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Equitable update
In November 2002 Equitable published its interim accounts for the 6 months to 30 June 2002.
The headline coming from these accounts is the deterioration in the Fund for Future Appropriations (FFA) from £1.1bn at 31 December 2001 to only £0.4bn.
The FFA represents the excess assets that the society has on a Companies Act accounts basis over and above the liabilities for guaranteed benefits to policyholders and other creditors. The FFA represents the assets available to support the terminal bonuses and to provide a cushion against adverse future experience. A reduction in the FFA makes the society more vulnerable to future uncertainties.
Equitable also states in the "Review of the Society's Current Financial Position" included with the accounts that "the Board recognises the possibility that the Society may not meet its Required Minimum Margin (RMM)...at all times in the future.". The RMM is the capital that the regulator requires Equitable to hold in excess of that required to meet its obligations to policyholders - effectively a safety margin. The statement regarding the RMM has led to another round of bad press for the Society.
There has been no precedent for a large insurer to become insolvent and quite what will happen if this occurs is uncharted territory. In such an event there would definitely be lots of problems for the society and members and the whole process could drag on for many years. It is possible members will not get payments for claims when they should and may not receive part of their guaranteed entitlements. Whilst the with-profit policyholders have taken the financial pain to date it is far from certain whether other policyholders (non-profit and unit linked) would escape unscathed in an insolvency situation
Why has the FFA fallen?
From analysis of the accounts it seems there are three main reasons for the drop: firstly investment losses caused by general falls in equity markets with no corresponding drop in liabilities; secondly terminal bonus payments on maturing policies and thirdly there has also been an increase in some provisions in particular for the possible mis-selling claims for non-GAR policyholders sold policies since the GAR problem came to light.
Is the FFA likely to fall further?
The society has in recent years been trying to stabilize the fund relative to liabilities by moving to a more cautious investment strategy by moving out of equities and into bonds and this has continued in the first 9 months of this year. The percentage of the fund in equities at 31/12/01, 30/06/02 and 30/09/02 are 25%, 13% and 5% respectively. This is likely to give more stability to the fund but at the expense of expected future returns, as in the long term equities are expected to give greater returns than bonds. In particular it appears that the low level of the FFA gives Equitable very little scope to increase the proportion of equities in future and benefit from any recovery in the stockmarket.
Also on 1 July 2002 the society has increased the deduction on early surrenders (Market Value Adjustments - MVAs) from 14% to 20% and for maturities from 4% to 10% and from next year there will be large deductions on the levels of with profit annuity instalments. These increased deductions significantly reduce or remove the strain on the fund of overpaying leavers and maturities.
These two factors will help stabilise the solvency of the fund but there are other risks that could affect solvency.
The largest of these risks is the high levels of guarantee built in to many policies (typically 3.5%). Currently no annual bonuses are being added to policies but the society must give these guarantees. If investment returns, net of expenses, were to be less than the guaranteed rate, the cost of meeting these guarantees would have to be met from the FFA, increasing the risk of insolvency.
Other possible strains on the fund are larger than allowed for compensation payments or future increases to these provisions, further drops in the few equities still held by the society, higher expenses in future than expected and the effect of increasing longevity on the Society's annuity portfolio.
Should I surrender my policy with the Society?
Individual members' circumstances are different and we strongly advise them to seek advice from an independent financial adviser before any decisions are made. For any member thinking of surrendering their policy there are a number of issues to consider, some of which are listed below:
- If the society was to become insolvent policyholders would be in an uncomfortable position; payments may not be for fully guaranteed benefits and payments may be delayed. No one is really sure of what may happen.
- The with profit fund continues to face risks regarding the high proportion of guaranteed liabilities and the risk of litigation from non-GAR policyholders who left the fund before the Compromise Scheme was effected. If the membership of the fund was to decrease rapidly these costs would be borne by fewer members increasing the cost for each member, but equally any compensation won by the society would be of greater benefit to each member. Investment performance will also continue to be constrained as explained above. Policyholders may therefore wish to avoid these risks and may be considering withdrawing from the fund instead.
- However, Market Value Adjustments (MVAs) as discussed above are currently being applied to withdrawals from the with profit fund. Policyholders will need to weigh the cost of these MVAs against any potential increase in investment returns available by investing these funds elsewhere. These MVAs may increase or decrease in future.
- Further, if there is any compensation won by the Equitable from its advisers or its past directors, strengthening the with profit fund, policyholders who have withdrawn from the fund would not benefit.
- Policyholders near retirement may be able to take early retirement without suffering MVAs if their policies include early retirement options without penalties, although Equitable have tightened their policy regarding early retirements.
- Policyholders who hold with profits annuities are not able to transfer out of the fund.
- The fall in investment markets has hit the life insurance sector very hard. Almost all would hold a significant proportion of their investment backing with-profits business in equities. Equitable have been forced by their poor solvency position to sell virtually all of their equity holdings prior to the latest market falls. Most others will not have been so fortunate. Monies transferred from Equitable may end up in another insurer with a similar problem.
Barnett Waddingham, November 2002.