Spotlight falls on insurers' insolvency tests

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The Independent Online

The sharp fall in the stock markets has put some insurance companies at risk of failing self-imposed solvency tests.

And there was evidence yesterday that companies were selling equity-based assets to maintain comfortable levels of headroom over their liabilities.

Traders and analysts said selling by some insurance groups was behind the heavy tradingthat saw the FTSE 100 fall 3.5 per cent in record volumes for the year to date. It was unclear whether any UK insurers were involved in the sell-off.

The selling was apparently prompted by fears the falls in equity markets this week posed a threat to insurance companies' free asset ratios ­ a measure of the degree to which assets exceed liabilities.

In the UK, insurance companies are required to have assets worth at least 4 per cent more than their liabilities, although in practice companies have much higher self-imposed insolvency tests. "They've not done any [selling] until today" said one analyst who declined to be named.

Royal & SunAlliance saw its shares tumble 12 per cent, to 300.75p, while other insurers fell by up to 5 per cent. Fears over the size of payouts in relation to the terrorist attacks added to the downward pressure.

RSA said yesterday it "expected to weather the present storm" through a contingency loan taken out in 1999, initially to cover risks relating to the millennium bug. "Clearly in these markets, it's about meeting regulatory solvency requirements," a spokesman said."Our position is acceptable."

Guidelines issued by the Financial Services Authority instruct insurers to readjust portfolios if a 25 per cent fall in equity markets would jeopardise their ability to cover their liabilities. But, to avoid forcing companies to sell shares into a falling market, the requirements are relaxed if stock valuations fall to certain proscribed levels relative to bonds.

For example, if the market falls between 10 and 25 per cent, requirements could be relaxed if price-earnings ratios are less than three-quarters of the inverse of the long-term gilt yield. On such calculations, insurers are under little pressure at the moment to sell.The watchdog relaxed other criteria last week.

But some sector watchers said investors were being too fearful about insurance companies.

Roger Hill, an analyst at UBS Warburg, said "When you look at long-term free asset ratios, they have been more stable than market movements would suggest. Also, before switching out of equities, insurers would have to consider the long-term interests of their policyholders. Historically, the winners have been the companies that have kept their nerve at times like this, rather than those that have sold."