EQUITABLE LIFE MEMBERS

EQUITABLE LIFE:  PENROSE AND BEYOND

- ANATOMY OF A FRAUD 

A paper by Dr. Michael Nassim

Last Updated: Friday, February 11, 2005 09:58 AM

The story before Penrose: a resume of some EARW main points:

Sophisticated Plans and Practices

Of central importance were seminal decisions and actions, which took place before Guaranteed Annuity Rate (GAR) policies were discontinued.  They overturned the traditionally successful business and insurance paradigm of the With-Profits Fund, affected all policies sold subsequently, and adversely influenced the manner in which the Fund was administered and represented.  Sophistries were the bedrock, and it is also relevant that they are in essence antithetical denials of the major lessons previously learned in the Society’s own history.  Of special importance was an overarching sophistry to the effect that a With-Profits Fund could be run on what has euphemistically been termed a negative technical solvency gap.  This arises when the sum of all total policy values exceeds the assets, whereas absolute insolvency arises when the assets are exceeded by the sum of the guaranteed portions only in all policies. These two criteria can give rise to very different valuations and expectations of the asset shares of individual policyholders.

Though the un-guaranteed portions are unconsolidated, and might do multiple duties to cover other contingencies until required, ultimately they are a “moral charge” on the assets.  In times when the unconsolidated terminal bonus element of policies is high this becomes important.  The Society maintained that it was in practice unimportant, because its declared practice was to pay out total policy values (including the unconsolidated element) in full, such that this was policyholders’ reasonable expectation.  Effectively, therefore, the moral charge was thereby made a real one, and the difference was only unimportant so long as the technical solvency gap remained small or intermittent.  But since this also implies a reserveless scheme, which could only work given well-nigh perfect forecasting, this was a vain and fallacious hope; of all people a succession of the Society’s qualified actuaries should have known better.

The solvency gap arose because the Society’s estate had disappeared, or was in process of doing so. How, why and when this occurred was held to be a matter of pivotal forensic importance, because the central sophistry sprang directly from it.  In the Equitable’s long history members and outsiders have repeatedly been tempted to raid the estate, and the Boards of Directors and the actuaries of the day had previously resisted this. It was therefore important to ask what other influences affected the Board and management on this final and fatal occasion, and if so why they were allowed.  The resulting gap led to the transition from a With-Profits Fund for old and established members to a With-Liabilities Fund for newer and future members, which in turn could not have happened unless the fund also degenerated into a Ponzi pyramid selling scheme, fuelled by irresponsibly high bonus declarations and total policy values.  In this it resembles the Lloyd’s debacle, and the ensuing “recruit to dilute” campaign whereby asbestos claims liabilities were transferred from old to new “Names”.  Hence also the need to find out from what level in the Society any “incentivised ignorance” of sales personnel originated.  This had be balanced against the more innocent picture of an office which was unduly influenced by commercial and marketing considerations and expanded too rapidly, giving away overmuch as incentives to gain new business and incurring excessive strain on any remaining reserves in the process.  Marketing considerations could also have led the Society to ascribe overmuch importance to the profitability of investments in its sole asset mix when investment certainty and insurance should have been its overriding priority.  Though there may be elements of truth in this, it did not explain the Society’s persistently duplicitous and irresponsible conduct, or the origins of the faulted paradigm on which that conduct was based. Nor did it explain why the repeated warnings against injudicious expansion by eminent actuaries in the Society’s own past were also neglected.   Expansion demands caution because new business involves a heavy insurance element before much premium has accumulated, while the existing estate has to satisfy the expectations of yet more members unless it is increased pro rata.  Moreover there is an inherent cost of chasing and winning the new business. The burden of all this is termed new business strain.

