From the Penrose report following the Equitable Life disaster, 2004.
The following may be regarded as the key conclusions arising from this report:
(1) The executive management of the Society resolved as early as 1983 on the approach to meeting the cost of annuity guarantees from terminal bonus that became the differential terminal bonus policy and formed the basis for the Hyman litigation. This decision was not communicated to the Board until 1993 and not to policyholders in any form until 1995.
(2) This policy was material to the decision not to start a new bonus series in 1988 and to market the new personal pensions as essentially a continuation of the earlier retirement annuity business. This exposed those joining the fund to the potential cost of the guarantees and was not adequately disclosed. The Board appear to have taken the decision not to start a new bonus series without adequate consideration of the relevant factors.
(3) The Society adopted a policy whereby unguaranteed terminal or final bonus became an increasing proportion of total allocations. This was in line with industry trends, but had the intended effect of reducing over time the share of benefits which required to be reserved for or recognised as liabilities in the Society’s statutory accounts and regulatory returns.
(4) As a consequence of this shift towards terminal bonus, and in the absence of any coherent or consistently applied smoothing policy, the Society began to over-allocate from the late 1980s onwards, with the effect that the realistic financial position (as reported regularly on internal systems and therefore known to the executive management) was progressively weakened, and policy claims progressively withdrew funds in excess of prudently calculated policy values. By the end of 2000, the position reached could only be dealt with by radical re-alignment of policy values, as happened in July 2001.
(5) The Society’s solvency position was bolstered over the period by the consistent (and frequently acknowledged) adoption of the weakest valuation basis? plus a series of particular valuation practices of dubious actuarial merit (the interest rate differential, financial reinsurance and the quasi-zillmer adjustment) and other financial adjustments and supports (increasing reliance on future profits and subordinated debt) that sought to anticipate future returns.
(6) The Board had insufficient knowledge and skills to provide an effective challenge to the executive it: critical areas, in particular in relation to product design and liability valuation. Internal systems were ineffective in ensuring that the Board could form an independent view of the financial position of the Society, and the Board accepted a position whereby the provision of financial and product information was too fragmented for a clear picture lo be formed.
(7) Regulation was based on an over-reliance on the appointed actuary, who in the case of the Society was also the chief executive over the critical period from 1991 to 1997, despite a recognition, of the potential for conflict of interest inherent in this position.
(8) The regulatory returns and measures of solvency applied by the regulators did not keep pace with developments in the industry, in particular the trend towards unguaranteed and unreserved for terminal bonus. Thus regulatory solvency became an increasingly irrelevant measure of the realistic financial position of the Society.
(9)The significance of policyholders’ reasonable expectations under the legislation was understood by the regulators, who had also developed over time a good appreciation of the factors involved. There was, however, no consistent or persistent attempt to establish how PRE should affect the acknowledged liabilities of the Society.
(10) The regulators also failed to give sufficient consideration to the fact that a number of the various measures used to bolster the Society’s solvency position were predicated on the emergence of future surplus. In the case of the reinsurance agreement, it is not clear on what basis the Society was permitted to take the credit against its potential annuity guarantee liability that it did.
(11) There was a general failure on the part of the regulators and GAD to follow up issues that arose in the course of their regulation of the Society, and to mount effective challenge of the management.
It is also significant to note that at all material times the appointed actuary of the Society was able to claim that the Society’s valuation practices were consistent with applicable professional standards, and that the auditors are able lo claim that the discharge of their duties met all applicable auditing standards.
Sounds familiar?