Life insurers’ balancing act: A quest for yield, illiquid investments and investor/regulator confidence
August 22, 2016
Blog snapshot:
- Life insurers are becoming increasingly creative with their investment strategies in their search for yield
- These investment strategies are inherently riskier
- Valuations of infrastructure investments will need to reflect a number of considerations to give investors and regulators confidence
As investment yields have plummeted and valuations have fallen, life insurers are becoming increasingly creative with their investment strategies in the search for yield. They have increased investments in higher return, illiquid assets, including committing over £25bn to UK infrastructure assets.
Aviva recently confirmed 80% of any new investments made will be in long-duration assets, as opposed to traditional gilts or corporate bonds. Prudential has allocated $3.1bn to infrastructure assets. Legal & General has set up an asset manager, Legal & General Capital, to focus on alternative investments – one recent example being their investment in high quality housing stock backing a fast growing pipeline of over 36,000 new homes. Legal & General has also committed $4.6bn to infrastructure assets, while Allianz is acting as a primary backer of the £4.2bn supersewer project in London.
Capital concessions
This trend is supported by the new delegated regulation under Solvency II, allowing capital concessions on qualifying infrastructure debt and equity investments. At the same time, banks are refocusing their investments on shorter term financing, leaving a funding gap for life insurers in the long-term infrastructure space.
*Data source: Preqin Global Infrastructure Report, November 2015
Whilst this investment strategy has a clear potential to enhance life insurance valuations, these portfolios are inherently more risky, with differences in covenants, terms of duration and more unpredictable cash flows which could introduce a greater degree of risk and volatility around these valuations.
Risk exposure
In addition to the common risks associated with more traditional investment strategies such as credit risk and assets/liabilities mismatching, these illiquid investments do expose life insurers to a range of additional investment risks. For example, valuations of infrastructure investments will need to reflect the following considerations:
- Political and economic uncertainty, in response to Brexit, which could result in changes of law and government policies in the medium to long term. This might lead to certain infrastructure projects being put on hold or fully abolished.
- Degree of local and European regulation, structures of ownership (public, private) and their impact on regulatory price resets and costs of funding.
- Terms and conditions including covenants (as they are not standardised and might have lock-up/default thresholds depending on the industry), as well as conversion options, non-callable periods and step-in rights.
- Duration of repayments, i.e. potential opportunities for early repayment or the existence of ratchet provisions.
As the risks are project specific, these investments are difficult to value using standard listed benchmarks. Life insurers, therefore, will need to demonstrate they have the right valuation expertise and framework for these assets. To give investors and regulators more confidence, they will need to be more transparent about the way they measure and monitor the value of these assets.
Do get in touch if you would like to discuss any of the points I raise here.
