Fool's Eye View

[ December 8, 2000 ]

Equitable Life -- 238 Years and Out

By Nigel Roberts

Chippenham, Wiltshire -- After 238 years, the world's oldest mutually owned insurance company has finally had to accept the inevitable and begun the process of winding itself up. The decision was brought about by the announcement released by the Prudential (LSE: PRU) that "it has ceased discussions with The Equitable." The Pru had concluded that it was not in the interests of either its shareholders or policyholders to proceed with a transaction.

So why would the fact that a takeover was not now going to happen prompt the management of Equitable Life to decide that enough was enough and they should start the process of closing the business down?

The decision has been taken because the House of Lords ruled in July that the company must honour the annuity guarantees it made on about 90,000 pensions in the 1970s and 1980s. Policyholders took Equitable to court after it refused to pay bonuses on these guaranteed annuities. The company had argued that a sharp fall in interest rates would disadvantage other policyholders, as paying out would mean that they would have to take money away from other with-profits policyholders. They would have to rob Peter to pay Paul, as Rob Davies (TMFEssex and Fool media personality) put it on Radio 5 Live today.

In order to avoid this, Equitable was trying to sell itself, allowing a massive injection of cash to cover the shortfall. Equitable have estimated that the cost of meeting the guaranteed annuities was about £1.5 billion, but it seems that the companies that have been interested in buying the business have concluded that the costs could be very much higher than this, possibly as high as £5 billion.

Equitable has now announced that it will take on no more new business, become a closed fund and run itself down over the next 30 years as its 650,000 policies mature. The company will continue to take premiums from existing policyholders and pay out money owed to them, but bonuses to policyholders will be lower in the future than thay have been in the past.

Equitable has about £30 billion of assets, which is currently a mixture of equities and fixed-interest stocks. According to the FSA the Equitable "will now need to review its investment strategy and, as is normal in a closed fund, this is likely to lead to a progressive move away from equities to lower risk investments over time." The aim of this is to ensure that it meets its current commitments but will cut the fund's growth and so reduce bonuses.

The question, though, is what with-profits policyholders should now do. Unfortunately this is far from clear. Each year a with-profits fund has a bonus added to it; once the bonus has been allocated it cannot be taken away. However, the biggest bonus is added at the end of the term when the policy matures. The move away from equities as an investment strategy will mean that future growth will all but disappear; so where will the future bonuses come from?

Policyholders have some choices to make, and it is currently pretty unclear exactly what is the correct thing to do. If you are a with-profits policyholder, there appear to be three things that you could consider:

1. Do nothing.
2. Stop any future contributions.
3. Move your funds elsewhere.

Clearly adopting option 1 is only sensible for the very short term. You should not bury your head in the sand and hope that this goes away. It's your money and you should think carefully about what you do with it. If you adopt option 3, Equitable Life will reduce surrender values by 10% as a way of penalising you and to encourage you not to move. If too large a number of policyholders choose option 2 or 3, it could cause difficulty for Equitable Life in the future.

Finally, while there do not appear to be any potential bidders hiding on the sidelines, it is not impossible that someone will come out of the woodwork and make an offer to take on the business and the liabilities. The Equitable Life brand has now been very badly damaged, but I am sure that it does have some value. But don't expect anyone to be willing to pay much for this now. The question is: do the business and the brand have enough value to warrant the purchaser taking on the black hole of the potential liabilities caused by the guaranteed annuity problem? And, even more important for a potential purchaser, can the size of this black hole actually be quantified?

Equitable has issued two telephone numbers for policyholders: 0870 900 8020 and 0870 600 2272.

Where Next?

Read the text of the Equitable Life statement on their website
A history of the Equitable Life
How to value a life company
Discuss the options on the Equitable Life discussion board