• The Treasury Committee is invited to briefly consider the events leading up to the “Equitable Life affair” so that the risk that was involved may be seen against its historical background
• A wide view should be taken of what is fair and reasonable to all ELAS members in the management of risk in the totality of circumstances and not a narrow contractual view, as presently seems the approach following the judgement of the House of Lords.
• ELAS's variable terminal bonus practice for with profit guaranteed annuity rate policies was fair and reasonable for all ELAS members.
• The practice was compatible with H M Treasury's Insurance Directorate's 1998 guidance to insurance companies. This guidance was not openly questioned by the Government Actuary in 1999.
• The House of Lords - ELAS v Hyman: the right answer to the wrong question?

Treasury Committee

1. I can understand the deep public concern over the ELAS saga and I am grateful that the Committee has decided:
   
   To examine the regulatory environment and the management of risk in the life assurance sector following the Equitable Life affair.
   
   My deep concern is that the Committee starts from the premise that “the Equitable Life affair” has been settled along fair and reasonable lines. I have studied the matter in depth since August last year. I have checked out many matters with ELAS senior management. As a result I feel most strongly that the matter has been resolved neither fairly nor reasonably.

 
2. From what I have set out below I hope that the Committee might first pause to carefully consider the complex matters that led to the "Equitable Life affair". I respectfully ask the members to give the matters consideration to ensure that the background to their enquiry is fair and reasonable to all ELAS members.

 
3. I hope to attend on 15th February and, should time permit, would be willing to clarify any of the following matters.

The Problem Pictured.

4. The graph below shows three levels of annuity, A, B & C, based on my policy with Guaranteed Annuity Rate (GAR) taken out in 1978, and presumes a pension in August 2000 at age 62:
   
   

(A) Policy states “Amount of the annuity from age 70 purchased by the first premium £36.95.” (rebased to £100 premium). The Guaranteed Investment Return (GIR) was 3.5% per year and the GAR at age 62, 10.8%: this is plotted on the graph. The policy, “shall confer a right to participation in the profits of the Society”: no level above GIR was given. At 62: policy accumulated value at GIR £203; annuity at GAR £22.

(B) August 2000 the policy value with all bonuses (policy asset share) some £1,900/£100 premium. Thus the Actual Investment Return/£100 premium (AIR) over 22 years some 14.6% per year on the premium paid and an annuity at GAR of £205.

(C) August 2000 GAR exceeded the Current Annuity Rate (CAR) of say 8%. Applying CAR the annuity reduces to £152.
 



5. In August 2000 to purchase an annuity at the policy GAR of 10.8%, when the CAR was say only 8%, required more funds than those represented by the then policy asset share. Purchasing at CAR gives the lower annuity (C). In a mutual society who should provide those extra funds to purchase the annuity at GAR?

 
6. Before attempting a fair and reasonable answer to that question the background facts and assumptions need to be carefully noted.

Historical Background and Assumptions.

7. 1957. ELAS, following the Finance Act 1956,  first issued retirement with profit deferred annuity policies.

 
8. Inland Revenue (IR) regulations required such policies to be written as deferred annuity contracts and to state an annuity in one of various ways. ELAS calculated this by a GIR on 95.5% of the premium (4.5% expenses deduction) and a GAR on the accumulated policy fund/asset share at pension age.

 
9. The GIR and GAR were prudent minimum annual rate of return and annuity rate respectively; so far as it is possible to forecast some 20 to 40 years ahead. It was anticipated that the CAR at maturity would exceed GAR.

 
10. Bonuses would be added to reflect any profits from investing the premium in a common fund. Further annual premiums could be paid.

 
11. The intention of the policy was that on maturity the share of the common fund attributable to the policy’s premium(s) and bonuses (accumulated fund or asset share) would purchase an annuity at the CAR.

 
12. ELAS is a mutual unlimited company. I believe it is arguable that a cardinal principle, inferred from Article of Association 4., that with profits policy annuities should only be purchased by asset share attributable to each members policy. Otherwise profits earned by a member’s premium, less expenses, in the common fund, could benefit a person other than the member. ELAS have considered my belief and do not accept it.

 
13. When the policy matured if CAR was greater than GAR then a greater pension annuity was purchased by ELAS for the annuitant. My policy covered this by the wording, "final annuity adjustment". Though on the plain wording "adjustment" might imply "down" as well as "up".

