I remember, back in the olden days (2000?) when I was a maths student at university, one of my friends was filling in a job application for an actuarial trainee post. One of the questions asked about the applicants to comment on something relating to actuaries in the then current affairs. When she was asking around for inspiration, I suggested that she write about the Equitable Life crisis. Many years later, and the fall-out is still rumbling on.
For those that don’t know, Equitable Life was an insurance company whose main business was in providing insurance/investment policies – things that as far as I can tell, are a combination of insurance and investment and used to be one of the preferred vehicles for saving and investing for retirement.
During the 1980s it offered Guaranteed Annuity Rate (GAR) policies, in return for regular investments each month policy holders were promised a guaranteed minimum return once the policy matured, and many people took these out planning to use them to supplement employer and state pensions in retirement. Equitable Life wasn’t the only company that offered such policies, many of the other large British insurers also did. . Projected returns were generally higher than are realistic today for all insurers, and Equitable Life’s were slightly higher again.
Returns on investments in the 1990s were not as great as in the 1980s, and the rates that the GAR policies were offering became unsustainable for Equitable Life. The management of the company assumed that it did not have to actually pay out the guarantee if there weren’t enough funds to do so, and sought a legal ruling to that effect in 1999. Unfortunately for Equitable Life, the High Court disagreed, effectively stating that a *guaranteed rate* meant that the rate, was guaranteed regardless of the insurers ability to make its total commitments.
The cost of losing the case was around £1.5bn, and the company has been effectively unravelling ever since. It closed to new business in 2000 and has gradually sold off most of its business to various other insurance companies including Prudential, Canada Life and Liverpool Victoria. Not only have the sales been dragging on and on, but there have been inquiries into what went wrong and several cases for compensation for different groups of policy holders.
Whenever you are managing investment money which has to provide an income you have to balance taking money out to meet your liabilities with ensuring that you don’t deplete the pot and risk being unable to meet future payments (you don’t for example want your pension pot to run out). It turns out that since around 1990 Equitable Life had effectively been taking too much money out to pay people whose insurance policies reached payout and not retaining enough in reserves to meet the promises it was making. In addition there were failures by the regulators and the Government Actuarial Department (GAD) to adequately check what was going on.
There doesn’t appear to have been any deliberate fraud going on; Equitable Life overused actuarial techniques in fairly common practice to justify their overstatement of their worth. Those techniques were judged to have been dubious by the inquiry into the debacle, and it also stated that “It is clear that Equitable’s returns were not understood by GAD actuaries throughout the 1990s” which sounds like a completely stupid idea.
What lessons does this have for the man on the street?
Well, the first thing I’d say is that when you take out an insurance/investment policy you are reliant on the insurance company accurately predicting how much money you are likely to have in the policy. It usually isn’t all that clear where the underlying investments lie, and I think that is not a good thing at all. I prefer to stick to basic investment funds – I understand how they work, and the risk that I am taking on when I invest in them.
My checklist for avoiding being a victim of something similar:
- understand how your investments work
- don’t put all your eggs in one basket – may as well use multiple different financial institutions
- if returns are better than others, then make sure there’s a real reason for this
- the magic money cupboard
- overpaying the mortgage or investing for retirement part 1
- understanding of inflation rising?