The Penrose Report into the collapse of Equitable Life – D2 Digest

The important finding is that Equitable went bust because, fundamentally, it had always distributed more in bonuses than was prudent. This was actually always a selling point for Equitable�s sales force; that they paid policyholders more and held less �surplus� capital. Helas. Life assurance is actually a very simple business (nothing beyond high school maths) What makes it complicated is trying to do it with too little capital, as you have to decide two imponderables:

a) what is an acceptable risk of ruin
b) what risk of ruin you are actually running

Estimating the first is merely intractable; estimating the second is a metaphysical impossibility, unless you are prepared to extend frequentist statistics into the realm of human actions. US life assurers don�t run these risks; they are generally fully funded, which is why US actuaries have two years� less training than UK � we demand higher returns from our life assurance and so we occasionally get these blow-ups. Lesson learned for investors; don�t invest your money with people who boast about their low solvency margin. Lesson not learned for economists; �acceptable risks�, are defined as those risks acceptable to people who have not lost money.

The genuine culpability, though, was the regulators and company a) assuming without advice that Equitable would win its case in the House of Lords and b) remaining open to new business after it had lost. Taking new investors� money to pay off old and hoping that investment returns improve, is exactly what Charles Ponzi did.

DD sez: It isn�t the government�s fault that Equitable collapsed. The people who invested post 1998 should get compensated the full amount by the FSA; for the rest, it�s a hell of a shame but if caveat emptor is to mean anything it has to mean this. This will presumably dent confidence in long term savings for private pension provision, but that�s all to the good; it can�t be a good idea for people to have �confidence� in a fundamentally unstable product


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