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Not an Equitable Life
Rajeev Shah from Barnett Waddingham's Life insurance consultancy team in the London office examines the background to the Equitable situation and looks at the options for policyholders.
On 8 December 2000, Equitable Life closed itself to new business as it announced that Prudential had pulled out of sale talks. The Equitable had put itself up for sale on 26 July 2000 immediately after losing its controversial test case concerning its approach on guaranteed annuity options in the House of Lords. The Lords ruled that the Equitable is not allowed to differentiate, when setting terminal bonuses, between policies choosing to exercise the option and policies that do not.
As a contingency measure to protect its solvency the Equitable had taken out reinsurance against the cost of the guaranteed annuities. However, the reinsurance was dependent on the Equitable winning the court case on its approach on guaranteed annuities.
When the Equitable lost the case and put itself up for sale, it decided to retrospectively withhold bonuses on its continuing with-profits policies for the period 1st January to 31 July 2000 to pay for the cost of the guaranteed annuities and protect its solvency. This was worth about 5% of with-profits policy values on average. The intention was to make good these bonuses when it achieved a sale. The Equitable also announced that it would reduce the terminal bonus element attaching to the with-profit funds of Group Money Purchase and AVC schemes if these were transferred or switched to another provider.
As the Equitable had previously pursued a policy of paying most of its profits out to policyholders it had not built up a substantial "inherited estate" which could be used to pay for the cost of guaranteed annuities and, being a mutual it could not rely on shareholders to bail out the policyholders either. This meant that the costs of the guaranteed annuities could only be met by reducing the benefits for all with-profits policyholders. The Equitable therefore decided to sell itself and use the proceeds to pay for the cost of the guaranteed annuities and to make good the lost bonuses from this period.
Interest in purchasing the Equitable was shown by many companies but, one by one, they all pulled out due to much uncertainty regarding the true cost of these guaranteed annuities and, possibly, other factors. Therefore the Equitable decided to shut itself to new business and, to protect continuing policyholders, imposed a market value adjustment of 10% on all surrenders, transfers and switches from its with-profits fund. This replaced the previous adjustment of 20% of terminal bonuses which was in most cases lower. The market value adjustment will not apply to contractual events like maturity, retirement or death.
The Equitable also decided to sell whatever parts of itself that it could. Many of the original suitors would have been very interested in the Equitable's salesforce as they are very productive and have a high net worth client base. The fund management arm is also attractive. However, the price achieved for them will depend on the Equitable's ability to retain its staff until it completes a sale.
With the closure to new business, the Equitable remains solvent and is still able to meet contractual or guaranteed obligations to its policyholders as the lost bonuses for the period 1st January to 30 July 2000 have effectively been used to pay for the cost of the guaranteed annuities.
Policyholders invested in the with-profits fund cannot therefore expect to recoup these lost bonuses. Further, they can expect lower bonuses in the future as the proportion of equities and property held within the with-profits fund is expected to be reduced from two thirds to around a half in favour of fixed interest securities such as gilts and bonds which are expected to give lower investment returns in the long-term. This is to protect the Equitable's solvency in the future, as there is lower investment risk associated with fixed interest securities. Hence, the eventual payout for these policyholders is likely to be lower than expected.
Policyholders invested in unit-linked funds are less affected as their funds cannot be used to pay for the cost of the guaranteed annuities. However, the future investment performance of their unit-linked funds could be adversely affected by the morale of the established fund managers at the Equitable. If the Equitable manages to sell its fund management arm along with a management contract for these funds and retain its best managers until then, their investment performance should not deteriorate much.
Benefits payable under non-profit policies are unaffected, as long as the Equitable remains solvent, as they are guaranteed.
Further, for all guaranteed benefits regardless of the policy being with-profits, unit-linked or non-profit, there is additional protection afforded by the Policyholders' Protection Act. This ensures that at least 90% of the guaranteed benefits are covered by an industry wide compensation scheme if the event of a life assurance company going bust.
The directors and the regulators have come under considerable fire from policyholders and the media questioning their handling of the Equitable's problems. They have questioned why the Equitable did not previously reserve for the cost of these guaranteed annuities and why the regulator allowed the Equitable to continue trading when it has been reported to have known about its solvency problems for some time.
Until it lost the court case, the Equitable believed that it could reduce the terminal bonuses paid to maturing with-profits policies that opted for the guaranteed annuity rates and so the effective cost to the with-profits fund and hence the reserves was negligible.
The regulator was keen for the Equitable to be sold after the Lords decision as it was in the best interests of the policyholders. To enable a quick sale to be achieved, the regulator let the Equitable continue writing new business even after it lost the case in the House of Lords.
Several policyholders have got together and formed action groups to investigate whether other options are available to the Equitable. Some policyholders without the guaranteed annuity option believe that their interests were not properly put to the House of Lords by the Equitable and so they may still be able to challenge the Lords decision.
Other policyholders are considering suing the directors and the auditors of the Equitable for not properly reserving for the cost of the guaranteed annuities in the past and for not disclosing their potential impact on the with-profits fund.
The non-executive directors finally bowed to policyholder pressure and agreed to resign on 20 December 2000. Meanwhile the FSA, the industry regulator, has said it will review its regulation of the Equitable and hopes to report on it within the next few weeks.
Our general thoughts are set out below but individual circumstances do differ and individuals would be best advised to consult an independent financial adviser before taking precipitate action. Most of these thoughts apply to both individual policyholders as well as policyholders investing in Equitable products through their employer's group schemes. Danny Wilding's article discusses the services that Barnett Waddingham can provide for employers and trustees of group pension schemes affected by the Equitable situation.
- With-profits policyholders considering moving their funds elsewhere will need to judge whether the transfer penalty imposed by the Equitable and charges at their new provider will be outweighed by the reduction in expected future returns in the with-profits fund.
- Those policyholders who are investing in the with-profits fund through pension plans and are over the age of 50 may be able to avoid the transfer penalty on purchase of an annuity. However, this is not a simple decision as it can affect whether they may be able to continue to contribute to a pension.
- With-profits policyholders will also be best advised to consider switching their regular contributions to unit-linked funds or to another pension provider. However, policyholders who have invested through their employer's group schemes will need to take into account whether their employer will continue paying contributions into their policy if they switch to another pension provider and should consult their employers. Employers may already have made alternative arrangements for their pension schemes or may in the process of doing so.
- There is less urgency regarding investments in the unit-linked funds. These will not suffer the cost of the guaranteed annuities and there are no penalties on withdrawing from these funds. However, the future investment performance of these funds will depend on the ability of the Equitable to keep its fund managers motivated. Policyholders should keep the performance of these funds under review and may consider moving them to another provider.
- As the benefits under non-profit policies are not affected, policyholders would probably be better off continuing paying premiums into them. Surrender values may not be payable anyway for some types of these policies, for example, term assurance. Moving to another provider may also result in higher premiums due to increase in age and deterioration in health since the policy was originally taken out with the Equitable.
Rajeev Shah, January 2001.