Equitable Life Assurance Society v Hyman

Facts

Equitable Life (est 1762) issued ‘with profits’ life assurance policies, which are a way of saving for retirement. If policy holders took benefits as a taxable annuity (i.e. with a payment annually), then they got tax exemptions on the premiums (and bonuses at the end of the year). They could choose to have their annuity at a "guaranteed annual rate" ("GAR") that would be fixed, or a "current annuity rate" ("CAR") that would fluctuate according to the market. The choice did not affect the premium. From 1993 the current annuity fell below the guaranteed one. Article 65 of the Equitable Life's Articles of Association said the directors could, at their discretion, vary bonuses and the company had relied on this since its foundation.

The directors of Equitable Life decided they would reduce the level of terminal bonuses for GAR policyholders, from the higher figure shown on the GAR policyholders' annual bonus notices, to a lower figure (if necessary to zero) so as to equalise the benefits so far as possible i.e. the policy proceeds with the higher terminal bonus times the CAR rate equalled the policy proceeds with lower terminal bonus times the GAR rate (the Differential Terminal Bonus Policy - DTBP). The Equitable's Annual Regulatory Returns, submitted each year to the regulatory authorities (the Department of Trade and Industry - DTI) had set out this practice since the 1993 (when the current annuity rate first fell below the guaranteed annuity rate). The Equitable's Annual Regulatory Returns had been scrutinized each year by the regulatory authorities and nothing adverse had been said by the regulatory authorities about the Equitable's Differential Terminal Bonus Policy (which had been introduced in 1993).

In 1998, because the GAR policyholders received a lower terminal bonus than they expected (they expected the higher terminal bonus and, in addition, the GAR rate) certain GAR policyholders complained. Mr Hyman was a representative policyholder. At no point, however, were the GAR policyholders ever paid less per annum (and nor was there ever any intention by the directors of Equitable Life to pay them less) than their guaranteed fund (i.e. excluding the non-contractual terminal bonus) times guaranteed annuity rate.

Judgment

The House of Lords unanimously agreed that there was an implied term in the Articles of Association such that the directors of Equitable Life could not exercise their discretion in the way they had because it defeated the reasonable expectations of the GAR policyholders as exemplified by Equitable having quoted the higher terminal bonus on each GAR policyholders' annual bonus notice (no other life office had quoted terminal bonus in its annual bonus notices to policyholders as terminal bonus can only be determined at policy maturity because of the volatility of financial markets). Although there was no express term in Equitable Life's constitution that constrained the discretion of the directors, it was necessary to imply such a term to uphold the policyholders' reasonable expectations. Lord Steyn gave the leading judgment.

Lord Cooke added that the discretion could be struck down, no matter how broadly it was drafted, in the same way as happens in administrative law (Padfield v Minister of Agriculture) and private law (Howard Smith Ltd v Ampol Ltd). The result of the discretion would not be consistent with the purpose of the policy.

Lords Slynn, Hoffmann and Hobhouse concurred with both. £1.5b of annuities needed to be paid in full.

Significance

Equitable Life collapsed after the case, because it was unable to meet its additional liability to GAR policyholders. It triggered an explosion of litigation and bitter recrimination among policyholders, directors, auditors, regulators and the government.

It must be said that this judgment is still somewhat controversial in legal circles and has been questioned:-

firstly, as it did not achieve fairness. This arose because there were both pension policies containing "guaranteed annuity rates" (GARs) and pension policies not containing "guaranteed annuity rates" (non-GARs). It seems reasonable to assume that any judgement would have applied equally well to the GARs and non-GARs i.e. mutatis mutandis, the reasonable expectations of the non-GARs should not be infringed in order to pay for the (now very expensive) "guaranteed annuity rates" of the GARs. In practice, the judgement resulted in a favouring of the GARs at the expense of the non-GARs. Equitable Life did not have enough money to meet, simultaneously, the reasonable expectations of the GARs and the reasonable expectations of the non-GARs.

secondly, as Lord Steyn (who gave the leading judgement in the House of Lords) stated "..the directors of the Society resolved upon a differential policy which was designed to deprive the relevant guarantees of any substantial value". However, one substantial value of the guaranteed annuity rates was to create a floor pension (the guaranteed fund multiplied by the guaranteed annuity rate) for the GARs which those policies without GARs (non-GARs) did not have. In the case, for example, of market annuity rates at age 65 being 7.1% p.a. - not untypical of market annuity rates the time of the Hyman judgement (as opposed to a guaranteed annuity rate at 65 of 11.72% p.a. as stated in the GAR policy document) - a typical guaranteed fund might have been £80,000 and a typical terminal bonus might have been £5,000 (thus total pension fund of £85,000=80,000+5,000).

Thus the floor pension would therefore have been £9,376 p.a. (80,000 x 0.1172) whereas the corresponding non-GAR pension would have been only £6,035 p.a. (85,000 x .071). Thus, as 9,376/6,035=1.55, the advantage of having a GAR would have been a 55% increase in the pension payable (as opposed to the corresponding non-GAR policy) and therefore a substantial increase. Thus, in this example, realistic at the time of the Hyman judgement, it was not true that the differential terminal bonus policy (DTBP) had deprived the GAR "....of substantial value" .

thirdly, Sir John Chadwick (a retired Court of Appeal Judge) stated in 2010 "The view is widely held among lawyers experienced in this field that the House of Lords' decision in Hyman was unexpected and did not accord with the principles that should have been applicable in relation to a mutual Society".

Thus there is evidence that the House of Lords judges in the Hyman case had not been properly informed. If they had been, they might have concluded (as did Lord Scott in the High Court) that the lower terminal bonus, combined with the GAR rate, was within the directors' discretion, provided that the lower terminal bonus rate was never negative (i.e. the minimum lower terminal bonus rate was zero) thus ensuring that the GARs had the substantial benefit of a floor pension, a benefit which the non-GARs did not have.

The real problem with Equitable Life was that they did not have enough money to meet both (1) the floor pensions for the GARs and (2) the normal pension for the non-GARs.

The lesson that can be drawn is that if you have un-hedgeable guarantees in a with-profits fund any life company (because the financial market is incomplete) must have built up an Estate (spare money set aside for a rainy day) as the 'rainy day' may arrive (as it did with the collapse of interest rates and annuity rates). But, as Lord Penrose discovered, at the time of the Hyman judgment, Equitable Life had no Estate - indeed Equitable's Estate was negative i.e. Equitable's liabilities, even with the differential terminal bonus policy (DTBP) being a lawful use of director's discretion, exceeded its assets.