The inequitability of Equitable Life


As is well known, the state pension, paltry and inadequate though it is, is a target for the stingy welfare benefit slashers who are forever seeking to enhance the profits of the billionaires at the expense of the poor. At one time they were slightly restrained in their greed by the fear that the poor would rise in revolution as they did in Russia, China and other places. But since the restoration of capitalism in the former USSR, capitalism is riding triumphant in the belief it no longer has anything to fear from the proletariat. It seems, therefore, very likely that Labour and Tory governments over the next few years will be ‘phasing out’ the state pension for the elderly, leaving people ‘free’ to make their own arrangements for support in their old age. This ‘freedom’ would be exercised with private insurance companies. Although the government might, as it currently does in the case of occupational pensions, waive tax liability on contributions made by employers and employees to these private pension schemes, that benefit would be more than offset by the fact that shareholders and managers of the insurance companies would be taking their cut in the profit earned on investing the pensioners’ savings.

Worse, however, is the fact that there can be no guarantee that by the time a person who has contributed all his or her life to a pension scheme comes to cash in their entitlement, it may turn out that the company’s funds have been diminished considerable as a result of the vagaries of the anarchic state of the capitalist economy. Events of the past few weeks have graphically demonstrated that even the ‘provident’ who have from their teens been setting aide a percentage of their pocket money towards providing for their pensions can find themselves in old age in much reduced circumstances.

The Equitable Life scandal

On 8 December 2000, Equitable Life – a company 238 years old, no less, which until this year

“was as safe as houses”

(

Guardian

, 9 December 2000, ‘Solvency queries Equitable didn’t raise’) – was forced to close its doors to new business because of its fundamental financial instability. This is a disaster which

“will ultimately impoverish more people, and to a greater extent, than the Lloyds of London losses a decade ago which largely hit those already wealthy”

(‘Equitable Life shock waves reverberate across industry’,

Scotland on Sunday

, 17 December 2000). Equitable Life is not insolvent, technically, but no fewer than 1.3 million policy holders and pensioners will see a major reduction in the returns they receive from their investment. For instance, any person who had an Equitable Life policy as part of an endowment mortgage scheme, would be likely to find that at the end of the mortgage period (usually timed to coincide with retirement), the money payable on the associated life policy turns out to be insufficient to repay the loan contracted on the purchase of the house, as a result of which repayments of the balance by the mortgagor have to be negotiated, just at a time when most mortgagors will be in receipt of a much reduced income.

The pensioners likely to be affected by a reduction in the returns on their pensions are many and various. According to Amanda Harvey in

The Scotsman

of 16 December, ‘Equitable policies in disarray’,

“…75% of the top 350 companies in the UK currently run an Equitable Life AVC

[Assisted Voluntary Contribution]

scheme.”

“Those potentially affected include MPs, employees of the BBC, the National Health Service, Sainsbury’s and other blue chip firms, who are still struggling to understand how a firm that was viewed as a model for the industry could find itself in this situation”

(

Independent

, 20 December 2000 ‘Ministers announce inquiry into scandal at Equitable Life’). Moreover,

“Equitable provided pension plans for the Personal Investment Authority, the Securities and Futures Authority and the Securities and Investment Board – which are all becoming part of the Financial Services Authority

” (

Observer,

21 December 2000, ‘Messy affair’). This is particularly ironic in view of the fact that the Financial Services Authority, as we will see further below, proved signally useless in drawing the timely attention of the public to Equitable’s problems, thus sharing responsibility for the losses that have befallen those investing in Equitable policies over the last two or three years.

Part of the reason that so many people are affected is the encouragement that has been given to people such as teachers and policemen to opt out of employer pension schemes in order to join instead these private schemes. In the public services, the representatives of private insurance companies were invited into workplaces by management to encourage employees to choose to go private, with the promise of higher returns for the future. Those, however, who plumped for the ultra-respectable Equitable Life, will undoubtedly be worse off.

What happened?

The reason Equitable Life failed is to do with annuity policies that it sold in the late 1950s to the 1980s, which guaranteed 11%-15% returns on investment. In those days of 20% per annum inflation, a guaranteed return of 11% would not seem all that much of a bargain, and most life insurance companies had to offer guaranteed returns of this order if they wanted to get any business. Equitable Life perhaps exposed itself more heavily than others in that it offered this guaranteed 11%-15% return not just on the money the policy holder was required to invest under the terms of the policy, but also in all and any extra sums he or she cared to invest at any future time. So any person holding such a policy today (there are about 90,000 of them) can invest more money whenever s/he wants and get an 11%-15% per annum return, a rate which compares extremely favourably with interest rates currently available from banks and building societies, or even stock-exchange investment.

