Vital questions to ask of a life policy

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The Independent Online
WHENEVER savers invest their money in an insurance com-pany's personal pension scheme or an endowment policy, the two most common questions they should ask are about the performance of its fund and the charges levied on it.

It is easy to see why performance is vital to an investor. Charges have also come under the spotlight, given the impact they may have on final payout. There is one other factor that savers should consider - a company's financial strength.

Companies are required to supply this information monthly to the Department for Trade and Industry, which takes into account their assets and any outstanding liabilities.

Ned Cazalet, managing director of London-based Kingfisher Asset Management, is the author of a recent study on the financial strength of 35 life companies. He recommends asking the following questions:

What is its free asset ratio?

This is the term used to describe the assets of a company. A company's FAR is calculated by its returns to the DTI. The way of doing this is to deduct the discounted present value of a life company's liabilities from its assets. The result is expressed as a percentage of the assets. The bigger the FAR, the more is tucked away for a rainy day. However, Mr Cazalet warns that FAR alone is a crude way of assessing strength. Other factors need to be taken into account.

What is a company's business mix?

Companies with a substantial proportion of with-profits business need a substantial amount of money in their funds to take account of future annual and terminal bonus payments to policy-holders. They also need money to fund new business activities, the more the better.

Many insurers also write other business, such as term assurance where there is a mortality risk but less of an investment risk.

If companies write so-called 'unit-linked' business, this should not impact on the long-term life fund. This is because the performance risk in unit-linked investments is carried directly by savers. Some firms remove unit-linked business from their FAR.

What is the company's bonus philosophy?

Many life companies have changed their bonus structures so they pay a lesser proportion of a sum assured, the guaranteed element of with-profits plans. They are deferring the build-up of this locked-in value.

Often, the greater the terminal bonus content of maturity payments, the greater the potential uncertainty of proceeds payable to policy-holders. That is why there is a need for a higher FAR in such cases.

What extra provisions is the company making?

Some life companies make additional provisioning in their funds for eventualities such as Aids claims. Earlier fears of heavy claims have not materialised, so provisioning is now being gradually released.

Other companies also set aside reserves to meet any liabilities for capital gains tax and, in a small number of cases, for terminal bonus payments. Identifying this provision makes it easier for an adviser to calculate the company's FAR.

What is a company's resilience test?

Companies also make provision for extreme levels of volatility on a fund's underlying assets. The figure is based on different assumptions of future changes in the price of equities, property assets and fixed-interest yields.

What is a company's new business activity?

Strong new business flows are a source of future profits. They also help to produce economies of scale in respect of administration costs.

Companies that do not attract enough new business will have to use more of their funds to look after their core of policy-holders.

The other side of the coin, however, is that if a company vacuums up a lot of new policy-hold- ers, particularly those who pay regular premiums rather than lump sums, the cost of acquiring them will deplete reserves.

Who owns the company?

Mutual companies are owned by their policy-holders,which means they only have their own resources to develop. If they get the balance wrong between solvency, investment expenses and new business, the financial strain could lead to them being taken over.

Against that must be measured the commitment of a proprietary company towards the life insurer it owns. Life Association of Scotland was part of ING, a giant Dutch insurance group. But many observers felt it was never part of ING's core business. It was taken over by Britannia Life, a highly valued part of Britannia Building Society.