Doubt over windfalls as Equitable Life surrenders

Picking the next mutual which is going to convert into a plc and list on the Stock Exchange is getting easier. With Equitable Life, the UK's oldest mutual, putting itself up for sale on Thursday after losing a landmark case over pensions rights in the House of Lords, none are safe - not even the most-established, respected and well-run.

Picking the next mutual which is going to convert into a plc and list on the Stock Exchange is getting easier. With Equitable Life, the UK's oldest mutual, putting itself up for sale on Thursday after losing a landmark case over pensions rights in the House of Lords, none are safe - not even the most-established, respected and well-run.

The Law Lords ruled that the mutual life and pensions group was wrong to cut bonuses to 90,000 pensioners who had bought guaranteed annuities between the 1960s and 1980s. Equitable cut these rates because of falling investment returns, but must now pay these policyholders £1.5bn in compensation after policyholder David Hyman's complaint was upheld.

Guaranteed annuities were widely sold in the 1970s and 1980s, promising pensioners a level of return irrespective of what happened on the markets. Take-up was high because the threat of inflation eroding the pensions was real. But falling bond yields have made them too expensive to honour in today's low-inflation environment.

Ironically, because Equitable runs itself as a mutual should, with profits distributed among members in the form of lower premiums on policies, it has little in cash reserves. Therefore, it must look for a buyer to cover these compensation payouts, ending 238 years of mutuality.

"Because of this need to address the adverse capital position, we have decided that it is in the best interests of our members to seek a partner," commented Alan Nash, Equitable's chief executive, after the ruling.

The trouble with offering guarantees is that considerable financial resources are needed to meet them. Pat Connolly, associate director at independent financial adviser (IFA), Chartwell, says that apart from Equitable, only Scottish Widows has found itself in this position. "Scottish Widows took a pre-emptive strike by joining up with Lloyds TSB so that it had the financial resources behind it to meet the guarantees," he says. "To run a good with-profits fund you need reserves. The Equitable just doesn't have them."

He feels that if Equitable hadn't made the decision to sell up, it would only have been a matter of time before the mutual had been taken over. "It is a good thing for Equitable policyholders," he adds. "If [the board] hadn't made the decision to demutualise, more and more funds would have left the company as policyholders went elsewhere. The longer that drags on, the more the company, and the policyholders, suffer."

Some feel that it has already carried on long enough. The Law Lords' judgment has finally settled what became a long-running dispute, starting when a High Court decision backing Equitable's handling of guaranteed annuities was overturned by an Appeal Court ruling.

Until a buyer is formally agreed, the exact direction of the business is uncertain. Possible companies rumoured to be interested in taking over Equitable include Axa, the French insurance giant, Aegon, the Dutch owner of Scottish Equitable, as well as Britain's Prudential or CGNU.

As with any demutualisation there are rumours of windfall bonuses. "Policyholders that waited for this outcome will gain the additional benefits of the combined terminal bonuses and guaranteed rates," says Jason Hollands at IFA, Best Investment. "We advise policyholders to hold on for up to 18 months in the event of a windfall resulting from the sale of the Equitable."

But not everyone is convinced that windfalls will be particularly impressive. Equitable's 600,000 policyholders are unlikely to receive Scottish Widows-sized payouts as a proportion of the purchase price - expected to be in the region of £4bn to £5bn - will need to be used to pay the compensation. Whoever takes over the business will also have to meet its liabilities.

Despite the demise of Equitable's mutual status, Peter Quinton at The Annuity Bureau, the independent annuity specialist, says the court ruling is good news for annuity holders generally. "I think this is the right decision in the end," he says. "It is good for consumers to realise they have some protection. It is right for the industry."

As far as the future of mutuals is concerned, the writing was on the wall long before Equitable's board made the decision to sell up. "When it comes to demutualisation, it is a case of 'when?' rather than 'if?'," says Mr Connolly. "It will happen to most of them at some stage.

"In the short term, all life companies are going to need strong financial resources behind them. The only mutuals that will continue are the very small friendly societies who are too small to demutualise."