FSA introduces new element to life insurers resilience tests

The new test will assist life insurance firms in planning their asset allocations across a broader range of market conditions, while at the same time maintaining prudent levels of capital.

We have in the past temporarily suspended aspects of the resilience test at times of extreme market turbulence and uncertainty, in order to alleviate the possibility of forced selling by insurers leading to a downward market spiral. We see no need to take such a step at present. But it has become apparent that the existing resilience test is insufficiently sensitive to the effect of past changes in equity market prices and can in certain circumstances cause perverse asset allocation. We believe that the test should take some account of past price changes while still requiring insurance firms to ensure that their asset holdings are resilient to market developments

The resilience test requires insurers to be able to meet regulatory solvency requirements even if equity market prices were to fall by up to 25%. In practice, insurers actively consider at all times their resilience to various types of market conditions.

In the new guidance issued today, the FSA has introduced an additional element to the resilience test, to take some account of past equity price changes, subject always to testing against the minimum of a 10% fall. In future, insurers should calculate the percentage change in the FTSE Actuaries All Share Index between the current level and the average daily closing level over the previous three months. If the change is negative i.e. if the market is currently lower than its recent average then the percentage change should be deducted from the 25% maximum to determine the percentage at which the stress test would be performed.

So, for example, if prices were 10% below their 3-month average, insurers would test their portfolios against falls of a further 15% - i.e. 25% minus 10%. Insurance firms should continue to calculate the stress test percentage on the existing basis which compares the price-earnings ratio of equities to the yield on government bonds, and utilise the lower number -but no lower than 10% - in their tests.

The text of the new guidance is available on the website or on request.

Notes for editors

1. The period over which equity prices should be averaged in the new guidance is 90 days. The new guidance will apply until 31 May 2003. In the meantime, the FSA intends to consult on incorporating revised guidance into the Handbook of Rules and Guidance on a more permanent basis.

2. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000; maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime.

3. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.