British offices weathering the pensions mis-selling scandals now face the guaranteed annuity rate debacle
Deteriorating capitalisation caused by recent fluctuations in the equity markets, a downturn in bond yields and the ongoing effect of the pensions mis-selling scandal have had the expected effect on UK insurance group ratings.
In the past 12 months only one company – J Rothschild Assurance – has had its rating raised, with five lowered and one (NPI) placed on creditwatch with developing implications.
Three of the four downgraded companies distribute primarily through direct salesforces – the hardest hit by the UK government’s mis-selling review, but also considered the least likely to adapt to a changing environment. Selling to the mass market through such a costly channel is no longer considered viable.
Today’s adverse investment conditions are also likely to trigger more consolidation in the sector, accompanied by some defensive demutualisations.
NPI’s sale announcement emphasises the lack of flexibility the mutuals have, with the feeling that only through a stronger parent company would its rating be raised.
Plummeting interest rates over the past two years, offering the prospect of long-term yields at around 4.5%, are also alarming the UK insurance community.
Whilst these have given rise to a significant increase in technical reserves, the yield drop also means that market values of insurers’ fixed-interest holdings have risen considerably. If an insurer’s assets and liabilities are closely matched these two effects should offset one another. However, offices running mismatched positions are likely to experience big solvency falls, particularly if equities remain dampened as an asset class.
A further problem concerns guaranteed annuity rates, based on relatively heavy mortality assumptions made by insurers in the 1970s and 1980s before the days of personal pensions. The often uncharged 6.5% guarantees effectively represent around 8% today if recalculated on recent mortality figures.
This is in an environment where interest rates are below 5%, and where many companies do not appear to have complied with ‘resilience’ requirements guaranteeing reserves against fixed-income yield changes.
A figure of £10bn (e15bn), similar to that suggested for pension mis-selling, has been quoted as the potential cost, although S&P believes some of the cost has been inflated by strong equity market growth in 1997 and that some companies that partially back their reserve with bonds will have offset the cost with rising values corresponding to lower yields.
In terms of market consolidation, although none of the country’s mutuals has been bought out since Scottish Amicable fell to the UK’s largest player Prudential, the present capitalisation problems are expected to push the mid-size mutuals down the same path, despite a few having bought themselves time by offering subordinated debt.
Newcomers into the UK life market such as Direct Line, Marks & Spencer and Virgin Direct have also failed to make a great impact, despite intense publicity, and are focusing their business largely on commodity products such as unit trusts, Peps and ISAs.
Similarly, the government’s plans to introduce quality control via CAT standards for life and savings products have had a lukewarm reception in the sales-orientated life market.
Bancassurance in the UK has also continued to lose market share, with one factor believed to be the daunting number of products put before customers in their bank branches.
On the flip side independent financial advisers (IFAs) have upped their share of individual single premium business to around 70% and direct marketing is steadily growing.
The introduction of stakeholder pensions had been mooted as a strong potential business line for insurers. However, the government’s proposed fee cap of 1% has scotched any thought of attractive margins and the new market no longer looks particularly promising.
Overall market growth is expected to be at a more moderate rate than in the past couple of years, with margins on new business thinner than in the past.
Consequently, most life companies recognise they must compete in the broader financial services market and are selling index tracker funds to both retail and corporate sectors or setting up fully fledged asset management operations to manage money.
If UK insurers are to survive they must continue the efficiency drives made in recent years and position themselves to offer supermarket-style added value to their business as opposed to competing on price.
And with events proving that few UK insurers have been prepared for the unexpected, the need to have financial strength over and above statutory solvency requirements has never been greater. Hugh Wheelan