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The test of strength

As the time draws nearer to the season of life-office year-ends and with-profits bonus declarations, IFAs (and others) will be as concerned as ever to identify which life offices are on the road to riches and which are on the road to less profitable times.

Financial strength brings investment freedom which in turn offers the potential of higher bonuses.

Financial weakness, on the other hand, will compromise investment flexibility and reduce earned returns, invoking a downward spiral of business contraction and expense inefficiency. The ever-increasing pace of mer ger and acquisition activity may offer the only appropriate solution for such offices.

A major problem that IFAs have faced in the past is how to access and interpret the right information to enable them to judge for themselves who the winners and losers will be.

All too often, they may be left grasping at single-point summaries, such as credit ratings, or wading through a swamp of marketing propaganda and/or bonus manipulation.

Fortunately, for those who have neither the time nor the inclination to examine the life industry&#39s regulatory returns nor to look behind a company&#39s report and accounts, there are software systems out there which offer a practical and welcome solution.


A useful first step – but only a first step – in separating the wheat from the chaff is to understand what each company&#39s solvency position is, in particular, what free assets does each company have over its required minimum (solvency) margin and how big are these free assets in comparison with the comp any&#39s liabilities

A number of such free-asset ratios are possible. While we show several, my own fav ourites are the non-linked free-asset ratio (NLFAR) and the solvency cover.

The NLFAR can be usefully applied to companies writing with-profits business, whether conventional or unitised. It relies on the perspective that the primary objective of free assets is to und erpin guarantees that a company has made in respect of its business, for example, rev ersionary bonuses or annuities in payment.

It also recognises that free assets enable a company to maximise those future ret urns which are needed to pay out those benefits, such as terminal bonuses, that are not guaranteed.

The NLFAR is produced by dividing the free assets of a company by the amount of the company&#39s non-linked liabilities – with-profits and annuities, etc. A high ratio denotes a strong office – one that has plenty in reserve to meet bonus payouts in the future. The figures in the table show the 1999 year-end NLFARs of many of the well known companies in the life and pension industry today.

Another useful indication of financial strength – from a slightly different perspective – is a company&#39s solvency cover. This looks at how many times over a company is able to cover its required minimum solvency margin (RMSM) – again, the higher the better.

In this case, we have found that there is a wide range, from those companies which have only 1.5 times the req uired minimum (Abb ey Life) to those which have as much as 8.9 times (Com mercial Union, as was).

It is helpful when looking at the table to know, for example, that:

l Clerical Medical&#39s position benefited from extra help of £163;500m from its owner (Halifax) during the year.

l Nine companies (including Allied Dunbar and NatWest Life) had a solvency cover of under 2.0.

l The company with the lowest free-asset amount (according to LifeBase UK) is Merchant Investors, with the prin cely sum of £163;3.3m. This contrasts rather sharply with £163;15,631.3m for Prudential and £163;9,435.9m for Standard Life

Three offices – two of which are mutuals – boosted their apparent and comparative solvency somewhat artificially by taking credit for future profits on the in-force business

We have chosen not to include all offices in the table. Some have so much free assets in relation to their new business and in-force business that they are able to spend these on inflating bonus payouts over their underlying asset shares. Whether these distributions of the estate continue into the future is, of course, a very pertinent question. By definition, they will run out at some point.

Business mix

Stricter valuation regulations for unitised with-profits business are likely to lead to a sharp rise in reserves and corresponding reduction in solvency for those companies which have written big volumes of with-profits bond business. It is estimated that an extra £163;15,000m may be required across the UWP providers in such additional reserves.

We look at the mix of new business for each company and distinguish between with-profits and unit-linked, among others. It shows clearly that a small number of life offices rely very heavily on unitised with-profits business. In some cases – but definitely not in others – it could be argued that this is not unconnected with the investment performance of the company&#39s unit-linked funds.

Investment freedom

Some commentators argue that the “real” assets – equities and property – proportion of a with-profits fund is the single-most important measure of a with-profits life company&#39s health and prognosis.

After all, one of the exp ected benefits of financial strength is the freedom that it gives offices to invest their with-profits funds for maximum long-term rewards. Does this follow through in practice?

Business contraction

In the life company world, it is easy to misinterpret a phrase such as “business contraction”. Many would, I suspect, consider it synonymous with declining new business.

The fact is that a company might be writing increased new business but still not gaining enough new business to offset the in-force business that could be falling off thr ough surrenders, maturities, death claims and forfeitures.

Managing the “offs” is critically important. LifeBase analysis shows that the in-force policy count of several offices is actually falling, notwithstanding the support of the traded endowment market, for one. It is also instructive to compare the “off” rates of one company with another.


Inevitably, in a world driven by shareholders on the one hand (maximising profits) and an interventionist government on the other (minimising charges), one cannot help but conclude with an analysis of life office expenses.

It is rare that shareholder interests and regulatory issues coincide but in expense minimisation they do.

Our analysis lays to rest any claims that bancassurers may have to be low-cost or efficient providers. Many of the highest-expensed companies are, in fact, bancassurers. In many cases, this may be as much to do with the high commission they pay themselves as to the inability to obtain critical mass and economies of scale.

Our analysis, I believe, also shows how few companies can really expect to survive in the 1 per cent stakeholder world without a major rest ructuring of their business operations, which many are planning right now.

The fact that, on past form, bancassurers might be exp ected to be among the last to meet the 1 per cent stakeholder limit is, of course, not unconnected with the recently announced proposals for changes in polarisation.


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