The Future Direction of the Society

The following letter has been sent to the Society's policyholders:

Dear Policyholder,

Our vitally important Compromise Scheme is in place and the uplifts have been made. In June you will receive a statement showing the impacts both of the uplifts and of the 2001 bonus announcement. We set out below important announcements on bonuses.

Of course other challenges persist.

Financial management

There has been a significant reduction since last autumn in the outflow of funds through early surrenders and policy maturities. In October 2001, that month's notifications from those seeking to claim maturity or early surrender had a total value of £776.5m, but by March 2002 the level had fallen to £237.1m. This continuing trend creates a welcome atmosphere of greater stability.

We attach an important paper setting out the Society's future strategy. As it makes clear, we must adopt a cautious bonus and investment policy. Equitable policies have unique flexibility as to how and when policyholders can take benefits, and the majority by value include a guaranteed minimum level of growth on their guaranteed value. These factors, coupled with the Society's historic low level of reserves, mean that as we stated in the Compromise Scheme we shall have a lower proportion of funds invested in property and shares (equities) compared to other with-profits providers, at least in the near future.

The negative stock market returns over the last two years have reduced other major pension providers' reserves and forced significant bonus reductions.While our lower stock market exposure throughout 2001 is therefore relatively good news, in the longer term we will need to explore ways to increase our equity holdings in order to boost investment returns.

'Policy values'

The apparent clarity of the term 'policy values' creates a false sense of security. It is not an absolute statement of the policy's worth like a bank or building society statement. 'Policy value' is a broad, indicative statement, of necessity subject to adjustment on a policy's early surrender or on maturity according to fund performance as is the case in other with-profits funds. This year's annual policy statements will clarify this by showing policy values in 'guaranteed' and 'indicative' form.

Bonus strategy

As with any with-profits fund, it is essential that policyholders leaving the Society do so with no more than their fair share of the assets of the fund and that the interests of continuing policyholders are protected. This principle defines the levels of financial adjustment applied to early surrenders. It also defines our policy on annual bonus and on the final bonus paid on maturity.

2001 and 2002 bonus declarations

The negative investment returns of 2001 and our requirement to hold prudent reserves mean we have set the non-guaranteed final bonus for all UK with-profits pensions policies at an accrual rate of 4% per annum for the last six months of 2001, rather than the annual rate of 6% we had hoped to give, i.e. 2% rather than 3% will be added to indicative policy values. There is no guaranteed bonus for 2001 (except of course, for those policies containing the 3.5% Guaranteed Interest Rate, where the annual 3.5% will be added to guaranteed policy values).

The effect of this bonus announcement and the equivalent announcements for other policies will be set out in your policy statements in June. The implications for with-profits annuitants will be covered in a separate letter to be sent shortly.

Investment returns have remained weak this year. Consequently in the interest of prudence the Board is not announcing an interim bonus for 2002. Instead we will wait to see how the fund performs during the year before announcing an appropriate bonus.

Fair asset shares on policy surrender or maturity

From now on, in line with other with-profits funds, policyholders wishing to surrender their policies early as well as those proposing to take benefits on maturity will be quoted a 'surrender value' or 'maturity value' respectively.

These values will be set in accordance with the principle set out above of ensuring that those choosing to leave the fund take no more than their fair share, and adjusted in the light of the circumstances of the fund.

The surrender value will be subject to the financial adjustment set at 14% with effect from 15 April both for individual and group schemes (although the latter will still have a group scheme calculation that could produce a higher percentage adjustment).

The maturity value includes final bonus and reflects that policy's fair share of the fund, which will not necessarily be the same as the indicative policy value. With effect from 15 April the maturity value for a UK pension policyholder choosing to take maturity now will be the indicative policy value calculated allowing for the new bonus announcements, adjusted down by 4%. The maturity value of a policy will not be lower than the guaranteed value of that policy.

As with other with-profits funds the surrender and maturity values will be kept under constant review and the adjustments will change to reflect investment conditions and the strength of the fund.

Continuing policyholders should be reassured that these changes announced today are designed to protect them from the damaging effect of excessive value leaving the fund.

