Documents: 30/09/2001 - EMAG's submission to the Sandler review of the retail savings industry September 2001 - Submission by EMAG to the Sandler Review of Medium and Long-term Retail Savings SUMMARY AND RECOMMENDATIONS We imagine the Review is aware of the difficulties facing The Equitable Life Assurance Society. The Equitable Members Action Group (EMAG) aims to provide all policyholder classes of the Society with information, but not advice. EMAG, which is independent of any commercial interests, has about 2000 members who pay a subscription of £20 to join. We wish to address two of the issues which the Review is considering, namely:-
Accountability and governance The Board of "Old" Equitable had a poor record in communicating openly with its members, which regrettably the new Board has not improved on. We have not yet been able to obtain the key terms and a financial evaluation of the Halifax deal, which is of material interest to the members. Recently the Board refused to provide the members with information about the financial review which the Society undertook, and was the basis of cutting policy values effectively by a fifth on 16 July, 2000. Although there may be a valid reason for providing no information, we have been given a succession of excuses which we regard as totally unsatisfactory. The attitudes of the Chief Executive in claiming that "Members have already been given all the information they need [about the review]" and of a Board member that "It would not be surprising that, if the details of the judgements made by the Board on all these issues were made public, some commentators would find them controversial and questionable" are not acceptable. They perpetuate the secretive attitude of the previous Board which has been a primary cause of the widespread distrust of the Society. To quote one of our Committee members "the Board embraces secrecy to protect themselves, not to protect the interests of their members", while another commented "The Society's refusal to come clean simply generates the suspicion that management is hiding some more unpleasant facts and members try to guess what they might be - hence some of the wilder speculation". By failing to maintain a high degree of openness with the membership, the Society has not only denied its owners the comfort of understanding the way in which their provision for the future is being managed, but denied itself a vital channel of review and criticism and has contributed to suspicion and distrust among its members and the media. The large mutuals have outgrown their origins as small groups of people banding together to pursue a common purpose, and they are now large "corporate" organisations pursuing multiple purposes (including those of management). In the process the basis of mutuality has been lost sight of, and many seem to think that the governance and board behaviour of a mutual should be like that of a public limited company (plc). But a mutual life office - even more so a closed mutual, which is in effect a private investment club - is very different to a plc in three crucial respects, namely:-
The Memorandum and Articles of The Equitable are written to insulate the Board from the members and to make it difficult for members to exercise their will:-
Furthermore we do not think that in a Society the size of The Equitable it is appropriate for directors to be appointed who are not "substantial" members of the Society. Yet fully half of the current directors have been "parachuted in" and taken out token £1000 policies to qualify for Board membership. We recommend that there should be legislation covering mutual life offices that:-
With-profits life assurance policiesThere are significant shortcomings of with-profits products, namely they can be risky; they are obscure and complex; they are ill defined and can be manipulated; and they are expensive for the return they provide; and they are not necessarily suitable for younger people:-
Furthermore:-
INTRODUCTION We imagine the Review is aware of the difficulties facing The Equitable Life Assurance Society, and knows that last February the Board agreed a deal with The Halifax. This provided that in return for an immediate sum of £500m and two possible further payments of £250m (which were contingent upon the members of Equitable agreeing a compromise) the Halifax would acquire all of The Equitable's assets, its unit linked business, and would manage the with-profits fund and provide the necessary administrative services to support the fund for a 10 year term. That Equitable Board co-opted its own replacements in April, and the members of the new Board were subsequently ratified at the AGM on 23 May 2001. The Review may also be aware that on 20 September the Board published a consultation document on the "Proposed Compromise". The Equitable Members Action Group (EMAG) aims to provide all policyholder classes with information, but not advice. EMAG, which is independent of any commercial interests, has about 2000 members who pay a subscription of £20 to join. Members of EMAG played a critical role in persuading The Equitable to commission Mr. Nicholas Warren to report on a number of issues, and has been an outspoken - but constructive - critic of aspects of the Society's behaviour. Based on our experience over the last year with The Equitable and our deepening knowledge of the life industry, we wish to address two of the issues which the Review is considering:-
