Along with millions of others, I have invested in a Standard Life (Standard) with-profits endowment policy. In February 2002, its surrender value was £82,000. Today, after additional premiums of £9,300, it is worth about £73,000. The policy has about five years to run, but should I continue to pay to lose more money? Or will a windfall from demutualisation compensate for the losses?

Sandy Crombie, Standard's new chief executive, says that at flotation, the group will be able to offer "a well diversified portfolio of businesses, which have good potential for growth". But how can we evaluate the businesses? The life fund is opaque. An alternative is to evaluate the main UK subsidiaries.

Standard has invested our capital in Standard Life Bank (Bank), Standard Life Investments (Investments) and Standard Life Healthcare (Healthcare). If Crombie and colleagues have invested wisely, perhaps their value will compensate for the UK life and pensions business that, Crombie says, "is very competitive and likely to remain so".

Bank began trading in January 1998. Its purpose was to "provide a competitive range of banking products and services at low cost". It sells, mainly, residential mortgages and retail savings. Low cost means low fixed costs; that is, Bank sells principally through intermediaries. It serves the UK mainstream market.

Before examining its accounts, common sense prompts the question: why invest here? Mortgage lending spreads are in long-term decline. Competition is fierce. The business eats capital - the lender pays broker commissions up front. And it is a commodity product, where the rate charged drives the business.

What do the 2003 accounts show? Standard's investment is a £600m- £230m loan, and £370m in ordinary shares. In 2003, Bank earned £4.6m. This was its first pre-tax profit. Retained losses are £125m.

Why has it done so badly? It appears to have four problems.

Earnings are poor quality and heavily reliant on mortgage lending. In a tough market, loans are vulnerable to refinancing by other lenders. Where they are material, commissions and fees improve income quality and reduce the risk of refinancing. Cash fees have no credit risk, and they help lock a borrower into a loan. At Bank, they only generate 5 per cent of earnings. A strong competitor's results show up Bank's weakness. Take Bradford & Bingley (B&B), which gets the same rating as Bank of A-, with negative outlook from ratings agency Standard & Poor's. At B&B, fees and commissions account for 36 per cent of earnings. It has reduced its dependence on plain mainstream mortgage lending where there are few opportunities to charge worthwhile fees.

Bank's second problem is that its main way of selling does not produce economies of scale. It sells through brokers, with a little help from its web site. B&B has 322 branches. It can add sales volume for free. Bank pays commission on all brokered loans - no free rides. As volume rises, brokers will press for bonus overrides.

A third problem is that poorly priced capital from the parent encourages waste. Bank and B&B have the same credit rating and both are subordinated debt borrowers, with loans of similar terms. But B&B pays its investors 7.05 per cent a year, while Bank pays 5.94 per cent to its parent. So Standard Life is giving away 1.11 per cent a year on £230m. This is on top of the losses of £125m that it has tolerated on its capital of £370m.

It is worth estimating the opportunity cost of Bank. Assuming an historic cost of Bank's capital of about 7 per cent, then Bank should be worth about £1bn. It is probably worth no more than £380m, a loss of £620m. If we use the 13 per cent cost of capital that JP Morgan Chase charges its business units, the opportunity cost is much greater. Its fourth problem is that Bank richly rewards failure. In 2003, with paltry profits, it paid its highest paid director £448,000 under its long-term incentive plan - a hike of 29 per cent over 2002.

Has Healthcare done any better? Healthcare's accounts show that Standard has invested £116m and Healthcare has lost £44m since 1994. Standard uses words like "excellent", "extremely successful" and "improving profitability", which create quite a misleading picture. The UK private health care sector grows slowly and offers poor returns to health insurers. This is not new. Nor, apparently, is Standard's ability to invest in failure.

Maybe Investments is a star? Crombie thinks so. He says: "Investments continued [in 2003] to build an outstanding track record and to attract money from a variety of sources."

Actually, the key question is the profitability of Investment's external client business. Investment's accounts show profits: £7.5m to November 2002 and retained earnings of £31m. However, how much disappears when the in-house business is consolidated out? What remains should be the real profits from real clients. Investments is coy. It uses reporting exemptions to avoid disclosing details of trading with the parent: "Note 24. Related party transactions. The company has taken advantage of the exemptions under paragraph 3C of the Financial Reporting Standard 8 from disclosing transactions with other undertakings of the Standard Life Group."

Standard's accounts show that 82 per cent of Investment's business is in-house. After five years, Investments is still overwhelmingly dependant on parent-sourced business.

How profitable is the third-party business? Neither Investments nor Standard will say directly. We can work out that business with external customers grew by 37 per cent, while business from the parent grew by a modest 12 per cent. This suggests that Investments might be discounting the cost of its services to grow its volume.

We do know that Standard has made an outrageously generous loan to Investments. In 2002/3 it cost 4.2 per cent. This was another subordinated loan and it should have cost about 2.85 per cent more. Such soft pricing encourages Investments to undercharge for its services.

What should we conclude?

Standard's diversification programme has failed. Capital is poorly priced and policyholder value destroyed. Standard's financial results are difficult to read. One has to juggle between group and subsidiary accounts to get the truth. Reporting exemptions are widely used - no cash flow at Bank and no third-party profit data at Investments.

Standard blames external factors for its with-profits problems. However, this analysis questions both Standard's investment performance, and the credibility of many of its public statements. Demutualisation windfalls? Why should investors buy into these businesses?

So what should we do?

We should stay angry. Our money has been wasted and we have been given the illusion of success. We policyholders should explore our remedies, urgently.

m.j.hogan@btinternet.com

Michael Hogan is a Standard Life policyholder.