 
14. 1979 Right given by Finance Act 1978 that policyholder holder on maturity could purchase from any life office an annuity with their policy’s accumulated fund if the CAR of other offices bettered ELAS’s.

 
15. 1988 With profit deferred annuities with GAR no longer sold. Personal pension plans introduced. IR regulations required a pension to be bought with the accumulated fund but no annuity nor annuity rate provision required.

 
16. Since 1957 the AIR on the policy premium has always exceeded GIR.

 
17. Until 1993, for some 36 years no less, the CAR always exceeded the GAR. The accumulated fund was used to purchase a larger annuity than that guaranteed.

 
18. If GAR had been used and not CAR the pension would still have given a larger annual pension than that guaranteed under the policy as AIR had been larger than GIR.

 
19. From October 1993 until May 1994 the GAR exceeded the CAR. From May 1994 until May 1995 the GAR was below the CAR. From May 1995 the GAR again exceeded CAR and still does. Even when GAR exceeds CAR, applying CAR instead of GAR would give a larger annual pension than that originally guaranteed under the policy because the AIR (in which I include all bonuses) had been larger than the GIR.

 
20. ELAS decided, AIR having exceeded GIR to such an extent (sometimes with only the annual bonuses), that in fairness to all ELAS members only the policy's asset share should purchase the pension. CAR was applied to asset share to calculate the annual pension (the Pension) payable.

 
21. The Fund needed to purchase the Pension was calculated using GAR. A final bonus merely increased the value of accumulated bonuses to the Fund to purchase the Pension at GAR. Such final bonus did not utilise all that policy's attributable asset share. Although all the policy's attributable asset share was needed to purchase the Pension at CAR.

 
22. If a CAR annuity was taken then a larger final bonus was given to increase the value of accumulated bonuses to that of the policy's asset share.

 
23. 1998. With GAR exceeding CAR in many companies, H  M Treasury's Insurance Directorate gave guidance to insurance companies (as set out in Martin Roberts', Director Insurance, letter of 18 December 1998 ref.DD1998/5) on how to proceed (advice withdrawn I believe after H.L. ELAS v Hyman judgement) and setting out various options. “The purpose of this letter is to provide some guidance to companies on the Treasury’s interpretation of PRE [policyholders’ reasonable expectations] in these circumstances [GAR’s].” ELAS’s then current practice, outlined above, was in line with one of the options. The whole letter needs to be considered in detail. The sound basis in equity undergirding the advice is, I believe, summarised in the sentence (fourth paragraph), “Generally we consider that it would be appropriate for the level of charge deemed to be payable by participating policyholders for their guarantee (or annuity option) to reflect the perceived value of that guarantee (or option) over the duration of the contract.”.

 
24. 1999. The Government Actuary wrote to all Appointed Actuaries, 13 January 1999 ref:DAA 11, in the light of the above HMT letter from Mr Roberts. He does not appear to demur explicitly from any points in the HMT letter. However a detailed examination of the letter shows a variance of sentiment. For example paragraph 6, “In assessing the extent of these liabilities, the company will need to make a prudent [sic] assessment of the extent to which any options are likely to be exercised. In this context I consider that, where the cost of meeting the guaranteed annuity benefits at maturity is significantly greater than the value of any alternative benefits, prudence will require the company to reserve for the contract at a level close to the full value of the guaranteed annuity.”. The Government Actuary does not openly disagree with the “the Treasury’s interpretation of PRE”. However the frequency of his use, and context, of the word “pruden(t)ence” leaves a distinct impression he took a differing view of PRE.

 
25. Some ELAS GAR policyholders, despite the fact that AIR had exceeded GIR giving a much increased pension at CAR over the policy guaranteed minimum, decided to insist on their GAR being applied to all the asset share of the policy and challenge the lawfulness of the ELAS's action.

 
26. The House of Lords decided that it was unlawful under Article 65 for ELAS to pay differential bonuses as above in 20 to 22. It amounted to ELAS using their discretion to override an implied policy contractual term.

 
27. 2000. In the light of the judgement ELAS withheld bonus allocations to all members for the period 1 January to 31 July to provide a fund of some £1.5bn to cover the potential liability (presumably following the Government Actuary's advice) of members with GAR policies. In substance, if not in form, all members were funding the GAR liability.

