Equitable goes to court to protect its lower bonuses

ANNUITIES LOOK set to become the latest scandal to rock the insurance world after tumbling international interest rates have left some companies struggling to meet pledges made in more buoyant economic climates. With the sharp eye of a women, Jane Austen appreciated just how important these innocent little contracts could be. It was Mr Bennet's inadequate annuity which triggered so much scandal, mayhem and romance in his own household.

Some policyholders have accused their insurers of engaging in Wickhamish antics which would have made the cold-blooded Mr Darcy blush.

One company, Equitable Life, has turned to the High Court in an attempt to clear its name and seek legal ratification for its action. A victory could have far-reaching implications not just for pensions, but for a range of life assurance investment and endowment policies.

The problem has erupted because, in the Sixties, Seventies and Eighties, insurers sold many hundreds of thousands of pension contracts, which were designed for conversion into an annuity at a rate determined at the outset.

Pensions comprise two components which loosely mirror each other. During the first phase, policyholders save regularly through their working life to build up a nest egg to fund their retirement. At the second stage, this money is used to buy an annuity, through which the insurer undertakes to makes regular payments to the policyholder until he or she dies.

Insurers use two factors to decide how much to pay by way of an annuity. One is gilt yields, which reflect underlying interest rates, and the other is life expectancy. Getting the sums right is crucial to avoid making very costly mistakes.

The current row has exploded because the industry guessed wrong for a very long time on both accounts. Life expectancy grew faster than predicted, and no one anticipated that gilt yields would plummet, taking annuity rates with them from a peak of 15 per cent in 1991, to their current nadir of about 8 per cent.

Some companies face serious financial consequences if they are forced to meet every guarantee. The Government's pensions guru, the chief actuary, believes a colossal pounds 7bn bill could be winging its way in the industry's direction, dwarfing the fall-out from the high profile pensions mis-selling.

Equitable Life has found itself in the centre of the stage, not only because it sold a large chunk of the business, but because many of its 100,000 policyholders with guaranteed annuities are incensed at the carrot and stick approach it has taken to shore up its position.

As their contracts mature, policyholders are being notified that if they wish to take advantage of the guaranteed annuity rate, they can. But they must expect to earn a lower investment return as a result. This effectively neutralises the value of the guarantee by reducing the pension to the same level as one with no guarantee.

But such a move is far from illegal. Buried away in the small print, most contracts point out that the terminal bonus is paid at the discretion of the company's directors, and is not guaranteed. This is the principle which the company hopes will be ratified by the High Court.

Equitable customers, some of whom are facing losses of more than half a million pounds, are furious. Stuart Bayliss, of Annuity Direct, which is advising the policyholders' action group, led by retired surgeon David Abrams says: "We shall argue that it was never the intention of the directors of the company to pay lower terminal bonuses. But what really alarms us is the implications of any judgment strengthening the directors' powers to axe terminal bonuses at their discretion."

Equitable's position is further undermined by the fact that many of the other companies which sold these policies are currently meeting their obligations. However, they are eagerly awaiting the outcome of the High Court hearing due later this year.