The obligation to pay all these policy holders 11%-15% on all the money they choose to invest with Equitable, when Equitable itself would be doing well nowadays if it managed to earn 6%-7% on capital investment, especially in view of the current stock market slump, has left Equitable with

“a black hole, nearly five times the size of the one that brought down Barings, the investment bank, in 1995″

(

Independent

, 15 December 2000, ‘Equitable members target FSA for damages’). The effect of this ‘black hole’ is that it sucks in profits that have actually been earned by investing the money of the vast majority of policy holders who have no minimum return guarantee, leaving these policy holders considerably out of pocket. Furthermore, because current guaranteed-return policy holders can continue to pump in new investment and demand the guaranteed return, Equitable’s liabilities are “

not just unhedged; they are also unlimited”

(

ibid

.).

Whose fault?

Who is to blame for this state of affairs? The obvious answer would appear to be the company’s management for issuing guaranteed-return policies in the first place. But it must be remembered that at the time these policies were issued, nobody dreamed that inflation would come down to the extent that it has, any more than they dreamed that house prices would ever fall – as they did in the 1990s – or any more than they foresaw the dramatic collapse in 1997 of the Far Eastern ‘tiger’ economies. John Willcock in the

Independent

of 16 December (‘Equitable’s management should never have sold products with a guarantee tag’) places the blame for what has happened on 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.”

Well, every fool can be wise after the event! Actually, if the Equitable management is to be blamed, it is not for trying to predict the future, but for NOT trying to do so and to assume things would carry on as they had done in the past. This assumption at the time was so universally made that its truth could hardly be questioned. Any management who, on the basis of a Marxist training and a longer historical perspective, had announced that, bearing in mind the conditions of intensifying economic crisis prevalent in the world, prices – and thus inflation – were bound sooner or later to fall would have been considered hopelessly over-cautious, if not an insane prophet of doom, a Cassandra, with absolutely no useful role to play in the running of a vibrant modern business.

Let it be said in passing that Bertrand Russell, as a leading proponent of the reactionary idealist philosophy of positivism, was aiming his barb precisely at those who on the basis of scientific principles do try to predict the future in human affairs in the teeth of popular prejudice. According to positivism there can be no science in human affairs because any principles proposed cannot, by the very nature of the subject matter, be subjected to verification processes of the kind a natural scientist might use for proving theories concerning natural phenomena. This is nothing more than making a virtue of learning nothing from history – and history will judge, and has judged, who is the fool in these matters!

Mobilising the reserves

The question then arises as to why Equitable Life was affected more adversely than other insurance companies who sold guaranteed-return annuity policies. The reason is that, unlike other companies, Equitable Life prided itself in distributing nearly all its profits to policy holders, thus maintaining high bonuses. As

The Times

of 19 December (‘The Equitable Life crisis’) reports:

“The company has always claimed to be the one ‘true mutual’ which paid out almost all of what it earned from investing its clients’ money. It even made a virtue of having low reserves, while other insurers kept money back from their policy holders to buttress them should they face financial problems.”

This policy, needless to say, was very popular and made Equitable policies very attractive to investors. Equitable’s boast

“that it was able to pay its higher returns because it did not build up a surplus”

was precisely what made it so popular when other companies were heavily criticised for accumulating vast ‘orphan’ assets, which were not distributed to anybody and which nobody had any right to claim. In fact,

“If it had built up a big surplus, Equitable might then have been forced to shed its mutuality because its assets would have looked more attractive to a bidder”

(

Guardian

, 15 December, ‘A pretty inequitable life’). In other words, any company with such a surplus is going to face a campaign to bribe shareholders – i.e., its policy or account holders – to vote to put an end to mutuality (i.e., the fact of its customers being its only shareholders) by the prospect of a windfall in the form of a payout of part of the accumulated surplus, while outside vultures swoop in to take control of the bulk of the assets concerned.

