Fears are mounting over possible dividend cuts by life assurers, after a demand from the Financial Services Authority that they hold enough capital to survive fresh market shocks.

Life assurers are being told to test whether they would have a capital buffer after what is in effect a 60 per cent reduction in equity markets from current levels, as well as a significant increase in bond defaults, according to people who are aware of the project.

The FSA is asking life companies to carry out the exercise before they announce their preliminary results. This has raised fears that if they have to conserve capital, they will be forced to cut their dividends, or raise money.

The FSA declined to comment, but it is understood that it had asked life assurers to look at the potential scenarios that could arise by the end of 2009. The regulator wanted the results back in a “fairly short timeframe”.

The regulator told the sector to test for a first wave of scenarios at the end of last year, and has since asked for other information on capital positions.

One life assurer said it was supportive of the latest exercise, but another said it flew in the face of recent pledges by the regulator not to force companies into knee-jerk reactions at the bottom of the market.

Companies were being asked to test for “a whole extra layer of stress …It’s a triple-stressed [scenario],” said one executive.

In the latest tests – regarded as more extreme than the December exercise – the FSA has told companies to test whether they would have a capital buffer in the event of a 1980s-style sharp and deep recession, according to people familiar with the plans.

This includes a 20 per cent reduction in equity markets from current levels, followed by another 39 per cent decline, which would take the FTSE 100 index to around the 2,000 level.

It is also asking companies to test whether they would have a capital buffer after a further significant increase in the returns that investors demand for holding bonds that are more risky than gilts and a significant decline in property prices.

The tests represent yet another change in approach by the FSA, which has alternated between pragmatism and strict solvency demands.

“Its like dealing with the police if they kept changing the crime laws,” added the executive.

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