Nervous investors, pulling their cash out of shares in search of safer asset classes, are also punishing the firms that have not manipulated their accounts. This better-safe-than-sorry attitude has dragged the entire stockmarket down.
Yet American firms are not solely to blame. Insurance companies, some of the largest holders of sha
res, have sold on a huge scale. Their unloading of shares has sent a falling market even lower.
Insurers are caught in the middle. They are affected by poor markets but are also responsible for part of the problem.
The insurance firms invest the premiums they collect from customers across a range of asset classes. One of the main recipients of their cash is the stockmarket, which historically has offered a higher rate of return than more conservative investments like bonds or savings accounts.
Enough money
Yet they must always have enough easily accessible money to cover their financial commitments. This ensures sufficient money is available to pay out claims from clients while growing the business and paying dividends to shareholders.
Because insurers have a significant proportion of money invested in the stockmarket if markets fall, the value of the insurer’s portfolio also falls. Ailing markets mean the portfolios are worth less so firms may be forced to resort to technical selling to keep enough money to hand. This means they are selling shares because the markets overall has fallen rather than because the individual shares were a bad investment.
A vicious cycle is created. This compulsory selling can be on such a massive scale that it depresses stockmarkets further. Investors see their returns falling and sell their shares. Overall share prices fall, forcing insurers to sell even more shares.
Since this series of events can have such a drastic impact on the stockmarkets, especially during the current atmosphere of investor apprehension, the Financial Services Authority (FSA) has stepped in.
It is one of the FSA’s roles to set out a series of guidelines to make certain insurers are able to fulfil their promises without taking unnecessary risks. It decided to relax one of these guidelines to ease the pressure on insurance companies, hoping to lessen their influence on the stockmarkets.
Testing relaxed
The regulatory body amended the portfolio stress test, also known as the resilience test. Insurers carry out stress testing when they look at their portfolios to check that if the stockmarkets fall by a certain percentage they would still have enough money to cover their liabilities.
In the past even if the stockmarkets fell by up to 25% insurers had to be able to meet regulatory solvency requirements – that is, still have enough money to keep the business viable according to the regulator’s rules. This test played an important role in the asset allocation of their portfolios.
Under the new rules, to give insurance firms more leeway, the recent performance of the stockmarket, as measured by the FTSE Actuaries All Share index, is taken into account.
Insurers compare the average daily closing level of this index over the past three months with the current level. If the current level is lower than the average then the percentage change between the two is subtracted from the 25% mark used in the resilience test. This provides a new percentage level for the stress test but is still subject to a minimum of 10%.
If, for example, the current prices were 12% below their three-month average the new level for stress testing would be 13% (25% - 12%). Insurers would now ensure their portfolios would sufficiently meet their solvency requirements even if the market fell by up to 13%.
Breathing space
This move has provided insurers with some breathing space but is not a long-term solution to declining stockmarkets. “If the stockmarket recovers, buying insurance companies some time may be enough,” said Ken Forman, a global investment strategist at Standard Life Investments.
“Yet if there is no recovery between now and December then the moving average will again be at 25%, which is too much of a challenge for weaker life assurance companies.”
While falling stockmarkets could eventually force insurers to sell some shares the revised rule reflects a more realistic view of market conditions. It may also be just the flexibility many firms need to succeed.
