Life Insurers' Financial Strength
Life assurance companies' returns to Financial Services
Authority:
a preliminary survey
by Chris O'Brien, Director, Centre for Risk and Insurance
Studies,
Nottingham University Business School
A preliminary survey of life assurance companies' returns to the Financial Services Authority confirms that policyholders should expect lower bonuses as a result of reduced investment returns.
The survey covers the 20 top with profit funds1. It shows that many companies have continued to increase their funds under management, and that, at the end of 2000, the free assets ratio2 of many companies was lower than in 1999.
Bonuses to with profit policyholders reflect, inter alia, investment returns and the surpluses which companies have. Companies have approaches to smooth payouts to policyholders. However, the FTSE 100 index reached a peak of 6930 on 30 December 1999 and is now (9 August 2001) about 20% below this. It is against this background that, not unexpectedly, many companies have already reduced bonuses.
The industry, through the Association of British Insurers, has recognised the need for improved communication with policyholders; and FSA, as part of its with profits review, is looking for better information for policyholders about the progress of their investments. The actuarial profession has also been considering improvements to the transparency of with profits business.
The annual returns which companies make to the FSA set out, inter alia, their assets and liabilities, and the required solvency margin. These can be used to calculate a number of ratios. This note refers to the "free assets ratio"2 Different ratios have different characteristics and none is ideal. We note that companies may have access to other assets to support their business. As regards the liabilities, the regulations prescribe a number of calculations, using a methodology which many would say is prudent but also artificial. Furthermore, the regulations require that the assumptions used are also prudent, leading to margins in the calculation. We need to recognise that companies carry out the calculations in different ways, and make different assumptions. Companies also have varying reassurance arrangements, which can affect the figures.
In the year 2000 there were a number of changes in the Insurance Companies Regulations, which, in many cases, have effectively meant that the degree of prudence in calculating the liabilities has increased. The outcome is that many companies have seen the value attributed to their liabilities increase. Liabilities will have also increased as a result of lower rates being used to discount future claims, as a result of reductions in rates of interest (for example, the yield on the 15-year gilt index reduced from 5.22% to 4.60%). Also taking into account that assets will have been affected by reductions in share prices (the FT-All Share Index fell from 3141 to 2964 in 2000), it is not surprising that the free assets ratios of many companies have reduced.
Bearing in mind that the standard valuation of assets and liabilities typically contains significant margins for prudence, the regulations allow companies to use "implicit items" (typically what is referred to as "future profits") in certain circumstances. Many companies choose not to do so, or to use less than the maximum amount that would be permitted.
Simple comparisons of free assets ratios should therefore be treated with extreme caution.
Nevertheless, this preliminary survey confirms that changed economic conditions have had an impact on life offices, and it is also to be expected that they will affect policyholders through bonus rates.
Chris O'Brien
9 August 2001
1 The with profits life offices with the highest admissible assets at the end of 1999
2 Using form 9 of the returns: line 21 (long-term fund admissible assets) plus line 22 (other assets) minus liabilities*, minus required solvency margin, expressed as a proportion of liabilities. *Liabilities are the sum of lines 23 (mathematical reserves) and 24 (other liabilities).
Financial data on insurance companies is also provided by Standard & Poors
6 Year-end 15 November; otherwise, figures are at year-end 31 December
