By Orla Ryan BBC News Online business staff

There may be trouble ahead, sings Fred Astaire, soothing the brow of those who have stumbled on life's weary path.

But the life insurance industry may rue the day they encouraged punters to "face the music and dance" or to "always look on the bright side of life".

In fact, they might have been better off listening to some of their own advice.

Life insurers sell pensions, endowments and with-profit bonds - products which rely on a rising market to ensure strong investor returns.

Music stops

But the market is no longer rising.

For the past two and a half years, it has fallen.

Face the music and dance - advises Nat King Cole

The falling price of shares has hurt thousands of people, but arguably the life insurance industry has been hurt particularly badly, because it invests in equities some 70% of the �350bn assets it manages.

In principle, managers should hold back some of the profits in good years - called excess capital - and use it to smooth over returns in bad years.

This practice of 'smoothing over' is a central part of the with-profits philosophy.

Independent insurance analyst Ned Cazalet estimates that insurers' cushion of excess capital has fallen from �130bn to �30bn in the past two years.

Life insurers may have to cut bonuses and raise exit penalties - serious blows to policy holders.

Even if the market starts to rise again, investors could see smaller bonuses for years to come.

And if the FTSE falls much further, some could even go out of business.

You can't say that more should have been held back in previous years to cover the situation now

Legal and General spokesman

Already, life insurers have taken measures to boost their financial strength - many are increasing exit penalties.

This week Equitable Life - which has over time reduced its equity holdings to 15% - has had to increase its exit penalties.

Legal & General raised its exit penalties last week, citing "continued falls in stock markets" and many others have also acted.

What is a with profits fund?

With-profits investments are "collective" savings products run by life insurers. Investors' money is pooled, and returns are paid in the form of bonuses, typically annual, with a terminal bonus when the policy matures. Managers hold back profits from good years and use it to smooth returns in bad years

.

Round in circles

Insurance companies are some of the biggest holders of UK shares and if they sell shares to cut their losses, shares fall further.

The Financial Services Authority (FSA) has relaxed it solvency rule in a bid to break the circle, hoping that this will help shore up the market - also providing some relief to life insurers.

While this should provide some assistance, concerns remain.

David Wharrier, insurance industry analyst at Fitch rating agency Fitch, said: "The main concern for life companies is [where they have given] guarantees to policy holders.

"Where they will suffer is where the stock market doesn't match the guarantees.

"If you are giving fantastic returns of 6% or 7% to investors and you are only making 4%, it doesn't matter how much the regulator helps."

Already, some policy holders have been hard hit.

Ned Cazalet said: "A big part of the payout comes in terms of final bonus.

"There some quite big cuts, rather bigger cuts than you would expect. You cannot smooth out a fall in the market of 30%."

Time to bond?

One solution for insurers is to get out of equities and put their money into bonds - traditionally seen as a more secure investment.

Life wasn't so equitable for this mutual's policyholders

Those who did this at the right time have fared well.

"Prudential sold about �15bn in equities, when the market was high," Mr Cazalet said.

"They stashed that money into corporate bonds, relatively speaking they have done very well.

"Contrast them with Standard Life and Axa... there has been a big gap opening up."

However, this could mean that insurers miss out on the gains to be had when the market starts to rise again.

Volatility safeguards

Some question why the insurers' profits from the rising market are not enough to tide them through - as this is the central principle of with-profits funds.

It could beg the question that they were reckless with these profits.

A spokesman for Legal & General said: "Assumptions are made, which include allowances for volatility in the market.

"Smoothing works very well on a year by year basis. You only do that within certain boundaries. Once the equity market starts bouncing outside it, you need to take other action."

Lack of experience

However, part of the problem - says Ned Cazalet - is that many life insurers never believed the market would continue falling.

"The equity bet has paid off for so long, but just because it has paid off in the past doesn't mean it will pay off in the future," he said.

There are few people around who remember the poor market conditions of 1973.

" What they are used to is the stock market going up. People do not have the culture of saying what happens if market goes down for five years."

The FSA - which regulates the industry - has previously played down reports that as many as 200 life insurers could be at risk.

An FSA spokeswoman said: "There has certainly been some excitable reporting, a number of firms have come out and commented on their strength. "