LESSONS FOR ACCOUNTABILITY AND GOVERNANCE Accountability to members Although The Equitable had a reputation of being more open than many other mutuals (and most proprietary companies) in providing information about the performance of the with-profits funds, it was not as forthcoming as it should have been in clearly identifying the performance of its unit linked funds. The stresses caused since 1999 by the successive court hearings regarding the rights of members with guaranteed annuity rights (GAR) policies have shown that The Equitable had a poor record in communicating both with its members and with the press. That, however, is in the past. With a new Board we hoped for a more enlightened approach, but were quickly disappointed. We asked the Chief Executive for the key terms and a financial evaluation of the Halifax deal, which is of material interest to the members, but were told that "I cannot agree that time spent preparing and publishing more historical information would be time well spent". Subsequently at the AGM we - the owners - learned that the provision of the further £500m is contingent upon the compromise being agreed by March 2002. Only with the publication of the Proposed Compromise did we also learn that the agreement contained six material principles that must be addressed. We regard it as inappropriate - but in keeping with the culture - that the then Board would agree to a deal that radically alters the Society, not only without recourse to the members but with a confidentiality agreement that precluded it from explaining the deal. Recently we have been very dissatisfied with the Board's refusal to provide the members with information about the financial review which the Society undertook, and was the basis of cutting policy values effectively by a fifth on 16 July, 2000. Although the recent consultation document "Proposed Compromise" includes many numbers, it did not provide members with any information about the financial state of the Society. There are two fundamental reasons why some version of the financial review should be available to members, one of principle and one of practical significance:-
Although there may be a valid reason for providing no information, we have been given a succession of excuses which we regard as totally unsatisfactory. Inter alia the Chief Executive has claimed that "Members have already been given all the information they need [about the review]. They have been told that assets are now sufficient to meet the liabilities". How do we know? Why should we believe him when he claimed in March that "It does not matter how many people leave - they are cash neutral to those who remain"? He was wrong. We regard it as unacceptable than an employee of our Society should presume to tell us what information we may or may not have regarding our financial affairs. Another Board member has written "It would not be surprising that, if the details of the judgements made by the Board on all these issues were made public, some commentators would find them controversial and questionable. Such controversy would do nothing to serve the interests of members as the Board strives to construct a compromise that is fair to them all". We do not for one moment accept this view, which perpetuates the attitude of the previous Board which has been a primary cause of the widespread distrust of the Society. If The Equitable knew how to communicate properly, there should not be a problem. To quote one of our Committee members "the Board embraces secrecy to protect themselves, not to protect the interests of their members". We are not the only ones concerned about Equitable's reluctance to provide information. A report by Bacon & Woodrow dated 25 July to the Principal Civil Service Pension Scheme observed:- "One question is whether the amount offered on transfer to another policy is "fair value" - for which the best guide is probably asset share. Unfortunately only Equitable Life has sufficient information to be able to calculate the member's asset share. One is forced to trust what Equitable Life say - and trust is at a low ebb at present". "There seems little real upside and plenty of potential downside risk. However the underlying investment or economic position remains impossible to analyse but our feeling is that there is now a more penal element in the surrender terms than before. This would be a 'penal' element relative to the concept of asset share - which in itself is not something that members would easily understand and where only Equitable Life know the "true" position". "Trustees need to press Equitable Life to release information to enable members to decide whether or not to stay". As another of our members commented "The Society's refusal to come clean simply generates the suspicion that management is hiding some more unpleasant facts and members try to guess what they might be - hence some of the wilder speculation. Being 'economical with the truth' is a much admired skill in our ruling classes, but in this situation the Board needs the trust of members and 'honesty is the best policy'." As we now know to our cost, The Equitable was formerly presided over by a chairman and Board which rarely challenged the executive, who conducted the Society's affairs with little internal discussion and review and devolved significant authority to relatively ordinary managers who we now know were not capable of understanding the implications of what they were doing. As part of the drive to grow the Society wrote new forms of policy without either taking legal advice, or considering the ways in which the new business might conflict with the old. By failing to maintain a high degree of openness with the membership, the Society has not only denied its owners the comfort of understanding the way in which their provision for the future is being managed, but denied itself a vital channel of review and criticism. The lack of openness is not only a primary cause of mistrust, but it has also allowed the Board and management to get away with inadequate performance. The governance of mutuals The large mutuals have outgrown their origins as small groups of people banding together to pursue a common purpose, and they are now large organisations pursuing multiple purposes (some of which may resulting conflicting interests between members). In the process - along with importing mainstream corporate culture and changing titles from "General Manager" to "Chief Executive" - the basis of mutuality has been lost sight of. The Equitable, like many (if not all) mutual life offices, is constituted as a company, and this leads people to think that the governance and Board behaviour of a mutual should be like that of a public limited company (plc). But a mutual life office - even more so a closed mutual, which is in effect a private investment club - is very different to a plc in a number of crucial respects:-
Weak governance facilitates a tendency for mutuals to be hijacked by "managerialist interests" at the expense of the interests of the mutual owners. For example:-
