Mitigating the downside, seeking the upside

Those charged with managing the assets of major insurers have seen levels of volatility over this year that have tested the resilience of their portfolios. Steering a course through the pandemic as its second wave sweeps across most of the developed world is going to test that resilience further.

So far, the impacts have varied enormously says Prasun Mathur, Head of Private Assets at Aviva.

“Different sectors have been affected differently. Our portfolio has been positioned very carefully so we haven’t been impacted too badly. During the first half, in our corporate credit book, we experienced no defaults, only 0.2% of the portfolio was downgraded below investment grade and  around 4% of the portfolio rated A or above has been downgraded to a lower letter. We are conservative investors and have a diversified portfolio. That has allowed us mitigation in the face of the pandemic”.

This doesn’t mean that there haven’t been challenges within the portfolio.

“Lending to the real estate space has been impacted quite profoundly, with structural trends like home working and e-commerce accelerating. This has influenced our prospective appetite in sectors like retail, leisure and office. On our existing portfolio, asset quality fundamentals remain strong with only a slight deterioration seen in some metrics, with only about 1.25% of the portfolio in arrears.”.

Equity release – a major business line for Aviva – has also been impacted as the client base tends to be people near or past retirement age: “There is an increased Covid risk for that age group. In the peak of the crisis, there was an impact on how you write new business as, under lockdown rules, you could not visit homes in order to complete an onsite survey”.

The equity release team quickly developed a remote survey process in response to allow customers to press on with their applications: “The teams spent a lot of time making sure remote valuation can support the underwriting of equity release.”

Even after the initial relaxation of lockdown rules so that face to face surveys could be used again, the option still remains for a customer to opt for a remote valuation if they wished: “A process has now been introduced whereby a customer has the option to choose either a remote or onsite survey.”

Interest in infrastructure debt has grown among insurers over the last few years, especially as governments have turned to institutional investors for the funds to support ambitious projects, even more so as the plans for economic recovery after the pandemic are rolled out. This will present a mixed picture to managers trying to find value, says Mathur.

“Airports for instance, which were very active and looked on favourably before the pandemic, are on hold. Debt structured pre-Covid would most likely require restructuring. You would want increased protection against the impact of the pandemic and you would want more interest. This might not always be palatable so when that is the case you just press the pause button”.

This sort of delay is not unusual with the financing of major infrastructure projects as they are long term and there is often a drawn-out waiting time.

Another impact was felt when trading in public corporate debt dried up at the start of the lockdowns, causing problems for pricing private debt.

“Pricing of assets on the private side depends on being able to create a premium over public corporate assets”, but this hasn’t stopped the search for suitable assets.

“You can get some bargains when the fundamental and long-term credit stories are strong.”

The talk of a green recovery could hold opportunities for insurers. There will be several factors that need to be balanced in order to make the assets that might be created off the back of it attractive to insurers, says Mathur.

Aviva has made a strong commitment to becoming a net zero carbon business and that, together with the Bank of England’s publicly stated expectations for the insurance industry to be investors in longer-term, illiquid assets that have a positive impact on climate change, means they are well suited to support a green economic recovery. “This encourages us to think that we are all moving in the right direction, although it is a work in progress for the entire industry”, says Mathur.

“That top level message has to translate into investment decisions. These investment decisions must integrate ESG into shareholder value generation. We need to think about these investments at a portfolio level rather than as individual trades”.

This difficult balancing act can be made simpler with regulation.

“We want to reduce long-term risks by investing in sustainable sectors, but such investments often come at a premium. If green is good, then the regulators should help find a way to hold less capital against good quality green assets.”

“The industry spends a lot of time on structuring and securitising assets to make them compliant from a regulatory perspective. I think this time would be better spent on true credit investment analysis.

“Maybe with Brexit on the horizon there might be an opportunity for us to adopt the best of both worlds. We buy into that”.

Even with a more sensitive approach to the capital treatment, a shortage of suitable assets will still be an issue as “this leads to higher prices and makes good returns difficult to achieve”.

He says all insurers will need to be alive to the opportunities and potential downsides as we emerge from the rigours of lockdowns. Some things will have been changed for ever, although many were trends that were already in play.

“The trend of digitisation and working remotely has been accelerated considerably”.

This has implications for transport, housing, offices and retail.

“All corporations are reimagining how much workspace they need. This doesn’t mean the office will disappear. Firms need the spark, magic, inspiration and ideas generation you get when you bring people together. This means big cities and their business centres will survive.”

Travel in all its forms – commuting, air travel, international business – will continue, although no-one can be sure how it will evolve. For the time being, a watching brief is required.

“We feel in the long-term these sectors will still be investible but the great unknown is how long will the current short-term conditions last”.

There has been plenty of discussion about where next for interest rates and the Bank of England has asked banks to review all their systems in case it feels it needs to push interest rates below zero. The path is being laid but there are few worries at Aviva if the Bank decides to travel down it.

“We have a close matching of assets with liabilities so have no immediate concerns about the prospect of negative rates. The continent is possibly less well immunised against the impact of further interest rate changes. Negative interest rates will make the equity story look better, however”.

After interest rates, the short-term future is dominated by the US Presidential election and the frantic search for safe, effective vaccines.

Even once a vaccine has been identified the uncertainty will not be at an end.

“The next big question is how quickly can it be deployed once it is ready”.

The challenges facing insurer CIOs and their teams will not ease anytime soon.

• Prasun Mathur was speaking to David Worsfold