What a rollercoaster week for Equitable Life policyholders. First there was tentative optimism as speculation prompted (by our own website, guardian.co.uk/money) about an announcement on compensation, then excitement following a leak to the press suggesting that, yes, compensation was on the cards ... and then deflation as the deal itself was announced by the government.

The speech started on a positive note for Equitable policyholders. Yvette Cooper, chief secretary to the Treasury, said she "agreed that there had been maladministration in particular areas" with regard to the regulation of Equitable, and that government action was merited. But then came the caveat. Protracted phrasing was used, but it essentially amounted to two words that have come to epitomise the Brown era in government: means-testing.

And then a further blow: to work out who has been "disproportionately affected" and how much they will get paid could take at least two and a half years, if not "significantly longer".

A judge has been appointed to consider first the total sum that has been lost by policyholders and then to work out what proportion of those losses are the fault of the government. Then he will need to work out which class of policyholder has suffered the greatest impact, taking into consideration, presumably, any detriment to those policyholders who have since died. And there was I thinking that means-testing for the pensions credit was convoluted.

It is obvious why the government is doing it this way. Until recently, it seemed, it had no intention of compensating policyholders. But the collapse of Icesave and subsequent bail-out of UK savers by the government resulted in increased pressure to offer some sort of recompense to Equitable customers, too. Yet the Treasury has to consider the cost to the taxpayer and the implications of any action. It doesn't want to be seen to be giving too much public money, not least because blanket compensation could set a precedent for future collapses. More controversially, it may not want to be seen to be giving lots of money to those well-heeled Equitable customers whose policies, in some cases, have not fared too badly.

But by using a complex system of means-testing after eight years of delay, the government has missed a golden opportunity to draw a line under the whole sorry story. This will not only infuriate the policyholders it wants to appease, but will also - more crucially - continue to fuel the negative public perception of pensions.

It looks like we are going to be reporting on Equitable Life for a long time to come.

l.bachelor@observer.co.uk

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Increasing numbers of people in final salary pension schemes will consider pension transfers following the high-profile demise of Woolworths and Waterford Wedgwood, say pension experts.

Both companies left large holes in their pension funds when they collapsed, and members now face smaller incomes than expected when they retire.

Final salary or defined benefit pensions have been regarded traditionally as the gold standard, and transfer value quotes - the amount of money you will be given by your pension fund if you swap schemes - have not been generous enough to encourage members to leave.

But in recent months, as increasing numbers of employers have gone bust, these schemes have started to lose their appeal. In the first 11 months of 2008, 77 schemes, including the Lehman Brothers pension fund, were referred to the government-sponsored pension lifeboat scheme, the Pension Protection Fund (PPF). At the same time, some employers that still run pension schemes have started offering better terms for transferring, making a move to a private money purchase scheme more attractive.

Aon Consulting, a firm that specialises in employee benefits, tracks the proportion of 55,000 employees in 30 companies who ask for pension transfer information, and reports a 63% increase in members' queries in the year to October 2008 compared with the previous year.

Paul McGlone, principal and actuary at Aon, says the sharp downturn in the economy and stockmarket is likely to provoke even more queries. "If you think the company [you work for] is unlikely to be around in 10 years to pay your pension, then you might well feel you want to take that money out and put it in a defined contribution scheme," he says.

Woolworths' scheme, which has about 8,000 contributing, deferred and pensioner members, is believed to have a deficit well in excess of £250m and it has been referred to the PPF. This scheme ensures that employees whose companies have gone bust, leaving their pension funds with insufficient money to meet their liabilities, will still get an income in retirement - but there are limits.

If you have already reached your scheme's normal pension age, you have had to retire early on grounds of ill health or you are receiving a pension in relation to someone who has died, the PPF will usually pay 100% of the pension you should have received at the time your employer went bust. These payments are not subject to any compensation cap.

