Simoney Kyriakou examines how insurers are reconsidering traditional investment models in this brave new world
The way in which we all invest is changing. Whether driven by moral or regulatory obligations, the shift towards a more sustainable future is reflected in climate pledges by companies the world over.
Insurance companies have been at the centre of change; during the past two years or more, these companies with their trillions of dollars-worth of investments have pledged to move towards a carbon-neutral or even carbon-negative portfolio.
But even as the shift away from traditionally high-income equity assets such as coal, mining and gas companies started to have an impact on insurance companies’ own portfolios, along came Covid-19 and, suddenly, dividends dried up.
In March 2020, the Bank of England and the Financial Conduct Authority told UK banks to scrap nearly £8bn-worth of dividends, to cushion against market falls. While companies such as Henderson Global Investors have predicted a bounceback in dividends globally, questions remain about where insurers’ investment and capital management strategies go from here.
And insurers are in a bit of a dilemma. On the one hand, insurers must assess whether they can continue paying dividends, to encourage investors and get the capital needed to grow.
After all, according to Willis Towers Watson (WTW): “It is the consistent returns that underpin why many investors are attracted to insurance stocks and provide their capital in the first place. Often, it boils down to one key thing: dividends.”
Historically, insurers have produced capital in excess of their growth requirements and the expectation is that future dividend payouts may remain consistent, in line with current market expectations.
For example, Ian Stokes, managing director for corporate markets UK and Europe at Link Group, says the organisation expects UK plc to yield 3.5% during the next year.
He says that while the outlook is still uncertain, “we have consistently seen companies deliver more in dividends than we thought likely at the beginning of the year”.
He adds: “Many companies took action to bolster their balance sheets during 2020. Dividend firepower is now much stronger as a result.”
This is encouraging, but another threat to insurers’ balance sheets is the need to grow their portfolios, as their investments underpin policy payouts.
As insurers shift away from high-income sectors, such as mining, and towards less liquid assets such as infrastructure, they may need to retain more capital to ensure they can meet policy claims. And this could affect future payouts: a Catch-22.
Response to policy
So how do they go about remodelling their investment strategies?
Part of the answer must lie in how insurers respond to national and international monetary policy decisions post-Covid. According to WTW: “Pre-global financial crisis, the stock response of the previous 50 or so years would have been to cut interest rates.
“But now the emphasis is likely to shift to a longer-term trend of capital investment from governments in, for example, infrastructure, to support economic recovery.”
As Guy de Blonay, fund manager, global equities, at Jupiter, comments: “In a low interest rate environment, insurance companies are under pressure to diversify their investments towards areas that offer better yields, including infrastructure and private equity.”
This is reflected in the UK government’s own push to encourage pension schemes and insurance companies to invest in potentially higher-yielding infrastructure investments, as stated in UK Chancellor Rishi Sunak’s 27 October Autumn Statement.
But there needs to be a policy shift if companies can fulfil the political will. According to the Association of British Insurers (ABI), £95bn could be freed up for re-investment if changes are made to the Solvency II regime, such as the government’s proposed changes to the Matching Adjustment and the Risk Margin mechanisms.
In February 2021, Huw Evans, ABI director general, said: “The insurance and long-term savings industry can do so much more to help our economy and society but only if Solvency II is made fit for purpose for the UK.”
A spokesperson for the ABI says: “While we can’t comment on behalf of the government, it is worth noting one of its objectives in the Solvency II call for evidence is ‘to support insurance firms to provide long-term capital to underpin growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the government’s climate-change objectives’.”
Solvency II rules in Europe are being modified to make investing in non-government bonds more attractive. But, as alluded to by the ABI, insurance companies must maintain an investment risk profile that is consistent with their product mix. According to Mr de Blonay: “The regulatory framework largely dictates what is and is not permissible. For short-term product lines, such as personal lines like auto insurance, investments should largely remain in low-risk fixed income products, whereas longer-duration business lines, such as life insurance, can be exposed to corporate credit, equities and alternative investment solutions, such as infrastructure and private equity.”
There is likely to be a shift to a longer-term trend of capital investment from governments to support economic recovery post-Covid and meet COP26 commitments.
Therefore, Mr de Blonay believes this would be a “logical” area of investment for insurers that are setting their own net-zero targets and aiming to ‘decarbonise’ their investment portfolios, given they have more than $30trn (£22.5trn) in assets under management globally.
He adds: “Infrastructure can be an attractive investment opportunity for them. These projects usually deliver predictable and stable cashflows that match their long-term liabilities, while also generating an illiquidity premium. In countries where insurers collect premiums, local infrastructure projects also offer a natural hedge against currency risk.”
As a result, he expects the current 3% of assets under management (AUM) allocated to infrastructure by insurance companies to rise. What this means then for investors and policyholders alike, is there will likely be a trade-off further down the line.
Premiums might have to rise slightly to offset the higher levels of capital that must be held as insurers allocate more to less liquid assets such as infrastructure. Dividend growth from insurers might not be as exciting as it had been pre-Covid.
But from a risk perspective, a divesting of potentially reputation-damaging stocks such as oil and gas, and a shift towards investments that boost social care, education and climate-friendly companies, can help to underpin insurance companies’ long-term business sustainability.
And maybe that’s a trade-off tomorrow’s investors are willing to take.
Simoney Kyriakou is senior editor of FTAdviser