The cost of compensation proposals published yesterday by the Securities and Investments Board will be borne by the life insurance companies and independent financial advisers who sold their policies.
The full scale of compensation will not be clear for at least three years because of the time it will take to trace all those investors who have been mis-sold personal pensions.
Many independent financial advisers will be forced out of business by the costs, and the industry predicts some small life insurance companies will become vulnerable to takeover.
Anthony Nelson, Treasury minister, welcomed the report by Andrew Large, chairman of the SIB, and said it would 'ensure that everyone who has lost out through mis-selling will be entitled to compensation. The investment industry can and will meet the cost.'
But, defending the Government's campaign for personal pensions, he said they remained 'a highly desirable product'.
The Association of British Insurers, the trade body representing the life insurance industry welcomed the proposals. Tony Baker, director- general, said: 'Any speculation now about the total bill will only be a guess.'
He said that from the research done so far all his members would be able to meet any compensation liability. The cost of reinstating someone into an occupational scheme was likely to be a few thousand pounds in each case.
He added that the incidence of mis-selling was not uniformly spread throughout the industry - some companies had a much higher level of opt- outs and transfers than others.
Many life insurance companies have already made provisions to allow for compensation, but these may now have to be increased.
David Prosser, Legal & General's group chief executive, called for occupational pension schemes to share the burden. He said: 'We believe the SIB is unfairly putting too great a burden on the of the costs of resolving the issue on the policyholders and shareholders of the life assurance industry.'
Legal & General made a provision against the costs of possible redress in the 1993 financial year. However, this did not make enough allowance for the administrative costs that are now proposed, he said.
Labour also criticised the SIB proposals. Alistair Darling, City spokesman said: 'The Government has a heavy responsibility for the lax regime of the late 1980s. The present system is increasingly discredited. The Government has ducked its responsibility.'
Chris Broxsom, chief executive of Axa Equity & Law, said: 'The important thing is that we restore confidence in personal pensions. The key is that we do not fall into the same trap again.
'One of the things that concerns me is the effect this will have on independent financial advisers. Many will be forced out of business. Others will have to find a lot of money. That will have to come from somewhere.'
John Beishon, director of the Consumers' Association, which helped to devise the guidelines, hit out at the compensation time scale involved. He said: 'Even for cases which will be reviewed, the time scales appear to have been arranged at the convenience of the pensions industry rather than the harm suffered at the hands of the individual pension holders.'
Mr Beishon demanded that the SIB should act to force company shareholders to pay. Much of the bill will be paid out of policyholders' rather than shareholders' funds, which he thought was unfair.
Geoffrey Lister, chief executive of Bradford & Bingley Building Society and a member of the Personal Investment Authority board, said that although he fully supported the SIB's stance, the scale of the problem was 'surprising'.
Bradford & Bingley is one of a handful of building societies that still operates an independent advice arm. Mr Lister said: 'It saddens me that many of our smaller brethren will go out of business as a result of their compensation liabilities.'
Despite using 100 out of its 600-strong authorised sales force to check on their colleagues to ensure proper advice, Bradford & Bingley has still set aside pounds 5m to compensate for past mistakes. Mr Lister said the figure would have to double this year.
Garry Heath, chief executive of the IFA Association, a trade organisation representing 3,000 independent advisers, fears that some of his members will be driven out of business.
He said: 'The SIB has adopted a sensible and practical approach.'
Mr Heath added that professional indemnity insurers would pick up some of the bill for advisers.
If advisers went out of business because of the claims, the Investors Compensation Scheme would be forced to pay out. The scheme is funded mainly by the insurance companies.
Insurance shares, which fell sharply when the City realised that cost estimates would be raised, lost only a few pence. View from City Road, page 29 (Photograph omitted)