EQUITABLE LIFE MEMBERS

EQUITABLE LIFE:  PENROSE AND BEYOND

- ANATOMY OF A FRAUD 

A paper by Dr. Michael Nassim

Last Updated: Friday, February 11, 2005 10:00 AM

Fat cats and poor mice, or further inequities in conduct of business.

It has thus been possible to look under the veil that the PR and the regulators left in place over the conduct of business, and see what affected many individual policyholders.  We have also seen that longer-term policyholders were consistently awarded greater returns, which for the increasingly dominant terminal bonus allotment was greatest over the years in which the estate was dispersed.   But that does not conclude the matter.  The Society’s problems might ultimately have been less serious had not the Trustees of the various pension schemes insured by the Society insisted that they be allowed to retain the GAR pensions for a further five years when the Society attempted to withdraw them in 1988.  Hence new scheme members enjoyed the relative advantages of GAR status for five more years, while it was denied to private members.  This is a serious inequity, of which the Society, scheme administrators, their consulting actuaries and trustees must often have been aware through their special knowledge and expertise.   The granting of this privilege would also have made any declaration of a DTBP within the grace period most unwelcome, such that it too had to remain secret for a further five years until 1993.  The effect this had on the Society’s finances hardly needs spelling out- and the resulting burden fell most heavily on the post-1988 private policyholders, all of whom were non-GARs.  How and why was it allowed?

Since the Society’s problems stemmed in part from the threat of losing its institutional business, there would have been a need to retain, replace or extend it.  How was this done, and what was involved?  If there was little in the PR on conduct of business vis-à-vis individual policyholders, on this aspect there is nothing, although some interesting questions arise from the Society’s attempts to consolidate the retention of as much FSSU business as possible over the 1977-9 triennium.   What was there in the regulations to safeguard the equitable interests of less well-informed private policyholders against the interested advantages enjoyed by companies and institutions?  How was that duty observed by the Old and New Boards of Directors and by the regulators?  And was it one that either Board of Directors should have recognised?  To all these questions there is as yet no answer.

This was not the only occasion on which such questions were relevant.  As the Compromise approached, at least some scheme trustees and their consulting actuaries negotiated mass exits from the Society in exchange for a 5% reduction in their members’ total policy values.  Individual policyholders were less fortunate; they had to forgo 10%.  Corporate and institutional clients could thus escape with a considerably lesser penalty; meanwhile Law Debenture Pension Trust plc, as the Society’s proxy Trustee for free standing AVC policyholders and the Society’s annuitants in the Compromise vote, delivered them into the Compromise.  Similar situations, therefore, but different outcomes depending upon Trustee interests?

Clause 2f of the Parliamentary Ombudsman’s Statement of Complaint for the Second Equitable Life Investigation adds a significant further dimension to these considerations.  For this we have EMAG to thank, and it reads:  “GAD had recommended ELAS as a pension plan or additional voluntary contribution provider in its advice to the administrators of the Principal Civil Service Pension Scheme and to other public sector pension schemes.  This led to a lack of proper separation of its responsibilities and to a clear conflict of interest between GAD’s role in providing advice to government bodies in relation to public sector pensions and in assisting the prudential regulators of ELAS.  This conflict of interest compromised the proper discharge of GAD’s regulatory functions.”   In the present context there is no further need to elaborate on why this is deeply worrying, but it is worth pointing out that the context is itself a useful framework for any relevant additional investigation.

So at last it emerges that at various times and in different ways scheme members and those with expert or inside knowledge and connections have fared better than individual policyholders.  In fact, there is a need to know how much this amounted to and agree the forms it took before any definitive explanation of how the Society’s funds were dispersed can be accepted.  If the Penrose, Baird (Equitable regulatory) and Corley (Equitable actuarial) Reports have not raised and dealt with the matter, it may also transpire that the ongoing Morris (general actuarial) Inquiry does not have the remit to tackle it.  Indeed, the writer finds it hard to see how the relevant questions can be answered without further regulatory and forensic investigation. Since the authorities have already deliberately elected not to conduct such a systematic investigation into private policyholders’ complaints, the possibility of a necessarily more rigorous investigation on the corporate, civil service and institutional front seems remote unless more forceful representations are made. Such representations are unlikely to come from the institutions, government and specialist bodies, corporations, trustees and actuaries themselves, and so private members must look elsewhere. They must also trust that old allegiances do not similarly inhibit the Opposition from assisting them further. 

Finale:  Cipher, crib, key and message.