Resolving the issues of the past

Herbert Smith

As you know, on our instructions our solicitors, Herbert Smith, wrote to former Directors, auditors and advisers seeking explanations for their actions. We are now receiving responses from the former Directors to the important questions contained in the letters from Herbert Smith. One former Director, Mr Jonathan Dawson, who was appointed in January 2000, replied before the others. We are advised that we have no case against him. We are currently examining the other replies as we receive them and expect to make an announcement shortly on how we will proceed.

The Society's former auditors Ernst & Young have not provided a substantive reply. We have therefore started legal proceedings against them.

We have reviewed replies received from the Society's former legal advisors. At this stage we are advised not to proceed against them.

As for the regulator, it is important that we wait for the outcome of Lord Penrose's inquiry. By doing this we avoid wasting policyholders' money on our own inquiries when Lord Penrose has access to many documents unavailable to us and will cover the ground we want to examine anyway. We had originally understood from the Government that Lord Penrose would publish his Report later this summer. However recently we have been concerned to learn from a Government statement that this may be delayed until next year. We have therefore contacted the Government and Lord Penrose to see whether we can assist further to make more rapid progress.

Policyholders will certainly understand that, given the complexity of the issues, it will be some considerable time before we see any tangible results from either the legal proceedings or the Penrose Inquiry.

Claims from former non-GAR policyholders

We need to ensure that valid claims are dealt with fairly and efficiently. Following discussions with the Financial Services Authority (FSA), our regulator since December 2001, and between the FSA and the Financial Ombudsman Service, we are working to identify potentially valid GAR-related claims from former non-GAR policyholders whose policies matured or were surrendered before the Compromise Scheme became effective.

Our first step is an independent review by the actuaries B&W Deloitte that compares, amongst other things, the performance of Equitable's products with the average performance of other comparable products, taking into account the relevant product characteristics and pricing (the terms of reference of the B&W Deloitte review are available on the Society's website at www.equitable.co.uk). The review will identify whenever particular categories of former policyholders may have suffered loss resulting from the financial effect of the GAR issue rather than investment performance.

In order for any compensation to be payable it will be necessary for former policyholders to show both that they have suffered loss as a direct result of the GAR issue and demonstrate that their policy was missold to them. We anticipate that such claims should not be extensive in scale.

The balance of the provision set aside to meet any GAR-related claims set out in the Interim Accounts will be used to meet costs of compensation identified by this review.

Our approach seeks to ensure fairness to existing policyholders who will effectively be funding any compensation, and proper compensation for former policyholders with valid claims. Any GAR-related claims made outside of this process through the Courts will be resisted vigorously.

Moving Forward

Removing anomalies and increasing fairness

The Society was criticised for removing concessions related to retirement annuities after the Compromise Scheme and for allegedly giving 'special deals' for certain group scheme early surrenders. In respect of retirement annuities the ending of GAR rights and allocation of compensatory uplifts under the Compromise Scheme means it would be unfair to continue concessions relating to GAR rights at other policyholders' expense.

There have never been 'special deals' for group scheme surrenders. However we have closed a loophole that enabled group scheme individual members to surrender early with a potentially lower financial adjustment than that applied to individual policyholders.

Further work is needed to make early surrender values reflect more accurately the circumstances of individual policies. Currently the administrative systems allow this for group schemes but not for individuals. We need to change this and are reviewing both the data used to calculate group scheme bulk surrenders and the systems work necessary to provide fairer individual surrender values. Both will take time.

Strengthening the Society's Corporate Governance

As we move into the next stage of the Society's activities, we add two non-executive Directors and one executive Director to the Board from 1 May 2002. Ron Bullen, an engineer and former general manager who has been Chairman of the largest policyholder group EPHAG, and Fred Shedden, a Scottish lawyer with wide business experience including several years former service on the Board of Standard Life, join as non-executive Directors. Charles Bellringer, the Society's Chief Finance and Investment Officer, an experienced chartered accountant who contributed greatly to the work on the Compromise Scheme, joins as an executive Director. The non-executive appointments follow independent assessment, interview and Board approval. New Directors require FSA approval and will be put forward for re-election at this year's Annual General Meeting (AGM).

