAR policyholders had to be implemented."(WE29)

WE-CONF2 underlined how "the GAR problem was compounded by the fact that historically the Society had operated a policy of maximizing bonuses and not building up a reserve. The Society's argument was that commercially a reserve of only £50m was required, based on the fact that... only a trivial percentage of GAR policyholders exercised their GAR option. The theoretical exposure was calculated at £170m."(37) It also reminded that EL's statutory accounts for 1998 and 1999 included "provisions of £200m for 'any additional liabilities which may arise through clients choosing to exercise GAR options under their policies'. It is important to bear in mind that these reserves were not made against failure in the Hyman litigation, they were against liabilities expected even if the Society was wholly successful in that litigation."

It appears that EL failed to react to market developments by not providing any consistent hedging or cover against the risk of GAR optioned being taken or against defeat in the Hyman litigation. In 1999 EL took out a financial reinsurance over £700 million to cover immediate payments required on the exercise of GAR options, "but this reinsurance was never intended to be claimed on. By its terms the reinsurance could only respond if the Society's bonus policy remained unchanged. Once the differential bonus policy (DBP) was ruled to be unlawful, the policy would be void. In other words, the reinsurance did not touch the question of the cost to the Society of providing benefits for GAR policyholders in the event the DBP being held unlawful." (WE-CONF-2)

2c)      Claims of Regulators' incompetence in failing to recognize the GAR risk

Delivering a technical analysis of the GAR issue, WE58 highlighted how "between 1997 and end 1998, long gilt yields fell very sharply indeed, causing there to be a sharp increase in the extent to which policyholders were "in the money" (and life offices were in trouble) with regard to GARs. When, in the early 1990s, the GAR problem began to lap at Equitable's shores, the Society (unlike the generality of its competitors) seemingly decided not to make reserves, but chose to deal with the problem in an entirely different way ... Equitable's conduct would appear to have been the result of its philosophy of not holding substantial excess capital. Quite simply, the Society knew it could not afford to honour its guaranteed annuity promises and, accordingly, sought to construct its bonus rate regime so that the guarantees would be worthless."

As reported in WE58, EL had devised as possible solution to charge policyholders for the cost of providing them a GAR, implicitly deducting it from the (discretionary) final bonus: "it would appear possible, depending on the particular circumstances relating to the contract, that any terminal bonus added at maturity could be somewhat lower than for contracts without such options or guarantees, and that this terminal bonus could in some cases be applied at current annuity rates ... Equitable's Nemesis came in the form of an independent financial adviser, Mr Bayliss, who, being a specialist in the retirement annuity sector, was instrumental in spreading the word that Equitable, in his opinion, had been treating its pension policyholders unfairly by juggling pension maturity values and annuity rates so as to deprive policyholders of the true value of their guaranteed annuity options. The agitation of Mr Bayliss and others led to the litigation that eventually saw the Society defeated in the House of Lords. Thus, EL's seemingly sophisticated approach and its dismissal of the GAR issue as being relatively trivial and having an impact of no more than £50 million ... caused (policyholders) to be mightily concerned to learn that a "£50m bagatelle" was, in fact, a £1.5 billion terminal disaster. " (38)

Mr. NASSIM specified in WE7 several alleged failures of regulators "to fully assess the risks inherent in Equitable Life's policies and to intervene accordingly:

- From 1973 onwards the regulators failed to react to ELAS making no explicit reservation for its increasingly dominant bonus form (terminal bonus), and did not examine the position from the realistic aspect required under a proper or reasonable interpretation of PRE;

- Despite contemporary informed actuarial comment the regulators failed to scrutinise the “With Profits Without Mystery (WPWM)” actuarial and insurance paradigm. Had they done so, they would necessarily have discovered that it was in essence a rationalisation for dispersal of its assets, and running a with-profits fund on an intermittently negative technical solvency gap. Under the WPWM paradigm there was no prudently equitable assurance, or real prospect of fulfilling policyholders’ reasonable expectations;

- From 1987 onwards the regulators allowed a with-profits fund to operate on a mostly negative technical solvency gap which betokened liability for present and future policyholders rather than profit;

- The regulators generally failed to appreciate the effects of conflicts of interest between the Society’s private and corporate/institutional clients, and the GAD’s position in recommending the Society as a civil service institutional pension scheme provider".

In his statement, Mr. SLATER (WE34) claimed that over more than a decade, the Regulators failed to fully acknowledge the potential danger of Equitable Life's practice of "voting bonuses in excess of the investment returns actually achieved and the similarly long history of understating liabilities."

In his oral testimony, Mr. SEYMOUR (H7) claimed that by not accumulating funds to cover for future bonuses during the years the financial markets performed well, Equitable Life had de facto been supporting its liabilities by functioning like a pyramid selling scheme without the regulator taking notice of it. "ELAS was declaring bonuses to show a higher level of performance than the competition in order to bring in new funds to cover its immediate outgoings. It was not maintaining a promised reserve fund ... The regulator could easily have determined the existence of a pyramid scheme together with the absence of reserves and taken remedial action as required by the directive. This was essential, particularly as the declared presence of a reserve fund was a key selling point throughout the Community."

WE-CONF23 also accused the UK Regulators of negligence in recognizing and failure to react to the GAR risk, stating that "any diligent investigation would have revealed the absence of a GAR provision. The fact that the regulators did not act to close down Equitable Life or enforce a substantial reconstruction encouraged the directors to do nothing and thus compounded the losses eventually suffered by those who held policies on 16 July 2001."

In H5 Mr. BAYLISS stated that "there was no doubt that ... in the new regulatory regime of the FSA, the returns were not adequate in terms of explaining the true situation or potential liabilities that hid in those funds ... They had been buying Equitable’s story on solvency margins for a very long time: as long as you are generating new sales to cope with it, then you are OK. If your new business is big enough, you can backfill the hole ... The problem was that the regulators realised there was a problem with GARs in 1998 and they did not know what to do about it. As to the other question of intervention and when, the regulators were aware through the Ombudsman, certainly in 1997 and 1998, that this was an issue. They had the documentation that we circulated to the press, certainly in the summer of 1998, if they had not had it earlier through individual clients sending it in ... I think they had the same problem of wanting or not wanting to intervene."

However, in WE46, non-GAR policyholder Mr. STONEBANKS challenged some of Mr. BAYLISS' evidence, asserting a clear divergence of interests between GAR and non-GAR policyholder groups and claiming that Mr. BAYLISS had been championing only for the rights of the former group, bringing the GAR issue to court and by doing so eventually leading to EL's downfall. "This was a mutual, equitable Society set up for the benefit of all members, so I was appalled that Bayliss should be demanding more for some ... Mr.Bayliss must have realised that if his demands were met then not only would Equitable have been put out of business, but, by adding £1.5 billion to their liabilities and destroying their major product, the Society would not have been worth rescuing. He must have known that if Equitable Life met his demands then they would be put out of business. And as Equitable's main product was unmarketable, there was no point in any other company taking them over. Was Stuart Bayliss set up by other major LifeCos to put Equitable Life out of business? I doubt if we will ever know, but this seems to me the only logical explanation for Mr. Bayliss' actions. Equitable was a major and successful player in the UK pensions industry and I can well understand that other LifeCos would like to see them go."

3.         Alleged Unfairness in the 2001 'Compromise Scheme'

When the 'Compromise Scheme' took legal effect (8 February 2002) after approval by the UK High Court "there were still close to a million people with an interest in the with-profits fund." (WE47)(39). The scheme was meant to stabilize the with-profits fund by reducing exposure to GARs, while at the same time eliminate the risk of legal action against EL for mis-selling, claiming the potential risks of GAR liabilities had not been disclosed to them when taking out their policies. As stated in WE80, the Irish Regulatory authorities were not involved in the Compromise Scheme agreement process.

The terms of the Compromise were that “all and any GAR-Related Claims that each Scheme Policyholder has and/or may have in relation to their GAR Fund and/or Non-GAR Fund ... shall be waived and settled fully, finally and irrevocably”, excluding explicitly “any complaint or claim to any ombudsman (including the Financial Ombudsman Service)”.

3a)      Timeline surrounding the 'Compromise Scheme'

20 July 2000:              House of Lords ruling, upholding the Appeal Court's ruling, declared unlawful the payout of differential bonus levels on GAR policies (thus forcing EL to put itself up for sale)

July-Nov. 2000:          Several companies considered a take-over of Equitable Life, but no bids materialize(40)

8 December 2000:      EL closed to new business and increases penalty fees for withdrawing funds to 10%(41)

20 December 2000:   EL Board offered their resignation

5 February 2001:        Halifax agreed to pay £1 billion to buy EL's 'operating assets' (sales force and non-with-profits policies), promising additional funds in case a compromise is found over with-profits policies(42)

14 February 2001:      EL instructed Nicholas Warren, QC to examine issues arising from GAR case

10 May 2001:             The 'Warren draft report' suggested non-GAR policyholders have valid rights for mis-selling

16 July 2001:            EL reduced policy values by 16% (of end-2000 level)

WE-CONF16 claimed EL decided for a flat rate cut in policy value, irrespective of their duration, instead of a cut to final bonuses(43) as recommended by the new Appointed Actuary Mr. Nowell, blaming adverse stock market conditions.(44)

August 2001              EL denied access to the Financial Review(45) to policyholders

20 September 2001:   EL drafted the Compromise Scheme pursuant to section 425 of the Insurance Companies Act 1985, based on a GAR buy-out and aimed at stabilizing the company's finances; the scheme is subject to policyholders' and High Court approval(46)

1 December 2001:      FSA became fully operational as UK single regulator

                                   Formal Compromise Scheme Proposal was sent to policyholders

7 December 2001:      FSA publicly endorsed the Compromise Scheme in its Scheme Circular(47)

11 January 2002:       Policyholders voted on the Compromise Scheme: approved if endorsed by over 50% of individual policyholders representing 75% of the value of both types of policies (GAR and non-GAR)

28 January 2002:       EL announced policyholders voted overwhelmingly in favour of the deal (98% non-GAR, 99% GAR policyholders)

8 February 2002:        High Court approved Compromise Scheme which became immediately operational; EL applied 10% exit penalty; Halifax injected the promised £250 million into EL

15 April/1 July 2002:  EL cut maturity value of with profits policies by 4% and 6%, raising exit penalty to 14%; at the same time, the EL 2001 report showed lavish bonuses paid to new Chairman and CEO(48)

In suggesting an explanation on how the need for the 16% cut in policy values of July 2001 had arisen, Mr. SLATER submitted a chart(49) showing that, over more than a decade, EL had not balanced its policy values with asset values, thus accumulating substantial deficits every year from 1989 to 2000, with peaks of 28% in 1990 and 20% in 1994. As a result of this "policy of declaring total bonuses in excess of actual investment performance encouraged hundreds of thousands of innocent new investors and the Society expanded hugely. Equitable Life's senior management clearly recognised the risks they were taking. On 27 June 2001 the new board of directors heard Chief Executive Charles Thomson’s view of the level of surplus he would have expected at the end of 1999. Thomson commented that at the beginning of 2000, the excess of policy values over the value of assets was approximately 3%, which would have been within the acceptable range. In response to a question, Thomson confirmed that under normal actuarial principles he would have expected there however to have been an excess in the value of assets over policy values of perhaps 6-7% at that time. At the beginning of 2000 the Society was short of assets (or had voted excessive bonuses) of about 10% (3%+7%) or £2½ billion. The loss of the GAR case in July 2000 increased this shortage to £4 billion. This was approximately the amount recovered by the 16% cut of policy values on 16th July 2001."(50)

Referring to the outcome of the Hyman litigation and its consequences, WE 46 cited Mr. Ned CAZALET, an advisor to the UK Treasury on life insurance, saying of the GAR policyholders: "They just shot themselves in the head. They could win a court victory. The question is: What are the consequences of winning? The Equitable is left facing a possible bill of £1.5 billion to cover the guaranteed annuity rates. It does not have that kind of money to spare."

Wrapping up the GAR issue on a more informal note, Mr. CAZALET concluded: "Think of the Equitable as a box of Smarties. The teacher promises a group of children four each. But the tube is smaller than the teacher thought and, when the sweets are shared between the whole class, there are only enough for three each. The disappointed group demands the promise be kept. The only way to get the extra Smarties is by grabbing them from their classmates. After a scrap, nothing remains but mushy chocolate and broken icing." (WE46)

3b)     The Compromise terms in detail

In practice, the compromise terms meant that:

- 70.000 GAR individual policyholders would get an increase of 17,5% in their policy value, in exchange for giving up their rights to a guaranteed annuity rate

- 415.000 non-GAR individual policyholders would get an increase of 2,5% in their policy value, in exchange for giving up their right to sue Equitable Life for mis-selling.

