Equitable's tragic tale spells the end of mutuality

Equitable Life
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It is hard to know who to blame most for the tragedy that has befallen Equitable Life and its members. The word "tragedy" is used advisedly, for the demise of Equitable Life is much more than just another financial disaster. Equitable is the oldest life office in the world and down the ages it became a byword for sobriety, thrift, trust and mutual ownership. It is even said to have given the word "actuary" its modern meaning.

It is hard to know who to blame most for the tragedy that has befallen Equitable Life and its members. The word "tragedy" is used advisedly, for the demise of Equitable Life is much more than just another financial disaster. Equitable is the oldest life office in the world and down the ages it became a byword for sobriety, thrift, trust and mutual ownership. It is even said to have given the word "actuary" its modern meaning.

The immediate cause of Equitable's demise is the crassness of last summer's judgment by the House of Lords, which ruled that the rights of a minority of policy holders with guaranteed annuities should be upheld. The Law Lords are an eclectic lot, sometimes capable of surprisingly liberal judgment. On this occasion, however, they chose to treat the issue in a narrow legalistic manner without any regard for the consequences of what they were doing.

Equitable Life is a mutual, which means that extra benefits to guaranteed annuity policies must be paid for by other policyholders. The minority is being favoured at the expense of the majority in a clear-cut case of robbing Peter to pay Paul. The divisiveness of the decision makes a mockery of the whole idea of mutual ownership, where members are all meant to be in it together. Since there is a limit to how far the policies of the majority can be raided to support the guarantee, the effect is to destroy a perfectly good business which might eventually have managed its way out of its present hole to produce an acceptable outcome for the great bulk of policyholders.

As it is, the outlook for remaining Equitable members looks a miserable one. It is not just that membership has proved worthless. The last chance of a windfall disappeared with the Pru. Worse, bonuses will have to be cut and the much more conservative investment strategy the society must adopt to maturity is bound to mean lower returns than other "with profits" life funds. Cashing in isn't much of an option either because of the surrender penalties of doing so. What's more, most Equitable endowment policies are set up in a way that doesn't allow contributions to be frozen. As rotten law-making goes, the Law Lords ruling on Equitable takes some beating.

But plainly there's more to it than a wrong-headed court judgment. That guaranteed annuity policies should have been marketed at all by apparently trustworthy actuaries whose job it is to guard against the possibility that the unthinkable might actually happen, is remarkable enough. That they should have been marketed on the scale that Equitable embarked on is odder still.

In its drive for growth, Equitable compounded the problem by deliberately maintaining a policy of much higher bonuses than others, helping to place the society at or near the top of the performance tables year in year out but endangering its long term future in the process. This approach was continued even after the guaranteed annuity problem started coming home to roost, in the misguided belief the courts would eventually rule in the society's favour. The upshot is that unlike most other life funds, there are no capital reserves to meet the liability that now has to be paid.

And so to the regulators, who can reasonably be seen as culpable too. Life funds are heavily regulated for solvency by the Financial Services Authority, and before the FSA came into existence, the Department of Trade and Industry. Arguably, regulators should have insisted on greater provisioning or a bigger capital reserve, along the lines adopted by Standard Life and others, especially since Equitable was more heavily exposed to the problem than others. They did not.

They might also have insisted that Equitable be closed to new business last July, in the immediate aftermath of the Lords judgment, instead of which it was allowed to stagger on and write thousands of new policies. Again, they did not, though in fairness it might be argued that such action would have destroyed any chance of Equitable being sold as a going concern.

As for Alan Nash, the chief executive, his judgement has proved so disastrous throughout that it is a wonder he's getting any payoff at all, let alone the £200,000 agreed. Before the Lords judgment, he could easily have sold Equitable for £2.5bn or more. There were several bidders prepared to gamble on the likelihood of a favourable outcome, including the Prudential. After the judgment, it was much more difficult. No one would buy without a cap on the guaranteed annuity liability, and there appeared no way of achieving this without returning to the courts to interfere with the original judgment. The FSA was also much more cautious in sanctioning the use of the Pru's orphan assets for use in bailing out Equitable than it has been in previous cases.

Hindsight is a wonderful thing and it is worth recalling that none of these issues was raised at the time, rather the reverse. Equitable used to receive frequent plaudits for the aggressiveness of its investment and marketing approach. Here was a mutual, it was often said, with the courage to pay its members the benefits of mutuality, rather than store them all up for a rainy day. It was also commendably more transparent than others and shunned high commissions.

And herein lies the greatest lesson of this sorry affair. It is as if mutuality is being undermined at both ends of the spectrum. Any mishap may be enough to sink those with a weak capital position, it transpires, even though capital reserves may have been kept deliberately low in the belief that it is right to pay out the benefits of mutuality. Nationwide, the standard bearer for mutual ownership among the remaining building societies, should take note. With a plc, there's always the possibility of calling on the capital markets when things go wrong. Not so with a mutual.

Nor are strong capital reserves any guarantee of the future, since it makes the company an obvious target for conversion and windfall gain. This is a terrible day for the life assurance industry as a whole, but it is an even worse one for the concept of mutual ownership. Equitable Life was there at the birth of mutuality. The tragedy is that it has survived long enough to witness its death too.


Nanny FSA

Sir Howard Davies, chairman of the Financial Services Authority, is a clever man who's done a great job in setting up Britain's all singing, all dancing financial regulator. But sometimes, he and his cohorts would be wise to keep their mouths shut. They've been at it again over the past week, first warning of a 1980s style house price bubble in the making, then tut-tutting over the banks' exposure to telecommunications lending.

Anyone can read the newspapers and it doesn't take more than a cursory glance at them to know that there is growing concern over whether telecommunications companies have over-extended themselves in bidding for third generation mobile phone licences and building the broadband communications infrastructure of the future. The numbers are vast, even awe inspiring. But for the FSA to come nannying along at this late stage to say to the banks "oh, do be careful" is pathetic.

At best this is another case of slamming the door after the horse has bolted - the habitual lot of regulators. But perhaps more worrying, it seems guaranteed to exacerbate the unnecessary panic already beginning to grip markets over a technology bust in the world economy. It is no part of a regulator's job to tell bankers how they should lend their money, and so far as anyone is aware, no regulatory rule or guideline has yet been broken in their rush to finance the New Economy.