The independent action group for current and ex Equitable Life policyholders, funded by contributions.

Equitable Members Action Group

Equitable Members Action Group Limited, a company limited by guarantee, number 5471535 registered in the UK

Documents: 17/09/2001 - Discussion paper on unitisation of the with-profits fund

17th September 2001 - EQUITABLE LIFE - UNITISATION


The basic business of an insurance company is to cover policyholders against risk. The risks, which may be covered, include death, injury, car crash, fire, flood and tempest. One of the ways such a business makes a profit is by investing the premiums it receives until some of the risks they have covered turn into claims e.g. the insured dies or his house burns down. Some Insurance companies also market their skills in this area by selling investment products such as those used to build a pension or a lump sum at a predetermined date or upon death. Equitable Life specialises in such products, particularly pensions.

All insurance company invest in much the same classes of assets, primarily shares quoted on the Stock Market (Equities), Government Bonds (Gilts), Loans and Mortgages (Fixed Interest) and Properties.


All insurance products include both an insurance of risk and an investment element, but the mix can vary widely. For example car insurance is mostly risk insurance. The policyholder is covered against the financial loss involved in crashing his car in the course of the next year. There is no investment element for him, but the company invests his premium and the fruits of that investment contribute to its profits.

At the other end of the scale a single premium bond is almost entirely an investment vehicle. The only risk covered is the early death of the policyholder, when the insurance company undertakes to repay at least the original premium.

Policies designed to build a fund for retirement are mostly investment vehicles, but they can include an insurance element, such as the cover against low annuity rates included in Equitable's GAR policies.

Annuity policies include both insurance and investment elements. The annuitant pays a single premium for the company to pay him an income for life. The risk he insures against is that of 'living longer than his money'. If he lives to 100 the company still keeps paying. The company has to invest that single premium so as to stretch the money out as long as possible.


The insurance element is always the responsibility of the insurance company, but the investment element (or risk) can be borne by either the company or the policyholder. Traditionally, the company has taken on the investment risk (whether investments go up or down) with the insurance risk (for example whether or not the house burns down). This still applies for most short-term (for example motor or fire) policies, but the trend in longer-term (life and pensions) policies is for the policyholder to bear the investment risk.

Of course the investment risk is a two-edged sword. If the underlying stocks in which the premiums are invested do well, then whoever bears that risk enjoys the benefit, if they do badly he loses.

Whole-of-life policies are a good example. They provide a lump sum on death and are commonly used to provide for dependants or to pay death duties. At one time, such cover was often written on the basis that the company took the investment risk. Whatever happened to investments, the policyholder's beneficiaries got a predetermined sum when he died. However, the advent of inflation meant that investments performed well in money terms and the insurance company profited. Conversely, the insured's beneficiaries got the predetermined sum on his death in currency that had been much devalued.

Then there is the matter of cost. If the insurance company is to be responsible for the investment risk then it will expect to include a charge for that cover in the premium. It the policyholder bears that risk, the premium is minimised.

Modern whole-of-life policies tend to be written on the basis that the policyholder bears the investment risk, the company just covering the possibility of his untimely death.


The unit-linked policy is the logical expression of the policyholder bearing the investment risk, rather than the insurance company. The company manages the underlying investments. Each premium paid buys units in the fund at the price ruling at that time. Unit values are recalculated and published daily. The calculation is straightforward - the price is simply the total value of fund assets divided by the number of units in issue. The policyholder can calculate the value of his fund at any time simply by multiplying the published price by the number of units he holds. He or his advisers can measure the performance of the fund by comparing the unit price history with benchmarks such as the FTSE -100 index.

The concept works in the same way as a unit trust. The insurance company issues units in exchange for premiums received and pays cash to cancel them. The fund can be made up of a mix of equities, gilts, fixed interest and properties at the insurance company's discretion, in which case it is called a 'managed fund'. Alternatively it can be subdivided into specialised funds investing only in one class of asset, for example equities or gilts. The policyholder (or his adviser) can construct his own personalised mix of sub-funds to suit his own requirements. Charges are transparent and written into the contract.

Unit linked insurance policies have been available in the UK for more than 30 years. The several pages of price information that appears daily in the financial press evidence the success of the concept. Almost every insurer, including Equitable Life until recently, offers such contracts.