If you have retired but have not yet reached the normal pension age of your scheme, or you are still working and not yet at retirement age, the PPF will pay you up to 90% compensation when you do reach pension age. This level of compensation is subject to an overall cap that is recalculated each year: between April 2008 and March 2009, the cap at the age of 65 equates to £27,770.72.

In addition, although many company pension schemes would offer index linking to make sure your income kept pace with inflation, PPF compensation payments rise in line with inflation each year subject to a maximum of 2.5% per year, lower than the current RPI at 3% or CPI at 4.1%. The increase only relates to that part of your pension accrued since 5 April 1997, so your retirement income will soon fall in value compared with the cost of living.

The trustees of your pension scheme should have checked the "covenant" of your employer - its ability to fund the pension scheme. But most of that process will be based on forecasts of the company's financial health - sensitive information that the trustees will not be allowed to pass on to you.

So if you belong to a final salary pension scheme, how do you decide whether you should transfer? Given the current economic climate, are you nervous about your company's strength? Has business slumped? Is the company laying people off? Is it part of a bigger group that might be able to help it out?

Tom McPhail of independent financial adviser Hargreaves Lansdown says that generally you should assume you are better off staying in the final salary scheme. "Usually the transfer values offered do not adequately compensate investors for the guarantees they lose when they transfer out. Sometimes employers offer enhanced transfer values, in which case they may be making a special effort to entice you out," he says.

In this case, the same basic principles still apply. Always take independent advice. This is a complex area, so consult a qualified professional. And think hard before accepting a cash-in-hand inducement. You are likely to end up spending it and retiring with a smaller pension. Increased transfer values are better, as the money goes into the pension.

But occasionally it is appropriate to panic. "The golden rule of panicking is that if you are going to do it, you should do it before everybody else does," says McPhail. "If your pension scheme is in deficit and you think your employer may be in danger of going bust, it may make sense to get out just to avoid the whole catastrophe and PPF trauma.

"This is particularly true if your pension entitlement exceeds £27,770, the current upper ceiling for compensation. Someone entitled to a £50,000-a-year pension could potentially suffer a major loss of pension rights even if the PPF bailed them out."

The PPF says it will take about two years to assess the Woolworths scheme. If it has insufficient money to meet PPF compensation levels, the PPF will take over the fund's assets and assume responsibility for paying income on retirement. If it has more than enough, the PPF will refuse to take the scheme on, but members should get a higher retirement income.

Those who retire in the meantime need not worry that they will miss out: they will receive the PPF level of compensation directly from the pension fund until the PPF completes its assessment.

Wake-up call for the pension sleepwalkers

If you are one of the million employees currently paying into a company money purchase pension scheme, you probably never take any active decisions on how your fund of money is invested. But perhaps you should. Like banks, some of these pension schemes are not the safe havens we once thought.

Research published by the Pensions Regulator last year "found many schemes operating practices that did not suggest high levels of vigilance" when it came to monitoring investment performance. It went on: "The suitability of funds appears to be most commonly reviewed every 2-3 years, with some reviewing them annually."

In the current climate, where stock markets can lose 10 per cent of their value in a day, a desultory investment approach could spell disaster. In these money purchase schemes, members build up their own personal fund and individuals are, therefore, exposed to investment risk.

More than 90% of members of these schemes just opt for the "default fund" into which trustees put people who make no active choice. This fund will typically be invested in a mixture of equities, fixed interest, property and cash, with the equity element often accounting for half. If individuals check the value of their personal pension pots in these schemes, some will see that the valuation has shrunk by a third over 2008.

People who really need to be careful about where their money is invested are those planning to draw on their funds in advance of when the pension scheme expects them to retire. About three-quarters of schemes automatically phase members into safer funds within five or 10 years of their 65th birthday, when they expect them to retire. But many people will want, or even need, to take that pension money in their 50s - and they would, therefore, want to reduce their risk to stock market volatility at a much earlier stage than the scheme will move them out of equities.

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