With the recently announced sale of the remains of Equitable Life, this weekend's blog seems a good time to start this series, which looks at what effect SMCR might have had on previous regulatory failures. This includes both the firm(s) involved and at the regulator.
It's easy now to underestimate the scale of Equitable's impact. The attached article points out the abiding impact of the failure on policyholders even two decades on. And despite subsequent events, there is a respectable argument that the FSA never truly recovered from the failure, didn’t regain its confidence, and, always living in the shadow of the next Equitable Report, struggled to deal with its implications. Almost 20 years on, it’s still not clear the lessons have been learned.
A brief recap of the story before looking at whether SMCR could have averted it.
August 1998: Equitable announced it was reducing the value of its Guaranteed Annuity Return (GAR) policies, which, in a period of low inflation, were paying out significantly more than either of its rivals, or its own investments.
January 1999: Having just assumed responsibility for the prudential regulation of insurance firms, the FSA (formed in June 1998 but only gradually assuming its responsibilities) issued a letter on insurance company solvency that had the effect of crystallising the shortfall in Equitable’s reserves – but at an estimated cost of c.£1.5bn, rather than the £50-200mn management had assumed.
September 1999: In a test case, the High Court unanimously backed Equitable’s right to reduce the bonuses of GAR policyholders.
July 2000: The House of Lords found Equitable’s action in breach of contract, reversing the High Court decision.
December 2000: The last of more than a dozen potential purchasers walked away and Equitable closed its doors too new policyholders.
The subsequent FSA review, commissioned from Ronnie Baird, the Head of IA, was only the first of many but, even reading it today, remains scathing. To summarise these briefly, the FSA:
1. “did not spot the issues to be addressed or, having spotted them, did not follow them up.”
2. There was a “poor level of communication between the two arms of regulation, prudential and conduct of business.”
3. The FSA did not need more resource but instead “a better application of resource”.
4. There was “a culture within IB-PIA (the Insurance Conduct Division) in which there is little appetite and capacity to examine the wider implications of an issue.”
5. The Review recommended the FCA apply “a more rigorous risk assessment process to specific situations where certain risks have escalated or crystallised, and where it is particularly important to plan for all reasonably considered outcomes.”
Could SMCR have helped?
This doesn’t seem like an SMCR-type situation. Equitable’s business model was an open secret. It was based on the assumption that the GAR wasn’t ultimately “guaranteed”, but that assumption was widely held, including by the FSA, and was initially supported by the courts.
The obvious possible exception might be the new solvency test the FSA introduced, where there is a question about knowledge and control of the business. But, it was a new test, and I can’t imagine SMCR would have made a significant difference to what happened.
Largely due to the extended period of its creation, lasting effectively from May 1997 to December 2000, the FSA comes across as silo’d during this period, and blind to risks that were hiding in plain sight. This should be classic SMCR territory. The regime would have forced Senior Manager accountability for Insurance firms to be concentrated in one person, as well as proper consideration of the various risks and options. Interestingly, the discipline of “reasonable steps” would probably have been the most effective element of SMCR in this situation.
The irony is that a combination of the UK’s twin peaks regulation – separating the prudential and conduct supervision of insurance firms - and the FCA’s complex matrix structure means that it might be as hard to respond successfully to the challenge of an Equitable today as it was 20 years ago.
There have been over 100 reports and inquiries into what went wrong, said Mr Weir. One of them, a 2008 report from the Parliamentary Ombudsman entitled A Decade of Regulatory Failure, runs to almost 3,000 pages. Another, from the European Parliament, describes Equitable’s guaranteed annuity rates as “a time bomb”.