FSA cautions life insurers over annual bonus rates

Millions of investors with endowments and personal pensions can expect their money to grow more slowly over the next 12 months after life insurers were yesterday warned they must "exercise prudence" in setting annual bonus rates.

In the wake of this year's stock market falls, the financial services authority has told life companies they must ensure they do not pay more than they can afford to with-profits policyholders. Most companies announce their annual with-profits bonus rates in January and February, and these are supposed to reflect the investment returns likely to be achieved going forward.

The FSA's announcement affects millions of people holding with-profits policies, including with-profits bonds, and was interpreted by some commentators as the regulator preparing the public for more gloomy news on bonuses following the cuts many companies imposed this year.

The FSA is understood to be concerned that competitive pressures might lead to some life insurers promising too much this year in order to keep ahead of rivals.

Its warning is also aimed at preventing a repeat of the Equitable Life fiasco. Equitable's problems were partly the result of it dipping heavily into its protective buffer of cash in order to pay above-average bonuses.

It will be carefully monitoring the bonus rate announcements and will be asking any insurers whose decisions look questionable to justify their actions.

John Tiner, the FSA's managing director, said it was up to insurers to determine bonus rates but added: "Companies have a responsibility to treat their customers fairly. In exercising that responsibility, following a period of adverse market conditions, companies should set bonus rates at levels that do not jeopardise payments to policyholders in future years."

He said insurers should set rates "that are in line with their ongoing financial soundness and that are a fair reflection of their ability to pay".

The regulator wants to ensure that insurers do not overpay in order to maintain their position in the all-important bonus rate league tables.

Patrick Connolly at independent financial adviser Chartwell Investment Management said it was no secret that annual bonus rates were going to come down again next year. He expects the average annual bonus to fall by 0.5% to around 4.25%.

Mr Connolly said the FSA warning was surprising because life companies have been criticised for being "too prudent" on bonuses.

Annual bonuses have been under pressure for several years, and in recent months stock market falls have forced several companies including Legal & General and Friends Provident to cut final bonuses.