Contact: David Wilson, ext 7407

1. Introduction

1.1 At 31 March 2004, the value of the Hampshire Fund's Additional Voluntary Contributions (AVC) Plan with Equitable Life was £5.894m. There were 1,027 active members and 332 members with preserved benefits.

1.2 The Panel last received an update on developments at Equitable Life in May 2003. On 8 March 2004, Lord Penrose's report commissioned by the Treasury on the events at Equitable Life was published.

1.3 This report summarises the conclusions of the Penrose Inquiry, and updates the Panel on other significant developments at Equitable Life over the past year.

2. The Penrose Report

2.1 Lord Penrose's terms of reference were:

To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society, taking account of relevant life market background; to identify lessons to be learnt for the conduct, administration and regulation of life assurance business; and to give a report thereon to Treasury ministers.

2.2 His key conclusions were:

· Equitable Life was largely responsible for its own problems.

· Any failures of the regulatory system were secondary - there may have been flaws in the regulatory framework but there was no negligence by the regulators or the Government.

2.3 Penrose was particularly critical of Equitable Life's executive management and directors. Senior executives were dominant, and the Board was weak. Too much reliance was placed on Roy Ranson, who was Chief Executive from 1992 and the Society's actuary from 1982 to 1997. Equitable Life's Board was given insufficient information to be able to assess the full extent of the risks and liabilities it faced.

2.4 Penrose identified the major initial problem as "over-bonusing" - promising more to policyholders than their share of the Society's assets in an attempt to attract new customers. Inadequate reserves were held to cover policyholders' reasonable expectations of future discretionary bonus payments.

2.5 The Society's questionable solvency position was bolstered by "dubious" actuarial techniques and other financial adjustments - in effect making over-optimistic assumptions on prospective returns.

2.6 Penrose was also critical of the regulatory system. The Department of Trade and Industry (DTI) was over-reliant on the Government Actuary's Department (GAD), which in turn placed too much trust in Mr Ranson, the Society's own actuary. However, Penrose made no allegation of negligence, concluding that these failures were a minor factor in causing losses to policyholders.

2.7 Following the publication of Penrose's report, Ruth Kelly, the Financial Secretary to the Treasury, made a statement to Parliament in response. The main points were as follows:

· The Government sees no need to offer compensation to policyholders in view of the minor impact of any regulatory failures. However, a Financial Service Compensation Scheme has now been established which should provide better protection in the future.

· The current Equitable Life Board will work with the Financial Services Authority (FSA) to assess whether the Society needs to change any current practices.

· The Government will assist the Financial Ombudsman to deal with complaints if necessary.

· New legislation will be put in place to protect policyholders from any unlimited liability if Equitable Life becomes unable to meet its obligations.

· A review will take place of corporate governance arrangements at mutual life offices to make sure they are fully accountable to their members.

· A review of the actuarial profession will be undertaken and the Accounting Standards Board will examine current practice for accounting for with-profits business.

· The Serious Fraud Office and the Department of Trade and Industry will decide whether any prosecutions should follow.

2.8 Shortly after the publication of the Penrose Report, the Board of Equitable Life issued a statement emphasising that the Society remains solvent. It called on the Parliamentary Ombudsman to re-open her inquiry into the affair. She has the statutory power to recommend compensation. Equitable Life continues to pursue its own claims against Ernst & Young and its former directors.

3. Other developments

3.1 Following advice from Hewitt Bacon & Woodrow in December 2002, all payments by Hampshire Fund members to Equitable Life's with-profits and unit-linked funds had ceased by July 2003. Since then, all premiums paid to the Society have been paid to its building society fund, other than AVCs paid for life cover.

3.2 Equitable Life published its Annual Report and Accounts for the year ended 31 December 2003 in April 2004. The key points are as follows:

· Pension policy values increased by a non-guaranteed bonus of 2% for 2003.

· Policyholders who have a "Guaranteed Interest Rate" (GIR), including Hampshire, will receive a 3.5% guaranteed bonus on the guaranteed benefits for 2003.

· The interim non-guaranteed bonus rate from 1 January 2004 will be 2% a year.

· The financial adjustment on transfer out of the with-profits fund before retirement remains at 11.1% of policy values.

3.3 Hewitt Bacon & Woodrow have attempted to obtain a guarantee from Halifax Life, who reinsured Equitable Life's unit-linked funds, that they would underwrite their value if the with-profits fund became insolvent. Halifax have refused to give such a guarantee. The FSA has also failed to provide any reassurance that the unit-linked funds are secure.

3.4 In the light of this, Hewitt Bacon & Woodrow have reaffirmed the advice they gave last year as set out in paragraph 3.1, on the grounds that Equitable Life's unit-linked funds are still exposed to the event of the insolvency of its with-profits fund.

4. The future

4.1 An Equitable Life Members' Action Group (EMAG) has been formed and has called on the Society to set up a "fighting fund" of £2m to help them pursue claims against the regulators. The Board of Equitable Life have been advised by their lawyers, Herbert Smith, that there is no realistic valid claim against the regulators, and that any claim from policyholders would be complex, lengthy and costly, with an uncertain result. Nonetheless, the Board have asked policyholders to vote on the proposal. The Hampshire Fund did not support the proposal. Forcing Equitable Life to spend a further £2m to help EMAG fight a legal case of dubious merit would only make matters worse.

4.2 It remains to be seen whether there is any scope for claims by the Hampshire Fund as policyholder against Equitable Life. In particular, the outcome of the investigations by the Serious Fraud Office and Department of Trade and Industry will be relevant here. If they conclude that prosecutions of any former directors of Equitable Life are appropriate, then it is suggested that the Hampshire Fund should seek legal advice on the prospects for a direct claim against the Society.

5. Communications with Fund members paying AVCs

5.1 Fund members paying AVCs were last updated on developments at Equitable Life in June 2003. Hewitt Bacon & Woodrow are in the process of preparing a draft member update on the position for the County Treasurer. This will form the basis of further guidance to be provided to members shortly.

Recommendations

1 That the results of the continuing investigations by the Serious Fraud Office and Department of Trade and Industry be awaited before any decision on whether to take direct legal action against Equitable Life.

2 That the remainder of this report be noted.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

Published works.

Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

None.