'Fat test' measures assurers' health

THEIR share prices are crashing, the returns on policies have slumped, and they are using profits they have yet to make to dress up the accounts. But does all this mean some life assurers are headed for the corporate grave? Unfortunately for policyholders, the chances are they will never know before it is too late.

A rare combination of events has conspired to fill both shareholders and policyholders with fears for the health of what were not long ago the bluest of blue-chip companies. Falling stock markets have slashed the value of the shares which underpin so much of the assurers' profits. As well as lowering their earnings, this could soon force them to sell huge chunks of their investments as a way of rebuilding their cash reserves against further hard times. Traditionally at this point in the cycle, the industry would find some partial cure in higher interest rates and inflation. But these are unusual times, and such medicine is currently nowhere in sight.

But fear not. The Financial Services Authority is on the case, armed with a series of complex diagnostic tools designed to tell whether your assurer merely has indigestion or is days away from cardiac arrest. Its key tool is a little-known assessment referred to as the resilience test, a form of corporate stress examination aimed at forecasting what would happen should your assurer be subjected to something nasty, such as a 25% fall in the FTSE 100 index.

The FSA diagnostic machine will tell whether the assurer would remain solvent in this event. If not, it will be forced to set aside extra cash, either by selling some of its shares or by raising it from shareholders, probably through a rights issue.

Of course, like any piece of modern medical technology, the FSA machine works only if it has already been told what constitutes insolvency. At first glance, this is simply a case of ensuring assets exceed liabilities.

But corporate health is a complex business, and the question of exactly when this gap is big enough to amount to solvency is a closely guarded secret between the FSA, chaired by Sir Howard Davies, and the company. Assurers are set different targets depending on the nature of their investment portfolios. Those in higher-risk categories have to pass the 'fat test' by a greater margin.

Any assets held above and beyond those needed to pass the solvency test are branded free assets. To be awarded a completely clean bill of health, an assurer must have an element of this excess fat which, according to the FSA, is not really excess, but is instead crucial to winning its approval. bAfter calculating all these complex ratios, one could be left feeling dangerously unwell. But isn't that why one has life assurance in the first place?