Equitable chaos prompts FSA warning to investors

Small investors may in future be warned to take care before investing in one of the country's most popular types of investment fund.

The Financial Services Authority is to review the way with-profits investments are run following the crisis at Equitable Life, the 238-year-old mutual insurer which was forced to close to new business last Friday.

Equitable closed after failing to find a buyer to plug a £1.5 billion liability for paying a guaranteed level of income on pension funds. The disaster grew out of contracts to pay the money from with-profits investments. These funds aim to smooth stock market peaks and troughs through the payment of bonuses which are distributed at the discretion of managers. The row at Equitable followed its decision to cut maturity bonuses on the guaranteed pensions.

The FSA has no plans to ban with-profits funds, in which more than £550bn is invested, but it may order insurers to explain the workings of the funds more clearly, and increase risk warnings.

Equitable believed its contracts allowed it to cut the bonuses, but the House of Lords ruled this illegal.

The insurer's difficulties have focused the regulator's attention on the complexity of with-profits funds and the snags that can arise when managers believe they have discretion to alter payments.

Although the Lords' Equitable judgment applies to specific types of contract, it is these funds' discretionary nature that is causing concern.

With-profits funds are at the centre of other controversies in the investment industry. They have resulted in the build-up of huge excess profits at some firms. Insurer Axa is due in court on 19 December to seeking a ruling on the way it plans to distribute its 'orphan' estate - a scheme attacked by the Consumers' Association as unfair.