In WE29 Professor David BLAKE claimed that "the compromise scheme proposal documentation of December 2001 (and the 2001 interim accounts) indicated to policyholders that the with-profits fund would face an uncertain future only if policyholders failed to vote for the compromise scheme proposal that removed the problem with guaranteed annuities (GARs). These documents gave no indication that, even if the CSP was approved, the with-profits fund would be close to technical insolvency." He added as a policy recommendation: "in future, investors should only be permitted to participate in the same pooled investment fund if they all get the same expected (or ex ante) return."(51)

Referring to the content of the Compromise Scheme proposition, WE29 reported that the EL board had argued that "four principles underpinned its proposed solution. It must be fair to all with-profits policyholder groups, easily understandable and implementable, as well as acceptable to the High Court." The Board claimed that the Scheme satisfied these principles in respect of GAR policyholders since it involved "fair value compensation to GAR policyholders based on a ‘realistic estimate’ of the value of their legal rights given up ..., it apportions the compensation to different GAR policyholders in accordance with their rights; it reduces that compensation by the value of any possible claim for compensation given up by the non-GAR policyholders; the compensation takes the form of a proportionate increase in GAR policyholders’ policy values in both guaranteed and non-guaranteed form."(52)

In the event that the Compromise Scheme were not approved at the policyholders' vote, the EL had board considered the following options(53):

1.  Maintain the current position, matching GAR liabilities with hedging instruments

2.  Entering bilateral agreements with policyholders

3.  Apply to the court for a ‘reduction of contracts’ (Section 58 of ICA 1982)

4.  Make suitable amendments to GAR policies(54)

5.  Liquidate ELAS.

The Board decided not to recommend any particular one of these options, as it argued that each of them had disadvantages. (WE29)

3c)      The independent actuary's report

Equitable Life had appointed an independent actuary, Mr. Michael Arnold(55), to assess the compromise terms. He stated however that it was his duty "to report to the Society alone ... and no duty is owed to any policyholder of the Society. In particular, it is not intended that this report constitutes advice to any policyholder." (WE-CONF9) He further specified that "this arrangement has effectively isolated the specified German policies from the GAR problems confronting all other with-profits policies. These German policies will not be party to or affected by the Scheme."(56)

In the report's summary, Mr. Arnold considered the terms of the Compromise to have been established "in a fair and reasonable way from an actuarial point of view" (WE67) and that "the Society has established the GAR cost on a realistic estimate basis ..." (WE29). He added that "in the event that the Scheme is not implemented, a full reappraisal of the asset mix would be required to establish a long-term stable investment mix which recognises that the GAR problem will be likely to persist throughout the lifetimes of remaining policies and as a result will cause an unsatisfactory solvency position to persist for the Society." (WE29)

He also warned that "the Scheme does not eliminate all potential risks related to guaranteed benefits", adding that "it is recognized that the Scheme may be disadvantageous for individual GAR policyholders ... close to retirement who may intend to exercise their GAR rights." His conclusion was: "The principal advantage of the Scheme for non-GAR policyholders is that the cost of the GAR rights is crystallized ... and the removal of such uncertainty will have advantages to all with-profits policyholders and for the future management of the Society."

3d)       FSA's role in 'Compromise Scheme'

As the Compromise Scheme was proposed under Section 425 of the ICA 1985, the FSA had no formal role in the process but, as a regulator, it had, under the FSMA 2000, the power to take action if it considered it appropriate, in order to protect the policyholders' interests. The FSA could also seek to be heard if the scheme was taken to court for formal approval after the policyholders' vote.

In its assessment of the Compromise Scheme published on 7 December 2001 (WE67), the FSA endorsed the terms of the deal, stating that "it had no reason to intervene to object to the proposals being put to policyholders" and specifying that "the FSA is content that, in relation to the relevant groups of GAR and non-GAR policyholders, the level of increase to policy values is a fair offer in exchange for the GAR rights and potential mis-selling claims that would be given up. While there are variations from person to person, within each relevant group, we are content that there are no categories of policyholder within the groups who would receive disproportionately greater or lesser benefits ..."

It concluded that the FSA "firmly believes that a successful compromise would, in principle, offer the best prospect of bringing stability to the with-profits fund and improving the outlook for concerned policyholders."

As far as the complexity of the proposed compromise is concerned, the FSA said it "believed it was important that the Compromise put to policyholders should be clear and should provide them with the information they need to form their own judgement about how to vote on the proposals put to them." However, it acknowledged that "much of the Compromise documentation sent to policyholders for the vote is complex ... We are content that it is sufficiently clear to enable them to form their own view on how they should vote, in the light of their individual circumstances."

The FSA further specified that it could not provide personal advice to policyholders, adding that "where Equitable Life policyholders believe they require assistance in deciding how to vote, they will need to seek independent financial advice." (WE67)

3e)       Complaints by policyholders

A large number of non-GAR policyholders and representatives of policyholders' action groups have submitted evidence and complaints about the Compromise Scheme. According to their claims, the Scheme had been devised in such a way as to harm policyholders from the beginning, suggesting that the subsequent policy cuts in April and July 2002 that promptly annihilated the modest uplift the Scheme had awarded them(57), had been foreseen, if not deliberately planned, by the EL management already when first proposing the Scheme in September 2001. Additionally, the regulator would have been aware of the fact that the proposed uplifts were fictitious, because they were not covered by sufficient assets.

Policyholders also complained that they had been led to believe that the with-profits fund would have been stabilized by the Compromise Scheme, a fact which proved to be untrue, as the fund remained subject to market fluctuations and the subsequent stock market fall during 2002. As a result, aggrieved policyholders claimed that after the Scheme was adopted in February 2002, non-GAR policyholders were definitely worse off than before, having signed away their right to claim redress from the Society, without having obtained any factual counterpart.

Equitable Life and the FSA (H4) have repeatedly argued that the subsequent policy cuts had nothing to do with the terms of the Compromise as such but were due to the drastic stock market fall in 2002 that weakened the asset base of the with-profits fund, and claimed that a market downturn of that magnitude could not have been foreseen at the moment the Scheme was devised in September 2001(58).

The Cazalet Memorandum of January 2001 sent to the Treasury Committee agreed that "it would be in the interest of the Society as a whole to resolve the guaranteed annuity option problem by having policyholders with pensions in deferment relinquish their options ... However, it is not at all clear that the GAR policyholders will vote for such a scheme, as it appears that the likely proposal will see the value of the GAR group's policies enhanced as a result of the up-front capital boost but that, on the basis of current market conditions, the subsequent loss of the GAR would cause a concomitant fall in annuity income in retirement ... If Equitable did succeed in persuading its policyholders to vote for what it calls the "compromise", this would not strengthen its financial situation considerably, notwithstanding the £250m kicker from Halifax, as the Society would incur substantial expenditure in buying out the GARs. The real benefit would not be the modest improvement in Equitable's solvency position, but the fact that the fundamentally unstable GAO problem would be eliminated" (WE58, page 14)

Referring to the Compromise Scheme, policyholder Mr. WEIR (WE6) claimed that "when Equitable Life proposed (with the participation of the FSA) a Compromise scheme in which policyholders would give up all their legal rights to sue in return for a very small increase in policy values, Equitable promised greater stability and hope for the future and that the Society would be putting £4 billion back into equity investments if the Compromise was voted through. But the increases in policy values were not guaranteed – indeed within just a matter of weeks the 2.5% increases had magically turned into 4% fund reductions! ... It is difficult to believe that at the time the Compromise was devised the management of Equitable Life didn’t already know full well that they were going to get people to sign away their rights based on a totally false prospectus, with the full knowledge of the FSA. Without a financial 'consideration' (however small) being offered to policyholders in return for giving up their rights to take legal action, the Compromise scheme would have been legally invalid. Yet in effect people were voting (although they didn’t know it) for a reduction in their funds and the removal of their right to sue the Society. The FSA allowed this to happen."

Mr. BELLORD (H2) also underlined the alleged unfairness of the Compromise Scheme "approved by the regulators, where many policyholders lost their right to redress. Charles Thompson (EL CEO) must have known at the time of the court hearing in February 2002 that they had not got the money, but he failed to tell the court.(59) Another point that needs exploring is that the regulators recommended acceptance of this compromise."

Mr. WEIR (WE6) claimed that "the FSA effectively recommended the Compromise as the best option for policyholders but was very careful not to publish this advice until 8 days after it had been granted immunity from scrutiny by the Parliamentary Ombudsman(60)! By a very strange coincidence, on the date of the first Compromise hearing in the High Court (26 November 2001) the FSA chose that particular date of all dates to put out a sensational press release concerning the so-called ‘Headdon side letter’ thereby completely drowning out news coverage of the terms of the Compromise: a 'classic spoiler'. This is circumstantial evidence that the FSA was working closely with Equitable Life and probably the Treasury to railroad the Compromise through."

In WE7 Mr. NASSIM claimed that "the list of elective omissions denotes regulatory failure before and after the Compromise, which was and remains knowingly deliberate ... The Compromise Scheme of arrangement was carried through to the detriment of members and with forfeiture of their legal rights."

Mr. DEPPE in WE81 also presented allegations of "fraudulent misrepresentation made by Equitable in May 1999 ... Equitable had concealed the GAR liability and recommended the sale of with-profits annuities. The single and only focus from April 2001 was to sell their 'Compromise'." He further related how at a meeting of Equitable with policyholders the ELAS Chairman Mr. Treves "was asked by the late (EP-Petitioner) Arthur White to state that all matters of a fraudulent nature had been dealt with in advance of the judicial 'Compromise' application. Mr. Treves refused to give this undertaking and Mr. White asked him to note his request and ensure the presiding judge at the application was made aware the very real possibility of fraudulent behaviour could exist. Mr. Treves did not carry out the express wish ... because it might have delayed or obstructed the granting of approval for the 'Compromise'. It was therefore never brought to the attention of the presiding judge that GAR liabilities had been concealed and WP annuities had been sold to unsuspecting policyholders."

The FSA denied allegations that the regulator would have known that the Compromise Scheme had been allegedly lacking supporting assets. Referring to the FSA's role in brokering the Compromise Scheme, the FSA representative Mr. STRACHAN (H4) explained that "the Equitable Life 2002 Compromise Scheme was carried out under the Companies Act rather than under Part VII (of the Financial Services and Markets Act 2000) and the final decision was sanctioned under an independent Court process. Nevertheless, we encouraged Equitable to go beyond what was required by the Companies Act to ensure that policyholders' interests were protected as far as possible, particularly through the appointment of an independent actuary to opine on the fairness of the proposals. We also oversaw the process of giving appropriate compensation to policyholders who left Equitable too early to benefit from the Compromise Scheme ... We concluded that, on the basis of the scheme that was presented for both GAR and non-GAR policyholders, the level of the increase in policy values was a fair offer for the GAR rights and mis-selling claims given up. Clearly, there were variations, but, overall, this was a reasonable compromise scheme."

Allegations that policyholders were not openly informed by EL that the Compromise scheme would not bring final stabilisation to the with-profits fund (WE-CONF16) but that any stock market fall would require further cuts in policy values (as indeed happened in April and July 2002), were also rejected by CEO Mr. Thomson, who claimed that "the with-profits fund has always been invested in a mix of investments and has consequently always been subject to the impact of market movements. There was never any suggestion that the Compromise Scheme would change the concept of with-profits. Further, the Board was not in a position to second-guess the future of investment markets." (WE70)

Mr. Anthony BOSWOOD QC stated in WE76 that, in his opinion, there were "in relation to the conduct of the Society's affairs in 2001 and 2002 various issues and questions which need to be addressed and answered, before excluding the possibility that policyholders, and indeed the court, were misled because relevant material was not put before them." (WE76, par. 4) He went on to state that "if the Board was aware, when the Scheme documentation was issued ... and debated in court, that the 2.5% uplift was likely to be entirely illusory unless there was some immediate and unheralded rise in equity markets (when 56% of funds were held in cash and fixed interest securities in any event) that was surely something that ought to have been mentioned to those, including the court, from whom approval of the Scheme was being sought. As it was, the financial information provided as part of the scheme documentation was seriously out of date by the time the merits of the scheme came to be debated. But the Society's board clearly did have financial information more recent than that ... which would have shown that the Scheme uplifts in policy values were likely to be illusory." (par. 9 and 10) As a consequence, Mr. BOSWOOD concluded suggesting that "those responsible concealed information which they knew to be relevant to the Scheme."

3f)      Claims of EL management not qualifying as 'fit and proper'

In the context of the alleged withholding of information when presenting the Compromise Scheme to policyholders, in 2005 EMAG sent a request to the FSA to open an investigation under Section 168 of FSMA 2000, in order to verify if 3 EL top managers (the Chairman, the Chief Executive and the Appointed Actuary) qualified as 'fit and proper persons' to perform their functions. If, in the light of evidence presented on the Scheme, the FSA investigation came to the conclusion that they had indeed withheld key information, they might not qualify as 'fit and proper' to perform their function. In that case, the FSA could withdraw that person's approval or take disciplinary proceedings under Section 63 and 66 of FSMA 2000.

Mr. Anthony BOSWOOD, QC (WE76) agreed to the point that if it was proven that EL top managers might have "concealed information which they knew to be relevant to the Scheme ... deliberate concealment of that nature would, in turn, suggest that the persons concerned might not be 'fit and proper persons', the precondition for the exercise of the FSA power to investigate" in Section 168(5) of FSMA 2000.

In a letter of 21 August 2006, the FSA stated that they "did not consider that there is cogent and compelling evidence and reasoning which leads to the prima facie view that information was deliberately concealed from us, the court or policyholders between December 2001 and February 2002", concluding that they "stand by the analysis and conclusions set out in our statement at the time of the Compromise Scheme." The evidence sighted gave no indication the FSA has been willing - or shown any intention of - formally opening such an investigation.

4.         Negligence in Conduct of Business (CoB) supervision

Allegations of CoB failure were addressed by a large number of policyholders not only against the UK regulators but also against the Irish Regulator (DETE/ISFRA)(61) and the German Regulator (BAV/BaFin)(62), who, according to 3LD provisions, were responsible for CoB supervision of EL's operations on their territory.

As claimed by WE-CONF26, "it was in accordance with the Third Life Directive for the FSA not to impose the Conduct of Business rules on branches situated in other Member States ... (but) effective PRE protection for ELAS ... branch business had to be ensured by FSA."(63)

In WE-CONF10 a policyholder complained in particular about the refusal by German regulators - systematically referring to the 'Home Country principle' as defined by 3LD - to assume any responsibility for improper operations of EL in Germany. This claim was supported by Mr. WESTPHAL in WS2 stating that "national supervision often plays a too passive role in the monitoring and enforcement process" and that "unless a 'critical mass' of complaints is reached, supervision will not get active in some Member States."

4a)       Allegations of mis-selling and misrepresentation in the UK(64)

Fundamentally, policyholders have been making two types of allegations against EL:

- mis-selling by knowingly misrepresenting facts about the company's financial position, especially in relation to the GAR risks;

- omission (possibly based on deceit), by failing to draw attention to the GAR risks, when that risk was a matter to be disclosed to existing and prospective policyholders.

Specific evidence for mis-selling was produced by a number of policyholders: Mr. SEYMOUR (WE53), presented to the committee copies of Equitable Life sales material clearly stating that the 'with-profits' fund "has the essential feature of smoothing out fluctuations in earnings and asset values generally associated with investments in such portfolios."(65) This claim proved to be untrue, as EL turned out not to have accumulated any significant reserves in the years of positive market performance to allow for any 'smoothing out'.

In a note to policyholders dated 26 January 2000 (WE53), Equitable Life claimed that the negative Court of Appeal ruling would not affect EL's economic risk profile, asserting "there will be no financial impact on the Equitable. The Equitable's solvency and status as an independent mutual are therefore not in question".(66) This point was later reneged in letters to policyholders dated 14 August 2000 (immediately after the House of Lords ruling) and 18 September 2000, where the widespread cuts in with-profit policies were communicated(67). Another false statement appeared in the above-mentioned 26 January 2000 note, claiming that "there will be no impact on bonuses for international business ... as none of the Equitable's international policies contain such guaranteed rates." This point was proved wrong by evidence that all policies, UK and non-UK, were managed in the same fund and there was no separate fund for 'international policies', as claimed by EL.

Another allegation of mis-selling and misrepresentation by EL was presented by Mr. NASSIM (WE7) who claimed that the regulators have "deliberately overlooked 'incentivised ignorance' and fraudulent general mis-selling, as despite what the Society told policyholders about the absence of commission fees, it paid its staff an as yet unspecified commission on sales. Nor do we know whether the commission was the same for all the Society’s products, or if it was greater for with-profits products. By refusing to admit or document general mis-selling and non-disclosure, the Society and the authorities have transferred the burden of proof to each individual policyholder ... It is hardly surprising that the FSA has belatedly said that it has conducted its own investigation and found no case for mis-selling by the Equitable, while refusing to publish the evidence."

Mr. JOSEPHS (WE69) claimed that "a continuous chain of evidence exists that demonstrates that Equitable set out to create an unlawful and misleading performance record that would survive for at least 15 years, and to use these rigged performance figures as their primary tool to bring in new policyholders and to increase the assets of the Society. However, the measures required to create the false performance figures also undermined the security of EL’s finances, so that the longer the deceptions continued, the greater was the scale of policyholders’ losses ... Equitable decided to create a favourable and continuing set of performance statistics by the simple device of overpaying specific cohorts of policyholders, whose premiums were received in or prior to the years 1975-1980. This was unlawful since it breached the Directors’ fiduciary duty to deal fairly between groups of policyholders ... They thereby deliberately put the WP Fund into effective deficit over a period of at least four years. No hint of this was given to policyholders ... The mass of policyholders remained in blissful ignorance of the threats overhanging their policies, and strenuous efforts were made to keep them in that state. Their attention was focussed on their ‘policy fund’, described as a ‘share of a central smoothed managed fund’, with their Total Policy Value representing their ‘smoothed asset share’".

In H8 Mr. BAIN also made a clear allegation of mis-selling, calling the Committee of Inquiry "to consider the treatment of 20,000 EL customers who were sold a product called 'managed pensions' between 1995 and 2000, and most of whom between 2001 and 2005 received little or no redress, despite being victims of what the evidence suggests was an orchestrated culture of mis-selling ... EL behaved as a company, without integrity, care or diligence, though with a great deal of self-interested skill." (WE72)

In WE81 Mr. DEPPE related meeting Equitable CEO Mr. Thomson in January 2003, asking him in a televised programme "how it had been possible for Equitable to instigate the marketing of with-profits related products in the post-September 1998 period without resort to wilful deception. He did not answer ... His eventual written response was to advise me that my complaint had been resolved by the 'Compromise' and the case was closed."

WE-CONF2 also added a number of mis-selling allegations, in particular for omitting to represent the GAR risk to prospective customers, a fact that damaged mostly Late-Joiner policyholders who took out EL policies after September 1998, i.e. after EL had already sought legal advice on the GAR problem with its solicitors and regulators. "Each of the members (Late Joiners) or at any rate most of them, received from the Society a 'Key Features' document relevant to the policy he or she was buying. It was a requirement of the PIA rules ... It is evident that these gentlemen (EL executive directors) knew the advice the Society was receiving from its lawyers about the (Hyman) litigation and the issues surrounding it; and they were all involved in the process of providing information to the Society's sales force for dissemination to policyholders and prospective policyholders ... By January 1999 the GAR problem was the subject of intense discussions in the press, which was putting out alarming articles and reports ... Clearly this made the writing of new business problematic. Yet new business was required f the Society was to avoid closure ... New with-profits policyholders needed reassurance at all events they could not be told of the GAR risks ... The Society adopted a policy of downplaying the GAR risks, misrepresenting the facts to prospective policyholders: the 'Risk Factors' section of the Key Features document provided being silent about the GAR risks."

Members of the Late-Joiners action group reported that EL salesmen gave them different stories to soothe their concerns: "that press reports that the GAR liabilities might be in the order of £1.5bn were wrong; that the maximum cost to the Society was unlikely to exceed £50m; that the GAR liabilities would be ring-fenced among the GAR policyholders; that reinsurance was in place to protect non-GAR policyholders." (WE-CONF2)(68)

Policyholder Mr. John GALVIN (WE-FILE15) complained that his decision to buy an Equitable Life policy was partly based on EL's reassurance of its solid financial standing confirmed by the "AA" rating obtained by the international rating agency Standard & Poor's(69) (annex to EL letter in WE-FILE15).

Referring to misleading information from EL to policyholders, Ms. KWANTES (H7) recalled that "when Equitable went to court on the GAR issue we all received letters to inform us that everything was fine, negative comments that had appeared in the press were nothing to worry about and there was a very impressive advertising campaign which gave us all a sense of security."

In H5 Mr. LLOYD, a former sales representative of Equitable Life in western England between 1995 and 2001, clearly dismissed all allegations of mis-selling by the Equitable sales force: "Telephoning for appointments, often to offer an annual review or a current update on policies, was nearly always welcomed by our clients. The news was often good and it was not difficult to propose new investments. The clients often commented on how their other providers did not offer the same level of service ... When the guaranteed annuity rate issue became known and talked about, which was I believe in around 1997 – that was the first time I had even heard about it – we very quickly received a briefing from the board. The briefing was to give clients a non-guaranteed final bonus and a GAR that only applied to the guaranteed element. That would be equivalent to giving that client 20% more than their fair share of the fund. This as a concept was not difficult to understand and not difficult to explain to clients from that point on. My own experience was that the response from clients who heard this explanation, including those who had GARs in their policies, was favourable." Client relations would thus have been good even in 2000 as "by approaching the whole issue during that period right up until the House of Lords ruling in July 2000, we had very little difficulty and very little problem with our clients accepting the explanation we were giving."

Allegations of knowingly misleading clients or possibly 'glossing over' unpleasant facts were equally and vehemently denied by Mr. LLOYD: "I do not believe there was ever a point when I questioned whether I was pushing or selling something that I should not be selling, and I do not believe that any of my colleagues felt that way either ... I can tell you that, in terms of the information we were given, we were never ever told: ‘you can say this, but you must not say that’, or ‘here is the true position, but you must not let people know this’. That was never ever the case ... I did buy the line that the Society knew what it was doing, knew how to run the business and did have a successful working model. So there was nothing to gloss over. I never felt at any point from that stage right up until 8 December 2000, the day it closed, that I was glossing over or keeping from my clients information that I had somehow discovered and was not divulging ... Certainly I never knowingly misled any of my clients and I do not believe any of the Society’s representatives would have continued selling contracts that they knew were misleading. I do not believe that to be the case. I think that, in hindsight, we were selling the with-profits fund in a way that, from what we now know, was reckless both for income drawdown and for with-profit annuities. It was a damaged proposition, but we did not know that. It was damaged because of the true nature of the liabilities in that fund, but we did not know that."

Mr. LLOYD admitted, however, that the risk profile of the products they were selling did not accurately reflect the reality, although the sales force had been apparently unaware of this: "I think the biggest mistake by far was the question of how we were allowed to sell the with-profits fund as low-to-medium risk when it almost certainly should have had a warning plastered all over it from about 1998 onwards ... I did not think it at the time, but in retrospect and hearing all the points being made I think we should have had a warning. The board should have been warning our clients that our with-profits fund should not be treated as low-to-medium risk, because there were issues that were unresolved and while they were unresolved, if anything, we should have withdrawn it ... With hindsight, I believe I was misled about the risks associated with the with-profits fund. I believe that now, I most certainly did not at the time ... I believe that something should have been done to prevent further clients – other than those already in it – committing money to a fund that had liabilities that were beyond its means."

Finally, on the selling material, Mr. LLOYD also denied allegations it was made to mislead clients, as "the material was not, as I saw it at the time, designed to mislead anyone. It was giving people a view of what we thought was a sound, well-run company and fund and encouraging people to invest because of the performance we had achieved over the years."

4b)      Allegations of mis-selling and misrepresentation in other Member States

Reporting further mis-selling allegations outside of the UK, Mr. SEYMOUR (H7), a policyholder who took out his policy in Belgium, related that "ELAS sales personnel approached potential customers throughout the Community stating that it was possible to invest in ELAS pension policies due to changes in the law. It stated that these policies were called “international” policies and were separately administered by a branch office outside the UK ..."

Another document(70) proved that ELAS had been claiming to provide something of a "smoothing fund" based on the build up of reserves: "ELAS claimed it was running its pension fund as a smoothing fund by holding reserves. The bonuses were declared annually and were specified as being 'guaranteed'. All documents stressed regulation in the UK in the back page ... I was also assured that it was exclusively regulated in the UK so I felt sure that what I had seen and been told was correct. At the point of sale the company had assured potential purchasers that the 'international' policies were separate from the UK with-profit fund." (H7)

Mr. SEYMOUR added that during an ELAS sales visit to Belgium in 1994, ELAS representatives informed him that "they were authorized to make such sales outside the UK. They also stressed that the content of their sales material was accurate, that the conduct of their business (was) sound, because their investment activity was regulated by the 'reliable UK regulator' (words of the ELAS representatives)." (WE36)

A number of other non-UK policyholders reported allegations of mis-selling or mis-representation of facts. Policyholder Mr. McCARTHY (WE-FILE16) reported that his decision to join Equitable Life was influenced by the Equitable's claim that it was a member of the "Insurance Ombudsman of Ireland Scheme". Mr. BERRY (WE-FILE13), an Irish policyholder, asked how it was possible that "the Equitable, in its circumstances, could be allowed to write new business (in Ireland) as late as April 2000. It could only do so because of gross dereliction of duty on the part of the Regulating Authority." Policyholder Mr. DUGGAN (WE-FILE14) claimed the Equitable policy had been sold to him as being "subject to the laws of Ireland". Policyholder Mr. TROY (WE-FILE4) considered he was mis-sold his policy in December 1999 as "the company had major difficulties with its liabilities to pension funds in the UK ... and I was not made aware or privy to this." Policyholder Mr. O'FARRELL (WE-FILE9) complained that he "was never informed of the potential GAR liability looming over the fund and the possible consequences to my pensions funds having to partly finance that liability."

An interesting statement in this context was made by Mr. Seamus POWER, a former EL sales representative in Ireland (WE-FILE2), who said that he had heard "about the GAR issue through the Sunday Times in late 1998. By then there were about 12 sales people and none of us had ever heard about the guaranteed annuities, as they were never sold in Ireland. We asked the management about the situation and were told it was nothing to do with us and to get on with the sales." Hearing about the Court case coming up in July 1999, he was told "as not having anything to do with the International Branch as these policies were never sold here and our funds were 'ring-fenced'." After the lost appeal case "we were told to keep selling as we re 'ring-fenced' and would not be affected by the outcome even in the worst case ... We continued to sell and more sales staff were recruited during this time ... When EL was closed to new business, we were all made redundant. Then the penalties were introduced and locked many policyholders into the position of either taking a 10% reduction in policy value or staying invested. It appears that the management of EL knew there were significant problems within the Society in 1998 and I think all policies sold after this date should be void."(71)

Countering allegations put forward by Irish policyholders who claimed to have been falsely informed by Equitable Life (i.e. that they had bought - or would be buying - into a separate 'ring-fenced' Irish fund unaffected by liabilities arising within the UK fund) EL CEO Mr. THOMSON (H8) replied that "Irish policies had a separate bonus series and notionally earmarked assets, allowing investment returns in Irish business to reflect investment returns in Ireland. So, for example, the 16% policy value reductions which applied in the UK in 2001 did not apply to Irish policies." He confirmed however that the Irish business was nonetheless part of the Society’s single with-profits fund.

But WE-CONF28 highlighted that, although it was correct that the Irish policies had not suffered the 16% policy value reduction in July 2001, "to compensate for this, higher penalties and lower bonuses were awarded to Irish policyholders."(72)

WE-CONF21 stated that "there existed nothing in EL's product literature which stated that Irish investments would somehow be kept separate from the rest of the with-profits funds." This statement was supported by ISFRA in WE80 claiming that "no evidence has been presented to support the allegations that EL were representing that an Irish 'ring-fenced' fund existed".

This statement was however not supported by evidence in WE-CONF28, which proved that at an EL press conference in Dublin on 14 March 2000 "Terry Curtis, International Actuary of Equitable Life UK ... stated that the Court of Appeal ruling had no impact on Irish policyholders who are ring-fenced from their UK counterpoints."(73)

WE-CONF28 further proved that on 12 December 2000 "Mr. Noel Creedon, managing director of the (EL) Irish operation insisted there would be no penalty in the Irish market for early encashment of with-profits policies ... We have a surplus on the fund at the moment ..." Both statements clearly indicate that EL was publicly referring to a separate Irish fund, and making Irish policyholders falsely believe that they were - or had been - buying into an EL fund which was separate from the main UK fund.

Referring to EL's alleged 'International Policies' Mr. SEYMOUR (H7) also reported that when problems at Equitable Life were being widely reported in the press in late 1999, Equitable wrote to all 'international' policyholders in January 2000 "reassuring them that their policies were indeed separate and would be unaffected by any court ruling on the company’s UK funds. It was only subsequent to the Court case that the company admitted that this was not true. On 14 August 2000 ELAS wrote to say that as a result of the loss of the Court case with profit bonuses would be reduced for 'all' types of policyholders and that the society was up for sale." (74)

 4c)      Allegations of 'churning' policyholders' contracts

In WE72 Mr. BAIN claimed that in the mid-1990s Equitable Life had devised a strategy to counter the sharp fall in interest rates which had increased dramatically its liabilities due to the GAR-policies on its books and threatened its minimum reserves margins. Thus, EL would have proposed to policyholders "a new-style pension plan which would enable deferring an annuity until age 75, but claiming the 25% tax-free cash immediately, and drawing down income in the meantime. The attractions of ‘managed pensions’ were powerful:

(1) they could be sold on the story that annuity rates might go up again

(2) they would create ‘new business’ from selling a new pension product

(3) they would generate cash from the tax-free lump sum, and the income, which could be invested in other EL products

(4) policyholders with guaranteed annuity rates would lose their guarantees, offering potential significant reduction of liabilities."

As in 1995 the UK general election - with Labour favourite to win - was only 2 years away, "EL’s salesforce was approaching its affluent clients who were over 50, or as soon as they turned 50, suggesting 'income drawdown(75)'", in spite of detailed guidance by the PIA (G-60) which considered it suitable only for a minority of people approaching retirement. "The first technique was a scare story: they worried clients that an incoming Labour government might easily scrap the entitlement to tax-free cash from pensions – 'better take it now, even if you don’t really need a lump sum, and draw down income, even if you don’t really need any income'.

As an insurance salesman’s obligation was to show that he had offered the client the most suitable product in the insurer’s product range, "the second technique was to withhold, or falsify, relevant information about the product – its tax status, for instance - or possible alternative products which in practice were never sold at all. Then, once the drawdown sale had been clinched, it was suggested that the tax-free lump sum, and usually the income too, should now be invested in other EL products. That miraculously created a triple sale, triple commission, and triple ‘new business’ sales, often of substantial sums well into six figures - from what was actually old business."(76)

A report cited by WE72(77) listed 200 cases of dissatisfied EL policyholders where "every single one had featured lack of information and misrepresentation at point of sale and for virtually all of these clients, doing nothing or taking a phased retirement plan had been best advice ... Income drawdown was a complex option requiring proper advice, but when sold directly there was substantial scope for commission abuse. What was the regulator doing? In February 1999 publicly available figures ought to have set alarm bells ringing in the PIA: EL’s sales force had already sold 11,600 income drawdown plans worth £1.35bn – almost twice the £750m sold by the next biggest player ... and four times the industry average. Moreover, EL had invested 95% of its drawdown money in its with-profits fund – whereas chief rivals Scottish Equitable (25% in with-profits) and Winterthur (very little) both said publicly that with-profits was not suitable for most investors. Why was EL so out of line with the rest of the industry? At last in May 2002 the FSA announced its concerns: it had discovered that drawdown could earn salesmen commissions of 6% compared with 1.5% in annuities, and said it was reviewing evidence of bias in sales."

Mr. BAIN concluded: "Thousands of pensions carrying valuable guaranteed annuity rates were wiped off the books, with customers typically not even informed that they had a guaranteed rate, let alone being offered an informed choice. How did EL get away with these flagrant breaches of conduct of business rules, not to mention the overriding principles of integrity and diligence? I believe the UK regulators firstly through incompetence failed to notice clear warning signals about this company’s conduct of business or give the consumer any protection from it. Secondly they failed to understand how these business practices enabled EL to misrepresent the value of its new business, among other things, in its critical financial reporting. Finally, they colluded with Equitable Life’s new board in a strategy to minimise financial and reputation damage to the company, the industry and the government. But this could only be done at the expense of policyholders’ proven legal rights." (WE72)

A similar allegation was made by Mr. JOSEPHS (WE69) claiming that "Equitable decided to misrepresent the asset backing for its newer ‘investment’ policies such as Personal Pensions and Insurance Bonds. It did this from 1987 via its sales force... Over time, Equitable pursued the goal of replacing older forms of policy with more ‘technically efficient’ versions, requiring even smaller capital reserves (because of more limited guarantees). To sustain apparent fairness, such policies received the same total return, but with a substantially increased proportion of final bonus to cover the reduced guaranteed element. The apparent fairness was a mirage because the whole of final bonus was contractually removable at any time, so that the price of increased ‘efficiency’ for the Society was substantially increased risk for the policyholder. These risks were deliberately concealed from the customers affected by such deliberate policy restructuring."

4d)      Claims of communication failure between UK regulators

Mr. NASSIM (WE7) claimed that "the prudential regulators failed to communicate effectively with those responsible for the regulation of the conduct of business by insurance companies, particularly in relation to ELAS’ published actuarial and insurance business paradigm, or to advise the Conduct of Business Regulators that the realistic position rather than the solvency position was the primary reference for potential customers".

ES-2 considered that in the UK "the prudential regulators did non see it as part of their remit to keep the CoB-regulators informed of problems in the life industry... There was little or no practical cooperation between them until the staff responsible for prudential supervision found themselves in the same building as the staff responsible for CoB ... Even then, it would take some time for each side to ... learn how to work together."

On this issue, the FSA representative Mr. STRACHAN (H4) explained that "there are broadly three sets of circumstances in which communications between regulators should formally take place. Those are when a company that has branched into other Member States becomes insolvent; when a company that has branched is de-authorised for any reason and when there are changes in circumstances, such as the closure of the branch. The first two conditions – insolvency and de-authorisation – were never triggered, so they are not relevant. When the branches in Ireland and Germany were physically closed following Equitable’s closure to new business, then there was contact with our counterparts at the time."

Mr. BAYLISS (H5) also stated that "there is no doubt that the FSA has done a lot of work on the part of its mandate in relation to prudential management of companies, and particularly in relation to with-profit ... The FSA has been much more active on the conduct of business, because that was perceived to be the industry’s weakness ... I think that in terms of its conduct of business requirement, the regulator was going through a learning curve and one that it could justifiably say was new, because to be honest the Treasury and the DTI had not had that type of role.

4e)       Communications between UK and foreign regulators

UK/Germany

Evidence seen in WE-CONF9 and WE-CONF17 suggested that the first contacts between UK and German regulators on prudential supervision issues concerning Equitable Life date as far back as 1995(78), after EL opened its German branch in Cologne in December 1992 and began selling policies by authorized agents. On 20 March 1995, the Bundesaufsichtsamt für das Versicherungswesen(79) (BAV) with reference to Article 5.32 of the Siena Protocol, wrote to the DTI recommending the use of new mortality tables drawn up by the German Actuaries Association for the calculation of premiums and cover reserves. Stating that it "could not assess to what extent the provisions on the interest rate of reserves applicable in the UK have been observed, it ... is possible the undertaking has not complied with the provisions of art.19 in conjunction with art.18 (1c) of TLD".

The BAV also uttered concern that the Equitable Life Deutschland marketing manager was quoted(80) as making no distinction between men and women in the application of annuities "which would have been contrary to actuarial principles applying in Germany". A reply from DTI, if issued, has not been presented to this committee.

A second exchange, this time between BAV and FSA, happened in the aftermath of the House of Lords ruling on 31 July 2000 - following media reports and enquiries from worried German policyholders - the BAV asked to be informed on the financial stability of EL, any actions taken by the FSA in relation to the company and the ruling's consequences for German policyholders.

The FSA reply came promptly on 7 August 2000 "subject to the disclosure restrictions in accordance with the provisions in the EC Insurance Directive". Thus BAV was informed that the FSA was "satisfied that EL remains able to cover the required margin of solvency, however the level of cover is below what both the FSA and the company would want to see on a long-term basis." The letter further added in very optimistic terms that "the company is putting itself up for sale and ... there are not expected to be any shortage of companies interested in acquiring Equitable Life, because of its strong reputation in the UK industry for efficiency ... We are monitoring the solvency position closely, but are content that the plans for the sale of the company can be expected to resolve the longer term concerns about the financial position. The management of the company appear to be handling the situation effectively and we are satisfied that in doing so they are seeking to act in the best interests of policyholders."(81)

Finally, the FSA confirmed that "policyholders of the (German) branch will be in the same position as UK policyholders", adding that "on completion of the sale of EL, the company expects to be in a position to restore the cut in the value of with-profits policies that will result from its revised bonus policy." It concluded hoping the information will enable BAV "to allay some of the broader concerns of German policyholders."

Then, as the sale of Equitable Life failed to materialize and it was forced to close to new business, BAV contacted the FSA again on 13 December 2000, asking for explanations in the light of their August letter. The FSA reply came again promptly on 3 January 2001 and - referring to previous phone contacts - reiterated the point that "EL remains solvent, existing policies remain valid and it is able to meet its contractual obligations to policyholders", going as far as defining "many of the press reports in relation to EL have been inaccurate and speculative" and closed by saying that the FSA "will not be requiring the company to provide a new valuation."

Following contacts between the UK and German regulators were limited to announcing the prospective closure of EL's German branch (30 June 2001) which prompted a reply from BAV reminding that "some policyholders only took out a policy with EL because it had a branch in Germany", and expressing their wish "that German policyholders continue to receive an optimal service in the future." BAV closed by requesting "a statement on how the German policyholders are to be served in the future." No reply from FSA appears on record, and contacts between regulators seem to have loosened afterwards, as BAV had to write again twice (on 7 November 2001 and 19 March 2002) asking FSA for a clear confirmation on the closure date of the EL German branch, which was shut down on 30 September 2001.(82)

Finally, referring to the sharing of supervisory responsibilities between the UK and German regulators during the period prior to the entry into force of 3LD, WE-CONF26 asserted that "under the regime of the Second Life Directive ELAS early German branch business has to be considered not a scenario of 'passive freedom of services'. It was the ELAS German Branch that actively approached German policyholders. This qualifies ELAS early German branch business for active freedom of services rather than art.13 of the Second Life Directive." As such it "was to be supervised by the supervisory arrangements of Germany and the BAV and not by those of the UK and the FSA."

UK/Ireland

As recalled by the Irish Financial Regulator in WE61 "EL operated a branch in Ireland from 1991 to 2001 and sold policies to Irish citizens. Under 3LD, the Irish branch was subject to prudential regulation by the UK regulator ... and closed to new business in December 2000, at the same time as the UK head office, and has not sold any new policies since then. EL is servicing its remaining Irish policyholders on a cross-border basis under the provisions of the 3LD ... There was no documentary evidence put to us that EL had breached any Irish financial services legislation."

Correspondence between the UK and Irish regulators on record (WE-CONF9) is limited to technical exchanges in 1994 and 1999 relating to changes in the 'EC requisite details' of EL's Irish branch, which had been operating since 1991 (WE38). Further exchanges happened in 2002, when the FSA informed the DETE(83) of the closure of EL's Irish branch and on its operating under passporting agreements from the UK as of 8 July 2002, joining a solvency certificate.

4f)       Misleading advertising on the German and Irish market

In early 2000, Equitable Life started an aggressive marketing campaign in Germany to attract more German clients. The BAV identified in EL adverts a misconduct on the ground that such advertisements were misleading in their use of terms such as guarantees, guaranteed terminal bonus, with-profit benefits and final bonus. Relating to this issue, Mr. WEYER representing policyholders' association DAGEV (H3, WE22) supported claims that Equitable Life's adverts were a case for misrepresentation.

Two advertisements in particular, published in large German newspapers(84) in February 2000, appeared grossly misleading: one advert ('13%', see picture below) suggested EL granted guaranteed rates twice the German average at that time; the second advert ('Buy German, Earn British') implicitly suggested EL policies were under surveillance of German regulatory authorities, which was clearly not the case for prudential supervision.

Questioned on this subject, the German financial regulator (BaFin) representative Dr. STEFFEN reported in H6 that Equitable Life Deutschland (ELD) had stopped the advertisement campaign after prompt intervention by the regulator (at that time still BAV).

However, WE-CONF17 shed additional light on this point, showing that the regulator's intervention was quite 'tame' both in timing and effectiveness. A first BAV letter of 12 April 2000 - some six weeks after the adverts had appeared in the press - asked ELD to comment on allegations of improper advertising, repeating its request on 29 May and 4 July 2000. ELD's reply finally came on 17 July 2000, apparently dissatisfying, as BAV had to put additional questions: while the effects of the House of Lords ruling on EL were widely debated in the UK press, BAV wrote again on 31 July 2000, contesting the adverts' legitimacy and asking to specify "whether the advert is still in use in this form; if not please send us a sample of the updated version." Even this request had to be reiterated on 12 September before finally getting a reply from ELD on 21 September 2000, in which ELD confirmed the advert had been withdrawn ... over six months after their first appearance in the German press!

On 10 October 2000, BAV acknowledged the withdrawal of the first advert, and intervened to stop the second advert, but again in very subdued wording and without issuing any direct order or setting a specific deadline ("I therefore ask you to withdraw this particular advert or any publicity of similar content").

No specific cases of misleading advertising by ELAS were reported in Ireland: the Irish Financial regulator stated in WE 80 that they were "not aware of any complaints having been received by the relevant Irish authorities charged with regulation of the insurance industry regarding misleading advertising by Equitable Life."

 

 

(1)

We recall the abbreviations used in this report for evidence submitted to the Committee:

H # = oral evidence given at EQUI Hearing; WS # = oral evidence given at EQUI Workshop;

WE # = written evidence filed on EQUI website accessible to public; ES # = external study;

WE-FILE # = written evidence not filed on website; WE-CONF # = confidential written evidence.

(2)

In all, 12.425 policyholders in EU Member States (Ireland, Germany, Belgium, Austria, Denmark, Finland, France, Greece, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden) and 980 in UK-dependencies (Channel Islands, Isle of Man, Gibraltar).

(3)

The Equitable Life Action Group Ltd.

(4)

see WE58 for more details.

(5)

Director of the Major Retail Groups Division at the FSA.

(6)

Director for Financial Services Policy at HMT.

(7)

Dr. Kern Alexander cited the following UK financial sector crisis prior to the Equitable Life case: Johnson Matthey Bankers insolvency (1984), BCCI collapse (1991), Lloyd's scandal (1994), Barings Bank collapse (1995), endowment mortgages scandal (1999).

(8)

"The directors of a with-profit office declare periodic bonuses intended to reflect the underlying trend of investment performance. In this way with-profit investors are protected to some extent from market swings. Many with-profit offices reinforce this by maintaining an ‘estate’ of surplus assets, which belongs to no one. This enables such companies to continue to declare bonuses during market falls." (WE34, page 1).

(9)

see WE32, para.66-67.

(10)

see Art.18 3LD, transposed by Regulations 58-75 of Insurance Companies Regulations 1994.

(11)

see Art.18 and Annex I 3LD, transposed by Reg. 27-33 of Insurance Companies Regulations 1994.

(12)

see Art.25, para.1 3LD.

(13)

see Art.29 and 39 3LD.

(14)

see Art.18 3LD.

(15)

'Saga Magazine' was originally a newsletter focused on providing value-for-money for people aged 50+; today it is a publication reaching over 1.25 million readers each month (source: www.saga.co.uk).

(16)

see WE53 annex N-1.

(17)

WE16, chapter 1, para.120.

(18)

see WE-CONF25, para.9-12, 18-20.

(19)

The Financial Ombudsman Service.

(20)

see also oral evidence by Lord Neill (H11) quoting the email as "seeking to' provide FOS with a basis' for considering Penrose-related complaints and that discussion to this end would take place between the FSA and the FOS in the week following 18 June 2004."

(21)

see WE-CONF5.

(22)

Allegations that the FSA could be (or have been) too 'industry-biased' in its supervisory and regulatory operations had also been judged "unfair" by expert Mr. McELWEE in H3.

(23)

Official Report, 28 June 1999; Vol. 334, c. 39.

(24)

see also 'timeline' in Section III.2.6 of this Part.

(25)

sections 168-170 and para.9 of the summary of findings, claiming that the FSA (with GAD) could not be said to have addressed the GAR reserving issue and any misrepresentation of EL's financial position "in anything less than a resolute manner", that their approach could not be described as 'passive' and that "FSA continued to insist throughout that Equitable conform to their full reserving requirements in the face of strong resistance from Equitable."

(26)

see reply of the former EL CEO Mr. HEADDON (WE45) and WE-CONF8.

(27)

This statement was made just 4 months before EL's closure for new business and the resignation of the EL board!

(28)

see WE75, point b).

(29)

Asked on this issue as an independent expert, Mr. Schneiter (Swiss insurance regulator) also stated that in his opinion "insolvency of an insurer should only be seen as a last resort measure" (H6).

(30)

see ES-1, page 9: "A life office had to notify the DTI any change of director, controller or manager and the DTI had the power to object the appointment of a new managing director, director or controller." Technically however, UK law did not formally exclude cumulating both roles.

(31)

Mr. Headdon had also been both CEO and AA of Equitable Life for some time.

(32)

see also the issue of "Managed Pensions/Income Drawdown" as detailed in WE72.

(33)

see WE-FILE22.

(34)

WE-CONF21 confirms that EL continued to take in new business after this date until it closed down to new business on 8 December 2000. For details on this period see also Chapter 18 of the Penrose report (WE16).

(35)

discretion power claimed by EL management under Art.65 of the Memorandum and Articles of Association of ELAS.

(36)

this sum comprising £200m to cover the lower GAR pension payouts between January 1994 and 20 July 2000 and £1.3bn for correcting future shortfalls.

(37)

see also para.4.15.3 of the Baird Report (WE17).

(38)

WE58, page 7-10.

(39)

WE29, annex A.2 details: "as of 30 June 2001 there were 70.000 individual with-profits policyholders with GARs, 415.000 individual policyholders without GARs, 105.000 GAR and 510.000 non-GAR policyholders in group pension schemes".

(40)

WE58 explains how "Equitable's approach to cost controls and operating efficiency... meant that it was always going to be peculiarly unattractive to a prospective purchaser (even leaving aside problems with guaranteed annuities) for the simple reason that it had become so efficient and lean that there would be only very slim profits to be generated for a shareholder were the Society ever to de-mutualise". Prospective buyers were also deterred by the fact that "a fundamental value of Equitable (pre 8 Dec. 2000) of £2bn at best had to be set against the estimated £4bn of required financial repair."

(41)

On 8 Dec 2000 Equitable Life lost its investment grade credit rating (AA/A+ held since 1993), as S&P downgraded it to BB/Watch negative (WE-FILE22).

(42)

"Equitable Life certainly has not been "bought" by Halifax plc. The arrangements entered into with Halifax were in respect of certain operations of the Society and did not involve the demutualisation of Equitable and/or the transfer of its long term business to any person. Accordingly, Equitable remained a mutual life office owned by its members." (WE58, page 13).

(43)

EL CEO Mr. Thomson (H8) claimed this decision was taken "to achieve greater fairness for all policyholders" (no specifications given, ndr) "after having considered a range of options with the AA."

(44)

This in spite of the FTSE-100 stock index declining only 6% between July 2001-April 2002 and EL's relatively low equity exposure (46%). For further details, see WE-CONF16 (pages 3-4) claiming that "half of the policy value cut derived from EL paying excessive bonuses for more than a decade".

(45)

EL CEO Mr. Thomson (H8) claimed that "the policy value decision was for the board, not for policyholders: following the decision they were told policy values were in line with assets, so they were able to take an informed decision, about whether to stay or leave."

(46)

see also letter of 29 October 2001 from EL to policyholder in WE-CONF19.

(47)

the FSA material included two opinions of Ian Glick QC and Richard Snowden and two opinions of Nicholas Warren QC and Thomas Lowe given on instruction of the Society (WE-CONF2, para.3).

(48)

WE29, annex A.30 details: "Charles Thomson, who became CEO in March 2001, was given a bonus of £275.000 in addition to his total remuneration package of £347.758 for the year to December 2001; Vanni Treves, who took over as EL chairman in February 2001, was given a bonus of £250.000 in addition to his remuneration of £58.750." On this issue Mr. Thomson explained in H8 that the decision to award these bonuses was reached "by the EL remuneration committee, chaired by Sir Philip Otton, and unanimously endorsed by the Society's Board. The Board agreed that the payments were appropriate, fair, justly deserved and certainly not overgenerous." (see also EL AGM, May2002)

(49)

WE34, page 2; data based on findings of the Penrose Report.

(50)

WE34, page 3-4.

(51)

WE29, para.5 and 7.

(52)

see WE29, annex A.17-18.

(53)

see WE29, annex A.24-25.

(54)

For instance a 'Schedule 2C transfer' under ICA 1982 or a 'Section 112 transfer' of the with-profits business to a third party under FSMA 2000 " (WE29).

(55)

for more details, see WE-CONF9.

(56)

The factual independence of Mr. Arnold was put in doubt in WE75 (point f), complaining that the EL board had "exercised control over him by restricting his instructions and permitting him to disclaim any duty of care to policyholders, and subsequently provided him with highly remunerative work." The FSA subsequently noted that "there had been no legal obligation for this appointment".

(57)

see WE6, WE7, WE-CONF16, WE-CONF.

(58)

Between September 2001 and September 2002 the FTSE-100 stock market index fell by 29%, but between December 2001 and April 2002 it remained basically unchanged.

(59)

These allegations were denied as "wrong and mischievous" in WE-CONF5, claiming that "the Compromise Scheme documents set out the position at that time in full detail."

(60)

On becoming the single UK Regulator on 1 December 2002, the FSA was formally independent from government and thus also from PO scrutiny.

(61)

The Central Bank and Financial Services Authority of Ireland Act 2003 stated that prudential supervision of the insurance sector and the services provided moved in May 2003 in its totality from the Department of Enterprise, Trade and Employment (DETE) to the Irish Financial Services Authority (ISFRA), and that actions of DETE in the insurance sector before the commencement of the 2003 Act should be construed as actions of ISFRA and/or the Minister for Finance (WE64).

WE80 further explains that until 2003, there were no CoB rules specific to the sale of insurance apart from the 'Provision of Information Regulations' (S.I. 15 of 2001) and S.I. 360 of 1994, both requirements enforceable through the Courts.

(62)

BaFin took over responsibility for the insurance sector from BAV in May 2002.

(63)

see WE-CONF26, page 4 and 5, para.1.

(64)

In May 2003 the UK Financial Ombudsman Service found Equitable Life guilty of 'material misrepresentations of fact'.

(65)

see WE53, annex D.

(66)

see WE53, annex F.

(67)

see WE53, annex G and H.

(68)

see WE-CONF2, para.38-40.

(69)

In fact, the S&P rating of EL was 'AA' (investment grade) from 1993-1999, downgraded to A+ (watch neg.) only in May 1999, then below investment grade (BB/watch neg.) only in December 2000. It was then further downgraded to B in June 2001 and CCC (high default risk) in September 2001. No credit rating has been awarded by S&P since 21 February 2002 (WE-FILE22).

(70)

Sales documents were submitted, see WE53.

(71)

In H4, Ms O'DEA stated that Equitable Life operated its Irish branch from 1991 to 2001 and closed to new business in December 2000 at the same time as the UK Head office.

(72)

see further details in the annexes to WE-CONF28.

(73)

WE-CONF28 also underlines the fact that this press conference, "just 4 months before the bubble burst in the form of the House of Lords ruling, had been used by EL to launch its 'European Fund' in Ireland... This was irresponsible and sinister. The timing of the launch indicates clearly that the Society was intent on extracting the maximum amount of money from the Irish market ..."

(74)

Copy of the letter submitted to the committee.

(75)

'income drawdown' is defined as a "facility which allows a delay in buying an annuity if rates should be low when retirement age is reached. Drawdown allows putting off buying an annuity to a maximum age of 75, giving an income directly from the pension fund in the meantime" (finance-glossary.com).

(76)

The appendix to WE72 lists a number of case studies supporting this claim.

(77)

Report by Alan Steel Asset Management, a Scottish IFA firm.

(78)

The German implementation law for the Third Life Directive came into force on 21 July 1994.

(79)

The current German single financial regulator, BaFin, was created in May 2002.

(80)

In the newspaper 'Die Welt' of 27 February 1995: see annex 2 of WE-CONF9.

(81)

This just four months before EL's closure for new business and resignation of the EL board!

(82)

Existing German policies are today being served through 'ELAS CSC Germany', Aylesbury, UK.

(83)

Department of Enterprise, Trade and Employment (insurance regulator 1989-2001); the Irish Financial Regulator (ISFRA) was established only on 1 May 2003.

(84)

"Buy German, earn British. High returns consistent with a high degree of security - the ideal savings strategy for German investors first had to be devised" and "13% returns: ask your insurer why they only give you half" full-page advertisements in "Die Welt am Sonntag", weekly newspaper, and "Frankfurter Allgemeine Zeitung", daily, in February 2000.


Conclusions PART III - REGULATORY SYSTEM

PART III - REGULATORY SYSTEM

Light Touch regulatory policy by UK Regulators

1.   There have been compelling accounts which indicate that the UK consistently applied, over a substantial period in the past two decades, both before and after the entry in force of the Third Life Directive, a light touch regulatory policy on the life insurance business. Submissions and statements show that a principles-based regulatory policy has now been extensively developed and implemented in the UK and is expected to be integrated into the Solvency II proposals.

2.   The committee understands that no regulatory regime can seek to eliminate risk and completely prevent all failures of regulated firms, as any such system would be likely to inhibit commercial enterprise, competition and innovation to the detriment of consumer choice. However, there have been numerous statements which suggest that the UK's light touch regulatory policy went a step too far and thereby contributed to a weak regulatory environment, which allowed the difficulties at ELAS to grow unchecked, when in a stronger regulatory system they might have become apparent at an earlier stage and the final crisis might have been prevented.

3.   It appears that UK regulators failed to react in a timely manner to the fact that ELAS had been chronically short of assets throughout the 1990s, as it did not properly reserve for future terminal bonuses which policyholders had been led to expect (even if they were not guaranteed). This occurred as a result of the rules for creating provisions covering future discretionary bonuses being kept deliberately vague by regulators, who appeared in turn merely to leave them to be dealt with unchecked by the Appointed Actuaries.

Regulatory shortcomings by UK Regulators

4.   There have been many statements and submissions which support a finding of regulatory failure and prudential supervision shortcomings by the different UK life insurance regulators (DTI/HMT/FSA), as well as by the GAD, in relation to the supervision of ELAS throughout the 1990s and specifically after the Third Life Directive entered in force in 1994.

5.   Likewise, there is ample material to indicate that if the UK regulators had correctly and diligently exercised their prudential supervisory and regulatory powers, as required by Articles 10 and 13 of the Third Life Directive, they ought in turn to have discovered and reacted to the weaknesses and risks inherent in ELAS's business model and operations at a time before a state of crisis became apparent.

6.   There have been a significant number of statements to the effect that the UK regulators failed to prevent ELAS from steering into its crisis and therefore failed to protect ELAS policyholders in the UK and other Member States from suffering financial losses as a direct consequence.

7.   Statements and expert advice received by the committee appear to contradict Lord Penrose's overall assessment that "principally, the Society was author of its own misfortunes. Regulatory system failures were secondary factors(1)". Particularly, his own report's 'Key Findings'(2) seem to be at odds with his above assessment, in that the Findings state that regulatory failures had indeed substantially contributed to creating a weak regulatory environment in which the ELAS crisis could unfold.

Failure to recognize the GAR risks

8.   There is a large body of material which suggests that the UK regulators failed to recognize - or even negligently underestimated - the potential impact of GAR policies on the financial stability of ELAS, particularly in the event of a substantial downturn in financial markets and given ELAS' reputation of applying thin solvency and reserve margins. It seems that when this risk was finally recognized by UK Regulators, it was to too late to reverse the situation and any subsequent regulatory action could only be a belated attempt at damage limitation.

9.   There can be little doubt that the equity bear market in 2001-2002 contributed to an acceleration of the ELAS crisis after the House of Lords' ruling. However, adverse market forces alone cannot be held out as the sole reason for the ELAS crisis, as is witnessed by the fact that not all UK life offices suffered a financial crisis of this magnitude. In the ELAS case, the available material suggests that a number of factors which clearly pre-dated the bear market, and in particular the GAR issue, had already created the basis for the Society's future financial problems.

