The City watchdog has confirmed plans for an inquiry into 30 million financial policies sold between the 1970s and the turn of the millennium amid fears over "rip off" charges and sub-standard service.
The Financial Conduct Authority (FCA) said it was investigating policies worth around £150 billion, sending shares in i nsurance firms slumping into the red once more after a torrid past week for the sector.
It will launch the investigation in the summer, scrutinising the treatment of customers who took out products such as private pensions, endowments, investment bonds and life insurance over a 30-year period.
The FCA - which will unveil further details in its annual business plan for the new financial year on Monday - is particularly concerned that many loyal customers of these older policies, many of which are no longer being contributed to, are not getting the same service as new customers and are locked in with high exit penalties preventing them from switching.
The move is a fresh blow for the industry just a week after the Chancellor gave pensioners the freedom to draw down as much or as little of their pension pot as they want, removing the need to buy an annuity.
And it follows yesterday's pledge by Pensions Minister Steve Webb to launch a "full frontal assault" on pension schemes giving poor value as he announced that a 0.75% cap will be imposed on charges from April next year.
FTSE 100 Index listed Friends Life insurer Resolution, which was set up in 2008 to consolidate the life insurance industry and is a major manager of closed funds, slumped as much as 13%, while Aviva fell 8%, Legal & General dropped 7% and Prudential declined 5%.
Phoenix Holdings, which has five million policyholders and is the UK's largest consolidator of closed life assurance funds, tumbled 15% in the FTSE 250 Index.
The latest probe comes as the FCA said it feared there was unfairness whereby some insurers use the returns from so-called "zombie" funds - which are shut to new customers and often neglected by existing clients - to pay bills from other parts of their businesses.
It is thought the FCA could consider banning exit fees on old policies, or asking firms to move customers to better products, increasing investment in the management of old funds, or cutting fees.
Clive Adamson, director of supervision at the FCA, told The Daily Telegraph: "We want to find out how closed-book products are being serviced by insurance companies, as we are concerned insurers are allocating an unfair amount of overheads to historic funds.
"As firms cut prices and create new products, there is a danger that customers with older contracts are forgotten. We want to ensure they get a fair deal. As part of the review we will collect information to establish whether we need to intervene on exit charges."
The regulator is also concerned some of these products are no longer suitable for policyholders, but that regular checks are not being provided.
Many older policies are sold from provider to provider as part of takeover deals.
Mr Adamson added: "Consolidation and outsourcing within the insurance industry means that policies taken out 10, 15 or 20 years ago are unlikely to be managed by the same brand, and by people in the same building as they were at their outset.
"We want to make sure that customers who have been 'sold on' are treated fairly. Some terms and conditions that were common 20 years ago are not what we would want to see now."
Legal & General called on the FCA to bring forward the publication of its business plan and details of the investigation after what it described as a "disorderly market" reaction to the announcement.
It added the group already has a "focus on high standards in governance".
It said: " Legal & General does not outsource customer administration: our customers benefit from the continuity of a single product and service provider.
"Our operating practices ensure we provide good value to our customers, and we have operated a programme of ongoing product reviews for more than 10 years."
Insurance expert Eamonn Flanagan at Shore Capital Stockbrokers raised concerns that any changes to exit penalties written into contracts could create "anarchy" among policyholders and impact on new business written by insurers.
He said: "If they put in place retrospective changes to contracts, it will make the industry wary about selling these products in future and that could only be to the detriment of consumers.
"You'll end up with dumbed-down policies."
The FCA stressed that it was not planning to scrap exit penalties for all policies sold between 1970 and 2000, as long as they were compliant at the time.
It said it was looking at how customers of accounts closed to new business are treated and will be reviewing a representative sample of firms and their policies.
"This is not a review of the sales practices for these legacy customers and we are not looking at applying current standards retrospectively - for example on exit charges," the FCA said.
It added: "As a forward looking regulator, we want to examine areas that are of interest and relevance to consumers and to firms and assess whether there is an issue that requires any action. No conclusions have been reached as work has not started."
Aviva, which saw shares close 3% lower, said it had already capped charges at 1% or less for pre-2001 group personal pension policies and had no material exit charges applying to its legacy book.
It added the probe could apply to around £200 million of its long-standing life insurance policies, but added its "treatment of customers has been fair and appropriate, and therefore any impact on the group's profits should be minimal, if at all".