Outlook: It's all very Equitable - but is it fair?

PART ONE - genesis of a debacle. What is it about the financial services industry that normally trustworthy custodians of other people's money seem so willing when the opportunity presents itself to take on unhedged, low probability risk without thinking about the high cost consequences if it ever comes home to roost?

The top brass at Equitable Life probably has as little idea of the answer to this question as the rest of us, but this week it has been in the High Court in London trying to deal with the consequences of one such bet that went wrong - in this case guaranteeing a minimum level of return on private pension policies.

For insurance companies, bets of this type seem fair enough; it is their business to insure risk. But for mutually owned life companies to indulge in such high wire activity is difficult to understand.

Guaranteed annuities are only the latest example of this type of collective management stupidity. Mortgage guarantees, which cost insurers an arm and a leg in the early 1990s, is another and as likely as not, so called "guaranteed high income bonds", which promise a minimum level of investment return on your money, will duly prove to be another case again.

One explanation is that when one company starts to offer such deals, then competitive pressure more or less forces everyone else to follow suit. It scarcely needs saying, however, that though the competitors that resist this pressure may lose out in the short term, they seriously win out on a longer term perspective.

Managements take on these risks, then, not just because everyone else is doing it, but also because they refuse to think the unthinkable - that what is meant never to happen does indeed take place. As Equitable policy holders are finding out, there are very few things in life that are guaranteed, but one is that the unexpected will always happen. Some life companies which sold these guarantees, notably Scottish Widows, had the foresight to forward hedge any potential liability. The fact that Equitable did not is doubly indicative of management failure.

Part Two - dealing with the consequences. Equitable Life, unlike most others caught up in the debacle, has chosen not to meet the liabilities arising from its annuity guarantees. When they were written, it seemed improbable to the point of impossibility that rates of return would fall as low as they are today. But even so, to now turn round and attempt, in effect, to rip up a legally binding guarantee, bought in good faith, seems dishonest, especially from an organisation that prides itself on a whiter than white reputation.

Equitable's legal case, now being argued out in the High Court, is a complex and technical one, but the moral defence is relatively simple. There is a reason why rates of return are much lower than they were. The fall in return has for most people been matched by an equally stunning climb in investment performance. What investors have lost on the swings, they've gained on the roundabouts.

The rate of income return may have fallen steeply, but there is a much bigger capital pot to earn it on. In these circumstances it is very difficult to argue that people's "reasonable expectations" - the ill defined jargon phrase used by life companies in such cases - have not been met.

Moreover, Equitable is a mutually owned company. There are no shareholders to pay for this liability, so that to the extent that it is met, it merely reduces the amount of money available to other policy holders. It therefore proposes to cut the final discretionary bonus on such policies, with the effect that all policies get the same, whether or not they are guaranteed.

So clear is the management about its right to do this, that if it loses the High Court case, it proposes to find another way of achieving the same outcome, always assuming the judge leaves room for such an approach.

It is hard to understand how Equitable Life could ever have entered into these unhedged guarantees. By the same token, however, it cannot be right that other policy holders are made to pay for them. Equitable Life hints darkly that if it does take the full pounds 1.5bn hit, it would be so financially weakened that it may have to demutualise and sell up. This would be a shame, but it may be that this "with profits" method of saving is past its sell by date anyway.

The with profits, pooled fund method was established in an altogether different age when less than transparent dividing up by trusted managers on a partly discretionary basis of investment gains was thought a perfectly reasonable way of operating. As this High Court case shows, it is progressively open to challenge by today's better informed and more individualistic savers.