The European Parliament's inquiry into Equitable Life will find the UK government guilty of failing to protect one million policyholders and declare that the government has a "moral obligation" to compensate them.

The single-issue inquiry, the first of its kind in Brussels for 10 years, will publish a 373-page report which says policyholders were deprived of the "rigorous supervision" and "adequate protection" stipulated by the European Union's Third Life Directive, and also of a fair hearing for their complaints by Britain's Financial Ombudsman Service (FOS).

The inquiry was expected to publish its findings formally next month. However, the entire report was released at the weekend by Diana Wallis, a LibDem MEP and member of the inquiry committee. The inquiry took evidence from across the industry, from Equitable's chief executive Charles Thomson, from Financial Secretary Ed Balls and from campaigners and policyholders. The Herald submitted detailed evidence in Brussels last November, focusing on mis-selling by Equitable Life salesmen and the failure of the complaints system.

In its conclusion, the report says: "It should be recalled that Equitable Life victims are not investors willing to take risks for the prospect of attractive returns. Rather, they prudently set aside money for their retirement with a highly reputable society, which led them to believe that their investment was absolutely safe. These policyholders were entitled to expect from the UK government thorough and rigorous supervision of all financial services providers ... including Equitable Life."

It goes on: "Had the UK regulators correctly applied the provisions of the directive, they would most likely have ... avoided the crisis at Equitable Life, which caused substantial losses to policyholders."

The current investigation by the parliamentary ombudsman, says the report, might well find maladministration, injustice, and the need to pay compensation. "However, the ombudsman's remit is limited in terms of both the time period and regulatory authorities covered ... In light of the above, the committee considers it appropriate to recommend strongly to the UK government to devise an appropriate scheme with a view to provide full compensation for Equitable Life victims both within the UK and abroad ... the committee sees it as a moral obligation for the UK government to assume responsibility for its failures and provide redress for citizens' grievances."

It says the compensation should be payable to all those non-GAR (guaranteed rate) policyholders and annuitants who were affected by the 16% cut in policy values in July 2001, and should cover all losses that were not market-related, "in particular those due to the society's practice (which remained unchallenged by regulators) of paying excessive bonuses during the 1990s".

The calculation should differentiate between policyholders according to when they joined, to reward those who had not benefited from the historic over-bonusing.

The report notes that a small minority of policyholders threatened Equitable with court action and reached settlements with confidentiality clauses, including the case revealed by The Herald of the Lanarkshire businessman who won £81,000 after a four-year fight and a "final offer" of £500.

It adds: "The high costs and risks under the UK legal system prevented the average policyholder from suing the society, and these consequently had to rely on the FOS as the only possible route to redress. The committee is of the opinion that this is clearly unfair."

Yet the FOS, says the report, froze all complaints and then appeared not to treat them on their merits, but on what effect resolving them might have on the society. There were "serious shortcomings" in the FOS's operation. "The committee therefore demands that the UK government urgently address these shortcomings, strengthen the FOS's capacities and ensure that it is truly independent from the Financial Services Authority."