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FINANCIAL SERVICES BOARD
- STRICTLY CONFIDENTIAL -
FEDSURE LIFE ASSURANCE LTD, now known as
INVESTEC EMPLOYEE BENEFITS LTD Inspection Report submitted to the Registrar of Long-Term Insurance in terms of the Inspection of Financial Institutions Act, No. 80 of 1998 by George Marx Flip Stander
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL -
Contents A. INTRODUCTION..............................................................................................................1
B. THE SCOPE OF THE INSPECTION................................................................................2
C OUR APPROACH TO THE INSPECTION.......................................................................5
D THE APPROACH FOLLOWED IN THIS REPORT .........................................................8
E BACKGROUND: FEDSURE LIFE .................................................................................10 Historic overview ............................................................................................................10 Companies, subsidiaries and divisions in the Fedsure Group........................................11 Executives and members of the boards of directors ......................................................13 Products .........................................................................................................................17 The Net Main Life Fund..................................................................................................18
F THE FINANCIAL PERFORMANCE OF FEDSURE LIFE SINCE 1997.........................19 Fedsure Life’s performance up to 2000..........................................................................20 The performance of Norwich Life ...................................................................................23 Fedsure Life’s performance since 2000 .........................................................................25 Structure and performance of the Net Main Life Fund ...................................................27
G STRATEGIC INVESTMENTS AND ACQUISITIONS ....................................................35 Saambou Holdings Ltd ...................................................................................................36 Inhold & Investec............................................................................................................38 FBC Fidelity Bank Ltd.....................................................................................................39 Norwich Ltd.....................................................................................................................41
Build-up to the takeover..............................................................................................41 Potential benefits ........................................................................................................41 The takeover transactions ..........................................................................................42 The price and funding of the purchase .......................................................................44 Restructuring of the transaction within Fedsure .........................................................45 Execution of the integration ........................................................................................48 Apparent failure of the integration ..............................................................................51
Sage ...............................................................................................................................54 Fedhealth........................................................................................................................54
H FEDSURE’S INVESTMENT MANAGEMENT................................................................57 Mandate of the Board Investment Committee ................................................................57 Asset liability management – in principle........................................................................58 Asset liability management – in practice ........................................................................61 Performance comparisons..............................................................................................62 The management of the Net Main Life Fund ..................................................................66 Measures to address shortcomings in the management of the NMLF ...........................68 Considerations for closing the NMLF to new business in 2000......................................72 Mismatching in the Immediate Annuity Portfolio.............................................................78 Criticism of FEDAM operations ......................................................................................78 Writedown of property values .........................................................................................78
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - I FEDSURE LIFE OPERATIONS.....................................................................................79
Board of directors ...........................................................................................................79 The statutory actuary......................................................................................................79 Operations Committee and Financial Committee...........................................................82 Operational divisions’ reports to the board .....................................................................82 Corporate Governance in general ..................................................................................83 Operational efficiencies ..................................................................................................85 Computer systems..........................................................................................................86 Management expenses ..................................................................................................87 Commissions and incentives for brokers and intermediaries .........................................88 Product design................................................................................................................88 The Fedsure Guaranteed Fund prior to the IEB takeover ..............................................89 IEB’s action with the Fedsure Guaranteed Fund............................................................89 Early terminations of policies (withdrawals and surrenders) ..........................................93
J THE TAKEOVER OF FEDSURE BY INVESTEC ..........................................................95 Background to the transaction........................................................................................95 The structure of the transaction......................................................................................98 The due diligence ...........................................................................................................99 The two capital injections .............................................................................................105 Addressing the NMLF at IEB........................................................................................106 The reinsurance agreement with Capital Alliance Life Ltd ...........................................108 The interests of policyholders.......................................................................................111
K CONDUCT OF THE FSB .............................................................................................113
L PROFESSIONAL CONDUCT OF FEDSURE EXECUTIVES, MANAGERS AND NON-EXECUTIVE DIRECTORS...................................................................................................118
General remarks...........................................................................................................118 Non-executive Directors ...............................................................................................118 Actuaries.......................................................................................................................121 The external auditors....................................................................................................125 Investment managers ...................................................................................................129 IT managers .................................................................................................................131 Property Valuators........................................................................................................132
M WHAT WENT WRONG?..............................................................................................133 Perspectives.................................................................................................................133 Were the reasonable expectations of policyholders met? ............................................136
N SECTION 2 OF THE FI ACT: ‘CARE AND DILIGENCE’ ............................................140 Introduction...................................................................................................................140 Fedsure’s main strategy as background.......................................................................147 The separation of policyholders’ and shareholders’ funds ...........................................149 The management of the Immediate Annuity Portfolio ..................................................151 The overweight in financial shares ...............................................................................151 Closing the NMLF to new policyholder investments.....................................................153
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - O RECOMMENDATIONS................................................................................................156
Recommendation 1: Record keeping ...........................................................................157 Recommendation 2: Standardisation of policy design..................................................160 Recommendation 3: Investigation into smoothed bonus policies.................................161 Recommendation 4: Compulsory annual analysis of surplus.......................................161 Recommendation 5: Interim financial results................................................................162 Recommendation 6: Independence of the statutory actuary ........................................162 Recommendation 7: Interests of policyholders in life insurer takeovers.......................164 Recommendation 8: Role of non-executive directors of life insurers ...........................165 Recommendation 9: The role of the ombudsman ........................................................165 Recommendation 10: Investment Regulations............................................................169 Recommendation 11: FSB conduct.............................................................................169 Recommendation 12: The role of the auditor ...............................................................170
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - List of Abbreviations Appello Martijn Appello, Deputy Managing Director of
CAL ASSA The Actuarial Society of South Africa Barrow John Barrow, Non-executive Chairman of the
Fedsure Group and of Fedsure Life D Barrow Douglas Barrow, non-executive director of
Fedsure Life Basserabie Arnold Basserabie, Chief Executive Officer of
the Fedsure Group Beak John Beak, statutory actuary at Norwich Life
prior to 1998 Bernstein Dr Morris Bernstein, Managing Director of
Fedsure Life BAC The Board Audit Committee of the Fedsure
Group BIC The Board Investment Committee of the
Fedsure Group Board of Directors/the board The board of directors of Fedsure Life Brewis Michael Brewis, former Executive Director of
Fedsure Life; head of Individual Life Burger Glynn Burger, joint Chief Executive Officer of
Investec CAL Capital Alliance Life Ltd, an insurer registered in
terms of section 7 of the LTIA CAS Fedsure’s Corporate Actuarial Services Companies Act The Companies Act, No 61 of 1973 FBC Fidelity FBC Fidelity Bank Ltd Fedsure/Fedsure Group The Fedsure Group of companies FEDAM Fedsure Asset Management Fedsure Life Fedsure Life Assurance Ltd, an insurer
registered in terms of section 7 of the LTIA. Unless otherwise indicated in the context, this abbreviation refers to the company prior to Investec’s involvement in the beginning of 2001.
Fedhealth Fedsure Health Ltd, a company in the Fedsure Group and a registered medical scheme
Fedsure Holdings Fedsure Holdings Ltd, the holding company of the Fedsure Group, listed on the JSE
Fedsure Investments Fedsure Investments Ltd, the holding company of Fedsure Life Ltd
FGF The Fedsure Guaranteed Fund FI Act The Financial Institutions (Investment of Funds)
Act, No. 39 of 1984 FI (PoF) Act The Financial Institutions (Protection of Funds)
Act, No. 28 of 2001
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - FSB The Financial Services Board established in
terms of the Financial Services Board Act, No. 97 of 1990
Hart Anthony Hart, former non-executive director of Fedsure Life
Herman Hugh Herman, Chairman of Investec and former non-executive director of Fedsure Life.
IAP The Immediate Annuity Portfolio, a portfolio of assets to back the liabilities in respect of immediate annuity policies
IEB Investec Employee Benefits Ltd, the successor-in-name to Fedsure Life.
Inhold Investec Holdings Ltd Inspection Act The Inspection of Financial Institutions Act, No.
80 of 1998 Investec The Investec Group, comprising a number of
companies including IEB, Inhold, Investec Ltd and Investec Bank Ltd
Jammine Azar Jammine, former non-executive director of Fedsure Life and Chief Economist at Econometrix
Killick Peter Killick, Fedsure Group Financial Controller King Adv Mervyn King SC, former non-executive
director of Fedsure Life; non-executive Chairman of Brait
Kirk Ian Kirk, Managing Director of Capital Alliance Life Ltd
Koseff Stephen Koseff, Chief Executive Officer of the Investec Group; former Non-executive Director of Fedsure Life
LTIA The Long-term Insurance Act, No. 52 of 1998 McGinn Andrew McGinn, former executive director of
Fedsure Life; head of Fedsure Employee Benefits.
Mitchell David Mitchell, former non-executive Deputy Chairman of Fedsure Life.
NMLF The Net Main Life Fund, a portfolio of assets held to support the policyholder liabilities, other than linked products and immediate annuities, and which included all shareholder funds
Norwich Norwich Holdings Ltd Norwich Life Norwich Life Ltd, a long-term insurer registered
in terms of section 7 of the LTIA.
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - Nurek David Morris Nurek, former non-executive
director of Fedsure Life, and executive director of Investec Bank Ltd.
PWC PricewaterhouseCoopers, the external auditor of the Fedsure Group, including Fedsure Life
Raftopoulos Gerald Raftopoulos, the Chief Actuary and appointed statutory actuary at Fedsure Life until 2001; executive director of Fedsure Life
Registrar The Registrar of Long-term Insurance Regulations Regulations published in terms of the LTIA Saambou Saambou Holdings Ltd, the holding company of
Saambou Bank Ltd Sacks Michael Sacks, former non-executive director of
Fedsure Life. Tapnack Bradley Tapnack, executive director of the
Investec Group; former non-executive director of Fedsure Life
Van Staden Naas van Staden, former non-executive director of Fedsure Life; former Registrar of Insurance until 1983
Whelan Ciaran Whelan, executive director of IEB
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - List of Annexures A: Inspection instructions B: Supplementary instruction C: List of persons interviewed D: General background: Long-term Insurance Operation E: Extracts: Financial Statements of Fedsure Life and Norwich Life F: The NMLF at IEB G: Letter to actuary in the Norwich merger
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - Summary of findings
This report sets out our detailed findings and conclusions and should be read in its
entirety. We have attempted below to produce a summary as coherent and concise
as possible, but it should not be seen as a complete summary of the report; neither
should the findings be interpreted out of the context within which we made them.
Where appropriate, we have referred to the relevant paragraphs in the body of the
report.
It should be noted that a clear distinction must be drawn between the conduct at
Fedsure Life before and after the takeover by Investec. In this report we generally
refer to Fedsure Life as it existed before Investec took over, and to IEB thereafter
(see paragraph 4 in Section B below).
Despite good faith, good intentions, and many skills at Fedsure Life, we were left with
the overall impression that what went wrong at Fedsure Life was ineffective asset
liability management. In our view, the single biggest lesson to be learnt from the
Fedsure Life experience is that asset liability management needs to be an integrated
discipline which should be understood, practised and acknowledged throughout the
operational and strategic management and governance of the company.
Our key findings are:
1) Fedsure Life was never in an unsound financial position, nor did it “fail”, nor
did it renege on any of its contractual commitments. It always met statutory
solvency requirements. It was bought by Investec as a going concern at a
price of more than R4 billion in an open market transaction (paragraphs 46, 49, 211, 272.3).
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - 2) Fedsure Life’s board and management were intent on running a sound life
insurance business for the benefit of policyholders in the first place, and
consequently to reap benefits for shareholders. We did not find any evidence
of irregularities, such as fraud or conduct in bad faith, by directors and senior
management (paragraphs 119, 120).
3) A number of adverse events that occurred in a relatively short period of time
pressurised the management and systems of Fedsure Life beyond its
capabilities. The key financial effects thereof were poorer bonuses allotted to
policyholders, reputational damage, and erosion of Fedsure Life’s financial
strength. These adverse events were:
• The operational challenges of the Norwich takeover;
• The problems at Fedhealth and TMA;
• The curatorships of FBC Fidelity and Saambou; and
• The unforseen deterioration in the stock market and the value of
financial shares, and in particular the Investec Group (paragraphs 46, 53, 103 – 112, 131, 114 – 118).
4) Fedsure Life had adequate corporate governance structures. In our view,
there is nevertheless evidence that there were certain corporate governance
shortcomings, flaws and failures at Fedsure Life.
5) There are indications of shortcomings in Fedsure Life’s management and
systems which, if they were more robust, would have enabled Fedsure Life to
better withstand the pressure referred to in (3) above.
6) Although some policyholders are probably aggrieved by the manner in which
IEB amended the bonus structure and underlying asset composition of the
Fedsure Guaranteed Fund, and by the nature of these changes, we are
satisfied that IEB inherited a difficult situation from Fedsure Life and has acted
reasonably and in the interests of policyholders as a group (paragraph 232).
7) We are satisfied that under the circumstances, IEB has implemented
reasonable measures to deal with the unbalanced and compromised nature of
the assets they received from Fedsure Life.
8) We are satisfied that the reinsurance agreement with CAL represented a
transfer of balanced assets and maintenance of policyholders’ expectations of
future bonuses and investment returns.
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - 9) We do not believe the reasonable expectations of Fedsure Life’s policyholders
to have been met. Since 2000 they received significantly lower bonuses
(lower than competitor insurers’ bonuses) than what they reasonably had
expected, service levels deteriorated from 1998, and their security became
eroded (paragraphs 280 – 283).
10) The Registrar would not have become aware of problems regarding Fedsure
Life’s portfolios unless Fedsure’ statutory actuary, Gerald Raftopoulos, had
mentioned it in his valuation report. This was due to shortcomings in the
reporting format received from insurance companies. The situation has since
been addressed. The new statutory return, introduced in 2001, provides for
additional information that should enable the FSB’s Insurance and Actuarial
Departments to detect possible mismatched positions in portfolios
(paragraphs 233 – 238).
11) In the statutory returns to the Registrar following the 1998 and 1999 year-
ends, Raftopoulos indicated in his valuation reports that the Net Main Life
Fund (NMLF) was underweight in bonds and overweight in equities. Since the
Registrar’s office is the final “watchdog” over the interests of investors and
policyholders, we believe that the two consecutive, similar reports should have
prompted further enquiries. The new quarterly reports should make matters
easier for the Registrar’s personnel (paragraph 239).
12) The asset liability management at Fedsure Life with regard to the NMLF and
the Immediate Annuity Portfolio (IAP) in the late nineties was not effective, for
the following reasons (paragraphs 47, 50, 51, 54, 123; 134; 148; 294 – 299; 300):
• For the NMLF there was an over-concentration of investments (see (14) below), largely due to historic strategic acquisitions (and their growth over
a number of years), in financial shares and in a few counters in the
financial sector, as well as in properties. The non-separation of
shareholders’ and policyholders’ funds and lack of financial controls within
the NMLF contributed to poorer investment returns than those needed to
match the reasonable expectations of policyholders.
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL -
• Lack of actuarial and financial control in the IAP led to a shortfall in the
value of assets earmarked for these liabilities vis-à-vis the value of the
liabilities.
13) The Fedsure Group made various strategic acquisitions throughout the 1990s
up to and including that of Norwich Holdings. Most of these investments were
held in Fedsure Life’s NMLF. The lack of a split between shareholders’ and
policyholders’ assets in the NMLF meant that policyholders’ funds were partly
used for these acquisitions. When some of these investments
underperformed, policyholders suffered a reduction in bonus rates, non-vested
bonuses and in their security (the free assets). Although a split between
shareholder and policyholder funds was not common in the life industry at the
time, it is our opinion that Fedsure Life’s management of the NMLF
represented an approach for policyholders that was more risky than what they
expected, although the board and management of Fedsure Life did not see it
as such.
14) The assets in the NMLF were unbalanced, with a large exposure to the
financial sector and properties. The overweight position in the NMLF in the
financial sector, and in counters in that sector, was not well managed. When
the board of Fedsure Life started a process of rectification in 1999, Inhold and
Saambou stocks were virtually illiquid due to the large share blocks held. The
situation was partly rectified about two years later, when Investec took over
Fedsure Life.
15) The board of Fedsure Life was aware of the overweight position in the NMLF
since the mid-1990s. The CEO and other executive directors, continually
assured the board that they were addressing the problem. However, it
appears to us that the board did not have adequate appreciation of the extent
of the sensitivity of this overweight position relative to the liabilities until it was
too late (paragraph 51).
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - 16) We believe that the acquisition of Norwich Holdings had a major negative
impact on the operational capabilities of Fedsure and especially Fedsure Life.
The decision of the executive management and the board to acquire Norwich
Holdings cannot be criticised, although the timing of the acquisition may have
been unfortunate (in view of other problems within the Fedsure Group at the
time). The takeover and eventual merger with Norwich Life were however
executed and managed in such a way that it had a negative impact on general
service levels and the systems environment at Fedsure. In our view, the
merger was probably the major cause of the problems experienced at Fedsure
Life since 1998 (paragraphs 103 to 112).
We make the following twelve recommendations (see Section O):
1) There is room for improvement in the recordkeeping of life insurance
companies in general, especially in respect of asset liability management
(paragraphs 154, 227, 251, 257). Shareholders’ and policyholders’ assets
should be clearly split (we have reason to believe this is becoming standard
practice in the industry at present). Although we did not inspect other life
insurers, anecdotal evidence seems to indicate that some of the problems
experienced at Fedsure Life may be present at other life insurers as well.
2) Research should be initiated into practically feasible standardisation of life
insurance and competing products in South Africa (paragraph 177).
3) ASSA should draft guidelines with regard to the product design, pricing,
valuation, investment mandates and valuation of smoothed bonus policies
(paragraphs 177 – 190).
4) The Registrar should impose a compulsory annual analysis of surplus on the
life industry that is more detailed than the one currently contained in
Statement C7 of LT2000 (paragraph 251).
5) Prior to the publishing, internally or externally, of interim financial results, a
certificate should be obtained by the actuary regarding the change of value in
policyholder liabilities (paragraph 45).
Financial Services Board Fedsure Life Assurance Ltd Report
- STRICTLY CONFIDENTIAL - 6) The independence of statutory actuaries should be revisited, and the
requirement in King II of a Board Actuarial Committee should be implemented
(paragraphs 251, 252).
7) The Registrar needs to implement better measures to protect the interests of
policyholders in especially hostile takeovers between life insurers.
8) The non-executive directors of life insurers should receive some form of
training in their duties.
9) Jurisdictional conflicts between the various offices of ombudsman and
adjudicators should be addressed. Preferably, a single “ombuds” office should
eventually be established to provide complainants with a single entry point.
10) The investment regulations should be revisited with regard to limiting
investments relative to the size of individual counters in the all share index,
and the spreading of free assets.
11) More self-regulation in the industry should be investigated, in order to lighten
the burden on the Registrar’s Office.
12) The audit profession should be part of the asset liability management team,
and may need to implement training modules for its members in the intricacies
of the life insurance industry (paragraph 259).
Financial Services Board Fedsure Life Assurance Ltd Report Page 1 - STRICTLY CONFIDENTIAL - A. Introduction
1. The FSB is an autonomous regulatory body that exercises supervision over
the business of financial institutions. The Executive Officer of the FSB is the
Registrar of various financial institutions in terms of Acts relevant to such
institutions. As such, the Executive Officer is also the Registrar of Long-term
Insurance in terms of section 2 of the Long-term Insurance Act, No. 52 of
1998.
2. This inspection was performed in terms of the Inspection Act which sets out
the powers and obligations of the Registrar and of Inspectors of financial
institutions. It is implied in this Act that Inspectors report their findings on the
affairs of a financial institution objectively and impartially to the Registrar.
3. The Registrar instructed us to carry out an inspection of the affairs of Fedsure
Life Assurance Ltd, which has since become known as Investec Employee
Benefits Ltd. Our instruction letters are respectively dated 15 May 2002 and
20 May 2002 (copies are attached hereto as Annexures A1 and A2).
Financial Services Board Fedsure Life Assurance Ltd Report Page 2 - STRICTLY CONFIDENTIAL -
B. The Scope of the Inspection
4 It appeared from information provided by the Registrar that complaints had
been brought to the attention of the FSB, the gist of which was that Fedsure
Life policyholders’ interests might have been compromised since 1998. The
complaints mostly stemmed from the fact that Fedsure Life had declared nil
bonus rates on its smoothed bonus portfolios, such as the Fedsure
Guaranteed Fund, at the end of 2000 and 2001.
In 2001, Investec Group Limited purchased the financial services business of
the Fedsure Group from Fedsure Holdings Limited, which included Fedsure
Life. It should be noted that we received conflicting versions as to the exact
date on which Investec effectively took control of the business of Fedsure Life.
We were told that from the beginning of January 2001, Investec management
was present at Fedsure Life, but only for the purpose of holding a “watching
brief”. It is clear that in June 2001, following regulatory approval, Investec
officially took over the management and control of Fedsure Life, and that
Fedsure Life’s name was changed to IEB in December 2001. The last
meeting of the Fedsure directors (prior to the appointment of the IEB board)
took place in May 2001.
However, if a “watching brief” denotes being a mere observer and not being
involved in the decision-making, we disagree with the above contention as far
as the period from the end of 2000 to the end of May 2001 is concerned. The
agreement between Investec and Fedsure, signed on 21 November 2000, and
other information presented to us appear to indicate the de facto position was
that Investec effectively controlled Fedsure from the beginning of 2001.
It should be noted that, unless otherwise indicated, our references to Fedsure
Life in this report are used in the context of actions of the board of directors
and management of the company prior to the involvement of Investec from
Financial Services Board Fedsure Life Assurance Ltd Report Page 3 - STRICTLY CONFIDENTIAL -
January 2001. Although the name change only occurred in December 2001,
we refer to IEB as Fedsure Life under Investec’s control from January 2001.
Despite perceptions in the public mind of Fedsure’s “demise”, it is important to
note that at the time of the purchase, Fedsure was not in danger of liquidation,
nor was it unable to pay its creditors. It was sold to Investec at a price of more
than R4 billion and was purchased as a going concern that still satisfied
statutory solvency requirements.
5 In summary, we were instructed to: -
• Determine whether the “board of directors and management” of Fedsure
Life observed the utmost good faith and exercised proper care and
diligence, as contemplated in section 2 of the FI (PoF) Act;
• Establish whether the board of directors and management of Fedsure Life
exercised appropriate corporate governance in the interests of
policyholders, with specific reference to the identification and management
of risks to protect the interests of policyholders;
• Determine whether the “reasonable expectations of policyholders were
infringed”, with particular reference to the declaration of bonuses and the
cancellation of non-vested bonuses during the period from 1998 to 2001;
• Determine whether it was “appropriate and necessary” to cancel non-
vested bonuses;
• Comment on the “appropriateness of legislation and practices”
implemented by the FSB’s Life Insurance and Actuarial Departments, with
particular reference to the introduction of changes to improve the
protection of policyholders’ interests, and whether such FSB practices
“would have been adequate” to reveal the financial position of Fedsure Life
from 1998 onwards.
Financial Services Board Fedsure Life Assurance Ltd Report Page 4 - STRICTLY CONFIDENTIAL - 6 We were instructed to cover the period 1998 to date. It however soon became
clear to us that it was necessary to inspect certain events that transpired prior
to 1998, in order to gain a full understanding of the position in which Fedsure
Life found itself from 1998 onwards.
7 Almost immediately after the inspection instruction was made public, the
Registrar received an objection from lawyers that represented some of the
former non-executive directors of Fedsure Life. The point was made that
section 2 of the FI (PoF) Act does not contemplate liability in terms of that
section of a board of directors, but provides for individual liability.
8 On 31 July 2002, we received a supplementary instruction from the Registrar,
in which we were advised that the words “board of directors and management”
in the instruction of 15 May 2002 were intended to mean the “directors,
officials and employees” of Fedsure Life individually. In addition, we were
instructed to report to the Registrar any information that we found important for
“regulatory consideration”, irrespective of the ambit of our initial instructions. A
copy of this instruction is attached hereto as Annexure B.
9 We were initially instructed to report our findings to the Registrar by 30 June
2002. Virtually from the outset, this deadline proved to be impossible, mainly
due to the sheer scope of the task and the volume of information that we
found necessary to digest. We therefore arranged with the Registrar to inform
him of our progress on a monthly basis.
Financial Services Board Fedsure Life Assurance Ltd Report Page 5 - STRICTLY CONFIDENTIAL -
C Our Approach to the Inspection 10 We studied thousands of pages of documentary evidence, including: -
• The minutes of meetings of the board of directors of Fedsure Life, including
a number of board packs, for the period March 1998 to 2001
• The minutes of meetings of the board of directors of Fedsure Holdings, for
the period 1995 to 2001
• The minutes of meetings of the board of directors of Fedsure Investments,
for the period November 1997 to 2001
• Financial statements of Fedsure Life and Fedsure Investments
• Statutory returns for the period 1997 to 2000
• Documentation provided by the Registrar, including complaints from
policyholders and correspondence
• Documentation provided by persons interviewed
• Documentation provided by IEB
• Documentation provided by Capital Alliance
• Minutes of meetings of the various board committees of Fedsure Life from
1997 onward, such as the Board Investment Committee, the Board Audit
Committee, and the Operational Committee (known as the Financial
Committee from March 2000)
• Minutes of meetings of the Executive Investment Committee from 1998
onwards
• Professional guidance notes of ASSA
Financial Services Board Fedsure Life Assurance Ltd Report Page 6 - STRICTLY CONFIDENTIAL -
11 Excluding members of the Registrar’s office, we interviewed about 50 persons
in Gauteng and Cape Town, including: -
• All the former directors of Fedsure Life who held an appointment during the
period 1998 to 2001, bar two
• Directors of IEB
• Members of senior management at Norwich, Fedsure Life and FEDAM
• Former directors of Norwich
• Former employees of Fedsure and Norwich, employed at various levels of
the organisations
• Representatives of some policyholders
• The Ombudsman for Long-term Insurance
• The Pension Funds Adjudicator
• Executive directors of Capital Alliance
A list of persons we interviewed is attached as Annexure C.
12 Despite initial concerns raised by some of the legal representatives of persons
interviewed, we ultimately received the full co-operation of all parties
concerned. We appreciate this and extend our gratitude to all involved. In
addition, we are grateful for the full co-operation from the start of this
inspection by the senior management teams of IEB and CAL; Messrs
Basserabie, Bernstein and Raftopoulos, and for the assistance of the
Registrar’s personnel in providing data and historical information.
The Registrar sent out a copy of this report to the parties concerned in
December 2002 and requested their comments. Various comments were
received and, if so warranted, certain issues dealt with have been
incorporated or clarified in this final report. However, none of these comments
persuaded us to change any of our key findings.
Financial Services Board Fedsure Life Assurance Ltd Report Page 7 - STRICTLY CONFIDENTIAL - 13 Various directors and members of management referred us to persons they
regarded as important to interview. Due to time, budget and urgency
constraints, it has been impossible to interview all parties who may have been
able to provide us with useful information, although we have endeavoured to
interview as many relevant parties as possible. Similarly, it is quite possible
that we have not perused documentation that may shed light on certain
issues. We are however satisfied that we have obtained ample information in
order to report the facts to the Registrar, and to draw inferences and
conclusions from those facts.
14 For obvious reasons, we relied heavily on information provided to us during
interviews with the various parties. We have endeavoured to take into
account that some of these parties may not be entirely objective regarding the
course of events, may not have remembered detail, may have been defensive,
and may have voiced opinions based on hindsight. What we could, we have
attempted to verify by using independent sources, but it should be noted that
this was not always possible.
15 The Registrar requested us to carry out the inspection with an emphasis on an
overview, rather than to get bogged down in the detail of specific matters. A
number of persons that we interviewed canvassed specific complaints and
issues with us. Although it was in certain instances necessary to study detail,
we did not carry out a forensic investigation by any means, and attempted not
to become sidetracked in issues that may have warranted investigations on
their own. However, such investigations will in our view be hampered by a
lack of evidence (due to the passage of time), and the amounts involved are
not necessarily significant.
16 We do not include a separate section on corporate governance in the report.
The matter is dealt with throughout, with due regard to legislation and the first
King Report on Corporate Governance (King II was issued after Fedsure Life
was taken over by IEB).
Financial Services Board Fedsure Life Assurance Ltd Report Page 8 - STRICTLY CONFIDENTIAL - D The Approach Followed in this Report
17 We have attempted to establish the facts as they were at Fedsure, and not to
rely on the benefit of hindsight. In this regard, we endeavoured to obtain
information on and take into account the general economic and business
background of the 1990s, in order to understand the context in which major
decisions were taken at Fedsure. Some of these decisions are – with
hindsight – easily open to criticism, but we try in this report to draw
conclusions on the facts available to decision-makers at the time.
18 In view of the complex nature of the life industry, and with a view to the
Registrar’s discretion to apply to the High Court to disclose parts of the report
in terms of section 10 of the Inspection Act, we have endeavoured to write this
report for as large an audience as possible. A number of technical terms and
concepts within the context of long-term insurance is used in the report. For
purposes of clarity, a general explanation of a long-term insurance operation,
in which technical terms and concepts are highlighted and defined, is attached
hereto as Annexure D.
19 The Registrar’s office posed certain specific questions that we were requested
to answer. These did not form part of our instruction as discussed above, but
were intended to provide us with focus on some of the main issues. In similar
fashion, Bruce Cameron, the financial journalist who publicly professed to also
have had a personal Norwich life policy, posed a number of pertinent
questions in articles on Fedsure. At the request of the Registrar, we have
attempted to address these questions in this report.
Financial Services Board Fedsure Life Assurance Ltd Report Page 9 - STRICTLY CONFIDENTIAL -
20 The inspection instruction contains two main components. In the first instance
it requires an inspection of the conduct of Fedsure’s directors and
management. In the second instance it questions the conduct of the office of
the Registrar of Long-term Insurance. In general, we have followed the
criteria below in expressing our views on these matters: -
20.1 Were Fedsure Life’s management actions properly taken to protect and
promote policyholders’ interests?
There are essentially three activities conducted in the management of a life
insurer, namely long-term savings/investment; insurance of risk benefits; and
administration. The conduct and results of directors’ and management’s
actions in this regard are assessed in measuring up to this criterion.
20.2 Was Fedsure Life’s operational housekeeping in order?
20.3 Did Fedsure Life practise good corporate governance?
20.4 Had policyholders’ expectations been met?
20.5 Was the Registrar’s conduct timeous and appropriate in the light of the
statutory dispensation that applied at the time?
20.6 Is there a need for change of the existing statutory supervisory dispensation in
any respect?
Financial Services Board Fedsure Life Assurance Ltd Report Page 10 - STRICTLY CONFIDENTIAL -
E Background: Fedsure Life
Historic overview
21 Fedsure Life originated as an insurer for the workers in the building industry.
The Barrow family was one of the founder members who started the business
in the 1930s. The group originally existed as the Federated Employers
Mutual, which insured compensation for occupational injuries. The short-term
insurer Federated General was established in the 1940s and the long-term
insurer Federated Life was established in the 1950s.
22 In 1987 the group created the Fedsure brand and listed the holding company
Fedsure Holdings Limited on the JSE. Fedsure Holdings owned 100% of
Fedsure Investments Limited, which in turn owned 100% of Fedsure Life
Assurance Limited. During the early 1990s the group decided to embark on a
course to become a comprehensive and major financial services group,
essentially through a series of mergers and acquisitions.
There is no doubt that the Fedsure Group did well for both policyholders and
shareholders from its inception. In 1987, after the listing of the group, it
enjoyed a market capitalisation of R188 million. In 1988, Fedsure Life had a
market share of 3.2% of long-term insurance net premium income. At the end
of May 1998, some ten years later, the group had a market capitalisation of
R11.4 billion and 4.5% market share of long-term insurance premium income.
23 Since its listing, the main shareholders of Fedsure Holdings were as follows:
23.1 The Barrow family owned on average 10%
23.2 Federated Employers Mutual owned about 11%
23.3 Various building industry associations owned approximately 7%
Financial Services Board Fedsure Life Assurance Ltd Report Page 11 - STRICTLY CONFIDENTIAL - 23.4 In 1991, Investec started with a holding of 20% but it gradually decreased to
13%
23.5 Sanlam, Old Mutual and other local or offshore institutions acquired stakes of
varying size via rights issues and open market transactions
23.6 Staff and executives owned on average 5%
24 We were told that the so-called “inner pool” of shareholders (the Barrow family,
the Mitchell family, Federated Employers Mutual, building industry associations
and certain individuals, including Basserabie) always owned a bigger stake than
Investec, so Investec had to “go with” what the inner pool decided.
25 Other than the life insurer and the short-term insurer, the new group acquired
businesses in asset management, healthcare and financial intermediary
services, both local and foreign.
26 In 1998, the Fedsure Group acquired the complete share capital of Norwich
Holdings and thereby all its financial services interests, including Norwich Life,
the life insurer of that Group. Fedsure Life and Norwich Life merged their
policyholder interests with effect from 1 January 2000, after the transaction was
sanctioned by the High Court in May 2001.
Companies, subsidiaries and divisions in the Fedsure Group
27 Prior to the eventual acquisition by Investec of the Fedsure Group during 2001,
the Fedsure Group owned or had owned the following companies or
subsidiaries:
Fedsure Life Fedsure Investments
Fedsure Asset Management Fedsure Properties
Fedsure Unit Trusts Fedsure Healthcare
Fedsure General Fedsure Participation Bonds
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Fedsure International Limited Fedsure Life Namibia
Safrican NFB Finance Brokers
TMA Investments Products Services Norwich Holdings
28 Investec effectively took over control of the Fedsure Group (excluding Fedsure
Healthcare) from January 2001. Fedsure Life’s name was changed to
Investec Employee Benefits in December 2001. With a few exceptions all
individual policies were reinsured with Capital Alliance Life, with effect from 31
May 2001 (following regulatory approval of Investec’s acquisition of the
Fedsure Group). IEB only retained the group business of the former Fedsure
Life and Norwich Life.
29 In the 2000 Budget and 2000-2004 Strategic Plans of the Fedsure Group, the
following interests were distinguished:
Fedsure Life: Group Benefits
Individual Life
Fedsure Credit Life (which we did not inspect)
Fedsure Healthcare: Fedsure Healthcare Funding
Fedsure Managed Health
Medicross
Fedsure Healthcare Networks
Financial Services: Fedsure Asset Management
Fedsure Properties
Fedsure Unit Trusts
TMA
Fedsure Participation Bonds / Trust
Safrican
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Fedsure International: Fedsure International Europe
Fedsure International Australasia/Asia
30 In the same document the plans for the following support divisions were
presented:
Group Finance
Group Human Resources
Group Information Technology
Group Marketing
Group Risk Management
Group Strategy
Corporate Actuarial Services
Executives and members of the boards of directors
31 At the time Investec acquired Fedsure Life, the executives responsible for
these companies/divisions were:
Fedsure Life M Bernstein
Fedsure Life Group Benefits A McGinn
Fedsure Life Individual Life M Brewis
Fedsure Credit Life NL Beddington
Fedsure Healthcare D Avnit
Fedsure Asset Management R Derman
Fedsure Properties E Loubser
Fedsure Unit Trusts D Stronach
TMA A Kritzinger
Fedsure Participation Bonds J Fields
Safrican Vacant
Fedsure International D Kowarski
Group Finance P Killick / D Barber
Group Human Resources P Krige
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Group Information Technology A Kritzinger
Group Marketing AH Barnes
Group Risk Management (Internal Audit) G Koen
Group Strategy D Kowarski
Corporate Actuarial Services G Raftopoulos
32 The Group conducted its life insurance business essentially through the
boards of directors of three companies namely Fedsure Holdings Limited,
Fedsure Investments Limited and Fedsure Life Assurance Limited. The board
committees were a Board Audit Committee, a Board Investment Committee
and a Board Remuneration Committee. These committees were common to
all three the boards.
33 The senior executives of Fedsure Life’s Group Benefits, Individual Life, Credit
Life, and Corporate Actuarial Services divisions reported to Bernstein.
Loubser of Fedsure Properties reported to Derman, the head of FEDAM.
Apart from these, it appears that all the other executives of the above
companies and divisions effectively reported to Basserabie, Chief Executive
Officer of the Group and the only executive director on the board of Fedsure
Holdings. According to Basserabie, ten senior executives reported to him.
34 From 1998, the persons indicated below served on the boards of these
companies as follows:
Boards of Directors Fedsure Holdings
Fedsure Investmentsº
Fedsure Life/IEB
Executive directors A I Basserabie 28/11/84 – 08/06/01 29/11/85 – 08/06/01 M Bernstein 27/01/92 – 06/05/01 27/01/92 – 06/05/01 M Brewis
17/08/98 – 31/12/00
A McGinn 17/08/98 – 08/06/01 G Raftopoulos 17/08/98 – 15/01/02
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Boards of Directors Fedsure Holdings
Fedsure Investments
Fedsure Life/IEB
Non-executive directors J Barrow 26/03/81 – 08/06/01 23/04/81 – 08/06/01 D Mitchell 26/03/81 – 08/06/01 23/04/81 – 08/06/01 M Sacks 01/10/89 – 08/06/01 01/10/89 – 08/06/01 E van Staden 01/07/83 – 20/05/99 01/07/83 – 20/05/99 A Jammine 01/09/89 – 08/06/01 01/09/89 – 08/06/01 D Barrow 01/01/92 – 08/06/01 01/01/92 – 08/06/01 A Hart 01/11/96 – 24/05/01 01/11/96 – 24/05/01 S Koseff 03/01/92 – 30/08/02 03/01/92 – Current D Nurek 01/03/99 – 30/08/02 03/01/99 – Current B Tapnack 05/06/01 – 30/08/02 05/06/01 - Current M King 01/03/99 – 08/06/01 03/01/99 – 08/06/01 G Burger* 05/06/01 – 30/08/02 05/06/01 - Current C Whelan* 05/06/01 – 30/08/02 05/06/01 - Current H Herman 25/02/94 – 30/08/02 25/02/94 – Current S Khanyile 01/03/99 – 08/06/01 03/01/99 – 08/06/01
ºIn liquidation as of 30 August 2002
*IEB directors appointed by Investec
Barrow was Chairman and Mitchell the Deputy Chairman of all the boards.
