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Moore&#39s code

Here is a solution for IFAs who have the hard job of telling clients in London and the South-east that they cannot get a mortgage because they need to borrow an income multiple of four or five to buy an even halfway liveable place.

Try this out with, say, Abbey National, or perhaps Halifax. When filling in the mortgage application form with your client add in a sum for “future profits” in addition to their salary.

For example, people in professions such as teachers, nurses, doctors, the police, have a fairly well defined career structure. As they gain more experience/training, their salaries increase. The increases are well defined, and highly visible. It works that way for certain jobs in the private sector too.

So if, after filling in the application, the person at Abbey, or Halifax who decides whether or not to lend money says “no, your client doesn&#39t earn enough to borrow this much”, point out that, on the basis of the client&#39s “future profits”, they would satisfy the lending criteria.

Using these future profits, the loan should be approved and the client should be able to move into the home of their dreams, or at least a small studio flat in Hackney, which is about all today&#39s first-time buyer in the capital can afford.

Sound crazy? Of course it is. There are reasons that lenders have controls over how they lend to ensure that customers do not find themselves financially stretched and can comfortably afford the repayments. This is not least because lenders were so cavalier in the 1980s which led to problems such as negative equity and widespread defaults when the economy took a nosedive.

Yet life insurers, including those owned by Halifax and Abbey, are allowed to get away with just the sort of trick I described. An analysis of 16 leading life offices&#39 returns to the FSA show that in 2001 10 life insurers bolstered their balance sheets with notional “future profits” compared with six in 2000.

The amount of mystical money conjured out of thin air also increased to more than £5bn from less than £3bn.

For those who think the analogy with the first-time buyer is stretched, these returns are used by credit-rating agencies, which occupy a similar role to people who say yea or nay to mortgage applicants at the banks for the international money markets, to rate insurers&#39 credit-worthiness. They are also scrutinised by the FSA.

The remarkable thing is this nonsense is perfectly legal under the regulatory framework. It is used by those at the top of the financial strength scale, such as CGNU, whose solvency was boosted last year by a notional £2bn, to Equitable Life (£500m) at the bottom.

IFAs might like to view free-asset ratios with a little more care in future, given that many insurers are bumping them up with money they do not have. The flimflam used by insurers to explain why they do this is justified is typical. “Standard practice,” says Halifax. So that makes it all right does it?

“Our assets are undervalued because of the markets and this gives a more realistic picture of our solvency,” says CGNU.

Really? A look at the stockmarket&#39s overall price to earnings ratio is a useful exercise because it shows how high share prices are compared with the money that quoted companies are earning.

Plotting this against time shows that shares are not particularly undervalued compared with previous periods. That, in fact, they have returned to a rather more realistic level than they were at when the dotcom stupidity reached its height.

So that explanation does not wash. The final excuse I have heard is that the FSA returns make it difficult to make comparisons between one life insurer and another. That methods of valuing assets differ and the use of future profits, or implicit items, levels the playing field. This is when you really start getting into actuarialese, when they do what the best defence lawyers do in fraud trials – confuse the issue as much as possible.

The FSA, it appears, is unhappy with methods of reporting life insurers&#39 solvency. So it should be. John Tiner really ought to go further and come out and tell it like it is. The system is a mess.

PR initiatives such as the ABI&#39s Raising Standards are all very well but the use of “future profits” to boost solvency on regulatory returns shows that insurers are still addicted as they ever were to using dubious practices, understood by only a small circle of people.

Public confidence will only be restored in the life insurance industry when it learns that the obfuscation, confusion and use of murky practices cannot continue.

People have a tendency to respect honesty, particularly from institutions they allow to look after their money. They deserve to be given the truth about these institutions in a clear and understandable form. Life insurers will suffer a credibility problem until such time as this happens.

James Moore is insurance correspondent at The Times

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