Life offices publishing results under the realistic reporting regime are revealing huge differences in the way they back up their with-profits business, according to research by consultant Ernst & Young.
The way that Friends Provident's business model is structured means it has no realistic free assets but relies on risk capital margin and external assets to achieve a 9 per cent solvency cushion on its with-profits book, according to E&Y's UK life insurance companies capital and solvency review of 2003.
Legal & General has only 1 per cent realistic free assets but an overall solvency cushion of 25 per cent, which is higher than all the other major life offices but backed by risk capital margin and external assets not ringfenced within the with-profits fund. E&Y says this is because L&G uses shareholder capital rather than free assets to back its with-profits business.
The average realistic free assets across with-profits prov-iders surveyed in E&Y's report stood at 5.9 per cent of with-profits liabilities. Wesleyan Assurance operates its with-profits business on realistic free assets of 26 per cent.
The figures – covering the 18 with-profits providers which produced realistic accounts relating to 2003 – show total with-profits assets of £258bn and realistic free assets of £14bn after meeting a risk capital margin of £8bn.
E&Y head of life actuarial practice Tim Roff says: “In highlighting their realistic position, some life offices have included additional capital in the shareholder fund and external assets which are not formally allocated to the with-profits fund but which, in extreme con-ditions, could provide fur-ther support to the withprofits business.
“When including these assets in the realistic results, it should be understood that there are usually no restrictions on taking these assets out of the company.”
Friends Provident director (corporate development) Rocco Sepe says: “Our demutualisation agreement with the FSA means equity that we raised to back the fund is protected for the benefit of policyholders.”
Legal & General spokesman John Morgan says: “L&G has said that it remains its firm intention to operate the with-profits part of its long-term fund without the need for external capital support. We are no different from any other insurer as all assets of L&G Assurance Society are there to meet its liabilities.”
Thirteen life offices got waivers relaxing valuation regulations for their with-profits funds – called Tiner waivers – when filing accounts under the FSA's new realistic reporting regime.
The FSA introduced Tiner waivers in 2003 as markets were in freefall because it believed statutory solvency rules for with-profits funds did not show sufficient flexibility to deal with sudden shocks in equity prices.
The waivers enabled life offices to weather market troughs without having to offload equities at the bottom of the market.
Of the 13 companies that had waivers at the end of last year, only L&G and Friends Provident chose not to use them.
The waivers relate to the relaxing of five different FSA rules relating to the use of gross premiums, conditions for equity yields, reinvestment rules, interpretation of when profits can be used and the nature of assets. Only Norwich Union's CGNU Life and CU Life funds obtained waivers on all five rules.
Life offices expect the need for waivers to disappear under the new realistic reporting regime. The existing waivers were last awarded in June 2003 and will remain valid until December 2004, when new waivers will need to be sought.
E&Y head of life actuarial practice Tim Roff says: “Most companies with Tiner waivers were permitted to use the waivers to reduce their regulatory liabilities.”
Norwich Union head of with-profits management David Riddington says: “Tiner waivers were a temporary measure as we move towards the new realistic reporting regime. Some companies that did not apply for waivers would not have done so because they were not geared up to do the sort of arithmetic needed to get a waiver in the first place.”