Barrow also chaired all the board committees.
The board members below served on the board committees at various times
from 1998 as follows:
Board Committees
Board Investment Committee
Board Audit Committee
Board Remuneration
Committee Executive directors
A I Basserabie Non-executive directors
J Barrow D Mitchell M Sacks D Barrow A Hart
Financial Services Board Fedsure Life Assurance Ltd Report Page 16 - STRICTLY CONFIDENTIAL -
Board Committees
Board Investment Committee
Board Audit Committee
Board Remuneration
Committee Non-executive directors
EW van Staden DM Nurek A Jammine S Koseff H Herman M King
The following persons (all executives and management) served on the
Executive Investment Committee of the Fedsure Group:
AI Basserabie PA Killick
M Bernstein EC Loubser
R Derman G Raftopoulos
M Brewis D Barber
A McGinn L Butler (from June 2000)
ICP Fraser
The Operating Committee of Fedsure Life, whose name was later changed to
the Financial Committee, comprised a number of senior executives and
members of management that changed from time to time. The senior
executives on the committee were: -
M Bernstein (Chairman)
AI Basserabie
M Brewis
A McGinn
N Beddington
G Raftopoulos
Financial Services Board Fedsure Life Assurance Ltd Report Page 17 - STRICTLY CONFIDENTIAL - 35 The boards and committees met regularly, with extensive agendas, minutes
and board or board committee packs.
36 Although the Chairman of the boards was non-executive, he had continuous
and extensive contact (weekly) with the Chief Executive Officer. In addition
Sacks, although also a non-executive director, was closely involved with
certain strategic investment matters.
Products
37 Within Fedsure Life it is evident that the life insurer marketed and serviced a
full range of products that enabled it to compete at all levels with other major
players such as Old Mutual, Sanlam, Liberty Life, Momentum Life,
Metropolitan Life and Sage Life. By 1998, it was a life company in a sound
financial position and it appeared as though it had all the operational
resources (human and otherwise) required to support its growth strategy.
38 However, its financial strength in 1998 to a large extent consisted of
unrealised capital appreciation of its holdings in strategic investments, in
particular Investec, Saambou and FBC Fidelity. Hence the structuring of
Fedsure Life’s financial (asset and liability) management around these
strategic investments is a key consideration.
39 Regarding asset liability management, Fedsure Life operated its business
essentially by considering three segments, namely the Linked Policies’ assets
and liabilities, the Immediate Annuity Portfolio’s assets and liabilities and the
remainder of the policy liabilities (i.e. with-profit/smoothed bonus policies and
non-profit policies) which, together with the free assets, were managed as the
Net Main Life Fund (NMLF). The figures relating to these three segments are
set out in Table 5 in Section F.
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The Net Main Life Fund
40 The NMLF was a crucial component of Fedsure Life’s operations. The CEO of
Fedsure, in an impromptu manner, described the NMLF as “a fund which
housed certain mainly with-profit liabilities for policyholders, with free assets”.
He further told us as follows (quoted verbatim from our interview with him):
• It was a portfolio which could enjoy a fair amount of flexibility.
• Derman was in charge of managing the investments of the NMLF.
• Properties had its own expert who reported to Derman.
• Apart from strategic investments, the fund manager could buy and sell as
other portfolio managers.
• It was Bernstein’s and Raftopoulos’s task to pull together assets and
liabilities in the NMLF.
• As managing director of the company, at the end of the day, the
relationship of assets and liabilities was Bernstein’s responsibility.
• Stocks [Neville Stocks, former deputy Managing Director of FEDAM]
reported regularly on the NMLF and never expressed concern about the
fund, except in late 1997, when he expressed serious concerns that the
fund was too heavily weighted in financials.
41 In summary, the NMLF housed all the assets of Fedsure Life that were not
used to support linked policy and immediate annuity policy liabilities. It
comprised of the assets backing all other policy liabilities in Fedsure Life, and
the shareholders’ interests in Fedsure Life.
42 The structure and performance of the NMLF are discussed in Section F below, and the management of this fund is addressed in Section H.
Financial Services Board Fedsure Life Assurance Ltd Report Page 19 - STRICTLY CONFIDENTIAL -
F The Financial Performance of Fedsure Life since 1997 43 In considering the financial performance of Fedsure Life, we distinguished
between three periods:
43.1 The period before Norwich Life’s business was merged into that of Fedsure
Life. It should be noted that although the Norwich Group was acquired in
1998, the actual merger of the life insurance funds of Fedsure Life and
Norwich Life only took place with retroactive effect from 1 January 2000.
43.2 The period after the acquisition of Norwich Life, up until the time that Investec
took over control (effectively 1 January 2001).
43.3 The period from 1 January 2001, under Investec’s control.
44 For the sake of convenience, we reflect below the financial performance of
Fedsure Life from 1996 up to 31 December 2000; the financial performance of
Norwich Life; the financial performance from 1 January 2001 under Investec’s
control; and the performance of Fedsure Life’s Net Main Life Fund since 1997.
It should be noted that financial statements for Fedsure Life were prepared as
at 31 December 2000 with and without the actual merger of the Fedsure and
Norwich life funds.
45 The financial performance of a life insurer is best measured in terms of the
statement of actuarial values of assets and liabilities. Hence the results from
those statements are included below.
It should be noted that monthly management reports at Fedsure Life before
2000, other than those following the annual actuarial reports, showed income
statements without taking changes in policyholder liabilities into account. We
are of the opinion that the statutory actuary of a life insurer should provide an
estimate of the change in policyholder liabilities with each such management
report; otherwise the reported financial performance of the company may be
Financial Services Board Fedsure Life Assurance Ltd Report Page 20 - STRICTLY CONFIDENTIAL -
misleading. Such monthly reporting will also highlight the need for proper
asset liability matching.
Fedsure Life’s performance up to 2000
46 Fedsure Life’s performance, as reflected at financial year end (31 December)
by the statements of actuarial values of assets and liabilities, was as follows
from 1996 to 2000:
Table 1 FEDSURE LIFE ASSURANCE LTD Statement of actuarial values of assets and liabilities (R’million)
2000 1999 1998 1997 1996 (1) Assets 31035.8 29122.5 21061.7 19665.6 18451.6 (2) Policy liabilities 28582.3 26263.1 18077.9 15972.1 15864.2 (3) Other liabilities 1095.6 1044.3 782.4 569.6 399.2 (4) Excess assets (1)-(2)-
(3) 1357.9 1815.1 2201.4 3123.9 2188.2 (5) Change in excess
assets -457.2 -386.3 -922.5 935.7 (6) Capital Adequacy
Requirement (CAR) 945.2 520.0 537.6 686.0 471.3 (7) CAR Cover Ratio
(4)/(6) 1.4 3.5 4.1 4.6 4.6
For the sake of completeness, the Income Statements and Balance Sheets of
Fedsure Life for the same periods are attached hereto as Annexures E1 and E2.
46.1 The above results include the Norwich business only in terms of the
investment that Fedsure Life had in Norwich Life and in terms of which
dividends were paid to Fedsure Life. In other words, the shares of Norwich
Life are included as part of the assets of Fedsure Life, so that Norwich Life’s
assets and policy liabilities have not been included on a look-through basis.
Financial Services Board Fedsure Life Assurance Ltd Report Page 21 - STRICTLY CONFIDENTIAL -
46.2 From Table 1, the following is evident:
(a) The solvency of Fedsure Life deteriorated from 1998, when it was still
in an extremely good position. It was, however, never insolvent.
(b) The CAR cover ratio reduced from 4.6 at the end of 1997 to 1.4 at the
end of 2000. The ratio was still good in 1999, but then deteriorated
dramatically in 2000.
(c) Fedsure Life would not have met its capital adequacy requirements in
2000, were it not for R700 million of new capital raised from its holding
company and sole shareholder, Fedsure Investments. Without this
capital injection, the CAR cover ratio would have been 0.7 – less than
the Registrar’s requirement of at least 1. It appears that Investec
provided R500 million of this amount.
(d) The change in excess assets strictly reflects the gain or loss for
shareholders for the relevant year, including new share capital raised
and after dividend payments.
47 The sources of change in excess assets (i.e. where the gains or losses arose)
are as follows:
Table 2 FEDSURE LIFE ASSURANCE LTD Sources of change in excess assets (R’million)
2000 1999 1998 1997 1996 Operational earnings 240.4 191 182 161.2 121.8 Investment income on free assets 30.9 120 140 146.2 106.8 Movements of free assets -1310 -116.1 -1028.3 516.3 85.5 Change in valuation basis -18.5 -355.2 -261 -22.3 New share capital issued 700 517.6 28.2 Dividends paid -100 -226 -216.2 -144.6 -103.9 TOTAL CHANGE -457.2 -386.3 -922.5 935.7 216.1 (Note: the terms “excess assets” and “free assets” are synonyms.)
Financial Services Board Fedsure Life Assurance Ltd Report Page 22 - STRICTLY CONFIDENTIAL - 47.1 In Table 2: -
(a) Operational earnings are the gains or losses from the life insurance
operations;
(b) Investment income on free assets are the realised investment earnings
(even if notionally allocated/apportioned) on free assets;
(c) Movements of free assets are essentially the unrealised investment
earnings on free assets;
(d) Change in valuation basis is an exceptional item that arises when the
actuary considers it appropriate, in view of new developments, to change
the basis on which policy liabilities are valued (and sometimes also the
basis on which assets are valued).
47.2 Since a more detailed analysis of the above results is generally not available
in the published statements of life insurers, we perused the internal
management reports, such as the valuation reports and explanations from the
statutory actuary of Fedsure Life, Raftopoulos, for the main reasons for the
decrease in surplus assets. For the year 2000 in particular, he reported the
reasons to the Board as follows:
a) Difficult investment conditions, with the ALSI and the FINDI decreasing
respectively by 2.5% and 7.4% year on year.
b) Low holdings of bonds and cash in the NMLF.
c) High holdings of strategic assets and property in the NMLF.
d) The writing down of assets by R454 million.
e) Losses in immediate annuity business.
f) An increase in the capital adequacy requirement, as a result of
mismatching in the immediate annuity assets.
g) Effect of changes in actuarial assumptions.
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47.3 Raftopoulos further commented that the weak financial position was mainly
due to asset and liability mismatching, and to a lesser extent to operational
issues. The increase in the capital adequacy requirement from R520 million at
the end of 1999 to R945 million at the end of 2000 was the result of
mismatching that arose in the Immediate Annuity Portfolio. Raftopoulos
calculated the loss that arose because of this mismatching to have amounted
to R253 million (see also Section I paragraph 159 below).
47.4 It is evident from Table 2 that Fedsure Life showed consistent growth in
operational earnings in the five year period from 1996 to 2000 (from
R121.8 million to R240.4 million). However, the movement in its free assets
eroded its CAR cover, and hence its solvency. In his valuation report for the
year ended 31 December 2000, Raftopoulos commented that “overall the
surrenders for 2000 are over double those for 1999” and “the overweight
position of financials in the Net Main Life Fund and the write-down of assets at
the year-end have resulted in Fedsure Life’s investment performance being
weak relative to Norwich and its leading competitors”.
The performance of Norwich Life
48 In view of the material effect of the takeover by the Fedsure Group of the
Norwich Group, it is also necessary to consider the financial performance of
Norwich Life. The statements of actuarial values of assets and liabilities of
Norwich Life for the period 1997 to 2000 reflected the following:
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Table 3 NORWICH LIFE SOUTH AFRICA LTD Statement of actuarial values of assets and liabilities (R’million) 2000 1999 1998 1997 Assets 13070.0 13044.0 11371.0 10573.0 Policy liabilities 11276.0 11000.0 9956.0 9366.0 Other liabilities 364.0 339.0 226.0 214.0 Excess assets 1430.0 1705.0 1189.0 993.0 Change in excess assets -275.0 516.0 197.0 CAR 576.0 860.0 950.0 546.0 CAR Cover Ratio 2.5 2.0 1.3 1.8 SOURCE OF CHANGE IN EXCESS ASSETS Operational earnings 150 124 40 Investment income on free assets 0 0 Movements of free assets -52 589 189 Change in valuation basis -273 -90 0 New share capital issued Dividends paid -100 -107 -32 TOTAL CHANGE -275 516 197
48.1 Norwich’s CAR cover ratio at the end of 1998 was slim but it recovered to 2.5
at the end of 2000, even after dividends of R239 million were paid to Fedsure
since 1998. We did not pursue the reasons for the increase, since it is our
considered view that Norwich Life policyholders did not suffer prejudice as a
result of the merger (this matter is addressed in Section G paragraph 108
below).
48.2 Norwich’s Income Statement (see Annexure E3) reflected a decrease in
premium income and an increase in policy benefits (largely increased
terminations), in view of the rationalisation following the takeover in 1998 by
Fedsure.
Financial Services Board Fedsure Life Assurance Ltd Report Page 25 - STRICTLY CONFIDENTIAL - Fedsure Life’s performance since 2000
49 From the beginning of 2001, Investec effectively took over executive
management control of Fedsure Life. The financial performance since then is
set out below:
Table 4 FEDSURE LIFE ASSURANCE LTD Extracts from Quarterly Statutory Returns for Fedsure Life, later known as Investec Employee Benefits Statement of actuarial values of assets and liabilities (R’million) 30/06/02 31/03/02 31/12/01 30/09/01
(after Capital Alliance deal)
30/06/01 31/03/01 (Fedsure Life & Norwich merged)
Assets 27 467 27 863 26 556 28 694 45 564 42 871 Policy liabilities 23 175 23 530 22 792 22 610 41 027 39 842 Other liabilities 1 032 1 810 1 756 4 088 1 610 1 431 Excess 3 260 2 523 2 008 1 996 2 927 1 598 CAR 866 867 963 963 1 226 1 226 CAR Cover 3.76 2.91 2.09 2.07 2.39 1.30
49.1 The increase of the CAR cover ratio during the first quarter of 2002 is notable,
despite the financial markets not showing dramatic recovery after the events
of 11 September 2001.
49.2 The Financial Soundness Valuation Report to the Fedsure Life Board on 30
September 2001, compiled by Raftopoulos, included the following extracts:
“It should be recognised that due to the difficult position that Fedlife is in, and
the development by management of an action plan for the guaranteed fund,
that these principles (i.e. followed in the valuation) are changing as thinking
develops.
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The entire report is based on the results before various final adjustments
made by Investec. (These adjustments increased the excess assets at 30
September 2001 from R1 996 million to R2 381 million.)
The capital adequacy requirement is based on very aggressive management
actions. The asset mix is weighted heavily towards equity and property, and it
is assumed almost all of any fall in these assets is passed on to policyholders
wherever possible through the removal of non-vesting bonuses and/or
declaring lower future bonuses.
The management actions must still be viewed as short-term actions, while the
mismatching position and asset mixes of the various portfolios are being
addressed.
Also, approximately R150 million of the CAR is a result of the current
mismatched position on the non-profit business which should soon be
eliminated.
Fedlife does not have a diversified portfolio of assets supporting its with-profit
business. Therefore the bonuses that are supportable by those assets will not
necessarily meet the expectations of policyholders. Over the last two years
returns on Fedsure’s assets have fallen considerably below those of a
diversified portfolio.
For periods prior to 1 January 2000 high level investigations show that
bonuses were reasonable relative to the returns on the underlying assets.
The removal of non-vested bonuses has not yet been implemented, but is to
be approved by the Board alongside its acceptance of this valuation report. In
lieu of the expected approval, a negative bonus stabilisation reserve has been
held. For this valuation it has been set at negative 10% of liabilities.
Financial Services Board Fedsure Life Assurance Ltd Report Page 27 - STRICTLY CONFIDENTIAL -
While the change in approach will impact policyholders, it should be
remembered that Fedlife had discretion in choosing the assets underlying this
business and it acted in good faith. In addition there is a history of satisfactory
performance except for the last two years.”
49.3 It is evident that since Investec took executive management control, a variety
of measures were implemented to improve Fedsure Life’s difficult position that
was largely caused by an overweight of equity holdings in the financial sector,
and in specific shares in that sector. Although Fedsure Life attempted similar
measures earlier, these were not all feasible or fully successful for a variety of
reasons. (See Section H paragraph 136).
49.4 It should be noted that we found no evidence of Fedsure Life or IEB ever
defaulting on any of their contractual commitments to policyholders or others.
Structure and performance of the Net Main Life Fund
50 In order to understand the relation of the NMLF to Fedsure Life’s entire life
insurance business, it is necessary to consider the breakdown of policy
liabilities.
50.1 The breakdown of Fedsure Life’s policy liabilities from 1997 to the end of 2000
were as follows:
Financial Services Board Fedsure Life Assurance Ltd Report Page 28 - STRICTLY CONFIDENTIAL -
Table 5
FEDSURE LIFE ASSURANCE LTD Breakdown of all policy liabilities (R’million) 31/12/2000 31/12/1999 31/12/1998 31/12/1997 (a) Unitised (L) 10 887 11 097 7 818 9 789 (b) Immediate annuities 5 456 3 971 1 657 1 651 (c) Other non-profit 1 195 336 549 412 (d) With-profit business 8 754 8 745 7 358 6 513 (e) Sinking fund business (L) 316 308 59 219 (f) Structured products (L) 2 094 1 774 550 0 (g) AIDS reserve 47 32 36 0 (h) Bonus stabilisation reserve 0 0 50 500 (i) Other -167 0 0 386 TOTAL POLICY LIABILITIES 28 582 26 263 18 077 19 470
Note: L = Linked
The assets in the NMLF, which included shareholders’ assets (i.e. free
assets), supported the liabilities in respect of the items in (c), (d), (g), (h) and
(i) in Table 5. The remainder of the liabilities constituted linked business and
the Immediate Annuity Portfolio. The liabilities in the NMLF constituted 34% of
the total policy liabilities of Fedsure Life at the end of 2000 (40% at the end of
1997).
50.2 Assets and policy liabilities in the NMLF for the same period compared as
follows:
Table 6 FEDSURE LIFE ASSURANCE LTD NMLF assets and policy liabilities (R’million) 31/12/2000 31/12/1999 31/12/1998 31/12/1997 NMLF policy liabilities 9 829 9 113 7 993 7 811 Free assets 1 358 1 815 2 201 3 124 NMLF total assets 11 187 10 928 10 194 10 935
Financial Services Board Fedsure Life Assurance Ltd Report Page 29 - STRICTLY CONFIDENTIAL - 50.3 Raftopoulos also compiled the following figures in his Actuarial Valuation
Reports to compare the performance of the NMLF with its Norwich equivalent
and a model portfolio:
Table 7 FEDSURE LIFE ASSURANCE LTD Approximate yield % 9 months to
Sept 2001 2000 1999 1998
Net Main Life Fund (excluding Norwich)
-6.1
-4.7
14.0
-4.1
Norwich equivalent of Net Main Life Fund
0.4
8.2
28.0
-3.3
Model portfolio (reflecting leading competitors)
4.1
3.3
31.1
Not
available
50.4 It appears that the imbalance vis-à-vis the model portfolio was a major
contributor to the deterioration of the financial performance of Fedsure Life
since mid-1998. This imbalance appears to have been the result of a
deliberate business strategy on the part of Fedsure Life. The minutes of the
meeting of the Board Investment Committee held on 13 November 1997
reflect the following:
“Whilst acknowledging that management had for some time been addressing,
and was continuing to address the question of where to house Fedsure’s
strategic banking interests, Mr Stocks [at the time the deputy Managing
Director of FEDAM] said that the NMLF had become overweight in financial
services investments and commented on some of the implications thereof .”
The minutes also reflect Basserabie’s response:
“Mr Basserabie acknowledged the points made and noted that the question of
where to house the strategic banking interests was receiving ongoing
consideration. He also noted that the NMLF was in a very strong financial
Financial Services Board Fedsure Life Assurance Ltd Report Page 30 - STRICTLY CONFIDENTIAL -
position, and that Fedsure’s strategic positioning in financial services had
been the major contributing factor to this strength, and in respect of Fedsure’s
ability to raise capital in the recent past.”
50.5 The meeting was attended by nine Fedsure Life directors, namely Basserabie,
Barrow, D Barrow, Bernstein, Hart, Jammine, Mitchell, Sacks, and Van
Staden. It appears from the minutes of the first Fedsure Life board meeting
following this BIC meeting that the matter did not serve on the agenda. There
is no doubt that the specific shares, mainly in Saambou, Investec and Inhold,
had performed well (and were still performing well) to the advantage of both
shareholders and policyholders. They had contributed hugely to the excellent
financial position of the NMLF, and no doubt played a role in the good
standing Fedsure Life enjoyed in the market at the time. There was no
pressing reason to sell the stock.
Furthermore, the holdings in these shares were still regarded as strategic
holdings that fitted in with Fedsure’s long-term plans. (The history of these
investments is dealt with in more detail in Section G below.) A change in
policy only occurred in 2000, when intense efforts were made to sell the
Saambou holding and to reduce the stake in Inhold and Investec.
50.6 It should be mentioned that according to Jammine, he had voiced the
overweight issue to the Board of Directors as early as 1995. Since the end of
1997, management reported regularly to the Board Investment Committee and
Fedsure Investments on the overweight position, and particularly on Inhold,
Investec and Saambou. This reporting appeared to have been largely in
relation to the total assets of Fedsure Life and/or in relation to the total assets
of the NMLF. The more or less collective view of the directors we had
interviewed was that the Board was aware of the issue from the late 1990s
and had considered the matter regularly, but since the company was doing
well, they did not see fit to act, other than monitor the situation. In our view,
the directors had limited perspective on the matter.
Financial Services Board Fedsure Life Assurance Ltd Report Page 31 - STRICTLY CONFIDENTIAL - 50.7 It appears to us that the management (and particularly asset liability
management of the NMLF and the IAP) of Fedsure Life was split between two
distinct compartments, namely the life company (Fedsure Life, responsible for
the policy liabilities) and the investment company (FEDAM, responsible for the
assets). In the remainder of this report, we frequently mention weaknesses in
Fedsure Life’s asset liability management. It is this compartmentalisation,
without adequate harmonisation between Fedsure Life and FEDAM, that lies
at the heart of these weaknesses.
In our view, the most critical aspect of risk management in a life insurance
company is its asset liability management. In this respect, it is our opinion that
the compartmentalisation was a fundamental flaw in the corporate governance
of Fedsure Life. Although it was (and is) common for life insurers to establish
separate investment management companies to manage the assets in their
portfolios, the management of this structure was ineffective at Fedsure Life,
particularly for the NMLF and the IAP – as is discussed in detail in section H.
50.8 It is certainly true that the strategic investments significantly influenced the
performance of the NMLF. The relative weights of these investments from
1997 were as follows:
Financial Services Board Fedsure Life Assurance Ltd Report Page 32 - STRICTLY CONFIDENTIAL -
Table 8 FEDSURE LIFE ASSURANCE LTD Breakdown in strategic holdings in the NMLF (R’million) 31/12/2000 31/12/1999 31/12/1998 31/12/1997 Market values Inhold 2 045 2 576 2 109 2 000 Investec Group 65 105 108 0 FBC Fidelity Bank Holdings 0 0 379 300 Thebe unlisted 176 0 Saambou Holdings 609 636 528 500 Saambou Limited 147 0 0 0 Norwich 844 Inhold & Investec as % of NMLF total assets 18.9% 24.5% 21.7% 18.3% Saambou Holdings & Saambou Limited as % of NMLF total assets 6.8% 5.8% 5.2% 4.6% FBC / Thebe as % of NMLF total assets 0.0% 0.0% 5.4% 2.7% Investec & Saambou as % of NMLF total assets 25.6% 30.4% 26.9% 22.9% Investec & Saambou & FBC as % of NMLF total assets 25.6% 30.4% 32.4% 25.6%
50.9 The large Investec/Inhold weighting begs the question as to whether Fedsure
Life was not in breach of the Investment Regulations published in terms of the
LTIA. Regulation 34 inter alia stipulates that up to 15% of policy liabilities may
be backed by a share of a listed company with a market capitalisation of more
than R2 billion (such as Investec in 1997). In its statutory returns to the
Registrar, any excess over 15% is deemed to be part of the free assets. Our
perusal of Fedsure Life’s statutory returns indicated that the company was
never in breach of the Regulations.
50.10 If 15% of the NMLF’s policy liabilities is considered to be supported by the
Inhold and Investec shares, the remainder of those shares’ values for the
same period is as follows (also expressed as a % of the free assets):
Financial Services Board Fedsure Life Assurance Ltd Report Page 33 - STRICTLY CONFIDENTIAL -
Table 9 FEDSURE LIFE ASSURANCE LTD Weight of Inhold & Investec shares in free assets 31/12/2000 31/12/1999 31/12/1998 31/12/1997 Inhold & Investec in excess of 15% of NMLF policy liabilities R636m R1 314m R1 018m R828m Inhold and Investec expressed as a % of total free assets of Fedsure Life 46.8% 72.4% 46.3% 26.5%
50.11 It is illuminating that at the end of 1999, almost three quarters of the free
assets of Fedsure Life could be argued to have been represented by shares in
effectively one company, namely Inhold (Investec having represented a small
portion). In none of the management or Board reports was this perspective
portrayed. It should be noted that conventional wisdom dictates that the free
assets are that of the company, to do with as it sees fit to the benefit of the
company. The financial services legislative environment does not interfere in
this regard, and nor should it. However, the free assets comprise part of the
security of policyholders. Where such free assets contain little distribution
over different investment sectors and specific counters, it resembles a more
risky situation than with a balanced distribution. This is clearly a consideration
that should be taken into account in the risk management, hence corporate
governance, of a life insurer. We question whether it is proper corporate
governance if the majority of the free assets is effectively represented by one
counter, despite the fact that the calculation of the CAR allows for a material
reduction in asset values.
51 We conclude that the Board of Directors were aware of the overweight
position in relation to the total assets or the NMLF’s assets. However, we
could not find pertinent documentation in which the overweight relative to the
policy liabilities or relative to the free assets of Fedsure Life was illustrated to
the Board. Although the Board was aware of the problem, it does not appear
that management – including the statutory actuary – had informed it
convincingly of the weight of the problem in relation to policyholders’ security.
Financial Services Board Fedsure Life Assurance Ltd Report Page 34 - STRICTLY CONFIDENTIAL -
This raises the issue of whether the Board had adequate information to
manage the problem effectively and timeously. In our view, they did not
receive adequate information during the period 1998 to 2000.
52 It should be noted that in our interviews with the directors of Fedsure Life, it
was established that the non-executive directors in particular were not able to
describe the NMLF in any perspective relative to the policy liabilities and/or the
free assets as set out above.
53 With regard to the overweight position, it is difficult to express an opinion on
the question whether the performance of Fedsure Life, and more particularly
the NMLF, led to any prejudice to the policyholders of Fedsure Life. A life
insurance operation is by its very nature a long-term operation. With
hindsight, it may be argued that it was incumbent upon the executives of
Fedsure Life and the Board of Directors to better manage the overweight
position since 1997. However, a number of directors raised the point that in
1997, and even in 1998 prior to the stock market crash in the last quarter of
that year, members of the Fedsure Guaranteed Fund that retired at the time
would probably have felt very well looked after. (One could argue that retirees
in 1999 and 2000 would have felt the same – see Table 11 at paragraph 131 below.) It is certainly true that the phenomenal growth in the strategic
holdings of Saambou and Investec/Inhold since the early 1990s (see Section G below) had contributed to healthy earnings for both policyholders and
shareholders.
The Russian crisis, the resulting market crash, the liquidity crisis of small
banks in 1999 and the fact that financial shares would fall out of favour could
not have been foreseen at the time.
Financial Services Board Fedsure Life Assurance Ltd Report Page 35 - STRICTLY CONFIDENTIAL - G Strategic Investments and Acquisitions 54 It is impossible to consider the issue whether the interests of Fedsure Life’s
policyholders were properly taken into account without referring to the
strategic investments made by the company since the early 1990s in some
depth. This is due to the fact that the strategic holdings held by Fedsure Life
were housed in the NMLF, in which both policyholder and shareholder funds
were held. There was no physical separation between these two components.
This had the effect that policyholders’ interests were inextricably entwined with
the fortunes of the strategic investments. Generally speaking, we view this
practice as neither good governance nor proper care and diligence as far as
policyholders’ interests are concerned. This issue, specifically as it relates to
Fedsure Life, is further discussed in Section N below (paragraph 294 and
further).
55 Fedsure, as most other life insurers, sought alliances with other organisations
(especially banks), primarily as a source of prospects to buy the products and
services it provided. These alliances were often structured as mutual
shareholding by the organisations. Looking for an alliance in the banking
industry (the local version of the “bancassurance” concept) was not
uncommon at the time – other examples are the still existing alliances
between Old Mutual and Nedcor, Liberty Life and Standard Bank, and the
FirstRand Group (Momentum and First National Bank).
56 As mentioned in Section E, Fedsure embarked on a deliberate growth
strategy from 1993. Obviously, in itself there is nothing wrong with such a
strategy. Prior to that strategic decision, it entered into alliances with both
Investec and Saambou. Apart from these two, the Fedsure Group acquired
strategic holdings in a number of organisations, including:-
Financial Services Board Fedsure Life Assurance Ltd Report Page 36 - STRICTLY CONFIDENTIAL -
First National Bank Sage
Thebe and FBC Fidelity Bank Norwich
SA Druggists and Medicross
57 Fedsure Life had major investments in Investec/Inhold, Saambou, FBC
Fidelity, Sage and Norwich. In this section we deal only with these strategic
investments, and discuss some issues regarding Fedhealth (through which the
connection with SA Druggists and Medicross existed).
Saambou Holdings Ltd
58 According to the directors that were on the Board at the time, Saambou
Holdings Ltd approached Fedsure Life to create an alliance because
Saambou could market Fedsure Life’s products at their branches. There were
synergies to be gained especially in the unit trust market. Fedsure Life
acquired 30% of Saambou in 1990, effectively in exchange for a company
named Planet Finance that operated in the Eastern Cape and which was
valued at R55 million. The Saambou shares were held in the NMLF of
Fedsure Life and constituted less than 2% of the NMLF at that time. Over the
next few years, Fedsure Life increased its stake in Saambou to 45% through
further purchases of shares by the NMLF. In 1997, the Saambou investment
constituted approximately 5% of the market value of the NMLF. As at
31 December 2000, the total book value of Fedsure Life’s shareholding in
Saambou Holdings was R176 million, and the market value was R609 million.
59 Basserabie, Sacks and Barrow served on the Board of Directors of Saambou.
60 According to Basserabie, there was no agreement between Fedsure Life and
Saambou regarding the sale of the Fedsure Life stake. Fedsure Life could in
theory sell part or all of its Saambou shares at any time to anybody.
Financial Services Board Fedsure Life Assurance Ltd Report Page 37 - STRICTLY CONFIDENTIAL - 61 Because of its strategic value, Fedsure Life however never attempted to sell
its stake in Saambou prior to 1999. The reasons furnished by a number of
directors were:-
61.1 It was in line with the strategic view of the Fedsure group to retain this holding.
61.2 The shares were bought cheaply, and they had shown phenomenal growth
through the 1990s. The holding was therefore an integral part of the strong
earnings and good performance of the the NMLF and Fedsure Life until 1998.
61.3 It was a good business decision to purchase the stake, as shown by the
subsequent growth of the share price.
61.4 For two or three years, Saambou Makelaars was in fact the biggest contributor
to Fedsure Life’s individual business.
62 When Investec took over Fedsure, at the beginning of 2001, the NMLF held an
interest of 40% in Saambou. The entire shareholding was retained in the
NMLF, following unsuccessful attempts to dispose of it. IEB distributed the
holding proportionately between the portfolios within the NMLF (such as the
Guaranteed Funds, the with-profit deferred annuities, and the Individual
Smoothed Bonus Portfolio). At the time of Investec’s acquisition of Fedsure,
the shareholding was deemed to be part of the free assets. In December
2001, when Saambou shares were trading at approximately R4.50, the
Fedsure Guaranteed Fund had approximately 46.3 million shares, which
accounted for 4% of the fund.
The shares were written down to zero as at 31 March 2002, following the fact
that Saambou was placed under curatorship (its business was eventually
disposed of to various parties). The shares are still held in the portfolio and if
anything is paid to Saambou shareholders, such a recovery will be for the
account of the policyholders.
Financial Services Board Fedsure Life Assurance Ltd Report Page 38 - STRICTLY CONFIDENTIAL - Inhold & Investec
63 Fedsure Holdings and Investec saw a mutually beneficial relationship in terms
of business and vision. The executives involved in the initial transaction told
us that they were of similar size, and saw certain synergies between the two
groups. An agreement between Fedsure and Investec was signed in
December 1991, with the transaction concluded in 1992. This entailed a
share swap in terms of which Fedsure Life received 27% of Inhold for
R97 million, and 20% of Investec for R128 million. Investec received a 20%
stake in Fedsure Holdings at that stage.
64 The Inhold/Investec purchase by Fedsure Life was funded by a share issue,
capital was raised via Fedsure Holdings, and the total shareholding to the
value of R225 million was placed as part of the excess assets in the NMLF.
No payment was made from the NMLF for these shares.
65 Inhold owned 50% of Investec. Fedsure viewed its Inhold shareholding as the
strategic investment, but Investec shares could be bought and sold freely.
The sale of Inhold shares by Fedsure Life was subject to pre-emptive rights in
terms of which the shares first had to be offered to Inhold, and if they did not
want to buy, Fedsure Life could sell to any party. It appears to us to be less
than good governance to have a policyholder investment portfolio hamstrung
by a condition that limits free trade of assets.
66 The reasons furnished to us for not selling the Inhold stake are similar to that
provided with regard to the Saambou stake. As with the acquisition of the
Saambou stake, the business decision at the time cannot be faulted.
67 Over the years the businesses of Investec and Fedsure turned out to be both
corroborative (for the cross-selling of products) and competitive (for instance,
both developed a substantial asset management capacity that competed in
the market).
Financial Services Board Fedsure Life Assurance Ltd Report Page 39 - STRICTLY CONFIDENTIAL - 68 At 31 December 2000, the NMLF held a book value of R266 million in Inhold,
with a market value of R2.0 billion (which constituted approximately 20% of
the fund). The overweight position that Fedsure Life’s share in Inhold
represented in 2000, forced Fedsure to sell parts of its Inhold stake. The
Inhold share did not trade actively in large amounts and was considered to be
more or less illiquid. Nevertheless, Fedsure succeeded in selling 20% of the
stake in 2000. Basserabie told us that they would have sold another 25%,
were it not for the start of the negotiations that ultimately led to Investec taking
over Fedsure.
69 Following the takeover of Fedsure, IEB dealt with this stake as follows:-
69.1 The shares were sold to other portfolios where asset managers deemed such
a holding appropriate.
69.2 Investec repurchased 35% of the NMLF holding at R160 per share (the
highest recorded price for the year).
69.3 The holding having been reduced by the aforesaid steps by about 40%, the
remaining shares were sold at market value to the shareholders’ fund (on
finalisation of the restructuring of the Fedsure portfolios in early 2002.)
FBC Fidelity Bank Ltd
70 Around 1991, Fedsure Life bought 28% of the shares in Fidelity Bank for
R14 million, out of “petty cash” of the Net Main Life Fund. It was not
principally viewed as a strategic holding, but according to Basserabie Fedsure
was mindful of the opportunities that the holding presented. Through rights
issues and further purchases the book value was increased to R50 million,
and in 1997 the market value was approximately R335 million. Basserabie
told us that these purchases may have been sourced from the NMLF or by
further capital raised, but since the amounts were small it was not much of an
argument either way.
Financial Services Board Fedsure Life Assurance Ltd Report Page 40 - STRICTLY CONFIDENTIAL - 71 In 1997, Fedsure Life sold its stake in BOE for more than R200 million and
acquired a further 15% of Fidelity Bank at a cost of approximately R230
million.
72 At that time Thebe had a stake in FBC Bank. In 1998 FBC merged with
Fidelity and Fedsure Life exchanged their 43% of Fidelity for 35% of FBC
Fidelity. Thebe Group controlled FBC Fidelity, having owned 50%. The
market value of Fedsure Life’s shares in FBC Fidelity was approximately R650
million prior to the market crash in 1998.
73 From the statutory returns, we obtained the following figures for the
investment by Fedsure Life in FBC Fidelity:
Book Value Market Value 31 December 1996 R38.4m R205.3m 31 December 1997 R219.4m R521.0m 31 December 1998 R239.3m R379.2m 31 December 1999 R271.4m R0.0
74 In 1999, FBC Fidelity Bank was put under curatorship and the shares became
worthless.
Financial Services Board Fedsure Life Assurance Ltd Report Page 41 - STRICTLY CONFIDENTIAL - Norwich Ltd
Build-up to the takeover
75 As part of their growth strategy, Fedsure contemplated the acquisition of or a
merger with Norwich possibly as early as 1994. In view of African Life’s
hostile approach to take over Norwich in the beginning of 1998, Fedsure felt
they could do the same, not necessarily in a hostile way. A “desktop” due
diligence was performed by the strategic division of Fedsure Life, and the
Board of Directors of Fedsure Life was approached early in 1998. (It is
understood that a desktop due diligence means the investigation of
information in the public domain on an organisation, without that organisation
necessarily knowing or participating in the supply of information.) Fedsure
officials also consulted with stockbrokers and analysts on the potential of an
acquisition of or a merger with Norwich. Early in 1998 the Board of Fedsure
Holdings approved the strategy to acquire Norwich.
Potential benefits
76 The Fedsure Life directors involved in the transaction told us that a takeover of
Norwich was attractive to Fedsure for the following reasons:
76.1 It would give great impetus to the growth strategy, individual life business
would increase 100%, group business by 50% and unit trust business by
200%.