Excessive deference to ELAS

10. It is also apparent that the UK regulators behaved with undue awe or deference towards ELAS, particularly given its long history and hitherto highly reputable status, leading them to consider it as the top pick of the life insurance industry and apparently believed to be too good and too reputable to make mistakes.

11. A number of witnesses and statements have asserted that it was precisely this attitude of deference which contributed significantly to the creation of a permissive prudential approach to supervision and a weak regulatory environment which in turn permitted ELAS to operate unchallenged, thus allowing the Society's financial weakness to build up unchecked over the years.

Shifting of responsibilities between UK regulators

12. The committee believes that the shifting of regulatory responsibilities between different UK regulatory bodies until the creation of the FSA was clearly detrimental to the efficiency of supervisory and regulatory action throughout the 1990s.

13. There are many statements which support the contention that communication weaknesses between the UK regulators contributed to a situation which allowed the growing problems at ELAS to go unchecked and develop into a crisis. However, in this particular respect, a number of statements have suggested that the situation in the UK has improved since the creation of the single Financial Services Authority.

Allegations of regulators' collusion with ELAS and/or deliberate fraud

14. The committee is not persuaded by allegations(3) of a deliberate and coordinated strategy of collusion between the UK regulators and the ELAS management, either of any obstruction of the investigation into the reasons for the ELAS crisis or of a deliberate and coordinated fraud at the expense of ELAS policyholders.

15. The committee is of the opinion that after the ELAS crisis had unfolded, as many parties have claimed , on a number of occasions, the UK regulators were slow, somewhat reticent and not always fully transparent in leading the ELAS investigation, as well as in reporting on it to the public, in particular to the policyholders concerned.

Compromise Scheme (CS)

16. There are numerous and compelling statements(4) suggesting that a large number of policyholders felt misled or deceived by ELAS and the Regulators when subscribing to and voting in favour of the Compromise Scheme.

17. The committee believes that, when voting on the CS, policyholders were not fully aware of the legal consequences of their decision.(5) This appears to be partly due to the complexity of the legal information supplied with the CS proposal, both by ELAS and the FSA, which may well have been beyond the understanding of the average policyholder.

18. The committee also believes that a clear warning should have informed policyholders that, by agreeing to the CS, the with-profits-fund's stability was by no means guaranteed in the long term and remained fully exposed to the fluctuations of financial markets and that the uplifts in policy values granted under the CS could possibly be wiped out by further cuts in policy values.

Mis-selling allegations

19. There have been many statements both direct and indirect, some of which clearly support the contention that ELAS was responsible for mis-selling and misrepresentation to policyholders and potential clients, in the UK, Ireland, Germany and in other Member States where it had operations.

20. In particular, there are statements(6) which suggest that ELAS misinformed policyholders and prospective customers on a number of issues, knowingly omitting to draw their attention to the GAR risk, even after ELAS had sought legal advice on the GAR problem with its solicitors and regulators.

21. The committee welcomes the Distance-Selling Directive of 2002 (Directive 2002/65/EC, amending Directive 97/7/EC), which successfully seeks to clarify legal provisions for the facilitation of the selling of insurance policies outside the Member State in which the company is headquartered.

22. The committee has heard further mis-selling allegations, suggesting that ELAS sales material claimed that the with-profits fund was smoothing out fluctuations in earnings and asset values. Furthermore, it was alleged that ELAS pursued an aggressive policy of churning existing ELAS policies towards newer investment policies which were highly profitable for ELAS, thus generating new business and commissions and requiring even smaller capital reserves, clearly contrary to policyholders' interests.

23. There are also statements to support a range of other mis-selling allegations in the other Member States where ELAS had sales operations, for example tempting prospective customers by holding out the potential investments to have specific qualities which did not actually exist, for example, the claims that Irish or international policies were ring-fenced, and that German policies were subject to the German Financial Regulator's control.

Negligence in regulators' Conduct of Business (CoB) supervision

24. The committee believes that the UK CoB regulators reacted late, if at all, in relation to the above mentioned ELAS sales and marketing practices. CoB regulators in the other Member States concerned also reacted late, partly because appropriate supervisory structures were not yet in place and partly because they expected to rely on the efficiency of UK regulatory supervision. However, it seems that once the problems surrounding ELAS had become commonly known or brought to their attention, Irish and German regulators' CoB supervision belatedly improved.

25. In general terms, the statements heard and submitted strongly suggest that regulatory supervision of life insurance in the Member States affected has improved in the past five years, in particular where a single insurance supervisory authority now covers both prudential and CoB supervision.

Communication failures between UK and foreign regulators

26. Many accounts supported the claim that communications between the UK, Irish, German and other regulators in relation to ELAS were unsatisfactory, if not clearly deficient, throughout the 1990s and up to 2002. In particular, the committee considers that the communications, if any, which took place were totally insufficient to deal with such an important issue as the ELAS crisis with obvious cross-border implications.

27. The committee firmly believes that the regulators' interpretation of the home/host country responsibilities in supervising life assurance companies was far too passive, with one tending to rely on the other. As confirmed by a number of statements, this behaviour itself contributed to a further weakening of the regulatory environment and led in particular to non-UK policyholders falling between two stools and the host regulator in Ireland and Germany appearing to be mere bystanders with little control over the insurance business being done in their territory, let alone in other Member States. The committee therefore supports work to examine the possibility of future regulatory supervision of companies at group level, in order to clarify regulatory responsibilities.

28. Statements and material provided to the committee give it reasons to believe that the communication between insurance regulators has improved since 2004 due to the closer cooperation of regulators within the newly created CEIOPS network of European regulators, which aims at a higher performance in cross-border supervision and regulatory action but too late to assist ELAS policy holders in the lead-in to the crisis.

29. However, the committee considers that where the host State notifies no "general good" rules to the home State authority, there is an inherent risk that neither the home nor the host supervisor looks at conduct of business rules because each would think that the other was enforcing its own rules.

30. Overall, the committee concluded that the development of the internal market in financial services was pursued ahead of concerns about ensuring that sufficient consumer safeguards were in place.

(1)

1 see WE 16, chapter 20, para.84.

(2)

2 see WE16, page 726: para.240, points 7-11.

(3)

1 see Part III, Section IV.1 (b) and (f).

(4)

1 see Part III, Section IV.3 (e).

(5)

2 see Part III, Section IV.3 (b) to (d).

(6)

3 see Part III, Section IV.2 (a) and Section IV.4 (a).


PART IV - REMEDIES

on the status of claims and adequacy of remedies available to policy holders

INDEX  PART IV

I.         Introduction

II.        Damages

1. Policyholders affected

2. Collective losses

            3. Individual losses

III.      Complaints to the UK regulators and official investigations

1. Complaints to the FSA

2. The Baird Report

            2. The Penrose Report

IV.      Actions by ELAS in relation to aggrieved policyholders

            1. Litigation against former directors and auditors

            2. The Compromise Scheme

            3. Complaints to ELAS and 'Policy Reviews'

V.        Allegations of fraud and the UK Serious Fraud Office

VI.      Claims against ELAS for mis-selling

1. Non-judicial - the UK Financial Ombudsman Service (FOS)

           a) Introduction

b) Treatment of Equitable Life complaints

c) Policyholders' criticism of the FOS's handling of complaints

2. Judicial - court proceedings

           a) UK legal bases for claims against ELAS

                       b) Limitation period

                       c) Court cases

VII.     Claims against the UK regulator

1. Non-judicial - the UK Parliamentary Ombudsman

2. Judicial - court proceedings

VIII.   The UK Financial Services Compensation Scheme and the decision not to close ELAS

IX.      The position of non-UK policyholders

1. Equitable Life's business in Ireland and Germany

2. Grievances of non-UK policyholders

           a) Motivations for investing with ELAS

           b) ELAS advertising

c) Allegations of mis-selling

d) Allegations of discriminatory treatment

e) ELAS information policy

3. Access to redress in the Member State of commitment

                       a) Supervisory authorities in the Member State of commitment

                       b) Financial Ombudsman schemes

c) Guarantee funds

4. Access to redress in the United Kingdom

a) Complaints to the FSA

                       b) Complaints to the FOS

c) The UK Parliamentary Ombudsman

d) The UK Financial Services Compensation Scheme

5. Court action

X.        Potential remedies for ELAS victims under EU law

1. The Third Life Directive

2. Primary EU law

           a) The right to petition and complaints to the European Commission

           b) Regulatory liability under EU law

c) Action for damages under Articles 235 and 288(2) ECT

3. Coordination mechanisms at EU level

a) FIN-NET

b) CEIOPS

XI.      The case for a European class action lawsuit

XII.     The need to compensate ELAS victims

Conclusions


I.         Introduction

Under this section of the report, the committee examines the damage or loss caused to policyholders as a consequence of the crisis of the Equitable Life Assurance Society (ELAS). It also identifies and assesses actions available to policyholders for obtaining redress, such as required under indent 4 of the European Parliament Decision setting up the Committee of Inquiry.

As regards damages, the committee does not, in view of the complexity of the issue and a lack of access to relevant data, attempt to identify exact numbers but rather tries to obtain a picture of the orders of magnitude involved and of the kind of situations in which policyholders find themselves as a consequence of the ELAS crisis. The committee has received ample written and oral evidence from aggrieved policyholders to this effect.

The report subsequently deals with some of the responses by the UK Regulator and the Society itself to Equitable Life's crisis, which were relevant to aggrieved policyholders. The following sections identify the routes of redress available to policyholders under UK law. Firstly, the possibilities open to policyholders to claim damages from the Society are analysed. The remedies referred to include both judicial procedures before the courts and non-judicial remedies such as alternative dispute settlement schemes. Secondly, the report examines ways for policyholders to obtain compensation from government both through the courts and by alternative means. The routes to redress under UK law are scrutinized on the basis of information received orally and in writing from witnesses and following research undertaken by the committee. The report also makes reference to the experiences of aggrieved policyholders in their efforts to obtain compensation.

The following parts of this section deal with the situation of policyholders who purchased their policies from ELAS branches established in EU Member States other than the UK, particularly Ireland and Germany. After identifying the particular grievances of these policyholders, the report looks at actions undertaken in relation to ELAS by the respective financial regulators in Ireland and Germany and assesses the situation of non-UK policyholders as regards access to redress in both their own country and in the UK. Oral and written evidence has been presented to the committee by aggrieved policyholders and regulators from both countries.

The last part of this section deals with remedies available to policyholders under EU law. Firstly, it investigates whether secondary law, such as for instance the Third Life Directive itself provide for redress mechanisms. Secondly, the report focuses on the system of judicial protection under primary EU law with regard to loss and damage caused to individuals by breaches of Community law for which Member States can be held responsible according to criteria developed by the European Court of Justice. Finally, the committee looked at coordination mechanisms at EU level, such as FIN-NET, which was established to facilitate the treatment of cross-border consumer complaints. The section continues with a reference to class action lawsuits and concludes by making the case for ELAS victims to be compensated by the UK Government.


II.       Damages

1.       Policyholders affected

In his statement before the committee, current Equitable Life CEO Charles THOMSON (H2) said that there were in 2001, when the events at Equitable occurred, "well over a million people who had an interest in the [Equitable Life] with-profits fund". Mr STRACHAN (H4) indicated that in 2000, there were approximately 1.7 million (with-profits and other) policyholders in Equitable Life. In a written statement (WE 47(1)), Mr THOMSON later specified that in 2001, roughly 1.5 million people had an interest in the Society's with-profits. This figure includes an estimate of the number of members of group pension schemes who are not policyholders themselves and so represents an estimate of the total number of individuals affected.

The vast majority of these were UK residents, but the Society also had about 8000 with-profits policyholders in Ireland (8300 according to Mr STRACHAN, H4) and about 4000 with-profits policyholders in Germany. "The EU aspect would therefore be around 1% of the issue by headcount", according to Mr THOMSON (WE 47(2)). In addition, there were approximately 6500 international policies which were sold through the Society's Guernsey office to individuals throughout the world (WE 47(3)). Mr SEYMOUR, EMAG director with responsibility for non-UK based policyholders, informed the committee in H7 that in the late 1990s ELAS had 13.405 non-UK policyholders, resident in 13 different Member States. In WE 53(4), he provides an exact breakdown of policyholders per Member State. Besides Ireland (6342) and Germany (3281), there appear to have been significant numbers of policyholders in France (1069) and Spain (728). In written evidence submitted by EMAG in their petition to the European Parliament, it is claimed that as many as 70.000 policyholders from outside the UK were affected in total (WE 14(5)).

Even though the numbers obtained vary slightly, it can be concluded from the evidence at hand that the Equitable Life crisis affected a large number of people both within the UK and in other EU Member States.

Ms KWANTES pointed out in H7 that Equitable Life's high reputation has attracted policyholders from various professional backgrounds: "80% of the lawyers in the UK had policies with Equitable Life ... Members of the medical profession, accountants, people working for well-known business names, ... members of the police force, thousands of civil servants and even Members of Parliament had policies with Equitable. So it really was thought of very highly." Mr WEYER (H3) stressed the high proportion, among German policyholders, "of academics and persons who have either considerable professional experience or are from the financial services industry itself". There has been a certain perception that the majority of Equitable Life policyholders tend to be affluent individuals. However, evidence received by the committee suggests that many policyholders are "small individuals" (Ms KWANTES, H7), who have suffered badly due to the crisis at Equitable. An Irish policyholder, for instance, told the committee delegation who visited Dublin on 6 October 2006 that she was forced to sell her house as a consequence.

Most policyholders affected appear to be of advanced age. Mr WEYER said that "the typical German customer is, as we see it, a married pensioner aged around 65" (H3). Mr SCAWEN, representing trapped annuitants stated in WE 23(6) that "we are all retired with an average age in the mid seventies, some relative youngsters ..., active both physically and mentally, and others reaching the end of their lives with all the associated problems of memory, physical and intellectual frailty that comes with the ageing process".

