All is not well at R&SA, and the current climate of unease and solvency fears are not helping. Jason Woolfe reports

BOB Mendelsohn must be nervous when he sees his staff reading the news in the morning.

He has became the latest chief executive to issue a statement rebutting press reports and trying to calm his workers' nerves.

At Norwich Union (NU), group chief executive Richard Harvey recently sent emails to bolster morale about falling share prices.

Mendelsohn's concern at Royal & SunAlliance (R&SA) is not dissimilar - that his staff should not believe reports that the group is in talks with the Financial Services Authority (FSA) over a recovery plan to rescue its solvency.

He was worried enough to send a letter to staff denying the claims.

He wrote: "Unfortunately, the underlying improvements in our operating performance and our capital position have yet to be reflected in our share price and, indeed, in much of the market commentary you may read."

"Much of the UK investment community and media remain sceptical about R&SA because, for a variety of reasons, we have not performed as well as they would have liked us to perform in recent years."

He also rebutted claims that the FSA was helping managers keep the company afloat and that the life funds were facing insolvency. He said R&SA's plans to raise £800m by selling off non-core businesses were well on track.

It is a message that was reinforced by R&SA finance director Julian Hance. The sell-off is driven by the company's risk-based capital analysis introduced by Hance in 1998.

Hance uses the approach to determine how much capital he needs both to run the group's insurance operations and to design its investment and reinsurance policies.

Balancing needs
In trying to balance capital needs with risk, Hance should be selling equities, but his plans to cut equity holdings from £3.5bn to £1.5bn this year could be held up if the markets stay in the doldrums.

The group sold about £900m of shares in the first quarter of this year and took out protection using derivatives on another £1.3bn.

Hance says most of the equities would eventually be sold.

"We will be looking to complete the programme by the end of the year," he says, but tells Insurance Times the plan could be delayed if stock markets keep performing badly.

He admitted the stock market falls since last year were a "big drag on performance" and the bear market has certainly taken its toll on R&SA's own share price. Last week it was trading at 239p, compared to 550p this time last year.

The risk-based capital approach relies on underwriting data from the last 13 years to predict how much capital is needed for the non-life business side. Stock market data going back to 1918 is used to model the investment side.

The system involves modelling possible outcomes given managers' solvency guidelines, which require 99% confidence of solvency not falling below 25% of net written premium over a five-year period.

Industry is `way behind'
Hance says the insurance industry needs to shake up its understanding of risk and how it manages capital.

He says that despite the nature of their business, insurance companies are "way behind" in the way they deal with the financial risks.

Too many balance sheets are saddled with risk, making companies suffer unnecessary volatility and holding back their efficiency.

He says: "Insurance companies are way behind the banks in the sophistication of the way they cope with risk. We retain a large proportion of the risks we write and our business model is a risk-taking model.

"By contrast a lot of banks, through a better understanding of risk and capital requirements, have moved from a risk-taking model to a risk-trading model."

Risks from insurance could be reinsured and risks from investment volatility could be transferred using securitisation to the financial markets, he says.

The company has been going out of its way to defend its approach to reinsurance, but the fact of the matter is that Mendelsohn is not getting the investor support that he thinks R&SA deserves.

He said in his letter to staff that the group had made a "solid" start to the year. But in the current climate of post-WorldCom uncertainty on the stock markets, that is unlikely to be enough to generate major gains in the share price.