ELAS Board’s policy of differential final bonuses was fair for all members.

28. As a GAR policyholder my pension would be reduced. In my example above from £205 to £152: some 26%: but £152 is some 590% above my guaranteed annuity of £22. I still support the Board’s former policy, now declared unlawful, on the following grounds.
    
    
29. My policy never guaranteed me any annual and/or final bonuses, let alone their size in £’s, only the hope of an undefined amount.
    
    
30. The GIR and GAR when set out in the policy, to comply with the then IR rules, were prudent minimum estimates; so far as it is possible to forecast some 20 to 40 years ahead. The GAR functioned as an estimate of the CAR at future pension age. As the final asset share is dependent on the overall AIR from bonuses (annual and terminal) at pension age, rather than GIR, I never know what my actual pension will be in £’s. It is impossible therefore to quantify my future loss.
    
    
31. It is reasonable to hold ELAS accountable for the GIR as it depends on ELAS’s skills of investment management. Over the 22 years of my policy to August 2000 the AIR has been 14.6% p.a. whereas the policy guaranteed GIR was a mere 3.5% p.a. plus an undefined share in any profits by way of bonuses.
    
    
32. It is unreasonable to hold ELAS accountable for the GAR. It depends on factors outside ELAS’s skills of investment management: e.g. CAR, government borrowing requirements, market demand for gilts, life expectancy; to list a few factors.
    
    
33. The plain and unambiguous intention of my policy, in substance if not in form, was that at pension age my asset share (the phrase does not appear in the policy: only the right to participate in profits) of the common fund would purchase an annuity for me at CAR. The GAR was in my policy to comply with the then IR regulations; not to guarantee me an annuity at above CAR.
    
    
34. If the GAR is now greater than CAR my policy’s attributable asset share cannot purchase an annuity at my GAR.
    
    
35. The only way my GAR annuity can be purchased is to use some of the common fund prospectively distributable to my fellow non-GAR members. I regard this as unconscionable and against the spirit of my policy, if not the letter, and of the principles of ELAS as a mutual society. It is not irrelevant to recall the ELAS motto, “Sic nos non nobis” - Thus do we, but not for ourselves.
    
    
36. My personal view, not shared by ELAS, is that adding to my asset share from the common fund to purchase my annuity offends, in spirit if not the letter, Article of Association 4. My policy reflects this Article in these words, “The Society shall be liable under this Policy to the extent only of its assets and property from time to time existing and available for satisfying claims hereunder”. I believe that it can be strongly argued in equity that the only assets available in a mutual society is the attributable proportion of the common fund commonly referred to as the policy’s asset share.
    
    
37. I became member of ELAS so that my premiums might benefit from management by a mutual society that minimised costs, maximised investment returns and distributed the maximum amount from the with-profit funds. I did not want retained surpluses building up that would not be distributed to the current generation of policyholders to meet their reasonable expectations; known as the ‘inherited estate’. For a detailed summary of the problem see 'Inherited Estate - Actuarial Position Statement’ - Faculty and Institute of Actuaries
    
    
38. I did not become a member expecting fellow members to indirectly fund a now discarded IR regulation, GAR, that through circumstances outside ELAS’s control is unexpectedly above CAR. I do not regard my policy as an insurance policy against the failure of actuaries to accurately forecast CAR some 20 years plus into the future.
    
    
39. If the GAR is insisted on the common fund will need a far greater proportion of fixed interest investments, as opposed to equity shares, for contingency reserves thus lowering the potential level of future profits and thence bonuses. The great anomaly is that the more successful ELAS’s investment policy and bonus distribution the greater the prospective liability while GAR exceeds CAR. This problem is further exacerbated by the fact that GAR policies have an option to add further premiums until an annuity is taken. It is impossible to quantify how many of the some 90,000 GAR members will exercise this option, at what premiums and for how many years. The result could be a growing retained surplus and increasing inherited estate that would not benefit the current generation of ELAS members. Yet the returns from their premiums would have funded it: eg no bonuses 1 January to 31 July 2000.
    
    
40. In my view, given the background facts and assumptions, a fair and reasonable answer to the question, “In a mutual society who should provide those extra funds to purchase the annuity at GAR?” is the GAR policyholder with their policy’s asset share. An answer supported by the Director Insurance, H M Treasury, in his letter referred to above at 23.
    
