Even the invincible can falter

Quite how one of the oldest and most respected mutual life assurance companies in the world turned into one of Britain's biggest financial scandals is bound to be argued over for many years - but that is precious little comfort to the one million-odd members of Equitable Life who are now facing losses.

Quite how one of the oldest and most respected mutual life assurance companies in the world turned into one of Britain's biggest financial scandals is bound to be argued over for many years - but that is precious little comfort to the one million-odd members of Equitable Life who are now facing losses.

The worst aspect of the case is how difficult it is to advise people what they should do. The court decision on Equitable's guaranteed annuities, followed by the collapse of the mutual's sales negotiations with the Prudential, has caught both regulators and analysts by surprise. On top of that, quite how the Equitable's beleaguered life fund will perform depends largelyon how many customers head for the door compared to how many stay. My own suspicion is that most with-profits policyholders would probably be better off staying, despite Equitable's decision to opt for a more conservative investment strategy, which will mean lower payouts for investors.

This is because of the "double whammy" facing leavers: first the Equitable has slapped a 10 per cent charge on with-profits policyholders who opt to leave. Second, any company you take your pension business to will impose its own raft of start-up charges. So, even a slower growth in your Equitable fund may be preferable.

This mirrors the endowment mortgage scandal in a number of ways. The Equitable only got into trouble over its guaranteed annuities in the first place because of a change in the economic climate. High interest rates and high growth rates in the stock markets in the 1970s and 1980s gave way to a low interest rate, low growth environment in the late 1990s and today. The guaranteed rates that Equitable promised to its investors looked perfectly reasonable in the 1980s but have become prohibitive to honour today. This collapse in stock market growth rates had the same effect on endowment mortgages, which looked like a good deal in the 1980s but which may now face shortfalls in the new low-interest-rate environment.

In another parallel, many endowment policy holders may be better off holding onto their present policy, however poorly it is performing, since selling a policy towards the end of its life means you miss out on its best years of growth.

One bitter irony of the Equitable case is that its emphasis on paying bigger bonuses than most other mutual assurers caused much of its present problems. Assurers usually build up a large cushion of "free assets" in their life fund to smooth the fluctuations in the stock markets which effect the value of their investments from year to year.

Equitable concentrated on keeping a low level of free assets, reckoning customers would prefer higher payouts to a large "cushion", and continued with this policy even when growth rates began to fall. Equitable's management had assumed they could make up for these slowing growth rates by interpreting their guaranteed annuity contracts in a certain way - by cutting their annuity rates.

I fully support the Law Lords who this year ruled that a guarantee is a guarantee, and the Equitable should not cut its annuity rates, even if the economic environment is now so different. And yes, that does mean that all the other members of the Equitable's life fund must accept poorer returns to meet these guarantees. But that is the fault of Equitable's management, which should never have sold these products with a "guarantee" tag in the first place. As Bertrand Russell said, the easiest way to make a fool of yourself is to try and predict the future, and Equitable's management, whose job it is to assess risk, must be judged foolish in the extreme.

The Financial Services Authority (FSA) should also take someof the responsibility for events. It's a shame it couldn't have bullied the other assurers into jointly launching a "lifeboat" for the Equitable, in the way that the Bank of England persuaded the banks in the 1970s to save their insolvent rivals.

On a brighter note, I am delighted to report that one of our contributors, Ginetta Vedrickas, was runner-up in the Housing Corporation's "Housing Journalist of the Year Award 2000" this week. The award is presented to the journalist who, in the opinion of the judges, has made the most significant contribution towards greater awareness of the role and importance of housing today.

There will be no "Your Money" sections over the Christmas period, so season's greetings to all our readers and have a happy and prosperous New Year.

* John Willcock is personal finance editor of The Independent

* j.willcock@independent.co.uk