FSA chairman warns of threat to insurers from further downturn in stock markets

Sir Howard Davies, the chairman of the Financial Services Authority, warned the City yesterday there was no certainty life insurers could make it through a worsening stock market downturn.

But while unable to rule out a life insurance failure, Sir Howard said most insurers could survive further drops in the FTSE 100 without breaching the regulator's solvency rules. These ensure life insurers have a cushion of funds above what they need to pay their customers.

His words come as Axa yesterday became the first major insurer to announce the inevitable drop in its annual bonus rates for with-profits policyholders. Life and pension policyholders with Axa Sun Life will see annual bonuses come down 1 per cent to 3 per cent. Bond customers will see their payouts cut by between 4 and 5 per cent. Exit penalties are also being increased.

"Down to 3,500 points does not seem to be a problem. Many of them are happy down to 3,000, but of course one can never give an absolute guarantee that there could be no failure," Sir Howard said.

The FTSE 100 lost a quarter of its value in 2002. As insurers hold most of their assets in equities – in some cases as much as 75 per cent – three years of stockmarket declines have stretched their finances to the limit.

In October the FSA moved to reassure investors the life insurance sector was keeping its head above water in the face of nose-diving stockmarkets. It asked the 20 largest insurers to value their assets and liabilities on a "realistic basis", which takes account of future investment performance. With the FTSE 100 then at 4,000, it found the companies had "significant ability to withstand further large falls in equity values".

Many insurers, including Prudential, Friends Provident and Standard Life, have had to make interim cuts to bonus levels, which are normally set once annually, at the beginning of the year. Policyholders in the coming few months are set to see much reduced bonuses.

As well as reducing bonuses, insurers have sought to shore up capital by other means, such as lowering their equity exposure to less volatile securities and withdrawing from costly lines of business.

Analysts believe the larger quoted insurers will have sufficient assets to withstand further falls, but some of the smaller companies may find staying in business increasingly difficult. Equitable Life has been seen as most at risk of going under, despite drastic cuts to policyholder funds and switching out of equities.