The obvious way ahead for Life

STANDARD LIFE, Europe's largest mutual insurance company, has bowed to the inevitable. Falling markets, relentless bad publicity about endowment mortgages, rules from the regulator limiting the amount of money that can go into equities and by how much returns can be smoothed have conspired to diminish the attractiveness of the with-profits product.

Customers have got the point. Such policies account for just 20% of Standard Life's new business against 40% two years ago.

That puts the mutual in an impossible bind because it is the surplus capital in the with-profits fund that supports the whole business. As with-profits has shrunk from a half to a third of the total, that capital has had to be spread more thinly over an ever wider base.

The trend will continue, so it becomes only a matter of time before shortage of capital constrains the ability of the business to develop and grow. The board could have sold out like Scottish Widows, cut back on expansion or sought to borrow more but going public to raise more money on the stock market is the obvious way out.

It will mean windfalls for policyholders, which can crudely be measured by taking the surplus on with-profits of £4.6bn and dividing it by the 2.6m members to give about £1,750 a head.

Ignoring the fact that it may not be divided up evenly, the actual amount will also be different because the business is likely to be valued on its profits stream and the value of its franchise, not on its surplus, when it floats in 2006.

Cost cuts announced today should boost those profits but, even so, what members will get is likely to be rather less that the £6000 a head it was estimated they would have received had they voted for demutualisation in 2000.

With hindsight, it was the wrong call then. But with hindsight, investment would be so easy we would not need savings institutions in the first place.

And if going public can solve the Edinburgh group's problems, perhaps one day it could also provide an escape route for Equitable Life.

Borse power

THE German economy may be struggling to get out of trouble, but Deutsche Borse, the Frankfurt-based operator of exchanges and clearing and settlement systems, today drew the line under another record year.

Since London Stock Exchange shareholders voted down the proposal to merge with Frankfurt five years ago, Deutsche B?rse shares have powered ahead, proving to be a massively more successful investment than the relatively slow-growing UK exchange.

Nor should that be a surprise. Britain may have been the more dynamic economy, but the German vertical business model - where trading, clearing and settlement are all within one organisation - seems far superior to the London approach, where each activity is under separate ownership.

It also has more international appeal. The German banks which controlled Deutsche Borse when it went public in 2001 have sold out, so it is now a 100% free float.

More than half its shares are held by British and US investors. In addition, three quarters of its turnover is generated outside Germany. London would not be offered such favourable merger terms now, as Deutsche Borse boss Werner Seifert made clear during his prolonged flirtation with the London exchange before Christmas.

At a media presentation of the year's results in Frankfurt today, Seifert made as convincing a case as you are likely to hear for the superiority of vertically integrated exchanges and settlement systems.

To illustrate the point, he compared his business - which has cash, equities, bonds, derivatives and over-the-counter products plus clearing and settlement under one umbrella - with a 'virtual' firm, a composite of the London Stock Exchange, Liffe, London Clearing House and Euroclear/Crest which together provide the equivalent services under the fragmented horizontal model.

Under each of four measures - headcount, productivity, profitability and fees charged - the German business performs much better.

It has half the employees, 25% more productivity and a cost base that is e160 million (£107 million) lower. And it has a business mix that is easier to grow. Revenues are split 50-50 between trade and post-trade, on-exchange and off-exchange and equities and bonds, so it has a presence wherever clients want to go.

Today's presentation should serve as a wake-up call. If any European exchange is equipped to be a global player operating across the range of financial instruments that securities houses wish to trade, it is Frankfurt, not London.