FSA puts watch on Royal & Sun solvency

City watchdog fears FTSE 100 fall to 3,500 level could inflict severe pressure on sector

Royal & SunAlliance, the cash-strapped insurance giant, is holding frequent talks with the Financial Services Authority in a bid to reassure the City regulator about its financial strength.

The FSA is thought to be concerned about the insurer's reserves, and has been monitoring liabilities on its books such as guaranteed-annuity policies, which promise to pay policyholders a fixed sum, and future asbestosis claims.

The City watchdog has been keeping a close eye on RSA for sometime. It is understood that it has become even closer to the company in recent weeks after it emerged that RSA was planning to try to raise around £1bn through a rights issue and also sacrificed its chief executive, Bob Mendelsohn, following criticism of its performance.

The fundraising has yet to be announced but speculation that the insurer needs such a large sum has prompted fears that it needs the cash to shore up its existing business as well as to finance new business.

Due to these fears, the regulator has been exercising its right to a "close and continuous relationship" with the company. The FSA never comments on specific companies, but it is always keen to be in regular contact with struggling companies, such as the mutual life assurer Equitable Life, which it made daily calls to at certain points last year.

The FSA's interventionist approach towards RSA – the UK's fourth largest insurer – is consistent with its new "risk-based approach" to regulation. This requires the FSA to spend most of its time looking at companies with large numbers of policyholders because they would have the biggest adverse impact on the public if they went bust.

A spokesperson for RSA denied that the insurer was in "crisis talks" with the FSA, saying: "They know our plans and are kept informed of any developments."

The insurer, which is expected to announce a rights issue on or before its third-quarter results on 7 November, is considering appointing external consultants to assess various parts of its business to give credence to its own estimate of liabilities.

Areas it might tender for external consultation include its pension fund, which is thought to have a funding gap, and its life fund, which contains the problematic guaranteed-annuity policies similar to those which brought down Equitable Life.

RSA stressed this was not an unusual step to take, saying "companies employ consultants to look at their business all the time". However it is thought that the consultants' views would be used to boost confidence that the bulk of money raised through RSA's intended rights issue would not be used to fill existing holes in the balance sheet.

The volatility of current market conditions and the fresh falls of the FTSE 100 have prompted renewed concerns by the FSA about the insurance sector. It takes the view that the industry could cope if the FTSE fell to 3,500, but that it would be under severe strain.

Sir Edward George, Governor of the Bank of England, echoed this cautious tone, saying he was "monitoring very closely" the risks posed to recovery prospects posed by ailing stock markets.

Speaking at a Birmingham conference organised by the Institute of Chartered Accountants, Sir Edward sounded a more upbeat note than previously, saying there were tentative signs of a recovery in manufacturing. "Looking forward, there is a reasonable prospect that global demand will pick up gradually," he said.

Separately, the UK's largest mortgage lender, Halifax, said the top end of the housing market continued to be very strong, reporting an 11-fold increase in the number of houses being sold for £1m or more since 1995.

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