The with-profit concept is a much older one developed to protect the policyholder from investment loss, while allowing him to share in some of the investment profit. The contract guarantees a future amount in consideration for the payment of the premium, so the insurance company takes on part of the investment risk. But the guaranteed future amount assumes very conservative investment returns. This means that risk is fairly small and the likelihood is that the insurance company will in practice make surplus profits. The contract further provides that the insurance company directors may apply any such surplus profits in awarding 'bonuses' in the form of value increases to with-profit policies.

The 'bonus' idea has become quite sophisticated. Bonuses can be either

  1. 'reversionary' in which case they are added to the amount guaranteed in the contract and cannot normally be taken back or

  2. 'terminal' in which case they are merely an indication of an amount which might be added to the contractual sums upon maturity.

To its credit (and current embarrassment), Equitable has for some years given policyholders a very clear indication of their prospective terminal bonuses. Many companies do not.

For a with-profit fund to work properly it is desirable for an insurance company to have assets over and above that which has been 'promised' to policyholders by way of guaranteed amounts and terminal bonuses. I will refer to this as the 'smoothing kitty'. In the good times (e.g. 1993-1998) the directors should declare bonuses of less than the profits so assets increase faster than the 'promises' and the kitty builds up. In bad times they can carry on declaring bonuses, knowing they have something in the kitty to cover them. Only in the event of a big or prolonged downturn do they have to start cutting bonuses. The result is that policyholders values should go upwards in a smoothed fashion insulated from the crude ups and downs of the market.

The success of this mechanism depends heavily upon the judgement of the directors. Setting bonuses is a very onerous task. If they are too 'generous' in good times, they may have to cut bonuses sharply when things turn down. If they are too 'conservative' they may be denying policyholders a proper return. It is one of those jobs that is easy with hindsight, but very difficult 'in real time'.


The Independent Actuary's report makes it clear that Equitable's 'smoothing kitty' was overdrawn at 31/12/00. The 'promises' exceeded the assets. This was partly because the old directors made no adequate provision for the GAR cost (about £2,000 million), but also because they could not have set much aside in the good years. The Independent Actuary did not say by how much the kitty was overdrawn.

'Black Monday' should have put the kitty back in the black by knocking £4,000 million off 'promises'. The directors are disinclined to tell us the current size of the kitty. However we are entitled to assume from their silence that there will not be much left after they have reduced the assets by the GAR cost and the non-GAR mis-selling cost. As Bacon & Woodrow pointed out, this does not augur well for the future. If our assets go down we will endure another value cut. If they go up the directors will retain a slice of the increase to rebuild the kitty.

Add this factor to the distrust engendered by the old board and a positive incentive to leave will still exist even if the compromise succeeds.

I believe the Board should include in the present compromise an undertaking to unitise the fund and to issue a combination of Equity, Gilt and Fixed Interest units to members, which they can subsequently rearrange to suit their individual circumstances. The members will be no worse off, in that with no smoothing kitty our values already go up and down with the market. We would be better off in that the fund would become transparent and we can do away with all that bonus jiggery-pokery.

Unitisation would address both members' lack of confidence and their inclination to leave.


The conversion of these to unit-linked may be difficult, but not impossible. Under the contract, the Society takes on the insurance risk (i.e. that the annuitant may live too long), but even in normal circumstances the annuitant takes on most of the investment risk. If the Society's bonuses do not match up to what was projected when he took out his policy, then his pension goes down. Without a smoothing kitty, bonuses will be almost directly linked to underlying investment performance, so pensions will be more erratic than expected.

Perhaps such policies could be converted to the closely related 'drawdown' ones. Here the individual's 'pot' is invested and the policyholder draws his pension from that pot. The older he is the bigger proportion he can draw. If the investments underlying that pot do well he can draw more, if they do badly he has to take less. These can certainly be run on a unit-linked basis. Those over 75, for whom drawdown is currently unavailable, may in any case be better off with a conventional annuity.


Unitising the with-profit fund will not be easy. All our contracts will have to be re-written. The obvious mechanism for doing this is S425 of the Companies Act, precisely the section under which the present compromise proposals are to be effected. It may be said that we should deal with the present compromise first. But will anyone want to go through all the palaver again in a year or two's time? Will there be anybody left? I believe an undertaking to unitise should be included in this compromise.

Equitable ran unit-linked business for many years. The conversion should be feasible.

EMAG 17/09/01