No one Escapes a Share of the Blame

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No one Escapes a Share of the Blame

By Andrew Bolger, The Financial Times

March 9, 2004

Lord Penrose's report is a withering demolition of the performance of Equitable Life's executives, the inadequacies of its board and the failure of government regulators to prevent the world's oldest mutual life assurer driving itself on to the rocks.

Although Lord Penrose follows his immediate predecessor Lord Hutton in sticking closely to his carefully framed terms of reference for a tricky government-commissioned inquiry, the Scottish judge shows a most un-Huttonesque willingness to dish out criticism to arms of the government - in particular the Government Actuary's Department.

But his 818-page report firmly places the main burden of responsibility for the Equitable Life debacle on the mutual's senior managers and directors.

Equitable Life policyholders have faced uncertainty and falls in the value of their policies since the mutual lost a legal showdown in the House of Lords, which left it with a £1.5bn pensions liability.

The dispute concerned the rights of Equitable's guaranteed annuity rate, which promised investors a minimum annuity rate when they retired, often as high as 11.5 per cent - way above comparable market rates.

Equitable tried to get around the problem by paying a smaller final bonus on the policies but, after a long legal battle, the Lords ruled that the mutual must meet the guarantees.

Equitable was forced to put itself up for sale, but on December 8 2000, it announced that talks with Prudential, the last in a line of suitors, had collapsed.

As a result, the mutual was forced to close its doors to new business on what it described as "a very sad day for all in the society", but "the only realistic option available". Exit penalties were raised and bonuses cut as the mutual struggled to stay afloat and curb the exodus of members.

Perhaps the Penrose report's most startling finding is that the 242-year-old society was not brought low just by losing in the summer of 2000 the House of Lord test case concerning its controversial stance of guaranteed annuity policies, which cost it £1.5bn.

The report says: "The picture that emerges is of a society [Equitable] that had deep-seated financial and management problems that pre-dated the emergence of the annuity guarantee problem . . . The judgment of the House of Lords precipitated a crisis, but was not solely responsible for it."

Lord Penrose instead points the finger at competitive pressures which led Equitable Life into a policy of "over-bonusing" - promising more in bonus payments to policyholders than was justified by their underlying share of the mutual's assets.

"Over the 1980s the society maintained competitive levels of bonus allocation by cutting back on its general reserves until, by 1987, it had over-allocated bonus so that its aggregated policy values on a realistic basis exceeded available assets."

Lord Penrose said there was a culture of "manipulation and concealment" on the part of some of Equitable's senior management, while its executive management failed to keep the board fully informed about the state of the company's finances.

Equitable's executive management resolved as early as 1983 to try to "solve" the problem of guaranteed annuities by cutting the final bonus of those with such policies - the stance that was rejected by the Lords.

Lord Penrose says: "This decision was not communicated to the board until 1993, and not to policyholders in any form until 1995."

He added that non-executive directors were wholly dependent on actuarial input from Roy Ranson, who was from 1992 to 1997 both chief executive and appointed actuary, but they were largely incapable of exercising any influence on the actuarial management of the society.

He added Mr Ranson did not inform the board about several important management decisions and the business risks inherent in the general actuarial management of Equitable.

Lord Penrose says: "At interview, I found Ranson to be highly intelligent and articulate, but manipulative. I was not persuaded that his memory was as inconsistent as he asserted, nor that he had put the society's affairs so completely behind him at his retirement that he could not comment on some of the matters put to him . . .

"Without the benefit of an adversarial process in which his evidence could be tested by cross-examination I cannot form any concluded view on the reliability of his evidence relating to his relationship to the board.

"But I note his own assessment that of his approach, in discussion with the regulators, as 'autocratic'. That coincides with other information available to me."

The report also says: "Ranson was frequently aggressive in his dealings with regulators. He was dismissive of regulators' views and concerns. He was obstructive of scrutiny, and often failed to answer questions."

Lord Penrose was dismissive of Alan Nash, who succeeded Mr Ranson as chief executive in 1997 and quit in 2000. The judge said: "Though a qualified actuary . . . I was persuaded he [Nash] was not qualified by experience to make a material contribution to, and had no significant part to play in, the actuarial management of the society."

The report says the board had fragmented information and, even if directors had all the relevant pieces of the jigsaw, they were most unlikely to have been able to piece them together.

The judge also says none of the non-executive members of the board had relevant skills or experience of actuarial principles.

"They were generally experienced in the financial services industry, but specialists, where they had specialist knowledge, in general finance, in investment and banking rather than life assurance. They could not be expected to make independent judgments without specific guidance from the actuaries on advising the board."

The report accuses the non-executive directors of being:

* Ill-equipped to manage a life office by training or experience

* Totally dependent on actuarial advice

* Ill-prepared to take necessary decisions because of the fragmented approach to instructing them

* Incompetent to assess the advice and challenge the actuaries if they had doubts about the material supplied.

The report is also critical of the regulatory regime during the 1990s, which was mainly conducted by the insurance division of the Department of Trade and Industry, advised by the Government Actuary's Department.

Lord Penrose said the approach to regulation was reflected in the resourcing of the DTI's insurance division which was "ill-equipped" to participate in the process.

And although GAD actuaries were held in high regard by the regulators, Lord Penrose said they did not appear to have challenged sufficiently the opinions and assumptions underlying actuarial valuation.

An indication of the tensions between Lord Penrose and GAD can be found in a reference to the fact that a "GAD actuary engaged in correspondence with Ranson in 1992 declined to complete the interview process with the inquiry".

Lord Penrose berates GAD for accepting the situation in which Mr Ranson came to hold simultaneously the office of chief executive and appointed actuary.

"With few exceptions he was, until a late stage, the only officer of the society to meet regulators or GAD and he acknowledged in discussions with the regulators and GAD that he ran the society in an autocratic manner. Despite the obvious dangers in such a concentration of authority and influence, and the lack of any qualified challenge within the society, and officials' clear understanding of the unsatisfactory aspects of the situation, no steps were taken effectively to prevent it from coming about."

The judge finds there was a failure by regulators and GAD to follow up issues that arose in their regulation of Equitable and to mount an effective challenge to the management.

However, the report concludes: "The deficiencies are not so obvious as some are inclined [or wish] to believe. Principally, the society was the author of its own misfortunes. Regulatory system failures were secondary factors."