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Verity&#39s VIEW

Since last week&#39s events in the US, there is a curious problem for anyone who tries to describe the financial landscape emerging from the destruction of the World Trade Center and the mass murder that went with it – language.

Words like “disaster”, “outrage” and “tragedy” have been previously applied so frequently by the press to events so trivial they have almost lost their linguistic force.

The habit of exaggeration in the past has robbed us of the means now to describe what happened with words that even approach the magnitude of horror.

The same applies to the markets. It is unfortunate that we are so used to applying aerial metaphors to the markets. When they are not “soaring”, share prices “dive”, “plunge”, “bomb”, “plummet”, “crash”, or “collapse”.

Anyone who wants to avoid offending the bereaved, trivialising their plight by using the same terms to describe share price movements, has to abandon that language.

I am writing before the re-opening of the New York Stock Exchange, so the financial consequences of last week are yet to be played out. But serious they will surely be. Already, on Monday, September 10, the FTSE 100 had hit a fresh three-year low. Anyone who bought a tracker fund four years ago has made barely any money at all.

But the biggest impact for the retail financial services sector has to be on the financial strength of life offices.

On Tuesday morning, the FSA had already taken a significant step. The stockmarket was nearly 30 per cent off its peak.

The tough “resilience test” requires life offices to have sufficient reserves to remain technically solvent if the market were to fall by 25 per cent (beyond what it has already lost). If their reserves are not sufficient, they have to sell equities and buy gilts.

That triggers off a vicious circle – depressing the market, depleting reserves and causing further equities to be sold.

Sensibly and pragmatically, the FSA temporarily suspended this rule. The last time it did so was in 1998, when the giant hedge fund Long Term Capital Management failed, just after the devaluation of the Russian rouble.

At least before 1998, the markets had been rising. Now, with the high-tech madness having come and gone, equities have lost a quarter of their value over two years.

I spent Wednesday explaining to my BBC colleagues why market value adjusters are only the most visible sign of how market slumps affect life offices.

Some had outrageously suggested that Equitable had “sneaked out” a rise in its market value adjuster from 7.5 per cent to 10 per cent, counting on media attention being distracted. Nonsense – Equitable is facing a huge outflow of funds and has to protect those who remain as much as it can.

Good luck to Vanni Treves pulling off a compromise deal with GAR policyholders – it will not be easy.

MVAs, after all, are hardly the worst of all financial evils. With a few exceptions, such as Standard Life, almost all life offices have been forced to protect their remaining policyholders with MVAs of between 5 and 10 per cent.

If customers truly are in it for the long term, market value adjusters should not trouble them any more than a slump in share prices should (unless prices stay slumped for years to come). And customers who do not vary the terms of their contract should, of course, avoid them.

More pertinent, perhaps,is the fact that so much of a life insurance contract&#39s projected payout is now down to term-inal bonus.

Falling stockmarkets have drained the weakest life offices of their strength. Can an IFA happily recommend the numerous life offices which are thinly capitalised?

True, any policyholder would rather have been in a with-profits investment for the last three years than, say, a FTSE tracking fund. But confidence in with-profits investments as a whole is being irresistibly undermined.

The farce at Equitable Life, the imposition of MVAs and the increased reliance on pur-ely discretionary terminal bonuses have all had their impact. But worse still are the prospects for the imme-diate future.

According to financial strength guru Ned Cazalet, some life offices have so little capital left that a cliche containing the phrase “bargepole” is appropriate. With so little room available for manoeuvre, we can expect terminal bon-uses to be slashed.

Further, many offices will have to raid reserves to pay reversionary bonuses, leaving some with almost nothing left to support the heavy up-front cost of writing new business.

That applies especially to business such as stakeholder pensions which requires a big outlay up front that will not be repaid for years.

Equitable&#39s isolation, as the one recent example of a life office forced to close to new business and sell whatever it can, may soon be over.


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