Outlook: Last cut is the deepest as Pru again takes axe to bonuses

Enron one year on; Not Goodenough
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Life insurance companies have been some of the strongest performing shares in the stock market over the past, month long rally. Unfortunately, the fact that the stock market has finally come to accept that the sector is not about to turn over and die after all hasn't made things any better for policyholders. For them, the pain seems to get worse by the day.

Life insurance companies have been some of the strongest performing shares in the stock market over the past, month long rally. Unfortunately, the fact that the stock market has finally come to accept that the sector is not about to turn over and die after all hasn't made things any better for policyholders. For them, the pain seems to get worse by the day.

Yesterday, Prudential said it was slashing terminal bonuses by a further 7 per cent, the third such cut in a year, bringing the average annual reduction to 12 per cent. The arbitrary nature of these cuts, which makes the terminal bonus on a policy maturing today worth 7 per cent less than one maturing yesterday, is one thing. Policyholders are also entitled to question why they are being made at all, when only a few months back the Pru was boasting that it had seen the stock market depression coming three years ago and acted accordingly.

Life assurance is a "smoothed" investment product, which means that policyholders are meant to get broadly the same, whether stock market conditions are good or bad. That's how it is sold and that's why most investors buy it. In good times, policyholders surrender some of the upside, so that in bad times they are not so exposed to the downside.

Only it doesn't seem to work that way. Equitable may be the nightmare case, but most life funds seem to have been mismanaged to some extent. Bonuses have been too high during the good times, presumably for the purpose of persuading more savers to buy, and there is not enough money to deliver the smoothed product now that the stock market is taking a pounding. If the Pru, probably the most solvent of the lot, is again having to cut bonuses to cope, it means that it is only a matter of time before others follow suit with deeper cuts still.

The Pru says it started shifting out of equities four years ago, but according to yesterday's numbers, it is still 47 per cent invested in them. Not so prudential after all, it would seem. The present crisis in the life assurance industry makes the strongest possible case for root and branch reforms proposed in the Ron Sandler report. Many of those affected by yesterday's ruling will be mortgage endowment holders. It is only the threat of insolvency that prevents Sir Howard Davies, chairman of the Financial Services Authority, from ordering the payment of industry wide compensation for mis-selling.

Enron one year on

Some years ago I attended a lecture at which an eminent US economist described what was then the very recent spate of economic and financial crises in emerging markets as a crisis of crony capitalism, by which he meant, corrupt, dictatorial government in combination with exceptionally weak standards of banking supervision and accounting transparency. The economic calamity to have befallen these countries said nothing adverse about the workings of capitalism as a whole, he insisted.

This was a time of US corporate and economic triumphalism, when the idea that three years down the line the US would be facing its own crisis of public trust in its companies and capital markets would not have been thought remotely possible.

It is almost exactly a year since Enron filed for Chapter 11 protection from its creditors, and the word Schadenfreude hardly begins to describe the pleasure taken in many parts of the world at America's post-bubble discomfort. After all the lecturing on crony capitalism and the rest, you can see their point. However, the reality is that the two events – the emerging markets crises and the American scandals – bear no comparison at all.

I'm a journalist, and I'm not in the business of belittling events, but I don't think that the spate of American scandals can properly be described as either the fault of crony capitalism, still less can they be seen as a crisis of capitalism. That there was a greed-inspired collapse in accepted standards of business and professional conduct is not in doubt. Nor is it in doubt that the scandals laid bare a wide range of faults in corporate organisation, regulation and oversight. Furthermore, the destruction of wealth and value involved in the US stock market collapse makes what happened in the Far East look like a vicar's tea party by comparison.

Even so, look at the US economy today – still growing with the strong dollar more or less intact – and you can hardly make the case for a crisis in capitalism. Rather the reverse. What Enron and the atrocities of 11 September have demonstrated is its extraordinary resilience.

The US economy is not yet out of the woods, but the very dramatic action that the US has been able to take in cutting taxes, increasing public spending and cutting interest rates in response to these events show how far mature capitalist economies have come. Time was when a stock market crash on the scale seen in the last three years would have resulted in extreme economic and social disruption. If this was a crisis at all, then the US seems already largely to have defused it.

The speed with which the US has purged the system of its miscreants and then rebooted is also impressive. Forget the Sarbanes-Oxley Act, Eliot Spitzer, and all the other law makers and prosecutors to have climbed on the post-bubble bandwagon, when the history books come to be written the most lasting corrective will be seen as the brutal destruction of Arthur Anderson, the accountancy practice at the heart of the Enron scandal.

This is capitalism as it is supposed to work, not through rules and regulations, but by making organisations and individuals liable for the consequences of their actions. That one of the big five global accounting practices, a firm that was meant to be a byword for professionalism and diligence, could be reduced to rubble within such a short space of time, is a terrible lesson to all.

As it happens, the coup de grâce for Andersen was not the failure of its Enron audit as such, but its alleged destruction of evidence in the aftermath of the collapse. By gambling on a quickie trial in which it faced a single charge, Andersen sealed its fate. I've never believed the deliberate cover-up story. However corrupt Andersen had become, or however implicated it might have been in the accounting fraud, this always seemed to me an unlikely turn of events, even for desperate men. Certainly, the case was never convincingly put.

But that didn't stop the jury convicting, for in essence they were trashing Andersen for the wider crime of Enron and all the other candy floss companies that had been allowed naively to flourish during America's New Economy boom. Policymakers can belly ache all they like about how to restore public trust in the capital markets, but retribution is generally the best starting point. One year after Enron, the US is already a long way down the road to reconstruction.

Not Goodenough

It wouldn't be the first time someone's trashed the business only to then buy it back at a fraction of the price, but Alan Goodenough's involvement in the bid for London Clubs International, the casino operator, is no good at all let alone good enough.

Mr Goodenough was chairman of LCI until 18 months ago, when he retired on grounds of "ill health" after the company's $180m investment in the Aladdin casino in Las Vegas. It scarcely needs saying that LCI lost its shirt in Vegas and has been trying to pay off the creditors ever since. Whether that had anything to do with Mr Goodenough's heart condition is unknown, but the share price has long looked like a bad night at the tables.

None of this is Stanley Leisure's problem. It would need to dispose of some casinos for competition reasons, Mr Goodenough has found City backing – from Hg, the old Mercury private equity business – and though he might have been bad enough for shareholder value, he's good enough to command the support of the Gaming Board to boot. What a racket.