In the past, life office financial strength tended to be quoted in a positive light, giving a boost to the company's market ing effort and generally providing an all-round smiley, happy feeling.
Now, though, as global equity markets continue on their meander south and the dust tries to settle on the Equitable Life disgrace, financial strength is being more correctly scrutinised as a measure of proximity to insolvency.
Should we be surprised by this subtle shift? I think not. Growing concerns around the “governance” part of corporate governance have not yet rea-ched US levels but, given the Equitable situation, the less than convincing performance of Independent Insurance and the massive shrinkage in the free asset levels of other UK insurers, the concern is justified.
Even if we consider the first two to be isolated incidents, there are some worrying parallels between Equitable Life and the industry at large. These arise largely around three little words – policyholders' reasonable expectations – an old phrase but one that has taken an increased significance following recent changes to valuation requirements.
Until companies were for-ced to recognise that PRE did not mean the company could slash annual bonus rates to zero and pay no terminal bonus, the garden was rosy. The FSA-prompted change, however, threw in a few thorns.
Indeed, it seems likely that actuarial wizardry is effectively becoming outlawed and that is no bad thing, in my view. But it does have a knockon effect on the financial strength of the sector, at least in headline terms.
When coupled with the perilous state of financial markets, there are few grounds for optimism. When Abbey National was forced to pump £150m into Scottish Mutual's long-term business, fund alarm bells should have begun to ring.
Further pressure on free assets will result from the Sandler review and the recently published FSA review on withprofits. These will collectively expose many of the actuarial nooks and crannies that have been employed for years to generate margin at the expense of policyholders (or PRE). Once policyholder knowledge is increased, you can be sure that PRE will increase too, putting greater pressure on the performance of the fund and the costs of capital guarantees and smoothing.
These will have the further impact of hitting new business levels on this most opaque of structures – once people are aware of what they are really buying in 2002, they will vote with their wallets. I understand that with-profits has provided attractive product terms and long-term returns in the past but those days are over – falling long-term interest rates, grea-ter regulation and diminishing free assets will ensure that.
All of which takes us back to the start – free assets. How many companies have spent the last few years proclaiming that their great financial str-ength will enable them to offer the strongest long-term returns as they will be most able to smooth out the peaks and troughs of stockmarket performance? How many of these companies have reduced their bonus rates and their equitybacking ratio more slowly than the rest of the market?
The reality is that the financial strength was used to fund huge volumes of new business, not to protect the PRE of the policyholders who came on board. Those IFAs for whom with-profits bonds are an attractive sale have pocketed the financial strength in lumps of 7 per cent of their clients' inv-estments while the life offices have simply sought to dilute returns in light of falling markets. The winner is the IFA. The loser is the client.
I do not expect free-asset ratios to fall as rapidly in future because I believe that a reality check has already occurred on recent practices – hopefully for once the industry will learn to operate in a more mature manner rather than simply seek out another scam with which to exploit unsuspecting punters.
David Ferguson is a director at the Abacus