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A consumer&#39s view

The FSA is facing the biggest test of its abilities and nerve since it came into being.

If it fails this challenge, it could result in a total collapse in consumer confidence which will have disastrous consequences for the retail investment industry for many years to come.

Falling share prices have left many of the life companies in a dangerous position as they face diminishing solvency margins. Meanwhile, several of the split-capital investment trusts have already gone bust, leaving investors with nothing.

The investment trusts&#39 debts are greater than the value of their assets and investors are pulling out of unit trusts, discontinuing pension contributions and cashing in life policies in droves.

The handling of the Equitable Life affair does not augur well. Senior officials at the FSA who regulate the life companies are the same individuals who failed to act as long ago as 1998 when the problems over guaranteed annuities were already known to the regulators at the DTI.

The FSA officials even failed to stop Equitable Life from taking on new business. Will they have the courage to act decisively this time?

Arguably, several of the life companies are already technically insolvent. The recent Money Marketing survey carried out by accountants KPMG paints a dire picture.

Australian Mutual Provident, which took over Pearl in 1989, handed over some £918m in “orphan assets” which would now come in handy had it not paid it all to the parent company.

The regulators at the DTI simply rubber-stamped the move. AMP&#39s offer to repatriate about £400m to boost Pearl AMP&#39s ailing financial position is not before time.

Pearl AMP&#39s free-asset ratio of -0.9 can only be improved upon by what the man in the street would call dodgy accounting – writing into the figures future profits.

The fact that future profits are allowed to be counted at all will come as a nasty shock to investors and does not say much for the regulator&#39s diligence in monitoring life company accounts. Admittedly, a little late in the day, it has been announced that counting future profits will be phased out by 2009.

Accountants have for some years been calling for a new Insurance Companies Act to standardise life companies&#39 accounts. A survey carried out in the late 1980s concluded that their figures were little better than “smoke signals”.

Transparent they are not, with companies frequently changing the basis of their accounting and no two companies&#39 accounting for their business in the same way.

Four other companies have free-asset ratios of under 1 per cent – Sun Life, Equitable Life and Cornhill with the industry average a miserable 5 per cent. With the FTSE 100 index plunging well below 4,000 last week, it is fast app-roaching the critical 3,500 level, where life companies are in real trouble.

The FSA already relaxed the resilience test in September 2001 and again on June 28 this year. To bend the rules still further could easily result in life companies trading while technically insolvent.

What does the FSA propose to do about this? Equitable Life already faces a court action for misselling brought by policyholders who bought life policies between the autumn of 1998 when the Department of Trade & Industry knew of Equitable&#39s guaranteed annuity problems and the spring of 2001 when disaster struck.

Many more such actions will undoubtedly be brought if the FSA allows life companies to trade while insolvent.

But unless share prices pick up fairly soon – which seems highly unlikely, given President Bush&#39s declared intention of dealing with Saddam Hussein in the autumn, not to mention the holiday season, when nobody deals – the FSA will have to act.

Its difficulty is that any moves to prevent companies which are insolvent from taking on new business could precipitate the very disaster it is trying to avoid.

If investors panic and start cashing in their life policies and unit trusts en masse – which could easily happen if the bear market continues – then the life companies would be forced into a mass sell-off of equities which would depress the market still further and have a domino effect on other institutions.

This is probably the worst crisis the FSA will ever face. Its handling of it will have farreaching consequences for savers and society as a whole which could reverberate over many decades to come.

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