    
41. I am very satisfied with my AIR, well in excess of the policy GIR. For me to insist on the GAR being applied to my policy’s asset share is being insensitive and unfair to my mutual members to the point of unconscionable behaviour; in short, greed. To ask for one’s pound of flesh is one thing; to cause a fatal loss of blood in the body corporate is another.

House of Lords: ELAS v Hyman - Right judgement for the wrong question?

42. Although AIR had exceeded GIR giving an increased pension at CAR well above the policy’s guaranteed minimum pension, (see graph above at 4 ) some GAR policyholders decided to insist on their GAR being applied to all the asset share of the policy. They challenged the lawfulness of the ELAS Board's discretion under Article 65 to declare differential final bonuses. The form of the action, drafted I believe by the GAR policyholders (represented by Mr Hyman), appears to have been akin to that of a construction summons on the true meaning of Article of Association 65.
    
    
43. In the House of Lords the issues were (1) the construction of the Society’s GAR policies; and (2) whether the directors of the Society had exercised their discretion under article 65 in an improper manner. However “Everything hinges on the meaning of article 65” and “The enquiry is entirely constructional in nature”. See speech of Lord Steyn.
    
    
44. Their Lordships decided that Article 65 on its true construction did not permit the Board of ELAS to pay differential bonuses as above. It amounted to the Board using their discretion to override the GAR policy contractual term. As a layman, but a “student” for many years of company law, I have carefully studied their lordships’ speeches. May I respectfully say I cannot fault the judgement as a matter of construction on the powers of company directors.
    
    
45. It would not be appropriate to invite the Committee to comment on what follows. However I hope the Committee might feel able to accept that there is an alternative way of looking at matters.
    
    
46. I very respectfully suggest that the relevant question and enquiry should not have been the true construction of Article 65 but one based on the principles of equity taking due account of various maxims of equity.
    
    
47. Taking all the factors into account is it fair, in the eye of equity, for the some 90,000 GAR policyholders to insist on the specific performance by ELAS of the GAR provision in their policies to the hardship of the some 290,000 non-GAR policyholders?As it has turned out also to the hardship of the GAR policyholders as ELAS has been forced to close to new business with the attendant future uncertainties.
    
    
48. The answer to this question is outside the powers of a Board of Directors. It can only be determined by a court of equity. Some of the factors which need to be taken into account in such an enquiry include:
    
    A. the original purpose of the GAR policy provision; see above 8-11 & 33. (their lordships assumed “the assumption on which the policy was based was that, when current rates [CAR] fall below the GAR, the annuity which the policyholder should receive would be higher than if there were no GAR.”, see the speech of Lord Cooke of Thorndon);
    
    B. AIR has greatly exceeded GIR resulting in an annuity purchased at CAR greatly exceeding the policy guaranteed minimum annuity even when CAR is below GAR;
    
    C. how accurately future CAR’s can be forecast to know how much liability reserves need to be provided;
    
    D. whether it is fair to offer non-GAR members the same rate of bonus as GAR members to enable GAR reserves to be built up;
    
    E. the reasonable expectations of GAR and non-GAR policyholders in a mutual society with its company regulations applying, in spirit as well as letter, to each policy;
    
    F. the fairness to all members of purchasing annuities only with policy asset share;
    
    G. the unfairness of expecting non-GAR members to indirectly fund purchases of GAR annuities through the investment returns of all premiums in a common fund;
    
    H. Article 57 without the approval of a members’ meeting forbids ELAS directors “To create or set aside out of the capital or revenue of the Society a special fund(s), and to give any class of its policyholders or annuitants any special rights over an interest in any fund(s) so created or set aside.” I believe this has been breached in withholding of bonuses in 2000 from non-GAR policyholders for the benefit of GAR policyholders: ELAS does not agree.
    
    I. the professional views of the Director Insurance, H M Treasury (see above 23);
    
    J. the effect of annuities purchased at GAR when it exceeds CAR on the liability reserves needed and the effect on investment policy;
    
    K. the undesirable risk of building up a large inherited estate.
    
    
49. It is acknowledged that the above has yet to be tested in the courts. Consideration is being given to such a move.