Outlook: New solvency test further undermines Standard's mutual case

ECB disappoints

Long gone are the days when Standard Life could convincingly argue it was the most solvent of Britain's legion of life assurers. The three-year bear market in equities, to which Standard Life was much more heavily exposed than peers, put paid to that. Yet despite growing doubts about the company's financial health, Standard Life has always been able to show a reasonably substantial surplus of assets over liabilities in its annual solvency returns, even after one of the worst bear markets in memory.

That picture seems to have been turned on its head by the move to a new, more "realistic calculation" of solvency which the Financial Services Authority is in the process of introducing. Standard insists that, even under the new method, it still satisfies minimum solvency requirements, but concedes that the cushion is much reduced from the level of £3.2bn, more than twice the legal minimum, that the old, Companies Act calculation shows for the year to 15 November last.

The FSA wants larger life assurers to apply either the new method or the old one, which ever is the most onerous, from this year onwards. The consequences for Standard, although not apparently life threatening, are none the less serious. Without an adequate capital cushion, Standard's ability to write new business is severely curtailed. Alternatively it may have to crimp bonuses in order to reduce liabilities, or further reduce its exposure to equities, limiting the upside in its investment performance.

When it was first mooted, the new, realistic calculation was widely welcomed by the industry as a much needed injection of sanity into a solvency regime whose rules had forced life assurers senselessly to dump equities through the bear market to safeguard capital. In practice, the new regime appears to be even harsher than the old one. The law of unintended consequences seems to have come fully into play. Many industry insiders believe the effect of the new regime will be to drive with-profits life funds even further away from equities and into bonds, which is bound to be bad for long-term returns.

Even so, most life assurers continue to support the principle of the new method. For those that have been rigorous in the application of accounting standards under the old system, or have a particularly benign mix of assets and liabilities, the new method will actually improve matters. But a large number admit to the system not working quite as anticipated. The new method requires life assurers to stress test liabilities against some quite improbable scenarios and, in a small number of cases such as Standard Life, it is throwing up unseen and unpalatable results.

Of course, that may be simply because Standard Life has all along been too sanguine about the true state of its liabilities. Its exposure to higher risk products, such as guaranteed annuities, is certainly much bigger than most of its peers, and may not have been properly accounted for. For obvious reasons, Standard Life was yesterday trying to present its difficulty with the new method as a systemic, industry-wide problem. True enough, Standard is the only life assurer to have fallen foul of the new calculation, but according to the company, that's because its year end is earlier than anyone else's and it has therefore become the first to encounter the problem.

Well, perhaps, but the suspicion is that Standard's difficulty with the new method will prove a good deal more acute than most.

I've long been a supporter of Standard Life's increasingly lonely defence of the mutually owned tradition, but I fear it may be losing the argument. There is a capital dilemma at the heart of mutual ownership in life assurance which has now been highlighted by Standard Life in two different ways. If there is a big surplus of capital, as occurred with Standard at the height of the bull market, then the company is bound to become a target for carpetbaggers keen to lay their hands on it.

That puts pressure on the management to reduce the surplus, which Standard has done with apparent abandon in recent years by hugely expanding the business, and with it the liabilities side of the balance sheet. Arguably, it also encouraged the management into its high risk and ill-fated gamble on equity markets. With the surplus squandered, Standard now has too little capital, but because it is mutually owned, it cannot turn to equity markets for help.

The truth is that Standard Life long ago outgrew mutual ownership, which is no longer an appropriate structure for such a large business. Fast growing in regions of the world as diverse as China, India and Germany as well as the UK, it's hard to fault Standard's strategic vision, but how does this benefit its mutual owners back here in the UK? The answer is that it has only succeeded in damaging them.

In a proprietary company, there would be a rights issue to fund such business ambition, and the capital markets would determine whether it was worth backing. But for Standard to have diverted capital from the UK into foreign expansion in a manner which has left the core UK life fund financially stretched seems hard to justify, certainly to the current generation of owner/policyholders.

I don't want to accuse Standard Life's board of blowing policyholders' money on high-risk empire building and first-class travel to far-away places. That would be unfair. In a PLC, the strategy would no doubt look sound enough. But for a mutual where policies are beginning to fall far short of expectations? The FSA's new method of calculating solvency may be the straw that finally breaks the mutual standard bearer's back.

ECB disappoints

What will it take to convince the European Central Bank that it needs to cut interest rates?

Over the past year, the euro has appreciated by more than 20 per cent against the US dollar, and there is now clear evidence that its strength is damaging the still barely perceptible economic recovery going on in Germany and France. Yet ECB officials continue to see the euro's strength as something to be proud of, a final vindication of the single currency after the humiliation of its early years.

Their position is reminiscent of John Major's posturing during Britain's membership of the ERM, when he boasted that the pound could finally look the German mark in the face, never mind that his misplaced pride in the exchange rate was crippling the economy.

Jean-Claude Trichet, the new president of the ECB, seemed subtly to alter the ECB's position yesterday when he refused to repeat his predecessor's view that a strong and stable single currency was in the eurozone's best interests. Instead he said that the ECB disliked excessive volatility on the foreign exchange markets. Yet he didn't cut rates to help ease the pain of Germany's exporters, nor did he seem much bothered by the euro's strength.

At some stage, the ECB will have to address the issue of the plummeting dollar with lower interest rates and currency intervention. Its failure so far to do so is a source of bemusement to policy makers in other jurisdictions, who not for the first time think the ECB has lost the plot.

Eurosceptics see the ECB as fundamentally flawed because it is required to set a single interest rates for too many regions and therefore settles on a middle way that suits no one. But that's not the primary difficulty. Nor even is it a problem of the ECB's multinational constitution and consensus driven approach to policy. Rather it is a problem of mindset. Europe's bigwigs quite like the idea of a strong currency. What's more, the ECB is still too fixated with the threat of inflation and not cognisant enough of the desperate need to boost growth. It was to be hoped that M. Trichet would take a more enlightened approach. It's early days, but so far there's little sign of it.

jeremy.warner@independent.co.uk