More about sophistry

First and foremost, the traditional estate is not a windfall inheritance to be squandered by the current generation(s), but is rather a charitable benefice held in trust, to be deployed for future generations as much as the present.  But the Society had gone further, and moved into deficit by over-bonusing the existing members.  So secondly, moving beyond disinheriting future generations and requiring them also to finance the “profligacy” of the current one only compounds this unfairness.  Thirdly and as mentioned, the actual or potential running on a negative technical solvency gap is the very antithesis of prudent axioms of insurance, and flies in the face of experience, which argues for positive financial strength.  Worse, it flouts the core concept of policyholders’ reasonable expectations, and the consequent appellation of unconsolidated bonuses and benefits as a “moral charge”.

When this business paradigm was presented as With Profits Without Mystery (WPWM), a paper read to both the London Institute and Edinburgh Faculty of Actuaries in 1989 and 1990 members of the audience were unhappy with all this, essentially because it betokened a fund with scanty reserves, and perhaps insufficient financial strength in the event.  They were also concerned that all policies were indiscriminately placed in the same unitised fund and asset mix, irrespective of their maturities or levels of guarantee, because under conditions of technical or absolute insolvency some policies would acquire inequitable claims on the remnants of the fund.  Not surprisingly they wanted policyholders and their advisers to be informed of the potential risks that all this posed in accordance with the Financial Services Act of 1986.  The published record shows that the expert discussants repeatedly emphasised the following:

• Adequacy and continuity of estate or reserves, to meet the needs of both present and future policies.

• The relative size of terminal and reversionary bonuses in policies, and the need to reserve for them.

• Potentially excessive mutual insurance arising from a pooled unitised fund in which the interests of policies of different lengths and levels of guarantee are indiscriminately placed.

• Given that the investment profile of a pooled unitised fund cannot be ideal for all policy types and durations, an additional mismatching reserve must be held.

• There is a consequent need to explain the potential inequity and risk this poses to policyholders and their advisers.

• Conversely, there is a need to explain the relevance of the guarantees, and how they will be met and charged for.

• Concerns about financial strength under all circumstances, given that the unconsolidated bonus element is used to take up new business strain while continuing to be paid out in full in the absence of an estate.

• The resulting duties of information.

The published words of the Appointed Actuary of the Society reveal that he paid overt lip service to duties of information to both policyholders and the Board of Directors, as indeed he had previously to reporting the “moral charge” incurred by the un-guaranteed terminal bonus element of policies in the official accounts. In practice, however, nothing effective was done in over a decade afterwards. And so all the important omissions, dissembling, concealments and deceits stemmed from the central sophistry, including dual and conflicting presentations of the new paradigm, firstly to a select but sceptical actuarial forum but then not the Society in full, and secondly of the accounts, an optimistic total policy asset share value version for members and a pessimistic discounted policy value asset share version for the regulator, which enabled the Society to survive for so long.

The coherence, consistency and duration of the ensuing misdemeanours indicated that when traced fully backwards they would have relatively few origins. As was explained in the main text of EARW, they are also tantamount to fraud because they satisfy the cardinal elements enumerated above. Hence it was concluded that there must be no residual doubt as to where in the Society’s organisation (or even via external association) the important elements of deceit arose, when they did so, and in response to what circumstances. Human nature and corporate life being as they are, it was felt pointless to call for a witch-hunt until it was clear to what extent the situation was a response to the pressure of evolving circumstances, or was more deliberately contrived. To understand all this required the recognition that there were persistently feudal aspects of organisational and institutional life.  But if the Society’s descent into fraud was insidiously cumulative, many officers and directors were thought either to have been too closely or loosely engaged to be aware of what the whole amounted to.  Even so one could not escape the conclusion that some did know, or perhaps that others too long suppressed their real doubts.  For the sake of the innocent this was held to need close attention. 

