Insurers cleared for move into derivatives: Sharp increase on markets may be passed to consumers later in year

INSURANCE companies could become big investors in derivatives following an easing of government regulations announced yesterday.

Whitehall officials made clear they expect the changes to lead to a rush of new insurance products based on derivatives. These could include a much wider range of policies with values linked directly to Stock Exchange indices.

Although some companies offer pensions and insurance contracts of this type, present rules put obstacles in their path because they depend on the use of derivatives.

These will disappear on Friday when new regulations come into force to implement the European Union's third insurance directive, which will give a single 'passport' to EU and European Free Trade Association insurance companies.

An insurer licensed in one country will have the right to operate in all other member states.

Derivatives are investments based on futures and options whose basic purpose is to hedge against fluctuations in the markets. Their widespread use for speculation as well has led to calls for tough new curbs.

But the new regulations, published yesterday by the Department of Trade and Industry, will still ban insurance companies from speculating in derivatives, while removing restrictions on their use for hedging.

As well as encouraging new products, this is expected to lead to wider use of derivatives for managing insurance company investment portfolios and smoothing out the effect of stock market gyrations. The new freedom should be a boost for futures markets such as Liffe.

Current restrictions on selling insurance products linked to derivatives include a requirement to apply separately for DTI permission for each. A company can still sell the product without permission, but there is a severe penalty because the value of the derivatives investment then has to be deducted from reserves.

Derivatives linked to the value of overseas stock market indices are also banned. The new regulations lift these curbs.

The new regulations include a requirement for bidders for insurance companies to seek permission from the DTI in advance. Shareholders must also seek permission to raise their stakes above a series of thresholds.

For the first time, insurance regulations will allow the creation of composite firms specialising in health care. These are common in the US.