There is trouble ahead for the financial services industry, the FSA warns
Insurance companies have been told that any cuts to the value of with-profits funds must be fair to their savers.
The warning has come from the Financial Services Authority (FSA), in its Financial Risk Outlook.
It says insurers will come under pressure from the recession, leading to falling policy sales and lower profits.
It also warns that firms which have sold annuities must make sure they have "sufficient reserves and capital" to cope with people living longer.
Several big insurers have slashed the value of their giant with-profits investment funds recently, along with the payouts being given to savers when their policies mature.
This has mainly been due to last year's huge fall in share prices and the value of commercial property.
Among the firms which have done this have been Norwich Union, Friends Provident and Standard Life.
Firms are also able to conserve the money invested in their funds by raising the charges they levy on people who cash in their polices early.
But the FSA says managers of with-profits funds had to tread carefully.
"There is a risk that the mitigating actions firms take to deal with their financial pressures may result in policyholders not being treated fairly," it says.
"Even if the actions firms take are consistent with our rules and principles, there is also a risk that poor communication may mean policyholders' expectations are different to their experience," it adds.
The Financial Risk Outlook is a wide ranging review of the problems ahead for the financial services industry in the light of the continuing credit crunch and the recession, which the FSA warns may be longer and deeper than is generally expected.
The review concentrates on the prospects for the banking industry, which so far has been the financial sector worst affected.
However the FSA issues clear warnings to the management of other businesses that they are not immune and must prepare for a downturn in their fortunes.
Life insurers that sell annuities are told again that they must take account of people living longer.
"This continues to be a significant risk and firms that do not adequately allow for improvements in mortality (particularly for older ages) will be under pricing their annuity products, overstating profitability and understating reserves," the FSA points out.
And general insurance firms are warned to expect higher claims on their protection policies.
"Firms need to ensure that contract terms are interpreted fairly and legitimate claims are met in a timely manner," the FSA says.
"Firms should also ensure that protection products sold to consumers are appropriate and that the consumer would be eligible for claims under their terms and conditions," it adds.
Although building societies are in a relatively strong position compared to banks, they too have been weakened by the financial and economic downturn.
Some will report a loss for last year, the FSA points out.
As they are mainly mortgage lenders, societies are exposed to further losses due to defaulting borrowers and falling house prices.
And the FSA says they will also have to cope with the effects of low interest rates, which will deter savers and thus restrict their ability to lend.
"This has resulted in a squeeze on margins for societies, which together with the higher impairment charges - and Financial Services Compensation Scheme levies arising from bank failures - can be expected to cut profitability in the short term," the Financial Risk Outlook states.