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Finding new areas to invest in that have not yet been saturated by other market players continues to be a theme for insurers as the market changes due to recent volatility.
Investment teams at insurance companies need to look into new areas while revitalising other areas that were previously dismissed. This sentiment came from Ricky Varaden, PhD, Senior Investment Manager, Legal & General Capital, and Angel Kansagra, Head of ALM, Lloyd’s, who spoke at a recent Clear Path Analysis webinar among other senior industry figures in conjunction with Aegon Asset Management. Their remarks have been published as part of a report: “Avoiding the crowds: Unearthing capital efficient fixed income opportunities for insurers”.
In it, Kansagra and Varaden spoke about what they’re seeing in the market and strategies they’ve utilised to get the best out of the current conditions – and how to avoid those crowds.
Angel Kansagra: As many of you know, P&C portfolios are cautious in terms of investment. The allocations are usually cash, government bonds, and some credit.
What we need in these portfolios is more allocation to alternative credit, which would widen the investment options we look at on a risk-adjusted basis. Effectively, this would mean tapping into both public and private markets.
We would be looking at investments around the two-to-four-year duration point, and there are quite attractive investment opportunities there, such as alternative credit in the form of emerging market debt, Collateralised Loan Obligation (CLOs), and – on the private liquid and maybe illiquid side – trade finance, Net Asset Value (NAV) finance, and some other options.
"Private credit gives you the opportunity to have an impact from your ESG policy, which is where you can access the market and get some yield."
I would also look at options that could provide some sort of inflation protection, such as estate or commodities. You wouldn’t have a high allocation in these assets, but they do act as a good diversifier within your portfolio.
Lastly, in the P&C portfolios, we need more private credit because there are opportunities out there. Private credit gives you the opportunity to have an impact from your ESG or responsible investment policy, which is where you can access the market and get some yield. From a capital point of view, they also look good due to the credit ratings we get on those assets.
We would like to expand the investment options for both public and private assets.
Ricky Varaden: Our portfolios need more sustainable and impactful investments from an ESG perspective. As insurers, we are investing society’s capital – and therefore have a responsibility to do it for society’s benefit.
I look at clean energy assets, which are akin to fixed income with a government guarantee in the form of cash for different contracts and long-term corporate power purchase agreements. However, in certain areas of clean energy, some of the sectors have become crowded over the last few years – like solar and wind farms within the developed markets – which has resulted in yield compression.
In the current higher-rate environment, despite the high energy prices, it takes a lot of skill to find attractive assets. There are new and exciting areas that can offer better returns and where the capital can have a greater impact. Here I am thinking about new technologies like hydrogen generation, geothermal and battery storage, and new geographies like emerging markets, where you can make a significantly greater decarbonisation impact per dollar spent.
Ricky: There are assets out there that on their own don’t look as attractive on the Solvency balance sheet, but with some credit enhancement can become attractive in terms of the return on Solvency capital. Internally, we call this ‘turning water into wine’. This credit enhancement can take various forms; it can be in terms of subordination in securitisation, or it can be an insurance wrap, or even through covenants and the terms in the deal itself.
"Some asset classes lend themselves better to this structuring such as the mid-market loans, broadly syndicated loan, and private credit assets."
Looking at the subordination, Keith mentioned the tranching into a junior and senior piece. The senior piece can be Solvency II compliant and Investment Grade (IG), but if the insurer takes both the junior and the senior then you don’t get the net capital benefit because otherwise that would lead to capital arbitrage. If the insurers are only taking the senior or a small part of the junior, then there can be a significant capital benefit.
This is turning a pool of sub-IG assets into attractive IG assets. Some asset classes lend themselves better to this structuring such as the mid-market loans, broadly syndicated loan, and private credit assets.
In terms of NAV lending, you might not have insurance wrap or subordination, but through the terms and covenants you have – for instance a low Loan-to-Value (LTV), cross-collateralisation between companies, or diversification – you can effectively have a pool of sub-IG, private equity portfolio companies backing a loan that is rated IG and therefore attractive to insurers.
Angel: There are some investing factors that we see in the P&C market. There hasn’t been very high allocation to private assets in the P&C books, especially in the UK and European markets. Once you invest in these private markets, you need to have capital modelling capabilities, and if you are a matching adjustment investor, you look at the credit risk but when we do capital modelling it is interest rate, credit risk, and illiquidity risk, for example. It means taking them through the risk teams and getting approvals.
