Falling ratios are far from critical according to Fitch

A top ratings agency has given the UK's life insurance firms a vote of confidence, despite recent tough market conditions.

The fall in bond yields over the first half of 2016 may be squeezing solvency ratios at Britain's leading life insurance companies but the decline is not enough to worry ratings agency Fitch, which said they "remain strong".

Under Solvency II, insurers must ensure that they set aside enough capital to deal with the worst level of losses they anticipate with a 99.5 per cent degree of certainty – i.e. losses they would only expect once every 200 years.

Solvency ratios effectively measure the amount of capital that companies have set aside to cover such potential losses.

Decreases in yields tend to increase the amount of collateral required to be posted to maintain the same ratio.

Fitch said:

Solvency II ratios declined in the first half of 2016 across the UK life insurance sector, driven by a fall in interest rates, particularly after the outcome in the referendum on membership of the EU. The 15-year gilt yield fell from 2.44 per cent to 1.56 per cent and yields continued to fall in July.

However, Solvency II ratios remain strong, despite the first half decline.

Fitch's report said that although ratios across Britain's major life insurers had dipped, they were still well above minimum levels. This led to Fitch reaffirming its position that the UK life insurance sector is "stable".

Although not a life insurer, last week the markets did not take kindly to Admiral's announcement that its solvency ratio had fallen from 206 per cent to 180 per cent.

The share price of the FTSE 100 giant, which specialises in car insurance, fell eight per cent last Wednesday, although it has subsequently recovered the ground lost.

The ratings agency did have a word of warning for the life insurance sector for the second half of the year. It said:

UK life insurers are exposed to potential regulatory action on their treatment of customers. In particular, the Financial Conduct Authority is investigating the potential mis-selling of standard annuities to customers who may have been eligible for an enhanced annuity because of reduced life expectancy.

The investigation is due to conclude in [the final quarter of 2016]. The European Insurance and Occupational Pensions Authority recently launched a Europe-wide review of conduct in the unit linked life insurance market, with results due in early 2017.

If regulatory scrutiny leads to adverse publicity, compensation costs or fines, this would clearly be negative for the insurers affected.