In spite of these facts of capitalist life, all the financial commentators are saying, again with the benefit of 20-20 hindsight, that Equitable Life should have put more in reserves to meet potential liability. For instance Melanie Bien in the I

ndependent on Sunday

of 17 December (‘Saving and borrowing: FSA feels the Equitable heat’) writes:

“While other life companies held back some of their profits to create billions of pounds of reserves, the Equitable was allowed to operate under different rules, boasting that every penny went to policy holders in bonuses”.

Obviously these financial commentators are not great mathematical geniuses – for putting more in reserves could only be done from funds that were actually, in the event, distributed to policy holders, including, overwhelmingly, the unguaranteed policy holders. This ‘remedy’ would just as much have been at the expense of the millions of unguaranteed policy and annuity holders as what has happened now. Had ‘reserves’ been built up, the loss would have been spread more thinly over time, and might even have passed unnoticed, but the unguaranteed policy holders would have paid the price just the same.

In fact what the management had been hoping to do was to remedy the injustice of non-guaranteed policy holders having effectively to subsidise guaranteed ones by withholding annual bonuses from guaranteed policy holders who opted to receive the guaranteed minimum on their policies rather than the market rate. Since the distribution of bonuses to policy holders is at the discretion of management, this scheme should have considerably rectified matters, and all the best legal advice, plus the overwhelming weight of opinion in financial circles, deemed this rescue plan unassailable. Unfortunately, however, it was a scheme which discriminated against guaranteed policy holders, rendering their guarantees if not worthless then at least a great deal less valuable. In July 2000 the House of Lords ruled that it was a breach of an implied term of Equitable Life’s contract with the guaranteed policy holders to give them a ‘right’ and then penalise them for exercising it. It was a strange decision from a practical point of view, as it gave the policy holders a right not only to their guaranteed minimum but also to bonuses on top of that. In addition it spelt death to Equitable Life.

In delivering its decision the House of Lords not only destroyed Equitable Life, it at the same time handed to those of us who oppose forcing people to make their own pension provisions, a very convincing weapon with which to fight our case, for, as the

Guardian

of 16 December rightly pointed out,

“the Equitable episode will have irrevocably crushed confidence in personal pensions, already tainted by mis-selling”

(‘Replacing safety with anxiety’).

Other scapegoats

Frantic to blame anyone and anything other than the true culprit – the capitalist system with its attendant anarchy – for the Equitable Life shambles, the financial press is turning its attention to other possible scapegoats, in particular to the actuaries’ profession, Equitable’s auditors and the Financial Services Authority, the government body which is supposed to act as a watchdog over the financial services industry and ensure that no frauds or improprieties are committed.

The

Financial Times

of 16 December (‘When with-profits wizardry fails’) put the blames on the secretiveness of the actuaries who make the calculations that lead to the decisions of management as to how much profit to distribute and how much to retain for the purpose of protecting policy holders from the ups-and-downs of the stock market and secure them a

“smooth”

rate of return. Says the

Financial Times

:

The promise of a ‘smoothed’ investment return … explains why with profits investment has been so popular. What few policy holders realise, however, is that the appointed actuaries enjoy positions of untrammelled power, with almost no accountability. This almost certainly contributed to the fall from grace of Equitable Life

[evidence offered in support of this assertion: none].

The power of appointed actuaries rests on two principles. First, these highly-trained number-crunchers … have complete discretion over the way in which financial reserves are built up and paid out.

Second, they are under no obligation to explain what they are doing. You have no right to know how the return on your policy has been calculated.”

The logic of this outburst parallels that of the Russian saying ‘There is a tree in my garden and my uncle lives in Kiev’. While no doubt there may be a case for giving policy holders more information about how their bonuses are calculated, it is very hard to see any link at all between this and the fact that Equitable Life made marketing decisions, as did other life insurance companies, that assumed high inflation rates were to be a permanent feature. Equitable Life was entirely up front, as we have seen, about the most important factor, namely, its policy of maintaining minimum reserves. When even many of the employees of the

Financial Times

, as well as government employees attached to various sections of the financial-services regulator, are prepared to put their cash into the company DESPITE its declared (nay, trumpeted) policy of maintaining low reserves, how would it be likely to help anybody to require its actuaries to publish pages and pages of explanations of their abstruse calculations?