76.2 Norwich had diversified interests in financial services, similar to Fedsure.
76.3 The two companies had similar target markets. (It should be noted that
Norwich executive management did not necessarily hold this view. Norwich
regarded itself as being more focused on a niche market approach, unlike
Fedsure.)
76.4 Fedsure Life was strong in Gauteng, Norwich was strong in the Western Cape
and Natal.
76.5 Fedsure Life was strong in life broker relations, Norwich was strong in bank
broker relations.
Financial Services Board Fedsure Life Assurance Ltd Report Page 42 - STRICTLY CONFIDENTIAL - 76.6 Cost savings through the removal of duplicate systems and through
economies of scale. These savings were estimated at R150 million per year.
76.7 Relief of the overweight in the financial sector and specific counters in
Fedsure Life’s NMLF.
The takeover transactions
77 The Fedsure Holdings Board decided to proceed by purchasing Norwich
Holdings shares in the market and to approach Charles Davies, Chief
Executive of Norwich. Although a discussion did take place between
Basserabie and Davies, this was apparently not successful and no further
deliberations took place on a possible transaction. In the nature of things, it
was also not possible for Fedsure to perform an on-site due diligence.
78 At the time, BOE and Norwich were engaged in extensive discussions
regarding a possible merger. Executives and staff of Norwich and BOE were
involved in discussions on strategic as well as operational issues. Norwich
staff was under a clear impression that the company was to be taken over by
BOE. Executives and staff of Norwich told us that for various reasons, they
were not keen to merge with Fedsure. It was apparently officially announced in
April 1998 (without Fedsure’s knowledge) that Norwich would become part of
the BOE financial services group.
In the meantime (without Norwich’s knowledge), the possibility of Fedsure,
BOE and Norwich working together was also deliberated by Fedsure and
BOE. (Since this is history, we did not interview representatives of BOE and
do not comment on their role.)
79 By April 1998 Fedsure had acquired 32% of the shares of Norwich Holdings
through purchases in the market, funded by issuing Fedsure Holdings shares
in exchange for Norwich shares. Fedsure’s share price was at an all time high
at that point, which implied that Fedsure was gaining Norwich’s assets on a
very cost-effective basis.
Financial Services Board Fedsure Life Assurance Ltd Report Page 43 - STRICTLY CONFIDENTIAL -
80 By April 1998, BOE owned 28% of Norwich Holdings. They also acquired an
option to buy a 20% stake in Norwich Holdings held by the Norwich
Policyholders Trust. The latter transaction would have been at a price of
R11.00 per share. In having been able to acquire 48% of the Norwich
Holdings shares, BOE was faced with the situation of making an offer to
minorities in terms of the Rules of the Securities Regulation Panel (the SRP).
81 BOE approached Fedsure and a meeting was held at the end of May 1998.
Basserabie, Sacks and Hudson from Fedsure as well as Fedsure’s legal
adviser attended this meeting, which we were told took place at short notice
during the course of one night. The deal was apparently concluded at around
4 o’clock in the morning. The outcome was that Fedsure acquired BOE’s 28%
stake in Norwich, and thereby control of Norwich. That caused Fedsure to
have had to make an offer to minorities, including the Norwich Policyholders
Trust. Fedsure bought the BOE shares at R13 a share and in terms of the
SRP Rules, this was the price that had to be paid to minorities.
82 Davies told us that he was unaware of the negotiations between BOE and
Fedsure, until somebody phoned him to say BOE was going to “greenmail”
Norwich (sell it on for profit). Following the conclusion of the deal, the Chief
Executive of BOE called him the next morning to say that Norwich was now
owned by Fedsure.
Davies’s view was that Basserabie probably did not have a choice but to
conclude the transaction. He told us that it was known in the market that
BOE was not going to pursue a merger. This left Fedsure with a large stake in
Norwich, but with no buyers in the market. Basserabie, on the other hand, told
us that Fedsure had planned the entire transaction well in advance, and that
there was no pressure to conclude the acquisition.
Financial Services Board Fedsure Life Assurance Ltd Report Page 44 - STRICTLY CONFIDENTIAL -
83 There was a legal dispute between BOE and the Norwich Policyholders Trust
regarding the sale by BOE of the Trust’s Norwich Holdings shares. The
dispute centred around the issue whether BOE, in terms of their option, had
the right to sell the Trust’s shares. The Trust further felt it was entitled to
R13.00 a share, and not R11.00 as originally agreed with BOE. The dispute
was eventually settled out of court.
84 Former Norwich executives and staff told us that the announcement of the
takeover came as a big and unpleasant surprise. They were not keen to be
part of Fedsure. Generally, they felt that their company was far more
advanced in administrative practices, “new era” products and technological
innovations than Fedsure. One executive told us that their collective view of
Fedsure was that of a “dinosaur” in the life industry when compared to
Norwich. Unlike Norwich, Fedsure was said not to have basic management
information tools such as a data warehouse and a workflow system.
The price and funding of the purchase
85 Norwich Holdings S.A. Limited was acquired by the Fedsure Group with effect
from September 1998 at a total cost of R3.606 billion. The acquisition of the
equity in Norwich Holdings was settled through an issue of shares by Fedsure
Holdings, Fedsure Investments and Fedsure Life respectively in the amount of
R1.764 billion, and the use of internal resources of Fedsure Life’s free assets
of R1.582 billion plus R260 million from Fedsure Investments. The net result
of these transactions was that Norwich Holdings became a 100% subsidiary
company of Fedsure Life.
Financial Services Board Fedsure Life Assurance Ltd Report Page 45 - STRICTLY CONFIDENTIAL -
Restructuring of the transaction within Fedsure
86 The implication of the acquisition for Fedsure Life at 31 December 1998 was
that the free reserves and/or share capital of Fedsure Life were to be reduced
by the value of the goodwill attributable to the acquisition of Norwich Holdings
in terms of Section 15A of the Insurance Act, 1943. This goodwill amounted to
approximately R2.951 billion, of which the issue of new shares funded
R1.764 billion.
Assuming goodwill was partly eliminated by way of a capital reduction
equivalent to the value of the new shares issued, this was to leave a net
balance of R1.187 billion (i.e. R2.951 billion less R1.764 billion). The reduction
of Fedsure Life’s free reserves or remaining share capital in the amount of
R1.187 billion would have weakened severely the balance sheet of the life
company.
87 Furthermore, the elimination of goodwill at Fedsure Life level would not have
resolved the goodwill problem at Group level. Accordingly it was decided that
the Norwich Holdings acquisition be removed from Fedsure Life to Fedsure
Investments. Hence Fedsure Life effected a capital reduction of ordinary
shares of R1.764 billion issued in respect of the Norwich Holdings acquisition.
The balance of the acquisition cost of R1.842 billion was transferred on loan
account to Fedsure Investments.
88 The net results of these transactions left a situation where the free assets and
capital base of Fedsure Life (prior to the acquisition of Norwich Holdings) was
not reduced, whilst the group wrote off its current total goodwill against
ordinary share premium in both Fedsure Investments (R3.099 billion) and
Fedsure Holdings (R3.277 billion), which arose from the issue of the shares.
Financial Services Board Fedsure Life Assurance Ltd Report Page 46 - STRICTLY CONFIDENTIAL -
89 In terms of the Harmonisation Project whereby South African accounting
statements were being brought in line with international standards, the
amortisation of goodwill by way of a charge to the income statement was
required. That would have affected the Group’s results and the availability of
profits for distribution. It was therefore argued to eliminate the goodwill at
once.
90 The transaction was then carried further as follows:
90.1 D&E Health Benefits was sold to Fedsure Health for R21.942 million
90.2 Norwich Investments was sold to FEDAM for R0.406 million
90.3 Norwich Life was sold to Fedsure Life for R28.194 million
90.4 Norwich Properties was sold to Fedsure Investments for R0.384 million
90.5 SBN Investments was sold to Fedsure Investments for R151.206 million
90.6 Spire Investments (including Claremont Life) was sold to Fedsure investments
for R135.259 million
90.7 Norwich Unit Trusts was sold to Fedsure Investments for R7.711 million.
91 All the above companies (all part of the Norwich Group) were sold at their
carrying value within Norwich Holdings, i.e. there was no profit on their sale.
92 Fedsure Investments then used the cash received from SBN, Spire and
Norwich Holdings to reduce the loan owing to Fedsure Life as follows:
SBN R279.6 million
Spire R360.0 million
Holdings R 70.4 million
TOTAL R710.0 million
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93 It was originally planned that when the share price of Fedsure Holdings
recovered, an issue of shares would be considered to repay the loan between
Fedsure Investments and Fedsure Life. However, early in 1999 Fedsure Life
bought Norwich Life from Fedsure Investments for approximately R1 billion,
and the loan was cancelled.
94 In summary, the Fedsure Group paid R3.6 billion for Norwich, at an average
price of approximately R12.50 per share. Approximately R1.9 billion of the
price was paid for by new issue of Fedsure Holdings shares. The remainder
of R1.7 billion had to be paid for in cash. It was ultimately decided that it
would be most appropriate for Fedsure Investments to acquire Norwich
Holdings, and then to sell to the constituent parts of the Fedsure Group each
company that they had an interest in.
95 Approximately R700 million worth of assets of Norwich that were acquired by
Fedsure was converted to cash. This partly funded the cash portion of the
purchase. The remainder of R1.0 billion therefore had to be paid for in cash,
and this was effected by Fedsure Life acquiring Norwich Life for R1.0 billion,
paid for in cash out of the NMLF. It could thus be argued that policyholders’
funds were used for at least part of the purchase.
96 The stock market fell severely and interest rates rose significantly between
May 1998 and September 1998, when the cash had to be paid. According to
Basserabie, some assets may have been realised for this purpose after the
market crash, which might have incurred losses to Fedsure Life for the cash
part of the Norwich purchase. It should be noted in this regard that at the
Fedsure Life board meeting of 1 October 1998, Raftopoulos outlined “key
measures to protect policyholder and shareholder funds following the market
crash…
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The effect on Fedsure Life’s solvency was not material, but liquidity had come
under added pressure in view of the cash element of the purchase
consideration for the Norwich Group” (as noted in the minutes of that
meeting).
97 The overall financial implication of the Norwich purchase for Fedsure Life was
as follows:
97.1 Fedsure Life paid approximately R1.0 billion for Norwich Life at the beginning
of 1999.
97.2 Fedsure Life received dividends of R107 million from Norwich Life during
1999, and further dividends of R100 million during the course of 2000.
97.3 In 2000, Fedsure Life also received R250 million as a capital benefit from a
reallocation of profits.
97.4 After the merger in 2000 of Fedsure Life and Norwich Life, there was release
to the free assets of approximately R700 million.
98 Viewed in this manner, Fedsure Life paid R1.0 billion and received R1.15
billion back over the course of three years. In addition, Fedsure Life acquired
the value of the Norwich business with an estimated embedded value of
R700 million, including shareholders’ funds.
Execution of the integration
99 Immediately after the deal was signed, a full integration team was assembled
by Fedsure on a full-time basis to effect the integration of the two companies.
This included assistance from a top international consulting firm with specific
integration expertise. We were told that the integration process then followed
a formal and detailed project plan.
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The integration of staff eventually saw very few Norwich employees retained.
100 The integration of computer systems in respect of the individual life business
was a major project that appears to have been ultimately unsuccessful. Group
business was apparently not adversely affected by the takeover as such (and
we did not investigate this aspect in further detail). Based on a review of the
information available to us, it is clear that this part of the merger was poorly
managed. Since it was not possible for Fedsure Life to perform an onsite due
diligence prior to the transaction, they were probably not aware of the extent of
the problem. We were also told of infighting among the respective information
technology teams, empire building and the protection of an alleged IT empire
at Fedsure, a walkout by the Norwich IT team, and a general lack of
leadership and proper project management. In addition, it appears that the
option of running the various systems separately – at least until a proper
decision had been taken – was discarded without due consideration.
We accept that the merger of major systems is seldom an exercise that runs
smoothly, but there is ample evidence of poor management in this instance,
compounded by poor decisions and indecisiveness. For example, for
individual life policies Norwich was implementing a system provided by a firm
called SDT, which they believed to be most suitable for the purpose. Fedsure
Life decided not to continue with SDT, but after some time reversed its
decision and attempted to implement it. According to Jaco Swanepoel,
executive director of SDT, this proved to be very frustrating for the SDT staff.
Eventually the project was abandoned, for which – according to Swanepoel –
“SDT was happy”.
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101 All the Norwich policy liabilities were invested through unitised investment
accounts. This was not the case at Fedsure Life, who was still working
towards this goal. Whereas former Norwich employees claimed that Norwich’s
computer systems were superior to those of Fedsure Life, the unitisation of all
policyholder liabilities was confirmed by the statutory actuary of Fedsure Life
in his Report on the Transfer of Assets and Liabilities of Norwich Life to
Fedsure Life. We view this as tangible proof that at least in some respects the
claims were valid.
However, the above does not say that there were no problems with Norwich’s
systems or records. There were certain deficiencies in its operations that had
to be contended with after the merger, and even after the Investec takeover
two years later. There was a substantial number of non-standardised policies,
which were not recorded on any system and of which it is alleged that only
Beak, the Norwich statutory actuary, actually knew the particulars of. Norwich
employees told us that a collection of these policies were known as “Arnold’s
cupboard”, the term having its origin in the name of the person who looked
after them. In addition, the Norwich records are alleged not to have been as
“clean” as Norwich staff had claimed.
Nevertheless, when IEB reinsured the Fedsure Life individual business to
CAL, it took CAL a relatively short time to transfer all records to its systems,
and to run the administration and investment of the Fedsure and Norwich
policies practically fluently. We view this as an example of what efficient IT
administration and management are able to achieve. In addition, CAL
managed to reduce the IT costs incurred from R10 million a month at Fedsure
to about R2 million a month.
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102 Following the takeover of Norwich Life, it was decided that Accounts were to
be administered from Norwich’s existing offices in Cape Town, while Actuarial
Services would remain in Johannesburg. This proved to be ineffective.
Corporate Actuarial Services complained regularly about the difficulties that
they experienced with data and accounts, particularly from FEDAM but also
from the divisions, i.e. the Individual Life Division and Group Benefits.
Apparent failure of the integration
103 It is our overall impression that Fedsure was ultimately unsuccessful in
merging the two entities operationally, and that the merger of the operations
proved to be more destructive than anything else. With the group’s other
problems at the time, the timing of the merger may have been the proverbial
straw that broke management’s back, and there are some unanswered
questions in this regard. Plain bad luck, such as the market crash in 1998,
also played a role. Be that as it may, minutes of the Fedsure Life board
meetings after the acquisition reflect that problems related to the merger
appeared not to go away. This had major implications for management
efficiency, management time, proneness to errors, and staff morale. From our
interviews, we formed the distinct impression that the human factor played a
major role. It was quite clear that Fedsure and Norwich staff never took to
each other; persons involved in the merger told us that they could never work
together as a team.
104 We find it peculiar that even though Bernstein was the Managing Director of
Fedsure Life, which was to be merged with Norwich Life, he had practically no
active part in the planning of and decision-making relating to the Norwich
transaction prior to its conclusion. This is especially so in view of the fact that
the two respective life divisions were the main components of the merger.
Financial Services Board Fedsure Life Assurance Ltd Report Page 52 - STRICTLY CONFIDENTIAL - 105 With the exception of Brewis, Fedsure eventually did not retain any Norwich
executive that was vested with executive authority. It appears that Basserabie
chose to rely mostly on his former Fedsure management who, generally
speaking, were not able to manage a suddenly much bigger and more
complex organisation. Following the merger, ten executives reported to
Basserabie, and he could simply not keep up with all divisions. With regard to
Fedsure Life (now including Norwich Life), only Bernstein reported to
Basserabie, with the exception of the investment function of Fedsure Life,
which was contracted to FEDAM. The executive in charge of FEDAM,
Derman, also reported to Basserabie.
106 For the envisaged benefits of the acquisition to materialise, it was crucial that
the life insurance operations of Fedsure and Norwich be merged under one
long-term insurance license. This was done in terms of section 37 of the LTIA,
and had to be sanctioned by the High Court. The merger was eventually
concluded with effect from 1 January 2000, but the court order was only
granted in May 2001. Norwich policyholders received an additional once-off
bonus of 4% as well as guarantees with respect to the determination of future
bonus distributions for ten years after the merger, in view of their sacrifice of
benefits under the so-called “90:10 rule”. This rule determined that
shareholder earnings were equal to one ninth of policyholders’ earnings.
Fedsure Life did not have such a rule for its policyholders and shareholders.
107 Fedsure Life had to raise R500 million in capital for the merger to be effected,
otherwise Norwich’s policyholders’ security would have been compromised.
However, after the merger there was a release of capital of R700 million,
caused by the better asset liability matching achieved through the merger.
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108 In our view, the scheme of transfer was a very detailed exercise in terms of
which Norwich policyholders’ interests were properly safeguarded. It should
be noted that this was an enormous exercise involving, inter alia, CAS, an
independent actuary appointed by the Registrar, and the FSB’s long-term
insurance department. Ade Animashahun, at the time a strategist with
Fedsure Life, was specifically tasked to oversee this particular exercise.
109 In order to really reap the benefits of the anticipated synergies, it seems
obvious that Fedsure needed to retain strong members of staff of Norwich. As
Basserabie put it, Fedsure needed the experience of Norwich’s personnel
regarding the systems and procedures of that company. But this would only
have been possible if good faith was established between Fedsure and
Norwich staff members. In our view, it could hardly have been possible to
achieve such good faith on the part of the staff being taken over in the
circumstances that Fedsure took over Norwich. The situation resembled a
forced marriage – at least one party was never given the choice to consent.
110 Although Fedsure believed prior to the takeover that the staff cultures were
similar and hence compatible, this turned out not to be so. It is clear to us that
the problem was far greater than any executive was prepared to admit during
our interviews.
111 Peter Stewart, a senior executive from Norwich retained by Basserabie in an
advisory capacity to assist with the merger, told us that Basserabie refused to
contemplate a suggestion that he needed to strip Norwich, get rid of the staff,
and get the merger over and done with quickly, specifically in view of the clash
of cultures. Persons representing both camps told us that Basserabie was
generally well liked by his personnel, and that he had a reputation of looking
after them. Ironically, by not taking this drastic route and thus forcing the
unwanted marriage, Fedsure appears to have lost considerably in direct and
indirect ways through their original attempt to benefit from synergies in
systems and people.
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112 The Norwich merger had a major negative impact on the Fedsure Group. It is
in our view debatable whether the decision to acquire Norwich was a good
one at the time, given the fact that Fedhealth already proved to be a problem.
Commercially, the transaction may have made sense. In terms of the Group’s
total financial performance, things may have gone differently if not for market
events beyond Fedsure’s control. Executives insisted that the decision was
sound.
However, we are of the view that the implementation of the merger was badly
managed by the Fedsure executives and senior management. Basserabie
agreed that Fedsure’s senior management was simply not able to cope with
the demands of sudden organisational growth. Also, by that time, other
problems in the Group meant that too much management time was being
spent on putting out fires.
Sage
113 Fedsure Life had held Sage shares for many years as an investment. In the
mid- to late 1990s discussions were held with Sage to merge the
organisations, but this did not come to fruition. Eventually, all (or a large part)
of it was sold to lighten the weight of financial shares in the NMLF.
Fedhealth
114 Although Fedsure Life did not own shares in Fedhealth (which was owned by
Fedsure Investments), the acquisition of the medical scheme business
interests that eventually became Fedhealth formed part of the broader
investment and growth strategy of the Fedsure Group. It is common cause
that the administration of Fedhealth was not able to cope with the rapid growth
in the division, and it clearly did not have executive management competent
enough to effectively deal with the problem.
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The problems experienced in Fedhealth received media exposure from the
late 1990s, and according to senior executives, this placed a public spotlight
on the rest of the Fedsure Group.
115 There is no doubt that the dissatisfaction of members and service providers
with Fedhealth’s inability to deliver timeous and efficient services caused
major reputational damage to the Fedsure Group, including Fedsure Life. It
severely affected Fedsure Life’s ability to attract new business. In addition,
the senior executives and some Board members told us that an unacceptable
amount of management time was spent on the issue. In the process, the
Fedhealth problems had dire financial consequences for the Group.
116 It is difficult to determine and assess the financial impact that Fedhealth had
on the business of Fedsure Life. According to the Fedsure Life executives,
there was no direct financial impact; the only effects were the reputational
damage and the loss of management time. Killick, the former Fedsure Group
Financial Controller, informed us as follows:
“In the year 2000 Fedsure Health incurred a loss of about R219 million. The
company was financed by a bank overdraft, a loan from Fedsure Investments
and an interest free current account from Fedlife in the amount of
approximately R141 million. The current account loan was reduced to
approximately R123 million as of 31 May 2001. Shortly after the effective date
of the Investec acquisition of Fedsure, that’s 31 May 2001, all amounts due by
Fedhealth were repaid to Fedsure Investments and Fedlife. Other than this
temporary interest free current account balance to Fedhealth, there were no
other negative effects of the position of Fedhealth on Fedlife.”
It may be argued that Fedsure Life was financially prejudiced in that it did not
receive interest on the current account loan on repayment, but the amount
involved is relatively insignificant and the impact on policyholders’ interests
would have been negligible.
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117 According to Bernstein, at the beginning of 2000 he and Raftopoulos heard
that Fedsure Life was paying Fedhealth staff’s salaries, also by way of a loan.
He said that both he and Raftopoulos “went ballistic” the moment they heard
the news, as this was done without their knowledge. They immediately
requested Basserabie to see to it that the practice was terminated (which it
was).
118 Fedsure Life was also earning premium income through Medway, which was
associated with Fedhealth and which also came under pressure due to
Fedhealth’s problems.
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H Fedsure’s Investment Management Mandate of the Board Investment Committee
119 The Board Investment Committee accepted its (revised) mandate on 3 August
1995 as follows (this mandate was confirmed on 6 May 1997 and we did not
find evidence of further changes since that date):
- “To approve the future investment strategies for the various portfolios
managed by FEDAM and Fedprop, taking into account the current
investment environment, expected trends and their potential impact on
asset values in both the near term and the longer term.
- To review the actions of management over the period since its previous
meeting.
- To consider, approve or otherwise investments which fall outside of
management’s authority.
- To refer specific matters to the main board in its discretion.
- To report on its deliberations to the main board at its next meeting.”
It is notable that there was no reference to the assets being invested in the
interests of policyholders, although this is probably implied. We consider it to
be an omission and oversight that there was no reference to asset liability
matching in this regard. Nevertheless, interviews with members of the board
(executive and non-executive) and management left us with the impression
that, all along, they were intent on running a sound life insurance operation for
the benefit of policyholders, and consequently for shareholders to reap
benefits therefrom. (For our views in this regard, see paragraph 292 below.)
Financial Services Board Fedsure Life Assurance Ltd Report Page 58 - STRICTLY CONFIDENTIAL - 120 In Basserabie’s testimony he indicated that the Board Investment Committee
was informed by FEDAM that for the NMLF the main purpose was to meet the
bonus expectations of the policyholders.
Although the BIC had certain designated members, its meetings were usually
attended by a large number of other executives and members of
management. Hence, even if it was not formally stated in the BIC’s mandate,
it was understood that the purpose was to meet policyholder bonus
expectations.
Asset liability management – in principle
121 The investment management of a life insurer should largely be dictated by the
nature of its liabilities. The manner in which investment policy and practice
are set to reflect the nature of the liabilities is referred to as asset liability
management.
122 Fedsure Life conducted its asset liability management according to the
following principles (taken from a memorandum by the valuator to the board of
directors of Fedsure Life, dated 5 March 1998):
“The general principle which Fedsure Life follows is to match the investment
profile of the liability with suitable assets. In this regard they have categorised
their liabilities into various risk profiles and corresponding to each of these is a
portfolio of suitable assets. To deal with exposure to a particular counter or
group of counters, limits exist which are adhered to by the fund managers.
Below is an outline of how these principles are applied in practice.
(a) Short-term liabilities
These liabilities are matched by money market instruments and short-term
bonds. Examples of these liabilities are death and disability benefits and
guarantees under certain products.
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(b) Immediate annuities
In the case of immediate annuities they purchase bonds and other fixed
interest instruments to match the cash flow of new business. Once every
year they review the entire portfolio with reference to the assets and
liability cash flow, because of movements during the year, and restructure
the portfolio to optimise the match of cash flow between assets and
liabilities.
[It is notable that there is no mention of matching by term.]
(c) Savings
Most of the contracts they sell are for long-term savings. In this regard they
rely primarily on equities and to a lesser extent on medium and long-dated
bonds, properties and money market instruments. The growth portfolios
with the highest level of guarantee will in general have the highest level of
bonds and money market instruments. For portfolios with no guarantees,
there is no need to have bonds.
(d) Derivatives
Derivatives are used for hedging purposes.
(e) Prudential Investment Guidelines
In all cases they follow the statutory investment guidelines.
Comparisons of assets by category are made with those of other life
insurers and in general Fedsure Life is in the middle of each category.
While this comparison depends on the composition of the liabilities, it is
nevertheless useful as a benchmark against other companies.
Financial Services Board Fedsure Life Assurance Ltd Report Page 60 - STRICTLY CONFIDENTIAL -
The Net Main Life Fund has the dual function of providing for the interests
of policyholders and shareholders. After meeting the policyholders’ bonus
requirements and setting up prudent reserves, the balance is held on
behalf of shareholders. This enables them to avoid a conflict of interests
between policyholders and shareholders and provides flexibility in dealing
with the needs and expectations of the various parties.
While there is merit in being overweight in certain counters, and this has
served them extremely well in the past and especially during 1997, it would
be imprudent to depart from the principle of limiting their holdings of
specific counters, except in special cases. As at 31 December 1997 they
only had one such special case which was the Investec Group and the
value of their holding on that date was R2 658.4 million, which was 27% of
the value of the Net Main Life Fund and 13.4% of the value of their total
investments. This can be compared to their free assets of R3 124 million.”
123 The mandates to FEDAM for investments of the linked funds gave them
complete freedom to buy and sell specific counters within the mandate.
FEDAM may not, however, have done so with all the investments backing the
liabilities in the NMLF, because some of these investments were strategic
assets backing both policyholders’ and shareholders’ funds (such as the
Inhold shares). This is in our view a contradictory principle in looking after the
interests of linked versus non-linked policyholders. Our opinion regarding the
physical separation of shareholders’ and policyholders’ assets is obviously
also relevant in this context.
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124 Fedsure Life performed its investment activities, broadly speaking, in the
following manner:
124.1 Investments of market-linked policies were conducted by FEDAM with
mandates and with unitised funds.
124.2 A specific portfolio of assets was identified and managed by FEDAM for the
Immediate Annuity Portfolio.
124.3 The Net Main Life Fund constituted the balance of the assets of Fedsure Life.
Within Fedsure Life the NMLF also served as the “bank account” or general
ledger through which all income and expenditure transactions were
conducted. Strategic investments were made out of the NMLF, typically
without the transaction going through FEDAM. When there was positive
cashflow, FEDAM would be given part of it to invest after other cash or
strategic investment needs were met. The NMLF also served as the bank
account of the market-linked portfolios. In other words, the NMLF provided the
outstanding expense accounts (see Annexure D Paragraph 5).
124.4 Fedsure Properties was a separate company that managed the property
investments, but they reported to FEDAM. Hence FEDAM consolidated the
property portfolios into the other asset portfolios which backed policyholder
liabilities. Property valuations were done internally, but JH Isaacs, an
independent property management company, was retained to do independent
valuations on a selection of properties every two or three years.
125 It is evident that the management of the NMLF was a pivotal aspect of
Fedsure Life’s business. The NMLF included the assets backing the non-
profit and smoothed bonus policy portfolios, and it included the free assets
(i.e. shareholders’ funds). There were no unitised investment accounts
attached to these policyholder liabilities.
Financial Services Board Fedsure Life Assurance Ltd Report Page 62 - STRICTLY CONFIDENTIAL - 126 The Board of Directors of Fedsure Life saw it prudent not to have a split of
policyholder and shareholder assets. Directors informed us that their entire
approach in principle was meant to solely serve policyholders’ interests. We
discuss this approach at paragraph 292 in Section N below.
127 Although Bernstein, the Managing Director of Fedsure Life, served on the
Executive Investment Committee, the investment function did not fall under his
control, since most investments were managed by FEDAM and Fedsure
Properties. Those executives ultimately reported to Basserabie. Bernstein
was not a member of the Board Investment Committee (although he attended
its meetings). The strategic investments were decided on at Fedsure Holdings
board level, of which Bernstein also was not a member. Strategic investment
decisions appear to have been discussed at Fedsure Investments and
Fedsure Life board meetings as well.
Hence the Managing Director of Fedsure Life was effectively not in charge of
investments in his company, yet he was responsible for the company. We
view this structure as a fundamental corporate governance failure in respect of
the management of the life company, and particularly the management of the
NMLF. (It should be mentioned that the external auditors, PWC, had in fact
brought a fairly general lack of clear reporting lines in Fedsure to
management’s attention.) In our view, Basserabie, as the ultimate decision
maker in that reporting line, should have addressed this matter. (See also our
comments at paragraph 134 below.)
Performance comparisons
128 The team at FEDAM proved to be successful until 1998, as shown through the
investment performance comparisons below in Table 10. However, the team
appeared not to have been able to function effectively in a bear market
environment, such as the one from August 1998, and was unable to recover in
1999. Patrick Ho, the Chief Investment Officer of FEDAM at the time, said
Financial Services Board Fedsure Life Assurance Ltd Report Page 63 - STRICTLY CONFIDENTIAL -
that in 1999, when the equity market went up by about 60%, FEDAM asset
managers only gave about 50% returns, and “didn’t shape up”.
Table 10 FEDSURE LIFE ASSURANCE LTD Fedsure Managed Fund – position relative to the market as surveyed by ABSA Consultants and Actuaries for single premium investments for terms of one, three and five years ending on the measurement date
Measurement date One-year Three-year Five-year Jan 1998 8/40 12/33 7/24 Apr 1998 2/32 6/32 6/24 Oct 1998 6/34 8/34 5/25 Jan 1999 8/33 9/33 4/25 Apr 1999 18/35 10/35 5/27 Jul 1999 21/38 11/38 7/27 Oct 1999 35/39 7/39 6/39 Jan 2000 34/42 8/42 12/32 Apr 2000 36/43 13/43 13/32 Jul 2000 43/44 15/44 18/33 Oct 2000 48/49 30/49 19/34 Jan 2001 37/51 40/51 25/33 Jul 2001 25/48 39/48 20/34
(For example, Fedsure Managed Fund ranked number 7 out of 24 funds for the investment
performance over five years to January 1998.)
The nature of the market-linked portfolios (such as the Managed Fund referred
to in Table 10) is such that life insurers only utilise the earnings obtained from
those designated portfolios of assets in their allotment of investment
performance to such policies. It would be in breach of the policy contract were
they to do otherwise.
130 In contrast to the linked policies, life insurers are not restricted to use only the
earnings of the designated portfolio of assets (if such a portfolio indeed exists)
in declaring bonuses on smoothed bonus policies. In good times, it is entirely
within their rights to declare less, and in bad times more. The entire
shareholders’ assets are in theory also available to declare bonuses on
smoothed bonus types of policies.
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131 The investment returns allocated to policyholders through bonuses of the
Fedsure Guaranteed Fund (FGF) are reflected in Table 11 below (prepared at
our request by IEB), which also compares them with that declared by
competitors. Note that this is the return allocated to policyholders; it does not
reflect the performance of the underlying assets.
The comparison has been made against similar products and against the
returns of market-linked funds (i.e. the Fedsure Balanced Fund) and average
market-linked balanced fund performance as shown in the Alexander Forbes
Large Manager Watch (LMW).
It is important to recognise the difference between a guaranteed fund and a
market-linked fund. A guaranteed fund demonstrates lower returns to cater for
the cost of the guarantee and also has a higher component of cash and/or
bonds to provide for the guarantee. On the other hand, market-linked funds
generally have a higher equity component and higher returns to compensate
the investor for downside risk. Long-term returns on market-linked funds may
not necessarily be a good comparison, as disinvestments/withdrawals may
occur at a point in time when market conditions are particularly adverse and
losses have to be incurred.
In addition, not all guaranteed funds are similar. The FGF is now a fully
vested fund and does not have a non-vesting component, whilst other
guaranteed funds still have non-vested components which can be reduced or
removed due to market conditions.
Against this background, the salient features of the results are as follows (a
comparison over a long period was difficult due to a lack of comparative data):
Financial Services Board Fedsure Life Assurance Ltd Report Page 65 - STRICTLY CONFIDENTIAL - Table 11 Rates of Return Comparison for Selected Funds
Year
Fedsure Guaranteed
Fund
Metropolitan Life (Old Series)
Old Mutual Guaranteed
Fund
Sanlam (Stable Bonus)
* Alexander Forbes LMW
* Fedlink Balanced
Fund
1980 14.10% 9.75% 1981 17.00% 15.12% 1982 17.25% 22.80% 1983 18.00% 15.68% 1984 18.00% 6.86% 1985 18.00% 21.78% 1986 19.25% 27.98% 1987 19.50% 19.75% 22.75% 18.95% 13.16% 1988 19.25% 18.25% 17.75% 18.75% 11.07% 1989 20.75% 20.00% 21.75% 19.00% 26.21% 1990 19.75% 19.00% 21.75% 19.00% 7.00% 2.39% 1991 20.75% 20.25% 20.75% 21.00% 27.30% 27.66% 1992 16.75% 19.50% 19.75% 20.00% 9.40% 7.76% 1993 17.00% 17.75% 15.75% 15.75% 35.00% 32.96% 1994 17.75% 20.00% 17.75% 18.50% 17.20% 17.88% 1995 15.25% 17.25% 14.65% 14.75% 14.70% 14.80% 1996 18.00% 18.75% 19.65% 17.75% 8.20% 5.22% 1997 17.50% 17.00% 18.15% 14.50% 7.90% 13.22% 1998 7.00% 7.65% 6.65% 4.65% -1.90% 3.32% 1999 12.00% 8.65% 9.65% 17.08% 41.60% 30.18% 2000 0.00% 14.29% 15.65% 13.58% 3.60% 1.40% 2001 -12.00%# 13.30% 15.15% 13.08% 5.80% 19.25%
IRR **since 1990 (Single) 13.22% 17.62% 17.79% 17.27% 15.34% 15.56% IRR since 1990 (Level) 11.49% 17.70% 17.86% 17.42% 15.62% 16.68% IRR since 1980 (Single) 15.52% 16.17% IRR since 1980 (Level) 14.95% 16.40%
Note: * These rates are net of charges of 2.5% on the LMW and the Fedlink Balanced Fund. ** IRR: Internal Rate of Return, per annum # This consisted of a nil vesting bonus declared, and 12% of non-vested bonuses cancelled.
Financial Services Board Fedsure Life Assurance Ltd Report Page 66 - STRICTLY CONFIDENTIAL -
The figures above are provided to state the facts regarding Fedsure Life’s
investment performance for policyholders. Our comments on this
performance are given in Section N below (from paragraph 302).
The management of the Net Main Life Fund
132 The FGF was part of the NMLF, together with with-profit deferred annuities
and other non-linked and non-immediate annuity policy liabilities. The
management of the NMLF is thus critical in understanding the declaration of
bonuses on, for example, the FGF.
133 Basserabie indicated that the NMLF was the responsibility of Bernstein, yet
Bernstein had no say in any of the strategic investment decisions, although he
was aware of the transactions. He attended BIC meetings and was a member
of the EIC. By Bernstein’s testimony, to be in attendance is not the same as
being a member of the Board; he was not a member of the Fedsure Holdings
board where the strategic investments were approved.
134 Even taking into account the complexities of a large company, structurally the
asset/liability management of the NMLF was awkward, to say the least, in the
light of the following:
134.1 The non-executive directors did not have a clear view on who was ultimately
responsible for the NMLF – mostly their (default) view was that it must have
been the Group chief executive, Basserabie.
134.2 Basserabie, in testimony and in minutes of the Operating Committee /
Financial Committee in no uncertain terms indicated it was the responsibility of
the MD of Fedsure Life, Bernstein.
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134.3 Bernstein testified he had no executive responsibility regarding investments in
the NMLF. FEDAM was owned by Fedsure Investments and ultimately by
Fedsure Holdings. Bernstein was not on the board of Fedsure Holdings,
although he attended the meetings of the boards. Although the company
records indicated that he was a member of the board of Fedsure Investments,
when interviewed he was actually not sure that he was.
134.4 The MD of FEDAM, Derman, reported to Basserabie.
134.5 Raftopoulos was a member of the EIC, but never served on the BIC or the
boards of Fedsure Investments or Fedsure Holdings.
134.6 There was no separation of shareholder and policyholder assets in the NMLF.
134.7 All shareholder assets were in the NMLF.
134.8 There was no centralised comprehensive regular reporting on the state of the
asset liability management in the NMLF, other than in the actuarial reports.
134.9 The NMLF served as the bank account for all the portfolios in Fedsure Life
(and to some extent in the Fedsure Group).
134.10 The NMLF was discovered as being used to pay salaries for Fedhealth and
TMA. When discovered by Bernstein he objected violently to Basserabie, who
then stopped it.
134.11There were apparently major problems with the reconciliation of assets and of
liabilities within the NMLF and between the NMLF and other funds of Fedsure
Life.
135 Regarding the point in paragraph 134.11, the following is quoted from Minute
6/1999 of the Board Investment Committee, held on 30 November 1999:
“Net Main Life Fund: Mr Barber updated the committee on the progress being
made with the reconciliations between bank and ledger accounts in Fedsure
Life. It had been decided to employ the external auditors to assist in this
regard.”
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Furthermore, in Corporate Actuarial Services’ monthly report to the Operating
Committee for the period ending 21 February 2000, Raftopoulos wrote:
“The lack of an integrated corporate ledger and asset management computer
system is providing set-backs for managing the business because of the
unavailability of data.”
We came to the conclusion that it was the joint duty of Raftopoulos, Bernstein
and Derman to perform the asset liability management of the NMLF, but that
Basserabie held the ultimate responsibility (Bernstein and Derman ultimately
reported to him). They were all hamstrung by the strategic investments.