Over the next year we will also undertake a constitutional review of the Society's Articles of Association to bring them up to date. A sub-committee of the Board has been established to carry out this review. We shall welcome contributions from policyholders. Any appropriate amendments will be put forward at the time of next year's AGM.

The Annual General Meeting

This year's AGM will take place on Monday 27 May at the Queen Elizabeth II Conference Centre, London, SW1 at 11.00am. We will circulate shortly to members the Annual Report and Accounts and other papers including voting documents for any resolutions and for elections to the Board. The Society's Articles require three members of the Board to retire by rotation at each AGM, but they can seek re-election. The three Directors retiring by rotation at this year's AGM are Michael Pickard, Peter Smith and Vanni Treves and they will all be seeking re-election.

Your Board and management team have worked very hard indeed to tackle the daunting challenges we faced when we took charge of the Society just one year ago. In that time much has been achieved but more remains to be done. We are grateful to many policyholders for their encouragement and their support for the actions we need to take to help the Society along the path to greater stability.

Yours sincerely

Vanni Treves
Chairman

Charles Thomson
Chief Executive

-- END -

Notes to Editors

The following document accompanied the letter:

Equitable Life 2002 and beyond

Following the successful Compromise Scheme, there are three important questions to answer for policyholders. What is the outlook now for your Society? What are our unresolved issues and how shall we deal with them? What can we do for policyholders to meet their reasonable expectations for the future?

I took over as Chief Executive only thirteen months ago. Although we have achieved a substantial amount, the investment climate has been very hostile, aggravating the problems we inherited and creating some new ones.

The Present Outlook

The Society is solvent but not financially strong

The fundamental uncertainties of GARs have been removed and the Compromise Scheme also improved the financial position in the Annual Report and Accounts by £1bn. These are real improvements compared to our pre-compromise position and they help underpin our solvency.

However, the investment climate and particularly the decline in the UK stock market have weakened the Society. Other with-profits funds have suffered similarly, reducing their final and annual bonus rates. Our year-end reviews also show that we need to increase provisions against potential claims beyond those set out in the Interim Accounts of 30 June 2001, which were considered appropriate at the time. The details will be set out in the Annual Report and Accounts. While of course there remains some uncertainty around these new estimates they are considered to be appropriate provisions against the potential claims. We shall do everything we can to control these costs which come directly from members' funds.

The majority by value of our policies contain a Guaranteed Investment Return (GIR) feature which adds 3.5% to guaranteed policy values each year. In addition we must reduce the impact on the fund from any further falls in stock markets. The effect of both of these is that, at least in the near future, we must continue to have a low proportion of the fund invested in property and shares (equity) and a high proportion in fixed interest investments such as government stock and corporate bonds. Doing this will enable us to honour these guarantees but it will also mean a relatively restricted bonus policy, with investment growth flowing through into final bonus rather than guaranteed bonus (other than for policies with the 3.5% GIR feature which will continue to get the 3.5% per annum increase in guaranteed policy value).

Dealing effectively with unresolved issues

Bonus Methodology

We have inherited a unique and unsatisfactory bonus methodology. The apparent clarity of 'policy values' creates a false sense of certainty. From the reaction to last July's announcement it is clear that Equitable Life's apparent transparency has, in fact, created considerable confusion. In a with-profits fund, 'policy value' only has real meaning when the contract reaches maturity or at an event during the life-time of the contract when benefits can be taken. At any other time 'policy values' can only give an indication of the approximate value of the underlying assets at a given moment. But this value cannot reflect the value of the assets at a subsequent date, the unrecovered costs or the impact on the fund of the behaviour of other policyholders.

Certainly 'policy values' take no account of the active financial management which our with-profits fund needs in its current position because so many policyholders have great flexibility as to when they can take retirement benefits. That flexibility allows policyholders to take their benefits when the assets of the fund are depressed which is obviously to the disadvantage of continuing policyholders.

