THE only way is down for life insurance companies. At least that's how it would appear from the performance of their share prices over the past seven days.
The plummeting value of their stock has re-ignited fears that insurance could be the next sector to follow the country's beleaguered banks into announcing rights issues in a bid to raise money from their shareholders.
Industry giant Legal & Genera
l was the main cause for concern last week. Its share price took a battering in the wake of speculation and bad news over its capital position and investment returns. By Friday it was down 37.5% on the week to 30 pence from 48p.
The downward spiral began on Monday when rumours were rife that L&G, the UK's third largest insurer, was in talks with the Financial Services Authority (FSA) about its deteriorating balance sheet. L&G chief executive Tim Breedon was adamant that any dialogue with the regulator did not go beyond routine discussions in the run-up to the publication of its full-year results on March 25.
But as the company's value continued to decline, it was forced to issue a "clarification" on its capital strength and reserves on Wednesday, stating that a rights issue was not on the cards. Any positive impact that the announcement may have had was wiped out 24 hours later when L&G said it was cutting payouts for most of its with-profits policyholders due to tumbling markets. At one point in the day its share hit a record low of 35.4p.
The turmoil around L&G had a knock-on effect on other insurers over the course of last week. Standard Life suffered a 11.8% fall to close at 172p, Aviva was down 12.6% to 291p and Friends Provident slipped 7.5% to 74p. The falls come as speculation is mounting that some may have to take drastic measures to shore up their balance sheets. This issue is coming to the fore with the FSA asking insurers to complete new stress tests over the next few weeks to help it "better understand" their capital position.
So just how short of money are L&G and its peers? Will insurance be the latest industry to call on shareholders for money if it is to avoid breaching the regulator's requirements for capital?
In its statement on Tuesday, L&G estimated its capital surplus was £1.6bn, reflecting falls in equity markets last year as the global recession strengthened its grip. The company expects an even rougher ride this year, saying it "believes it is appropriate to reserve on a more prudent basis". It more than doubled the money it had set aside to cover potential defaults in its £22.5bn corporate bond portfolio to £1.2bn.
Breedon was keen to make it clear that no stone had been left unturned in an effort to secure the company. "The planned additional reserves… follows a sector-by-sector review of our portfolio, and default experiences from the 1930s and subsequent recession," he said.
But this statement in itself was enough to send shockwaves among investors and policy holders. It means insurers are now factoring in corporate bond defaults hitting post-Great Depression levels which peaked in 1935.
Analysts remain more concerned about L&G's capital position than they are about its main rivals. What L&G did last week was to move in line with Standard Life, Prudential and Aviva by vastly raising its provision for credit defaults on corporate bonds.
Kevin Ryan, analyst with ING, says: "The value of bonds seems a more acute issue for L&G." There is concern that some bonds in which it is invested may be worth nothing. The company's mix of business is also seen as more risky than rival insurers as it has a heavy exposure to pension annuities and the protection market, which has been hit hard by declining sales of mortgages.
Nic Clarke, insurance analyst with Charles Stanley, says that while Breedon has told the market the company has no need for a rights issue, the reality is that "we'll have to see how bad it gets".
One reason that L&G's share price has been hit particularly hard is the firm's failure to disclose its capital position earlier. Last month L&G refused to provide an expected update alongside its full-year sales numbers, exacerbating investors' concerns. In contrast, Friends Provident and Standard Life both provided details of their capital levels with their trading statements.
"L&G does seem to have had more than its fair share of suffering. We downgraded its stock a few weeks ago over concern about its capital position," says Clarke.
While in the short term, at least, Clarke and other commentators do not expect L&G to be forced into a rights issue, they do predict it will cut its dividend.
MF Global analyst Peter Eliot says: "Our view is that things aren't as bad as the shares would suggest. A rights issue is looking at the very pessimistic side of expectations."
Of course, other insurers are not without their woes.
Aegon cancelled its final dividend last October when it received a ?3bn injection from the Dutch state. Standard Life's worldwide life and pensions sales were down 5% last year to £16.1bn and Friends Provident's dropped by 11% to £1bn.
Clarke says: "At the moment Standard Life and Friends Provident are two of the stronger life insurance companies, while L&G and Prudential are at the weaker end because of their higher exposure to the corporate bond market. Aviva is somewhere in the middle."
However, most analysts do not expect any rights issues in the UK insurance sector for the foreseeable future. "My guess is that a rights issue is something they would want to avoid," says Ryan. He explains that getting a rights issue away in the current market would require large discounting and, therefore, the backing of a vast number of shareholders.
Pru, however, may prove to be the exception if it decides to press ahead with plans to buy AIG's Asian assets.
Last year, Mark Tucker, chief executive of Pru, described Asia as "the only region in the world that is expected to record high single-digit economic growth rates in both 2008 and 2009… We remain highly positive about the medium to long-term prospects for Asia. In this context, we are of course monitoring closely AIG's disposal programme and considering what, if any, opportunities may arise that would create additional value for our shareholders."
Clarke says: "If Pru was capital constrained and was potentially looking at doing a rights issue, if it could wrap it up as raising money for an acquisition it could make it somewhat more palatable for shareholders."
Pru made no mention of any plans for AIG when it reported a 5% rise in 2008 sales to £3bn on Friday. It also managed to increase its surplus by transferring of its Taiwan operations to the China Life Insurance Company of Taiwan for a nominal sum. Proving to be a rare bright light in the insurance industry, Pru's share price closed at 285p, up 4% on the day.
