Rothesay Life came out with a tier three bond last week, while Pension Insurance Corporation is looking to issue a restricted tier one bond.
Both base their business around bulk annuities: they assume the risk of funding defined-benefit corporate pension schemes for an upfront fee.
Last year business was brisk in the sector, with £24bn of liabilities transferred to insurers, according to advisory firm Willis Towers Watson. This was double the amount of business written in 2017, and smashed through the previous 2014 record of £13.2bn.
Not included in that figure was Rothesay’s mega acquisition of a £12bn legacy portfolio from Prudential plc.
So far this year PIC has picked up £1.2bn of liabilities from Dresdner Kleinwort Pension Plan, part of Commerzbank, among other deals. The firm says part of the reason behind its planned bond issue is to “support further business growth due to the very strong demand for pension risk transfer across the market”.
With scale a barrier to entry on the insurer side, the incumbents have a natural advantage.
But investors in these firms should take care.
First, the asset side of the business faces perils. Just Group, a bulk annuity player, was severely affected by increased scrutiny from the Prudential Regulation Authority into equity release mortgages (ERMs), which it used as an investment opportunity.
Its share price has dropped by more than half in the last year, while its tier three bond issued in February 2018 dropped at one point to a low of around 90 cash points.
Admittedly, other bulk annuity specialists are less exposed to ERMs. But they still tend to look for yield in long-dated, less conventional assets, and the recent dovish tilt by global central banks means the trade-off between liquidity and return will only get sharper.
Bulk annuity firms benefit more than other insurers from the matching adjustment in Solvency II capital requirements, allowing them to “match” long-dated illiquid investment to their liabilities. The PRA has faced pressure from the industry to interpret the rules more flexibly. But it could equally tighten the requirements at some point.
Second, the P&L is opaque. Raymond Tam, senior analyst of European insurance at CreditSights, says “conflicting performance measures and a general lack of consistent disclosure” make profitability calculations challenging.
Another danger flagged by Tam is the ability of the insurers to raise capital internally without disappointing shareholders: he says they are walking a “tightrope”, while already looking highly leveraged. This could press pause on their ability to take full advantage of growth opportunities and, more worryingly for debt holders, to adapt to any capital shocks.
In this light, the postponement of ReAssure’s IPO may be worrying. Majority shareholder Swiss Re blamed the delay on “heightened caution and weaker underlying demand in the UK primary market from large institutional investors”. While ReAssure does not take on bulk annuity liabilities, it operates in a parallel sector, buying closed book life insurance policies.
Finally, the debt instruments the firms are putting on the table are unknown quantities. Tier threes and RT1s are in a sense the insurance equivalent of banks’ senior non-preferred and additional tier one bonds, but are less widely used. They are untested in the event of a bail-in.
Bulk annuity has been a bright spot for the UK insurance industry recently. But illiquidity of investments, regulatory uncertainty, complex business models and obscure debt instruments are all red flags, despite the recent bull run in FIG bonds.