There was no comprehensive automated reporting or accounting system in
terms of which the total position of the assets and liabilities could be monitored
on a regular basis. At every actuarial valuation a view was simply taken on
the total assets excluding those backing the market-linked policies and the
immediate annuities, and those assets were compared to the remaining policy
liabilities. Even this exercise was a difficult one to perform, especially after the
Norwich takeover.
Measures to address shortcomings in the management of the NMLF
136 From 1999, minutes of meetings of various forums reflect that there were
actions taken to address the concerns regarding the management of the
NMLF. For example, PWC would have been appointed to do a major
accounting system for the NMLF, but this was stopped in the light of the
Investec takeover of Fedsure.
137 On 17 November 1999, Raftopoulos wrote a memorandum to the Fedsure Life
board on the projected financial position as at 31 December 1999. The
following is quoted from that memorandum:
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“1. The NMLF provides the benefits for policyholders with non-linked policies
and for shareholders. It is currently underperforming relative to our needs
and below is an explanation.
2. Following the financing of about half of the purchase of Norwich Holdings
from the NMLF and the August 1998 market crash, the NMLF has
temporarily lost its balanced structure (meaning, inter alia, around 70% in
equities vis-à-vis the model portfolio’s 55%). It is underweight in gilts and
money market assets and overweight in equities in general and in financial
counters in particular. With the current lower than expected growth of our
largest holdings of strategic shares and the loss in value of our holdings in
FBC/Fidelity, the year-to-date performance (1/1/1999 to 30/10/1999) of the
NMLF is around 3%. This has implications in the following areas for the
financial year ending 31/12/1999, unless there is a marked increase in the
values of certain shares:
i. It will be necessary to use a negative bonus stabilisation reserve to
provide competitive bonuses and to demonstrate solvency.
ii. Our free reserves will be reduced relative to those of our competitors
but it will be possible to pass the dividend test which is a prerequisite
for the payment of dividends.
3. The situation should be looked at in perspective. Although the values of
certain counters concerned are very low, there is nothing fundamentally
wrong with these counters (other than FBC/Fidelity) and it would be
reasonable to regard the situation as being of a temporary nature.
Management is in agreement with this point of view.
4. To maintain premium income and to increase it, it is essential that we
increase bonuses which are in line with those of our leading competitors.
This would require bonuses of around 10% on a gross basis with suitable
adjustments for expenses, tax and profits for each class of business and
would necessitate the use of a negative bonus stabilisation reserve which
Financial Services Board Fedsure Life Assurance Ltd Report Page 70 - STRICTLY CONFIDENTIAL -
is generally accepted actuarial practice and is also acceptable to
investment analysts. In this regard it should be remembered that Fedsure
Life has been fortunate in not having to use this measure so far, while it is
believed that all our leading competitors have done so.
………….
7. Management has and continues to treat the rebalancing the NMLF [sic] as
one of Fedsure Life’s top priorities. The approach agreed upon is:
a. Do not sell equities because of the large upside potential expected
during 2000.
b. Use future net inflows to reduce the ‘overdraft’ of the NMLF.
c. After achieving (b) invest future contributions for the NMLF into money
market assets and very short dated bonds whenever possible, from
cash inflow.
d. Sell some property at suitable prices over a period of 12 months. Invest
the proceeds in suitable money market assets and bonds. In this regard
it is planned to sell around R1.0 billion of property over the next 12
months when suitable opportunities arise.
e. Re-allocate strategic assets to other portfolios and sell small holdings of
these when market values of shares have reached suitable levels to go
into cash and then bonds when interest rates are high enough.”
The strategy in (b) and (c) could possibly be argued to have been unfair
towards new policyholders or new money. New investors would obviously
wish to enjoy the benefit of buying in at the reduced share prices following the
1998 market crash, and not merely earn overdraft interest rates. This matter
is more fully discussed at paragraphs 142 to 147 below.
138 On 21 May 2001, that is after Investec effectively took control of Fedsure Life,
Raftopoulos wrote a memorandum to the Boards of Directors of Fedsure Life
and Norwich Life in which he reported on the management action approved by
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the board at a meeting held on 8 March 2001. Amongst a long list of items, he
reported the following:
“The NMLF is being restructured in stages to deal with the closing of the
smoothed bonus business to future contributions from existing schemes.
Contributions from new schemes will be diverted to other investment
portfolios. This suggests a more liquid investment strategy to deal with asset
outflows to other investment houses and to other Fedsure Investment
Portfolios. Where possible assets in the NMLF will be sold to other portfolios
which are expected to grow in future.”
He furthermore reported on a variety of measures to rectify the mismatching or
imbalances in the various portfolios of the NMLF and IAP. These were:
138.1 Around R130 million of tradable equities were to be sold in the market as
conditions permitted.
138.2 Following the merger with Norwich Life, an injection of R600 million of cash
was being housed in the NMLF. This would have been moved to the annuity
fund to eliminate the shortfalls in that fund.
138.3 Investec had provided proposals for securitising property.
138.4 Agreement was needed to sell some of the properties Fedsure Life and
Norwich Life held over the next 3 – 4 years to reduce the exposure to
property.
138.5 Investec was negotiating with prospective buyers about the sale of Saambou.
138.6 The NMLF would be subdivided in nine portfolios with a view to achieving our
cashflow objectives through suitable matching of assets and liabilities to
enable Life and Group Benefits to each manage their own balance sheets.
138.7 Regular meetings were held to ensure that they were on track to meet their
objectives.
138.8 The Inhold shares were being allocated to other investment funds to the extent
permitted by the mandates to reduce the concentration in the NMLF.
Financial Services Board Fedsure Life Assurance Ltd Report Page 72 - STRICTLY CONFIDENTIAL - 139 Revisions to business plans were also being put in place. These were:
139.1 In the case of the Individual Life Division, there was a curtailment of new
business to assist with financial soundness.
139.2 In the case of Group Benefits, the smoothed bonus fund was not accepting
future contributions, which would have been directed to other funds.
139.3 New products were being developed with low capital requirements.
139.4 Investment mandates had been reviewed to take account of the new situation.
139.5 Their rates for immediate annuity business were made less competitive than
they used to be.
140 The overweight and imbalanced position in the NMLF is discussed in
Section F above. Fedsure Life could have taken a number of possible actions
to alleviate this position in the NMLF. In summary, these were:
- using the Norwich Life/Fedsure Life merger to spread assets
- selling of the entire Saambou shareholding
- selling of part of the Inhold & Investec shareholdings
- selling property
- buying derivatives
- selling to linked portfolios.
141 The period between November 1999 and May 2001 was a turbulent one for
Fedsure Life. It is notable that the board and management of Fedsure Life
were fully aware of the situation in and their options regarding the NMLF at the
end of 1999. However, it appears as though pertinent action was only taken
once Investec took control from 2001 (or following commencement of the
takeover talks in 2000).
Considerations for closing the NMLF to new business in 2000
142 Since it was possible to effect the measures of correcting the NMLF to a large
extent in 2001, we question whether this was not possible a year earlier, in
which case fewer policyholders and less policyholders’ money would have
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been negatively affected through the various deficiencies in the asset liability
management of these portfolios.
This raises the concern whether Fedsure Life really acted in the best interests
of new policyholders enrolled during 2000, and new money invested by
existing policyholders during 2000. Single premiums of R4.8 billion were
written in 2000 and recurring premium income increased from R3.134 billion in
1999 to R3.284 billion in 2000, which includes the Norwich Life business. The
policy liabilities were as follows:
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Table 12 FEDSURE LIFE ASSURANCE LTD Policy liabilities (excluding Norwich Life business) – R’billion
31 Dec 2000 31 Dec 1999 Linked portfolios 13.3 13.2 IA Portfolio 5.5 4.0 NMLF 9.8 9.1
143 It was reported to the Fedsure Life Board in February 2001 that the Life
Division showed a modest increase in 2000 over 1999 in both single premium
and recurring premium new business. Furthermore, Group Benefits exceeded
their 2000 budget in single premiums but were significantly below their (very
ambitious) recurring new business targets.
144 It is evident that some new money must have been invested in the NMLF
since there were claims as well as significant policy surrenders and other
terminations. Ade Animashahun of IEB estimated that almost R1 billion of
new money could have been put into the NMLF during 2000.
145 We put the question to the directors whether it was appropriate to invest new
money in the policy portfolios of the NMLF in 2000. The responses of
Basserabie, Bernstein and Raftopoulos, in summary, were that new
policyholders would have participated in the expected upswing of the market,
and it would have been a major blow to the image of Fedsure to take such
drastic action at that stage. Raftopoulos’s full answer, in a document dated 23
November 2002, was as follows:
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“The memo of 17 November 1999 was based on data as at 31 October 1999
and contained a projection to 31 December 1999. During the two months
between 31 October 1999 and 31 December 1999 the ALSI increased
substantially and this impacted shares in the NMLF. Based on projections at
31 October 1999 it was difficult to see how bonuses could be afforded but with
the benefit of hindsight Fedsure Life earned 14% on the NMLF and declared
bonuses of 12% without the use of negative bonus smoothing reserve. Other
insurers did better according to our model portfolio and earned 31% because
their portfolios were balanced and they did not have losses of the FBC/Fidelity
and Thebe magnitude.
The other factors that played a role in this decision was the increase in the
Dow Jones Industrial average in the last quarter of 1999 and the high
international interest rates which were expected to reduce and it was hoped
that there would be a spin off effect on the JSE which would increase the
values of the NMLF financial shares.
The other key factor was the effect that closing a fund to new business would
have on the confidence and hence the benefits of policyholders, with the
illiquid situation of the NMLF. The view of management all round was that a
closure would result in a liquidity crises with severe consequences for
policyholders. At the end of 1999 it was very difficult, if not impossible, to sell
properties and I personally believed that it would have been a miracle to
obtain 50% of their market value if sold over a period such as two years.
Further, negotiations with Liberty for a merger had failed and the CEO was
trying to find other merger partners, to protect the policyholders’ interests.
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At the end of December 2000 there was a very different situation. Below are
some of the key points;
- Fedsure Life was forced to make large asset writedowns.
- The return on the NMLF had declined to minus 4.7% at the end of 2000
and according to the model portfolio was 3.3%.
- The surplus assets at 31 December 2000 were much lower than those at
31 December 1999.
- Fedsure’s competitors were expected to declare high bonuses and in fact
did so.
- Fedsure’s competitors had higher surplus assets because of their better
comparative performance during 1999.
- At the end of 2000 Investec had indicated that they would take over control
of Fedsure Life.
- Fedsure Life was not able to obtain adequate new capital to continue
writing this with profit business, even after the injections made by Investec.
From the above you can see that the situation had changed fundamentally
from 31 December 1999, which made it impossible to continue writing this
business. In this regard please see paragraphs 11.1, 14.4, and 14.6 of the
actuarial report to the board as at 31 December 2000. (I wish to reiterate my
view that the interests in Thebe, FBC/Fidelity, Norwich and the other asset
concentrations contained the seeds of Fedsure’s downfall and without those
assets Fedsure would still have been in business today.)
The memo of 21 May 2001 is a follow up of actions required in terms of the
valuation report.
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It is a pity that no formal conclusion was noted in the board minutes for the
meeting in November 1999, but I believe that the explanation given above
about Fedsure Life expecting improved conditions and the liquidity issues
facing the NMLF give credence to the fact that it was not in the policyholders’
interests to close the NMLF to all new contributions around January 2000. I
recall a discussion on this issue at the November 1999 board meeting,
especially with reservations being expressed about the feasibility of selling
property and the board must have agreed to accepting new contributions
because of the negative effects a cessation of these would have had on
policyholders’ interests and there was no communication about any cessation
of new contributions. To substantiate this conclusion, there would have been a
lot of internal activity and external publicity had it been decided by the board to
stop accepting new contributions for the NMLF.
A point to note is that while there was a significant inflow of premiums there
was also a significant outflow.”
It appears that the possibility of closing the NMLF to new money from early
2000 was not a consideration presented to the Fedsure Life board. Neither
does it appear that the board considered this from its own initiative.
146 In hindsight, the new money invested in 2000 in the NMLF turned out to have
suffered the gravest negative financial impact among Fedsure Life’s
policyholders. Our opinion on this issue is discussed in Section N (from
paragraph 308).
147 The rebalancing of the NMLF from 31 December 2000 was taken further by
Investec and is discussed in Section J.
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Mismatching in the Immediate Annuity Portfolio
148 The mismatching in the IAP discovered at the end of 2000, despite the
theoretically acceptable asset liability management situation, questions the
true ability of Fedsure Life to have performed proper asset liability
management within this portfolio. Raftopoulos wrote in a document of
1 March 2001 to the Board of Fedsure Life that “because of inadequate control
and misunderstandings the immediate annuity portfolio became
mismatched…”
The mismatch had two elements. Firstly, the term of the assets was shorter
than the term of the liabilities. Secondly, the valuation basis had to be
strengthened for the expected longer longevity of annuitants.
Criticism of FEDAM operations
149 Operationally, FEDAM was criticised severely by CAS and by the external
auditors. The situation prior to 1998 is not known to us. It is possible that the
Norwich takeover was the sole or major contributor to administrative failures at
FEDAM.
Writedown of property values
150 The continual writedown of property values by the FSB, the external auditors
and eventually by Investec during the take-over, puts a question mark over the
real quality of the valuations of Fedsure Properties. This is despite the fact
that they had J H Isaacs regularly performing independent valuations. We did
not investigate this in further detail.
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I Fedsure Life Operations
Board of directors
151 Fedsure Life was governed by its Board of Directors as set out in Section F above. Basserabie was Chief Executive Officer of the Group. Bernstein was
the managing director of Fedsure Life. Two executive directors were in
charge of the Individual Life Business (Brewis from 1999) and the Group
Business (McGinn) respectively, reporting to Bernstein. Raftopoulos, valuator
and statutory actuary also reported to Bernstein. Raftopoulos later joined the
Board of Directors. A separate operational report was produced for the Credit
Life business by N Beddington (not a member of the Board). These four
appeared to be the major operational divisions of Fedsure Life, while the
investment function was contracted out to FEDAM.
152 Board meetings took place every quarter. There were also a number of
special board meetings. Reports on the operational activities of the company
were made to every board meeting and presented in a document titled
“Business Plan Review”. The accounting function appeared to have been split
between the Individual Life and the Group Benefits divisions, each responsible
for its own accounts. Killick, Group Financial Controller, was responsible for
all the financial aspects (excluding investments) of the group. His duties
included the preparation of accounts and attending to tax issues. Killick
reported to Barber, who reported to Basserabie.
The statutory actuary
153 Raftopoulos, as valuator and statutory actuary, had to have access to all
information on the assets, income and expenditure, and the policyholder
liabilities of the company. He obtained information from FEDAM, Accounts
and from the Individual Life and Group Benefits divisions for purposes of
actuarial valuations.
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154 The state of a life insurer’s operational health (in contrast to its financial
health) can often be judged by the experience of the actuarial department in
its collation of information to conduct the actuarial valuation. Raftopoulos was
extremely critical of the operational quality of Fedsure Life. He told us in no
uncertain terms that Fedsure Life was “operationally weak”. He postulated
that it was apparently acceptable in view of the fact that Fedsure Life was
financially sound and doing well, at least until mid-1998. To put matters in
perspective, he indicated that his impression was that the industry at large
was operationally in a poor state.
155 Raftopoulos was critical of expense overruns, yet management reports to the
Board continually showed management expenses within budget and under
control. We did not attempt to reconcile these contradictory remarks.
156 In contrast with other executives who told us that Fedsure Life was on time
with company results and statutory reports, Raftopoulos testified that Fedsure
Life was usually very late with its tax returns. We did not verify this.
157 Raftopoulos was quite critical of other divisions’ ability to produce data
necessary for actuarial valuations. If the data was not late, it was in poor
condition, necessitating his staff to spend a lot of time in making corrections.
This put CAS’s resources under continuous pressure. He did not receive
much joy from the senior executives when he complained, although Bernstein
attempted to address the problem.
158 The technical role of the actuary of a life insurer is:-
158.1 to ensure sound premium rates, where he/she is usually in conflict with
marketers who want the smallest premiums and the biggest benefits,
158.2 to ensure the financial soundness of the company, where he/she is usually in
conflict with the marketing department who wants the highest bonus rates and
the shareholders who want the biggest dividends and
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158.3 to ensure proper asset liability management, where he/she may be in conflict
with the investment managers who simply want to invest for the highest short-
term returns, and who are often not as sensitive to the needs of the policy
liability profiles.
The single biggest discipline which ties together all the different operational
activities and their efficiencies in the life insurer, is the analysis of surplus.
This was not done by Fedsure Life, which is a major shortcoming. This was
not a statutory requirement nor mandatory in terms of the actuarial
profession’s guidelines.
159 We did not investigate in detail the soundness of new business premium rates
of Fedsure Life. The mismatch in the Immediate Annuity Portfolio is, however,
a telling tale. A loss of R253 million was attributed to the mismatch in the
annuity portfolio at the end of 2000, which was said to have been caused by
two factors:
Firstly, the average term of the assets was shorter than that of the liabilities.
Following a drop in interest rates, the value of the liabilities increased by
R200 million more than the increase in the value of the assets.
Secondly, it was discovered that annuitants were experiencing lower mortality
and hence longer life expectancy, which was not allowed for in the premium
rates nor in the valuation of the liabilities. Once discovered, this was
immediately rectified. The value of the liabilities was increased by R100
million and premium rates increased. The external actuaries, Tillinghast,
made this discovery during its actuarial due diligence prior to the Investec
takeover.
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It is important to recognise that mortality rates do not improve overnight, they
take years to show meaningful trends. A “sudden discovery” of this nature is
reason for concern about fundamental control measures in the actuarial
department. Indeed, a regular analysis of surplus would have shown the
tendency almost automatically and early.
Operations Committee and Financial Committee
160 Apart from the reports to the Board, the operational divisions met monthly for
the Operations Committee (OPCO) meeting. This was later referred to as the
Financial Committee (FINCO). Only management and executives served on
these committees.
Operational divisions’ reports to the board
161 Whereas the operational divisions’ reports to the board continually referred to
performance on a variety of aspects, these reports were often in contrast to
what was reported at the OPCO or FINCO meeting. For example, it was
continually minuted at OPCO/FINCO meetings that CAS had to spend 50% of
its time correcting errors for which other divisions in the Group were
responsible. CAS had particular problems with FEDAM. We did not find any
reference to this in board reports. It became evident that from the latter half of
1999 there were severe operational strains, which were either not reported or
not appropriately emphasised to the board (or Board Audit Committee).
162 Although no organisation is operationally perfect, it appears that problems in
the company were generally downplayed when the operational divisions
reported to the board. The minutes of Fedsure Holdings, Fedsure
Investments and Fedsure Life presents a “good news” picture; although
problems were reported to the boards, these were in the vast majority of
instances accompanied by the happy news that “management was addressing
the problem”. More than one person confirmed that this view is a factually
correct reflection of the situation. The reason most advanced was
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Basserabie’s apparent reputation of not reacting well to bad news – such
news had to be presented to him together with a solution to the problem.
While this may be a commendable character trait, we have more than a
suspicion that, ironically, executives and senior managers as a result rather
tended to gloss over serious problems.
163 In addition, the external auditors reported serious breakdowns in the control
environments of FEDAM and Accounts, after the Norwich merger. For
example, in their final audit findings for the year ended 31 December 1999,
PWC reported on page 16:
“Investments managed by FEDAM: Unsatisfactory overall control environment
or material breakdown in control environment.”
The following year, PWC reported:
“Satisfactory overall control environment with some significant weaknesses in
controls”.
The nature of these weaknesses was not addressed in the final audit report.
164 The Fedsure Group also had an Executive Investment Committee (EIC).
165 As is probably common to all life insurers, the reports to the Board focused on
premium income in terms of existing and new business.
Corporate Governance in general
166 In general, the Fedsure Group adhered to the principles set out in the King
Report on Corporate Governance in form. Although we did not particularly
investigate the efficiency of internal control measures in Fedsure Life, it
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appears from the minutes of the board that these measures were regularly
tested and improved from 1998 onwards.
167 In particular:
167.1 Fedsure Life had a well-diversified and informed group of non-executive
directors on the board.
167.2 The board agendas and information packs were comprehensive and detailed.
167.3 Executives had ample opportunity to report to the board.
167.4 All the requisite Board Committees, i.e. a Board Audit Committee, a Board
Investment Committee and a Remuneration Committee were in place.
167.5 The actuary’s department, despite problems, was generally equipped to
perform their duties.
167.6 An internal audit department was functioning, and appears to have become
more effective from 1998.
167.7 Staff and procedures were in place to execute all statutorily required duties of
the company.
168 Nevertheless, we have some doubt regarding the substance of corporate
governance practices in Fedsure. As set out in the course of this report, one
example is that there was a lack of emphasis regarding operational problems
in the reports to the board. Also, we have doubt regarding the quality of
information provided to the external auditors, given the concerns PWC raised
in the audit management reports (though we do not suggest that the lack of
quality information was intentional).
169 It appears, though, that no expense was spared to improve the quality of
operations. There is ample proof of this, such as the contracting of outside
parties, including auditors and actuaries, to assist with various tasks. Be that
as it may, following the Norwich take-over there were fundamental governance
problems that Fedsure appears to have been unable to address effectively.
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170 Other than the issue of the split of policyholder and shareholder monies in the
NMLF and prior to the Norwich take-over, there were a number of concerns
regarding the operational efficiencies of Fedsure Life, such as:
170.1 no analysis of surplus by the actuary (due to a lack of adequate record-
keeping)
170.2 no unitised investment accounts for non-linked policy liabilities
170.3 no paperless workflow and imaging system
170.4 no centralised record keeping / accounting of assets and policy liabilities in the
NMLF
170.5 a fundamental flaw in the system that was supposed to ensure proper asset
liability matching of the IAP
170.6 apparent inability of FEDAM to render market related investment returns in the
bear market that followed since October 1998.
171 After the Norwich takeover, it appeared that the operational flaws were either
exacerbated by the attempted merger, or the merger itself created new
problems. The constant and serious complaints by CAS as well as issues
continually raised in the management reports of the external auditors were
proof of this. After Investec’s takeover, Investec officials also complained
about bank reconciliations not done for years by Fedsure Life (and other
divisions) in certain cases. Furthermore, the unfortunate event surrounding
the release of results to analysts in the middle of 2000 when incorrect figures
were released, without the knowledge of the actuary, points at systemic
inadequacy and inappropriate corporate governance at operational level at the
time.
172 Whereas Fedsure Life management previously had little difficulty in achieving
its new business budgets, they had to renege on their 1999 budget for
Individual Life business. The reasons given to the board as reflected in the
minutes emphasised external factors, whereas other sources indicated
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internal problems following the Norwich merger. Increased surrenders and
terminations obviously aggravated the situation, both in terms of perception in
the market place and in terms of the added difficulties in FEDAM to conduct
investment management in a negative cash flow situation.
In other words, FEDAM found it much more difficult to maintain market-related
results while they had to contend with a net realisation situation instead of a
net investment situation. It is obviously equally difficult to decide on the right
time and price to sell as to decide on the right time and price to buy. From
1998 onwards, FEDAM clearly had difficulty adapting to, and recovering from,
a bear market.
Computer systems
173 Computer systems dictate the administrative and operational success or
failure of a life insurer in modern times. The merger of operations of Fedsure
Life and Norwich Life was a critical test for the robustness of the systems and
the proficiency of the managers and executives in charge of the IT function. It
is apparent that Fedsure was not successful in this regard in respect of the
individual life business, although there can be no doubt as to the good
intentions of Fedsure Life to get it right. Evidence of these attempts existed
even prior to the Norwich takeover.
174 After the Norwich takeover Fedsure Life’s ability to service policyholders came
under severe pressure. There were increased terminations, staff resignations,
systems problems and poor investment results and bonuses. All these factors
combined to create an extremely uncomfortable situation to maintain high
standards of service. This was exacerbated by an apparent indecision on the
part of IT management as to how to approach the systems merger. These
culminated into more complaints with the Ombudsman for Long-term
Insurance and the Pension Funds Adjudicator. Prior to the Norwich takeover
by Fedsure, these offices did not have a particular concern with either of the
two insurers. Both offices commented that there was no lack of willingness on
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the part of Fedsure Life, IEB or CAL to resolve the issues, but since 1998 and
prior to the Investec takeover, it was clear to them that administrative
problems prevented Fedsure from reacting to complaints promptly.
Although not necessarily pertinent to Fedsure, our interviews with persons at
the offices of the said Ombudsman and the Pension Funds Adjudicator
revealed a general problem regarding jurisdictional issues between the offices.
We address this further as part of the recommendations in Section O.
Management expenses
175 Although it is not a pure means of comparison due to different companies
doing business differently, account differently and running different mixtures of
business, Fedsure Life’s acquisition and management expenses as % of
premium income are compared to the industry in Table 13 below with their
competitors. This comparison is presented from figures disclosed in the
annual reports of the Registrar of Long-term Insurance for the reporting years
1997 and 2000.
Table 13 FEDSURE LIFE ASSURANCE LTD Acquisition and management expenses as % of gross premium income
1997 1998 1999 2000 Industry average 13.2 15.5 12.2 10.5 Fedsure Life 12.9 11.6 7.9 14.7
It appears, as a very general observation, that Fedsure Life was not out of line
with the industry. A more detailed comparison of administrative cost
efficiencies to its competitors is difficult to do with published information. We
did not pursue this.
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Commissions and incentives for brokers and intermediaries
176 Incentives for intermediaries and brokers are mostly a controversial issue in
the life insurance industry. The better an intermediary is treated financially
and otherwise, the more business they tend to introduce to the insurer. There
were allegations of loans given to brokers which were on most favourable
terms. IEB, after the takeover, discovered a number of such loans and
insisted on repayment. In some cases they were told that Fedsure Life did not
require repayment. The amounts involved appear not to have been significant,
and we did not investigate this aspect further. IEB has taken legal steps to
recover these funds.
Product design
177 The fundamental design of life insurance policies has been questioned in
criticism of Fedsure Life in the media. In addition, there were allegations of
certain policies being issued on either too favourable terms, or in ways that
seemed close to being illegal or at least undesirable. We did not have time to
investigate this aspect thoroughly. However, the practice, which is not
uncommon in South Africa, of the contractual terms of the Guaranteed Fund
into which many retirement funds invested, has to be put under scrutiny. This
practice is described in more detail below.
Not unexpectedly, our interviews with certain policyholders and
representatives of policyholders revealed a general dismay regarding the
transparency of their life policies’ operation, terms and conditions. It led us to
conclude that standardisation of life insurance and competing products should
be addressed by the industry.
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The Fedsure Guaranteed Fund prior to the IEB takeover
178 The Guaranteed Fund, as explained above, awarded vesting and non-vesting
bonuses. Only the vesting bonuses were guaranteed. Hence the name
Guaranteed Fund is a misnomer, and may be misleading. As experienced by
IEB, the actual cancellation of part of the non-vested bonuses met with great
dissatisfaction from clients. Secondly, the terms upon termination, i.e. that the
guaranteed portion only gets paid out in instalments over ten years, also met
with great dissatisfaction. Investors in the Guaranteed Fund were informed
that the underlying investments of the fund would be in a balanced spread of
assets, implying a fairly large (at least 50%) equity portion, since it is the latter
that tends to provide inflation beating returns in the long run. (At least this has
been the conventional wisdom).
179 The fact that 15% of the Fund was effectively invested in one share, Inhold,
raises serious questions as to whether the fund was in fact invested in a
balanced spread of assets. In view of the fact that it was within the Investment
Regulation requirements of both the Long-term Insurance Act and the Pension
Funds Act at the time, it is difficult to contend that Fedsure Life made
misrepresentations or that they departed from the (implicit) mandate that they
had from policyholders.
IEB’s action with the Fedsure Guaranteed Fund
180 When Investec took over the business of Fedsure Life (changing its name to
IEB), it changed the FGF to a fund that only provides fully vesting (i.e.
guaranteed) bonuses, which they guaranteed would not be less than 4% p.a.
for five years. In the process they also changed the underlying investment
structure to contain, as at the end of 2001, 80% in money market and bonds,
8% in offshore equities, 8% in property and 4% in Saambou.
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In addition, they closed the FGF to new business. They also retained their
contractual right not to pay out terminations in lump sums, even at market
value (which at the time is less than the guaranteed fund value).
181 The changes to the nature of the FGF were made in a rather one-sided
manner by IEB, although they did communicate them through extensive
roadshows. Some policyholders (represented by the trustees of retirement
funds) and their advisers are critical of these practices. It is clear that IEB has
a major challenge in this respect, having inherited the unbalanced asset
composition from Fedsure Life for the NMLF, including the Guaranteed Fund.
182 The IEB bonus philosophy is that all returns, after deduction of charges,
accrue to policyholders. This net return may be adjusted for a smoothing
reserve, if appropriate, in respect of with-profit business. Any smoothing
reserves accrue to policyholders.
183 The returns on the NMLF in 2001 were determined in accordance with the
aforesaid bonus philosophy. The returns were as follows:
Table 14 Returns on the NMLF for 2001 R’million Actual loss on NMLF to 31/12/2001 R1 236 Items allocated to shareholders (R 242) Net Loss R 994
The net loss was equivalent to 12.2% negative return on the NMLF.
Financial Services Board Fedsure Life Assurance Ltd Report Page 91 - STRICTLY CONFIDENTIAL - 184 The options considered by the management of IEB included:
184.1 Set up a negative bonus stabilisation reserve to the extent permitted
184.2 Shareholders to cover the full extent of the loss
184.3 Pass on the loss to policyholders, where non-vested bonuses allowed for this
in terms of the policy terms and conditions.
185 In November 2001, the management of IEB conducted a country-wide
roadshow for the benefit of policyholders and financial advisors, advising them
of the progress on the restructuring of the Fedsure Group and of specific
portfolios. It was indicated that bonus declarations in the past had been in
excess of actual returns, and that capital depreciation in 2000 and 2001 would
be passed on to policyholders via adjustment to non-vested bonuses. We do
not agree with the view that Fedsure had over-declared in the past: since
shareholders’ assets could be used to support smoothed bonuses, and
Fedsure Life always met solvency requirements, the point that they
overdeclared in the past is not valid.
186 According to Whelan, the Managing Director of IEB, after considering
feedback, IEB decided not to adjust the losses in 2000 but only to deal with
the losses in 2001.
187 A full presentation of the results of the proposed action was made to the FSB
before any final decision was taken by IEB.
188 After consultation with the management of IEB, the external actuary and their
legal advisors, the following action, effective 31 December 2001, was taken:
188.1 Normal vesting of 10% of the non-vesting bonuses occurred
188.2 12% of the total account balance was deducted from the non-vested account,
subject to a maximum of the non-vested account. As many accounts did not
have 12% in the non-vested account the total reduction of non-vested
balances amounted to 10.56% of total balances.
Financial Services Board Fedsure Life Assurance Ltd Report Page 92 - STRICTLY CONFIDENTIAL - 188.3 The balance of the non-vested account after deductions was then fully vested.
The newly ring-fenced Fedsure Guaranteed Fund was restructured to reflect
these changes and a minimum guarantee of 4% per annum for five years was
introduced.
189 The final allocation of capital depreciation for the 2001 year was as follows –
Table 15
FEDSURE LIFE ASSURANCE LTD
Allocation of capital depreciation in 2002 R’million Total capital depreciation R1 236 100% Cancellation of non-vested bonuses R 588 48% Absorbed by shareholders R 648 52%
Thus, shareholders who held approximately 12% of the value of the NMLF
absorbed 52% of the capital depreciation.
Communications were sent out to all clients informing them of the effect of the
adjustment of the non-vesting bonuses on their respective funds.
190 We recommend that the practice of guaranteed fund or smoothed bonus
policies, both group and individual, be reviewed by the actuarial profession
with regard to
(a) the presentation to policyholders
(b) the reserving for guarantees and
(c) the appropriate asset structure to back such liabilities.
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191 We were made aware of clients that had difficulty in getting responses from
IEB regarding administrative and other enquiries and queries. We are of the
opinion that IEB is doing their utmost in handling these at the best of their
abilities and with the best of intentions. However, the sheer volume,
aggravated by the takeover, staff changes and media comments, have slowed
down their efforts. It is believed that the situation is improving.
192 Whereas there is room for difference of opinion regarding IEB’s conduct in this
regard, we do not consider IEB’s conduct as unreasonable or unlawful.
Early terminations of policies (withdrawals and surrenders)
193 Fedsure Life started to experience significant withdrawals and surrenders in
the wake of their poorer investment performance and the perceived problems
in the group. Because of the depressed market values following the October
1998 stock market crash, which were aggravated by the overweight in
financials of the NMLF, Fedsure Life had to revert to a market value adjuster
in respect of group benefits.
194 It follows that affected policyholders who cancelled their contracts in this
period, found themselves with poor returns, if not capital losses. Life insurers
set their bases for calculating early termination (as on surrender or withdrawal)
by policyholders such that the life insurer (being shareholders and remaining
policyholders) does not lose. In fact, some measure of profit could be taken in
lieu of the potential profit that the policy would have made for the insurer had it
remained in-force.
We did not attempt to quantify these potential losses to policyholders.
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195 Regarding the Guaranteed Fund, Fedsure Life and IEB have refrained from
paying out cash (even at market values) as surrenders/ withdrawals of whole
groups. Hence, IEB – entirely within its rights to do so – insists on the
contractual stipulation of paying out in ten annual instalments. This has been
met with great dissatisfaction from funds who lost confidence in Fedsure
Life/IEB. Yet IEB maintains it is in the best interest of all policyholders in the
Guaranteed Fund, and will allow once-off withdrawals as soon as they have
rebalanced the fund and stabilised the situation so that such withdrawals will
not compromise remaining policyholders’ interests. Under the (less than
perfect) circumstances, we do not have a problem with this approach.
Financial Services Board Fedsure Life Assurance Ltd Report Page 95 - STRICTLY CONFIDENTIAL -
J THE TAKEOVER OF FEDSURE BY INVESTEC Background to the transaction 196 The relationship between Investec and Fedsure dates back to about 1991,
when, following talks, the companies decided to acquire a stake in each other.
The history of and circumstances surrounding the alliance are set out in
Section G above.
In the light of various perceptions regarding the reasons for and manner in
which Investec acquired the Fedsure Group, we considered it necessary to
describe that process and the parties’ perspectives as we found it. Moreover,
the Registrar requested that we review the transaction and report whether
policyholders’ interests were protected during the process.
197 It appears to be common cause that during middle to late 2000, Investec
Group Limited approached Fedsure Holdings Limited regarding a possible
acquisition of certain companies in the Fedsure Group. These companies
included Fedsure Life and the financial services companies within the group
(such as FEDAM and Fedsure Bonds), but excluded Fedsure Health. The
initial approaches appear to have been made to Barrow. The first mention of
a possible transaction in the minutes of the Fedsure Holdings board meetings
was on 13 November 2000, when it was noted that discussions between
Fedsure and Investec that were the subject of “a joint cautionary
announcement published on 10 November 2000”, had “placed a different
perspective on the need for a restructuring” (which management was in the
process of planning).
Although there were synergies between the two companies, Koseff explained
to us that the main reason Investec made a deal with Fedsure was based
more on market perception than anything else. At the time, the share price of
Fedsure Holdings was falling, and the views expressed by analysts were
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putting pressure on Fedsure. The markets perceived Investec to have had an
operational relationship with Fedsure, while in fact – said Koseff – there was
no relationship. The Investec directors did not involve themselves in the
management of Fedsure, and did not “manage the money”. We confirmed
with the Fedsure Life senior executives and members of senior management
that Investec in fact did not interfere in the operations of Fedsure Life. But
market analysts continually enquired what Investec was going to do about
Fedsure, and, as Koseff put it, “they were making something that wasn’t our
problem, our problem”. Consequently, the Investec executives believed that
morally they could not just walk away from Fedsure, and thus started pursuing
a deal.
198 Investec was faced with three options:
198.1 The unbundling of the Fedsure shares to Investec shareholders. This was not
seen as a realistic option and Barrow (with whom Investec initiated talks) did
not back it, although it was the route Koseff personally wanted to follow.
Strategically, with the London listing of Investec on the cards, Investec did not
want a stake in a life insurer. It would still have received fair value at the time
if it sold its Fedsure Holdings shares and distributed it among shareholders; in
fact, subsequent to the events certain shareholders had enquired as to why
they did not “just walk away from this thing”. However, in the words of Koseff,
it “became apparent to Investec that the market may perceive the unbundling
as walking away from a problem and it’s Investec’s culture to deal with
problems and not walk away from them”.
198.2 Fedsure Life could be sold to an interested party. At the time, Basserabie was
exploring a possible merger between Fedsure and Liberty Life with the latter
company’s CEO, Roy Anderson. Koseff told us that Investec was aware of
this, supported the talks, and in fact saw it as the “preferred route” for “Liberty
[to] take over Fedsure”. This was however not to be. Although the board of
Fedsure Life was not officially informed as to the reason for the failure, we
were told that at the time, Fedsure still saw itself as the senior partner in a
Financial Services Board Fedsure Life Assurance Ltd Report Page 97 - STRICTLY CONFIDENTIAL -
merger, with Basserabie as CEO; this view was apparently not shared by
Liberty Life.
198.3 Investec could acquire Fedsure Life. Investec was prepared to take this route
if the Fedsure Group stuck to a strict timetable, subject itself to a due
diligence, and co-operate in such a manner as not to compromise Investec’s
impending London listing. Assurances in this regard were eventually obtained
from the Fedsure executives.
199 In Koseff’s view, Investec did not have to do a deal with Fedsure – or vice
versa, for that matter. Senior executives from both Fedsure and Investec told
us that the negotiations took place on a level playing field. It was clearly not a
matter of Investec “coming to the rescue” of Fedsure.
200 Initially, Basserabie was offered an executive position in the Investec
structure. The specifics were never discussed, but due to the fact that the
negotiations eventually turned acrimonious, this was not pursued.