Close poring over the cipher, crib and contributory material has yielded both the key and a message.  The key turns out to comprise instrumental members of a senior management team in their central executive position.  As the Society grew, that position became consolidated into an autonomous power base that was not properly accountable either to the Board of Directors or the Society’s owners and members. Their leaders maintained that the Society’s actuarial and business paradigm, design of a complex heterogeneity of investment products, the keeping of Companies Act and regulatory accounts, product particulars and the sales platform were properly executive and professional matters and not primary responsibilities for other members of the Board.  In due course they similarly assumed responsibility for risk management over the years 1993-2000, which in theory included the policing of their own activities, but in practice was used to ensure that their tactical plans and version of events were followed.  Such information as they imparted to the Board was of an incomplete, discontinuous and fragmentary nature, and in respect of items relating to policyholders’ reasonable expectations was not statutorily compliant.  The resulting situation is not entirely unique, and its common elements have recurred more than often enough elsewhere.

At the same time, the growing size and importance of the executive function and modernisation of the Society’s corporate governance led to more team members becoming executive directors on the Board. The necessary increases in prestige, prospects and power must have been a spur to the ambition of more senior executives. As in many management hierarchies, upward progress may have depended on feudal allegiances and evidence of loyalty as much as upon ethical and professional competence.  The feudal pyramid once climbed and a directorship attained, a larger landscape of opportunity with wider horizons appeared.  The new vista held temptations as well as more weighty duties and responsibilities, because further success now depended upon pleasing the non-executive directors and the Society’s more influential customers.  Grace and favour appointments such as Sherlock’s inaugural chairmanship of LAUTRO (Life Assurance and Unit Trusts Regulatory Organisation) beckoned.  From current knowledge, leadership succession and instrumental team membership appear consistent with feudal lineage.

If the key comprises characters and their motives, attendant circumstances composed the message.  Understanding the message involves following the chain linking causes to effects either from the top downwards, or from the bottom upwards.  The “top down” approach is central and organisational; this the PR has done well, and mostly well enough for it to complement prior findings in EARW and a “bottom up” approach based on examination of the details of conduct of business, and its effects upon customers.  It is thus most unfortunate that external constraints have caused the PR to be very sketchy on the “bottom up” approach, which of necessity means that some important details in the middle of the chain are still missing.  As we have seen, for similar reasons there has been no help from the Treasury and regulators in elucidating the essential common features revealed by a “bottom up” approach, but in spite of all there is sufficient emergent consensus among individual members, policyholders, action groups and class legal actions to determine what they are. From it their universality can be deduced, and this in turn means that local branch offices and the Society’s field force must have operated in a state of “incentivised ignorance”.  These surmises have variously been and continue to be substantiated or confirmed, and so now they track back to more senior echelons in the management structure.  Though it seems inherently likely that very senior sales and marketing personnel were material to the situation, the PR does not tell us whether they were also instrumental team members who were party to critical knowledge withheld from Board, members and regulators alike. Meanwhile it seems relevant that from 1976 onwards marketeers were also executive directors.

We do, however, know that at least one other instrumental member of the senior management team was not a qualified actuary.  He was co-inventor of the discredited WPWM actuarial and business paradigm, who under the circumstances improperly assumed responsibility for risk management in 1993.  Otherwise, apart from the actuaries, it is unclear who the instrumental members were, how membership varied after 1982, and what might have been the extent of Sherlock’s own involvement.  Until we know, it is unwise to speculate upon the cameradie, personal loyalties and even friendships which may have come to bind it together over and above original feudatory allegiance.  Somewhat perversely those bonds may have included an initial sense of loyalty to the Society, and via misguided attempts to save it have led to its founding principles, reputation and product base being first entirely traduced and then betrayed.  Similarly, there is no inkling as to whether outsiders became affiliated to the instrumental group.  Considerable importance attaches to the answer because of the Society’s perceived need to chase corporate and institutional business, with all the adverse effects it has had.  This the PR has failed to address, and so as with private policyholders, the “bottom up” and “top down” details of the process remain officially unknown.  But as explained, the resulting inequities that have so far surfaced are very serious, such that they and the relevant regulatory environment must now be explored.

