View more on these topics

A less FAR-sighted approach

In the current economic climate, policyholders and financial advisers are understandably concerned about the future viability of life insurance companies. Since insurers&#39 FSA returns for 2001 were made publicly available, many press articles have championed free-asset ratios as indicators of financial strength.

However, in an issues paper on regulatory reporting published by the FSA last November as part of its with-profits review, the regulator warned that a meaningful comparison of free-asset ratios is not straightforward. This is because the ratios are affected by factors such as the basis used to value liabilities, the mix of assets held, the use of financial engineering, the existence of any inadmissible assets and the mix of with-profits and non-profit business. Similar concerns about FARs were expressed more recently in the Sandler report.

The issue is further complicated by the absence of a standard formula to calculate FARs from figures in the form 9 solvency statement. Some formulae include the solvency margin in the free assets while others exclude it. The free assets can then be compared with the company&#39s assets or with its liabilities. The latter will produce a higher ratio.

These factors are highly significant. Standard Life&#39s 2001 FAR could be as low as 5 per cent or as high as 20 per cent depending on the formula used and the mix of other variables listed above.

Current confusion thwarts the FSA&#39s aim of improving consumers&#39 understanding of financial matters. Therefore, it was hardly surprising when the FSA proposed in late July that two additional forms, 9A and 9B, should be required to supplement the information disclosed in the existing form 9 in the returns of insurance companies and friendly societies.

Form 9A would analyse the effect of financial engineering. Companies would have to clearly detail the effects of financial engineering on their solvency statement. For this purpose, financial engineering would consist of implicit items, financial reinsurance and contingent loans but not subordinated debt, which is regarded as core capital.

Form 9B would be an analysis of companies&#39 with-profits funds on a stand-alone basis, with the effect of financial engineering again shown explicitly. The form would end with a statement of with-profits funds&#39 FARs using a defined formula.

Full details of this proposal are given in CP144, A new regulatory approach to insurance firms&#39 use of financial engineering. The closing date for comments is October 31. However, the FSA has stated that it intends to bring these reporting changes for life insurance business into effect in time for companies&#39 2002 returns. It expects this information will improve comparisons of life insurers&#39 financial strength.

The FSA has also taken the opportunity in the consultation paper to remind companies that the prohibition on making misleading promotional statements applies to statements made about financial strength.

The proposed changes will make a significant improvement to the current state of disclosure on financial strength but will still leave several aspects requiring consideration and investigation.

Focusing solely on FARs is rather like underwriting simply on proposers&#39 height-to-weight ratios without regard for their sex, age, smoking habits, family history and so on. What are some of the other factors that should be taken into account once FARs become more regularised?

The value of liabilities will continue to be influenced by the asset mix because shares generate a lower discount rate (and, hence, higher liability values) and suffer a harsher resilience requirement. So, the FARs of with-profits funds will have to be considered in the context of the funds&#39 assets.

What about the mortality assumptions, particularly for annuity business? Are a company&#39s assumptions weaker than those used by its peers? How do its expense levels compare?

There still remains the fundamental issue that solvency statements are but snapshots of a point in the past. Advisers and their clients are more interested in the future than the past.

What are the company&#39s future strategies? Are they realistic and does the company have the management skills and the finances to achieve them? Could its investment strategy, the quality of its customer service or its sales volumes be adversely affected?

These important issues are taken into account by Moody&#39s and Standard & Poor&#39s. It is these company assessments that should be scrutinised by advisers to gain a meaningful picture of a company&#39s strength, financial or otherwise, not the crude and simple free-asset ratio.

Recommended

NU moves into structured bond arena

Norwich Union is entering the structured product market with a four-year monthly or annual income bond linked to the DJ Eurostoxx 50 index of leading European companies.The Prosper bond, which opens for investment this week, guarantees an annual income of 6 per cent paid monthly, annually or as a lump sum on the day before […]

Poor&#39s enters Fof market in link-up with Schroders

Ratings agency Standard & Poor&#39s is entering the multi-manager market through an exclusive agreement with Schroders to offer IFAs and financial institutions a global funds of funds service.In a major departure from its core business, S&P is reass-essing funds that it has already rated to create a panel of recommended products for which Schroders will […]

How surveys seek signs of subsidence

When it comes to predicting the future of the property market, two distinct camps are emerging. Some sources say there are no signs of an imminent crash while other reports herald the end of the house-price boom.HSBC economist John Butler says many new reports and surveys on the property market should be taken with a […]

MCCB admits only 60% will hit exam deadline

The Mortgage Code Compliance Board has revealed that just 50,000 of the 84,000 advisers registered will qualify by its December 31 exam deadline.The MCCB believes this figure is sufficient to protect the public.But broker franchise Mortgageforce warns there could be consumer detriment if it is mainly independent brokers who are forced out rather than those […]

Health - thumbnail

Absence management systems gone AWOL from UK’s SMEs, reports Jelf

A quarter (23 per cent)* of the UK’s small to medium-sized enterprises (SMEs) do not have an absence management system in place, according to new research from Jelf Employee Benefits. Despite 69 per cent* of organisations having a system in place, three-quarters (75 per cent) report that it is not providing them with sufficiently empowering absence or health data to inform an effective wellbeing programme.

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment