Life assurers join the selling frenzy as stock market retreat turns into a rout

Financial turmoil: FTSE 100 plunges 5.4 per cent as equity markets around the world go into freefall

Life insurance companies were yesterday thought to be some of the biggest sellers of equities, as they fought to maintain sturdy reserves in the face of the dramatic decline in the stock market.

Rumours swept through the City that life insurers, whose assets account for 20 per cent of UK equities, were adding tailspin to the plunging market as they offloaded equities in favour of safer fixed-income investments.

The FTSE 100 plunged 229.6 points to close at 3,994.5 yesterday as the main market gauges on Wall Street also dived. The Dow Jones fell as much as 5 per cent to 8,245 before staging a dramatic rally in late trade that left it down just 45 points at 8639.

As the FTSE 100 fell to its lowest level since December 1996, Britain's biggest insurance companies rushed out statements stressing that they were not close to breaching their solvency requirements and were not forced sellers of equities.

But insurers were widely thought to have sold more shares in order to be prudent. Defined-benefit pension funds were also thought to be major sellers, after a number of providers have decided to switch into bonds in order to ensure their assets match liabilities.

Life insurers technically only have to have 4 per cent more assets than liabilities in order to be solvent, but that level is viewed by the industry and regulators as completely inadequate if companies want to function properly, with enough capital to write new business.

Most life offices in fact make sure that assets are at least 10 per cent greater than liabilities. While insurers might not technically be forced to sell equities at the moment, because their solvency cover is still above 4 per cent, a number feel it is prudent to buy bonds in order to stay above 10 per cent.

The Financial Services Authority would not comment on yesterday's falls in the FTSE 100, but it is monitoring the state of the insurance sector, and particularly the life offices, very closely. The FSA has already tampered with its resilience test, which monitors solvency, a number of times in the past few months in order to avoid insurers having to sell large tranches of shares and thereby forcing the market down further.

The City watchdog denied that it was considering suspending the resilience test altogether. But it has come under pressure in the past from insurers to relax the rules and could make further changes.

Aviva, the recently renamed CGNU, said: "We remain in a position of relative financial strength and we are not a forced seller of equities." Royal & SunAlliance and Prudential also said they were not in a position where they had to sell equities in order to shore up reserves.

But analysts believe most insurance companies have been selling shares for some months and the trend is accelerating.

Ned Cazalet, an independent life insurance analyst, said: "There is not a whole load of people rushing to sell now. They have been selling for a while ­ that is partly why the market has not really gone up. But the selling trend is accelerating as people who were betting on the market rising have now started to sell."

Mr Cazalet said the continued trend off falling markets was "monumental" because it marked the end of the era when companies could base their business on offering guaranteed payouts backed by expectations of high returns on equity investments.

This applies both to life offices, which have run into trouble recently as they have tried to ensure that they can meet promises made in the 1980s and before. It also applies to defined-benefit pension funds, which could easily pay out generous pensions for much of the 1990s because of the bull market.

The spotlight has been on insurers for some months, after two years of falling markets have left them at one of their weakest points since the 1970s.

Insurers which have sold significant tranches of shares include Prudential, which transferred much of its portfolio into bonds two years ago, and Britannic Assurance. Boots moved its pension funds' assets into bonds a few months ago.