What ails Britannic? Longevity

Britannic's profits warning yesterday left the entire insurance sector reeling and the Birmingham-based company facing questions about its strategy.

It could not have come at a worse time for the industry, already nursing a bad new year hangover. The worst performance of the FTSE 100 since 1974 and the index's third consecutive annual fall meant that many insurers ended 2002 at their weakest point for many years.

Britannic's stark admission that it will not pay a dividend and the unprecedented decision to defer any decision on bonus payments to its one million policyholders were a reminder of the strains still facing the industry.

Britannic's share price halved to 164p, the lowest level in more than 10 years, and larger rivals also felt the shockwaves. The biggest fallers of the day included Prudential, down 12.5p to 448.5p, Aviva, 16.5p lower at 463.5p, Legal & General, off 4p to 96.5p, and Friends Provident, down 4.5p at 119.25p. Even banking group Lloyds TSB, which has a large insurance arm, felt the impact. It fell 15p to 434.5p, gaining an unwelcome place on the big fallers board.

The wider market, measured by the FTSE 100, ended the day at 4,001, down 4 points.

One analyst said: "This shows that when the market is around 4,000 problems remain for the industry."

The level of the FTSE 100 has been an issue for the insurance industry since the September 11 terrorist attacks and the turmoil that followed in the markets. Last week Sir Howard Davies, the outgoing chairman of the financial services authority, admitted that stock market falls might yet pose problems for some insurers although he believed most would be able to cope.

The fall in the market has two big impacts on the insurance industry: it affects the value of its investments and its regulatory solvency measures, because these are in part based on the value of its investments.

'Precautionary'


Andrew Goodwin, insurance analyst at Commerzbank, said: "The whole sector is under pressure, particularly because in the UK the insurance industry is relatively exposed to equities."

Britannic described yesterday's decision as "prudent precautionary action" to maintain financial strength in the light "of the worst annual equity performance since 1974".

On top of that, it raised the issue of "annuitant mortality", the actuarial term for the fact that people are living longer. Some analysts admitted that they had not considered annuitant mortality to be such a big issue. One said: "Our view is now that annuitant reserves will have to increase, even if Britannic is a bit special."

Bigger insurance companies addressed the issue of how to deal with falling stock markets last year by tapping their shareholders for fresh funds. Legal & General took its begging bowl to the market first, raising £1bn, while European insurers Aegon and Zurich Financial Services also made emergency rights issues.

Others tapped the bond markets but Paul Thompson, Britannic's new finance director, said yesterday that none of these routes was "appropriate" for Britannic.

While analysts were able to draw comparisons between Britannic and the wider insurance sector, they were quick to point out that the group had problems of its own.

Mr Goodwin also noted that Britannic had a higher exposure to the equities market - about 72% - for longer than many of its rivals. This made Britannic particularly vulnerable to further falls in share prices. Mr Thompson said yesterday that its equity holding had now been reduced to 42%.

Its attempts to address its cost base were also well known; it has cut 2,000 jobs in little more than two years.

Britannic was at pains to demonstrate yesterday that despite its drastic action it was 50% above its regulatory requirements because its free asset ratio stood at 6%, compared with the required minimum of 4%.

This failed to prevent speculation that Britannic would find it hard to survive just nine months after the company hired Merrill Lynch to find a merger partner in order to provide "scale".

In the summer Britannic blamed volatile markets for its inability to find a suitor. Yesterday, Mr Thompson would only say that the insurer was "not ruling anything in or anything out".

Some believe that Britannic, which has diversified rapidly in recent years, could be broken up and sold off in parts. In addition to the life operation, there are an asset management business, a retirement solutions arm and a mortgage business, Britannic Money.

Analysts at Merrill Lynch put a theoretical sum-of-the-parts valuation on Britannic of 325p per share - but admitted that a value of 200p was more realistic based on its ability to pay dividends in the future.

Others warned that the sorry state of many of its rivals might mean that bidders were slow to emerge. "Whether other insurers have got the energy or the inclination to take over a company like Britannic is another matter," one analyst said.

An industry source noted that if anything was going to entice bidders out of the shadows, yesterday's announcement was an obvious lure. The intentions of Royal London continued to be the subject of gossip.However, its fund managers are nursing losses on their 12% stake in Britannic.

They are not alone. Some of the biggest names in the investment community are also suffering from the slide in Britannic's fortunes. They are unlikely to tolerate inaction for long.