From our separate announcement on bonus policy set out in the letter that accompanies this paper, you will see that we have taken the first essential steps to change the bonus methodology to resolve this sort of problem. The final bonus will change whenever necessary to reflect the impact of the various factors affecting the fund including, most importantly, investment performance. This approach brings us much more into line with normal practice of other with-profits funds.

Surrender value methodology

We have also inherited a unique and unsatisfactory surrender value methodology. Currently the 'financial adjustment' applied to individual policies surrendered before maturity is not as refined as we would like. In addition, the system for group rather than individual policies gave apparently anomalous results. In the case of group schemes the recording systems set up by Equitable Life were more flexible than those applied to individual policies. This reflected the smaller number of group schemes which by their nature were likely to see significantly higher levels of contractual and non contractual transactions.

Again we have taken the essential first steps to eliminate these problems. Group and individual surrenders have been brought more into line with generally the same level of financial adjustment. We have commissioned an external survey of the group approach to see if further changes are necessary, and intend to review the individual system for surrender values later this year. We will then have a clear basis for removing any anomalies that remain.

The outsourced administrative service arrangements with the Halifax

We need for our members and policyholders a reliable, supportive, high-quality, low-cost service so that we can return to being a low-cost, high-quality Society. This is the intent of the original deal with the Halifax (now HBoS) which the new Board inherited. While we are grateful for the hard work of many individual staff members we are talking to HBoS to improve the present outsourcing arrangements by setting and agreeing specific performance targets.

We need to resolve any outstanding claims and the uncertainty they bring

Our aim is to ensure that fair, well-founded claims are paid with a minimum of fuss and expense. We intend to resist opportunistic claims and those based on hindsight. Clearly those who walk away from an investment contract because the market has fallen should not be paid compensation from members' funds for that market fall and we shall resist those who take this approach.

Meeting policyholders' reasonable expectations

We need a period of consolidation

Our strategy is to keep moving the with-profits fund closer towards being a conventional with-profits fund. The current investment climate makes this more difficult. While the current weak performance of the equity markets means that other with-profits funds are also showing negative returns, there is some unavoidable risk of our fund getting locked into having a very low equity content if markets fall substantially further due to our need to meet contractual guaranteed growth commitments and the flexibility of when policyholders may take benefits.

We need to introduce a fairer bonus and surrender value system

We have taken the first steps as explained above and will continue to eliminate anomalies and improve fairness as quickly as possible.

Examining what can be done for long-term policyholder

With all of the legal constraints that now surround how the fund is managed, our room for manoeuvre is limited in the immediate future. The low equity content of the fund may not be a disadvantage in the short term - it has not been in 2000 and 2001 – but we need to find a way to restore a higher equity content over the next few years.

If this cannot be done by investment growth (e.g. because the fund has too little invested in equities) we shall need to investigate how to achieve the result by another route. One possibility worthy of examination could be to allow policyholders to opt to swap their existing contract for a new form of contract with higher equity backing. This, of course, would have to be done in a way that did not disadvantage the continuing policyholders who had decided not to change. We shall work on this.

Helping with-profits annuitants

It has not proved possible to produce any options that are likely to be particularly attractive to large numbers of with-profits annuitants without disadvantaging other policyholders. However, given these constraints, we are writing to with-profits annuitants to gauge their interest in the limited options that are available to rebase their annuity, so providing a lower income for a number of years but higher income in the longer run.

Conclusion

We inherited a company that had been run in a unique way. It had a unique advantage in its low costs but it had many other features that make its financial management challenging.

It is very easy to be wise with hindsight, but the aggregation of risks within the Society is something that should have been of serious concern. The extent and depth of these risks has been a great challenge to the new Board. We wish that these risks had been recognised and remedied prior to our appointment. That said, in the interests of continuing policyholders we shall take action both to resolve these risks and, where appropriate, to seek redress. The process of dealing with the past is likely to last for years. However, we will move with all possible speed.

The significant achievement of the Compromise Scheme, changed bonus methodology, greater sophistication in our financial management, work on reducing costs and improving service levels and the approach taken to managing outstanding claims all mark important progress towards our goal of securing the future of the with-profits fund and managing it for the benefit of all of our policyholders.