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The Actuary The magazine of the Institute & Faculty of Actuaries

Governing Equitable Life

The relationship between the board of a life company and its actuaries has come under scrutiny with the publication in March of the Penrose report. In August 2001, Ruth Kelly MP, the financial secretary to the Treasury, asked Lord Penrose to enquire into the circumstances leading to the (then) current situation at Equitable Life.
The report has highlighted the problems caused by the board’s over-reliance on the executive management of the company, and in particular on certain individuals in the actuarial department. It sounds a caution about the reliance of boards on ‘specialists’ in a company, but does not address how, in practical terms, boards can ensure they have sufficient skills to effectively challenge their specialist advisers.
In its 818 pages, the report identifies a number of areas in which the non-executive members of the board of Equitable Life in effect delegated their responsibilities to the executive management, leaving key decisions to be made not by the board but by company executives. The concentration of power in one individual who held the dual roles of appointed actuary and chief executive for a significant period was severely criticised by Lord Penrose.

Who governed Equitable Life?
Formally, the board of directors governed Equitable Life. As a life insurance company, the board might generally have been expected to act on the recommendations and advice of the actuarial department. However, board members should not only have understood the advice they were receiving, but challenged it. They should also have acted as the central decision-making body of the company.
It seems that this did not happen at Equitable Life. Lord Penrose reported that ‘at all material times [Roy Ranson, the company’s actuary and later also its chief executive” had de facto executive control of the relevant areas of the business’ and that board members had little understanding of the issues relating to core parts of the company’s business, and little involvement in the associated decision-making process. Equitable Life’s actuarial department controlled many strategic decisions. However, it was the fact that a discrete part of the management not only made those decisions, but made them without any real scrutiny or challenge from the board, that Lord Penrose saw as being ‘arguably the first and most significant failure’ in relation to the company.
The report describes how decisions regarding the valuation of the liabilities of Equitable Life, product development, and the reserving implications of guarantees were what ultimately set Equitable Life on its financial path. The decisions in these areas were not properly addressed by the board, were outside the scope of the audit committee, and were for the most part determined by the actuarial department. While the actuaries at Equitable Life should have had input and influence in these areas, the board should have ensured that it remained the body that made informed decisions.
Lord Penrose is careful to avoid coming to a final view on the board’s performance. While noting that in certain areas it must depend on actuarial advice, he says that the question of whether this dependency was so extensive as to amount to a total abrogation of the board’s responsibility is not within his remit.

How did this situation come about?
How was it that the actuarial department at Equitable Life came to control so much of the decision-making process, and how did the board allow this situation to continue?
Part of the answer must be the nature of Equitable Life’s business. In regulatory terms, and in practice, the life insurance industry’s dependence on the advice and analysis of the actuarial profession, and the specialised work that actuaries undertake, mean that it is not surprising that actuaries are at the forefront of decisions affecting the business.
This need not have meant that the board was entirely reliant on the company’s actuaries, however. Lord Penrose notes that the board of a life office can be as competent as any other in reaching decisions based on intelligible advice. In fact, the more common complaint about the relationship between the actuaries of a life company and its board is that the actuaries have insufficient input into board decisions, not that the actuaries have too much control.
At Equitable Life, the problem appears to have been a combination of the corporate culture and the personalities involved. One former board member described the governance structure of the society until the late 1980s as being characterised by ‘gentlemen and players’. The board members consisted mainly of city professionals who had little knowledge of the workings of a life office, and the management, which was geographically removed from the board at the insurer’s office in Aylesbury, and with whom the board members had ‘little cultural connection’.
The dominance of Equitable Life’s actuarial department was seemingly a result of the specialised nature of life insurance and the personalities of the individuals within it. Lord Penrose described Roy Ranson, the society’s appointed actuary from 1982 to 1997 and its chief executive from 1991, as ‘autocratic’. He went on to say that Mr Ranson conflated his external duties in relation to certain matters to an exclusive ownership of those matters, regardless of the directors’ responsibilities.
The problems arising from the actuarial department were compounded by the make-up of the board. Lord Penrose found that, for the most part, board members did not understand how the application of actuarial concepts could affect the business, leaving them to rely almost exclusively on the actuarial department to determine important matters. The actuaries were left to identify the problems and risks of the business and, largely, to decide on the strategy for dealing with them. Lord Penrose concluded that the board had insufficient knowledge and skills to provide an effective challenge to the executive in critical areas. Questions from board members about certain aspects of the business did not result in proper explanations from the appointed actuary.
By way of example, the lack of a comprehensive audit committee was attributed to ‘the intransigent resistance of the executive’ to attempts by board members to encroach on their exclusive areas of interest. In the words of Lord Penrose ‘the [audit” committee was totally dependent on the actuaries for advice on what was material as well as advice on the solution of any problems that arose’.
Lord Penrose highlights the distinction between what is the ‘technical actuarial area’, which is the proper preserve of the actuary, and the exercise of discretionary powers based on technical material. It is this latter area that should be within the capability of board members. He said: ‘it appears to have been a particular conceit of the actuaries that the exercise of discretion was as much their exclusive preserve as the arithmetic that instructed it. In general it is the defining characteristic of an expert that he or she can communicate the results of his or her expertise with sufficient clarity to enable any reasonably intelligent person vested with a decision-making power effectively to exercise that power.’
Lord Penrose observed that the rationale for actuarial involvement in product design had been explained to the profession at the ‘With-profits, without mystery’ presentation given by Roy Ranson to the Institute of Actuaries in 1989. However, he said that, in practice, at Equitable the actuarial department had almost total control over product design.

Could this happen elsewhere?
Lord Penrose was careful to confine his comments to the peculiarities of Equitable Life’s situation. The problems with controlling key areas of decision-making and risk management at Equitable Life may have been partly attributable to certain characteristics of the company. Its mutual status meant that it had no shareholders to answer to, and there was limited scope for policyholder action. While the Insurance Companies Act 1982 contained general requirements that a company be soundly and prudently managed, Equitable Life was not subject to the more rigorous standards of governance expected of a listed company.
Arguably, the presence of shareholders and the adherence to a code of good practice such as the 2003 Combined Code would have gone some way to preventing the types of problem found at Equitable Life. It remains the case, however, that even with the structures of good governance in place, the success of a company ultimately depends on the competence of those in charge. Unless the board of a company has the skills and information necessary to make informed decisions, there will always be scope for things to go wrong.

The future
The comments by Lord Penrose do not sit comfortably with the move by many boards to engage the services of independent directors. The implication from the report is that a board member of a life office must have a more than cursory knowledge of actuarial concepts to be a real challenge to advice from professional actuaries employed by the company. Yet in practice, achieving this is not easy. Perhaps more than anything, the Penrose report identifies the importance of having board members not just with the right technical skills to do the job at hand, but the right personalities to identify and stand up to any dominating influence in the company.
It is easy to judge the actions of those involved against contemporary standards of best practice, rather than in the environment in which they were operating. The directors of Equitable Life would no doubt assert that they strove to do their best for policyholders. With hindsight it is clear that they lacked the skills or information to do so, and could not provide an effective challenge to the dominance of certain individuals at the company. Whether those at Equitable Life now have to pay for that is a matter for the courts to decide. The case of Equitable Life against 15 of its former directors is due to be heard by the High Court in 2005, and a Serious Fraud Office investigation is under way.
The Treasury has responded to the criticisms of the actuarial profession in the Penrose report by announcing a review of the profession by Sir Desmond Morris. The aim of the review is to deliver a more ‘open, challenging, and accountable professional culture’. However, whether the existence of such a culture would have protected the policyholders of Equitable Life seems doubtful.