Virtually no party closely connected with Equitable Life as it grew to become a widely-respected life insurer in the second half of the 20th-century escapes criticism in Lord Penrose's hefty tome on its demise, which was published yesterday.
The first thorough analysis of the near-collapse of Equitable is a crystal clear analysis of serious mistakes and failures by its board, including executives and non-executives, and by a series of regulatory bodies.
Now the 818 pages produced by the Scottish judge will be closely scrutinised by policyholders who fervently hope the findings of his 30-month inquiry will provide the firepower they need to win compensation.
While Equitable Life was dealt a deep blow when the House of Lords ruled in July 2000 that it had to hand over £1.5bn to one group of policyholders, it was the way the society was run - with its combination of arrogance and marketing zeal based on its mutual principles - dating back to the 1970s which fundamentally weakened its foundations, Lord Penrose says.
"The provisions [to pay for the ruling] was in absolute terms a material sum. But its impact would have been less if the society's capital base had not already been eroded by over-allocation of bonuses. On previous experience, the shock would have been sustainable," he writes.
One of the fundamental problems lay with Equitable's decision to blaze a trial and get ahead of competitors by writing new products, such as guaranteed annuities. Also to blame was the culture of Equitable, which was based on promoting a view of mutuality which said all investment returns should be paid out to policyholders rather than keeping some back in an "inherited estate" to deal with unexpected problems.
Equitable stole a march on its competitors by offering the attractive new products and by paying out more than its competitors, the report points out, because it was able to regularly top the league tables with its superior returns.
However, while other insurers may have been drawing on deep reverses they had already built up, or also being able to use the fact that they were owned by shareholders and therefore had access to the equity and debt markets, Equitable's mutually-owned status meant it had only one pot of money to draw on - that belonging collectively to its policy-holders. Yet its over-generous bonus policy meant it was paying out to policyholders more than their fair share.
As a result, Lord Penrose says, Equitable was in a state of serious financial weakness, a problem the society tried to address by employing "extreme actuarial techniques" to manipulate key assumptions.
The society embarked on issuing debt and taking out a reinsurance contract to try to bolster the appearance of its reserves but, the report says, there were some at Equitable who were aware by 1997 that it would take as much as 15 years to try to restore the equilibrium between the promises it had made to policyholders and the assets on its balance sheet.
As well as employing various financial devices to pull itself out of its financial hole, Equitable also embarked in 1994 on the policy that was to be dramatically overturned by the House of Lords, paying different bonus rates to different groups of policyholders.
The society's plan was to cut part of the bonus paid to those with guaranteed policies, in a bid to even out the payment overall to be in line with returns to those who did not have a guaranteed element in their policy.
Lord Penrose says this policy was "ill-conceived, poorly expressed and confusing". Letters to policyholders at the time did not explain the move, being "generally uncommunicative". In addition, as the House of Lords itself devastatingly ruled, Lord Penrose suggests the move was unlawful, on the basis that one aspect of with-profit policies is to take into account "policyholders' reasonable expectations" when calculating bonuses.
Despite attempts to mitigate the situation, the gap between assets and liabilities widened to the extent that it was "overdrawn" to the tune of £4.4bn by July 2001 - the fateful month Equitable under its new management of Vanni Treves and Charles Thomson sliced 16 per cent off the value of all with-profits policies.
While the society as the time attributed the swingeing cut to the slump in the stock market, Lord Penrose says this factor was "in part responsible". But he adds it was also due to "the cumulative effect of over allocation, and in particular the resulting overpayment on maturities and other claims from 1987 onwards".
Many of the problems were down to the running of the society, characterised by Lord Penrose as a group of weak non-executive directors who did not challenge its autocratic management.
Lord Penrose acknowledges that Equitable's non-executives have argued that they did not have the actuarial skills to be able to sufficiently scrutinise and challenge decisions taken by its management which later turned out to be disastrous.
He says he accepts, for example, the evidence of some non-executives who said they did not know about Equitable's differential bonus policy.
Recorded in the report is the defence of the non-executives that they relied for information on the society's auditors, regulators and the Government Actuaries Department, which provided expert advice to regulators.
But Lord Penrose also illustrates why this position is unsatisfactory, pointing out that the board as a whole had formal responsibilities and that its responsibilities to policyholders were "comprehensive".
"Under the articles of association" of the society, "formal responsibility for [bonus] declaration lay with the board at all times", the report says.
Lord Penrose adds that the emerging picture of Equitable having promised to pay out more than it had in reserves could have been uncovered by the non-executives, had they made inquiries.
"In view of the estimates being made internally, it would have been clear to the board, if they had sought and obtained information about the aggregate position on the with-profits fund, that correcting the over-distribution would take many years," the report says.
Lord Penrose adds that whatever the finer details of where responsibility lay, the situation was highly undesirable. "One would with to ensure that the future conduct of life businesses reflected acceptance by non-executive and other directors of personal responsibility," he says.
If Equitable's non-executives did not know enough about complex rules governing life companies and did not try hard enough to find out about them, they were up against a small group of directors who ran the society with a vice-like grip and did not welcome interference.
Roy Ranson was Equitable's appointed actuary from 1982 to 1992. From 1992 to 1997 he combined the role with being chief executive of the society.
By his own admission, Lord Penrose notes, Mr Ranson was "autocratic" in his approach to regulators. The judge's own view of Mr Ranson, whom he interviewed as part of his probe, was that he was "highly articulate and intelligent, but manipulative".
