Free assets of life office with-profits funds tended to contain more "soft" assets such as contingen...
Free assets of life office with-profits funds tended to contain more "soft" assets such as contingent loans and future profits in 2002 than hard capital, suggests a study conducted by Mercer Oliver Wyman.
But they are also no different to most other European funds, suggests MOW, as the capital base of many European life companies is not necessarily reflected by its free assets within the with-profits funds.
Data compiled on 28 UK life offices indicates that around 70% of free asset capital - compared with 30% in 2001 - was actually made up of softer capital such as future profits, contingent loans, subordinated debt and financial reinsurance.
Of the £24bn of 'free assets' held in with-profits funds and life companies, at least £17bn is calculated as soft assets to provide financial protection, says Anthony Stevens, head of Mercer Oliver Wyman's insurance practice.
While this could be seen to have negative implications for the financial security of a company, it does indicate that firms are able to consider alternative investments to equities and shore up investments during volatility, says Stevens.
"Deterioration in the quality of underlying capital reflects the industry's ability to manage more actively its capital base in response to pressure on solvency margins, and the willingness of capital markets (and Life Offices parents) to provide alternative forms of non-equity funding," he says.
"Such deterioration does not mean bad news for policyholders, as arrangements such as contingent loans/subordinated debt provide a similar level of protection as equity funding," adds Stevens.
Furthermore, suggests Stevens, it would be unfair to suggest that UK life offices are placing themselves in more danger than other firms by using such a high percentage of soft assets, as the capital base of many leading continental European insurers is comprised, on average, of more than 50% of lower quality forms of capital, such as future profits and hybrid/subordinated debt instruments.
"Given the increased leverage inherent in the use of softer' forms of capital, debt-holders (and shareholders in the case of banking parents who have provided such contingent financing) need to look more carefully at the economic solvency of the underlying Life funds," continues Stevens.
"The existing approaches to measuring the capital adequacy of Banks with Life Insurance operations does not differentiate between well capitalised and less-well capitalised Life Funds. Even under the proposed Basel II reforms of Banking capital requirements, the treatment of Insurance holdings remain simplistic and essentially de-linked from the capitalisation levels of the insurance subsidiary," adds Stevens.
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