Outlook: Compensation culture rules, despite Penrose

So who's to blame for the Equitable Life débâcle? Not us, was the message Ruth Kelly, the Financial Secretary to the Treasury, was keenest to get across in her parliamentary statement yesterday. Rather it was all down to the culture of manipulation and concealment of the society itself and to failings in the regulatory system before Labour came to power in 1997.

Once in Government, Labour moved to address these failings by creating the Financial Services Authority, which has now put in place the necessary degree of prudential regulation and oversight to prevent anything like Equitable happening again. So that's it, then; it was all the fault of the management, which concealed the truth, and the previous government, which allowed an inappropriately "light touch" regulatory environment.

Leaving aside the fact that this is a somewhat biased account of Lord Penrose's 818 page report, what does Ms Kelly's analysis say about the case for compensation? There is none, says Ms Kelly, who seems not to regard it as the least bit inconsistent to blame the previous government for regulatory failure but at the same time deny there is any case for compensating policyholders for the consequences of those failings.

Government compensation requires a finding of maladministration, Ms Kelly insists, and there is no such finding in Lord Penrose's report. Furthermore, there is already in existence an industry-wide compensation scheme, which would give policyholders 90 per cent of their minimum guaranteed entitlement should Equitable become insolvent.

Neither point seems to me particularly relevant. Lord Penrose was specifically asked in his terms of appointment not to adjudicate on the matter of compensation, so even if he thought there was maladministration, he would not have been able to make such a finding. As for the existence of a life insurance compensation scheme, it is not particularly helpful for Ms Kelly to cite it as a key difference between Barlow Clowes, where government compensation was paid, and Equitable Life. The only reason it wasn't used in the Barlow Clowes case, leaving the Government to pick up the tab for compensation instead, was that Barlow Clowes was not an insurance company and was therefore not covered by the scheme's predecessor.

As it happens, Ms Kelly is right to resist the case for compensation. Governments should not as a general rule of thumb be handing out compensation to investors. This should be the case even when there is regulatory failure involved, for no system of regulation can be 100 per cent full proof, especially when confronted with a management hell bent on obstruction and obfuscation. To guarantee the financial system against failure in all circumstances would be prohibitively costly, and by removing all risk, would condemn investors to correspondingly pathetic rates of return.

Ms Kelly cannot have it both ways. The attempt to foist whatever regulatory blame there is for Equitable onto the previous Government is cynical and disingenuous. Labour has been in power now for nearly seven years now. For how much longer can it credibly blame any problem that occurs under its watch on the failings of the previous regime? The present Government had been in power for more than three years at the time Equitable was forced to close to new business. It may well be that by the time Labour came to power the die had long since been cast, but in truth, the FSA was no more capable of recognising the seriousness of the situation than its predecessor regulators.

At the time of the fateful House of Lords judgement, the FSA admittedly still didn't have its full powers, but it was already in existence and had been for several years. What's more, the main cause of the mischief, the society's high exposure to guaranteed annuities, was well known, yet the FSA had made no concerted attempt to grip the problem. Insurance regulation is now being dramatically tightened, but this didn't pre-date the Equitable débâcle, it was in direct response to it, in parallel with international developments in insurance regulation.

Don't get me wrong. I'm not trying to have a go at the FSA, which in most respects seems to have acted correctly throughout the saga. On one occasion it was quite plainly fraudulently misled. But to insist that there was some defining turning point in the way regulation of insurance was approached which exactly coincides with the date of Labour's general election victory in May 1997 is a ridiculous over simplification of what occurred. In fact, there was an evolution of approach, which didn't finally reach its conclusion until long after the horse had bolted. By that stage Equitable and others were already dead in the water.

The truth of the matter is that most regulation is of necessity reactive, not pro-active. When he's not blaming the management, which seems to have acted both deviously and with appaling disregard for the interests of its policyholders, Lord Penrose blames the lax regulatory system. Nor is this simply a case of systemic failure; Lord Penrose cites a large number of instances in which regulators failed to heed warnings, or ask the right questions.

Hindsight is a wonderful thing, but it is a regrettable fact of all regulation that problems don't tend to get recognised or addressed until after they've exploded in everyone's face and it's too late to do anything about them. At that point there's invariably an horrendous over reaction, which can frequently end up doing more harm than good. The Dangerous Dogs Act is only the most famous example. This Government has been particularly good at reaction, but it is not yet clear that the investment landscape is a better place for it.

The Government's policy on long term savings, to the extent that it has one, can reasonably be described as a complete shambles. Labour came to power determined to improve on Britain's generally poor propensity to save, yet six years into power and it has singularly failed in this endeavour. If anything, long term savings levels today are lower than they were back in the mid 1990s. The Government's approach to the savings market has been characterised by a bewildering series of initiatives, all of which have placed heavy demands and costs on the industry for no noticeable improvement in results. Post Penrose, there is to be a legion of others.

Ms Kelly smugly affirmed that most of Lord Penrose's recommendations for change had been anticipated and were already in place, but that didn't stop her from ordering another three Government reviews, from the governance of mutual life offices, to standards in the actuarial profession, and accounting for with profits business by life assurers.

The near collapse of Equitable Life was a disgraceful example of lax, deceitful and unprofessional practice all round. Whether it also amounted to fraudulent behaviour will be up the SFO and the DTI to establish. That a mutual life assurer apparently thought it acceptable to continue writing business when it had paid out all its capital in bonuses to maturing policy holders, leaving itself no cushion if things went wrong, is an utterly damning indictment for all concerned, management and regulators.

Yet the changes now being heaped on the industry in an attempt to win back public trust in our savings institutions won't make people more willing to save. The long term effect will only be to limit choice and innovation. Combined with government initiatives to limit what can be charged, it is leading many operators to question whether it is any longer worth devoting capital to the UK market at all.

The Government won't pay compensation, but it is most insistent that the industry does when ever the occasion demands it. The system for determining mortgage endowment compensation, where the provider has to demonstrate there was no mis-selling to avoid a legitimate claim rather than the other way round, is a case in point. The process shows disturbing signs of spiralling out of control, driven by the knowledge that those who don't claim are subsidising those who do.

Increased regulation is all very well, but in the savings industry as in so many others, it is in danger of killing the goose that lays the golden egg.

jeremy.warner@independent.co.uk