Should Equitable investors wait for compensation?

While the Parliamentary ombudsman’s conclusion that the government was significantly to blame for the collapse of Equitable Life and that it should pay compensation to over a million policyholders who lost money in the debacle is welcome news for policyholders, there could be a very long wait for compensation. 

Tom McPhail of IFA Hargreaves Lansdown wonders whether policyholders would not do better to take the hit of a 5% penalty now, possibly forego compensation and reinvest at what could be nearly the bottom of the market.

Ann Abraham, the Parliamentary ombudsman, recommended that the government set up a compensation fund in six months time and allow two years in which to determine the level of redress owed to policyholders. But if you wait for compensation you could miss the opportunity to recoup losses by switching into alternative investments.

‘Even if the government does decide to pay compensation, it will take its time – no decision even in principle before the autumn – and any payments will be fiendishly complicated to calculate,’ warns McPhail.

He points out that many investors in Equitable have still done better than those in other with-profits funds. Determining which investors have experienced losses that are directly attributable to regulatory failure and calculating a suitable level of redress will take a very long time.

And government institutions have a long history of going slow. For example, the Financial Assistance Scheme, set up to compensate those who lost all or most of their pensions when their company got into difficulties, is only now, several years down the line, starting to make meaningful payments. With the economy looking like moving into recession, government is not going to be in any hurry to pay out what could be several billion pounds to Equitable policyholders.

There is the possibility that a transfer out of the Equitable with-profits fund now would exclude an investor from any future compensation payment. But this has to be balanced against the very real risk that investors could suffer years of further poor investment performance to no real benefit – either because they do not eventually qualify to receive compensation, or because they find that they could have received the compensation even if they had transferred out earlier.

If the government does come up with some compensation it is going to be tough about the amount it pays out. While there is no doubt that the government failed properly to regulate Equitable Life – in particular its decision not to stop the company from taking on new business in 1998 when Equitable’s problems were widely acknowledged – there is still dispute over the Court case.

Some believe, quite legitimately, that Equitable did not deserve to lose the case because bonuses are discretionary. Had it won, it would have been able to reduce terminal bonuses to those with guaranteed annuities to cut its costs and arguably could have traded out of its difficulties.

‘Equitable investors need to take a realistic view of the possible timing and amount of any future compensation payment for their own personal circumstances,’ says McPhail. ‘This needs to be balanced against the costs and benefits of reinvesting their remaining funds elsewhere in order to achieve the best possible growth on their investments.’

The biggest single reason for getting out now is that the Equitable Fund is only 1% invested in equities. A policyholder exiting the £6.8 billion fund would take an immediate 5% hit as a penalty, possibly forego compensation (although that is by no means certain), but would be investing in shares at a low point with every chance of substantial capital gains. 

The effective return on the fund for 2007 was just 1.9% and the fund is 77% invested in fixed interest securities. The fund paid no guaranteed bonus in 2007 and 4% to 5% on life and pension policies.