201 Koseff said they made it clear to Basserabie that for economic reasons the
Fedsure head office was not going to survive the acquisition. He said it was
spending about R250 million a year at the time, and since Investec had its
own head office infrastructure, a duplicate structure made no sense. The
Investec approach would be to identify business units at Fedsure head office
that belonged in operating units, such as the Actuarial Department and parts
of Information Technology, and integrate those with their Investec
counterparts. Accounting in Cape Town would be moved to Johannesburg.
The remainder, such as Human Resources, Marketing, and Group Accounts,
would be closed down following the acquisition and their employees
retrenched.
202 It should be noted that at this time, various discussions took place – some of
them reflected in the minutes of the board meetings of Fedsure Life and
Fedsure Holdings – regarding a possible move of the Fedsure head office (or
parts of it) from the Johannesburg CBD to Sandton.
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The structure of the transaction 203 The transaction between Investec and Fedsure was concluded prior to the due
diligence process. The reason was that Fedsure did not want to become
“damaged goods”, or be left in the lurch if the due diligence uncovered
possible deal breakers. Thus, in terms of the agreement Investec could not
subsequently walk away from the transaction on the basis of the due
diligence. Both parties agreed that the Fedsure Group might not have
survived such an event.
204 Instead, the parties agreed that Investec would be entitled to a price
adjustment if the due diligence justified this. A threshold or “buffer” of
R300 million was included in the agreement. This was to avoid a so-called
“nickel and dime” argument about issues that would in the larger scheme of
things be negligible amounts. Disputes would be settled by arbitration.
205 The price initially agreed upon was R5.2 billion. This was based on the
embedded value of the life company, and a premium for the non-insurance
business (excluding Fedhealth). The purchase price was to be paid by an
Investec share offer at (initially) a ratio of about 13.2 Investec Ltd shares for
every 100 Fedsure Holdings shares (Investec Ltd would have issued about
23.2 million shares at R226 per share), plus a cash consideration of
R250 million. Koseff discussed this with Sanlam and Old Mutual, Fedsure
Holdings’ two largest shareholders, who pursuaded Investec to increase the
purchase price by two million Investec shares. Since Fedsure Life was an
audited and regulated public company, and since Investec was represented
on its board, Koseff and his colleagues viewed it as improbable that there
would be a material discrepancy in the purchase price. Koseff’s only concern
was a possible decrease in the in-force value (or embedded value) of Fedsure
Life (represented to be about R2.3 billion in June 2000). He received
assurances from Raftopoulos that this value would not change for a number of
Financial Services Board Fedsure Life Assurance Ltd Report Page 99 - STRICTLY CONFIDENTIAL -
reasons (the value of the assets would not change; bonds and markets were
relatively flat at the time; and liabilities were changing at a slow pace).
206 The agreement was signed on 21 November 2000. According to Basserabie,
Investec was effectively responsible for managing the assets and liabilities of
Fedsure Life from the beginning of 2001, and the final takeover was to be at
the end of May 2001.
The due diligence 207 Investec appointed two of its directors, Glynn Burger and Bradley Tapnack, to
lead its due diligence teams. Tapnack described the purpose of the due
diligence to us as determining “whether or not the surplus lay within certain
parameters – sustainability of income was a by-product of the due diligence
process. The entire due diligence was about valuing assets and liabilities…”.
There was a number of teams with different responsibilities, who reported to
Burger and Tapnack every second day.
For actuarial input, the due diligence was performed by the British firm
Tillinghast, an international firm of consulting actuaries specialising in
insurance. The issue of matching assets and liabilities in the various portfolios
was left to it. According to Tapnack, the “findings of Tillinghast… was the
extent to which such findings would either shrink or increase the surplus”.
We were provided with a draft copy of the Tillinghast report, and were told that
there is no one single, final report regarding the due diligence done by the
Investec teams.
It is not in dispute that Fedsure opened its books completely to these teams,
and that they had full access to whatever information they required.
Financial Services Board Fedsure Life Assurance Ltd Report Page 100 - STRICTLY CONFIDENTIAL - 208 As far as Fedsure Life was concerned, some of the problems highlighted
during the due diligence process were:
208.1 There were “difficulties” in the accuracy, reliability and quality of information
relating to policyholders (according to Tapnack). Information was poorly
reconciled.
208.2 There were general “reconciliation difficulties on the accounting side”, as
Tapnack put it. For example, it was found that reconciliations at TMA had last
been done in 1998/9.
208.3 Bank reconciliations for some accounts had in certain cases not been done for
years.
208.4 The IT systems posed particular data reliability problems.
208.5 Assets had been overvalued. The problem was compounded by the fact that
there was a number of unlisted assets (such as bonds and debentures for
which no documentation could be found), loans, unlisted securities and future
income streams from property values.
208.6 There were incorrect recordals of loans (secured loans turned out to have
been unsecured), or no documentation could be found regarding loans.
208.7 Policyholder and shareholder assets in the Net Main Life Fund could not be
easily separated.
208.8 The general administration was not up to standard as far as the management
of volumes, policyholder administration, service and turnaround times were
concerned.
208.9 There was a mismatched position in the Immediate Annuity Portfolio.
209 The due diligence commenced shortly after the agreement between the
parties had been signed and appears to have been more or less finalised by
12 December 2000. As Burger politely put it, during the due diligence process
“errors were found and the price adjustment as contemplated in the acquisition
agreement was applied”.
These “errors” led to a downward adjustment in the asking price of
R5.2 billion. In terms of a list Investec provided to the Fedsure executives on
Financial Services Board Fedsure Life Assurance Ltd Report Page 101 - STRICTLY CONFIDENTIAL -
12 December 2000, price adjustments were mainly based on the following
adjustments to valuations and provisions during the due diligence process:
209.1 The property portfolios were overvaluated by R736 million
209.2 Participation bond book and provision for life fund properties: R62 million
209.3 Leave pay provision: R37 million
209.4 Taxation provisions (E&Y): R66 million
209.5 Staff share scheme provision: R122 million
209.6 Closing international operations: R35 million
209.7 TMA and Unit Trusts: R75 million
209.8 Current asset write-offs and general reconciliation differences: R115 million
210 We heard from all parties that the negotiations relating to the price
adjustments did not proceed smoothly (to put it mildly), and it was clear to us
that there are still hard feelings on the subject. During our interviews with
them, executives of both Fedsure and Investec alleged (or suspected) bad
faith from the opposite side at times. There were three price adjustments in
total, and the final one was the result of an agreement between Investec and
the Fedsure shareholders, following what appears to have been an
increasingly acrimonious breakdown in communication between the respective
executives.
211 On the one hand, Investec believed its reputation had been damaged along
with that of Fedsure, since the latter had made the market believe that there
was nothing wrong with Fedsure Life. The due diligence showed otherwise to
Investec. The adjustments – which obviously meant that the R300 million
buffer had been breached – thus “came as a shock to the market”, according
to Koseff. On the other hand, Fedsure saw Investec’s actions as extremely
damaging to its reputation, and also saw it as unnecessary bargain-hunting in
a deal neither party could renege on. For example, King told us that as far as
he was concerned, the (incorrect) perception at the time that Investec had
“saved” Fedsure was a “public relations exercise to try and squeeze some
more reduction of the price”.
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Based on figures furnished to us by Roland Krabbenhoft, the former company
secretary of Fedsure Life now with IEB, the first adjustment led to a
R350 million reduction in the purchase price. The second adjustment meant a
further reduction of R555 million. (According to Basserabie, this second
adjustment was actually due to an injection of capital by Investec so that the
Norwich merger could proceed.) The price was then about R4.591 billion,
comprising just over 19.2 million Investec Ltd shares at R226 per share (at a
final ratio of 9.75 Investec Ltd shares for 100 Fedsure Holdings shares) and
the cash consideration of R250 million. Following the third adjustment (a
value reduction claimed by Investec of about R224 million, and settled with the
Fedsure shareholders), Investec finally paid R4 367 958 104 for Fedsure.
(According to Basserabie, there was no third adjustment and as such no
agreement was entered into with the Fedsure shareholders. We did not
attempt to reconcile these conflicting versions.)
In addition, Investec carried the cost of the reduction of staff, the reinsurance
agreement with CAL and an impairment charge of some R463 million.
212 The results of the due diligence were discussed at a Fedsure Holdings board
meeting on 22 December 2000. In summary, the following was minuted:
212.1 The total gross adjustments amounted to R2.36 billion “which, after allowing
for the buffers, was R1.86 billion”.
212.2 The Fedsure property portfolio had been valued at current market value,
based on Investec’s experience in the market and in terms of the basis
specified by Tillinghast.
212.3 “It was acknowledged that in the gross figures produced by Investec, certain
adjustments would be for the account of policyholders and not shareholders”.
212.4 There appears to have been “genuine differences of opinion” relating to
certain valuation matters during discussions between the respective senior
executives and chairmen. Investec felt that the matter should be settled and
that arbitration should be avoided.
Financial Services Board Fedsure Life Assurance Ltd Report Page 103 - STRICTLY CONFIDENTIAL - 212.5 Herman confirmed that “on the table was an adjustment of R350 million
against the originally published acquisition price together with the contingent
liability in respect of TMA remaining with Fedsure Holdings”. Derman pointed
out that “the R350 million requested would equate to a gross adjustment of
R1.25 billion”.
212.6 The Investec directors having left the meeting, the board had a lengthy
discussion, and concluded that there would be no price adjustment should the
matter be referred to arbitration. It considered a number of issues, amongst
others the likely impact arbitration proceedings would have on the transaction,
and also on Investec’s share price. Eventually, the board agreed “to the
principle of a commercial settlement based on a R350 million adjustment plus
the assumption of the TMA liability”. Following professional advice, the board
then more specifically agreed to endorse the transaction with Investec based
on the R350 million adjustment “plus a reasonable dispensation on the
holdback of Investec shares to cover the assumed TMA liability”.
213 In December 2000, Raftopoulos informed Koseff that the in-force value of the
life company had decreased to R1.2 billion, and had not remained in the
region of R2.3 billion, as expected in June 2000. Koseff told us he confronted
Raftopoulos about the issue. Raftopoulos responded that he had not been
allowed to say what he wanted during the negotiations. Raftopoulos
confirmed this version of events to us. Basserabie emphatically denied that
Raftopoulos had not been allowed to say what he wanted to. According to
Basserabie, the decrease in the in-force value was due to a variety of factors,
including problems surrounding the Investec transaction, the annuity loss (see
paragraph 148 above) and asset writedowns as at 31 December 2000 (which
could not have been foreseen in June 2000), the removal of the negative
Bonus Stabilisation Reserve, the declaration of a nil bonus, and anticipated
terminations as a result of these problems from March 2001.
214 Matters appear to have deteriorated markedly by the time the next Fedsure
Holdings board meeting was held on 1 March 2001. Basserabie reported that
Investec “was alleging that there had been misrepresentations of factual and
Financial Services Board Fedsure Life Assurance Ltd Report Page 104 - STRICTLY CONFIDENTIAL -
financial information which formed the basis of the consideration for the
transaction, on the grounds of the drop in embedded value and the
deterioration of profitability experienced from June to December 2000 ”.
Management “confirmed that such allegation was unfounded”, and pointed out
“that the transaction was based on Fedsure’s results as at 30 June 2000”.
It was therefore decided to formally challenge Investec’s allegation, requesting
them to substantiate the basis thereof.
215 Interestingly, it was minuted that “management confirmed that Fedsure’s
financial results would have been in a similar position had the transaction not
taken place”. Earlier in the meeting, the deterioration of profitability from June
to December 2000 was discussed. The draft financial results inter alia
showed a loss of R889 million at Fedsure Life, and a total loss of
R1 319 billion for the year across the Group. The discussion regarding the
reasons for these losses led Nurek to request “confirmation from management
that past disclosure (eg 2000 interim results, 1999 final and interim results)
had been appropriate and accurately reflected the state of affairs of the Group
at the time of reporting”. He expressed concern for the legal liability of
directors in the case of misrepresentation. Barber responded that the
emphasis placed in the commentary to the results may have been open to
criticism, but he confirmed that the results “properly reflected the position as
understood at the time”.
Further confirmation was however called for, and at the board meeting of
8 March 2001 it was concluded that “disclosure had been made more than
sufficient to enable an intelligent reader of the relevant accounts to understand
that whilst Fedsure’s operating position had remained reasonably bouyant, the
underlying financial strength and reserves associated with the Life operations
had diminished over this period”. From our own reading of the relevant
financial statements, we agree with this conclusion.
Financial Services Board Fedsure Life Assurance Ltd Report Page 105 - STRICTLY CONFIDENTIAL - 216 As stated above, the due diligence also uncovered a mismatched position of
assets and liabilities in the Immediate Annuity Portfolio, which came to light
after 31 December 2000 and which came as a “shock” to management.
Raftopoulos admitted that this was a mistake on the part of CAS, and said that
they were “remiss in not having sufficient resources to do that exercise
regularly”. The matter is dealt with elsewhere in the report.
The two capital injections 217 During the course of the acquisition negotiations, Investec twice injected
capital into Fedsure Life, the second of which was (at board level at least)
regarded as a reduction in the purchase price:
217.1 In November/December 2000, as part of the agreement between the parties,
Investec paid an amount of R500 million to Fedsure. The amount was
accounted for as a loan to Fedsure Investments, with this company
subscribing for new capital in Fedsure Life. According to Basserabie, one of
the reasons for the loan was that Fedsure would have raised capital for the
benefit of the life company in any event (due to a substantial decrease in its
free assets in 1999/2000), were it not for Investec’s approach.
According to Koseff the amount was primarily to facilitate adequate capital
cover to ensure the success of the merger of the Fedsure/Norwich life funds;
the additional funds would have ensured a surplus for shareholders. It later
turned out that the funds were in fact used by Fedsure Life to meet its capital
adequacy requirements. According to Basserabie, the funds were always
intended to be used by Fedsure Life to meet its capital adequacy requirement.
It was noted in the minutes of the Fedsure Holdings board meeting of
26 October 2000 that “after the legal merger of Fedsure Life and Norwich Life,
the combined entity would have a lower capital adequacy ratio (CAR). In
order to maintain Fedsure Life’s solvency ratio and in order to satisfy the
Financial Services Board and the independent Actuary, additional share
Financial Services Board Fedsure Life Assurance Ltd Report Page 106 - STRICTLY CONFIDENTIAL -
capital had to be injected into Fedsure Life”. Management then advised that
four banks had been approached regarding “the raising of new capital”, and
that negotiations had been entered into with two of these banks “for at least
R400 million worth of funding”. The board appears to have agreed with this
approach, and then discussed the mechanics of the transaction between
Fedsure Investments and Fedsure Life. There is no mention in the minutes
that Investec would be involved in the loan.
217.2 In April/May 2001, an amount of R600 million was injected into Fedsure Life.
The main purpose of this amount was to facilitate the merger between the
Fedsure and Norwich life funds. According to Basserabie, Fedsure was under
obligation to see the merger through, although they had already sold the
business to Investec. Because of this, it was agreed that Investec would
make the payment, with a concomitant reduction in the purchase price.
The matter was discussed at the Fedsure Holdings board meeting of 8 March
2001. Barrow, the Chairman, reported on meetings with Herman, Koseff and
others relating to the Norwich merger. It was minuted that because “Fedsure
Life’s financial position had recently deteriorated, it was considered not
possible to proceed with the merger unless some R600 million capital was
injected into Fedsure Life”. The board then accepted Barrow’s proposal that
the “agreement between Fedsure and Investec be amended, in exchange for
Investec agreeing to inject R600 million capital into Fedsure Life to facilitate
the Norwich Merger”. At the time, the number of “Investec consideration
shares” was reduced to a ratio of approximately 11 Investec shares for each
100 Fedsure shares to provide for the R600 million reduction; it was noted that
the cash consideration to be paid by Investec (R250 million) remained
unchanged. (We are not entirely sure how this arrangement fits in with the
explanation of the purchase price provided by Krabbenhoft [see paragraph 211 above]. According to Krabbenhoft, this amount was ultimately also
accounted for as a loan to Fedsure Investments.)
Addressing the NMLF at IEB
Financial Services Board Fedsure Life Assurance Ltd Report Page 107 - STRICTLY CONFIDENTIAL - 218 At our request, Whelan, the executive director of IEB, documented the
process followed by IEB to address the various problems in the NMLF at the
time of the acquisition. A copy of this document is attached as Annexure F.
In summary, IEB:-
218.1 Established the correct liability values in the NMLF;
218.2 Verified the existence and valuation of all assets;
218.3 Adjusted asset values;
218.4 Allocated assets to liability pools, including the separation of shareholder and
policyholder assets.
With particular regard to the strategic holdings, the approach adopted is also
contained in Annexure F and is summarised in Section G above.
219 We discussed the current status of the NMLF portfolios at IEB with Whelan at
some length. It is not difficult to see the problems IEB has inherited from
Fedsure Life in this regard; mainly, as Whelan put it, IEB is still “hamstrung” as
far as the more or less illiquid holdings in the portfolios – principally the
property holdings – are concerned. Although IEB is “working the problem”, it
does not appear that this issue would be fully resolved in the short to medium
term. On a question as to the options IEB is at present considering in
disposing of these assets, he responded as follows:
Financial Services Board Fedsure Life Assurance Ltd Report Page 108 - STRICTLY CONFIDENTIAL -
“Well our strategy with regard to the property company that now exists, that
holds all these properties [the Investec Property Group] is to lower the short to
medium term in a responsible manner to reduce the property exposure and to
liquidate as much of the property as possible, but in a responsible manner.
You can sell all the good stuff quite easily tomorrow. There’s also now a
reasonable portion of vacant land that we’ve got to decide how do we deal
with that? Do we just sell it off wholesale, or try and build something on it and
sell it off retail? But it is to try and improve the returns on the fund and to
liquidate the property exposure in as quickly and a responsible manner as
possible.”
220 As far as the asset mix of the portfolios is concerned, Whelan mentioned that
their structure does not yet reflect the portfolio structure Investec Asset
Management (IAM) would have adopted for the same types of funds.
The reinsurance agreement with Capital Alliance Life Ltd 221 On 24 August 2001, IEB (then still known as Fedsure Life) and CAL signed a
reinsurance agreement with regard to Fedsure Life’s individual life policy book.
(IEB retained all the employee benefits business.) The effective date of the
agreement was 31 May 2001. The agreement states that the effective date
reinsurance premium (EDRP) payable by Fedsure Life at that date was R11
247 079 208, which is the exact value of the liabilities in respect of the
aforesaid individual life policy book. In addition, Investec paid R620 million for
45 million shares in Capital Alliance Holdings Ltd in October 2001; it owns
about 29% to 30% of Capital Alliance Holdings (but does not have Board
representation).
222 According to Martijn Appello, Deputy Managing Director of CAL, CAL received
about 480 000 policies from Fedsure Life to administer, including immediate
annuities. They also received approximately R450 million of the NMLF’s
liabilities, backed by the same amount of assets (including about 3% of the
NMLF’s Saambou holding).
Financial Services Board Fedsure Life Assurance Ltd Report Page 109 - STRICTLY CONFIDENTIAL - 223 In terms of the agreement, and with effect from 31 May 2001:-
223.1 CAL reinsures all pre-effective date policies issued by Fedsure Life and which
are in force as at the effective date;
223.2 Reinsures all post-effective date policies issued by Fedsure Life until
31 August 2001, as well as the continuation options1;
223.3 Fedsure Life is not to retain any liability for the risks covered – CAL assumes
full responsibility;
223.4 Although Fedsure Life retains primary liability to policyholders2, CAL is liable
for all insurance obligations accepted in respect of the policies covered by the
agreement, and is to pay the claims directly to the insured;
223.5 To avoid a mismatch of liabilities assumed by CAL against which specified
assets are held, and to avoid market disruptions, payment of the EDRP is
made in specie (as opposed to a full cash payment); in other words, payment
is made by the transfer of a portfolio of assets;
223.6 CAL was entitled, within 14 days after having signed the agreement, to swap
identified assets for alternative assets of equivalent value held by Fedsure
Life;
223.7 Post-EDRPs (for policies issued between 31 May 2001 and 31 August 2001)
were to be paid in cash or in specie, as appropriate (in specie payments were
provided for single premium policies where a specific investment portfolio was
established)3.
224 Investec Asset Management does the asset management in terms of a
discretionary mandate. According to Ian Kirk, Managing Director of CAL, CAL
does not involve itself with the asset management, apart from having set
certain parameters and goals for IAM.
1 Continuation options: options held by Fedsure Life clients as at the effective date, which options entitled the holder thereof to take out a long-term insurance policy or to extend such a policy, with or without additional cover. 2 Due to the fact that policyholders had entered into agreements with Fedsure Life, and not with CAL. 3 According to Appello, very few new policies were issued after 31 May 2001.
Financial Services Board Fedsure Life Assurance Ltd Report Page 110 - STRICTLY CONFIDENTIAL -
225 According to Appello, a scheme of transfer in terms of section 37 of the LTIA
should be completed by March 2003. The effect will be that IEB is “taken out
of the picture” - policy agreements will be directly between policyholders and
CAL.
226 It is clear to us that CAL has been quite successful in converting both Norwich
and Fedsure policies to its computer system, after having spent about
R8 million in new hardware. The conversion was not without problems – not
least because of the variety of systems used by Fedsure and Norwich – but
was completed ahead of schedule. Kirk and Appello informed us that:-
226.1 The IAP was converted to CAL’s system within a month;
226.2 The first month-end on the new system for Norwich policies occurred at the
end of July 2002;
226.3 The first month-end on the new system for Fedsure policies occurred at the
end of August 2002.
227 Hennie Nortjé, the Director: Operations at CAL (who was also in charge of the
conversion process), told us that the biggest problem was the fact that
Fedsure’s line of business (or policy administration) system was not
synchronised with its general ledger system. There was a lack of proper
reconciliation, and the policy administration system had not been properly
updated. But in the process, CAL managed to cut the IT expenditure by
approximately R100 million a year – a reduction of 80% from about R10
million a month incurred by Fedsure Life.
228 CAL “substantially” took over most of Fedsure’s staff, according to Nortjé.
These comprise 168 persons from the Johannesburg office; 60 persons at a
call centre in Cape Town; 25 temporary staff members (whose contracts were
not renewed), and 40 information technology specialists under contract. The
decision was taken not to retrench any personnel members, in order to
improve and retain staff morale.
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229 We were informed that about 10 000 of the policies received were suspect as
far as their values were concerned. Nortjé informed us that the situation is
being managed, but is made difficult insofar the applicable data received from
Fedsure and Norwich was in poor condition. In October 2002, only 2 188
Fedsure policies and 174 Norwich policies remained of which CAL had to
reconstruct their histories and determine their values.
230 CAL’s call centre initially handled about 4 200 complaints per day regarding
Fedsure or Norwich policies (out of a total of 5 000 calls per day). By
September 2002, these calls were down to about 2 500 a day (out of a total of
4 000 calls per day). The complaints have become mostly routine. However,
CAL initially received an unusual number of out of the ordinary requests, and
as a deterrent (in order to “get control of the book”) temporarily charged a
service fee for these, but put a stop to the practice following enquiries by the
FSB. These requests have since decreased to normal levels.
We visited the call centre and, with the prior consent of a few policyholders,
made some enquiries on the spot regarding their policies. We view the
responses received from the call centre personnel as completely satisfactory.
The interests of policyholders 231 It should be noted that the takeover of Fedsure by Investec was in the first
instance a commercial, arms-length transaction between two respected,
consenting organisations that had a long history of co-operation. Investec
directors had been on the respective boards of Fedsure throughout the 1990s;
one would expect that they knew the pros and cons of the organisation quite
well by the time the transaction occurred. Ultimately, the transaction was
successfully concluded following some obviously tough negotiations that
included allegations of various kinds by both parties, but in our view these are
not worthy of further investigation. Clearly, neither of the parties to the
Financial Services Board Fedsure Life Assurance Ltd Report Page 112 - STRICTLY CONFIDENTIAL -
transaction felt strongly enough to take any kind of action against the other
based on the respective allegations.
232 It is our considered opinion that in the process, IEB nevertheless paid due
regard to the interests of policyholders. Investec has been criticised for
decisions regarding the Fedsure and Norwich policyholders that could not
have been easy to make; according to Whelan (and other Investec executives)
IEB has suffered as a result of these decisions. We are aware that it has
furthermore come under fire for its service levels (at least initially) and
responses to queries in respect of the Fedsure Life business.
It should however, in our view, be borne in mind that IEB inherited a situation
from Fedsure that was less than perfect (following the Norwich acquisition),
and in the interest of policyholders (and shareholders) was obliged to manage
the situation as best it could. We do not view the steps taken by IEB as
unreasonable. It is true that they were taken in a more or less one-sided
manner, and some decisions may have been unpalatable to policyholders and
shareholders; but in our view the IEB executives have at all times tried to take
into account the interests of policyholders as a group, as opposed to the
interests of individual policyholders or groups of policyholders only.
Certainly, some members of the Fedsure Guaranteed Fund may feel
aggrieved about the new bonus dispensation (the guaranteed minimum bonus
rate of 4% and changed asset composition decided upon by IEB [see
Section I from paragraph 180 above]). This dispensation is in contrast with
policyholders’ expectations (created by Fedsure Life in its marketing of the
fund) of a balanced portfolio of assets with a significantly higher equity
content. Having regard to the flawed composition of this fund, it is however in
our view not reasonable to blame IEB for this outcome.
Financial Services Board Fedsure Life Assurance Ltd Report Page 113 - STRICTLY CONFIDENTIAL - K Conduct of the FSB 233 The Registrar became aware of the problems at Fedsure after the Investec
due diligence investigation at the end of 2000. The statutory returns for the
financial years 1996 to 1999 continued to reflect Fedsure Life in a financially
sound condition, with a minimum surplus asset to capital adequacy ratio over
the four years of 3.54 and an average of 4.0.
234 Fedsure Life did not at any stage breach the statutory solvency requirements,
and appeared to have complied with the applicable legislation in every
respect. Certain adjustments made during the determination of the purchase
price payable by Investec and minimum requirements imposed by the FSB in
terms of the transfer agreement between Fedsure Life and Norwich Life, made
it necessary for Investec to inject additional capital. This ensured that Fedsure
Life continued to meet the required statutory and imposed solvency
requirements.
235 The annual statutory returns submitted by Fedsure Life indicated that the
insurer continued to comply with the investment spreading requirements and
this included the combined business of Fedsure Life and Norwich Life at the
end of December 2000.
236 The mismatched position in the portfolios would not have been detected by
the Registrar were it not explicitly mentioned in the actuary’s valuation report.
This was due to shortcomings in the reporting format received from insurance
companies. The new statutory return, introduced in 2001, provides for
additional information that should enable the FSB’s Insurance and Actuarial
Departments to detect possible mismatched positions in portfolios. The FSB
however continues to rely on the statutory actuary to report on the business of
insurers.
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237 The FSB’s dilemma as financial services supervisor is that it will only be able
to take action if it is aware, or made aware, of a particular problem (such as
that an insurer may not be financially sound). Although the Registrar is also
entitled to act without evidence of any problem, such a pro-active approach is
simply not feasible. Ultimately, the question is what information it receives
from an insurer that should prompt the Registrar into action. If the statutory
returns indicate that an insurer complies with the Investment Regulations, and
that it meets the statutory solvency requirements, the Registrar’s office cannot
in our view be blamed if it decides to move on to more pressing matters, given
the huge volumes of documentation the Registrar’s personnel regularly have
to deal with.
238 The events at Fedsure Life certainly highlighted shortcomings in the regulatory
process. It is obviously not in the public interest if the official supervisor is the
last party to hear about a major problem at a major financial services provider.
To address some of the shortcomings, the Registrar has introduced the
following important measures:
238.1 From the end of 2000, the FSB requires quarterly reporting by all long-term
insurers. This was done to solve the problem of only receiving annual
information that is often outdated. The quarterly returns are due one month
after the quarter end.
238.2 The FSB further introduced pro-active on-site visits. These are being
performed on a regular basis from 2001 and also indicate the risk areas to
which insurers are exposed, including problems with regard to asset
management that may detrimentally affect the company.
Financial Services Board Fedsure Life Assurance Ltd Report Page 115 - STRICTLY CONFIDENTIAL -
239 What information did the Registrar receive from Fedsure life in its statutory
returns? The company certainly met the Investment Regulations in every
respect, and it not only met but exceeded the solvency requirements.
According to the Registrar, the FSB only became aware of the mismatched
position in the NMLF during March 2001, having been verbally informed of it
by Bernstein. However, in the statutory returns following the 1998 and 1999
year-ends, Raftopoulos indicated in his valuation reports that the NMLF was
underweight in bonds and overweight in equities. In view of Fedsure Life’s
compliance with solvency and investment requirements, the Registrar’s office
did not consider it necessary to react to this. Following an enquiry from us,
the Registrar’s office indicated that it is common occurrence among long-term
insurers to notify them of such a situation in the statutory returns; hence the
FSB did not react to it.
Although we accept this to be so, and despite the huge amounts of information
dealt with at that office, we believe that the mere occurrence of the same
insurer reporting the same issue in two consecutive returns should at least
have prompted further enquiries. As far as the investing public is concerned,
the Registrar is the institution of last resort, the final watchdog acting in its
interests. In our view, policyholders – who more often than not invest funds
“niksvermoedend” and “Godvresend”4, in the words of one of the persons we
interviewed – should rest assured in the knowledge that the Registrar’s
personnel cast more than a beady eye on information placed at its disposal.
Given that the returns were submitted annually, this was probably an
administrative failure more than anything else. However, the new quarterly
returns should adequately address the problem.
4 Unsuspecting and God-fearing.
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240 There are measures that could improve the regulatory framework to, in future,
timeously detect and/or prevent the deterioration of a long-term insurer, as
experienced at Fedsure Life. Many of these have been identified by the FSB,
and we make some suggestions in Section O.
241 Following an internal investigation, the Registrar’s office prepared two
extensive reports on the matter dated 26 October 2001 and 8 March 2002.
From these reports the FSB concluded:
241.1 that Fedsure Life always met the statutory solvency requirements;
241.2 that the deterioration in the financial position of Fedsure Life was due to poor
investment performance of certain specific assets and poor asset liability
management;
241.3 that separation of policyholder and shareholder assets should be a mandatory
requirement;
241.4 that the spread of investments per policy liability type be judged;
241.5 that the role of the statutory actuary be better supported to better achieve
independence of policyholder and shareholder interests;
241.6 that takeovers or mergers of life insurers be better regulated for the sake of
protection of policyholder interests, particularly with regard to computer
systems; and
241.7 that the FSB improves its regulatory role through more regular and more
timeous reporting as well as more contact with insurers through on-site visits,
regardless of whether they suspect problems or not.
We are in full agreement with these findings and recommendations.
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242 As far as the Norwich merger is concerned, the Registrar appointed an
independent actuary in August 2000 in terms of section 38(1)(c) of the LTIA to
report on the transaction’s effect on policyholders of both life companies. His
mandate stipulated that he was to report to the Registrar “on the effects of the
proposals on the policyholders of both the long-term insurers concerned”. A
copy of this mandate is attached as Annexure G. We are satisfied that this
was duly communicated to all Norwich policyholders in various information
documents, prior to the Court approval of the scheme of transfer in terms of
section 37 of the LTIA.
Financial Services Board Fedsure Life Assurance Ltd Report Page 118 - STRICTLY CONFIDENTIAL - L Professional Conduct of Fedsure Executives, Managers and Non-
Executive Directors General remarks
243 To manage a life insurer requires the full-time or part-time appointment of a
number of professionals who ultimately act as a team in exercising their duties
to the company and its stakeholders, particularly policyholders. We comment
on some of these (not specifically dealt with elsewhere) below. It is extremely
hard to single out a specific individual as a professional whose conduct in
isolation would actively jeopardise a company of the size of Fedsure Life,
unless it was intentional or clearly negligent. Such a case would most likely
have met with disciplinary action from the company itself. We did not come
across any such conduct other than that of Killick and Barber following the
mid-2000 release of erroneous results to investment analysts.
244 Apart from the non-executive directors, who had a very specific role to play,
we also comment on the roles of the actuaries (coincidentally, all the senior
executives on the board were actuaries), the external auditors, investment
managers, IT managers and property valuators.
Non-executive Directors
245 The non-executive directors were appointed for reasons of business interests
and/or their particular skills or acumen. Some of them were members of
recognised professions in their own right such as the actuary, Hart, and the
chartered accountant, Sacks. Apart from their normal fiduciary duties, and
their duties towards policyholders, some of these directors took on additional
duties by serving on Board Committees.
Financial Services Board Fedsure Life Assurance Ltd Report Page 119 - STRICTLY CONFIDENTIAL -
246 In the nature of their non-executive roles, these directors were solely
dependent on the information provided to them through the Board packs
tabled at Board meetings, together with the opportunity for discussions at
these meetings, both formally and informally. We established that they were
provided with quite comprehensive board packs prior to board meetings. In
addition, there is no question that they had full access to the executives of the
various divisions. Hart and Van Staden especially met regularly with
executive managers outside the boardroom.
247 In interviewing the non-executive directors, we formed the following opinions
regarding the execution of their roles:
247.1 Some of them seldom (if ever) participated in the discussions at Board and
Board Committee meetings. Some of them were however very active
participants, such as Van Staden, on whose experience and skills a number of
the others relied.
247.2 Few of them had a clear understanding of the operation of the NMLF,
particularly the relationship between (matching of) the policyholder liabilities
and the assets.
247.3 They believed the matching of assets and liabilities to be managed by
Basserabie, Bernstein, Raftopoulos (all actuaries) and Derman.
247.4 They were aware, and some of them acutely so, of the overweight in financials
and in specific shares, particularly Inhold/Investec. At around the end of 1997,
they consciously arrived at a considered opinion that it was acceptable to
policyholders and shareholders that the overweight in financials and specific
counters be treated as management had suggested to them. This situation
remained until 2000. The fact that the legal limits in terms of the Investment
Regulations were not exceeded was comforting to them. Despite this, some
non-executives raised concerns as early as 1995 that the situation was not
acceptable in the long run.
Financial Services Board Fedsure Life Assurance Ltd Report Page 120 - STRICTLY CONFIDENTIAL -
247.5 They fully trusted management in the latter’s endeavours to correct the
overweight situation. It is uncertain whether there in fact were committed
endeavours in this regard before 2000, when management inter alia took
decisive steps to reduce the Inhold holding.
247.6 They took comfort in the fact that the executive directors Basserabie,
Bernstein, Raftopoulos, Brewis and McGinn were all qualified actuaries, as
well as the fact that the non-executive director, Hart, was also an actuary.
247.7 They appeared to have had full confidence in the skills of the investment
managers, particularly Derman, Ho and Loubser.
247.8 They relied on the skills, insight and business acumen evident among them,
in particular on Herman and Koseff (from the banking industry), Sacks (an
experienced chartered accountant and Chairman of Netcare), van Staden (a
former Registrar of Financial Institutions), Jammine (a well-known
economist), and from 1999 King (of corporate governance fame).
247.9 They did not have reason to form the impression that executives or
management were hiding material information from them.
247.10 Barrow, the non-executive Chairman, was very involved in the affairs of
Fedsure and practically met weekly with the Chief Executive.
247.11 They appear not to have been made aware of the serious operational
problems that started to appear in the second half of 1999.
247.12 They were generally well informed, and supported the growth strategy of
Fedsure and particularly the acquisition of Norwich Holdings.
247.13 They were well informed of the problems regarding Fedhealth, TMA, and
FBC/Fidelity.
247.14 Most of them were not specifically conversant with the provisions of section
2 of the FI (PoF) Act prior to this inspection.
247.15 Most of them supported the idea of some form of training of non-executive
directors regarding the life industry, although some had reservations
regarding the continued willingness of non-executive directors to serve on
boards in view of the greater emphasis being placed on fiduciary duties and
corporate governance. Some expressed reservations about such training,
Financial Services Board Fedsure Life Assurance Ltd Report Page 121 - STRICTLY CONFIDENTIAL -
emphasising that non-executive directors are usually selected specifically for
the broader skills and experience they bring to a board.
248 Subject to our comments in Section N below, the non-executive directors
were largely an experienced and able group, and we have no reason to
believe that they did not attempt to fulfil their fiduciary duties towards the
company to the best of their ability.
Actuaries
249 Fedsure Life had a team of at least ten full-time qualified actuaries in its
service in 1999/2000, and it made use of external actuaries for special tasks
or peer reviews. Approximately half of EIC and OPCO members and all the
senior executives on the board (Basserabie, Bernstein, McGinn, Brewis,
Raftopoulos) were actuaries. There can be no doubt that Fedsure did not
underestimate the importance of the role of actuaries in running a life insurer,
both strategically and operationally.
250 We are of the opinion that the professional duties of actuaries need to be
distinguished in their operational capacity and their duties towards the
management of the company for the sake of all stakeholders and the public
interest. Raftopoulos and his subordinate actuaries in CAS were specifically
tasked with the operational duties of actuarial valuations, soundness of
premium rates and asset liability matching. Basserabie and Bernstein were
not involved in these day-to-day operational actuarial duties, and it was in
order for them to rely on the other actuaries for the execution of these duties.
However, they had a duty to ensure that adequate resources were made
available to Raftopoulos and his team to execute their duties.
251 With regard to the conduct of this team, we formed the following opinions:
251.1 There were adequate resources to perform the operational duties under
normal circumstances.
Financial Services Board Fedsure Life Assurance Ltd Report Page 122 - STRICTLY CONFIDENTIAL - 251.2 There was inadequate support from other divisions, in particular FEDAM and
Group Accounts, following the Norwich takeover, which resulted in CAS
spending too much time in correcting errors that were supposed to be handled
elsewhere in the group. This was a dangerous situation and it appeared that
Raftopoulos did not succeed adequately in conveying his concerns in this
regard to the senior executives and/or the board.