The succession of events leading to the Society’s increasingly desperate straits, its descent via innovative expediency into bad faith, and a decade of increasingly serious non-disclosure of critical background information which by 1987 had become fraudulent has been chronicled.  History has also revealed that a definitive blueprint for traducement was written within, between and even behind the lines of the 1989/90 WPWM manifesto paper successively read to the Institute and Faculty of Actuaries.  The sophistry-laden paradigm it described was a post hoc rationalisation of the inequitable dispersal of the Society’s free assets, which had occurred during an ill-judged attempt to retain existing business and expand, and which became seriously disrupted by the immediate turmoil and inflationary after-effects of the 1973 oil crisis.  If that were not bad enough, the paradigm also fallaciously sought to justify crossing over into over-allocation.  Moreover, because what was then also known and not disclosed included a contingency plan which nullified its central undertaking, the paradigm was uttered in fraudulent bad faith. And once over-allocation had been extended by technical devices which eroded solvency margins, and loans or adjustments which inappropriately anticipated future income, the Society’s fate was sealed and ultimate betrayal became inevitable. The with-profits fund thereby degenerated into a modified Ponzi scheme levered off the dominant un-guaranteed fraction of policy values, and ended in the usual way.  In the course of it a minority of earlier members received substantially more than their fair share, and the great majority of later members paid dearly for the consequences.

So much for the poachers, but what of the gamekeepers?  First we have seen that, in considering conduct of business and prudential regulation in relation to emergent viewpoints on PRE, outgoing Insurance Directorate Actuary George Newton had by 1987 clearly identified and drawn attention to the major problems that were later to affect the Equitable, and that following his departure his advice was ignored with disastrous consequences. On the one hand this is retrospectively inexcusable, and on the other it is ironic in that 1987 was also the year in which the Society definitively crossed over into fraud.  Hence, notwithstanding the organisational deficiencies which led to co-operative failure of the prudential and conduct of business regulatory arms identified in the Baird Report, there must also have been a more fundamental problem of responsible attitude.  This has been reflected in the Opposition stance on prudential regulatory failure, and in the depositions by the action groups to the Parliamentary Ombudsman.  Now we may also reasonably infer that similar attitudinal problems could underlie the informed and deliberate failures in both prudential and conduct of business regulation by the FSA to which attention has previously been drawn.  With this knowledge, and in revisiting the axiom that: “No regulatory apparatus can function any better than the milieu in which it operates”, it was earlier found helpful to distinguish between deficiencies or failures of organisation and resources (“systemic factors”), operational factors, and those arising from individual or collective stance and attitude.  And the unpalatable fact is that regulatory failure has been total from 1973 to the present day.  That always was, and has over-long remained, a profoundly serious matter.

It is thus only a matter of time before the whole situation becomes more widely understood and agreed.  Beyond that point the carefully constructed defensive positions of the Society, Treasury and regulators can no longer hold.  All the interested parties will then be much exercised, and if disaster is to be avoided they will at long last be compelled to co-operate openly and constructively in a climate of common understanding.  Without wishing to pre-empt that co-operation, the writer believes that one rallying point for it may be the granting of a “virtual estate”, in order to underwrite a less defensive investment strategy and thereby restore with-profits status to the Society’s remaining policyholders.  As and when policyholders die out, the residue of the virtual estate would revert to the underwriter.  Since inflationary pressures are again mounting, something of the sort will become increasingly necessary.  Under the circumstances it may not be unreasonable to ask the Government for underwriting assistance.  That said, Chancellor Brown’s roughly £500 million hole below the Society’s solvency waterline is another obvious rallying point.  Holding the balance will demand overall fairness and a reasonable degree of sympathetic restraint from the action groups.

Without reasonable co-operation the Government’s hand-washing of any responsibility for regulatory failure, and its more deliberate aspects in the irregularities surrounding adoption the Compromise, will both come in for increasingly critical appraisal.  And if the Treasury and the regulators continue to act inappropriately, ultimate responsibility passes to the First Lord of the Treasury and Minister for the Civil Service in the person of the Prime Minister. If he in turn fails, then remedy will be sought in Europe and through the courts.  But whatever the outcome, so great has been the damage that it is hard to see how the political reputations of the Chancellor of the Exchequer and ex-Treasury Minister Ruth Kelly can survive it.  On the Society’s side of the fence the New Board can expect more grilling on how the reality of the Compromise squares with their prospectus, the Society’s true financial position in consequence, and on the balance of their representation and guardianship of the interests of different classes of policyholders or private versus corporate/institutional members.

The handling of the Equitable Life crisis, rather like that of the Second Iraq War, has been one of the defining issues of our times.  We should with reason fear that, unless the profound malaise in public life that they have revealed can be contained or cured, English parliamentary democracy may not last a thousand years. 

Dr. Michael Nassim.  December 30^th 2000