The obstacles to direct action by members The Memorandum and Articles of Association of The Equitable appear to be written to insulate the Board from the members. There is no provision for members either to put a resolution to the AGM or to call for an extraordinary general meeting (EGM), and so members have to fall back on the provision in the Companies Act that an EGM must be called if holders of 10% of the shares require it. Although getting support of 10% of the votes of a FTSE company only requires the fund managers of a few major institutions to telephone each other, getting 10% of The Equitable's voting members to support a resolution would require a mail shot to all members. The cost of sending a letter to 450,000 members would be of the order of £125,000, which is prohibitively expensive for a group of members or an action group dependent on, at best, modest subscriptions. We note that the Building Societies Act 1986 prescribes the maximum number of members required to put a resolution to the AGM or to call an EGM on a sliding scale by size of society. For the largest Society, The Nationwide with 6 million members, the maximum number of members required is 500. The voting for directors can be "arranged" so that those whom the chairman and incumbent Board want elected are voted in. In 2000, Mr. Edward Doogan, a member who expressed dissatisfaction with its investment performance, put himself forward for election to the Board. The chairman wrote a letter to members stating "Your Board strongly recommends that you vote to re-elect the existing directors who are retiring at the meeting?and against the resolution to elect Mr. Edward Doogan?the facts quoted in his candidate's statement are correct but are in our view selective". Mr. Doogan won 241,9391 votes for and 246,619 against, which was an achievement given the way the voting is run, an issue to which we now turn. At first sight the results of the vote at this year's AGM for new directors appear to show overwhelming support for the recommended directors, each of whom gained an average of 386,400 votes and 73,698 against, and little for the "independents", each of whom gained an average of 81,616 votes and 376,698 votes against. But further analysis shows that the voting results were largely dependent upon the chairman's mandated proxy votes and his free proxy votes2. The majority of votes cast for those elected and against the "independents" were proxy votes cast by the chairman. The voting arrangements are a direct consequence of the form of voting by resolution for each director, which requires members to vote for and against each resolution and allow proxy voting. Indeed if a voting paper is signed but the votes are left blank, the voter is deemed to give the chairman power of proxy. The Building Societies Act 1986 allows for both voting by resolution and postal voting, which the Nationwide adopts. Under postal voting the yes votes for each candidate are totalled and those with the most votes are appointed. There is no proxy voting (and signed blank forms are void). Selecting a Board The foregoing highlights the fundamental problems with elections to large mutuals, namely:-
Although we accept that the chairman and the incumbent Board should have a say in the election of some of the Board members (and indeed they have a common law obligation to recommend a suitable Board for carrying in a company's business), we do not believe that the incumbent Board or the chairman should have what amounts to patronage of them all. It may result in packing the Board with trusties, all of whom are to varying degrees beholden to the chairman for tenure. We note that the Cadbury report enjoins non-executive directors to bring "an independent judgement to bear on issues of strategy". One of the directors of The Equitable has stated that the "directors debate matters freely, openly, and from a number of different points of view". They may well do, but how do we know? To adapt a phrase "independence should not only be done, but seen to be done". Perhaps if one or two of the "Old Equitable" Board had exercised genuinely independent judgement rather than accept the "Aylesbury" line, we might not be in the current mess. Finally, we do think that in a Society the size of The Equitable it is appropriate for directors to be appointed who are not "substantial" members of the Society. Yet fully half of the current directors have been "parachuted in" and taken out token £1000 policies to qualify for Board membership. Although we do not query the need for a portfolio of skills on the Board, the Board could no doubt have benefited from their type of wisdom by employing consultants or employing them as consultants. Strengthening accountability and governance We believe there is a need for an institutional framework which strengthens the governance of mutuals and ensures that they are directed by genuine members, and that there should be a number of directors who are elected on a "free vote" and who are independent of the chairman and incumbent Board. Their role should be clearly to act as a "check and balance" and if necessary to "throw grit in the system". This may not be City practice and it may not suit the conventional non-confrontational culture and tolerance of sloppy performance of the British middle class, but it may improve performance and accountability. We recommend that there should be legislation covering mutual life offices that:-
WITH-PROFITS LIFE ASSURANCE POLICIESYour consultation document asks a question: "What factors drive the demand for with-profits products? In particular, why has there been such a substantial increase in sales of with-profits bonds?". The answers are easy. The sale of with-profits life policies has evolved historically because purchasers thought that "with-profits" sounded better than a vanilla annuity, which was the main alternative in the 1950s, 1960s and early 1970s before the development of unit linked life products. On the producer side the development of sizeable with-profits funds created vested interests in the life companies to sell the product through highly bonused salesmen and well commissioned financial advisers. Because the with-profits policy and the fund is not transparent and veiled in actuarial mumbo jumbo, they were not only able to obscure the high sales costs, they were also able to use the funds as a basis for business development. On the purchasers' side, they heard the sales story of secure returns plus a measure of equity growth, and had no idea of the character of the product nor the risks that may be hidden in a fund, see below. The recent sale of with-profits bonds is the consequence of a big marketing push by life companies that in the times of risky volatile stock markets, they offer a safer means of investment which should perform better than saving with banks or building societies4, but once more few purchasers have any idea of the character of the product nor of the risks that may be embedded in the main fund. The great majority of purchasers of financial products are financially illiterate. There are some significant shortcomings of with-profits policies, namely they:-