251.3 The mismatching that was revealed at the end of 2000 in the IAP came as a
surprise to everyone, including Raftopoulos. Although unacceptable from a
professional duty point of view, this was most probably a direct result of the
overstretched situation in CAS following the Norwich takeover.
251.4 The strategic investments were a straitjacket for the execution of proper asset
liability management within the NMLF by everyone responsible for its
performance. From 1999, Raftopoulos informed the FSB of the overweight
position in his reports.
251.5 The absence of analyses of surplus prior to the Norwich takeover is indicative
of less than desirable conduct, but initiatives were afoot to rectify the situation.
251.6 The debacle regarding incorrect information supplied to the analysts in mid-
2000 cannot be blamed on Raftopoulos. Bernstein testified that it was a bad
error. Raftopoulos went to Basserabie and Bernstein and they agreed with
him. Barber and Killick were disciplined thereafter.
251.7 We were not in a position to examine in detail whether the alleged “aggressive
approach” of the actuarial valuations of the last two years was tantamount to
unprofessional conduct. It is understood that ASSA is conducting an
investigation in this regard. However, we have no doubt that Raftopoulos and
his team would not have deliberately misled the company or other
stakeholders to present a better picture of the company than was reasonable
to present. It should be borne in mind that there is considerable room for
difference of opinion as to what would constitute too liberal assumptions in
calculating the financial soundness of a life insurer, which mostly depends on
the unfolding of future demographic and economic events as well as the
actions of the company in response to such events.
Financial Services Board Fedsure Life Assurance Ltd Report Page 123 - STRICTLY CONFIDENTIAL - 251.8 The actions reported by Raftopoulos towards the end of 1999 (see paragraph
137 above) that new positive cashflow be used to balance the NMLF could be
considered not to be in the interests of policyholders, particularly new
policyholders. Such a step could have been taken to protect the image of the
company, for the sake of shareholders and current and future policyholders. It
may be argued that it would have been the correct approach, and in the
interests of current policyholders, to close the fund (such as the Guaranteed
Fund) to new investments and to use future shareholder profits to rebalance
the asset portfolio. It was after all the strategic investments, which were
generally funded by shareholders, which caused the imbalance. Shareholders
benefited from these strategic assets in the past. Policyholders did not share
extraordinary profits from those, but did receive bonuses in the upper end of
the market. From 1997 the overweight in financials and specifically in
Inhold/Investec was a more risky approach and shareholders should have
been prepared to bail out policyholders were that risky approach to cause
“losses” to policyholders. Raftopoulos reported these steps to the Fedsure
Life board, and the board was responsible for the continuation of writing new
business into the existing portfolios. This issue is further addressed in
Section N below.
251.9 Although there is no evidence of a conflict of any kind, we do not view it as
good corporate governance that the statutory actuary of a life company is also
a member of its board (as was the case with Raftopoulos in the years prior to
the Investec takeover).
252 Raftopoulos made some allegations, both to the Registrar and us, that he was
to some extent hampered in his duties by the Chief Executive, and that as a
consequence he could not completely independently fulfil his duties.
Basserabie, not surprisingly, denies this. In his interview with us, Raftopoulos
however stressed that his duties were never interfered with to the extent that
he had to amend the results generated. We are not in a position to express
an opinion one way or the other, but believe the matter to be of no
consequence. It should however be mentioned that the question remains why
Raftopoulos did not report this to the board, or board members, or the
Financial Services Board Fedsure Life Assurance Ltd Report Page 124 - STRICTLY CONFIDENTIAL -
Registrar, or ASSA prior to mentioning the issue for the first time in response
to a query from the Registrar.
253 In our interviews with executives who were qualified actuaries (but not
employed in the technical actuarial capacity), it was evident that the technical
actuaries (CAS) were too far removed from investment management. This, in
our view, inhibited proper asset liability matching. The reason for this conduct
had (partly) to do with a general legacy in the life industry, and it is therefore
difficult to lay blame as a result of inappropriate corporate governance and
poor care and diligence at the time.
254 Regarding the professional conduct of the other actuaries in executive
positions, particularly Basserabie, Bernstein, Brewis and McGinn, there
appears generally to have been good intentions on their part to assist CAS in
performing its duties.
255 The strategic investment decisions (e.g. purchase of Norwich and retention of
Inhold) were board decisions, to which these members were well-informed
parties, even though, except for Basserabie, they were not directly involved in
the decision taking and execution of the transactions.
Financial Services Board Fedsure Life Assurance Ltd Report Page 125 - STRICTLY CONFIDENTIAL - The external auditors
256 PricewaterhouseCoopers had an extensive relationship with the Fedsure
Group. It appears from documentation we had reviewed that Fedsure relied
heavily on their expertise, and that the company regularly utilised the services
of PWC for a variety of projects, such as the development of an internal audit
risk management program. For the six years prior to the Investec takeover,
the two audit partners involved were Malcolm Dunn and Barry Stott.
257 We interviewed Dunn and Stott, who provided us with their perspectives on
Fedsure. Their views were as follows: -
257.1 They had an open door to management and the senior executives, and both
Barrow and Basserabie took the problems they reported seriously.
257.2 If measured by the first King report, Fedsure had all the necessary corporate
governance structures, procedures and responsible persons in place. In their
view, corporate governance in the group “was not that bad”.
257.3 The independent non-executive directors had a keen interest in the operations
of Fedsure.
257.4 Barrow, as Chairman, should maybe not have chaired all the board
committees. (This view finds support in King II.)
257.5 Fedsure Life was “not out of line” at the time in failing to separate
shareholders’ and policyholders’ assets. In their experience, it is only recently
that life insurers started separating these funds.
257.6 There was no discernible cashflow in the NMLF, and they could never “see
what was going on in the fund”. In their view, and based on their audit
experience at other life insurers, Fedsure did not control the NMLF as well as
other life companies controlled similar funds (funds that also contained
“potted” assets). PWC was aware that the assets and liabilities in the NMLF
never quite matched, but as auditors they were not involved in asset liability
management. They ensured that all assets were in fact in the fund, and that
these were fairly valued.
Financial Services Board Fedsure Life Assurance Ltd Report Page 126 - STRICTLY CONFIDENTIAL - 257.7 They were not involved in the strategic investments, other than from an audit
perspective (that the assets existed and how they were valued).
257.8 The NMLF was too heavily invested in financials, and in certain other non-
performing assets.
257.9 They were aware that the NMLF was used as a kind of “internal bank” within
the group at some stage. They realised this when they discovered at
FEDAM that in the money market portfolios, “funds had to borrow from each
other to fill the gaps”. The detail was not available to them, but having made
certain assumptions, they approached management. Basserabie “went
through the roof”, and management “went in with a fine tooth comb” to fix the
problem.
257.10 They did not regard FEDAM as particularly good in reporting the detail of
cashflow and movements in portfolios.
257.11 The lines of responsibility at Fedsure were not clear enough.
257.12 Their impression was that “management did not have a free hand to run the
place as they liked”.
257.13 They never saw an analysis of the surplus at Fedsure, but with possibly one
exception, this was not out of line with the rest of the life industry.
257.14 They did not regard Fedsure’s computer systems as powerful enough to
cope with the workload.
257.15 Fedsure did not fail – the “market killed Fedsure”, as a result of the over-
concentration of assets in the financial sector and in counters in that sector,
coupled with bad investments. When financial shares tumbled, Fedsure was
“badly hit”. At the same time, management resources were thin due to
problems with the Norwich merger, and at TMA and Fedhealth.
258 Dunn and Stott provided us with a number of management reports. Having
perused these, we believe that PWC did not stand back in bringing problems
to the attention of management. They commented in robust fashion on
operations, strategically and otherwise, at the end of 1999 and 2000.
Financial Services Board Fedsure Life Assurance Ltd Report Page 127 - STRICTLY CONFIDENTIAL - 259 There is some doubt whether PWC had a proper appreciation of the severity
of certain of the deficiencies that they in fact pointed out. It appears that
management apparently succeeded in convincing them that they would rectify
most of these, particularly at the end of 1999. Some issues were certainly
addressed by management. Nevertheless, the situation worsened during
2000, but at the end of that year the Investec takeover negotiations and due
diligence had been concluded, with the result that this was PWC’s final audit
at Fedsure.
For example, in the audit management report for 1999, PWC inter alia
reported as follows regarding the NMLF:
“At present the NMLF acts as a pool for the investments of shareholders and policyholders, other than linked policyholders. Legally, it should be noted that
the policyholders always have first claim on these assets. Furthermore the
nature of these assets are closely linked to the requirements of the
policyholders. No allocation of the investments is made between shareholders
and policyholders. In our view the assets should be allocated to reflect the
different investment profiles of the two stakeholders and to more closely
measure the performance of the portfolio to expected returns for the different
investment profiles of the two stakeholders and to more closely measure the
performance of the portfolio to expected returns of the different investment
profiles. In addition, this will improve the matching of policyholders’ liabilities
to suitable assets. We believe that good corporate governance principles
should dictate that these assets are separated to avoid any independence
conflicts.”
Financial Services Board Fedsure Life Assurance Ltd Report Page 128 - STRICTLY CONFIDENTIAL -
Management’s response was noted as follows:
“An investment strategy has been drawn up which takes these matters into
account. The four fund approach to tax will also require the allocations to be
made.”5
A year later, in the audit management report for 2000, the same issue was
noted in exactly the same wording, and management’s response was also
identical.
260 The Registrar requested us to express an opinion on whether the auditors
could have done more to prevent the deterioration of the financial situation at
Fedsure Life. In terms of Chapter 13 of the first King report, an external audit
is one of the cornerstones of corporate governance. The task has to be
fulfilled objectively and with high ethical standards; even though auditors work
with management, they should be conscious of their accountability to
shareholders (and, one might argue, policyholders). Auditors of life insurers
also have a duty towards the Registrar, who has to approve their
appointments. In terms of section 19(5) of the LTIA (read with section 20(5) of
the Public Accountants and Auditors’ Act, No. 80 of 1991), auditors of life
insurers are under obligation to report to the Registrar a material irregularity
that has caused or is likely to cause financial loss, if the management of the
insurer has failed to satisfy the auditor within a certain time period that there
was no such irregularity, or that steps have been taken to prevent or recover
the loss. (Auditors of banks have a similar duty.)
5 The maintenance of four funds for tax purposes, namely a fund for taxed policies owned by individuals; a fund for policies belonging to companies and other corporate bodies; a fund for approved fund business; and a fund representing the corporate reserves of the life insurer.
Financial Services Board Fedsure Life Assurance Ltd Report Page 129 - STRICTLY CONFIDENTIAL - 261 To an extent, we believe the external auditors had the same dilemma as that
of the office of the Registrar (see Section K above). The company was
solvent and complied with statutory requirements and guidelines. None of its
practices were out of line with that of the rest of the industry, with the
exception (as noted by Dunn and Stott) that the NMLF was less well managed
than similar funds at Fedsure Life’s competitors. In having brought this
problem to the attention of management, management indicated in its
response that they were in the process of addressing the problem (but then
proceeded not to, judging by their similar response in 2000). In PWC’s
experience, management took them seriously and addressed their concerns.
They were not primarily involved in the strategic acquisitions. Even though the
financial situation of Fedsure deteriorated, the company was still able to raise
capital and there was no danger of liquidation. Ultimately, another company
purchased Fedsure as a going concern.
In the light of the Investec takeover at the end of 2000, it remains an open
question whether PWC should at that time have taken stronger action, and
maybe have qualified its report in this respect of the NMLF – even with the
benefit of hindsight. Investec had performed its own due diligence with the
involvement of Tillinghast, and we found ample evidence to suggest that by
December 2000, Investec was fully aware of most problems in Fedsure Life
and the NMLF. In the light of events subsequent to the takeover, the question
is probably academic.
Investment managers
262 There is certainly evidence of problems at FEDAM, especially after the
Norwich takeover. It is a valid question whether the asset management team
was equipped to manage a merger of assets of this nature. The criticism
expressed by the external auditors and CAS on the lack of internal controls
and the accuracy and timeliness of information from FEDAM was a fairly
damning accusation. Despite this, it appears that the situation did not improve
completely satisfactorily until the Investec takeover.
Financial Services Board Fedsure Life Assurance Ltd Report Page 130 - STRICTLY CONFIDENTIAL -
263 In the minutes of a meeting of FINCO on 20 November 2000, Raftopoulos
noted with regard to the NMLF:
“[The] actual portfolio does not reflect our [CAS’s] investment mandate.”
The lack of adherence to mandates in managing the assets of the NMLF is
questionable conduct. In addition, we were told that FEDAM’s mandates
regarding internal investments (i.e. investments managed on behalf of other
divisions in the Group) were either not of a formal nature, or insufficient.
264 The lack of a centralised reporting system for the NMLF can be partly blamed
on the conduct of the investment managers responsible for the NMLF, since
they were jointly responsible for the management of this fund. Ho, the Chief
Investment Officer at FEDAM prior to the Investec takeover, told us that
FEDAM only managed certain assets in the NMLF, and was not responsible
for or aware of the nature of the liabilities. The property portfolio was not
FEDAM’s responsibility, either, although the head of Fedsure Properties
reported to Derman.
265 It should be mentioned that with regard to the NMLF, investment managers
were faced with a less than ideal situation, since they were not allowed to
trade as freely in the strategic investments as in other counters. We were also
told of personality clashes between members of CAS and FEDAM, which
Bernstein said he was ultimately unable to resolve and that appears to have
had a negative impact on operations.
Financial Services Board Fedsure Life Assurance Ltd Report Page 131 - STRICTLY CONFIDENTIAL - IT managers
266 It appears that following the Norwich merger, Fedsure found itself with four
essentially different systems that supported different functions and products,
two of their own (an “old” mainframe, and a new system of R45 million that
they never could get to operate properly) and two taken over from Norwich (a
mainframe and an SDT system). A decision was taken to merge these
systems and not maintain them separately, and the ultimate result was that
despite strategic plans and lots of talk, the systems were never merged,
leaving CAL and Investec with significant difficulties at the end of 2000. It
appears that the decision to merge the systems was followed by a lot of
indecision on how to effect the merger.
267 We were provided with fairly detailed (and sometimes conflicting) information
as to the reasons for this failure. The minutes of the Fedsure Life board and
board committee meetings from 1998 indicate numerous deadline extensions
of the systems merger, also based on various reasons.
268 It is fairly clear that the Norwich information technology environment was
superior to that of Fedsure, but this did not necessarily mean that the Norwich
operation would have transferred without problems to the much bigger
Fedsure environment.
269 We did not investigate these matters in detail. It is however clear that the
inability to incorporate the Norwich policies effectively into the Fedsure Life
system, and the indecisiveness of action in this regard (some of which is
addressed elsewhere in this report), raises questions as to the professional
ability of the IT management at Fedsure. (As stated elsewhere in this report,
these comments relate to the individual life business.)
Financial Services Board Fedsure Life Assurance Ltd Report Page 132 - STRICTLY CONFIDENTIAL - Property Valuators
270 In view of the various instances where property values were written down, or
were found to be questionable (such as during the Investec due diligence),
this issue is of concern to us. CAS provided Fedsure Properties with a model
and basis to do property valuations. Apparently, JH Isaacs’ valuations were
generally accepted to be accurate. The extent to which property write-downs
were made or suggested, plus the overweight of properties in the NMLF, make
this a material aspect of the financial management of the NMLF. We did not
investigate this in greater detail.
Financial Services Board Fedsure Life Assurance Ltd Report Page 133 - STRICTLY CONFIDENTIAL -
M WHAT WENT WRONG? Perspectives
271 In the preceding sections of this report various facts, opinions and conclusions
have been stated regarding alleged or possible problems or shortcomings in
the conduct of Fedsure Life and/or IEB. This section attempts to firstly provide
perspective on the question as to what went wrong and secondly to answer it.
272 Some of the key perspectives on Fedsure that are to be emphasised are the
following:
272.1 Since 1993 Fedsure embarked on an ambitious growth strategy for which it
cannot be blamed. Some of the subsequent acquisitions turned out to be bad
investments, and in some instances the timing of the investments was
questionable. It is at this stage impossible to say whether that should have
been foreseen; suffice it to say that boards of directors cannot be flawless in
their decision making for the entire duration of their existence.
272.2 The market capitalisation of Fedsure Holdings was R11.4 billion at the end of
May 1998. Fedsure Life was estimated by Raftopoulos to have had excess
assets of R4.5 billion at that stage, including a bonus stabilisation reserve of
R500 million. Norwich Holdings had a market capitalisation of approximately
R3.5 billion at that stage, and Fedsure held approximately a third of the
Norwich Holdings shares. The joint market capitalisation of the two groups
would therefore have been around R13.7 billion. Fedsure completely took
over Norwich later in 1998 at a total price of R3.6 billion. At the end of 2000,
Investec bought the Fedsure Group for R4.3 billion (excluding Fedhealth).
The market capitalisation of Fedsure Holdings at the end of October 2000 was
R3.8 billion. We were told that between May 1998 and December 2000, the
financial index fell 24%. (Since Fedsure Holdings was a financial services
group, we consider the financial index to be an appropriate index by which to
adjust the market capitalisation of Fedsure Holdings to reflect market forces.)
Financial Services Board Fedsure Life Assurance Ltd Report Page 134 - STRICTLY CONFIDENTIAL -
Reducing the R13.7 billion by 24% leaves approximately R10.4 billion. The
difference between the adjusted market capitalisation of R10.4 billion and
R4.3 billion that Investec paid for the group, represents a crude estimate of the
loss suffered by Fedsure shareholders over this period, i.e. a 59% loss.
Fedsure’s share price increased by 83% for the twelve months to May 1998,
approximately double the increase of the financial index. Hence, for the
period May 1997 to December 2000, the loss to shareholders would have
been approximately 46%. (The value of R10.4 billion included Fedhealth,
which Investec did not purchase and thus was not included in the R4.3 billion.)
272.3 Fedsure Life never defaulted on any policy claims, or payments to its
creditors, or on statutory solvency tests. It did extremely well for most of the
1990s. Still, nil bonus rates were declared at the end of 2000 and the end of
2001 on Fedsure Life smoothed bonus policies, and up to 12% of non-vested
bonuses were removed at the end of 2001. Fedsure Life linked policy returns
deteriorated relative to the market after 1998. From 1999 policyholders
suffered deteriorating administrative service, mainly due to the problems with
the Norwich systems integration and the fact that IT managers had to cope
with the Y2K conversion. In addition, policyholders’ security was severely
eroded after 1999. Surrendering policyholders received poor value for money
following reductions in surrender values due to the poor performance of the
NMLF. The FGF is still not appropriately structured, and policyholders may
continue to earn less bonuses than expected. See in this regard from
paragraph 280 below. 272.4 More than 2000 people formerly employed by Norwich and Fedsure lost their
jobs and were not taken up in the Investec group or in CAL. Intermediary or
broker contracts may also have been sacrificed through no fault of those
intermediaries or brokers. 272.5 Both the Fedsure and the Norwich brands have disappeared from the life
insurance scene. The industry has lost significant competition, but will
hopefully gain in efficiency through the lessons learnt from the Fedsure
experience.
Financial Services Board Fedsure Life Assurance Ltd Report Page 135 - STRICTLY CONFIDENTIAL - Reasons
273 Fedsure Life’s gain up to 1998 in its share price, bonus earning power and
solvency was largely attributable to its huge unrealised gain in the value of its
strategic investments, in particular Inhold/Investec, Saambou and
FBC/Fidelity. After the market crash in 1998, much of this unrealised gain
vanished, with consequent major pressure on the share price, policy bonuses
and solvency. Although reliance on these strategic holdings did not per se
constitute negligence, it was a fairly high-risk approach which rendered good
returns for some time, but then fell back. For policyholders, the problem was
compounded by the fact that shareholders’ and policyholders’ funds were not
separated in the NMLF.
274 The lack of separation in policyholders’ and shareholders’ funds in the NMLF
implied less discipline than would otherwise have been the case. The practice
was not uncommon among life insurers in the middle 1990s. This was
however a corporate governance issue, which would have contributed to some
extent to the poor performance. However, as mentioned elsewhere, there is a
great deal of legacy in this and Fedsure ultimately intended to rectify it.
Events simply overtook their intentions in this regard.
275 The underlying insurance business of Fedsure Life was sound until 1998,
although not extremely efficient and therefore did not contribute spectacular
profits. The Norwich takeover was operationally too taxing for management, in
particular FEDAM. The inability to properly manage the takeover had major
consequences for asset liability management.
276 The growth strategy culminated in two major transactions, Fedhealth and
Norwich. We formed the opinion that executives and management at Fedsure
Life and in the Group were not able to cope with the sudden growth in
activities and responsibilities. It was a judgment error on the part of the board
and management to think that Fedsure had the capacity and the capability to
manage such growth, and Basserabie confirmed this to us.
Financial Services Board Fedsure Life Assurance Ltd Report Page 136 - STRICTLY CONFIDENTIAL -
In addition, many other financial services groups have burnt their fingers in
health care. Many will also testify to mergers and acquisitions that took a
much higher toll in more respects than anticipated.
277 Fedsure had the bad luck to suffer a variety of setbacks in a relatively short
period, as described in the preceding sections of this report.
278 As stated above, Fedsure did well for most of the 1990s for both shareholders
and policyholders. Basserabie – known at the time as “Mr Fedsure” in the
market – was regarded as having provided good and strong leadership, and
as a consequence, the board appeared not to have asked too many
questions. Maybe that leadership was too strong, with too little reliance on
other executives. When things started to go wrong and the company
experienced rapid growth, we believe the leadership burden on the chief
executive to have become close to unbearable, with other executives unable
to cope.
279 Some of the reasons for Fedsure’s position in 2000 are addressed elsewhere
in this report, such as our view that the extent of problems was not properly
communicated to the board, generally poor housekeeping, and corporate
governance flaws or failures.
Were the reasonable expectations of policyholders met?
280 It is obviously a difficult task to determine policyholders’ expectations, since
policyholders do not necessarily constitute one uniform class of persons.
There is little professional guidance that we could find to provide us with
criteria against which to measure Fedsure Life’s conduct or performance.
However, it is customary in international actuarial practice not only to provide
for contractual commitments in calculating the value of policyholder liabilities,
but also to provide for the reasonable benefit expections of policyholders.
Financial Services Board Fedsure Life Assurance Ltd Report Page 137 - STRICTLY CONFIDENTIAL -
Such expectations would be created through marketing material and include
rates of bonuses or investment performance that are not guaranteed.
In our opinion, at the very least, policyholders have three broad expectations
regarding the conduct of their life insurer. They reasonably expect financial
soundness (i.e. security), good investment returns and good service.
• Financial soundness: Life insurance policyholders entrust huge amounts
of savings and premiums for risk benefits to the life insurance industry.
They do so knowing that the track record of the industry is a good one and
that sophisticated control mechanisms, statutorily and otherwise, exist.
Intermediaries will not be able to sell policies of an insurer that does not
meet statutory or market measures in terms of security. It is therefore
obvious that a policyholder will only pay premiums to a life insurer that is
financially secure and he or she will expect that insurer to be managed in
such a way that it will remain secure. Erosion of security (to marginal
levels) is not what policyholders expect from their life insurer.
• Good investment returns: Apart from the fact that the marketing material
and sales talk of insurers and their intermediaries or brokers create
expectations of good investment returns with policyholders, insurers have
the resources and acumen to deliver on these expectations. Policyholders
invest their money with life insurers recognising that these are safer
investments than other avenues (such as unit trusts), but also expect to do
better than pure savings with banks. However, actual performance in view
of specific portfolio compositions chosen by the policyholder, or as advised
by his/her adviser, is an area where there is room for difference of opinion.
Nevertheless, we view it as obvious that performance significantly poorer
than the market for comparable savings products, does not meet
policyholders’ expectations.
Financial Services Board Fedsure Life Assurance Ltd Report Page 138 - STRICTLY CONFIDENTIAL -
• Good service: It is reasonable for policyholders to expect prompt replies
upon requests, queries or claims. Turnaround times for such services can
reasonably be expected to be a matter of days for the vast majority thereof.
When turnaround times become consistently longer, it falls outside the
reasonable expectations of policyholders.
281 The expectations regarding security and investment returns are linked. The
following extract from the 30 September 2001 Financial Soundness Valuation
Report of Fedsure Life, puts it into proper perspective:
“When assessing the financial strength of Fedsure Life, consideration needs to
be given to the extent to which policyholder expectations are provided for. For
non-profit and market related business expectations are dictated by the
contractual terms and unit values. For with-profit business (which is mainly
smoothed bonus business) expectations are not clearly defined, but
fundamentally policyholders will expect returns over the longer term consistent
with the performance on a diversified portfolio of assets.
They will also expect competitive bonuses (this having been stated in our
marketing literature). Competitive bonuses should however be consistent with
the return of a diversified portfolio, and as such we use these returns to
measure what our policyholders expect.”
With regard to the investment performance of the NMLF and FEDAM, see
paragraphs 128 to 131. There was a clear deterioration in performance since
1998.
282 The quality of service enjoyed by policyholders is greatly determined by the
efficiency of an insurer’s administration and computer systems. In addition,
staffing levels and staff morale will inevitably have an effect on service
delivery. Numerous complaints (from policyholders and their representatives)
were brought to our attention regarding a deterioration of service levels at
Fedsure Life from around 1998. In addition, this was confirmed by the offices
Financial Services Board Fedsure Life Assurance Ltd Report Page 139 - STRICTLY CONFIDENTIAL -
of the Ombudsman for Long-term Insurance and the Pension Funds
Adjudicator.
As mentioned elsewhere, we are satisfied that IEB and CAL are doing their
best to restore service levels and are achieving success in that regard.
283 In the light of the fact that –
• Fedsure Life policyholders’ security was eroded from a CAR cover ratio of
4.6 in 1997 to 1.4 at the end of 2000,
• FEDAM underperformed,
• service levels deteriorated, and
• the situation inherited by IEB necessitated drastic measures as discussed
elsewhere in the report,
it is not difficult to come to the conclusion that the reasonable expectations of
policyholders have not been met over the period from 1999 to 2002, accepting
that not all policyholders have suffered in the same manner or to the same
extent. We are satisfied that measures are in place to alleviate or compensate
for these setbacks and value reductions under the IEB/CAL dispensation.
Financial Services Board Fedsure Life Assurance Ltd Report Page 140 - STRICTLY CONFIDENTIAL -
N Section 2 of the FI Act: ‘Care and Diligence’ Introduction 284 Our instruction was to report whether, in our view, the directors (and others) of
Fedsure Life observed the utmost good faith and exercised proper care and
diligence in terms of section 2 of the FI (PoF) Act. Legal representatives of
the former directors of Fedsure brought it to our attention that this Act only
commenced on 23 November 2001, when it repealed its predecessor, the FI
Act. We view this as a moot point, since the wording and intention of the two
corresponding sections - section 2 in both the FI (PoF) Act and the FI Act –
have essentially remained the same.
285 One should expect that all directors and employees of financial institutions
should be aware of the provisions of section 2, especially since the Act makes
non-compliance a criminal offence. Yet we found that few of the Fedsure
directors, with hardly any of the non-executive directors, were aware of its
existence prior to this inspection. One reason for this lack of awareness is
probably that there is no case law in point on section 2 (despite a number of
prosecutions for contraventions of its provisions), and no or little indication of
what exactly constitutes, or does not constitute, observance of “the utmost
good faith” and the exercise of the “care and diligence required of a trustee”
with regard to policyholders’ funds within the context of the life industry. It is
common law that the duties of a trustee require the highest degree of utmost
good faith and care and diligence. Part of the answer is dictated by common
sense, but when it comes to operational issues, the matter becomes more
complex.
Financial Services Board Fedsure Life Assurance Ltd Report Page 141 - STRICTLY CONFIDENTIAL - 286 Section 2 of the FI Act provided as follows:
“A director, official, employee or agent of a financial institution or of a nominee
company controlled by a financial institution who invests, keeps in safe
custody or otherwise controls or administers any funds of the financial
institution or any trust property held by or on behalf of the institution for any
beneficiary or principal-
(a) shall, in the making of an investment or in the safe custody, control or
administration of those funds, observe the utmost good faith and
exercise proper care and diligence;
(b) shall, in the making of an investment or in the safe custody, control,
administration or alienation of the trust property, observe the utmost
good faith and, subject to the terms of the instrument or agreement by
which the trust or agency concerned has been created, exercise the
usual care and diligence required of a trustee in the performance or
discharge of his powers and duties; and
(c) shall not alienate, invest, pledge, hypothecate or otherwise encumber
or make use of the funds or trust property or furnish any guarantee
(whether or not, in the case of an insurer, such guarantee is
incorporated in a policy) in a manner calculated to gain directly or
indirectly any improper advantage for himself or any other person at the
expense of the institution, trust, beneficiary or principal concerned.”
This Act defines “trust property” as any “corporeal or incorporeal, moveable or
immovable asset kept in trust”.
Financial Services Board Fedsure Life Assurance Ltd Report Page 142 - STRICTLY CONFIDENTIAL - 287 Section 2 of the FI (PoF) Act provides as follows:
“A director, member, partner, official, employee or agent of a financial
institution or of a nominee company who invests, holds, keeps in safe custody,
controls, administers or alienates any funds of the financial institution or any
trust property -
(a) must, with regard to such funds, observe the utmost good faith and
exercise proper care and diligence;
(b) must, with regard to the trust property and the terms of the instrument
or agreement by which the trust or agency has been created, observe
the utmost good faith and exercise the care and diligence required of a
trustee in the exercise or discharge of his or her powers and duties; and
(c) may not alienate, invest, pledge, hypothecate or otherwise encumber or
make use of the funds or trust property or furnish any guarantee in a
manner calculated to gain directly or indirectly any improper advantage
for himself or herself or for any other person to the prejudice of the
financial institution or principal concerned.”
In terms of this Act, “trust property” means any “corporeal or incorporeal,
moveable or immovable asset invested, held, kept in safe custody, controlled,
administered or alienated by any person, partnership, company or trust for, or
on behalf of, another person, partnership, company or trust”.
It is clear from the above wording that the obligations imposed by both Acts
are the same. Nevertheless, the FI Act was applicable during the tenure of
the former Fedsure directors, and our findings below refer to that Act.
Financial Services Board Fedsure Life Assurance Ltd Report Page 143 - STRICTLY CONFIDENTIAL - 288 Both Acts make contravention of the provisons of section 2 a criminal offence.
Section 9 of the FI Act provides for a sentence of a fine of R10 000 or
imprisonment of up to 10 years, or both (in the FI (PoF) Act the term of
imprisonment has been increased to 15 years).
289 Our instruction from the Registrar in this respect has proven to be a difficult
task, for various reasons. There is no pertinent case law on the interpretation
and application of section 2 that we are aware of. In order to place our
findings below in context, we view it as necessary to state here our
interpretation of section 2 (which is the same for both Acts). We have had the
benefit of a variety of views of the legal representatives of the directors we
interviewed on their interpretation of this section, and we also respond thereto
below.
For the purposes of this discussion and unless indicated otherwise, we
concentrate on section 2(b) of the FI Act, which in our view is the provision
applicable to the assets kept in Fedsure Life’s life fund, including the assets
backing policy liabilities in the NMLF.
289.1 It appears that section 2 codified the common law relating to the duties of a
trustee and made it applicable to any director, official, employee or agent of a
financial institution who invests, keeps in safe custody “or otherwise controls
or administers” the funds of the institution and trust property.
289.2 We believe the intention of the legislature and the wording to be clear and to
have been stated intentionally wide. Section 2(b) imposes a duty on a director
(amongst others) of a financial institution to observe the utmost good faith and
exercise care and diligence relating to trust property. The legislature in fact
went further, and made non-compliance with section 2 a criminal offence.
289.3 Having due regard to the definition of “trust property” within the context of the
FI Act, the latter term to our mind simply means, or at least includes, the funds
of an investor or policyholder that have been placed in the hands of a financial
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institution to invest, keep in safe custody, control or administer. It does not
make sense to interpret the term as only being (literally) the property of a trust;
if this was the intention, the entire section would have been meaningless.
289.4 The degree of care and diligence required is the same as that required of a
trustee. Section 2(b) does not state that the director etcetera must literally be
appointed as a trustee; neither does it state that the funds should be dealt with
in terms of a trust deed. The “instrument or agreement by which the trust or
agency concerned has been created“ is in our view the mandate in terms of
which the funds are dealt with. When the financial institution is a long-term
insurer, this mandate to our mind connotes the agreement that constitutes the
relationship between the insurer and the policyholder (such as an insurance
policy) or, in the case of group benefits, with a retirement fund, such as a
pension fund.
289.5 With specific regard to the position of a director, section 2 is in our view clearly
not merely a repetition of the fiduciary duties of a director towards his or her
company. In the first instance, the matter only concerns directors of financial
institutions as defined in the respective Acts. Secondly, section 2(b) primarily
relates to the relationship between the director and policyholders or investors
(the “beneficiary or principal”), not to the relationship between the director and
his or her company. Moreover, the legislature decided to visit non-compliance
with an offence and criminal sanction, which is not the case with a breach of
the common law-based “normal” fiduciary duty. We cannot see any other
possible interpretation than the intention to impose an additional duty on a
director of a financial institution when he or she deals with the funds entrusted
to such institution. During the course of the inspection, it has been argued
that our interpretation would abrogate (i.e. repeal or cancel) the common law
principle that a person should not be answerable to two principals (in this
case, policyholders and shareholders/the company). It is our understanding
that it is in the nature of legislation to abrogate common law principles if the
legislature sees fit to do so. In this case, any other interpretation would render
the provisions of section 2 meaningless. We furthermore disagree with the
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legal representatives’ contention that our interpretation would lead to an
absurdity, in that conflict may arise where a director acts in the interests of a
policyholder to the detriment of the company. Such a potential conflict
obviously exists and have existed for a vast number of years; would have
existed even in the absence of the Act and its predecessors; and directors
need to manage it appropriately and fairly (as was always the case). In our
view, the Act makes it imperative that this conflict is properly managed. The
conflict is aggravated where shareholders’ and policyholders’ funds are not
separately managed, but pooled together. (It is interesting to note Fedsure
Life’s approach in managing this conflict regarding the NMLF – see the views
of the directors in this regard in the second bullet in paragraph 292 below – in
contrast to IEB’s approach.)
289.6 As set out below, we express our views specifically regarding the control of
the funds in the NMLF by certain individual directors of Fedsure Life, and
whether they exercised proper care and diligence in this respect. We were
referred to South African case law of 1924, where control was envisaged to be
de facto (in other words, physical or actual) acts of control. Other case law
brought to our attention describes control as “the possession of it or the
management of it”, or “the power to hinder or prevent”. In the modern financial
services environment, managers and executives hardly ever physically or
actually deal with funds, but make decisions at various levels (including board
level) that determine the fate of funds under management. We respectfully fail
to see how such decisions do not constitute control of the funds within the
ambit of the respective Acts, as was contended by the legal representatives.
In our view, if an individual contemplated in section 2 is in a position where he
or she is able to dispose of, or determine or hinder or prevent the fate of, the
funds concerned, that suffices to constitute control, and liability in terms of the
section may arise.
Financial Services Board Fedsure Life Assurance Ltd Report Page 146 - STRICTLY CONFIDENTIAL - 289.7 It was further contended that non-executive directors specifically cannot
control funds as contemplated in section 2. The legal representatives based
this argument on the following contentions. Firstly, the structure of the
Fedsure Group was such that all funds were under the management and
control of FEDAM, which possessed mandates for this purpose from the other
companies in the group (including Fedsure Life). FEDAM had its own board of
directors, and the funds of the NMLF were “mixed” with other funds. It follows
that Fedsure Life itself was not in control of the funds. Secondly, it is a
“preposterous preposition [sic]” for a non-executive director under these
circumstances to arrive “at the offices of Fedam and instructing them to
dispose of a major asset”. As for the first contention, the outsourcing of asset
management is common within the industry, and there is nothing wrong with it.
However, the fact that the management of investments is outsourced to a third
party can never mean that the financial institution to which a principal or
beneficiary entrusted those funds, may abdicate its responsibility with regard
to the control of those funds. As to the second contention, we do not believe
the example used or the distinction between an executive and non-executive
director to be helpful. The proposition postulated may be preposterous, but
the point is rather that any director who is party to a board decision that
constitutes control of funds contemplated in section 2, may fall within the ambit
of the provision. The question then arises as to proper care and diligence.
This is a factual enquiry on whether such a director had all relevant facts in his
or her possession at the time of the decision (which, in this case, we believe
the non-executive directors of Fedsure Life not to have possessed). To state
the issue differently: if a board has full decision-making powers over
investment funds, and – with complete information at its disposal – makes a
patently poor decision that results in the value of the fund being destroyed,
why should a non-executive director who knowingly partook in the decision not
be liable towards investors, or criminally liable in terms of section 2? We
cannot see any cogent reason why only executive directors would be liable.
Financial Services Board Fedsure Life Assurance Ltd Report Page 147 - STRICTLY CONFIDENTIAL - 290 We considered the question if it is possible to contravene section 2 if other
statutory requirements are met. In our view, this is possible in principle. With
regard to the overweight position in the NMLF, the question is more pertinently
whether a finding of a lack of care and diligence (section 2(b)) with regard to
the control of the NMLF is possible even if the fund complied with the
investment regulations. If an overweight position constitutes an unacceptable
degree of risk to policyholders, it is at the very least a corporate governance
problem and directors (depending on the level of knowledge of the extent of
the problem) should take responsibility for their decisions in this regard.
291 Fedsure Life did not ultimately fail in the sense that it was liquidated, or had
serious solvency problems, or suffered losses due to recklessness. We found
no evidence that directors ever acted in anything less than good faith.
Fedsure was sold to Investec as a going concern for over R4.3 billion in a
normal commercial transaction. Yet, there were deficiencies in the
management of the company, particularly with regard to the NMLF, that
obviously did not arise by itself, and that would not, in our view, fall within the
ambit of “the usual care and diligence required of a trustee”. The decisions
taken in this respect led to a reduction in value of policyholders’ savings, and
eroded their security. The fact that Fedsure Life was apparently not out of line
with industry standards at the time, brings the matter of hindsight to the fore,
which only increases our difficulty in expressing an opinion.
