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Warning of low life expectancy for the industry

The financial services industry faces challenges on many fronts. Stakeholder is unlikely to return a profit for the majority of providers, the financial strength of life offices is being squeezed and consumers are rejecting equities for deposit-based accounts.

This gloomy picture is painted in Cazalet Financial Consulting&#39s Life 2001 study of the industry. Influential and outspoken author Ned Cazalet claims a combination of poor stockmarket returns and mushrooming unstable liabilities from guaranteed annuity options is eroding the financial strength of many life offices.

Cazalet also accuses some life offices writing unitised with-profits business, including with-profits bonds, of “living in a fool&#39s paradise” by failing to properly take account of meeting the guarantees embedded within these contracts.

He believes around 40 life companies are affected by guaranteed annuity liabilities, for which they have had to set aside more than£10bn. He points out they have been further hit by regulations requiring them to increase reserves, causing a further blow to solvency he estimates at£16bn.

The study criticises the way that life companies present their accounts, accusing them of “transforming a Mr Bean into a veritable Charles Atlas at the stroke of a pen”.

The Life 2001 study says: “What is extraordinary about that which might, in other circles, be called blatant book-cooking is that in many cases it is unashamedly carried out with the intent of making things seem better than they are (or otherwise might be).”

The scramble for stakeholder market share means providers are cutting margins to the bone to achieve the 10 to 15 per cent market share most accept as necessary to potentially make a profit in around 12 years time.

But the Life 2001 prognosis for the industry is bleak. It says: “There will be stakeholder slaughter, with many more losers than winners, leading to widespread destruction of policyholder and shareholder capital in the industry.”

Scottish Widows senior technical manager Ian Naismith says: “There is an expectation that the future of stakeholder will be formed by the survival of the fittest. I think it is probably true to say there will be more losers than winners.”

Anticipating a continued period of poor equity returns, Cazalet says it will get harder to persuade consumers to shift from deposit-based accounts to take on equity risk for little or no discernible benefit. He slams product providers for using double-digit past performance figures reflecting high inflation and high investment returns to win business from today&#39s investors in a low inflation and low return environment.

He predicts it will become harder to sell equity fund products as past performance figures become less impressive.

But Naismith says: “We certainly do not see any significant signs of investors moving to deposit-based products. We have had a period of low returns but in the long term equities have always performed better and it is often said people should buy when the market is low.”

Although the struggle for stakeholder market share has been widely predicted, Life 2001 spells out statistics that will come as uncomfortable home truths for many life company executives.

Further, Cazalet&#39s criticism of the difficulty in comparing financial strength figures will add weight to the FSA&#39s plans to bring life office accounting closer in line with that of banks.

An upturn in the stockmarkets would see many problems eased but, for the moment, Cazalet&#39s prediction of blood on the life industry&#39s streets seems a fair one.

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