The product is obscure, complex, ill defined, and can be manipulated and risky With-profits policies with many, if not most, life offices obscure risks, obscure expenses, obscure charges, obscure investment performance, incorporate obscure terms, and the return is ill-defined and subject to the discretion (which can amount to little more than manipulation) by the life office:-
terminal bonus as % of:-
Although there is a financial rationale why life companies have generally moved towards lower annual bonuses and higher terminal bonuses7, the range shown by the two pairs of companies where each of the pair pays a similar total sum is unlikely to have any tangible financial rationale. Another example of a practice that had no financial rationale was that of a company which paid terminal bonuses of about 50% on policies of less than 20 years and 160% on policies, of 25 years. Although this practice might have looked good from a marketing perspective allowing the company to proclaim its performance over 25 years, it had no financial rationale. Again a Scottish mutual life office declared a "centenary bonus" which was not justified by its underlying finances, and this subsequently led to the company's sale. Equitable has been good in stating the returns on its investment and allocating bonuses so that over a run of years they equal the returns made. Some other offices have built up large reserves which have become "orphan assets", which are essentially unfair to earlier generations of investors who have been underpaid. In view of our very unsatisfactory experience of with-profits some members of the Committee of EMAG consider that if the compromise is voted through, the fund should be unitised to give members defined asset shares and eliminate smoothing and along with it the associated actuarial hokey-pokey. Further consideration might then be given to splitting the fund into a set of sub-funds - essentially managed funds - with different risk profiles from which policyholders could choose. Not generally appropriate for younger people From an economic/risk perspective the with-profits policy is often not appropriate for younger people. Although the security of annual bonuses which are guaranteed may be desirable for people who are approaching retirement age and would suffer financially if not "hedged" against a possible sharp fall in equities around when they are approaching retirement age, the security offered requires the fund to invest in fixed interest instruments which are less risky but over the years provide a lower return that more risky equities. As a general rule, younger people should be more heavily invested in equities than older people and thus they may disbenefit from the proportion of a with-profits fund invested in generally lower yielding fixed income investments. With-profits policies appear on average to be expensive for what they provide A study by the FSA8 found that the return net of expenses on all with-profits funds over the period 1993-98 (which included a stock market boom) was only 6.0% p.a., while charges averaged 3.17% p.a. of fund value. Furthermore in order to obtain £1 worth of market return then (ignoring different tax arrangements) on average one had to invest the following sums in different products:- £1.60 with-profits funds £1.45 actively managed UK unit trusts £1.33 actively managed US mutuals (unit trusts) £1.25 UK index unit trusts £1.10 US index mutual funds The with-profits fund performed poorly. Alex Henney Committee Member, EMAG on behalf of the Committee of EMAG 1Note that members are entitled to up to ten votes each depending on the value of their policies - with inflation most have ten. 2 Analysis of the average votes for each incumbent Board member Total 386,400 Of which 278,415 (72%) mandated to chairman and 101,818 (26%) chairman's proxy votes Analysis of the average votes against each incumbent candidate Total 376,698 Of which 152,798 (41%) mandated to chairman and 203,936 (54%) chairman's proxy votes. 3 In order to reduce the risk of manifestly insensitive candidates self-promoting themselves, there may be a case for a procedure to prepare a list of suitable persons similar to the Occupational Pensions Regulatory Authority's list of independent trustees - admission to the list might be controlled by the FSA. Companies would be required to circulate the members with details of the candidates who had been put forward for Board vacancies together with their statement of why they should be elected, and each could prepare a video that could be played from the website. 4For example the current pitch of Friends provident "With-Profit Fund Brochure" is " a steady fund?[that] smooths the daily ups and downs of the markets". 5i.e. once a person has a GAR policy it is open to the policyholder to continue contributing to the policy. 6Equitable traditionally paid out a policyholder's asset share, and has no orphan estate which is why the House of Lords decision (which discarded asset share) has brought it down. There is an analogous situation with long term endowments, where the growth of the traded endowment market in recent years for assigned policies is a reflection of the fact that policyholders who wish to turn their policies into cash receive poor value from life companies if they terminate their policies early. Since the Equitable traditionally paid out a policyholder's asset share, the Association of Policy Market Makers has observed there is little or no market in Equitable policies. 7The annual bonuses are guaranteed and so are secured by investing in fixed interest instruments, while terminal bonuses are flexible and do not require such security and so allow a fund to invest more in equities which although riskier are expected to provide a higher return over the long run. 8The Price of Retail Investing in the UK by Kevin James of the Financial Services Agency, February 2000 (available on www.fsa.gov.uk). |