Why Didn't Anyone Warn us?

With her 60^th birthday coming up on August 5^th, Jean Sampson was looking forward to retirement. A divorce at 56 had left her without any private pension. So for the next four years she put all she could from her modest salary into an Equitable Life pension scheme. Six weeks before her birthday, she asked how much her fund would be. On June 28^th Equitable said it would be nearly £17,000. That would buy her a very modest pension – around £100 a month at most – but it was hers. She handed in her notice, applied successfully for a part-time job, and looked forward to doing less. Then, on 17th July she read in the newspaper that Equitable was cutting 16% off the pension savings of its customers. She was devastated.

"I had handed my notice in because everything seemed on track, retiring on Friday 3^rd August and starting my new job the next Monday. I was over the moon when I got that little job, small as it was. I knew life was going to be a bit tough but I was prepared to accept that, the hours I do now are very long. Now they have taken my world away."

Jean of course is not alone. Equitable Life has a million customers and they all see the value of their pension savings cut by up to 16%. And that was just the start – growth in their savings would be frozen for six months, future growth was cut from 8% a year to 6%, and all that was on top of cuts last year which wiped £1.5 billion off the value of their funds. Equitable has confirmed to Saga Magazine that Jean will lose nearly £2500 of her pension savings, slashing her pension by £15 a month. If she had retired two weeks earlier she would have avoided the loss. Equitable spokesman Alistair Dunbar said

"The valuation we sent on June 28 was in fact for more than the underlying assets were worth and that has had to be corrected. We did allow a period of grace for those who were in process before the announcement and were completed by 23 July. But we had to draw the line somewhere."

Jean feels betrayed.

"It’s so grossly unfair for a couple of days, when I was actually writing to them at that time. It is so cruel. Within a few days of writing to me they have taken my money. It was totally misleading and unfair. They must have known when they wrote that letter. I don’t think they should be allowed to do this. They have broken our confidence, our trust."

Another person who feels his trust has been broken is retired surveyor John. He told Saga Magazine he may have lost £45,000 "I’m actually too gutted to add it all up. I have a pension fund and two bonds. I went with them because my father did, they were long established, and the professional classes used them."

Indeed they did. Equitable Life was the ultimate safe bet, numbering lawyers, doctors, and architects – as well as financial journalists – among its customers. So how did one of the country’s most respected and well connected insurance companies get into such a mess?

Equitable was founded in 1762 when America was still a colony, Boswell had not met Johnson, and Watt still had to patent his steam engine. But five years earlier a mathematician called James Dodson had worked out the principles that still underpin the life insurance and investment plans that we all rely on. Equitable was the first to use his maths to fix for life the premiums people paid and on death give a guaranteed payout. It was an immediate success.

For the next two hundred years the history of life assurance in the UK was the history of Equitable Life. In the 1950s it began providing pensions to the middle classes. And when the pension revolution spread to everyone in the late 1980s, Equitable remained a trusted beacon of probity in a world where other insurance companies were busy mis-selling billions of pounds worth of pension plans to millions of hapless customers.

Equitable paid no commission to insurance agents or independent financial advisers. It had no shareholders – its customers were its owners. And it kept its reserves low, returning to its members far more of the money their savings earned than other life companies did.

But a time-bomb laid in 1957 was ticking away at its heart. It introduced a new product – a guaranteed pension for life. That meant predicting how long people would live and the level of interest rates for up to 40 years into the future. A tough job even for the actuaries at the world’s oldest mutual insurance company. And by 1993 it became clear they had got it wrong. Life expectancy had grown and interest rates fallen far more than its actuaries had forecast. The pension promise could not be kept.

The company tried to wriggle out of its obligations, paying newly retired people less than the guarantee. Many complained; some threatened legal action. Equitable went to court to prove it was right. But in July 2000 the House of Lords declared it was wrong. A guarantee meant what it said – Equitable had to pay.

Faced with finding £1.5 billion to meet its promises, Equitable slashed returns on its funds and put itself up for sale. Six months later no-one had bought it and on December 8 the company closed to new business and its managing director resigned. To prevent a mass exodus of customers it doubled the penalty for anyone moving to another insurer – Equitable would keep 10% of their money, later raised to 15%. Over the next five months the chief executive, the President, and all the Directors resigned. And then in July came the latest blow as the new Board realised the true financial mess Equitable was in and told customers their pension funds would be cut by a sixth and future growth promises cut by a quarter. The only good news was that the exit penalty was halved to 7.5%.

The extent of Equitable’s difficulties was hidden because of the way the company was run. Like most insurance companies, it paid out its investors on what is called a ‘with profits’ basis. Each year the company’s actuaries look at how much the total investment fund has grown, and then work out how much to pay that year – what they call an annual or guaranteed bonus – and how much to keep back. In good years they keep a lot back so they can pay out more in bad years, smoothing out the ups and downs of the stock market. When a customer cashes in a policy, their share of this retained money is calculated and doled out in what is called a terminal or final bonus. This way of running a company’s accounts makes it almost impossible to assess a company’s assets and liabilities.

Almost, but not quite. The Financial Services Authority now regulates companies that offer financial products. And when it took over regulating the insurance industry from the Treasury in January 1999, it knew there were problems at Equitable. A leaked memo to its Managing Director dated November 5, 1998 from a civil servant called Roger Allen expressed concern about whether Equitable had the reserves to pay its guaranteed annuities. He said "the information received to date is unconvincing and raises serious questions about the company’s solvency". But the Financial Services Authority gave no public warning. And Equitable continued to sell policies to people for another two years. The £200 million a year watchdog never left its kennel, let alone barked.

Altogether Equitable has around a million people in its with profits fund. But only 90,000 individuals and another 100,000 in company plans have guaranteed annuities. If those guarantees are to be met, the 810,000 other policy-holders will have to pay for them, including tens of thousands who first joined Equitable after the regulators knew it was in trouble but told no-one.

As this edition of Saga Magazine arrives on your doormat all Equitable’s members will be getting a letter inviting them to give their views on a deal to sort out the company’s financial difficulties. It will not make pleasant reading. The minority with the guaranteed annuities will be asked to give up their rights in exchange for an increase in their fund, probably of around 20%. They will then be free to use that bigger fund in the marketplace to buy an annuity at current rates. The majority with the non-guaranteed annuities will be asked to pay for it, maybe by further cuts in their expected rewards. For the deal to go through, half the policyholders in each group will have to vote yes – and between them the ‘yes’ votes will have to account for at least three-quarters of the value of the funds invested.

If that happens – and the courts approve it – by the end of March 2002, Halifax, which bought a lot of Equitable’s business in February, will pay £250 million into Equitable’s funds, with up to another £250 million over the following two years.

If the compromise deal is not approved, Halifax will not make the payments and things will get worse. Further cuts in the value of all funds may be imposed to ensure that there is enough money to meet the unlimited liability to the 190,000 policyholders with guarantees. And the pensions that most people can expect to get will be smaller still.

September 2001

e-mail Paul Lewis on paul@paullewis.co.uk