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Relief at relaxing of reserve rules

The FSA&#39s decision to relax reserving regulations last week has given life offices and the stockmarket some breathing space in a time of falling equity prices.

The regulations were in danger of compounding existing poor market conditions by forcing life offices into selling equities to raise capital to meet rocketing reserving levels.

To ease the situation, the FSA has dropped one of the resilience tests which aim to ensure life offices have sufficient reserves to cover liabilities under certain market conditions. The particular test covered the scenario of a 25 per cent fall in equities alongside a 3 per cent rise in long-term interest rates.

The FSA says this scenario is no longer likely, even with events in the US last week.

Cazalet Financial Consulting principal Ned Cazalet says: “To create the reserve to protect them from the market, companies have been selling in the market, which is driving it down further. But the regulator does not want the resilience test itself to cause a fall in the market.”

Providers have reacted positively to the news and are pleased the FSA is responding dynamically to market conditions.

Prudential group actuary Graham Clay says: “When the market has already changed, you still have to allow for further future changes. It has a cumulative effect and, as things change, the resilience tests become more onerous. This is a perfectly logical step to make.”

The FSA was concerned the tests would trigger unnecessary short-term equity sales as companies struggle to meet the reserving requirements.

Head of actuary&#39s department William Hewitson says: “It would be inappropriate if consideration of such an unlikely scenario were to encourage insurers to switch out of equities into fixed-interest securities at a level which could be to the longer-term detriment of policyholders.”

Such selling of equities could not only harm the stockmarket but could cause policyholders to lose out.

Royal & Sun Alliance chief actuary Mike Kipling says: “We continue to review our asset position. No company likes being driven down an approach simply to meet regulation requirements. If you do change your position, it should be to match policyholder liabilities.”

This is as yet only a temporary measure but the FSA will be consulting on more permanent changes to the tests next year. But the changes do mean that companies have more flexibility to set their own asset

Kipling sees the move as part of an ongoing long-term shift by the FSA towards giving more control to individual companies to manage their own capital requirements.

He says: “Before, there were three scenarios which covered a set of share and fixed-interest moves. Now, actuaries are able to consider other assets and how they might move. What were arbitrary tests of one-size-fits-all for all companies are now more flexible. But it will make financial strength less transparent when comparing company with company.”

Clay says this is part of a move towards the style of regulation used for banks, where each company sets its own risk controls. He says: “It is sensible to remove a specific test which is necessary and gives companies greater freedom to manage their investment strategy as they see appropriate.”

But experts say it does not ease the position of companies in a financially weak position. Cazalet says: “It does not give companies a get-out-of-jail-free card and does not give people more solvency. Some companies may have been making daily adjustments to their asset mix.

“The regulator will be keeping an keen eye on the financial position of some life offices.”


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