FSA accuses itself of inaction over downfall of Equitable Life

The Financial Services Authority yesterday accused itself of failing to follow up or even spot critical issues as the crisis at the Equitable Life Assurance Society unfolded during 1999 and last year.

A 268-page report into the City watchdog's handing of the affair said that key FSA staff had been reluctant to get involved in tackling the problems generated by Equitable's obligations to members with guaranteed annuities. A court ruling in July last year forced the society to cut the value of its members' pensions by thousands of pounds, by obliging Equitable to honour bonuses guaranteed to some 90,000 policyholders. The decision, by the Law Lords, left Equitable short of £1.5bn.

It has now emerged that the FSA was repeatedly overoptimistic about developments and was inadequately prepared for the numerous turns for the worse that have characterised Equitable's recent history. It was over a year after the crisis began before a dedicated cross-departmental meeting about Equitable was convened.

These are the findings of the FSA's director of internal audit, Ronnie Baird. When Equitable closed for new business in December, the FSA gave him the brief of investigating its own role in regulating the society.

Mr Baird said the report was not about apportioning blame. He traced Equitable's downfall to guaranteed policies written many years before the FSA assumed responsibility for insurance regulation. "Accordingly, applying hindsight, it is fair to say that, by 1 January 1999, the 'die was cast' and we have seen nothing which the FSA could have done thereafter which would have mitigated, in any material way, the impact of the outcome of the court case as far as existing policyholders were concerned, or made any material beneficial difference to the final outcome so far as Equitable Life was concerned," he says.

But he goes on to detail repeated oversights and lapses on the regulator's part, including:

* The FSA's lack of preparedness for the House of Lords's judgment stemmed from a lack of scepticism about the outcome based on a misconstruction of the legal briefings, and on being influenced by Equitable's confidence in its case. It did not envisage Equitable being forced to put itself up for sale.

* There was a failure to press for proper financial information in early 1999, despite receiving inadequate responses from Equitable. That left the FSA less able to decide whether it needed to take any further action to protect policyholders or potential policyholders.

* The FSA did not investigate the absence of an appropriate statement on Equitable's 1998 returns on the risks surrounding a successful challenge to its practices regarding final bonuses, despite court proceedings beginning.

* Policyholders risked being misled about Equitable's financial strength because the FSA did not make the society disclose that a key reinsurance contract depended on the outcome of the court case.

* The process by which the FSA allowed Equitable to register future profits in its reserves for 2000 was flawed.

* The FSA developed an overoptimistic view of the saleability of Equitable. It missed a significant obstacle to Equitable's sale by not questioning the basis for reserving against liabilities arising from top-ups made to guaranteed policies.

* The FSA should have reviewed whether Equitable's letter to policyholders of February 2000 was misleading.

* The first meeting to plan for the outcomes from the court case took place on 18 July 2000, just two days before the verdict, despite the FSA learning on 4 July of indications Equitable might lose.

* It took nine months for the FSA's department responsible for the former Personal Investment Authority to act on a memo in January 1999 warning of the implications to its duties.

* There was a delay to consideration of whether Equitable would be able to pay out compensation claims.

The FSA once described its general responsibilities to the Treasury as "aiming to minimise, but not eliminate, the risk of company failure by identifying early signs of trouble, and taking preventative action". However, Mr Baird notes that at the period under review, the FSA was still in its infancy and was far from being the fully-fledged super-regulator it is meant to be. It was still operating under powers belonging to the host of separate regulators it was intended to replace.

Mr Baird points to a lack of communication between the two main arms of the FSA charged with overseeing Equitable, the so-called "prudential" regulator, responsible for assessing the health of its business, and the "conduct of business" regulator, which assesses matters such as Equitable's communications with its members.

Neither regulator appears to have communicated much with the other. The conduct-of-business regulator ignored warnings from its counterpart to consider the effect that policyholders topping up guaranteed funds would have on those without guarantees. Its staff were "reluctant to get involved and take ownership" of the issue. Mr Baird said: "Neither was properly and consistently aware of what the other was doing."

The theme of the report's recommendations is that the FSA should become more proactive, although there are proposals to overhaul the framework for assessing solvency disclosure of information by companies. Ruth Kelly, economic secretary to the Treasury, has asked Sir Howard Davies, the FSA's chairman, to submit a response by 20 November.

"We will be pleased to [become more proactive], and to explain in detail how we plan to carry forward all the recommendations," Sir Howard said yesterday. Many issues had already been addressed, he said, but "we will take [the] lessons to heart".