Prudential, the UK's second largest insurer, sensationally dropped plans to return some of the £8.7 billion of extra capital in its with-profits fund to policyholders today in a move set to enrage some of the 4.5 million customers that will now lose out.

The Pru, which had already delayed today's update by six months, told policyholders that they would be denied the benefits of any payout from its so-called inherited estate - the excess capital that builds up in a fund during its lifetime.

Nick Prettejohn, the chief executive of Prudential in the UK, said the insurer had concluded that the current operating model for its £79.1 billion with-profits fund remained in the best interests of current and future policyholders as well as shareholders.

He said the Pru had made its decision "after comprehensive and extremely complex analysis".

Mr Prettejohn defended abandoning plans for the payout, which he said would have been relatively small when set against the size of the estate.

He said the Pru was moving to protect the strength of the fund as well as the interests of future policyholders.

The decision comes after Pru executives, including Mr Prettejohn, received a high-profile grilling at the hands of the Treasury select committee of MPs earlier this year.

Also at the hearing was Aviva, the owner of Norwich Union, which is currently in the thick of talks with Clare Spottiswoode, the policyholder advocate, over the terms of a potential payout to more than 1 million of the insurer's customers.

It also comes after the regulator, the Financial Services Authority, embarked on a review that could ban insurers from using some of their inherited estate to pay misselling claims. Prudential has paid out £1.6 billion so far. This incensed MPs.

In their subsequent report, published earlier this month, the select committee berated the FSA for failing to tackle the innate conflicts of interest between insurers and their policyholders when it comes to decisions about the future of surplus with profits funds.

In a reattribution of an inherited estate, policyholders receive a one-off cash payment in exchange for giving up the right to future bonuses from the fund.

Insurers argue that they need the excess funds to help underwrite new business and maintain the strength of the fund.

Analysts at Keefe, Bruyette & Woods interpreted the Pru's decision as good news. They said it removed a "poison pill" that had prevented activist funds from pushing for a restructuring at the insurer.

Tim Young at Collins Stewart said: "It is now inconceivable that Prudential will return to the reattribution question in the foreseeable future. An important support to the valuation has thus evaporated."

Mr Prettejohn denied that the Pru had been influenced by the publicity surrounding inherited estates. He acknowledged that it was unlikely to revisit the plan "in the near or medium term future".

Pru shares added just 0.5p or 0.1 per cent to 551.5p.

Dominic Lindley, policy adviser at Which?, the campaigning consumer group, said: "Our initial reaction is that policyholders need to be confident the inherited estate will be used for their benefit. The crrent FSA regulations don't do enough to protect their interests."

Mr Lindley said Which? would also be calling for a "rigorous and independent assessment" of all insurers inherited estates to establish whether they have surplus capital that might be distributed.

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