2.       Collective losses

The total losses incurred by policyholders (and indeed the shortfall against policyholders' reasonable expectations) cannot be quantified precisely. Mr LAKE, Chairman of the Equitable Members' Action Group (EMAG), stated that the across-the-board cut of 16% to the total value of all pension policies, which ELAS applied on 16 July 2001, equalled £4 billion. Lord PENROSE indicates in WE 16(7) that the reduction intimated in July 2001 was valued at £4.9 billion (including a separate adjustment of with profit annuity values of £630 million). Additional market value adjustments have been imposed since then. Furthermore, the incomes of about 45.000 so called with-profits annuitants have been cut continuously "to the point where 35% decreases are now typical and incomes are still declining", according to Mr LAKE (H1). The FSA stated that it has not carried out a calculation of total losses, suggesting that this could only be done on a policy-by-policy basis (Mr STRACHAN, H4).

Furthermore, even if exact figures were known, it would be rather difficult to determine which part of the losses can be attributed to mismanagement by the Society (and hence give rise to possible claims) and to which extent they were a consequence of external factors, such as the weak performance in financial markets at the time. Mr THOMSON (H2), claims that "the only loss that is clearly due to the particular circumstances of Equitable Life is related to the Guaranteed Annuity Rates (GARs) i.e. related to the Hyman judgement in July 2000". Other losses would be market-related, namely due to sharp falls in stock-markets during the early years of this decade, and would also have happened to a greater or lesser extent with providers of other with-profits funds. Mr STRACHAN (H4) was also of the opinion that the policy cuts were made principally because of the very sharp falls that had occurred in equity markets. This view is contested by EMAG (see below).

Thus, in WE 47(8) Mr THOMSON points out that one "needs to be careful to define what is meant by collective losses incurred by policyholders, [since] the with-profits policies are investment contracts and consequently are subject to investment losses as well as investment profits in the normal course of business". He indicates that Equitable Life has assessed losses caused by the Society's special circumstances in several ways (WE 47). Firstly, in connection with the litigation against the former auditors and former directors(9), it "took advice on possible losses arising based on the value of the Society in 2001 if certain actions had been taken earlier". This revealed losses of up to £2.05 billion to the Society (i.e. to members in aggregate as owners but not to policyholders). Secondly, the society assessed the losses suffered by policies without GARs as a result of the impact of GARs in connection with the Compromise Scheme (see below(10)). The losses addressed by the scheme, which did not however cover all non-GAR policyholders, amounted to £850 million. The Rectification Scheme(11), which corrected past retirements to allow for GAR, amounting to £103 million, might also be taken into consideration. Total GAR related losses would be a maximum of around 5% of policy value, according to Mr THOMSON (H2; WE 47), equalling around £1.5 billion at the time.

The Penrose report, however, concludes that over-bonusing was a significant cause for the financial weakness of ELAS, which required the cuts in policy values (WE 16)(12). Referring to the report by Lord Penrose, EMAG stated that the latter calculated the cost of excess bonuses actually paid away to departing policyholders during the 1990s at £1,800 million, to which it would be necessary to add the (un-quantified but substantial) total excess bonuses included in continuing policies in order to arrive at the total cost of over bonusing: "Whichever method is used, over-bonusing resulted in Equitable Life being at least £2 billion short of assets, representing about half of the policy value cut of 16th July 2001" (WE-CONF 16). The view that declaring excess bonuses in the 1990s seriously weakened Equitable Life's finances and that the policy value cut on 16 July 2001 was intended to recoup such excess bonuses is strongly supported by evidence from accountant firms (WE-CONF 23 and WE-CONF 24) and a legal opinion of Mr BOSWOOD (WE 76): "Whereas the stock market falls since December 1999 might have accounted for around 5,6% of the 16% cut implemented, the remainder was due to, first, the need to recoup GAR costs ... and, second, the need to rebalance the With Profits Fund to bring assets in line with aggregate policy values ... The real cause of the insufficiency of assets was not the fall in equity markets but, rather the payment of excess bonuses during the 1990s".

Explaining how the need for the 16% cut of July 2001 had arisen, Mr SLATER highlighted in WE 34(13) how, over more than a decade, EL had not balanced its policy values with asset values, thus accumulating deficits each year from 1989 to 2000 (even very substantial deficits, such as 28% in 1990 and 20% in 1994). As a result of this "policy of declaring total bonuses in excess of actual investment performance encouraged hundreds of thousands of innocent new investors and the Society expanded hugely. Equitable Life's senior management clearly recognised the risks they were taking. On 27 June 2001 the new board of directors heard Chief Executive Charles Thomson’s view of the level of surplus he would have expected at the end of 1999. Thomson commented that at the beginning of 2000, the excess of policy values over the value of assets was approximately 3%, which would have been within the acceptable range. In response to a question, Thomson confirmed that under normal actuarial principles he would have expected there however to have been an excess in the value of assets over policy values of perhaps 6-7% at that time. At the beginning of 2000 the Society was short of assets (or had voted excessive bonuses) of about 10% (3%+7%) or £2½ billion. The loss of the GAR case in July 2000 increased this shortage to £4 billion. This was approximately the amount recovered by the 16% cut of policy values on 16th July 2001."

As outlined in WE 8, policyholders may, depending on personal circumstances, also have incurred supplementary costs, such as penalties for early withdrawals, legal costs or reinvestment expenses, in addition to damages they have suffered as a consequence of cuts in policy values or annuity payments.

3.       Individual losses

The committee received numerous written representations from policyholders, which illustrate their personal losses(14) as a result of reductions in incomes or policy value. Moreover, several witnesses referred to personal losses (Mr WEIR, H2; Ms KNOWD, H2; Mr SCAWEN, H3) or illustrated 'typical cases' (Mr WEYER and Mr SCAWEN, H3) in their oral testimonies before the committee. For instance, Mr SCAWEN representing ELAS annuitants indicates that "my loss of income both to date and in the future is enormous. For many annuitants, where their only source of income is from the Society, their future standard of living has to decline and in many cases they will be seeking financial support from their families or social security, or be forced to sell their homes in order to subsist. These people prudently set aside money from their earnings to provide themselves with a comfortable lifestyle during their retirement, a lifestyle that has been stolen from them by the Society" (WE 23(15)). While it is clear that the individual losses differ considerably, depending on the class of policy, acceptance or not of the compromise agreement and other individual circumstances, the evidence obtained by the committee confirms the view of Lord PENROSE, who states in his report that "it is clear that many Equitable policyholders have suffered and will continue to experience real financial hardship as a result of seeing the returns they had expected from their savings very dramatically reduced" (WE 16)(16).

Some witnesses also emphasised the worry and distress they have suffered in addition to their financial losses. "I can tell you there were sleepless nights, there was tension ... this is not just about legalities; there is a human story behind it" (Mr KNOWD, H2). Ms KWANTES in H7 struck a similar note: "[It] caused so much trauma to so many people. I have heard from so many people who really have had sleepless nights over a long period of time. People have become physically ill over it, which I think is very sad."

As mentioned above, the various classes of policyholder are affected to different degrees. Generally speaking, policyholders without GAR's who had purchased policies after 1988 have had to foot the bill for the implementation of the judgement by the House of Lords ("Hyman case"), which ordered the Society to meet its commitments to GAR policyholders. Among the non-GAR policyholders, two groups seem to have been particularly disadvantaged: The first group are the so-called late-joiners, who joined shortly before Equitable Life's near-collapse. Some of them even joined after the House of Lords judgement as the "Society continued to take in new business from after the decision of the House of Lords on 20 July 2000 until it closed to new business on 8 December 2000" (WE-CONF 21). According to Mr WEIR (H2), Chairman of the Equitable Late Contributors Action Group, the late joiners "were persuaded to invest money with Equitable Life long after the society knew that it was in deep trouble ... and later on were asked to pay for all the problems without having gained from any of the supposed benefits". Similarly, EMAG argues in WE-CONF 16 that the 16% flat rate policy value cut fell more heavily upon those non-GAR policyholders who joined late and had therefore never benefited from the over-bonusing. This view is supported by Mr BOSWOOD in WE 76(17). Mr THOMSON (H8) took a different view: "The reason for applying reductions at a flat rate was to achieve greater fairness to all policyholders. That decision was taken by the board having considered a range of options with the appointed actuary". The second group is referred to as 'trapped annuitants'. As Mr SCAWEN (H3) pointed out before the committee, "we cannot or are not allowed to transfer our policies to another provider. Thus, the Society can reduce and has reduced our annuity payments by substantial sums, in my case by some 40%, with the prospect of continuing reductions in my income for the rest of my life".

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See also point IV.1.

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See IV.2.

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See also IV.3.

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inter alia page 691.

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Pages 3 and 4.

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See, for instance, WE-FILE 1, WE-FILE 2, WE-FILE 3, WE-FILE 4, WE-FILE 5, WE-FILE 6, WE-FILE 7, WE-FILE 8, WE-FILE 9, WE-FILE 11, WE-FILE 12, WE-FILE 13, WE-FILE 14, WE-FILE 15, WE-FILE 16, WE-FILE 19, WE-FILE 20, WE-FILE 33, WE-CONF 3, WE-CONF 19.

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Page 745.

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III.      Complaints to the UK regulators and official investigations

1.       Complaints to the FSA

After the events at ELAS, there has been continuing outrage and demand from the policyholders for explanation and redress. According to EMAG's petition to the European Parliament (WE 14(1)), many of them complained directly to the UK regulatory authority in the form of FSA (Financial Services Authority). EMAG says that the FSA rejected all complaints (WE 14(2)). The FSA's representatives before the committee did not make any specific comments on the treatment by FSA of policyholders' complaints (H4) but rather referred to the UK Financial Ombudsman as the competent body for dealing with such complaints. Mr STRACHAN (H4) only noted in general that "we sympathise with the position of policyholders and understand the strength of feeling that has led them to make a series of complaints but we consider that these complaints reflect a misunderstanding of what regulators could or should have achieved in a case such as Equitable Life". He added that "a regulatory system neither can nor should aim at avoiding all failures".

WE 32 and WE 37 outline the FSA's regulatory objectives according to Section 2 of the Financial Services and Markets Act 2000. Hence, the FSA is responsible, among other things, for preserving both market confidence and consumer protection. Some policyholders have expressed dissatisfaction with the way in which FSA has pursued the latter objective with regard to Equitable Life and put forward the strong allegation that the FSA has tried to obstruct policyholders from getting redress and failed in its role to protect consumers. EMAG claims in WE 44 that "the FSA is compromised in respect of investor protection because its annual running cost ... is funded by the industry" and calls it "a body with monopolistic control over consumer protection, whilst being in thrall to its industry paymasters". Specifically, EMAG alleges that FSA had failed to impose a generic approach to compensating aggrieved investors. It even accused the FSA of having "orchestrated a cover-up" in order to avoid compensation payouts: "There has been systematic foreclosure of any effective means of redress" (WE 44).

Naturally, the FSA strongly rejected these allegations (see WE 37): "I am aware that the point has been made to this committee that, because it is funded by the industry, the FSA is somehow "in the pocket" of the firms it regulates. I wish to place on record to this committee that such concerns are entirely misplaced. We are a statutory regulator established by Parliament; ... Regulated firms across all financial sectors must pay for the costs of regulation. Our fee-raising powers are statutory and our fees are levied compulsorily on each of the 33,000 or more firms we regulate according to a series of objective formulae and measures. The FSA staff who supervise firms have no policy or operational involvement in the fee-levying process, which is managed by a separate organisational function within FSA with a separate management reporting line through to the FSA board."

In relation to the protection of consumers in general and ELAS policyholders in particular Mr STRACHAN (H4) pointed out the following: "The FSA provides full information for consumers about its objectives, plans, policies and rules. Consumers have access to the FSA through its Consumer Helpline [and] our website is a further important source of assistance for consumers, providing comprehensive information specifically for them on financial products, regulation and their rights. Recognising the importance of issues surrounding Equitable Life, and the large number of policyholders involved, this website brings together information relevant to Equitable Life policyholders" (Mr STRACHAN, H4). Furthermore, he noted that "we have taken initiatives for the benefit of Equitable policyholders since the closure of new business." In this respect he referred in particular to the FSA's exercise of influence on ELAS when the compromise scheme was devised (see section IV.2.)

In summary, individual complaints to FSA did not result in redress for aggrieved policyholders.

1.       The Baird Report

EMAG informed the committee that the large number of complaints led the FSA to set up an internal inquiry (WE 14(3)). The inquiry was conducted under the leadership of its Director for Internal Audit, Mr Ronnie Baird, in order to determine if the FSA had failed during the 23-month period of its supervision immediately prior to the closure of ELAS to new business. Mr BRAITHWAITE pointed out in H11 that it was precluded from looking at the period of primary negligence from 1990 to 1998. Nor did the inquiry address the question of possible redress for policyholders' grievances.

2.       The Penrose Report

Policyholders also complained to HM Treasury according to EMAG's petition (WE 14(4)). In August 2001, HM Treasury set up an inquiry under senior judge Lord Penrose. His terms of reference were to inquire into the circumstances leading to the Equitable Life crisis and to identify lessons to be learned for the conduct, administration and regulation of life assurance business. However, his inquiry (and thus the report published on 8 March 2004) did not address two questions, namely, who is at fault for the problems encountered by the Society and who deserves compensation as a consequence (WE 16(5)). On the latter issue, Lord Penrose notes that he had "invited individual policyholders to assist [him] by formulating their claims in order to ... help form a view about the potential liabilities of the Society ..." and that the information thus received "made clear that very substantial claims were involved" (WE 16(6)). However, Lord Penrose emphasises that he "cannot adjudicate on the policyholders' complaints" and states that "the expectation that many have expressed that this report will provide views on the validity of claims and their value will inevitably be disappointed" (WE 16(7)). Nevertheless, Lord Penrose was keen to point out that the human impact of the events at Equitable should not be understated and that "... damage [was] done not only to policyholders' financial resources but to their self-esteem and their confidence in their ability to manage their affairs" (WE 16(8)). He concludes that "with few exceptions, those who have suffered have been the innocent victims of this affair" (WE 16)(9).

In conclusion, neither the Baird and Penrose reports nor any of the other official investigations(10) resulted in remedy for policyholders. Expressing the frustration of policyholders, EMAG complains in WE 44 that "report after report has been published but none had the remit to address culpability or authorise compensation".

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E.g. 'The Corley Report' (WE 50) or UK Parliamentary Ombudsman's first report ("The prudential regulation of Equitable Life; 4th Report-Session 2002-2003).


