Home > News > 2001 > November 2001 > Equitable Compromise Proposal
Equitable Compromise Proposal
Summary of the proposal
On 20 September 2001, Equitable Life started consultation on its compromise proposal. A proposal was made necessary due to the instability of the Equitable with profit fund following the House of Lords decision regarding the treatment of Guaranteed Annuity Rates (GARs) and the possibility that non-GAR policyholders might sue the Equitable for misselling. The background to the reasons for the instability is given in the appendix.
The compromise proposal seeks to stabilise the Equitable with profit fund by:
- Asking GAR policyholders to relinquish their GAR options and to waive their right to sue for loss arising from misselling claims by non-GAR policyholders in return for compensation through increased policy values; and
- Asking non-GAR policyholders to waive their right to sue for misselling in return for compensation through increased policy values.
For the compromise scheme to succeed, 50% by number and 75% by policy value of those voting in both the GAR and non-GAR policyholder classes must vote in favour.
The compromise scheme
The level of compensation varies by policy classes within the with profit fund. It reflects Equitable's estimate of the value of legal rights surrendered as well as each class's share of the with profit fund. Part of this compensation is paid for by the additional £250m payable by the Halifax if a compromise scheme becomes effective before 1 March 2002.
The compensation payable varies according to the types of GAR that have been given over the years as well as by the age of the policyholder. Compensation rates are shown for sample ages in the table below.
| Age at 31.12.2001 |
Retirement annuity policies issued before October 1975 ("Flexible" form of GARs) |
Retirement annuity policies issued after September 1975 ("Fixed" form of GARs) |
All other GAR policies (with the "Flexible" form of GARs) |
| 30 |
|
16.3% |
16.5% |
| 45 |
3.5% |
16.3% |
19.1% |
| 54 |
3.9% |
16.3% |
20.4% |
| 75 |
7.2% |
16.3% |
16.9% |
For Retirement Annuity policies issued after September 1975, the compensation is 16.3% of policy value at all ages.
At retirement, policyholders will be able to use their increased fund to buy a range of open market options. Alternatively, policyholders who have already reached an age where they can take their contractual retirement benefits under their policy can take their GAR rights if they retire before the compromise scheme becomes effective.
For non-GAR policyholders, the compensation is 2.5% of policy values at all ages.
The compensation to be paid will increase both guaranteed and total policy funds. Therefore the proportion of the policy fund that is guaranteed will not be changed. (The Equitable can reduce the non-guaranteed final bonuses but cannot reduce the policy value to below the guaranteed fund.) With profit annuitants (who are all non-GAR policyholders) will have their current pension level increased by 2.5% and all future increases or decreases to their pension will operate from this increased level.
The compromise scheme does not stop policyholders who have left the Equitable with profit fund from suing for misselling.
Benefits of the compromise scheme
The benefits of the compromise proposal are:
- The with profit fund would be stabilised, reducing uncertainty and thus the associated costs and expenses, leading to an increase in the overall investment returns that can be allocated to with profit policy funds.
- The Equitable currently reserves for GAR costs on a prudent basis. The release of these margins and the improved stability in the fund will allow greater investment freedom and the possibility of higher bonuses in the future.
- The increased stability would reduce the incentive for younger and non-GAR policyholders to withdraw from the Equitable, again increasing the investment freedom for the with profit fund.
- A payment of £250m from Halifax would be received (if the proposal were completed before 1 March 2002) along with the possibility of another £250m from the Halifax if the ex-Equitable sales force met its business targets. This money would be used to increase payouts to with profit policyholders.
- Bonuses are more likely to be paid in the future and the Equitable may start to declare guaranteed bonuses again.
The role of the court
The scheme needs to be approved by the High Court as the policyholders' contracts are being altered and they are giving up certain rights to sue. The Court will expect a report from an Independent Actuary on the fairness of the scheme. The Court will also require an explanatory statement to be sent out to all policyholders together with a document setting out the operation of the scheme.
It is possible that there may be a better scheme but it is likely to be more complicated and expensive, thus reducing the incentive for non-GAR policyholders to accept it. The Court will not seek to establish that the scheme is the best possible for all concerned but will approve the scheme if it establishes that:
- The scheme constitutes a genuine compromise or arrangement between policyholders and the Equitable;
- There is some element of accommodation on each side; and
- The rights of policyholders are not being expropriated without compensation.
Voting process and timetable
Separate meetings will be held for the 2 classes of policyholder; GAR and non-GAR. If both classes of policyholders approve the scheme, the matter will then be brought before the High Court and, if sanctioned, will become effective.
Policyholders holding both GAR and non-GAR benefits can vote twice: once as a member of the GAR class of voters and again as a member of the non-GAR class.
