The Financial Services Authority is in talks with Royal & Sun Alliance, as the company's failing with-profits funds threatens to leave thousands of policyholders out of pocket.

The insurer's Sun Alliance & London Fund, used by tens of thousands of homebuyers with endowment mortgages is at the centre of concern.

The fund also has an �847 million pounds liability for guaranteed annuity rates for pension customers.

With a huge amount of cash needed to meet its liabilities, the fund has just 20% of its �9 billion pounds worth invested in shares - calling into question its long-term growth prospects.

Annual bonuses on endowments and pensions have already been drastically cut.

RSA is the latest insurer to run into trouble after being hit by a combination of large insurance payouts and weak global markets.

Two of its four investment funds are in particular trouble, both are with-profit funds with a combined worth of around �20 billion pounds.

With-profits funds pool investors' money and pay returns in the form of bonuses - typically paid each year and then in the form of a final bonus when the policy matures.

In theory, investment returns are supposed to be guaranteed by a 'smoothing' effect.

In good years, insurers should hold back some money for years when investment returns are low.

But the recent poor savings environment has exposed the fragility of some of these funds and led to questions about their management.

Many insurers have slashed bonuses, and millions of endowment holders have been warned that they may not be able to pay off their mortgages.

Policyholders with Equitable Life have been among the worst hit, after the insurer could no longer guarantee payments.

Now some industry analysts are concerned that RSA could suffer a similar fate.

R & SA estimates it will lose up to �215m related to the destruction of New York's World Trade Center after the 11 September attacks.

The company is also expecting to pay out up to �15m in claims over Enron's bankruptcy and �371m to claimants who have contracted diseases related to asbestos exposure.

To compound its misery, R & SA has said it intends to write to around 50,000 customers who may be entitled to compensation over the payment of guaranteed pensions.

The decision follows a ruling by the House of Lords, which forced rival insurer Equitable Life to honour promises to its policyholders over guaranteed annuities.

The insurer's two other funds, the R & SA Linked Assurance Fund and the Phoenix Fund have so far not been affected by the crisis.