Know your own strength

By DAVID BUDWORTH
Updated:

 

One important lesson to come out of the Equitable Life crisis is that the financial strength of a company should be a key consideration for investors. Many of Equitable's policyholders were shocked to find out how desperate the mutual's financial position was when it closed for business - so dire that it couldn't find a buyer. But the warning signs were there.

More than a year ago the biggest rating agency - Standard & Poor's - downgraded Equitable Life. It was concerned about how much money the insurer had in reserves to meet its commitments. In May 1999 it was downgraded from AA (Excellent) to A+ (Good). In December its rating was lowered again to BB (weak).

Rating the financial strength of an insurer is particularly important if you're considering a with profits investment. Survey after survey show that financially strong companies consistently give better returns on with profits funds. And as more than a million Equitable Life customers are now finding to their cost when a life office is in a poor financial state with-profit returns will drop

David Aaron of independent financial adviser The David Aaron Partnership, says: 'Assessing financial strength is an essential element in selecting a With Profits life office. With Profits bonds are designed as medium to long term investments therefore the importance of a life office being strong enough to meet its commitments when the bond reaches maturity is very important to the investor.'

Aaron recommends using Standard & Poor's rating as a good indication to how deep an insurer's pockets are. Ratings go from AAA (superior financial strength) to CCC (extremely weak).

Another way of determining an insurer's strength is to look at the free asset ratio. This is the amount of cash an insurer has left after it has met its liabilities. The more free assets it has the more investment freedom, which should mean it can make more money.

Recently published tables of free asset ratios show that a number of with-profits funds are in similarly dire straits to Equitable Life. These include funds operated by the likes of Royal & SunAlliance, Guardian, NPI and Scottish Equitable. Policyholders are unlikely to suffer the same fate as those in Equitable, though, as most of the companies concerned have been bought out by larger parents with deep pockets. But they may still receive lower returns.

Aaron warns against only using the free asset ratio as a measure of financial strength. He says: 'Investors must note that selecting a company solely on its free asset ratio will not guarantee the best returns over the investment periods. What it will indicate is which companies have the potential to do well.'

Assessing the financial strength of a company can be difficult if you don't know what you're looking for so talk to a good independent financial adviser who should have access to this kind of information.

• David Aaron Partnership has just published a With Profits Guide which includes a list of the top bonds on the market and an overview of the financial strength of life offices. To receive a copy telephone 01908 281544. It costs £2 to cover postage and packaging.

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