Lord Penrose adds that he was "not persuaded" by arguments by Mr Ranson, who is over 70, that "he had put the society's affairs so completely behind him that he could no comment on some of the matters that were put to him".
Mr Ranson's role was critical to the direction Equitable took over almost 20 years. He was key to some of its most controversial policies. Mr Ranson "persistently emphasised that there was no need to reserve for accrued terminal bonuses in regulatory return". He also did not warn his board about certain risks, such as adopting a differential bonus policy.
Mr Ranson, who has been given the chance to comment on Lord Penrose's findings, argued that the strategy of cutting bonuses in order to lessen the cost to Equitable of the guarantees it had issued was something the board as a whole was aware of.
Lord Penrose says: "He has denied that the decisions were management decisions, and at the same time contended that implementation was not something that merited report to the board."
If Roy Ranson ruled Equitable autocratically, Chris Headdon, who took over as chief executive in December 2000, when Equitable was forced to close to new business, adopted the same line was his more dominant predecessor, Lord Penrose finds.
As appointed actuary to Mr Ranson, Mr Headdon came up with various options for dealing with the guaranteed annuity problem on Equitable's books and warned his superior that opting for differential bonuses could cause problems.
But, when that was the policy that was selected, "He Headdon acquiesced in the implementation of that approach as Mr Ranson's assistant."
The report adds that "Mr Headdon's personal responsibility was not avoided by reliance on Mr Ranson's actions and experience."
Lord Penrose also highlights the fact that it was Mr Headdon who signed a controversial reinsurance contract in the 1990s to try to off-load some of Equitable's risk from its balance sheet.
However, due to terms set out by Mr Headdon, the contract "did not and was never intended to transfer risk. Rather it facilitated an accounting exercise that appeared to reduce net liabilities while leaving the society exposed to the gross loss."
Alan Nash succeeded Mr Ranson as chief executive in July 1997, resigning in December 2000.
Although Mr Nash did a stint at the helm of Equitable - at one of its most troubled times - he did not make any of the decisions which led to its demise, Lord Penrose says.
"Though a qualified actuary, who occasionally initialled reported with Mr Headdon, I was persuaded that he was not qualified by experience to make a material contribution to the actuarial management of the society," the report says.
The Regulatory Regime
While Lord Penrose puts the fundamental blame for Equitable's downfall at the door of its own management, he conveys a picture of serious inadequacies in the way it was policed. Those responsible for its supervision dating back to the 1980s were the Department of Trade and Industry, the Treasury, the Government Actuaries Department and, since 1999, the Financial Services Authority.
"The practices of the society's management could not have been sustained over a material part of the 1990s had there been in place an appropriate regulatory structure adapted to the requirements of a changing industry that happened to manifest themselves in an extreme form in the case of Equitable Life," Lord Penrose says.
The report finds evidence both of serious problems with the supervisory system, and of individuals cases where regulators too lax to uncover vital evidence of the highly risky policy Equitable was pursuing.
One area were the system itself was wanting was in its scrutiny of complex instruments such as using future profits to bolster its fragile reserves - a technique Equitable relied on.
However, while the strategy is frowned on now, in the 1990s it was seen as legitimate. "In the context of the regulatory framework in force regulators could not have done otherwise" but to allow Equitable to include as yet unearned profits in its reserves, the report says.
But Lord Penrose also pinpoints instances where regulators did not seem sufficiently on the ball. He argues those supervising Equitable should have been concerned about its decision to issue debt "should have alerted regulators to the society's weakening position overall".
There were also problems with the regulator's attitude to the reinsurance contract taken out by Equitable, which had it written into its fine print that it was only in force if Equitable's bonus policy remained the same. The bonus policy was in fact changed by the House of Lords case.
Lord Penrose writes: "Even without the benefit of hindsight, the contingency that the society might lose the case, undermining the reinsurance cover, should surely have been regarded as material."
He adds that while regulators insisted that Equitable should note that it might lose the case, they did not take the cost of such an eventuality into account.
Lord Penrose singles out the Government Actuaries Department for criticism on several counts. He says that it, and other regulators, were aware that Equitable's finances were weak by 1994, when it embarked on cutting bonuses to guaranteed policyholders. Yet its probing of Equitable was "weak and lacked challenge".
Lord Penrose raises the possibility that Ernst & Young, auditors of Equitable, might have a case to answer to policyholders keen to win compensation from the major accountancy firm over the way it oversaw Equitable's finances.
While his thoughts are confined by the fact that Equitable is already pursuing E&Y through the courts, Lord Penrose says: "There may be a comprehensive failure by industry and by standard-setting bodies" to follow produce reports which "reflect the realistic financial position of life offices".
He adds that the current approach of auditors has in some cases be "over-reliant on appointed actuaries."
THE MAIN POINTS
* The society 'was the author of its own misfortunes'
* The board began to over-pay bonuses in the late 1980s. By 2001, Equitable was £4.4bn 'over-drawn'
* Executive management failed to keep the society's board fully informed about the true state of the company's financial position
* Equitable's non-executive directors had a poor understanding of the society's financial position
* The society failed to communicate relevant information to policyholders
* The regulatory system 'failed policyholders'
* There was complacency and a lack of robustness in the regulatory process
* Regulation over-relied on the society's appointed actuary
* Management was unchallenged by regulators and GAD
* Regulation didn't keep up to date with industryReuse content