UPDATE 4-UK regulator to probe fairness of "zombie" savings pots
* Probe is third knock to savings sector in two weeks
* Policies written before 2000 will be inspected by FCA
* Insurers are the top six fallers on the FTSE-100 index
* Legal & General says market disorderly due to probe news
* FCA launches external probe into how it handled announcement (Adds FCA board to investigate how announcement handled)
By Chris Vellacott and Huw Jones
LONDON, March 28 (Reuters) - Britain's financial watchdog will investigate whether people locked into some 30 million pension and other savings plans sold by insurance firms in the 30 years after 1970 are treated fairly compared with new clients, it said on Friday.
Shares in insurers including Aviva, Legal & General , Prudential, Resolution and Standard Life fell sharply on speculation the probe could lead to changes that affect the profitability of the products.
The investigation is the third blow in two weeks for the industry, after the government unexpectedly said last week that retirees would no longer be forced to use pension pots to buy annuities - a major source of insurers' income - sending shares in the sector sharply lower on the day.
On Thursday the government announced a cap on management charges for some workplace pension schemes.
The Financial Conduct Authority's (FCA) investigation unveiled on Friday relates to about 150 billion pounds ($249 billion) of savings policies sometimes described as "zombie funds", which are closed to new investors and typically owned by elderly people who might have forgotten about them.
The watchdog is concerned these savers are being treated as a captive market because of costly penalties for withdrawing early or stopping further payments which were built into these policies, written before 2000 when interest rates and expected returns were higher.
"These accounts have been closed for many years in some cases, but there are still valid issues to be looked at around the question of the service that consumers receive in relation to those accounts," the FCA said in a statement.
"Are they getting the right information? Are they getting the right level of service? Are these investments still appropriate?" the watchdog added.
The FCA was due to announce the probe in its annual business plan to be published on Monday. But an interview with a senior FCA supervisor in the press on Friday outlining the review sent shares in insurers tumbling.
This prompted requests from the industry for the watchdog to bring forward its announcement, which it did barely two hours before close of trading in a market Legal & General described as having become "disorderly".
In a rare move after the end of trading, the FCA issued a second statement saying its board acknowledged market concerns regarding press coverage of the planned investigation.
"The board will conduct an investigation into the FCA's handling of the issue involving an external law firm and will share the outcome of this work in due course," the FCA added.
Such a step will be embarrassing for the FCA just as the young watchdog, which marks its first anniversary on Tuesday, is trying to establish its credibility.
The Daily Telegraph newspaper had said the probe could lead to exit penalties being waived for some savers. But the FCA said the review wouldn't look at sales practices - such probes have led to hefty fines - and it was not looking to apply current standards on old policies, such as on exit charges.
This helped insurers' stocks recover some of their losses, but at 1525 GMT they still accounted for the six biggest fallers on the benchmark FTSE-100 index, with Resolution down 7 percent, Aviva sown 5 percent and Legal & General off 4 percent.
Tim Tookey, chief financial officer of Resolution, told Reuters the group operates a customer committee staffed by senior members of its closed and open life businesses that ensures rules are followed on treating all customers fairly.
The UK government is seeking to encourage people to save for old age at a time when public coffers are stretched and people live longer.
Finance minister George Osborne announced earlier in March retirees wouldn't be forced to buy an annuity with their pension pots, in the biggest shake-up in pensions in nearly a century.
Then on Thursday the government said annual management charges on workplace pension schemes that automatically enrol employees would be capped at 0.75 percent from April next year to "end rip-off pension charges".
The FCA review will start this summer and is due to be concluded by the end of the year.
Analysts said any ban on so-called exit fees which, in extreme cases, eat up half the savings pot, would be a heavy blow for insurers.
"Should investors be allowed to exit policies and look for a better deal, the sector may be punished with large outflows of money from some zombie funds," Mike van Dulken, head of research at Accendo Markets, said.
There are 30 million such funds in existence, dating back to the 1970s, but the FCA will only look at a selection of them.
The head of Chesnara, which buys up closed life and pension books, said it had little to fear from the review.
"It doesn't look like it's going to be a major issue for us because we only do closed books ... We haven't got the ability to start overcharging people in old funds, and we've only got old funds," said Chesnara Chief Executive Graham Kettleborough. ($1=0.6019 British pounds) (Additional reporting by Esha Vaish; Editing by Alexander Smith, Greg Mahlich and Mark Potter)
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