Fedsure’s main strategy as background
292 Fedsure Life performed well until 1998 but ended up in 2001 with less than
satisfactory investment performance and security. The major reasons for this
are attributed to policy and strategic decisions that Fedsure Life developed
and adopted over a period of approximately twelve years which were not
adequately supported by management and operational system capabilities.
The series of adverse events (see paragraph 53 above) proved the
inadequacy of the management and system capabilities. These policy and
strategic decisions were:
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• To grow the Fedsure group to a major financial services group, to be able
to compete with the biggest in its market.
• Not to separate shareholder and policyholder monies in the NMLF, as all
decisions in the company would be taken to be in policyholders’ interests.
Directors told us that as such, this approach prevented conflicts of interest
between policyholders and shareholders. The philosophy was that if
policyholders were looked after, shareholders would automatically reap the
benefits.
It is our considered opinion that these two decisions were incompatible, even
though each one on its own is fully justifiable and commendable for the
interests of policyholders and shareholders respectively.
To grow as a financial services group inherently contains risks that one would
not be able to align with policyholders’ interests, even though policyholders
may share in the upside. Examples of these were the risks associated with
the strategic investments, such as in TMA and Thebe/FBC/Fidelity Bank. This
argument holds regardless of whether Fedsure Life’s funds or other funds in
the group were used for the purpose, because the entire group shared in the
reputation of the Fedsure brand.
Also, the investment in FIPS was done in the NMLF and resulted in an alleged
loss of R70 million. These kinds of investments should typically not be made
with policyholders’ funds. The fact that this was relatively small probably could
be argued that it was funded out of excess assets. There is obvious danger
when all the “small” transactions add up to a major portion. It raises the
question of the consequences if the life insurer’s only shareholder is another
company in the group – in this case, Fedsure Investments. (There is of
course the matter of a potential conflict of interest when the life insurer’s
directors, who make decisions regarding strategic investments affecting both
shareholders’ and policyholders’ funds, are also directors of the life company’s
sole shareholder. In line with the modern structure of life companies, this is
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probably a common occurrence, and save to say that this risk should be
carefully managed, we do not venture an opinion on the matter.)
293 Interestingly, the investment in Fedhealth was not made with any Fedsure Life
funds – neither shareholders’ nor policyholders’ funds. Yet, the problems
suffered by Fedhealth eventually had a major negative reputational impact,
with ensuing loss of policyholders and new money for Fedsure Life.
The separation of policyholders’ and shareholders’ funds
294 It is our considered opinion that a separation of policyholder and shareholder
funds would have created more discipline in weighing the return and risk
profiles of policyholders versus shareholders. Although such a separation was
not standard in the industry at the time, the auditors of PWC indicated that
Fedsure Life did not manage the NMLF as well as its competitors did with
similar types of funds.
295 Fedsure’s growth strategy cannot be questioned by shareholders.
Policyholders would obviously benefit through a successful growth strategy.
However, it is our view that policyholders’ funds should not have been
exposed to the risk of significant losses if the growth strategy failed. To
finance a growth strategy with policyholders’ money, thereby investing large
chunks in single companies (like Fedsure Life did with Inhold/Investec,
Saambou and FBC/Fidelity), appears to us to be approaching the practice of
running a pyramid scheme, i.e. using new policyholders’ money to provide
returns on old policies.
296 Even though large parts of these investments were financed through issue of
new shares, the non-separation of policyholder and shareholder funds meant
that, once paid for, there was no discipline in the allocation of these
shareholdings between the two categories. During the last couple of years, it
could be derived that 15% of the NMLF’s policy liabilities were backed by
Inhold/Investec (see Section G).
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297 In the above context, and within their paradigm and the general industry
standards until mid-1998, we cannot argue that the Fedsure Life executives
exercised no or improper care and diligence. However, it is our opinion that
the extent of the care and diligence was not at such a level that it ensured
management and systems robust enough to withstand the adverse events
experienced by Fedsure Life.
In this regard, Bernstein told us:
“Data is never in a perfect state in any life company and maybe Fedsure Life
was maybe slightly worse than others or meaningfully worse. I don’t know. It’s
very difficult to know. To say they were in shambles, I would disagree … we
got our annual reports out on time, our half-yearly reports on time. Raftopoulos
was very stressed in corporate actuarial and it wasn’t an easy situation and
Basserabie and myself made sure that we appointed extra people to help
him.”
Also, Raftopoulos reported in CAS’s monthly report to OPCO for the period
ending 20 January 2000 that an investment strategy for the NMLF was being
prepared and it included separation of shareholders’ and policyholders’ funds.
In our view, it is incumbent upon the industry to ensure that management and
systems are in future robust enough to withstand similar adverse events. Our
recommendations in this regard are contained in Section O below.
298 By today’s standards, we do not view the care and diligence exercised by the
executives of Fedsure Life in the control of policyholders’ funds in the NMLF
with regard to the separation of policyholders’ and shareholders’ assets as
meeting the requirements of the care and diligence expected of a trustee.
However, we suspect that at the time, many a life insurer would have been in
the same position. It should be noted that in our interviews with the executive
directors they were unanimous in recommending a clear split between
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policyholder and shareholder assets for the future. We are of the view that the
current situation with CAL and IEB is one which passes for proper care and
diligence.
The management of the Immediate Annuity Portfolio
300 The mismatching of the IA portfolio that was “discovered” at the end of 2000
(as discussed elsewhere in this report) (see paragraph 148 above) must, in
our opinion, be ascribed to poor management, for which Raftopoulos and CAS
were mainly responsible. We accept that they were under severe pressure
following the Norwich takeover, but this oversight from a statutory actuary – in
not overseeing proper matching of assets and liabilities, and in not adjusting
the valuation basis for improving mortality rates – cannot, in our view, be said
to meet the standards of the care and diligence required of a trustee.
301 We believe the findings of the investigation of ASSA into possible actuarial
misconduct may shed more light on the matter.
The overweight in financial shares
302 There is no doubt that the board, management and senior executives were
aware of the overweight position in financial shares in the NMLF, specifically
in Inhold/Investec and Saambou, although we do not believe the non-
executive directors of the board were properly informed as to the extent of the
problem and associated risks until late in the day. However, Fedsure Life still
met the requirements of the investment regulations. (Even if the investment
regulations were applied only to the assets and liabilities in the NMLF,
Fedsure Life would still have complied.)
303 The result of the overweight was that policyholders received less returns than
what would have been the case had Fedsure Life in fact invested according to
the model portfolio contemplated by the statutory actuary. The departure from
this model portfolio was a conscious and deliberate act on the part of the
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executives of Fedsure Life, fully realising the risks associated with such an
approach.
For investors who had been with Fedsure Life for a long time, this lower return
meant a potential reduction of their accumulated funds of approximately 13%
in 2000, and a further 25% in 2001; and for newer policyholders, a reduction of
13% in 2000 and 13% in 2001.
For the older recurring premium policyholders, it is significant that their twelve-
year average return is 11.5% per annum, compared to comparable funds with
Sanlam at approximately 17.5% per annum (after deduction of cost charges
but before income tax). The detail of these comparisons is provided above in Table 11, Section H. It should be noted that IEB took control from 2001, and had full discretion on
the bonus rates to be declared at the end of 2001. We were informed that the
Investec representatives had been involved in deciding on the nil bonus
declaration at the end of 2000, when Fedsure Life was still legally in control of
the business. Both these bonus declarations had to be made recognising the
asset and liability position of the Fedsure Guaranteed Fund that was built up
over its period of existence. Hence, the good performance of the FGF until
1999 could be ascribed to the successful investment strategy until that time,
but the poor bonuses of 2000 and 2001 were the result of the legacy of the
asset liability buildup up to 1999 (the overweight in financials and in specific
counters), and adverse events that occurred thereafter.
304 The Fedsure Life Balanced Fund achieved a comparable 16.7% over the
twelve years, with 1.40% in 2000 and 19.25% in 2001. Generally speaking, it
was the same team of investment managers and indeed the same Board
Investment Committee who were responsible for all the investments of
Fedsure Life funds. The markedly lower return to policies in the NMLF must
therefore be largely ascribed to the overweight in financials in the NMLF.
Financial Services Board Fedsure Life Assurance Ltd Report Page 153 - STRICTLY CONFIDENTIAL - 305 The poor historic returns are exacerbated by the fact that the asset portfolio is
at present still not quite in the desired balanced situation. No new money is
invested in the existing portfolio.
306 The general lack of good housekeeping including the absence of a separation
of shareholder and policyholder monies in the NMLF, must, in addition to the
overweight position, also have contributed directly and indirectly to the poor
performance. (Evidence of the direct effect is the loss in the IAP at the end of
2000, which was due to poor asset liability management.) Moreover, by the
time management started to take action the holdings were fairly illiquid and
could not be easily disposed of.
307 In our view, it could be argued that the senior executives in charge of the
NMLF, did not exercise the care and diligence expected of a trustee in the
control of these funds. We are of the view that we cannot find the same with
regard to Derman of FEDAM and Raftopoulos of CAS, since they were not in
a position to exercise full control of the NMLF (although they were involved in
the administration of the fund).
Closing the NMLF to new policyholder investments
308 We considered it a possible neglect of care and diligence that Fedsure Life
allowed new money to be invested in policies backed by the NMLF in 2000.
This argument is made in the context that Fedsure Life realised it was in
financial difficulty at the end of 1999 (see paragraph 137 above) but only in
2001, after Investec took control, were the funds closed to new money. The
general arguments of executives for not closing the policies to new money in
2000 were:
• new money would have enjoyed improved returns in the upturn of the stock
market and in particular financials that was expected to occur in 2000
• closing of the fund would trigger a further spate of lack of confidence with
more surrenders and withdrawals
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• constant efforts were taken to reduce the overweight
• the merging of the Fedsure Life and Norwich policyholder funds would in
any case alleviate the overweight
• Investec had the moral backing of the public and policyholders to take the
drastic action as it was perceived that Investec rescued Fedsure Life.
It should be noted that we found no reference to a consideration of the issue
whether the fund should have been closed to new money in the
documentation we perused. The viewpoints above were all elicited as a result
of questions posed by us during the course of the inspection.
309 It is notable that when Fedsure Life decided on a nil bonus rate for 2000, it still
declared a dividend of R100 million to its sole shareholder. According to
Bernstein (who was under the impression that no dividend was declared), the
guidelines for paying a dividend would have prevented them from doing so,
but this would only have been evident after the results of the actuarial
valuation in February 2001. They must have passed the dividend test to do
so. In March 2001, namely at the time that a nil bonus was declared to
policyholders, no dividend was declared to Fedsure Life shareholders, but by
that time the Investec transaction was concluded in principle and shareholders
knew more or less what their proceeds were to be.
310 With hindsight, it is simple to argue for closure of the FGF to new money from
the beginning of 2000. At the time, the prospects (hopes) for a recovery of
financial shares and balancing of the NMLF dictated keeping the fund open for
new money. In view of Van Staden’s testimony that a board should consider
closure of the segment of the business that is suffering until the problems
have been sorted out, we find it notable that the Fedsure Life board did not
even appear to have deliberated the closure to new money. Moreover, a year
later after Investec took control, it was indeed closed. All in all, we accept that
the situation at the beginning of 2000 was a difficult one, and we find the
explanations furnished by the executives as a result of our questions entirely
satisfactory. However, we view as questionable the omission by the Fedsure
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Life executives to bring the issue of possible closure of the FGF to the
Fedsure Life board (in other words, that the executives did not revert to the
wisdom of the board on such a material matter). The board should have been
placed in a position to at least consider the option, in view of the financial
difficulties of the NMLF that Raftopoulos reported at the end of 1999.
In our view, it is at least questionable whether proper care and diligence was
exercised by the Fedsure Life executives in not bringing this issue to the
attention of the board.
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O RECOMMENDATIONS
313 The life insurance industry is around 100 years old in South Africa. It is
recognised for its provision of valuable financial support in unfortunate
contingencies like death and disability. It is also recognised for its mobilisation
of long-term investment, a critical ingredient to bolster economic prosperity
and growth.
The local life industry delivered and attracted some of the most proficient and
successful entrepreneurs and business leaders in the country, to mention but
a few, people like Andreas Wassenaar, Donny Gordon, Mike Levett, Marinus
Daling, Monty Hilkowitz, Adrian Gore, Laurie Dippenaar and Roy Anderson.
There are numerous testimonies of the cleverest of members of school and
university classes who were appointed by life companies and are now in top
paying jobs in this industry. The actuarial professional examinations are
notorious for being the most difficult of exams.
With regard to Fedsure Life in particular, it had a very strong board. It
managed to attract without difficulty and at various times eminent personalities
with a vast array of skills such as Mervyn King, Gerald Stein, Naas van
Staden, Hugh Herman, Morty Sacks and Stephen Koseff. It provided its
directors with what Naas van Staden, almost 80 when he retired from the
board, termed as the most comprehensive board packs he had ever seen.
Yet, the company ultimately failed to live up to expectations.
314 So why is it that with all the brilliance, experience, training, information
technology advances and huge amounts of money being spent, the statutory
actuary of Fedsure Life confessed that his company was operationally weak,
and told us that the rest of the industry was not likely to be much better? We
have received more than anecdotal evidence regarding the rest of the
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industry, and we suspect that Fedsure Life, in terms of operational
weaknesses and poor housekeeping, was definitely not the sole culprit.
315 Despite the good faith, good intentions, and many skills at Fedsure Life, we
were left with the overall impression that what went wrong at Fedsure Life was
ineffective asset liability management. There was too big a reliance on the
Chief Actuary to manage that. In our view, the single biggest lesson to be
learnt from the Fedsure Life experience is that asset liability management
needs to be an integrated discipline which should be understood, practiced
and acknowledged throughout the operational and strategic management and
governance of the company.
316 The Registrar requested us to make recommendations regarding the general
industry for his consideration, based on the Fedsure experience. In Section K above, we mention some recommendations from his office following the FSB’s
internal investigation. We concur with those – except that we believe the
FSB’s load should be lightened, rather than burdened. Finally, it should be
noted that most of our and the Registrar’s recommendations relate to
housekeeping – a facet we believe the industry has no excuse not to have in
order.
Recommendation 1: Record keeping
317 Each asset (investment) and each liability (i.e. policy contract) should have a
computerised record. The particulars on these records should facilitate all
operational functions that involve them.
318 A computer system should support the maintenance of these asset and policy
records that separately logs (records) all movements (changes) in the records.
The system should enable an independent reconciliation of the in-force at the
beginning of the month with the in-force at the end of the month through
separately recorded movement transactions. These reconciliations should be
the subject of both external and internal audits.
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319 Although the current quarterly statutory returns do require data on numbers
and movements of policies, there appears to be room for manipulation of
these figures. The audited figures, reconciled through in-force policies and
movements of policies, are the only means whereby the veracity of these
figures can be ensured.
320 All policies that entail an investment portion should have its investment in a
unitised fund, and the number of units in the fund (or funds) should be
maintained on the policy record.
321 Each singular liability type that entails investment should be supported by one
or more unitised investment portfolio(s) (fund), the composition and
management of which should meet that type of policyholders’ expectations.
The investment managers of those portfolios should contract to mandates with
regard to their management of the fund. Internal and external audits should be
undertaken to ensure upkeep of and adherence to the mandates.
Each such combination of liability type and asset portfolios should have its
matching status certified on a monthly basis jointly by the investment manager
and the “liability manager” (likely to be the statutory actuary or his/her
subordinate).
322 It follows that an approach as set out above will necessarily ensure separation
of the assets supporting policy liabilities and free (shareholder) assets.
However, shareholder assets are a mixed bag, for it may contain things like:
- loans to policy portfolios to fund the outstanding expense account
- provision of risk capital to portfolios where investment or other guarantees
are provided
- provision of risk capital to pure risk policies, such as term insurance and
group life insurance
- strategic investments
Financial Services Board Fedsure Life Assurance Ltd Report Page 159 - STRICTLY CONFIDENTIAL -
- funding of business ventures that would support the business, such as
loans to brokers.
323 The latter argument tends to indicate the need for a party to be in charge of
the corporate funds who very much acts as a “merchant banker”, where all the
other divisions of the life insurer are its clients. The accounts and records of
the “merchant banker” should also be reconciled and audited, internally and
externally.
324 The concept above is not a new one for the life insurance industry in South
Africa. It appears that the discipline required through the demutualisation
processes of Old Mutual and Sanlam forced them into this kind of
dispensation. We are aware of a relatively small life insurer whose systems
are very conducive to, if not already fully facilitating, the approach described
above.
325 It is not for us to be fully prescriptive in this regard. However, we wish to
recommend that a panel be constituted to draft the guidelines for and
implementation timeframe of this process. In our view, the panel should at
least comprise representatives of the following parties:
- the FSB,
- the actuarial profession,
- the audit profession,
- the LOA,
- representatives from the investment management community, and
- representatives from the IT community who are involved in life insurance
computer systems
326 We are convinced that the audit profession should be part and parcel of this
proposed initiative. The training of auditors equips them uniquely to contribute
to the risk management of life insurers. However, the Fedsure Life experience
indicated that there was under-utilisation of this resource, despite intentions to
Financial Services Board Fedsure Life Assurance Ltd Report Page 160 - STRICTLY CONFIDENTIAL -
the contrary. Auditors’ active participation in this initiative may lead to pertinent
professional guidelines and training on their part.
327 We have also contemplated to recommend that an “actuarial audit” performed
by external actuaries should be implemented. We leave it to the panel to
deliberate on this.
Recommendation 2: Standardisation of policy design
328 Some resistance to the approach in Recommendation 1 above is likely to be
raised in the light of the complexity and variety of new and old policy designs.
If for no other reason, this is a clear indication that designs should be
consolidated and simplified.
329 The life insurance consumer is inundated with most confusing documentation,
fine print, misrepresentation and misunderstanding on the part of insurers and
intermediaries/brokers. South Africa will not be a lone campaigner should it
take drastic action to simplify and standardise product design and product
offerings.
330 We recommend that the FSB and the industry initiate (academic) research into
desirable and practically feasible standardisation of life insurance and
competing financial services products in South Africa. As part of this
research, the standardisation suggestions are likely to be determined by
policyholder expectations. Hence it is expected that the research will define
and differentiate these expectations to a level that may be used in setting
investment and other mandates for the asset liability management of those
portfolios.
331 In this respect, we believe cognisance should be taken of other financial
service providers, such as the unit trust and retirement fund industries, and the
levelling of the playing fields among those industries considered.
Financial Services Board Fedsure Life Assurance Ltd Report Page 161 - STRICTLY CONFIDENTIAL - Recommendation 3: Investigation into smoothed bonus policies
332 Alongside with Recommendation 2 above, but more urgently, it is advised
that ASSA be requested to draft guidelines for product design, pricing,
valuation, investment mandates, and termination conditions for smoothed
bonus policies, including reversionary bonus policies. This stems from the
problems encountered with the management of the NMLF by Fedsure Life in
support of, inter alia, the Fedsure Guaranteed Fund. Obviously asset liability
management was an issue, but there are more considerations, such as bonus
guarantees, cancellation of non-vested bonuses, and lack of lump sum early
terminations.
Since Investec took over the Fedsure Life business, major structural changes
were effected in that Fund. This caused dissatisfaction amongst policyholders
who allege that their expectations are not being met. This dissatisfaction also
has to do with the fact that the name “guaranteed” fund is actually a
misnomer, since there are non-guaranteed (cancellable benefits) in this type
of fund.
Recommendation 4: Compulsory annual analysis of surplus
333 We recommend that the Registrar require an analysis of surplus from the
statutory actuary in the annual returns, more detailed than currently required in
LT2000 Statement C7. ASSA should provide guidelines according to which
the analysis of surplus should be done, similar to their guidelines on financial
soundness valuation and calculation of capital adequacy requirements.
The analysis of surplus should be a confidential document, i.e. not for public
consumption, in view of the sensitive commercial and competitive information
that it may contain.
Financial Services Board Fedsure Life Assurance Ltd Report Page 162 - STRICTLY CONFIDENTIAL - Recommendation 5: Interim financial results
334 We recommend that interim financial results, such as monthly management
reports, quarterly board reports and quarterly statutory returns contain a
certificate by the statutory actuary on the change in the value of policyholder
liabilities. If full actuarial valuations of the liabilities cannot be performed that
frequently, the actuary should apply his/her mind and provide a best estimate.
(See in this respect paragraph 45 above.)
It is our view that where interim management and board reports of income
statements only showed premium income, investment income, claims and
acquisition and management expenses, they may have been misleading as to
the underlying financial performance of the life insurer.
335 This should be supported by the monthly asset/liability matching status
certificates, as proposed in Recommendation 1.
Recommendation 6: Independence of the statutory actuary
336 In Fedsure Life’s case, we suspect that the statutory actuary, for whatever
reason, was not able to exert the influence to adequately have his data and
financial soundness concerns addressed.
337 King II requires a Board Actuarial Committee, with which we concur, so long
as there is a clear separation of the executive actuarial function and the
governance role of such a Board Committee.
338 We recommend that ASSA be tasked with the drafting of a pro-forma charter
of the Board Actuarial Committee with possible reference to:
- the members of the committee,
- the role of the committee, e.g. approving underwriting and premium rate
bases, policy conditions, valuation bases and asset liability matching
bases/ measures,
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- approving procedures,
- approving results and returns,
- advising on human resources,
- the relationship with the Board Audit Committee, and
- the nature of the reports to the Board.
339 We do not intend to propose just another governance body to exist in form
rather than in substance. Hence, unless the Board Actuarial Committee can
really add value to better risk management and better long-term performance
for policyholders and shareholders alike, it will simply be a further cost burden
for policyholders to carry.
340 If there is a Board Actuarial Committee, it should be their prerogative to advise
on the appointment of external actuaries for the sake of peer review. In the
absence of a Board Actuarial Committee, external peer review would be
necessary to safeguard the independence of the actuarial judgment on the
financial soundness of the life insurer, in particular the protection of
policyholders’ interests.
341 It should similarly be a consideration of the Board Actuarial and Board Audit
Committees if they wish to have independent actuarial assessments/audits of
the actuarial data and systems. In the absence of these Committees paying
attention to this aspect, the guidelines for statutory actuaries should be
expanded to include considerations for appointing external actuaries to do
data and systems audits, other than just peer reviews of the actuarial
valuation.
342 Finally, Raftopoulos also became a member of the board of Fedsure Life in
1999. The fact that a board of directors serve other interests apart from that of
policyholders and the public interest, may conceivably put an actuary in a
position of conflict (though we have no evidence that this was in fact the case
in this instance). It may be advisable for the Registrar to issue guidelines in
this regard.
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Recommendation 7: Interests of policyholders in life insurer takeovers
343 The takeover by the Fedsure Group of the Norwich Group included the
takeover of Norwich Life. There is little, other than the Competitions
Commission, to prohibit a company’s shares (particularly if it is listed) being
bought and sold in the market whereby effective control, as in a hostile
takeover, can be achieved. In the case of a life insurer, such change of
control may have an effect on the interests of policyholders of either the
insurer being taken over, or those of the purchaser if the purchaser is also a
life insurer.
In the case of Fedsure, it is our view that the merging process with Norwich
negatively impacted on the service levels enjoyed by policyholders of both
insurers. One of the main reasons was the problem with the integration of the
respective systems. We recommend the consideration of some form of due
diligence (in both hostile and friendly mergers) whereby the Registrar is
satisfied that the process is at least properly planned in such a manner as to
cause minimum disruption of service levels.
344 Norwich policyholders’ interests regarding their benefits have been
safeguarded adequately through the court process required in section 37 of
the LTIA. However, the Fedsure Life policyholders in the NMLF might have
been prejudiced in respect of their benefits, because it could be argued that
they partly funded the Norwich purchase. (We concede that this is not that
clear-cut, since Fedsure Life had free assets in excess of R3 billion when the
NMLF had to pay approximately R1 billion for Norwich Life.)
345 We are of the opinion that effective new control of a life insurer may impact
negatively on policyholders’ interests. Such a transaction should therefore be
subject to some mandatory arrangement, possibly the approval of the
Registrar, that all policyholders who may be affected by the transaction would
have adequate protection.
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There are many arguments for and against such intervention (or interference)
in the free market. Hence we propose that a panel of senior executives and
statutory actuaries of life insurers be tasked to make recommendations in this
regard.
Recommendation 8: Role of non-executive directors of life insurers
346 There is much emphasis on the fiduciary duties of trustees of retirement funds
and medical schemes. As a consequence, training in the peculiarities of those
businesses has become the norm. Life insurers’ non-executive directors face
exactly the same fiduciary duties in terms of the FI Act.
347 Through the Fedsure Life experience, we have profoundly realised the lack of
appreciation of the technical complexities of life insurance on the part of many
non-executive directors. It is accepted that they have in the first instance been
appointed for their particular expertise, experience and skills, but they are first
and foremost directors of a life insurer with all concomitant fiduciary
responsibilities. One would not have them chased away for fear, neither does
one wish to make actuaries of all of them, but there can only be benefits
gained by providing them with better orientation of the full dynamics of the life
insurer’s business.
348 The Registrar is advised to look into ways of better aligning the skills of non-
executive directors for the sake of policyholders and shareholders of life
insurers alike.
Recommendation 9: The role of the ombudsman
349 There is currently a major shortcoming with regard to conflicts in jurisdiction
among the various offices of ombudsman or adjudicator to the financial
services industry in South Africa. The FSB may do well to take a bold stance
in this regard to ensure a smooth and comprehensive service to financial
services consumers.
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350 To illustrate the potential dilemma faced by the consumer, we sketch the
hypothetical situation of an umbrella retirement fund established by a broker
organisation. Although the situation described here is exceptional, it contains
elements of jurisdictional conflicts that are quite common in the industry.
350.1 The benefits of the fund are entirely arranged through endowment assurance
policies underwritten by a long-term insurer; these policies are taken out by
the fund and are ceded to the member of the fund upon death, disability or
retirement. The insurer is also the administrator of the fund.
350.2 The broker organisation appointed the trustees of the fund. The broker
organisation also has a minority shareholding in the long-term insurer. Some
of the trustee members are in the employment of the broker organisation,
some work for the insurer and some are independent. Those who are
independent are remunerated by honorariums by the broker organisation.
350.3 The members of the fund are recruited by the broker organisation from various
employers and the benefits are essentially meant to top up those members’
other occupational retirement fund benefits, as well as to provide the unique
benefits offered by endowment assurance policies (such as them being used
as collateral) after they are ceded to the members.
350.4 The members have investment choices in terms of their endowment policies
with a number of investment funds operated by the long-term insurer, but also
from some external unit trusts. The endowment assurance policies
furthermore contain a special disability benefit that is fully reinsured with
Lloyd’s.
Since the benefits of the fund described above are fully insured with a long-
term insurer, the fund is exempt from audit and valuation in terms of section
2(3)(a)/9 and 9A of the Pension Funds Act.
Financial Services Board Fedsure Life Assurance Ltd Report Page 167 - STRICTLY CONFIDENTIAL - 351 Conceivably, a member of this fund could experience problems with:
- the broker
- the (trustees of the) fund
- the insurer as administrator of the fund
- the insurer as insurer of risk benefits
- the insurer as investment manager
- the (external) unit trust manager
- the Lloyd’s representative.
Which office of ombudsman or adjudicator does such a member approach if
he/she is not satisfied with the answer from the administrator (i.e. the insurer),
who is likely to be the first port of call? Depending on the circumstances, one
of the offices concerned may take the view that if a case is not clearly within
its jurisdiction, it does not have (or attempt to vest) jurisdiction out of principle,
and may inform the complainant as such; another office may be more
sympathetic and may try to vest jurisdiction, or attempt to assist in other ways.
In our view, neither of these approaches can be faulted (concerning the first
approach, especially given the volumes and the resources available at the
respective offices). However, it is fairly clear that a situation may arise where
the complainant is sent to and fro, and it may take a considerable period of
time before his/her query ends up on the appropriate desk, or receives the
attention it deserves.
It is obvious that the nature of the query will determine which
ombudsman/adjudicator is the appropriate office. This is the crux of the
problem - even the determination of such nature or office may be difficult.
Firstly, more often than not the complainant is not an expert by any means
and may not be able to communicate his/her problem properly. Secondly, the
first person to assess the query must be an extremely knowledgeable person
about the financial services industry in general in order to correctly direct the
query. Thirdly, the person who actually deals with the query must be
Financial Services Board Fedsure Life Assurance Ltd Report Page 168 - STRICTLY CONFIDENTIAL -
extremely knowledgeable in the specific field of expertise in order to correctly
adjudicate on the matter.
352 In our respectful view, the current system is therefore flawed in that it may
leave the consumer exposed. It should also be borne in mind that by the time
the ombudsman/adjudicator office is approached, the complainant has already
walked a road with an unsympathetic broker or insurer, and it may be late in
the day for him/her.
353 We were informed that (as is probably the case with the FSB) the
ombudsman/adjudicator offices tend to experience difficulties in recruiting the
right calibre staff. An alternative that could be pursued is the appointment of
in-house persons as ombudsman. An in-house ombudsman would, for
example, be a retired senior employee of an insurer who acts as ombudsman
for complaints against that insurer. Such a person’s knowledge of the industry
and the company may, in our view, greatly enhance the quality of service
rendered to the consumer.
354 We recommend that serious consideration be given to the establishment of an
integrated “ombud” system for South Africa, to ensure the expeditious and
informal handling of customer complaints against participants in the financial
services industry. A proliferation of isolated “ombud”-type bureaux (which
appears to be the tendency at present) does not, in our view, serve consumer
interests as would a comprehensive, integrated complaint management and
dispute resolution system for all financial services consumers. A centralised
port of entry for consumer complaints should be the first step towards this
objective which, over a reasonable time, should culminate in a consolidated
complaints forum.
Financial Services Board Fedsure Life Assurance Ltd Report Page 169 - STRICTLY CONFIDENTIAL - Recommendation 10: Investment Regulations 355 The investment regulations are currently being revisited by the FSB and
ASSA. We recommend that consideration be given to -
• Relating investment limits on listed shares to the relative size of those
counters to the all-share index or another more appropriate index.
• Set guidelines (not prescriptions) on the spreading of free assets, and also
on the reporting of the spreading of the free assets to the Registrar. Recommendation 11: FSB conduct 356 The returns submitted to the FSB are obviously so voluminous that it is
virtually impossible for the office of the Registrar to evaluate them in time for
corrective action, given its present resources. The FSB is probably not of its
own accord financially able to attract ample numbers of suitably qualified
persons for in-depth supervision.
357 Hence, the office of the Registrar has no other recourse than to rely on the
industry and its professions to assist it in its regulatory duties. In our view, the
South African long-term insurance industry and its policyholders cannot afford
the luxury of a super-staffed regulator. The industry should therefore do its
utmost in terms of automated regulation or self-regulation to ensure a safe
environment for the consumers it serves.
Financial Services Board Fedsure Life Assurance Ltd Report Page 170 - STRICTLY CONFIDENTIAL - Recommendation 12: The role of the auditor
358 In Recommendation 1, we proposed that the audit profession be part of the
panel that should investigate proper record keeping for purposes of improved
asset liability matching. In that process, it may be realised that pre- and post-
qualification training of auditors in the intricacies of life insurance is required.
We sincerely support developments in that regard. While we by no means
wish to imply that the service rendered by external auditors to life insurers in
general is not up to standard, we simply believe that the skills and expertise
external audit firms are able to contribute to effective asset liability
management are vital.
____________________ ___________________
George Marx Flip Stander
Date:____________________
Financial Services Board Fedsure Life Assurance Ltd Report Page 171 - STRICTLY CONFIDENTIAL -
ANNEXURE A.1 F I N A N C I A L S E R V I C E S B O A R D Rigel Park 446 Rigel Avenue South Erasmusrand Pretoria South Africa PO Box 35655 Menlo Park Pretoria South Africa 0102 Tel (012) 428-8000 Fax (012) 347-0221 e-Mail [email protected] Int +27 12 428-8000 Int +27 12 347-0221 Toll free 0800110443 Internet: http://www.fsb.co.za
Enquiries:
A Swanepoel
D. Dialling No.: (012) 428 8050/1
Our ref: 10/10/1/42/9
Fax: (012) 347 8785
Date: 15 May 2002
e-mail: [email protected]
Adv. P P Stander 332 30th Avenue VILLIERIA 0186 Dear Sir
INSPECTION OF FINANCIAL INSTITUTIONS ACT, NO 80 OF 1998 You are hereby appointed in terms of section 2 of the Inspection of Financial Institutions Act, No 80 of 1998 (“Inspection Act”) as an inspector. You are instructed in terms of section 3 of the Inspection Act to carry out an inspection of the affairs of Fedsure Life Assurance Limited (“Fedsure”) now known as Investec Employee Benefits Limited. The inspection should cover the period from the beginning of 1998 to date and should –
1. Determine whether the board of directors and management of Fedsure observed the utmost good faith and exercised proper care and diligence, as contemplated in section 2 of the Financial Institutions (Protection of Funds) Act, No. 28 of 2001, (formally Act 39 of 1984) in exercising and discharging their duties in the management and administration of the company and in particular policyholder funds.
2. Establish whether the board of directors and management of Fedsure
exercised appropriate corporate governance in the interest of policyholders with regard to and in particular, 2.1. Whether the risks to which Fedsure was exposed were identified and
managed in an appropriate manner, and 2.2. Whether the board of directors managed the affairs of Fedsure in such a
manner as to protect the interests of policyholders.
3. Determine,
Financial Services Board Fedsure Life Assurance Ltd Report Page 172 - STRICTLY CONFIDENTIAL -
3.1. Whether the reasonable expectations of policyholders were infringed in the declaration of bonuses during the period from 1998 to 2001 and the cancellation of non-vested bonuses, and
3.2. Whether it was appropriate and necessary to cancel non-vested bonuses.
4. As a result of information obtained during the inspection, comment on the
appropriateness of legislation and practices implemented by the FSB’s Insurance and Actuarial Departments. In particular, 4.1. Whether any changes should be introduced to the Long-term Insurance
Act, 1998 in order to improve the protection of the interests of policyholders in the light of the Fedsure experience, and
4.2. Whether the statutory returns (as applicable today), on-site visits and other investigations as currently practised by the FSB would have been adequate in the period from 1998 onwards to reveal the financial position of Fedsure. If not, whether amendments need to be made to such returns and procedures in order to improve the protection of the interests of policyholders.
You should please report your findings and the factual basis on which such findings were established, in writing to the Registrar of Long-term Insurance by 30 June 2002
REGISTRAR OF LONG-TERM INSURANCE
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ANNEXURE A.2 F I N A N C I A L S E R V I C E S B O A R D Rigel Park 446 Rigel Avenue South Erasmusrand Pretoria South Africa PO Box 35655 Menlo Park Pretoria South Africa 0102 Tel (012) 428-8000 Fax (012) 347-0221 e-Mail [email protected] Int +27 12 428-8000 Int +27 12 347-0221 Toll free 0800110443 Internet: http://www.fsb.co.za Enquiries:
A Swanepoel
D. Dialling No.: (012) 428 8050/1
Our ref: 10/10/1/42/9
Fax: (012) 347 8785
Date: 20 May 2002
e-mail: [email protected]
Mr GL Marx Private Bag X 17 HALFWAY HOUSE 1685 Dear Sir
INSPECTION OF FINANCIAL INSTITUTIONS ACT, NO 80 OF 1998 You are hereby appointed in terms of section 2 of the Inspection of Financial Institutions Act, No 80 of 1998 (“Inspection Act”) as an inspector. You are instructed in terms of section 3 of the Inspection Act to carry out an inspection of the affairs of Fedsure Life Assurance Limited (“Fedsure”) now known as Investec Employee Benefits Limited. The inspection should cover the period from the beginning of 1998 to date and should –
5. Determine whether the board of directors and management of Fedsure observed the utmost good faith and exercised proper care and diligence, as contemplated in section 2 of the Financial Institutions (Protection of Funds) Act, No. 28 of 2001, (formally Act 39 of 1984) in exercising and discharging their duties in the management and administration of the company and in particular policyholder funds.
6. Establish whether the board of directors and management of Fedsure
exercised appropriate corporate governance in the interest of policyholders with regard to and in particular, 6.1. Whether the risks to which Fedsure was exposed were identified and
managed in an appropriate manner, and 6.2. Whether the board of directors managed the affairs of Fedsure in such a
manner as to protect the interests of policyholders.
7. Determine,
Financial Services Board Fedsure Life Assurance Ltd Report Page 174 - STRICTLY CONFIDENTIAL -
7.1. Whether the reasonable expectations of policyholders were infringed in the declaration of bonuses during the period from 1998 to 2001 and the cancellation of non-vested bonuses, and
7.2. Whether it was appropriate and necessary to cancel non-vested bonuses.
8. As a result of information obtained during the inspection, comment on the
appropriateness of legislation and practices implemented by the FSB’s Insurance and Actuarial Departments. In particular, 8.1. Whether any changes should be introduced to the Long-term Insurance
Act, 1998 in order to improve the protection of the interests of policyholders in the light of the Fedsure experience, and
8.2. Whether the statutory returns (as applicable today), on-site visits and other investigations as currently practised by the FSB would have been adequate in the period from 1998 onwards to reveal the financial position of Fedsure. If not, whether amendments need to be made to such returns and procedures in order to improve the protection of the interests of policyholders.
