FOOL'S EYE VIEW
Breaking Down Equitable's Settlement

By James Carlisle
September 21, 2001

Equitable Life's compromise proposals are landing on doormats around the Country and members finally have a chance to see what the Board and their advisers have been cooking up over the last few months. My first impression is that the cooking has been pretty good. The documents, though lengthy, are mostly presented clearly and in plain English. It's possible even to get the main gist of it, which is quite an achievement given the subject matter.

The bottom line of the proposals is for members to give up various rights of uncertain value, in exchange for an immediate and known uplift in the value of their policies. This exchange of uncertainty for certainty should help members to plan their lives. It should also enable the fund to adopt a more suitable long-term investment strategy, potentially increasing the pot for everyone.

Although the proposals talk of uplifts for everyone, it's really just a means of sharing out what's there. Since the pot is limited, whatever is added to people's policies now reduces the amount that can be added later. Anyway, with that in mind, we can look at the proposals and see how the uplifts for the two main classes of policyholder were calculated.

GARs

The holders of guaranteed annuities (GARs) are being asked to give up their rights to those guarantees. These have a value because the guaranteed rate is higher than the annuity rate you can now get in the open market, but the value is uncertain because no one can say how rates will change in future.

Equitable Life has made its best assessment of the total value of the guarantees on GAR policies and come up with £1.06b, which it says is worth 20.5% of their total policy values. From this is subtracted what the Board thinks is fair for the GARs to pay for their share of the cost of settling the claims of the non-GARs (which I'll come to in a moment). That amounts to £222m and leaves £838m (or 16.2% of policy values).

Finally comes the GARs' share of the £250m that Halifax have agreed to chip in if a compromise is reached before next March. That appears to be £67m (although I make it £62m on a strict pro rata basis) and takes the total uplift to £905m, or 17.5% of policy values.

It's important to point out, though that 17.5% is just the average uplift. The precise amount that GARs stand to get varies from 3.5% to 20.4% of policy value, depending on age and the precise terms of the policy (because these things affect the value of the guarantees).

Non-GARs

The non-GARs' proposed entitlements are more tricky. The legal advice seems to be unanimous that non-GARs have a potential claim for being mis-sold their policies (on account of not being told about the potential liability to GARs). The total value of these potential claims, if successful, is estimated at £850m.

It gets more complicated, though. Some individual claims have more chance of success than others, with the probability of success thought to range from 20% to 70%. In addition, because any compensation would be paid from the with-profits fund itself and non-GARs themselves make up for around 75% of the fund, then there is the prospect of them paying up to 75% of their own compensation themselves.

In terms of how much of their compensation they should pay themselves, it seems that all the lawyers were able to agree on was that it is unclear. Giving it their best shot, they came up with the non-GARs paying anywhere from none to 75% of their own compensation (somewhere between 25% and 65% is thought most likely). This, by the way, is why there is uncertainty over the GARs' share of the non-GARs' compensation.

Having accounted for both these effects, the Board reckons that £220m is a fair and reasonable estimate of the total value to the non-GARs of their potential mis-selling claims. That amounts to 1.4% of total non-GAR policy values. On to this is added their £183m share of the injection from Halifax. That increases the non-GAR uplift to £403m, or 2.5% of policy values.

Settling Out of Court

Although it's possible to get the gist of what the compromise proposal is saying about members' rights, it's still pretty much impossible for the typical member to put a value on them. How many members can really assess the chances that a mis-selling claim might have in court? How many members can assess the future cost to the Society of providing the guaranteed annuities? How many can do both? Treves and Co are only able to come up with estimates themselves through the teamwork of a vast array of lawyers, actuaries, accountants.

Voting against the compromise would essentially be to say "I understand my rights and can value them better than Treves, the Board and all the QCs and actuaries". The Motley Fool is the first to say that individuals are capable of understanding and taking charge of their own finances, but there are limits.

More: Equitable Life discussion board