A.M. Best Report: UK Life Insurers Show First Signs of Recovery Amid Stable Equity Markets.

OLDWICK, N.J. -- A.M. Best Co. expects the profitability of the U.K. life sector to continue its recovery during 2004, owing largely to the relative stability of the equity markets. The demand for with-profits products is expected to stabilize after the severe declines of the past two years. However, full restoration of demand is unlikely, as bonus expectations continue to be low. A.M. Best anticipates a further increase in sales of unit-linked and protection products in 2004, as the attractiveness of these products is impacted by the relative stability of equity markets.

Recent changes in reserving requirements for future bonus declarations are encouraging U.K. life companies to reassess their with-profits strategies. A.M. Best believes that a small number of with-profits specialists characterized by solid capital bases will dominate this business line, leaving the majority of U.K. life companies focusing on protection and unit-linked products.

The expected shift to protection products will increase new business strain. Nonetheless, financial performance is likely to remain strong during 2004, as this strain is offset by stable investment returns. Results on an achieved profits basis will be higher because of the earlier profit recognition of the new business.

Most free asset ratios (FAR) have improved after three years of decline, once again as a consequence of the recovery of equity markets during the second half of 2003. While acknowledging the limitations of FAR as a measure of financial strength, A.M. Best believes that the reduction of implicit items included in its calculation, combined with its return to 2001 levels, is an indication of the reduced pressure on the companies' position.

Risk-based capitalization will continue to improve gradually, driven by the ongoing reduction of the equity backing ratio, the increased emphasis on less capital-intensive protection products and the increased utilization of soft capital (i.e. reinsurance and debt).

Although still facing challenging times, the U.K. life sector continues to recover. Overall, new premium volume is declining, still reflecting a weak, although stabilized, demand for with-profit business as low bonuses are maintained. This reduction in premium volume has been offset partially by a premium increase from pension contributions and sales of unit-linked policies owing to improved equity markets in the second half of 2003. The collective increase from the 10 largest U.K. life companies was 2% in 2003.

Notwithstanding, the decline experienced in with-profit sales until the end of 2003, together with pressures from potentially higher regulatory capital requirements for guaranteed options products, are driving U.K. life companies to reassess their strategies, including potential closure to new business. Companies trying to offset solvency pressures by closing their with-profits funds to new business may face adverse public reaction and negative impact on their overall business profile. However, those for which with-profits business remains strategic may consider launching new products while ensuring higher capital efficiency and transparency. A.M. Best expects the with-profits business to concentrate among a small number of highly capitalized and strongly branded companies.

On the other hand, those with strained risk-based capitalization and relatively small with-profits portfolios are likely to consider closing these funds and focusing on protection products and, equity markets allowing, on unit-linked products and annuities. This approach will undoubtedly contribute to improved risk-based capitalization, but limited demand for protection products could seriously intensify competition in an already commoditized sector.

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A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at www.ambest.com.