The Downfall of Equitable Life in the United Kingdom: The Mismatch of Strategy and Risk Management

By O'Brien, Chris | Risk Management and Insurance Review, Fall 2006 | Go to article overview

The Downfall of Equitable Life in the United Kingdom: The Mismatch of Strategy and Risk Management


O'Brien, Chris, Risk Management and Insurance Review


ABSTRACT

This article considers the downfall of Equitable Life Assurance Society in the United Kingdom, founded in 1762 and the first life insurer to operate on an actuarial basis. Its failure to manage the risks implicit in guaranteed annuity options led to a financial crisis, and it ceased to write new business in 2000. We analyze the Society's risk management practices, and find that they were inconsistent with its strategy, which highlighted customer focus. It lacked the discipline to balance short-term advantage to customers with the long-term needs of the organization. We also highlight the use of participating policies, and the way in which they were used to transfer risk to policyholders. Finally, we draw some lessons for other life insurers from Equitable Life's experience.

INTRODUCTION

The year 1762 saw the foundation of the Equitable Life Assurance Society in the United Kingdom, the first insurer in the world to establish life insurance on an actuarial basis (Ogborn, 1962). Unlike many life insurers in the early days, it survived and prospered; in 1997, it was the fourth largest life insurer in the United Kingdom.1 Then, following a court case it lost in 2000, severe financial problems led to the Society putting itself up for sale and, failing to find anyone willing to buy it, it closed its doors to further new business and outsourced its administration to a bank. A new board was elected in 2001, and the firm is now a shadow of its former self, its assets of £15,637 million at the end of 2004 being only 46 percent of their end-2000 value.

The Society's fragile financial position has affected its policyholders, some of whom have seen the pensions they receive from the Society cut by 30 percent. Equitable Life is a mutual, and there are no shareholders to help. The high profile problems led to a number of reports: the Treasury Select Committee (2001), the Corley Committee of the actuarial profession (2001), the Baird report (2001), the Parliamentary Ombudsman (2003), and Lord Penrose (2004), whose report was commissioned by the U.K. government. There is outstanding disciplinary action against some of the accountants and actuaries involved. Also awaited is a further report from the Parliamentary Ombudsman, who has been investigating whether the government's regulation of the Society was inadequate; if this were found to be so, it would lead to policyholders claiming compensation from the government.

In this article, we focus on the strategy of what appeared to have been a successful life insurer. What risks arose as a result of that strategy and how were they managed? We also consider what part was played in the downfall of the Society by its being a mutual organization. The Society emphasized that mutuality enabled it to focus on its customers. This is laudable; but there are conflicts between looking after the short-term interests of customers and the longer-term interests needed to ensure that the entity itself survives and is able to meet policyholders' future needs. Hence, did this focus turn out to be a liability rather than an asset?

The article begins by setting out the events leading to the downfall of Equitable Life, including an explanation of the policies it issued that contained guaranteed annuity options (GAOs), which led to the Society's financial problems and to the court case it lost. It then goes on to assess the Society's strategy and risk management practices, and its use of participating policies. Finally, we draw some lessons for other life insurers from Equitable Life's experience.

EVENTS LEADING TO THE DOWNFALL OF THE SOCIETY

Pension Policies with GAOs

The downfall of the Society arose from certain pension policies that it issued between 1957 and 1988. Like most of the Society's policies, these were participating policies (known as with-profit policies in the United Kingdom), so that some of the Society's surplus was allocated as additional benefits in the form of dividends (bonuses in U. …

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