How the FSA is stepping in.
The insurance industry insists that nothing is wrong and on the surface that appears to be true. Third quarter results have been released this week by insurers and they are gloating about the strength of their capital positions. Aviva unveiled a healthy regulatory surplus of £1.3bn and the group’s chief executive, Andrew Moss, assured: “We are taking an active and prudent approach to managing our capital.”
But beneath the surface industry commentators and regulators are grumbling concerns, encouraging the insurance sector not to be complacent and are building up teams of experts in the event that something goes wrong.
Financial Services Authority (FSA) is building a team of advisors to deal with any further crisis. It already has city law firm Ashurst on board but is expanding its panel further. Together with its advisers the FSA has kept a close eye on the insurance sector. “We are concerned about all firms in this current crisis and we have been speaking to them whether they are in the insurance, banking sector or whatever. They have regular chats with us and of course we speak to the ABI as well.”
The Bank of England’s (BoE) is also keeping a watchful eye out. Its financial stability report out this week warned that the insurance sector had emerged as an area of potential concern.
You can’t blame the regulators for feeling there’s a need to be prepared. After all, Bear Stearns made assurances about its capital adequacy before it went under so why should anyone believe that it’s all rosy in the insurance market too? Insurer Aegon’s appeal for £2.39bn in aid from the Dutch government will have made regulators and governments even more nervous.
So should the insurance industry be bracing itself for another American Insurance Group (AIG) blow up? Another AIG scenario is unlikely say commentators because it was exceptional with its position on credit default swaps (CDS).
But what else could be the problem if insurance companies have not underwritten toxic derivatives to the extent that AIG did? A lack of capital could result in a company going bust but it appears that UK insurers are well capitalised.
A hit to insurers’ investments will cause problems. So any further dramatic falls in share prices or bond defaults could send insurers begging for funds from regulators. Given the extreme market volatility, this is a possibility.
Nick Boakes, director of group communications at Friends Provident assures his group has this covered as it is investing in government gilts and triple A rated corporate bonds. These types of investments are relatively safe but as Keith Nicholson, senior UK Insurance Partner at KPMG, points out it depends on which government gilts insurers have invested in. “Some governments have had to go to the International Monetary Fund [for aid], although I suspect insurers would be investing mostly in UK government gilts rather than others.”
Nicholson agrees corporate bonds are a relatively safe option but warns insurers shouldn’t bank on stellar returns. “By investing in triple A rated corporate bonds their risks of default would be lower but that would also mean their returns are lower,” says Nicholson.
There are still many things that could go wrong. Defaults of corporate bonds are a possibility. Rating downgrades could push insurers to seek more capital to retain or improve their ratings. In the current crisis, capital will be hard to come by. Banks aren’t lending to each other and so won’t lend to anyone else and governments have stressed their coffers.
We haven’t by any means seen the end of or the full impact on the credit crisis. More aftershocks are bound to be felt within the banking, asset management and insurance sector as well as elsewhere. Results may be robust now but it remains to be seen if insurers will still be boasting about healthy figures in this fourth quarter and 2009.
