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Savers who lost money in the Equitable Life pension company should start receiving compensation payments in the middle of 2011, the government has announced.

Treasury minister Mark Hoban confirmed that 1.5 million savers would be compensated for their "relative loss as a consequence of regulatory failure".

An independent commission has been set up to advise on the best way to allocate payments.

It will report by January 2011.

Mr Hoban said the total amount of compensation on offer would be revealed this coming October, at the time of the government's public spending review.

However, he warned that the scope of the scheme might be limited by the government's desire to cut public spending and rein in its budget deficit.

"The scheme will be a significant spending commitment for this government and cannot be considered in isolation from the other spending decisions that it will need to make over the coming months, and what is affordable in that context," Mr Hoban said.

The Equitable, one of the UK's leading private pension companies, closed to new business in 2000 and subsequently came close to collapse.

It became evident it had been telling savers that their polices were worth far more than was actually the case.

When the situation was crystallised following a High Court test case in 1999, it was forced to reorganise its finances by slashing the value of its savers' policies to bring them into line with reality.

This meant not only reducing the value of the pension pots then being accumulated by savers, but also meant reducing the pensions already being paid to some of its customers.

An Equitable Life bill has now been introduced to Parliament which will pave the way for the Treasury to make the compensation payments.

Mr Hoban confirmed the scheme would follow the recommendations of the 2008 report from the Parliamentary Ombudsman.

She had recommended the scheme should offer "fair and transparent payments to Equitable Life policyholders, through an independent payment scheme, for their relative loss as a consequence of regulatory failure".

However she gave only a cautious welcome to the government's plan.

"While the Ombudsman would welcome the delivery of justice to those affected by the Equitable Life affair in a speedy, simple and transparent manner, it is not clear from the material presented to Parliament whether such justice will be delivered," said a spokesman for the Ombudsman, Ann Abraham.

"Once the Ombudsman has had time to consider the material presented to Parliament today, she will inform Parliament of her views," the spokesman added.

The Equitable Members Action Group were more unhappy about the proposal.

"This is not what we voted for when both Tories and the Lib Dems promised to do the right thing in their manifestos. We have been waiting 10 years for justice and we still have not got it," a spokesman said.

The former High Court Judge, Sir John Chadwick, who was asked by the previous Labour government to devise a much more limited scheme, aimed only at those who had suffered "disproportionately", has also .

He was asked to work out how much money was lost because of government maladministration in the way the Equitable was regulated.

Sir John said that the investors' absolute loss should be put at between £2.3bn and £3bn, but the compensation should be capped for each policyholder at between 20% and 25% of that.

After further downward adjustments that would have implied a total payout of between £400m and £500m.

But he also said the relative loss suffered by policyholders, compared to what would have happened if they had invested in comparable pension policies, was in fact between £4bn and £4.8bn.

However, Mr Hoban explained that it would be unfair to use these higher figures, which were due to "the strong performance of comparable life companies", because some investors would receive more than they had actually lost.

"Consistent with the Ombudsman's recommendation, Sir John has advised that relative loss for an individual policyholder should be capped at the absolute loss they suffered," Mr Hoban said.

"If the proposed cap is adopted, then the figure would be £2.3bn to £3bn," he added.

Mr Hoban said the coalition would take Sir John's findings into account, but they would not be decisive, not least because his findings were contentious.

"Sir John's work is an important building block to help the government understand how maladministration led to relative losses at Equitable Life and how that loss can be quantified," Mr Hoban said.

"However, this government has always made it clear that Sir John's review is just one of the building blocks in resolving what is a complex matter and that there are other judgements to be made in determining the final shape of the scheme," he added.

After reorganisations and shrinkage of the closed company, there are now only about 200,000 people still saving with it.

However, the move will affect 1.5 million policyholders, who had about two million policies between them.

Compensation may also be payable to descendants of policyholders who have died.

Chris Wiscarson, Equitable Life's chief executive said: "More has been achieved in eight weeks than in the previous eight years.

"The timetable, the transparency and the total amount stated for relative loss of over £4bn at last represent a proper basis for doing right by Equitable policyholders."