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"The Equitable Life: Boards sued for not using derivatives"

10 September 2000, The Sunday Times, London 

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In my book "Key financial instruments: understanding and innovating in the world
of derivatives" (Feb 2000 Financial Times Prentice Hall), I pointed out that
"boards have been successfully sued for not using derivatives". I also asked
"why did they <The Equitable> not manage the interest rate risk either by
altering the duration of their investments in fixed-rate government securities
or by re-insuring. <through derivatives>? The losses in the Equitable case dwarf
those that arose <in banks> through using derivatives."

They could even have set up of a captive interest rate derivatives unit to
manage the risks under the guaranteed rates policies.The beauty of
the derivatives or re-insurance market is that one man's risk is another's
diversification reward. Furthermore, there are many classes of borrowers that
benefit from lower interest rates. Variable rate mortgages, bank, corporate or
government bonds which included minimum interest rates could have been used as a
source of interest rate insurance. Perfect hedging at a reasonable cost would,
indeed, have been impossible. But risks could have been better managed. And
adding together lawyers' fees, the value of the loss of reputation for "fair
play", increased advertising spending and, inevitably,demutualisation fees we
would get a figure far in excess of derivative-writers' profit margins.

There remain some interesting questions that I have not seen answered. What
valuation, at the time of marketing and sale, did the Equitable place on the
interest rate guarantees provided ? Did they obtain external valuations of such
guarantees in the derivatives or capital markets? What strategy did they put in
place to manage the risks once they had chosen to self-manage them? What
valuation did the Equitable's auditors place on the liabilities inherent in
these guarantees? And most interesting - what did these auditors make of the
nature of the guarantees provided at the time they were given?

Warren Edwardes,

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