Cazalet warns of big cuts in with-profits payouts

Life insurers have almost no capital available to pay bonuses to their with-profits policyholders for last year, having wiped out their surplus funds of about £40bn in the stock market during 2002.

The grim estimate comes from Cazalet Financial Consulting, ahead of a run of bonus declarations from the sector. Life insurers splashed out nearly £20bn in bonuses for 2001, and about £5bn on writing new business. This left the sector with £41bn of spare capital at the start of 2002, almost all of which has now been lost in the equity market slump, meaning the prospect for bonuses is slim.

"Even if companies had made an investment return of zero on their funds this year, bonus payments would have been a huge chunk taken out of their £41bn of spare cash. But the value of these funds went backwards in 2002 in the region of £40bn, so where will they find the money for £20bn of bonus payouts? Or even £5bn to keep writing new business?" said Ned Cazalet, who runs Cazalet Financial.

Axa Sun Life, for example, paid out £400m in bonuses to policyholders in 2001, leaving it with, on Cazalet's calculations, £1.2bn to spare at the start of 2002. Based on the investments the with-profits fund held at the start of 2002, the fund would have fallen by £1.4bn last year.

Many companies, including Norwich Union, Prudential, Pearl and Standard Life, did, however, reduce the equity content of their funds throughout 2002 in favour of less volatile asset classes, which may have helped stave off some their investment losses.

Mr Cazalet calculates that Norwich Union had £2.1bn of surplus capital at the start of the year after paying out £1.3bn in bonuses for 2001, but may have lost up to £2.5bn in 2002 on the stock market. Norwich Union will today tell policyholders what annual bonus they will receive for last year. It has already made a number of interim cuts.

Mr Cazalet said while some life insurers will fare better than others, most will have no choice, given their investment losses, but to severely cut back on bonuses.

The stark situation facing life insurers and their policyholders was made apparent in the profits warning from Britannic last week. It told policyholders it was likely to forgo paying an annual bonus to its policyholders entirely and told its shareholders they were unlikely to receive a final dividend. The move, intended to shore up its much-depleted reserves, sent shares down 50 per cent.

Bonus cuts also represent bad news for shareholders, as they are only entitled to a portion, usually 10 per cent, of what is paid out to policyholders.