IV.      Actions by ELAS in relation to aggrieved policyholders

This section examines actions undertaken by Equitable Life in response to the crisis and whether these have served to bring relief to policyholders.

1.       Litigation

Firstly, Equitable considered pursuing legal action through UK or European Courts against the UK Regulator. "We took legal advice as to whether the Society should be pursuing what had gone wrong with the European Courts ... but were clear from the advice that we received that there was no route open. ... We were also clear that there was no realistic prospect of successfully suing the UK regulator" (Mr THOMSON (H2). ELAS provided the advice it received from leading Counsel as WE 71. The document considers potential claims by the Society and/or policyholders against both the prudential regulators and conduct of business regulators. The law firm indicates that "we do not consider that legal action by the Society against the regulators would be cost-effective" and therefore advised the Society "not to proceed with such an action." As to the funding by the Society of claims by policyholders, they "identified ... difficulties of bringing such claims and concerns as to whether the Society can or ought to fund such claims" and concluded that "it is difficult to see how such a course could be justified" (WE 71).

By contrast, "following consideration of the legal, audit and actuarial advice that [it] received and with very strong backing from policyholders and from action groups", the Society proceeded to pursue its former directors and its former auditors for alleged breaches of duty "culminating in court proceedings [in 2005]" (Mr THOMSON, H2). The committee has received a number of documents from the Court case ELAS vs. Ernst&Young (WE-CONF 14). According to the court documents, two types of breach were alleged. First, in each of the years 1997, 1998 and 1999 it is alleged the statutory accounts should have included very substantial technical provisions in relation to GAOs. Second, for each of the years 1998 and 1999 it was also alleged that the accounts should have disclosed contingent liabilities and uncertainties in respect of the Hyman litigation. ELAS claimed to have suffered loss by not selling the business and assets (either in September 1998 or 2000), loss of the chance of such sales and loss by declaring bonuses which would not have been declared. Mr THOMSON (H2) pointed out that the loss pursued through these proceedings was corporate loss, i.e. the diminution of the value of the society as an entity and not individual policyholder losses.

Eventually the Society had to drop the case because it was not able to establish a causal link between the alleged failures and the losses incurred. "To our great disappointment we were unable to establish that loss has been caused that could be attributed to [the] defendants" (Mr THOMSON, H2). In H8 Mr THOMSON deemed it "a pity that nobody can be held to account for what happened" because he would have "some difficulty in believing that this was entirely accidental" (H8).

Mr CHASE GREY, however, believes that the court actions by ELAS against its former directors and auditors "were commenced ... not with the real intent of covering damages but to distract policyholders, to divert press attention and most probably to incur further wastages of time in the investigative process and the time allowed to policyholders under the Limitations acts to commence compensation proceedings" (WE 40(1)). "The ELAS Chairman ... - by profession a lawyer - and (the)Chief Executive ... have each explained (in my view with great hypocrisy) the need to discontinue these actions on the basis that ELAS in the course of the proceedings had found that they were unable to prove loss, a point a competent lawyer would have checked before proceedings commenced" (WE 40(2)).

In a letter of 2 December 2005 addressed to policyholders (annexed to WE 35), ELAS provides the following explanations in relation to the litigation against former directors: "Your board launched the claims based on careful consideration of detailed legal advice. In the light of that advice, the Board considered that it would have been a dereliction of our duties as directors and our responsibilities to policyholders not to pursue the claims on your behalf, while it remained cost-effective to do so. We have continued to review the claims with the legal team throughout, in order to ensure that we kept up to date with developments in the strength and cost-effectiveness of the claims. Based on the firm advice of our legal team, we concluded that we must settle the litigation against the former directors with as little additional costs as possible. ... Clearly, this is not the outcome for which we have worked so hard over the last four years and we are extremely sorry that we have been unable, through the Courts, to secure redress for policyholders. Lord Penrose reached clear and forceful conclusions as to the downfall of the Society. However, we must accept that it is a different matter to satisfy a Court that the role of the former directors constitutes a responsibility that leads in law to culpability and redress."

2.       The Compromise Scheme

The Compromise Scheme is dealt with exhaustively in Part IV of the report. However, given its relevance for the situation of aggrieved policyholders, certain aspects of it will be revisited below with particular emphasis on the concerns expressed by policyholders.

Section 425 of the UK Companies Act 1985 enables a company to put into effect 'a compromise scheme of arrangement' between the company and its members or its creditors or any class of them, subject to the consent of interested parties and of the court. The scheme becomes binding if it is approved by a majority in number representing three-fourths in value of the creditors or class of creditors or members or class of members and by the court (see ES 3(3)). ELAS devised such a scheme with the intention of stabilizing the with-profits fund by reducing exposure to GARs and, at the same time, eliminating the risk of legal action against ELAS for mis-selling on the basis of alleged failure to disclose the GAR risk to prospective non-GAR policyholders. In practice, it was proposed that GAR policyholders would get an increase of 17.5% in their policy value in exchange for giving up their rights to a guaranteed annuity rate. At the same time, non-GAR policyholders were offered an increase of 2.5 % in policy values(4) in return for giving up their right to pursue claims, either by legal action or through the Financial Ombudsman Service.

According to ES 3(5), the Scheme was the result of an extensive consultation process involving policyholders and regulators and was developed under intense publicity. EMAG called it a "massive consultation process that was just cosmetic PR window dressing" (WE 75). In ES 3 it is also emphasised that there was a certain degree of time pressure because a payment of £250 million by Halifax was conditional upon a compromise becoming effective by 1 March 2002. Hence, "the time available for the completion of the development and the approval of the scheme was much shorter than a scheme of such complexity would normally require" (ES 3(6)).

The Scheme finally met with the approval of an overwhelming majority of each class(7) of Equitable's policyholders. It is notable that Mr Justice Lloyd rejected the suggestion that overseas policyholders should be treated as a separate class for the purposes of voting for the compromise agreement.(8) Nor were the with-profits annuitants treated as a separate class. The compromise scheme took legal effect on 8 February 2002 after approval by the High Court. The Society estimates that when the Compromise Scheme took effect, "there were still close to a million people with an interest in the with-profits fund", although a significant number of policyholders had left during 2001 (WE 47(9)).

Equitable's Board claimed at the time that the Scheme involved "fair value compensation to GAR policyholders based on a ‘realistic estimate’ of the value of their legal rights given up ..., it apportions the compensation to different GAR policyholders in accordance with their rights; it reduces that compensation by the value of any possible claim for compensation given up by the non-GAR policyholders and the compensation takes the form of a proportionate increase in GAR policyholders’ policy values in both guaranteed and non-guaranteed form" (WE 29(10)). By contrast, representatives of policyholders claimed that the scheme was "inequitable"(11) and that it "deliberately obfuscated and discounted legal advice [indicating] that policyholders without [GAR] had a strong case for mis-selling"(12). In particular, EMAG considers in WE-CONF 16 that the first across-the-board cut in values of 16% in July 2001 - which in its view was not only a result of the lost GAR case and a fall in stock markets but also (to a large extent) a consequence of a decade of over-bonusing by ELAS - fell unfairly upon more recent non-GAR policyholders, who had not previously benefited from over-bonusing as did pre-1990 (predominantly GAR) policyholders. As outlined under point II.3., Mr THOMSON (H8) took a different view: "The reason for applying reductions at a flat rate was to achieve greater fairness to all policyholders. That decision was taken by the board having considered a range of options with the appointed actuary". Mr BOSWOOD in his opinion (WE 76(13)) supports the view of EMAG that the flat-rate cut failed to take into account the over-bonusing to early policyholders. EMAG believes that the Compromise Scheme had given ELAS an opportunity to rectify the situation. Instead, the scheme proposed GAR uplifts of 17.5% against non-GAR uplifts of 2.5%. In his report, Lord PENROSE declines to comment on the fairness of the Compromise Scheme (WE 16(14)).

Moreover, policyholders told the committee that the increases in policy values were not guaranteed: "Within a matter of weeks, the 2.5% increase magically turned into a 4% reduction" (Mr WEIR, H2), so policyholders "lost their rights to redress in return for an uplift which turned out to be a cheque that bounced" (Mr BELLORD, H2). Indeed, after the uplift in policy values had been credited on 1 March 2002, the Society announced a further cut of 4% on 15 April 2002, which more than eliminated the 2.5% uplift credited to non-GAR policyholders just six weeks before. The with-profits annuitants suffered a similar experience, as the Society reduced the Overall Rate of Return by 4% subsequent to the approval of the agreement. Therefore, some policyholders expressed doubts as to the legal validity of the compromise agreement (see for instance oral statement by Mr WEIR, H2 and Mr SCAWEN, WE 23(15)).

In response, Mr THOMSON claimed that the Society had set out all details of the Compromise Scheme in the accompanying documents. "The uplifts are very clearly set out in the Scheme documents and had both guaranteed and non-guaranteed elements. Market movements meant that we had to reduce non-guaranteed bonus subsequently. That risk was clearly identified in the documents..." (WE-CONF 5(16)). However, Professor BLAKE suggests in WE 29(17) that the information provided to policyholders by the Board in connection with the Compromise Scheme Proposal was inadequate. Among other things, he criticised that "most of the information concerning the status of the fund was out of date, there was virtually no information on what was going to happen to the fund after [the compromise scheme would take effect and it] was not clearly spelled out what ... policyholders were foregoing by voting for the [scheme]" (WE 29(18)). Mr SCAWEN also claims that the full state of the Society's finances had not been disclosed. Otherwise, with-profits annuitants would "surely not have accepted the offer" (WE 23(19)). EMAG criticised that "the Compromise documentation did not address the over-bonusing, the benefit derived from it by GAR policyholders, the unfair nature of the 16% policy value cut to non GAR policyholders [and] the possibility of a compensating adjustment in favour of non-GAR policyholders" (WE-CONF 16).

Moreover, EMAG comments in detail on the second cut in policy values of 15 April 2002, which more than eliminated the uplift credited to non-GAR policyholders. As stated above, ELAS argued that this had become necessary due to "market movements". EMAG contends that the market fell by about 6% (equivalent to a 3% fall in Equitable Life's asset values) between July 2001, when the 16% cut was introduced, and April 2002, when the second cut was made. However, "all of this fall happened before the Compromise Scheme was published in December 2001 [and] there was no further significant market fall before the policy value cut in April 2002" (WE-CONF 16). EMAG considers that by failing to explain to non-GAR policyholders that, without an immediate surge in the stock market, a further policy value cut would be required, ELAS may have deliberately misled policyholders. In contrast, Mr. THOMSON insisted in H8 "that the markets carried on falling after the Compromise Scheme was through in February 2002 and the board had no choice but to reflect those changes in market values in the non-guaranteed benefits." Mr BOSWOOD (WE 76(20)) agrees with EMAG's assessment and suggests that "this is something which ought to have been mentioned to those, including the court, from which approval for the scheme was sought". He thus thinks it is possible that "those responsible deliberately concealed information which they knew to be relevant to the scheme". In view of the above, EMAG asked the FSA to investigate the issue. The latter however refused to do so with reference to its discretion (WE-CONF 16).

Mr THOMSON responded to allegations that the compromise documentation had been inadequate by underlining that the scheme was sanctioned by the High Court. He quoted the judge as follows (H8): "I am in no doubt that it is a scheme such as an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonably approve. I am also satisfied that neither on account of any inadequacy of information or otherwise in the procedure, nor in respect of any of the substantive points made to me, is there the slightest reason to suppose that it is not a proper scheme which having been approved by the requisite majorities of the various classes ought to be sanctioned by the Court. I will so order."

Policyholders in general criticised the fact that the FSA recommended policyholders to accept the compromise or even promoted it.(21) "The FSA was party to the rush to push the majority of the members of the Equitable to sign up to a flawed compromise, led on by insinuations that, if the compromise were not agreed, The Equitable would collapse, and by the suggestion (which has not been realised) that, if it were agreed, the fund would return to stability. ... Those who did not go along with the compromise that was endorsed by the FSA and withdrew their funds appear likely to end up better off than those who remained. In view of its unequivocal endorsement of the compromise, this should be embarrassing to the FSA, since it is supposed to protect the policyholders' reasonable expectations.(22)"

In his statement before the committee, Mr STRACHAN (H4) commented on the FSA's involvement in the compromise: "The Compromise Scheme was undertaken as part of an independent court process under the Companies Act. In that particular process, the FSA had no formal statutory role". In WE 37 the FSA points out that it "nevertheless encouraged Equitable to go beyond what was required by the Companies Act to ensure that policyholders' interests were protected as far as possible, particularly through the appointment of an independent actuary to opine on the fairness of the proposals". Furthermore, the FSA "reviewed and assessed the Compromise Scheme proposals being put to Equitable Life's with-profits policyholders to ensure that the interests of all policyholders had been properly taken into account" (WE-CONF 8). In doing so, the FSA took account of the following considerations: "Firstly, that a successful compromise scheme would, in principle, offer the best prospect of stability for Equitable Life and its policyholders. The second – which concerns the fairness issues – was an assessment as to whether there was a fair exchange for the rights and the claims of each group affected. The third consideration was that there should be clear and comprehensive information provided to policyholders and, fourthly, we took account of the independent actuary’s assessment of the proposal" (Mr STRACHAN, H4). The independent actuary stated in his report that "from an actuarial point of view the terms of the Scheme have been established in a fair and reasonable way" (WE-CONF 9(23)). Policyholders, however, alleged that the actuary failed to address a number of important issues, which would have been important for policyholders' understanding of the proposal (see WE-CONF 16) and furthermore questioned his independence from ELAS (see WE 75).

In its assessment of the compromise scheme (WE 67) the FSA concludes as follows: "The FSA is content that, in relation to the relevant groups of guaranteed annuity rate (“GAR”) and non-GAR policyholders, the level of increase to policy values is a fair offer in exchange for the GAR rights and potential mis-selling claims that would be given up. While there are variations from person to person, within each relevant group, we are content that there are no categories of policyholder within the groups who would receive disproportionately greater or lesser benefits". The FSA furthermore suggests that, "the scheme of arra