As the City giants feel the pinch, how safe are our savings?

After the worst month for stock markets in 15 years, the financial industry is grappling with the implications for investments

September was the worst month since the crash of October 1987 for the stock market, putting extra pressure on the already strained balance sheets of the life insurance companies that manage most of Britain's pensions and savings.

September was the worst month since the crash of October 1987 for the stock market, putting extra pressure on the already strained balance sheets of the life insurance companies that manage most of Britain's pensions and savings.

Yesterday the UK's City watchdog, the Financial Services Authority, tried to calm nerves, saying the majority of insurance companies were robust and could cope with further substantial falls. Yet even the most financially resilient are feeling the pinch. Standard Life, the UK's third-biggest insurer, this week slashed payouts to policyholders.

So, with many City analysts warning that further pain could be in store for almost anyone with a pension or savings, we examine the likely implications of this uncertain climate.

I don't own shares, so why do the falls in the stock market affect me?

You may not own shares directly but if you are saving in a pension fund, an endowment mortgage policy, or an individual savings account (Isa), it is likely at least part of that fund is invested in shares.

The fall in share prices in the past two years has led to a drop in the value of policies, prompting insurance companies to cut bonuses, which build every year, and to reduce the final payouts when policies come to the end of their agreed term. In the case of mortgage endowments, it was predicted months ago that 35 per cent of polices were unlikely to yield enough to pay off the original home loan.

How serious it is? Do I face an impoverished old age?

Some people are already experiencing distress, such as those whose endowments are falling short. But for people who have been investing for more than 10 years, the present climate of negative investment returns have been considerably softened by the very high returns made in the bull run in the equity markets in the Eighties and Nineties.

Most investors have also not been exposed to the full horrors of the recent negative stock market returns. On average, pension fund managers have shifted about 50 per cent of individuals' investments out of equities and into safer areas such as government or corporate bonds, or cash.

But prospects for the long term will be heavily affected by how long share prices remain in the doldrums, and on whether growth in the years to come returns to the realm of double digits – seen as unlikely – or grows more gradually.

The stock market has been falling for many months. Is this situation likely to get any worse?

Even the biggest brains in the City do not know but contributing factors include whether we go to war with Iraq, which could destabilise international oil prices. Another worry is what happens to the fragile economy of the United States. In the UK, many fund managers fear the FTSE 100 index of leading stocks may end the year at around the symbolic 3,500 mark – a low not reached even in the aftermath of 11 September.

The City fears it would be harder to pull the UK out of a slump than before. The 1974 market collapse in the UK was ended when a group of big City institutions decided to act together and start buying, but that would be harder to do this time because the problem is global.

What happens to pensions and investments if the FTSE does reach a new low of 3,500?

Insurers have been adjusting their holdings since last year to take account of the slump in share prices but fresh falls would mean at least some companies would have to transfer even more of their assets from shares to bonds. They do this when times are tough because they have to comply with financial regulations which require them to guarantee they have enough money to pay sums already promised to policyholders. Insurers tend to hold much of the guaranteed sum in bonds, which are more stable than equities, to make sure they meet this.

Another consequence of fresh falls in share prices would be insurers increasing the exit penalty, known as a market-value adjuster, on individuals who want to cash their investment in early.

Could my insurer end up going bust?

The FSA yesterday said most insurers would be able to cope if the FTSE dropped to 3,500 or even lower. But some insurers have shown signs of distress. This year, Royal & SunAlliance was forced to close most of its life insurance business to new customers because it could not afford to continue, and Pearl, another life insurer, had to be bailed out by its parent, the Australian AMP, when it ran out of money. Neither of these is expected to end up in receivership but if any on the sector do, policyholders can claim most of their investments back from the independent Financial Services Compensation Scheme.

How do I tell if it is going to go bust?

Ordinary people simply cannot. Most financial information is not in the public domain because it could start a rush of people wanting to get out, almost like a run on a bank. Financial regulators do not want this to happen.

For some guidance, you can ask an independent financial advisor to look at measures such as the "free asset ratio" of a company you are thinking of investing with. But this will not provide the full picture of a company's financial health.

Even if my insurer is financially solid, should I stick with it if the prospects for the stock markets don't look good?

The problem with not sticking with an insurance policy is that you suffer by cashing in, or "surrendering", early. You lose the final bonus, which can be worth half the total bonus, and most insurers are imposing extra exit penalties. Most experts say it is best to stick with the policy if possible.

If you have an endowment, you can try to sell it to another investor, which tends to provide a better settlement than trading it with the insurance company. But the price of traded endowments has fallen recently. If you do not want to, you can try to sell your endowment

Why not cash in and put my money into something else, such as property?

In the first place, you will lose the tax if the money is in a pension scheme or Isa. The UK housing market has performed much better than shares in the past two or three years. But closing a pension fund or Isa would mean sacrificing lots of tax benefits and there is no guarantee the value of property will continue to soar.

Who is to blame for this mess?

The root of the problem is the fall in the stock market, and it is hard to blame that on any one factor. For once, it does not look as if it can be pinned on ill-thought economic policy, either by this government or America's. As often happens, the market crashed following previous excesses, notably the dotcom boom of the late Nineties. The uncertainties from 11 September have added to that.

Some insurance companies, notably Equitable Life, have committed the cardinal sin of not maintaining sufficiently high reserves to protect their policyholders against such a crisis. But when even Standard Life and Prudential start cutting bonuses, you can be sure no one would have escaped entirely.