By Huw Jones and David Milliken
LONDON (Reuters) -Britain's proposed changes to capital rules for insurers could lead to the government having to bail out policyholders, as happened 20 years ago after the near-collapse of life assurance company Equitable Life, the Bank of England said on Monday.
Late last year Britain's finance ministry overrode the BoE and proposed looser rules for insurers and related investment companies which it said would help the sector to invest in infrastructure and boost economic growth.
"I don't think that it's likely, all things equal, that it's a risk to financial stability, but it is a risk to policyholders," BoE Governor Andrew Bailey told parliament's Treasury Select Committee.
"I will mention Equitable Life ... it can happen," Bailey added .
Equitable Life, established in 1762, closed to new customers in 2000 and almost collapsed after making unsustainable guarantees to policyholders.
BoE Deputy Governor Sam Woods said this case showed how risks could "come home to roost if there is not enough capital backing pensions".
"Now you can look at history for guidance as to what is likely to happen if that occurs. I would say it is highly likely that comes back to the public purse, if that occurs," Woods said.
Britain's government estimated that Equitable Life's policyholders lost 4.1 billion pounds ($5 billion), and it later paid them 1.l billion pounds in compensation.
Woods warned last year that reducing how much capital insurers held would not be a "free lunch", as it could make firms less able to make payouts on policies during a crisis.
The government, however, had made its decision on insurance reform and there was a need to move forward now, Woods said.
The BoE would not use proposed new powers for regulators to "reverse engineer" changes to insurance rules that went against the spirit of the government proposals, he added.
Bailey said the BoE had not agreed to accept the government's proposals on insurance capital rules in return for the government withdrawing plans to give itself powers to veto decisions by financial regulators.
Bailey said he would not consider that sort of "trade".
Britain has proposed a string of financial market changes, known collectively as the Edinburgh Reforms, to boost the City of London's global competitiveness after the European Union cut off its access to most clients in the bloc after Brexit.
The reforms include a review of rules on the direct accountability of bankers for their decisions, known as the senior managers regime, and ease a requirement on some banks to wrap their retail deposits with a bespoke capital cushion.
The BoE wanted to be "very closely engaged" on the detail of those reforms, Woods said.
($1 = 0.8203 pounds)
(Additional reporting by Suban Abdulla;Editing by William Schomberg and David Evans)