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An Equitable Solution

all policy holders should be given guaranteed annuity rates

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Interview with David Walker at Investors Week for his article Why it's time to pull the plug on with profits bonds. 11 October 2001


Warren Edwardes, in his best-selling book Key Financial Instruments: understanding and innovating in the world of derivatives, (Financial Times Prentice Hall) asks "Why did they (The Equitable Life) not manage the interest rate risk either by altering the duration of their investments in fixed-rate government securities or by re-insuring (through derivatives)?"

Whilst the answer to that question remains a mystery, Warren, the inventor of several landmark financial products has a solution to the current impasse.

The Equitable's guaranteed annuity rate policyholders (GARPs) were right to sue to protect their guarantees and The House of Lords was right to uphold their case. They were given guarantees and would have expected that an eminent insurance company would have taken steps to manage the inherent interest rate risk and not seek to reduce their bonuses.

But non-GARPs have an equally strong case for case for being mis-sold policies, not only by not being advised of the GARPs, but more importantly, they were entitled to believe that The Equitable would have managed or reinsured the risks on its obligations.

The non-GARPs were therefore mis-sold and penalised to the value accruing to the GARPs.

An Equitable solution, that should find favour with Their Lordships, would therefore be for non-GARPs to be given GARs. But GARPs with guarantees lower than other GARPs have also been penalised to the extent of the interest rate risk mismanagement on the higher rate GARPs. All non-GARPs and GARPs should therefore be given equal guarantees at the highest GAR. As The Equitable is a mutual, and every member would be guaranteeing every other, this would mean that the identical GARs that all members would have would be worthless and, at a stroke, would make The Equitable a solvent going concern. There would remain funds obtainable from the former management, auditors and their professional indemnity insurers.

The so-called compromise should be rejected by non-GAR policyholders and The Equitable should consult members before fighting them in the courts and incurring further legal expenditure.


For informed and expert comment on this highly topical issue, speak to Warren Edwardes, author of Key Financial Instruments and ceo of the financial product innovation and risk management consulting firm, Delphi Risk Management. Edwardes often acts as a derivatives expert witness.

Nicola Farnell of CITPR: 01908 542777, 07799 664658, nicola.farnell@citpr.com

Warren Edwardes, ceo, Delphi Risk Management: 020 7724 4606, 07941 916328, we@dc3.co.uk


The 1760s saw the founding of two eminent British financial institutions. The Equitable Life was founded in 1762 and Barings was founded in 1763. Nearly a quarter of a millennium later, the latter came crashing down through the misuse of derivatives; whilst the former's demise was as a result of the insurance company failing to use derivatives to manage interest rate risk.

The losses at the Equitable estimated at between GBP 1.5 billion and GBP 5 billion could have been mitigated through using derivatives explicitly or through the principles behind derivatives and dwarf the losses that arose at Barings and elsewhere through using derivatives.

There remain some interesting questions that have to be answered. What valuation, at the time of marketing and sale, did insurance companies place on the interest rate guarantees provided? What external valuations of such guarantees did they obtain in the derivatives or capital markets? What strategy did they put in place to manage the risks once they had chosen to self-manage them? What valuation did the insurance companies' auditors place on the liabilities inherent in these guarantees?
And finally, The Equitable stopped giving GARs in 1988. So they were clearly aware of the inherent dangers in such policies. UK interest rates in fact rose in the following years. They were therefore fortunate in not having hedged a downward movement in rates. But why did The Equitable not take advantage of their good luck and buy lower cost interest rate insurance in 1990 or 1991?

key financial instruments: understanding and innovating in the world of derivatives Warren Edwardes is author of "Key Financial Instruments: understanding and innovating in the world of derivatives" Feb. 2000, Financial Times Prentice Hall ISBN 0273 63300 7 London 

related articles

"APRs - misleading, misused or just plain misunderstood", 8 Apr. 1995, The Times, London  link

"Less Technophilia - have faith in fools", Leader Column, Apr. 1999, Treasury Management International, London link

"Guaranteed annuities - no excuse for not managing risk" 12 February 2000, The Times, London  link

"The Equitable Life: Boards sued for not using derivatives" 10 September 2000, The Sunday Times, London  link

Delphi Risk Management: Delphi creativity Delphi communication & Delphi control are the Innovation, Communication & Risk Management arms of Delphi Risk Management Limited 

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