Standard Life today announced plans to reimburse 97,000 investors who lost money in its Pension Sterling Fund at a cost of £100m.
The move follows a string of complaints from consumers and financial advisers that they were mislead about the safety of the £2.1bn fund and the assets in which it invested.
Promotional literature for the fund gave the impression that it was wholly invested in cash, and as a result it was popular with people looking for a safe haven for their pension pot in the final years before they retired.
But in reality around of half of the money was held in mortgage-backed assets, and investors were shocked on 14 January when Standard Life announced it was slashing the value of their holdings by nearly 5 per cent.
The life insurer today apologised to its customers and said it would be injecting £100m into the fund to restore the value of people's policies to their previous level before the reduction was made.
It will also compensate people who have since moved their money out of the fund or used it to buy an annuity, and it has changed the way the fund is marketed.
The group issued a statement saying: "Having conducted our own review of the literature for the Pension Sterling Fund and listened carefully to what customers and advisers have been saying to us, it is clear that many people were not fully aware of the nature of the fund.
"Furthermore, some customers would not have anticipated that units in the Pension Sterling Fund could fall by such an amount in one day. With hindsight, some of the literature we provided in respect of this fund fell short of our own high standards.
"Against this background, we feel strongly that the right thing to do is to put all customers back to the position they would have been in had we not reduced the value of the fund on January 14."
The fund invests in bank and building society deposits and floating rate notes, a type of bond which pays a variable rate of interest, the majority of which are asset-backed securities.
But while the fund had only 3 per cent of its assets invested in mortgage-backed securities in December 2004, this had mushroomed to 55 per cent by September 2007, although it had fallen back slightly to 44 per cent last month.
Standard Life said it would continue to operate the Pension Sterling Fund in the same way, as it contained high quality assets.
But it added that customers should be aware that the value of the fund could fall, and people who were not happy with this level of risk could transfer to its Managed Cash Fund.
Independent financial adviser Hargreaves Lansdown, which had written to Standard Life demanding compensation for investors and threatening to refer the matter to City watchdog the Financial Services Authority, welcomed today's announcement.
Tom McPhail, head of pensions research at Hargreaves Lansdown, said: "Credit where credit is due, they prevaricated for a while and tried to wriggle out of it, but I am delighted that they are doing the right thing.
"It is nice to see a large financial institution doing the honourable thing."
He added that with the £100 million injection into the fund it could now be a good investment proposition, although he said there was also a chance the value of the assets it held could fall further.