Investment: When paying up is not playing the game fairly

Equitable Life is trying to treat all policyholders equally, so why are a group suing the mutual society over annuity rates guaranteed over 20 years of selling pensions?
FOR ANYONE who writes about investment, there are few assignments less welcome than trying to defend an insurance company against customer accusations of not doing well. But sometimes justice requires even those of us who hold the industry in a less than favourable light to make an exception.

Equitable Life is being taken to court by irate pension policy- holders over guaranteed annuity rates. They claim Equitable ratted on the promises made for 20 years when it sold them pension policies.

In a conscious invocation of the pensions mis-selling scandal, they want the courts to rule the company was guilty of misrepresentation when it guaranteed minimum annuity rates on tens of thousands of pension contracts. Interest rates have plummeted, and the annuity rates the insurance company guaranteed are substantially above the rates obtainable today.

On the face of it the Equitable has no case. When annuity rates are at 8 per cent, as they are today, it means that anyone with a pension fund valued at pounds 100,000 can expect to receive pounds 8,000 a year as income until they die. Nobody disputes that the Equitable guaranteed to pay much higher rates on thousands of pension contracts it sold in the 1970s and 1980s. Rates of 10 per cent to 13 per cent were typical then. Translated into hard cash, the difference could easily amount to pounds 5,000 a year for every pounds 100,000 accumulated in your pension fund.

If the litigants win, it will be serious indeed for the Equitable, which rightly takes pride in its reputation as the oldest and the lowest-cost life insurance company in the country. In a business not best known for either efficiency or integrity, the Equitable stands apart on both counts (though in the last two to three years its investment performance seems to have dipped rather worryingly).

Both sides seem to be acting from genuine motives. But the closer you look at the arguments, the more apparent it becomes that this "scandal" is actually no scandal at all. It is not about mis-selling, but about wider principles of equity and insurance company practice. Nobody can criticise the guaranteed annuity holders for wanting a better deal out of the company, but it is not clear to me that they have right on their side.

I feel those who are bringing the action have little chance of winning(though they may win concessions in an out-of-court settlement). If they do win, the other 500,000 policyholders with the Equitable will regret it, since it will cost them money, and threaten the end of the principles that make buying a policy from a company such as the Equitable worthwhile.

The real issue is not the rate at which their annuities are guaranteed. Rather it is about the value of the fund to which this rate should be applied. Equitable's case is that it intends to honour its guaranteed rates in full. But it does not intend to apply that rate to the fund value to which the applicants think they are entitled.

Instead, it intends to apply the higher rates of the past to a smaller pot. To do this, it is proposing not to pay the normal level of terminal bonus on the policies of the aggrieved policyholders. As most people know, terminal bonuses can amount to anything from 20 per cent to 60 per cent of the total value of a long-term life fund. These bonuses are, and have always been, set by the insurance company at its discretion.

The bonus system is far from ideal. It allows insurers enormous scope to fiddle around with bonuses so they can, legally, discriminate between one type of policyholder and another, without outsiders being much the wiser. The irony is that the Equitable is one of the few companies that actually tells you each year what the value of your "asset share" of its life fund is.

Equitable operates on the principle that all its policyholders are entitled to be treated as equitably as possible. It undertakes that the benefits policyholders receive when their fund matures will broadly reflect the value they earned through the contributions they made and the investment returns achieved.

The company says policyholders with guaranteed annuity rates have already earned more than their asset share in the fund, so to pay a terminal bonus would be an unreasonable one-off redistribution of the assets in the life fund in favour of one set of policyholders versus another. As a mutual society, only other policyholders pay the bill for the guaranteed annuity rates.

The issue comes down to whether the Equitable is entitled to cut the terminal bonuses to nothing in pursuit of this principle? And is that reasonable and fair? To a layman, the answer to the first question is yes. The second issue is not so clear-cut. True, the affected policyholders stand to receive a lower income than they might expect, but the fall in interest rates that brought down annuity rates so sharply has been one of the factors behind the growth in the stock market, where the bulk of the life fund is invested.

The 20-year returns on the fund have been considerably higher, in nominal and real terms, than anyone who bought a pension policy at the time could reasonably have expected.

The case for aggrieved policyholders now depends on proving in court that the sales literature the Equitable and its in-house salesmen used when selling the policies many years ago failed to make clear the guaranteed annuity rates would be applied to a fund that might not qualify for a terminal bonus. This argument has force - but little merit. The important issue is whether there is underlying injustice. And in my view that case has not yet been made.

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