You should please report your findings and the factual basis on which such findings were established, in writing to the Registrar of Long-term Insurance by 30 June 2002
REGISTRAR OF LONG-TERM INSURANCE
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ANNEXURE B
F I N A N C I A L S E R V I C E S B O A R D Rigel Park 446 Rigel Avenue South Erasmusrand Pretoria South Africa PO Box 35655 Menlo Park Pretoria South Africa 0102 Tel (012) 428-8000 Fax (012) 347-0221 e-Mail [email protected] Int +27 12 428-8000 Int +27 12 347-0221 Toll free 0800110443 Internet: http://www.fsb.co.za Enquiries:
Mr L.G.T. Wessels
D. Dialling No.:
(012) 428-8095
Our ref: Mr Wessels
Fax:
(012) 347-7622
Date: 31 July 2002
e-mail:
Mr G.L. Marx & Adv P.P. Stander P.O. Box 11337 HATFIELD 0028 Per telefax : (012) 460 0672 / (011) 805 8261 Sirs INSPECTION OF FEDSURE LIFE ASSURANCE LIMITED (“FEDSURE”)
1. Your attention is drawn to the letters dated 15 May 2002 and 20 May 2002 in terms of which you were respectively appointed as inspectors for the purpose of carrying out an inspection of the affairs of the above institution.
2. You are advised that the words”board of directors and management” as they appear in clauses 1 and 2 of my aforesaid letters were intended to refer to the directors, officials and employees of Fedsure individually.
3. Similarly in clause 2.2 “board of directors” must be understood to mean the directors individually.
4. Please also note that if in the course of the inspection you should become aware of facts or information concerning the affairs of Fedsure, which in your discretion should be reported to the Office for regulatory consideration, such disclosure must be made, irrespective of the exact ambit of your instructions as contained in clauses 1, 2, 3 and 4 of my aforesaid letters.
5. While urgency still prevails, the date 30 June 2002 is no longer achievable and your report must please be submitted by 31 August 2002.
Yours faithfully
Financial Services Board Fedsure Life Assurance Ltd Report Page 176 - STRICTLY CONFIDENTIAL -
REGISTRAR OF LONG-TERM INSURANCE
Financial Services Board Fedsure Life Assurance Ltd Report Page 1 - STRICTLY CONFIDENTIAL -
ANNEXURE C LIST OF NAMES OF PERSONS INTERVIEWED Ademola Hammad Animashahun Douglas George Barrow John Albert Barrow Arnold Ian Basserabie John Beak Morris Bernstein John Andrew Bester Mike Brewis Glyn Robert Burger Bruce Cameron Capital Alliance Life Ltd Martijn Apello Ian Kirk Hennie Nortjé Lloyd Chapman Paul Scott Clipsham Tony Dardis Charles Davies Richard Preston Derman Gillie Gehle Kobus Hanekom Anthony Hart
Financial Services Board Fedsure Life Assurance Ltd Report Page 2 - STRICTLY CONFIDENTIAL - Theo Hartwig Hugh Sidney Herman Patrick Ho Azar Paul Hindelly Jammine Peter Alfred Killick Mervyn Eldred King Stephen Koseff Roland Krabbenhoft Penelope Disa Krige Andrew McGinn David Haddon Mitchell David Morris Nurek Ombudsman for Long-term Insurance Judge Jan Steyn Don MacKay Pension Funds Adjudicator John Murphy Naleen Jeram PricewaterhouseCoopers Malcolm Dunn Barry Stott Gerald Raftopoulos Andrew Bertram Rainer Michael Ivan Sacks
Financial Services Board Fedsure Life Assurance Ltd Report Page 3 - STRICTLY CONFIDENTIAL - Graham Stavridis Peter Stewart Jaco Swanepoel Bradley Tapnack Colin van der Meulen Phillip van der Walt Naas van Staden James Ciaran Colum Whelan
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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ANNEXURE D
GENERAL BACKGROUND: LONG-TERM INSURANCE OPERATION 1 Introduction
The operation of long-term insurance is complex in that the product (i.e. a
long-term insurance policy) is a relatively intangible and non-transparent one.
This section serves to provide a brief descriptive background to the operation
of long-term insurance in general. Furthermore, certain terms and concepts
are not necessarily universally used and accepted, so that it is necessary for
the purpose of this report to define them within this context.
2 Savings and risk products
2.1 Although a company such as Fedsure Life is referred to as a long-term
insurance company, it needs to be recognised that the vast majority of
premium income of most long-term insurers (referred to below as life insurers)
is in respect of long-term savings. A life insurer’s business therefore requires
distinction between the long-term savings benefits and the risk benefits.
In a nutshell, the management of a life insurer entails three main activities:
(a) provision of long-term savings benefits (i.e. investment or asset
management);
(b) provision of risk benefits such as on death and disability; and
(c) administration of the entire operation (including acquisition of new
business) in a cost-effective way.
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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In short these three main activities are referred to as
- investment,
- risk underwriting and
- administration.
2.2 A description of the products (i.e. type of benefits or policies) of the life insurer
therefore should start with the distinction between savings and risk products.
However, this is not so simple because one policy can entail a mixture of
savings and risk (in a way that is often only discernable by the actuary of the
life insurer).
An example of such a mixed policy is a conventional endowment assurance policy that pays out the sum assured upon survival of the assured at the
maturity date of the policy, or upon the death of the assured prior to that date.
Immediately after the issue of such a policy, practically the full sum assured
represents a pure risk benefit. At maturity the benefit ought to be paid out of
the accumulated savings (investments) over the term of the policy. The
amount of the accumulated savings is created by the investment of the
balance of each premium after paying for the cost of the (pure) risk benefits
and administration costs. Hence there are no risk benefits at maturity of the
policy. Furthermore, the better investment returns are earned on the
accumulated funds, the better the proceeds at maturity could be.
2.3 It is important to recognise that proper management of a life insurer’s affairs
(which is also required by statute, such as – in South Africa – the Long-term
Insurance Act, No. 52 of 1998) means that each policy is managed to pay for
its own benefits – hence it is not operated in a manner that the premiums on
the next policy (or policies) may be used to pay for a previous policy’s. This
latter practice is referred to as “cashflow underwriting” and its risks are the
same as that of a pyramid scheme.
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The requirement of not running a pyramid scheme is effected through the
holding of reserves (policyholder liabilities) in respect of all in-force policies (i.e. policies that have not matured). The principle on which these
reserves is calculated is that at any point in time and for each policy, a reserve
must be held that is adequate, together with future premiums to be paid in
terms of that policy together with its future investment returns, to pay for the
expected cost of benefits and cost of administration of the policy, for its entire
likely future existence. Actuaries are trained to do this and this is why there is
a requirement that every registered life insurer must have an appointed actuary (also termed statutory actuary or valuator).
3 The annuity policy
3.1 A somewhat peculiar product is the annuity policy. In its purest form the
policyholder pays a single premium in return for a regular (monthly) fixed
income for life, or at least for a minimum period of (say) ten years. This
product is largely a savings type, but it also insures the risk of living too long.
The main utilisation of this product is the compulsory purchase of annuities
(also referred to as pensions) with at least part of the proceeds at maturity
date of a retirement annuity policy. The retirement annuity policy enjoys the
tax advantage of deductibility (although limited) of contributions, in return for
the deferment of the proceeds of the policy over the whole life of the
policyholder, ostensibly relieving the State of some part of the burden of old
age pensions.
3.2 A huge variety of annuity policies is available today, ranging from the fixed
fully guaranteed version to the so-called living annuity. With the living annuity
the entire compulsory proceeds (of the retirement annuity policy) is paid into a
unit trust of choice of the annuitant, who may withdraw the units at a maximum
and minimum rate of 20% and 5% respectively of the remainder of the units
year by year.
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4 Non-profit and with-profit policies
4.1 Conventional policies
4.1.1 A further distinction in the design of long-term insurance policies is whether
the premiums and benefits are fully guaranteed (i.e. fixed or non-profit) or
whether the policy participates in profits (so-called with-profit).
Long-term insurance policies started as non-profit whole-life insurances and
endowment policies. The whole-life policy provided for payment of the sum
assured at death, whenever that would have occurred. Endowment policies
provided for payment of the sum assured at maturity (usually age 60 or 65 of
the policyholder) or earlier death. These policies had the sum assured as a
fully guaranteed (fixed amount), i.e. upon a claim at death or maturity the sum
assured and no more nor no less would have been paid.
4.1.2 Long-term insurance policies need to be distinguished from short-term insurance policies (e.g. covering property damage) in that the former are
non-cancellable contracts as long as the premiums are paid by the
policyholder. Short-term insurance policies can be cancelled in the sense that
they are renewed month by month at the discretion of the insurer.
4.1.3 In time it was realised that life insurers tended to make handsome profits on
the non-profit contracts – because the actuary’s assumptions when setting the
premiums and benefits of the policy at its inception, were conservative. The
actual performance (in terms of mortality, investment returns or administrative
costs) generally turned out better than what was allowed for in the calculation
of the premiums.
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In return for an additional premium insurers then allowed policyholders to
participate in the profits, i.e. with-profit policies were issued. The nature of this
profit sharing was that the actuary evaluated the financial position of the
insurer from time to time (typically annually) and should the performance be
satisfactory, bonuses were allotted to the with-profit policies. These bonuses
were allotted as increments of the sums assured and were termed
reversionary bonuses – arguably because the payment of the bonus
reverted to the same conditions of payment as the sum assured.
In other words, the cash value of the nominal amount of the bonus as an
increment of the sum assured, was not the same as the nominal amount. The
cash value is typically not known to the policyholder and would in any event be
significantly less than the nominal value (simply because it is a contingent
payment and it is discounted for interest).
4.1.4 Actuaries have been conservative in the declaration of these bonuses for two
reasons; they could not risk allotting bonuses that could not be afforded in the
long run and secondly, a mere reduction in the bonus rate from one year’s
bonus declaration to the next, would be seen as poor performance by the
insurer. Hence the rates at which these bonuses were declared tended to
remain stable, or marginally increased from time to time. This process resulted
in a gradual and stable growth over time in the benefit payable at death or
maturity (i.e. the sum assured plus bonuses) of a specific policy.
4.1.5 At first this bonus, as an increment to the sum assured, was a permanent
addition as soon as it was allotted (i.e. declared). In becoming permanent it is
said to vest, i.e. it is guaranteed in the same way as the (basic) sum assured.
In time (in the 1960s), the popularity of investing in shares (equity) through
unit trusts (growth funds) illustrated high (yet volatile) growth in investors’
savings through these vehicles. They appeared, in good times, to provide
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better performance of returns than the rather non-transparent, stable, and
non-comparable reversionary bonuses of long-term insurance policies.
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Life insurers reacted thereupon by declaring non-vesting reversionary
bonuses, which were supported (or funded) largely by unrealised capital
gains. These bonuses were termed terminal or claims bonuses and only
vested at claim stage. In other words, if the policy did not become a death or
maturity claim and unrealised gains reduced through reduction in market
values of the underlying investments, insurers could decrease or totally
remove (i.e. cancel) these non-vested bonuses.
4.2 Universal life policies
4.2.1 The term “conventional policies” is used to depict the non-profit and
reversionary bonus types of policies. From the 1970s, life insurers realised
the shortcomings of the conventional with-profit policies and redesigned long-
term insurance policy benefit structures through various phases until they
culminated in the so-called universal life design for individual policies.
The universal life design was aimed at providing transparency and
comparability with other investment products. As such the premium payable is
split in three parts being an administrative cost deduction, the premium for risk
benefits, and the remainder that is considered to be invested as the long-term
savings portion. These three elements are more fully described below.
• The premium that is deducted for risk benefits varies from month to month
depending on the probability of the risk materialising at that point and the
size of the risk benefit (i.e. excess of the benefit e.g. at death over the
accumulated investment account) at that time.
• The administrative cost deduction typically consists of three parts; a fixed
nominal Rand fee per policy, a percentage (approximately 2% to 5%) of
the premium and a percentage (approximately 1% to 2%) annually of the
accumulated investment account.
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• Investment earnings on the savings portion are added in the same way as
with savings accounts with banks or as the case is with unit trusts. In the
policyholders’ regular policy value statements they are then shown what
the accumulated savings portion is, which is then directly comparable to
the progress in either a savings account or a unit trust account.
4.2.2 The nature of the investment account was further enhanced in that the
policyholder could choose to have his or her investment returns on the
accumulated fund added in a stable or in a market value-related fashion.
The stable (or smoothed) version meant that the insurer had a discretion of
how much to declare; it would tend to declare less than what was actually
earned in times of good investment returns, but it could also declare more
than actually earned in poorer times. The latter event gives rise to the
possibility of a so-called negative bonus stabilisation reserve, i.e. the value
of the policyholders’ accumulated investment accounts actually exceeds the
market value of the underlying investments. In these circumstances insurers
may use a negative bonus stabilisation reserve in their balance sheets.
The stable bonuses for universal life policies also adopted the dual character
of the earlier reversionary bonus system in that there are vesting and non-
vesting bonuses. Again, the vesting bonuses tend to be funded through
realised investment returns and capital gains whereas the non-vesting bonuses are supported by unrealised capital gains.
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4.2.3 In cases where the policyholder chooses to have his or her investment
account in a designated fund (such as a unit trust) where the policyholder fully
shares in the actual performance (good or bad) of that designated fund, the
policy is said to be a linked policy (sometimes this is also referred to as a unitised policy). It follows that a linked policy actually provides no profit for
the insurer on account of investment returns on the policy’s accumulated
investment. In contrast, smoothed bonus policies still allow for that opportunity
and are therefore considered part of the insurer’s with-profit portfolio of
policies.
4.2.4 It is therefore apparent that non-linked policies are much less transparent than
linked policies. Although universal life policies are designed to be transparent,
the irony is that the transparency is limited to the value of benefits only at
claim stage, i.e. death or maturity. Upon early termination (surrender) of the
policy the published value of the accumulated investment account is not
available. (In very new exceptional designs, the accumulated investment
account may be payable upon early termination.)
5 The outstanding expense account
5.1 The administration of the universal life policy behind the scenes (i.e. what the
policyholder does not see) requires another element; the so-called
outstanding expense account. The costs of acquisition (including
intermediaries’ commission) of a life policy typically exceeds the amount of the
first few premiums. The deduction for administration costs from the premium
that is shown to the policyholder, is not enough to pay for these initial
expenses. Hence there is a loan (by shareholders and/or other policyholders)
to the new policy. Such a loan is repaid over the life of the policy through the
regular administration cost deductions which are designed, in time, to meet or
exceed the actual ongoing administration costs. The outstanding expense
account is therefore the balance of this loan.
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5.2 Upon surrender of a policy, the value of this loan needs to be deducted from
the accumulated balance of the investment account, so as not to involve a
loss to shareholders and remaining policyholders.
6 Unitised and segregated investment funds supporting policy liabilities
6.1 Although it is advisable, there is no law that states that the underlying
investments of the accumulated investment accounts as shown to
policyholders, must in fact be a physical portfolio (as is the case with unit
trusts). Insurers therefore may hold notional (hypothetical) investment
portfolios in support of these accounts but then they run a material risk of
mismatching (refer to paragraph 10.2 below). It needs to be remembered that
the number of these portfolios that would support specific policy types could
run into the hundreds for an established life insurer. It is a major administrative
challenge.
6.2 The advisable practice is to have unitised funds supporting these different
types of policies with their unique types of investment accounts in exactly the
same way as the requirements and practice are for unit trusts. However, since
the long-term insurance industry developed over a much longer history, the
conversion of older conventional policies into the universal life design, often
presents an almost insurmountable practical obstacle.
7 Individual versus group policies
7.1 Most large life insurers conduct two main lines of business, namely individual
and group. For individual business there is an individual policy contract for
each policyholder. Where groups of lives are insured, the corollary to the
universal life policy design, is the deposit administration system. The
distinction between savings and risk is the same as regards individual policies.
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Individual members of group schemes do not get detailed policy contracts but
only summaries of their benefits.
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7.2 Charges under the group policy are specified as percentages of payroll, or of
contribution or of the value of the assets and are payable as and when
contributions are paid. There is generally no “outstanding expense account”
with group business.
7.3 Under the deposit administration system, the nature of the bonuses is as for
individual universal life type polices, i.e. bonuses are declared akin to savings
accounts or unit trusts, also with the distinction between stabilised (vesting
and non-vesting) bonuses vis-à-vis fully linked investment performance.
8 Policy benefits upon early termination
8.1 When a life insurer issues an individual life insurance policy, it is for a long
term. The essence of the contract is that as long as the policyholder pays the
premiums the policy remains in-force and the benefits will be paid as
stipulated in the policy, typically on death, disability or maturity.
8.2 There is also a clause which stipulates that if the policyholder wishes to
terminate the policy prior to the normal claim stage, which is referred to as the
surrender of the policy, the benefits payable will be determined in the
discretion of the actuary. There is no amount specified or even a basis on
which such amount will be determined.
The actuary, in calculating this amount, takes the following into account in
determining such a value:
• The insurer must not lose money through this because it would
prejudice remaining policyholders.
• Hence all unrecouped expenses must be recovered; implying the
deduction of the outstanding expenses account from the investment
account in the universal life policy design.
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• Policyholders surrendering their policies are likely to be in good health,
meaning those who do not surrender would on average be expected to
experience worse mortality and morbidity, implying more reserves
should be retained for them thereby reducing surrender values of those
leaving the pool.
• The insurer would have made a profit in the long run and hence a
policyholder surrendering could be “penalised” for breaking the
contract.
• Particular care must be exercised with smoothed bonus policies not to
pay surrender benefits funded by unrealised gains of underlying
investments, typically represented by unvested bonuses.
8.3 The policy contract usually also stipulates that if the policy is surrendered prior
to expiry of the “waiting period” of up to three years, no surrender value exists.
8.4 For group / pension policies, an individual member’s withdrawal benefit is
stipulated in the rules of the fund, typically a return of contributions with
interest. If an entire group or fund wishes to cancel their contract with an
insurer, different rules or practices apply. Often, a cancellation could only be
effected through a pay-out over ten annual instalments. This condition is
sometimes waived, and insurers pay out the lesser of the underlying market
value of the assets and the fund value (being the capital account plus vested
and unvested bonuses).
9 Administration and computer systems
9.1 The administration of a modern life insurer is a complicated one that cannot be
conducted without sophisticated computer systems. Due to continual changes
in markets, products and services as well as legislative and corporate
governance requirements, life insurers are virtually in a permanent state of
revising their computer systems. It is costly, time consuming and errors can
cause major disruptions in the business.
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9.2 Computer systems are typically required for the following:
• accounting
• on-line recordkeeping of policy records to collect premiums, pay
benefits and service policyholders
• new business acquisition and broker / intermediary administration (e.g.
commission systems)
• asset / investment management
• actuarial valuation (assessment of liabilities).
9.3 It is practically impossible for most insurers to have all policy records
computerised in such a way that there are no exceptions. There are always
exceptions to the ideal for a variety of reasons, such as old policies that were
never converted to computerised records and special policies issued with non-
standard terms or conditions. For example, there was something at Norwich
Life called “Arnold’s cupboard” – a number of special policies that did not carry
fully computerised records. Arnold was apparently the person in charge of the
(manual) administration of these policies. Although there are risks associated
to these practices, it is common amongst life insurers.
9.4 In view of the fact that savings business constitutes the majority of premium
income and liabilities of most life insurers, it follows that the asset liability
management (see paragraph 10 below) should also be facilitated through
efficient computer systems. The key to this is having unitised investment
portfolios and that each policy carries on its computer record the number of
units it holds in the various investment portfolios. This is the practice for
modern linked policies, but few insurers are likely to have their old
reversionary bonus policies administered in this way. Even modern smoothed
bonus universal life policies may not carry units of the underlying asset
portfolio(s) on record but only the (notional) investment account with accrued
bonuses.
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9.5 Proper asset liability management would dictate the maintenance of units for
all policies with savings type benefits, regardless of whether they are fully
linked or not. Reconciliation of units on policy records with the actual
investment portfolios then becomes an automatic and powerful discipline.
10 Matching of assets and liabilities
10.1 It is a fundamental tenet in the management of a life insurer that proper
cognisance be paid to the nature of the policyholder liabilities when investing
the policyholders’ funds. This is loosely referred to as matching of assets and liabilities and involves arguments such as the following:
• Matching by currency: If the liabilities (policy claims) are to be paid in
Rands, the investments should be in Rands.
• Matching by term: If claims are due in the short term, the investments
must be short-term.
• Matching by policyholder expectation: If the policyholder was
indicated stabilised growth, the investments should be in asset types
that render stabilised growth.
10.2 Departure from a matched position, entails risk for the insurer in that the value
of the assets may change out of proportion to the value of liabilities upon a
change in economic circumstances. Mismatching is the term used to indicate
that there is not proper matching between assets and liabilities. For example,
if the policy liability is a guaranteed maturity amount of R100 000 in five years’
time but the underlying asset matures only in twenty years’ time, an increase
in interest rates would reduce the value of the asset by more than the value of
the liability. If the value of the asset exactly matched the value of the liability
prior to the increase in interest rates, the net effect after the change will be a
shortfall. A decrease in interest rates would similarly result in an excess of the
value of the assets over the value of the liabilities.
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10.3 Nothing prohibits an insurer to depart from a matched position in an attempt to
earn better investment returns for policyholders or shareholders. However, the
insurer is expected to remain fully conscious of the outcomes if the decision to
so depart turns out to be for the worse.
Obviously, there is more room for such “speculation” with shareholders’
assets, since companies generally speaking have more discretion when it
comes to investing shareholders’ funds. For this reason it is prudent,
although not at present a statutory requirement, to clearly split policyholder
and shareholder assets.
11 Sources of shareholder profit
11.1 Most life insurers today are proprietary. They exist (partly) for the opportunity
that this kind of business presents for profits. Shareholders of long-term
insurance companies gain their profits essentially from the following sources
(described here in the context of the new universal life policies):
(a) investment earnings on existing shareholder funds1,
(b) investment earnings on policyholder funds in excess of (i) that required
to build policyholder reserves2 plus, (ii) that part of investment earnings
used to allot bonuses to with-profit policies,
(c) the profits made over time through the loan of the outstanding
expenses account as described above (of which the biggest source is,
in time, the management fee charged on the accumulated investment
account),
1 Shareholder funds are (represented by) the excess of the total value of the assets (after deducting current liabilities) of the life insurer over the value of the policyholder liabilities. A life insurer is prohibited by law to have other (long-term) liabilities such as loans. 2 The amount of the policyholder liabilities is calculated by, inter alia, discounting at interest the expected future claim payments.
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(d) the profits made if the cost of risk benefits is less than the premiums
charged for it; and
(e) profits on terminations of policies where the reserve held for the policy
(and which is fully released upon termination of the policy) exceeds the
benefit (e.g. surrender value) paid to the policyholder upon termination.
It should therefore be clear that the opportunity for profit by shareholders is
also directly derived from the three basic activities of a life insurer, namely
investment, risk underwriting and administration, as referred to in paragraph 2
above.
11.2 Before the development of the universal life design and specifically before the
dawn of the linked policies, life insurers’ shareholders gained their earnings by
far on investment earnings in excess of what was needed to support
policyholder benefits. This clearly focuses the mind as to the importance of the
investment function in a long-term insurer. The opportunity for major profits on
the risk benefits or the administration charges, has been and remains
relatively small. Long-term insurers are under tremendous pressure to sustain
the same future relative levels of profitability for their shareholders as they did
towards the end of the twentieth century in the face of
• competition from other savings providers such as unit trusts
• increasing popularity of linked (non-profit) policies and
• squeezed cost recovery margins in view of competition and
transparency of modern products.
11.3 The value of a life insurer to its shareholders is best illustrated with a brief
example:
• Suppose a new life insurer is created by its shareholders supplying
R50 million in cash as capital.
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• Thereafter the insurer writes R100 million of new business premiums
for recurring premium policies in its first year.
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• R10 million was paid in the first year for death claims and R45 million
for administration and acquisition of the new business.
• At the end of the year the actuary calculates the value of the
policyholder liabilities at R80 million.
Ignoring investment income, the insurer will have assets of R95 million at the
end of the year (R50 million plus R100 million minus R10 million minus
R45 million) and liabilities of R80 million, hence a net asset value of
R15 million.
Can it now be argued that the shareholders lost R35 million (having invested
R50 million)? No, because the insurer has existing policy contracts in terms of
which future premiums must be paid and from which future recoveries and
profits could be made.
Hence there is need to calculate the value of the future profits to be made on
the existing policies. The actuary would do this calculation and may render a
result of say R40 million. If this value is added to the net asset value of
R15 million, an amount of R55 million is arrived at, indicating R5 million growth
in shareholder value compared to their original capital input. The figure of
R55 million is referred to as the embedded value and is a better reflection of
the value of the company to its shareholders. The embedded value obviously
excludes a value that could be put on the future profits to be generated by
future new business– colloquially referred to as goodwill – and in actuarial
terms referred to as the appraisal value when this goodwill is added to the
embedded value.
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12 Evaluation of solvency of a long-term insurer
12.1 The Actuarial Society of South Africa issues guidelines that are approved by
the Registrar of Long-term Insurance and which are used by the statutory actuary (valuator) of a long-term insurer in assessing the solvency of the
insurer. The Registrar also approves of the appointment of the valuator. These
guidelines are fairly detailed and comprehensive. The key principle that is
applied in assessing the solvency is that the value of the assets should
exceed the value of the policy liabilities (including other current liabilities) by
an amount at least equal to the capital adequacy requirement (CAR):
• The value of the assets is generally taken as the market value
thereof, for example the price on the valuation date of shares listed on
the securities exchange.
• The value of the liabilities is calculated prospectively as a reserve as
explained in paragraph 2.3 above, based on the reasonable benefit
expectations of policyholders and not only the contractual guarantees.
• The CAR is calculated to take into account various negative departures from the value of the assets and the assumptions underlying the calculation of the liabilities, also taking into account
the actions that management might take should such negative
experience be forthcoming, for example the removal of non-vested
bonuses if the market values of assets fall significantly.
12.2 The ratio of the amount of the excess of the assets over the liabilities divided
by the CAR, is termed the CAR cover. Industry norm appears to consider
CAR cover of at least two as desirable, in the context of the current bases for
calculating the liabilities and the CAR. However, the Registrar only requires
CAR cover of at least one.
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ANNEXURE E1
INCOME STATEMENTS AND BALANCE SHEETS (See Section E: Financial Performance of Fedsure Life) FEDSURE LIFE ASSURANCE LTD: INCOME STATEMENT Company 2000 1999 1998 1997 1996 INCOME 8430 9444 5504 4633.7 5994 Premium Income 6835 8157 4402 3550.5 5066.8 Recurring 2003 1812 1566 1429.1 1270.6 Single 4832 6345 2836 2121.4 1117.1 Premium income from discontinued 2679.1 Net investment income 1595 1287 1102 1083.2 927.2 OUTGO 6935 4604 3124 2733.8 2079.6 Commission 463 314 244 224.8 176.8 Admin 513 384 261 232.4 192.9 Policy benefits 5906 3835 2561 2151.7 1615.5 Taxation 53 71 58 124.9 94.4 INCOME LESS OUTGO 1495 4840 2380 1899.9 3914.4 TRANSFER TO LIFE FUND 2534 4529 2058 1592.5 3685.8 DIVIDEND FROM SUBSIDIARY (NORWICH) 100 107 PREFERENCE DIVIDEND -15 -15.6 -15.6 NET INCOME -939 418 307 291.8 213
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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ANNEXURE E2
INCOME STATEMENTS AND BALANCE SHEETS (See Section E: Financial Performance of Fedsure Life)
FEDSURE LIFE ASSURANCE LTD: BALANCE SHEET Company 2000 1999 1998 1997 1996 ASSETS 31035 29122 21061 19665.6 18451.6 Gilts 3643 2876 908 2130.7 2231.7 Bonds 4268 3972 3264 3322.2 3527.9 Equities 14851 15069 10757 9611.5 6737.9 Property 1757 1986 1886 1629.9 1408.7 Holding company 844 75.3 68.3 Subsidiaries 1947 2182 806 899.8 847.1 Deposits 3331 2062 1824 1289.9 351.2 Other non current assets 88 Plant and equipment 116 109 Financial leases 161 40 Goodwill Current assets 961 826 684 706.3 3278.8 EQUITY AND LIABILITIES 31035 29122 21061 19665.6 18451.6 Share capital and share premium 1818 1118 1118 1118.5 600.9 Non-distributable Retained earnings -461 578 401 294.9 232.1 Minorities Long-term liabilities Insurance funds 28582 26381 18760 17682.6 17219.4 Current liabilities 1096 1045 782 569.6 399.2
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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ANNEXURE E3
INCOME STATEMENTS AND BALANCE SHEETS (See Section E: Financial Performance of Fedsure Life) NORWICH LIFE SOUTH AFRICA LTD INCOME STATEMENT Group
2000 1999 1998 1997 INCOME 2145 2397 2923 3127 Premium Income 1455 1702 2157 2461 Recurring 1281 1323 1388 1403 Single 174 379 769 1058 Net investment income 690 695 766 666 OUTGO 2462 2412 2408 1904 Commission 80 94 146 142 Admin 142 128 202 203 Policy benefits 2215 2151 2021 1511 Taxation 25 39 39 48 INCOME LESS OUTGO -317 -15 515 1223 TRANSFER TO LIFE FUND -467 -139 475 1136 NET INCOME 150 124 40 87
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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ANNEXURE F
1. The first step was to establish the correct liability values and this was
accomplished via the actuarial valuations at 31 May 2001 and 30 September
2001 which were completed in November 2001.
2. The next step was to verify the existence and valuation of all assets. This was
done during the completion of the financial statements for 31 May 2001 and 30
September 2001. The May 2001 accounts were finalised in October 2001 and
the September 2001 accounts were finalised in November 2001.
3. There was much adjustment to asset values due to –
3.1 Overvaluation of assets.
3.2 Incorrect recording of assets.
4. The next step was to allocate assets to liability pools, which was done as follows
–
4.1. Assets which were obviously shareholder assets were allocated to
shareholders (i.e. fixed assets, loans and certain other inappropriate
investments).
4.2. Where possible, suitable assets were allocated to specific liability pools (i.e.
bonds to annuity liabilities).
4.3. The balance of the assets were then allocated proportionately to the various
portfolios. This included assets such as Saambou, Inhold and the properties.
4.4. The portfolios were then restructured by selling inappropriate assets and
purchasing suitable assets. Unsaleable assets were sold to the shareholders’
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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portfolio (i.e. private equity and property, etcetera) as it was imperative to try
and match policyholders’ portfolios to avoid mismatching losses.
5. The main assets and their treatment is more fully described as follows –
5.1. Saambou Holdings Limited (“SHL”)
5.1.1. The NMLF held a 40% interest in SHL. Investec, immediately after the
acquisition, stated their intention to dispose of this investment. The
disposition of SHL was handled by Investec Corporate Finance.
5.1.2. Only one “tentative” bid was received for SHL which bid was made at
net asset value but subject to a due diligence and various other
conditions. The net asset value at the time was approximately R6,00 per
share before any due diligence adjustments. As the share was trading at
R9,00 and analysts were forecasting trading ranges of R12,00 to R15,00
per share, no deal was concluded.
5.1.3. Investec appointed three people to the board of SHL to oversee the
management of the investment.
5.1.4. The possibility of hedging the SHL exposure was also considered by
assets managers but this was not possible due to the size of the
investment and the liquidity of the stock.
5.1.5. The SHL shares were allocated proportionately to all the portfolios that
participated in the NMLF.
5.2. Investec Holdings Limited (“Inhold”)
5.2.1. The NMLF had a large exposure to Inhold – approximately 20%.
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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5.2.2. Initial steps were taken to reduce this exposure by selling shares to
other portfolios where asset managers deemed it appropriate. In
addition, approximately 35% of the holding was repurchased by Investec
at a price of R160,00 per share – the highest recorded price for the year.
5.2.3. The aforesaid steps reduced the holding by 40%. The asset managers
also investigated various hedging strategies.
5.2.4. On finalisation of the restructuring of the portfolios in early 2002, the
remaining Inhold shares were “sold”, at market value, to the shareholders’
fund.
5.3. Property
5.3.1. The NMLF had a large exposure to individual properties.
5.3.2. All properties were transferred to a property holding company structure.
This structure facilitates management and liquidity. In addition a bond
was issued for 1/3 of the exposure which assisted with the matching of
the portfolios.
5.3.3. After restructuring the portfolios shareholders absorbed as much of the
excess property exposure as possible.
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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ANNEXURE G
F I N A N C I A L S E R V I C E S B O A R D Rigel Park 446 Rigel Avenue South Erasmusrand Pretoria South Africa PO Box 35655 Menlo Park Pretoria South Africa 0102 Tel (012) 428-8000 Fax (012) 347-0221 e-Mail [email protected] Int +27 12 428-8000 Int +27 12 347-0221 Toll free 0800110443 Internet: http://www.fsb.co.za Enquiries:
Melonie
D. Dialling No.:
012-428 8052
Our ref:
10/10/1/105/2
Fax:
012-347 8788
Date: 2 August 2000
e-mail:
Send by facsimile: (011)781 3174 Mr R D Williams Hymans Robertson & Co. (Pty) Ltd P O Box 1818 RANDBURG 2125 Dear Mr Williams LONG-TERM INSURANCE ACT, 1998 : SECTION 38(1)(c) FEDSURE LIFE ASSURANCE LIMITED (FEDSURE) AND NORWICH LIFE SOUTH AFRICA LIMITED (NORWICH) 1. This Office was informed by the above two insurance companies that it is their
intention to merge the businesses of the two companies shortly. The merger will necessitate a Court approval for the transfer of long-term insurance business in terms of section 37 of the Long-term Insurance Act, 1998.
2. In this regard this Office has, subject to your acceptance, decided to appoint you
in your personal capacity in terms of section 38(1)(c) of the Act, as the independent actuary to investigate and report to the Financial Services Board on the proposed transaction. Subject to paragraph 13 of my letter you would be more than welcome to consult with other professional persons, should you so wish.
3. In January 1999, Fedsure acquired 100% of the issued share capital of Norwich. 4. Corporate information:
Mr Ade Animashahun (Tel :(011) 332 6196; Cell 082 806 7417) has been designated as the contact person to deal with the proposed application to merge
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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the long-term insurance businesses. Please feel free to liaise with him on this matter.
4.1 Fedsure is a Johannesburg based long-term insurer, registered to issue
assistance, disability, fund, life, and sinking fund policies.
Address 1 De Villiers Street c/o Harrison Street Johannesburg
TEL: (011) 332 6000 FAX: (011) 332 6337
Chairman: Mr J A Barrow Public Officer: Mr P A Killick Statutory Actuary: Mr G Raftopolous Auditors: Pricewaterhouse Coopers Inc
Partner: Mr B Stott
The size of Fedsure at 31 December 1999:
Share capital: R 1 118 523 mil (share premium included) Assets: R 28 575 505 mil Liabilities: R 28 192 778 mil Surplus: R 382 727 mil
4.2 Norwich is a Johannesburg based long-term insurer (formerly Cape Town),
registered to issue disability, fund, health, life, and sinking fund policies.
Address 1 De Villiers Street c/o Harrison Street Johannesburg
TEL: (011) 332 6000 FAX: (011) 332 6337
Chairman: Mr J A Barrow Public Officer: Mr P A Killick Statutory Actuary: Mr J W Beak Auditors: Pricewaterhouse Coopers Inc
Partner: Mr H Bosman
The size of Norwich at 31 December 1999:
Share capital: R 28 195 mil (share premium included) Assets: R 12 966 268 mil
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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Liabilities: R 12 098453 mil Surplus: R 867 815 mil
5. Your principal duty as independent actuary will be to prepare a report to this
Office on the effects of the proposals on the policyholders of both the long-term insurers concerned. In preparing your report you will take account of the proposals regarding any policyholders trusts and any other "ringfencing" that may exist. Under the circumstances it would be useful if you could arrange to meet with this Office so that we can discuss our views and define more specifically the information we will need to dispel our concerns.
6. More specifically, your report will cover and give an opinion on (separately for
each category of policyholders where relevant):
6.1 the likely effects of the scheme on the security and reasonable benefit expectations of policyholders;
6.2 the possible loss of value to policyholders resulting from the Scheme. This
will include for example, as a consequence of associated expenses, taxation, undervaluation of assets and / or the fairness of the split of assets between policyholders' funds and shareholders' funds;
6.3 the likely effects of the scheme on any former "ringfenced" business;
6.4 the process of communication with the policyholders; and
6.5 whether you are satisfied that the information provided was relevant,
reliable and free from bias. 7. In preparing your report you will have to take into consideration the transferee
company's preparedness for and its plans for ensuring readiness of the expanded company. You will have to report on whether sufficient human and financial resources are available and whether systems will meet the requirements of the expanded company.
8. In preparing the report you shall inter alia take account of the professional
guidance set out in Guidance Note 15: Transfer of Long Term Business of an Authorised Insurance Company - Role of the Independent Actuary, issued by the Institute of Actuaries and the Faculty of Actuaries.
9. In preparing your report you shall consider the ways in which both companies
have conducted their long-term business in the past, taking into account the particular circumstances of each category of policyholders and having regard inter alia to:
9.1 previous transfer documentation and court rulings;
Board Members: Ms G Marcus (Chaiperson) W J Haslam (Deputy Chairman) S Maree S I Kotane G K Morolo Mrs H Wilton Executive Officer: J van Rooyen C:\WINDOWS\TEMP\FEDSURE REPORT PUBLICATION VERSION.DOC Melonie van Zyl
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9.2 the terms of policies in force; and
9.3 past practices and internal working arrangements relating to the financial management of long term business and in particular the methods used to identify and quantify earnings and to distribute it to policyholders by way of bonus.
10. You will liaise with the auditors with regard to any aspect of their work which
interacts with yours including, for example, computer systems and data integrity.
11. You shall also consider the appropriateness of the proposed arrangements for
the financial management of the business following implementation of the Scheme, having regard to the view of the Statutory Actuary of both the companies and the conditions, if any to be imposed by the Scheme on the future operation of the business.
12. Please confirm that you have no past or present connection with the company
concerned. From our side we confirm that the appointment as Independent Actuary in respect of the Scheme has not been offered to any other actuary.
13. Please be advised that the parties to the transaction will be responsible for the
payment of your fees and costs and that you will be responsible for concluding the arrangements with them.
14. Please confirm your acceptance of the above offer to be appointed and also
your acceptance of the terms of reference. Yours sincerely
ANDRE SWANEPOEL DEPUTY EXECUTIVE OFFICER