For group schemes
- There will be one vote per trustee board.
- Policy values can be split between policies and within one policy.
- Where trustee boards hold one or more policies which have both GAR rights and non-GAR rights, they will be able to vote at both the GAR and non-GAR meetings.
- If trustees vote for and against at one meeting, the votes will cancel each other out for the purposes of assessing whether a majority in number have voted for the scheme, but will still contribute to the vote by policy value.
The timetable indicated by the Equitable is:
| 12 October 2001 |
Consultation period closed |
| Early November 2001 |
Application to court to convene scheme meetings |
| Mid-November 2001 |
Receipt by policyholders of scheme documents |
| December 2001 |
Scheme meetings and vote counting |
| January-February 2002 |
Court approval and registration at Companies House whereupon the scheme becomes effective |
Issues for trustees and managers of Group Money Purchase and AVC schemes
This document sets out the issues that trustees should consider before deciding how they will vote on the proposal.
Trustees need to look at the compromise scheme from the point of view of the various groups of scheme members affected. For each group of policyholders, trustees will need to assess whether the compromise scheme would be to their benefit and vote accordingly. When considering the compromise proposal, trustees may need to divide their members into more groups than just the GAR and non-GAR groups used by the Equitable for voting purposes. Within the GAR class, the financial impact for members varies with age, sex, type of GAR and the ability to pay future GAR premiums into the with profit fund. Within the non-GAR class, the financial impact varies according to when the policy was bought (which determines the strength of any case to sue for misselling) as well as with age. Based on the assessment of these factors, trustees may then need to split their votes between these groups.
The table below summarises our understanding of the different groups of policyholders that may need separate consideration. Depending on particular circumstances of scheme design, further groups may also need to be identified.
| GAR policyholders |
Non-GAR policyholders |
Split by
Age:
- Near retirement
- Younger policyholders
Ability to pay future GAR premiums:
- Those eligible to pay future GAR premiums
- Those who cannot
Type of GAR:
- Retirement annuities purchased before October 1975
- Retirement annuities purchased after September 1975
- All other GAR policies
Sex:
|
Split by
Age:
- Near retirement
- Younger policyholders
When the policies were purchased
- Between September 1998 and December 2000
- Between late 1993 and September 1998
- Prior to late 1993
|
Further notes are set out below on each policyholder group.
GAR policyholders
Split by age
For GAR policyholders near retirement, the value of their GAR option may well exceed the compensation being offered. The age used to decide which group a particular policyholder falls into will depend on the type of GAR option available. For this group of policyholders, the issues to consider are:
- These policyholders will not gain much from the potentially increased future bonuses arising from stabilising the with profit fund and thus the value of the GAR options may exceed the compensation being offered.
- However, the maximum GAR option value assumes that no tax free cash lump sum is taken and that there is no need to seek more flexible annuity options other than that available under the GAR option. If the maximum tax free cash lump sum were to be taken the value of the GAR option is accordingly reduced and the compensation becomes better value. Similarly, if flexibility is desired in the way the pension is taken, the value of the compensation relative to the loss of the GAR option is again increased.
- GAR policyholders who have already reached an age where they can take their contractual retirement benefits under their policy can take their GAR rights if desired provided they take retirement before the compromise scheme becomes effective. However, within Group Schemes, the scheme rules may not allow this and so this group of policyholders may be better off rejecting the deal.
GAR policyholders who are not near retirement face the risk that the Equitable has not adequately reserved for the cost of GARs and so GAR policyholders retiring in the near future may get more than their fair share of assets.
Split by ability to pay future GAR premiums
Where a GAR policyholder is able to pay future GAR premiums, the compensation may be worth less than the loss of the GAR option while for a GAR policyholder not able to pay future GAR premiums the compensation may be worth more than the loss of the GAR option.
Split by type of GAR
The compensation paid to GAR policyholders will reflect the type of GAR held. Consequently, each group will need to be considered separately when assessing the fairness of the compensation being offered.
Non-GAR policyholders
Split by age
If the compromise is accepted, younger policyholders will have a greater opportunity to benefit from the with profit fund's increased investment freedom. Indeed, for the older policyholders, the 2.5% offer may be worth less than any potential court awards from suing the Equitable for misselling.
Younger policyholders may also have a greater desire to seek certainty regarding their investments as they will be invested in the with profit fund for a longer period.
Split by date of purchase of policy
The ability to sue and win compensation for misselling is expected to vary according to when the policy was purchased. However, the compensation offered does not distinguish between policies in this way.
Group Final Salary and Hybrid Schemes
Hybrid Schemes
For these schemes, members are entitled to final salary benefits or, if better, money purchase benefits. As members benefit from GARs or non-GARs only if the money purchase benefits are paid, the issues are similar to money purchase schemes.
