Outlook: Life asssurance companies feel the heat as markets melt

Railway bizarre

Share prices among Britain's major life assurance/insurance companies are looking about as sick as an Equitable Life pension, and it is not hard to see why. The stock market is bombing, threatening solvency and alienating savers, public confidence in the industry is at rock bottom after a series of high profile débâcles and, to cap it all, the big savings institutions are subject to half a good dozen (no exaggeration) government-inspired investigations and reviews, all of which promise upheaval of some sort. No wonder shares in the FTSE 100's four big assurers – CGNU, Prudential, Legal & General and Royal & SunAlliance – are now lower than they were in the immediate aftermath of 11 September, markedly so in the case of the first of these companies.

From the outside, the industry seems to be in a right old mess. News that Abbey National has been forced to pump a further £150m of capital into its life offshoot, Scottish Mutual, has added to the hysteria that surrounds the sector. To most outsiders, the fact that life assurers have routinely begun to use assumed future profits to shore up their solvency margins has come as a revelation, and makes matters seem more worrying still. Equitable Life has demonstrated that even the most trusted of life companies can go horribly wrong. Are others about to go the same way?

Some smaller life companies may yet be forced to close to new business. Quite a few, besides Equitable, already have. Warnings like the one from WPP yesterday that there may be no pronounced recovery in the advertising market until the Presidential elections and Athens Olympics in 2004 make the outlook for stock markets seem dire, piling on the pressure for life assurers, and further alienating already damaged investors. Even so, at this stage there is no reason to think the larger companies are about to suffer some life threatening cash crisis.

Abbey National is being forced to recapitalise Scottish Mutual because the life arm has always been run with minimum capital on the basis of a guarantee from the financially healthy parent company. HBOS may find itself in a similar position with Clerical Medical, which has been expanding fast in recent years and where there is a consequent appetite for more capital.

Use of future profits in solvency returns has produced a further bout of the heeby jeebies, but in most cases there's limited justification for it. The rules, many of which are out of date, require highly conservative reserving by life companies to ensure they are capable of meeting future liabilities. In Britain these rules are more demanding than they generally are elsewhere. With normal mortality and interest rates, the life fund is bound to deliver some degree of future profitability, so although it may seem dangerous to rely on profits yet to be earned, in the case of life assurers, it may also be reasonable, especially since the effect is merely to compensate for rules which in other respects may be unnecessarily onerous.

Even ignoring the £2bn of future profits included by CGNU in last year's solvency return, the life assurer's reserves are about two and half times the legal minimum. The Pru and L&G don't use future profits at all in their solvency calculations, so their position looks correspondingly healthier. If the FTSE 100 continues to fall steeply, and stays depressed for some years, then these companies will be in trouble. But so will everyone else too. Some industry leaders are privately spitting tacks over widely reported remarks last week by Sir Howard Davies, chairman of the Financial Services Authority, to the effect that alarm bells are ringing about the financial health of life assurers. Never mind the fact that what he actually said was a little bit different. "So alarm bells are ringing", suggested the interviewer. "I hear them", said Sir Howard.

The comment has none the less further damaged confidence in an industry already reeling. Likewise the forthcoming Ron Sandler report on the savings market, widely billed as another giant blow to the life assurance industry. In fact, Mr Sandler's primary purpose is that of rebuilding public trust in the savings market through the introduction of proper rules on transparency and accountability.

The effect will be to reduce the profitability of some products, but it won't destroy the industry. Nor can it if the Government is serious about wanting to bridge the savings gap. With everyone so jumpy, regulators, government and their agents have to be more careful than ever about what they say and do. No one is suggesting they should attempt to cover up the truth, or pull their punches on an industry in serious need of modernisation and reform, but it helps no one to have a blind and unnecessary panic, least of all, the saver. Don't forget, this is an industry which has been largely insolvent once before, during the oil shocks of the mid 1970s, but survived to fight another day never the less.

Railway bizarre

Students of railway history will recall that just before Stephen Byers pulled the plug on Railtrack, the company was limbering up to ask the taxpayer for another £5bn to keep the network going. Some time later this week, lawyers permitting, Mr Byers' successor, Alistair Darling, will announce that Railtrack's successor, Network Rail, will get an extra £10bn to make sure the trains run on time while Railtrack shareholders end up with 250p a share in compensation.

It makes a joke of the Government's original assertion that Railtrack was costing the country too much and that the new not-for-profit organisation chosen to replace it would do an altogether better, cheaper and more cost efficient job for the taxpayer. Ian McAllister, the ex-Ford man brought in to run the railways, has taken one look at the state of the network and its investment needs going forward, and realised what his predecessors at Railtrack knew all along – train sets are expensive businesses.

He has also recognised that if Network Rail is to go into the financial markets to raise billions more on top of the money it will receive from taxpayers and train operators, then it needs financial security and regulatory certainty. Admittedly, some of the extra funding will be needed to pay for the escalating costs of projects like the West Coast Mainline, which Railtrack had badly under-estimated. A little over half the £10bn will also be in the form of contingency funding, which Network Rail will only be able to draw on in extreme circumstances – say if the network suffers a series of Hatfield-style disasters in quick succession.

But part of the £10bn represents money which will be available to Network Rail if the Rail Regulator Tom Winsor refuses to allow the company as much money as it asks for in its interim funding review. So much for independent regulation if Mr Winsor can be second-guessed in this way.

The simple truth is that the railways will cost the taxpayer every bit as much – and probably more – with Network Rail in charge and Mr McAllister on the footplate. That's not just directly, through straightforward capital grants and access payments, but indirectly, through the higher amounts the City will charge Network Rail in return for providing it with finance. What therefore was the point of pulling the rug from under Railtrack, other than as a piece of supposedly popularist butchery? One for the students of railway history to ponder.

jeremy.warner@independent.co.uk