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Outline the cases of, the Equitable Life pension scandal and the mis selling of precipice bonds. Comment in both cases on how far these were the consequence of regulatory weeknesses - Essay Example

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Equitable life pension scandal and misspelling of precipice bonds Equitable life was a UK’s mutual insurer that was over two centuries old. The company had a loyal customer base, commanding over 1.5 million policy holders and with business valued…
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Outline the cases of, the Equitable Life pension scandal and the mis selling of precipice bonds. Comment in both cases on how far these were the consequence of regulatory weeknesses
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Extract of sample "Outline the cases of, the Equitable Life pension scandal and the mis selling of precipice bonds. Comment in both cases on how far these were the consequence of regulatory weeknesses"

Equitable life pension scandal and misspelling of precipice bonds Equitable life was a UK’s mutual insurer that was over two centuries old. The company had a loyal customer base, commanding over 1.5 million policy holders and with business valued over 20 billion pounds at its peak. However, management decisions dating back to 1950 was the company’s waterloo, and it eventually closed down to new business in 8 December 2000. At the time of closing down to new business, the policy holders lost up to 50% of the value of their pension fund and investment.

It was a case of a management decision gone wrong. Equitable life’s financial woes had their foundation in a decision by the company between 1950s and 1980s. The management undertook to sell annuity policies that guaranteed the investors a return of between 11% and 15%. At the time of undertaking this venture, the inflation rate was unusually high, at a rate of around 21% per annum. Insurance companies, therefore, had to offer incentives to get business. Therefore, the companies had to offer a guaranteed return rate so as to win new business.

Indeed, a return rate of 11% seemed a fitting bargain for the company at the time, but a turn of event conspired to turn the tide against the company. The company’s mistake was that unlike other companies’ it went an extra mile and guaranteed not only the investment made at that time, but also any future investment that the policy holders decided to make. Therefore, the policy holders could invest and get the guaranteed rate even when the rate seemed extremely uncommonly extravagant as compared to those offered by the banks and other financial institutions.

One of the events that contributed to equitable life’s problems was the slump in the stock market. Following this slump, the rate of interest went extremely down. Consequently, at the time, an investor could have been doing extremely well business wise, if they managed to get 6-7% out of the investment. For the company, however, it had to pay its guaranteed policy holders the guaranteed rate of 11%. In addition, the guaranteed policy holders could still make any amount of further investment at the guaranteed rate.

This made equitable life’s liabilities not hedged and unlimited. In essence, therefore, the company was getting around 6% for any investment it made while it paid the guaranteed policy holders a minimum of 11%. This left equitable life with a colossal black hole that culminated with the company using profits made from investing the money from the majority of the policy holders who had no a minimum return guaranteed, to their detriment. Another factor that contributed to equitable life’s imminent financial instability was failure to maintain a reserve.

This way, they failed to cushion the policy holders in case of a financial meltdown. This was what made equitable life more unprotected unlike other companies that offered a guaranteed return rate. Indeed, the company gratified itself with the fact that it distributed nearly all its profits to policy holders and, therefore, had higher bonuses. Moreover, the company boasted of the fact that it left a small reserve. As a result of its distribution rate, their policy became a darling of many investors.

People criticized many companies that held reserves. They argued that the surplus was inaccessible to the policy holders. Consequently, equitable life lacked the means to offset any potential liability that would arise and indeed arose. Had the company built up a reserve, it would have spread the loss over time making it unnoticeable. The question then was who to blame. Lord Penrose in his report stated that the society was the principal author of its own misfortune. Nevertheless, he pointed out that the management could not sustain this practice over material part 1990s had there been an appropriate regulatory structure.

The U.K regulators failed to intervene to protect the public from this deceit, even though the company was technically insolvent for the better part of 1990s. Ms Abraham in her report points to the inactiveness of different regulator under which the scandal slipped their attention. In the report, she concluded that a series of regulatory failures occurred as the result of the regulators approaching equitable life in a casual manner. The regulator did not question nor seek explanation for the issues in equitable life’s regulatory returns, permitting misleading information concerning the insurer and failing to identify the problems, all which a reasonable regulator should have detected based on the information available.

Moreover, her report also points that FSA provided reports that was misleading and inaccurate both to the public and the society’s policy holders concerning the state of the society. At the end of 2000 while reality was dawning to the policy holders of equitable life, other investors were also mourning. This is because they there was a slump in returns from other sectors such as banks and building societies. It was in this background that investment opportunities in strong sounding and lucrative bonds surfaced.

The firms limited number of the bonds they issued which had a maturity period ranging between 3 to 5 years in most instances. They also guaranteed a healthy, regular income and annual growth from these bonds at a rate that exceeded other financial institutions and indeed seemed singularly extravagant luring the investors. However, the amount of the original capital that was available to the investors depended on a complicated formula that was in turn subject to the performance index of some or a number of shares.

Consequently there was the risk that an investor could not get all of the capital invested and in some instances any for that matter. The firms offered the bonds under complex terms, which the potential investor, could not grasp. Indeed the investor did not fathom the extent of the real risk that they were subjecting their savings. Though their literature and documents did, in fact, describe the investment as a high risk and in some instances contained a warning that the capital was not secure, the firm’s representatives at the point of sale convinced the investors that the risk involved is minimal and made them believe that their capital was secure.

Consequently, there was no full disclosure to investors as to the risk facing their savings. This coupled with the fact that the firms were mostly dealing with people who had no proficiency with this line of investment. The result was that there was the risk of the firms ‘mis selling’ the bonds. FSA itself admitted to regulatory failures in a submission to parliamentary select committee. The regulatory body submitted that some past sales promotions allowed in error. Moreover, the firms used Abbey National name so that they could give their promotion credibility.

In the words of Norman Lamb, a liberal Democratic MP, the FSA should have forced the firms to inscribe a warning in the promotional literature just like the cigarette companies. This way, the investors would know that though the interest rate was double digit, they risked losing all their investment. Instead, FSA gave the go ahead to shoddy selling practises. The regulatory body’s comment in the bonds literature signalled implicit comfort that their literature had met the standard.

The body also admitted that though it had given warning to the potential investors, they had little chance in the face of the powerful selling financial service industry. In conclusion, therefore, the two scandals were a tremendous setback to investors especially the retirees who had put all their life savings in the line. All this fraud happened under the watchful eyes of the regulators who had the best chance of protecting the public against the practises of these firms. Works Cited "Equitable Life: Regulators failed you, says report.

" The Guardian. Web. 7 Oct. 2011 . "Issue 26 - March 2003 - Financial Ombudsman Service." Financial ombudsman service. Web. 7 Oct. 2011 . “08 The inequitability of Equitable Life." Larkar online. Web. 7 Oct. 2011 .

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Outline the cases of, the Equitable Life pension scandal and the mis Essay. https://studentshare.org/macro-microeconomics/1757739-outline-the-cases-of-the-equitable-life-pension-scandal-and-the-mis-selling-of-precipice-bonds-comment-in-both-cases-on-how-far-these-were-the-consequence-of-regulatory-weeknesses
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Outline the Cases Of, the Equitable Life Pension Scandal and the Mis Essay. https://studentshare.org/macro-microeconomics/1757739-outline-the-cases-of-the-equitable-life-pension-scandal-and-the-mis-selling-of-precipice-bonds-comment-in-both-cases-on-how-far-these-were-the-consequence-of-regulatory-weeknesses.
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