[A-List] UK pensions crisis, consolidation and privatisation

["Keaney Michael" <Michael.Keaney@xxxxxx>]

Stock market meltdown threatens to claim scalps of smaller life
companies
City watchdog puts more insurers on insolvency watch as fear of failures
grows
By Katherine Griffiths
The Independent, 14 June 2002

Life insurance companies have been fighting a particularly nasty virus
that has attacked their share prices over the past few months, brought
on by poor investment returns and an annoying desire by the Government
to intervene by changing the rules governing the industry. While the
entire industry is feeling the pain, observers believe that more months
of gloom will spell the end of the road for many of its smaller players.

The last few years have seen big insurance companies and banks snap up
smaller life offices, such as Abbey National's acquisitions of Scottish
Provident and Scottish Mutual.

This was mainly a response to the unprecedented pressure companies are
under to offer products such as stakeholder pensions at rock bottom
charges - an objective which is only possible to achieve profitably on a
very large scale.

But observers believe this wave of mergers will not equip insurers to
cope with the ongoing problems of stock markets which continue to fall
and potentially costly demands that may come out of Government reviews
on a range of subjects that are in their final stages.

Times have been tough for the insurance industry as a whole in recent
years. Because underwriting frequently makes a loss, insurers
historically have relied on investment returns to make money. So falling
stock markets have hit hard.

The life industry has suffered particularly because its performance is
closely tied to equity returns and, in the case of with-profits
products, requires large layers of extra capital to underwrite returns
to policyholders. Unlike companies offering general insurance such as
motor and property cover, life companies were also disadvantaged in the
aftermath of 11 September since when they have not been able to hike
premiums.

The difference is reflected in the direction of insurers' share prices,
with non-life companies experiencing a steady rise this year as
investors have been keen to benefit from the higher prices general
insurance is generating, while life companies have been under a cloud.

Despite these obstacles, many small life insurers have so far managed to
survive along with their bigger competitors. Roman Cizdyn, an analyst at
Commerzbank, points out that the UK life insurance market has seen far
less consolidation that its Continental counterparts, saying: "In
Britain the biggest companies have a bit more than 10 per cent of the
market [each]. On the Continent the number one player alone would have a
market share in the 20s."

Part of the reason for the slower pace of consolidation in the UK is
that its with-profits structure has enabled many small mutually-owned
organisations to keep going because they have, over decades, built up
reserves known as orphan assets, which they have been able to dip into
to underpin current losses in the last few years.

But all insurers' reserves invested in equities have been eaten away in
the last two-and-a-half years and observers suspect smaller companies
are about to reach the bottom of the barrel - leaving them with the
options of closing to new business or running out of cash.

The former option would not be welcomed, but would be a lot more
appetising for companies and for policyholders. Closing to new business
would not have a particularly negative effect on policyholders, because
companies would have to run their funds for customers until their
policies matured.

Richard Burden, an analyst at Goldman Sachs, said: "The big will get
bigger and the small will get smaller and disappear because of the
pressures in the market."

The consolidation could take several forms, and is likely to be driven
to a degree by giants such as CGNU, Prudential or Standard Life snapping
up small businesses that they can squeeze some profits out of.

But another likely scenario is that large insurers will not have to
bother buying their smaller rivals because sooner rather than later many
small funds will have no choice but to close their with-profits funds to
new customers and then run off the business over several years.

"Bigger companies are already getting more new business proportionately
and it looks like they can simply fill the void left by smaller
companies by putting more business through independent financial
advisers - they won't have to pay the goodwill necessary to actually buy
them up," Mr Burden said.

Ned Cazalet, an expert in the life insurance industry, says many smaller
companies have in fact gone beyond the point of being attractive
acquisitions. "A lot are unconsolidatable - they are creaking away,
ebbing capital like a large hole in Eliza's bucket," he said.

The picture may look bleak, but advocates of the life insurance industry
- and in particular their key with-profits products - stress that very
few companies have sunk into insolvency yet and predict it would take a
substantial further fall in the stock market to force significant
numbers of companies to shut up shop.

One analyst who is bullish about the market believes that the FTSE 100
index would have to go as low as 3,500 points before serious numbers of
life offices were forced to close their doors. "Before that point they
could switch equities into bonds, cut bonuses to policyholders, dip into
their resilience provisions and still have a number of other options
left," the analyst said. But many life companies have already taken
these actions. A number have moved into bonds to protect themselves
against the stock market and almost all have sliced policyholders'
bonuses dramatically this year - though they could clearly cut bonuses
further.

Others have even closed their with-profits funds, including Royal &
SunAlliance, which closed its SunAlliance & London Assurance and Royal &
SunAlliance Life and Pensions funds to new customers in December because
it did not have enough capital to support substantial increases in
with-profits business. Abbey National, plagued by problems in other
parts of the bank, is also considering closing its with-profits
business, which operates through its Scottish Mutual subsidiary, because
it is running out of money.

Companies are also well aware that Sir Howard Davies, chairman of the
Financial Services Authority, is watching them like a hawk and does not
want them to resort to what is known as "financial engineering", such as
buying reinsurance contracts to cover liabilities, in order to keep
their funds going.

The City regulator is keen to prevent panic in the industry and a run on
life assurers' already depressed shares. John Tiner, the ambitious head
of insurance regulation at the FSA, yesterday dismissed a report that
said his organisation viewed 200 insurers as high risk. He said this was
"plain wrong".

The FSA conceded, as pointed out by the ratings agency Fitch, that 200
insurers fall into its "high impact" category, which it defines as
companies which would cause havoc by going bust because they have so
many customers. There is no suggestion that many of the companies in
this category are in danger of actually being anywhere near to breaching
their solvency requirements. In fact only 39 companies - out of an
industry with 900 players - are currently in insolvency proceedings.

Nevertheless, Sir Howard is particularly sensitive about the
ramifications of life assurers going under because he is still clearing
up the mess of the demise of Equitable Life - once one of the most
celebrated members of the sector.

Indeed, Mr Tiner has made it known that he is keen for life offices that
are limping along to shut to new business, so that the possibility of
another melt-down is avoided. A number of life offices are on a tight
rein and are currently being asked to update the regulator about the
state of their finances weekly.

If the future of the life market is the emergence of ever larger
insurance companies in the retail market, commentators also believe that
the future will involve the end of all but a very few mutually-owned
institutions.

This trend has already started - the 10 largest life offices today
contains only one mutual, Standard Life, whereas a few years ago it
would have included five.

In today's tough conditions, mutuals will come under more pressure. Mr
Burden of Goldman Sachs said: "Mutuals have less flexibility about what
they can do in difficult times because they have less access to capital.
This is why Friends Provident joined the market last year - to improve
its capital position and its credit rating."

Analysts believe that even the mighty Standard Life, which had surplus
capital two years ago of £9bn in place as a buffer to falling markets
or other unexpected problems, has seen a considerable amount of that
money eaten away and may have to raise money in the markets later this
year.

The cases of Royal & Sun and Abbey also prompt analysts to think that in
the future, big will not just mean being a major financial services
company with a sizeable life insurance business. One observer said: "It
will mean being able to say you are seriously big in the life market and
can pack a big punch. That will mean having something like 20 per cent
of the market."