However, if final salary benefits are paid, the employer may benefit from any GAR options as in Final Salary Schemes (see below), and so the trustees may also need to consult the employer.
Final Salary Schemes
The Equitable has not yet explained how any compensation arrangements will apply to Group Final Salary Schemes but we understand that they are currently working on splitting the policy values of these schemes between GAR and non-GAR liabilities.
Here, scheme members do not directly benefit from GAR rights but the employer may do so. However, there may be attaching money purchase benefits such as AVCs where the members would be directly affected by the presence of GARs.
Therefore, for these schemes, the trustees need to consider the same groups as for money purchase schemes and consult with the employer.
Occupational schemes in wind up or where the employer is insolvent
Trustees will need to seek individual legal advice appropriate to the circumstances of these schemes.
What happens if the Compromise Proposal fails?
The Equitable Board has considered alternatives and come to the conclusion that the only viable alternative to the proposed compromise would be to continue as it is, having to take account of the uncertainties arising from the potential future cost of GARs and the threat of litigation by non-GAR policyholders.
In this case, the investment policy would continue to be restricted and future long-term investment growth on policies is likely to be lower than if the compromise proposal were accepted. In order to give itself maximum flexibility, the Equitable is also unlikely to declare any guaranteed bonuses in the future. Further, the Equitable may also decide not to declare any more non-guaranteed final bonuses if the situation worsens, with the effect that the value of GARs would be reduced.
Many policyholders, particularly younger and non-GAR policyholders, may decide to withdraw from the Equitable with profit fund due to the continuing uncertainty. This could further restrict the investment policy, potentially worsening the current situation and force an increase in the penalties applied on non-contractual withdrawals as well as further reducing the non-guaranteed bonuses allocated to policies.
Some non-GAR policyholders may win compensation for misselling through litigation but legal opinion is divided as to whether or not this would form a prior claim on the with profit fund. If not, with profit policyholders would in effect end up paying for most of the compensation themselves. Legal opinion is also divided on the likely level of compensation that might be awarded if the litigation were successful.
Conclusion
For policyholders as a whole, the compromise scheme provides a solution to the majority of the Equitable's difficulties. However, for particular groups of policyholders, it may not be in their interests to accept the compromise proposed, as the compensation provided may be worth less than the reduction in their rights.
1. We recommend that all trustees should read the document prepared by Lovells for the Equitable entitled "Information for trustees of occupational pension schemes".
Barnett Waddingham, October 2001.
Appendix – Background to the Compromise Proposal
Guaranteed Annuity Rates enable policyholders to exchange the value of their pension fund on retirement for an annuity at a pre-agreed rate. As long term interest rates reduced in recent years, GARs provided higher pensions than were available from market annuity rates. Equitable tried to mitigate the cost of the GARs by reducing the final bonuses given to policyholder who exercised their GARs such that the effective pension was closer to that available on market annuity rates.
The House of Lords ruled that Equitable could not give a lower final bonus to policyholders who exercised their GARs. Further, by ruling that the Equitable could not apply a different bonus policy to GAR and non-GAR policyholders, the House of Lords also stopped the Equitable from charging the cost of GARs just to the GAR policyholders. Hence, as the cost of the GARs still have to be funded from the with profit fund, all policyholders invested in the with profit fund now have to contribute to the cost of the GARs.
The final cost of the GARs would only be known when all the GAR policyholders have retired in about 40 years time. This causes considerable uncertainty and means that the Equitable has to reserve for the cost of GARs on a prudent basis. The Equitable had to reduce the policy values for all its with profit policyholders in order to pay for the cost and to set up the necessary reserves. The impact of all this instability has been that the Equitable has been forced to close itself to new business and sell its operations. Many non-GAR policyholders have left the fund in the light of future uncertainty over their fund values. The Equitable's investment policy has also been altered as a result to invest more in low risk assets, reducing the expected long-term returns for all with profit policyholders.
The Equitable has also received legal opinions that non-GAR policyholders may have a case against the Equitable on misselling grounds as they were not informed about the presence of GAR liabilities in the with profit fund. The strength of such a case is likely to depend on the value of GARs and the state of play of the legal action when the policy was taken out. This has caused further uncertainty and could increase the reserves that the Equitable needs to hold in order to meet these claims.
All this is creating additional costs which have to be met out of the with profit fund, reducing policy values for all policyholders, and the resulting uncertainty is creating a potential drag on the Equitable's long-term investment performance. Therefore, in order to stabilise the with profit fund, and perhaps to reduce the volume of withdrawals by non-GAR policyholders, the Equitable needs to find a compromise that will remove the ongoing uncertainty arising from the GARs.
Barnett Waddingham, November 2001.