A more pertinent question may be why Equitable’s auditors, who were presumably informed of the legal action commenced by the guaranteed-return policy holders in 1995, failed until 1999 to require the company to disclose in its annual accounts its potential black hole. Even if they had, however, the fundamental problem would not have been cured. Assuming the financial press and professional investment advisers had paid heed to the auditors’ warnings, it would merely have meant that after 1995 the number of new unguaranteed policy holders would have declined. With fewer unguaranteed policy holders to bear the weight of servicing the guaranteed policy holders, the losses of each unguaranteed policy holder would have been greater still. Nevertheless, it is quite possible that people who purchased unguaranteed policies after 1995 and before the black hole warning was issued will be able successfully to sue the company’s auditors for negligence.

The Treasury and the Financial Services Authority, like the auditors, also failed to draw public attention to the problem of Equitable’s potential black hole, even though they were certainly aware of the problem in late 1998:

“The Treasury knew more than two years ago about financial difficulties at the world’s oldest mutual life insurer, Equitable Life, according to a leaked government memorandum obtained by the ‘Guardian’.

“In a damning assessment of Equitable’s financial health, the Treasury told the City’s watchdog, the Financial Services Authority, in November 1998 that it had ‘serious questions about the company’s solvency’, adding that the information obtained from the company was ‘unconvincing'” (‘Secret warning on Equitable, Guardian, 19 December 2000).

It seems the authorities were able to persuade Equitable to insure against actual insolvency, but again this did not touch the fundamental problem of unguaranteed policy holders subsidising guaranteed ones. The failure to issue a public warning is possibly justifiable on the basis that the best legal opinion at the time was that the guaranteed policyholders’ court case would fail – as indeed it HAD failed in the lower courts – and it was premature to cause a panic over a black hole which would probably never happen. Nevertheless, it is the watch word of all those who promote the cause of private pension schemes that every individual should have a ‘choice’, and the concept of ‘choice’ requires that prospective investors be given all information relevant to the assessment of risk. The possibility, even if it did not seem high, of Equitable losing the court case should have been costed out and potential investors should have been warned (a) by the company itself, (b) by its auditors, and (c) by the government and its watchdogs who were certainly aware of the problem. As has been stated above, this would not have made the problem – whose cause is the anarchy of the capitalist system – go away, but it might have enabled newer investors to avoid the trap.

Government rescue

Because of the anarchy of capitalist production, ALL investment carries at least some degree of risk. Fundamentally at fault in driving millions of teachers, doctors, nurses, policemen, financial services regulators and

Financial Times

journalists to ‘choose’ to place at risk the funds earmarked to support them in old age is the government which makes very little social provision for Britain’s elderly to enjoy a comfortable retirement. A miserly state pension and woefully inadequate support services for the elderly is all that is on offer. Since the bourgeoisie sees no advantage in squandering its profits on providing (through taxes on its income) a comfortable old age (or comfortable any other age) to a mass of proletarians, everybody is left to their own devices. The relatively well-off can purchase comfort in old age, but cannot avoid the risk of losing money that they invest for the purpose. Where do you put the money you save? Your bank could fail, your shares could become worthless, houses you buy for renting could attract bad tenants or suffer uninsurable damage – or the rental market could collapse. There is no hiding place away from capitalist anarchy. One can only hope to be lucky.

Nevertheless, in view of the failure of the FSA ‘watchdog’ to bark when it ought to have done so, pressure is growing on the government to compensate in some way the unguaranteed policyholders of Equitable Life. The government, needless to say, is resisting the demand that it should come to the rescue, on the ‘principle’ that it would only do so if Equitable Life were insolvent, which it is not. Policy holders, however, who include

“barristers, high court judges and senior executives of FTSE 100 companies, none of whom are used to taking anything lying down”

(Melanie Bien,

op.cit.

), will certainly leave no stone unturned in their quest to get the government to pay compensation. If they succeed, then proletarians such as school teachers and nurses, who have throughout their lives frequently been forced to take

“lying down”

all kinds of capitalist assaults on their quality of life, may also benefit.

Nevertheless, those who want to see an end to injustices such as those surrounding the Equitable Life fiasco will get nowhere in the long run unless they turn against the capitalist system itself rather than confining themselves to trying to ‘smooth’ the worst effects of its inherent anarchy.

In the meantime, insofar as it is possible to do so under capitalism, all that pertains to the welfare of ordinary people – housing, pensions, education, health care, etc. – should be provided to a decent level by the state and under no circumstances left to the vagaries of the capitalist market.