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Monday, 18 November, 2002, 16:19 GMT
Q&A: What if Equitable closes down?
Q and A
Struggling mutual society Equitable Life on Friday revealed that customers receiving pensions could see their income cut by up to 20%.

Now, fears are mounting that the Equitable will be wound-up before it becomes insolvent.

The BBC's personal finance reporter, Andrew Verity, surveys the crisis, and scenarios investors face.

What dilemma do Equitable's policyholders face?

Equitable Life policyholders face a difficult dilemma following the recent warnings about its financial state as to whether to withdraw their money, or to wait to see what happens.

Policyholders withdrawing their money currently face a 20% exit penalty for leaving.

So far, that has encouraged many to hang on in the hope that a stock market recovery would rescue of the stricken life insurer.

Many have drawn comfort from the existence of the Financial Services Compensation scheme.

The scheme would ensure policyholders received 90& of what they were owed if the Equitable became insolvent.

Might Equitable break the solvency rules? Is that different to real insolvency?

Until now, Equitable itself has stopped short of a warning of real insolvency.

Instead, it has warned that it may break the regulator's solvency rules.

Equitable may break those rules without becoming fully insolvent - that is, unable to pay what it has guaranteed to its customers.

The rules require Equitable to hold a "required minimum margin" - a safety cushion between the value of its investments (assets) and the payouts it has guaranteed to policyholders (liabilities).

For every 100 it has guaranteed to pay, a life insurer must typically have at least 104 in its coffers - a required minimum margin of 4%.

If it had less than 103 it would be breaking the regulator's rules.

But it would still have just enough assets to cover its liabilities and so would remain economically solvent.

If it only had 99 in its coffers for every 100 of liabilities it would be economically insolvent.

What happens if Equitable does become fully insolvent?

There is huge uncertainty over this because it would be unprecedented.

Only one life insurer has gone bust in the last 10 years - Oak Life, in 1993.

It was so small and its products so much simpler than Equitable's that it is a poor reflection of what might happen in the Equitable case.

Wouldn't I be guaranteed to get 90% of my money from the Financial Services Compensation Scheme?

No. Existing compensation arrangements do cover 100% of the first 2,000 of a claim and 90% of the rest.

Contrary to some reports, there is no 48,000 upper limit on life insurance because it is classed as an insurance contract.

Would it be 90% of everything in my policy?

No. Only of the guaranteed parts of it.

Unfortunately life insurers can repeatedly cut the value of your policy without affecting their solvency - so long as they do not eat into the guaranteed amounts.

The guaranteed parts are the contributions you have made to the policy plus the annual bonuses.

They do not include the terminal bonuses, which would simply disappear if the life insurer went bust.

But it would be 90% of those guaranteed bits?

Not necessarily.

If Equitable or any other life insurer went into administration, an independent actuary would be asked to advise the administrator on the amounts guaranteed to policyholders.

If, for example, the actuary thought the group had been too generous in the annual bonuses it had allocated to policyholders, the administrator might reduce those amounts.

So it could be 90% of a lower figure.

Could I be sure of getting even that money?

Not absolutely.

If Equitable did become economically insolvent regulators would first try to transfer policies to another insurer or issue substitute policies.

If that proved impossible and the group went into administration, the administrator would first charge a fee (perhaps up to 100m, according to Equitable's directors) then pass out whatever was left in the fund to policyholders.

The Financial Services Compensation Scheme (http://www.fscs.org.uk/faq/) would then try to make up the difference between what was left in Equitable's funds and the 90% compensation figure.

Could the Financial Services Compensation Scheme afford to bail policyholders out?

A firm of Equitable's size going into administration would be unprecedented - at least since compensation arrangements were set up the early 1970s.

The FSCS would have to issue a levy on other life insurers - most of whom are in their worst financial state for years - perhaps running into 100s of millions, or even billions, of pounds.

If many policyholders withdraw their money all at once, will that push Equitable into insolvency?

No.

If Equitable has done its sums right, the exit penalty will ensure that no policyholder walks away with more than their fair share of the assets.

So, in theory at least, those who remain should be no worse off because others have left.

However, they will retain responsibility for other imponderables such as compensation for misselling.

That could work in their favour if Equitable has overestimated its compensation bill, but against them if that bill grows.

What is Equitable's position on going into liquidation?

Equitable has said there are "no advantages and many serious disadvantages to the society and its scheme policyholders by liquidating the society.

"In particular, it is likely that all non-guaranteed bonuses would be lost, benefits could be scaled back still further, competing legal claims would be likely to delay payments for years and annuity payments would be suspended."

Consequently, Equitable has been striving to avoid liquidating the society.

See also:

18 Nov 02 | Business
15 Nov 02 | Business
29 Oct 02 | Business
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