The Fall

The underlying situation all this created was thus highly fertile ground for future trouble. After the initial market perturbations caused by the 1973 oil crisis there followed an inevitable period of brisk inflation and high interest rates such that equities also increased in monetary value and many pension funds began to acquire surpluses; at the same time traditional safe investments like fixed interest securities became less attractive.  But when more normal conditions eventually returned interest rates fell and there was an eventual secondary reactive dip in the value of equities, which were no longer an indiscriminate hedge against inflation. Under these circumstances growing numbers of earlier policyholders (pre-1988) exercised their rights to guaranteed annuity rates (GAR) when they retired and took their annuities.  The Equitable With-Profits Fund became technically insolvent, and to such an extent that the Society reneged on policyholders’ reasonable expectations by cutting the terminal bonuses of those exercising the GAR option. As is now common knowledge, the House of Lords deemed this selection against one group of policyholders unlawful, and this decision precipitated the current crisis.

Causes and Consequences of Regulatory Failure

EARW explained why, in considering the conduct of government and regulators past and present, any rigorous analysis should cover three distinct periods, namely:

1.      The role of the DTI/FSA* and governments of the day in the events leading up to the crisis precipitated by the GAR issue. (*Department of Trade & Industry; Financial Services Authority)

2.      The handling, or lack of it, by the present government, Treasury, FSA and the judiciary in the run up to the Equitable Compromise Scheme arrangement.

3.      Ditto in the events since the Compromise.

EARW also stated that, in practice, no regulatory apparatus can function any better than the milieu in which it operates.  It provided evidence to the effect that, besides the Society, Government and the regulators had chosen to ignore the evidence for general mis-selling along the lines of the Lloyd’s fiasco before, during and after the Compromise Scheme.  Hence it was concluded that the informing and guiding influence of Government had also been deficient; had this been better exercised the consequences of regulatory failure would not have attained their present dimension. Instead the Government has chosen to be inactive and silent, which continues to gain it three advantages:

·         A low profile and reduced need for uncomfortable decision-making

·         Avoidance of responsibility

·         Delay in settling for its share of financial consequences until as many Society members as possible have in different ways accepted less than their due.

But because some of the deficiencies occurred long before, during and after the Compromise Scheme vote, both political parties may have some responsibility for them.  Readers were asked to remember that that the government of the day indemnified Lloyd’s by special Act of Parliament before the Lloyd’s Bubble burst.  It was feared this might also inhibit the Opposition even though the Equitable Bubble is big enough to involve around 2% of the electorate directly, not to mention their dependants (Between 1957 and 1988 the Society had expanded to 170,000 members holding GAR rights; by contrast a further 930, 000 members without GAR rights were recruited over the next 12 years). (Happily, the Opposition have since risen to the challenge.)  Meanwhile, governmental and regulatory inaction has had three enduring consequences for the Society and its members:

·         It denied the New Board of Directors constructive external help at a crucial time.

·         It allowed the Financial Services Authority to avoid reassuming its responsibilities, and advise on whether or not members should accept the Compromise Scheme.

·         It has condemned the New Board to persist with and defend the discredited paradigm and all its consequences, to the detriment of members past and present.

Even so, the New Board should have known better than to maintain that mis-selling did not have a central and generic character such that future litigation could only be individual and piecemeal, or that the total shortfall in the funds was solely due to the GAR liability and could be as little as 1.5 billion pounds.

Basic Wrongs Suffered by Policyholders (for full details see main EARW article):

Most if not all have suffered the following:

·         Loss of the security and benefits of a longstanding and traditional estate, most notably including loss of ongoing With-Profits Fund character and status.

·         Excessive and inequitable mutual insurance, partly caused by unequal guarantees or the hidden penalties thereof; not yet fully resolved.

·         Greater deficiencies in the Fund than revealed by the New Board.

·         Harm arising from fraud, whether primarily intended or in response to circumstance.

·         Harm resulting from regulatory deficiencies and government inaction, notably including:

·         The necessity for the Society to persist with a discredited and deceitfully imposed paradigm.

The main EARW article also addresses factors affecting individual categories of policyholder.  These largely depend upon their guarantee class, whether or not they accepted the Compromise Scheme, whether they are now annuitants and their status as voting members or otherwise, which in turn calls into question the role of their Trustees.