The search by insurers for quality long-dated assets has intensified with the traditional demand from annuity providers and other term insurers topped up by those with profits funds and unit linked portfolios looking to include some illiquid assets to enhance returns. The demand is also being fuelled by motor insurers facing a significant growth in periodical payment orders (PPOs) for multi-million-pound personal injury claims.
This growth in demand and some of the options for meeting it formed the back drop to an exclusive Insurance Investment Exchange breakfast round table, hosted by Axa Investment Managers. This was attended by senior investment managers from a range of insurers, all looking for fresh insight into how they might find opportunities they can have confidence in.
The growth in demand from insurers for long-dated income generating assets has coincided with other trends that have conspired to depress the supply. This started with the restriction in the supply of long government bonds and was exacerbated by the penal treatment of some structured products under Solvency II. Added to this has been the complexity of origination and management.
The discussion round the table focused on two options of particular interest to insurers – long lease assets and infrastructure debt.
The key feature of long lease assets is that they are backed by real assets, which could be ground leases, social housing or long-lease property with typical life spans of 15 to 20 years. Some of the assets offer both defensive and return opportunities. Inflation-linking – either to CPI or RPI – is becoming more common, making them even more suitable for matching.
The long-lease property market in the UK is currently worth around £25bn and is growing, especially in sectors such as care homes, student accommodation and public sector offices. The growth is being driven by a variety of demographic, social and political trends. For instance, 15% of over 85s are in senior care accommodation and the proportion of 85s in the population as a whole is set to rise steeply over the next few decades. In the world of student accommodation, it is estimated around a quarter of the current stock falls short of the requirements and expectations of today’s students and needs to be replaced.
These factors help avoid volatility and are usually free from the pull of market cycles. Over the long-term this produces annual returns in the range of 6% to 8% across the main long-lease sub sectors.
Infrastructure debt similarly offers the benefits of low correlation of the underlying assets with economic cycles. The key is to focus on debt that is linked to assets that have long-term “essentiality”. The discussion revealed that this is not always as easy as it might seem.
The only sector that is currently rated as Aaa by Moody’s is water, a perpetual essential, although even this sector carries some risk in the financial structure of the companies and the risk of customers not paying bills. Other sectors might also seem to offer excellent prospects, but the world sometimes moves on unexpectedly. City centre car parks were once considered “trophy assets” in an infrastructure portfolio but over the last ten years their gleam has been tarnished by a combination of Uber, better public transport and congestion charging.
However, the infrastructure debt market is opening up for insurers as banks retreat from lending long term due to their regulatory constraints, the investor base becomes more professional and the regulation of insurer solvency become more favourable. This makes it attractive to insurers looking to diversify their portfolios while aiming to generate an additional return by capturing an illiquidity premium.
Another potential advantage is that the right assets – in sectors such as renewable energy – have a positive environmental or social impact, increasingly important with the emerging importance of the sustainable finance agenda.
You can register your interest in forthcoming Insurance Investment Exchange breakfast round tables through the website. They all take place in the City and typically last for 60-90 minutes.