FTSE 350: Life assurers strong on income

The BoE’s decision to raise interest rates to 0.5 per cent was welcomed by the industry, helping cushion Solvency II levels, albeit modestly. For example, prior to the rate increase, Aviva (AV.) estimated that an increase of 25 basis points would increase its Solvency II ratio – calculated as a proportion of its liabilities – by 4 per cent. However, interest rates are still historically very low and with UK growth still weak it is unlikely that there will be any significant uplift anytime soon. Regulators will only take ‘baby steps’ given the ongoing squeeze on discretionary incomes.

This low-rate environment has led some of the UK’s life assurers to diversify their businesses even further. While Standard Life went the whole hog in merging with an asset manager, Aviva and Legal & General (LGEN) have both been growing their investment management arms. Aviva Investors has benefited from transfers from 2015 acquisition Friends Life, as well as investing in its multi-asset (AIMS) funds. It gained £534m in net inflows during the first half of the year, taking assets under management to £351bn, while its flagship multi-asset funds doubled in assets to £12bn. For Legal & General Investment Management, a bias towards multi-asset and liability-driven investment strategies makes sound strategic sense, given their growing popularity with defined benefit (DB) pension schemes.

Despite rising markets, the substantial deficits of final salary pension schemes – which pay out a guaranteed income for life – is a problem unlikely to ease during 2018. The pension deficit of FTSE 350 companies may have reduced by an aggregate £8bn in 2017, according to consultancy Mercer, but ‘guarantee values’ – the amount needed to pay retirement benefits – grew by £36bn. That’s driving demand among scheme sponsors to undertake ‘bulk annuity’ transactions, where an insurer takes on the responsibility of paying the retirement income of a large chunk of retired scheme members. Legal & General has placed particular focus on that market. UK bulk annuity sales during the first-half of 2017 were up £0.9bn to £1.5bn, while its retirement business also completed an £800m longevity insurance transaction. Just (JUST) – formed via the merger of Just Retirement and Partnership Assurance – has also invested in its pension de-risking business. Sales of its de-risking products were up 80 per cent during the first half.

While some industry commentators thought the introduction of George Osborne’s pensions freedom changes sounded the death knell for the individual annuity market, it looks to be stabilising. In fact, Legal & General reported individual annuity sales that were more than double the previous year at £345m during its first half. Meanwhile, Just also reported a ‘levelling-off’ in the decline of individual annuity sales.

However, one of the brightest hopes for growing premiums and investment income during 2018 are the Asian wealth management and health and protection markets. The life assurer ploughing this market the deepest is Prudential (PRU), which makes the bulk of its new business sales in the region. Management is concentrating on expanding its product range and distribution partnerships. In particular, it is trying to penetrate the Chinese life assurance market, where it is ranked number four in terms of its market share. Its efforts are beginning to pay off – China is now the third-largest contributor to new business sales. Crucially, its skew towards Asia is also working wonders for its cash generation. That not only gives it a good chance of maintaining its sector-leading Solvency II ratio of 202 per cent, but gives it plenty of opportunity to grow the dividend, too.

Favourites

Aviva upgraded its guidance for cash generation for the next two years from £7bn to £8bn. As a result, it plans to deploy £3bn in excess cash over 2018 and 2019 to repay debt, fund acquisitions and provide additional shareholder returns. The income case gets better: it also increased its payout ratio target to between 55 and 60 per cent of operating EPS by 2020, by improving earnings quality and cash flows from businesses that are becoming less capital intensive. The shares are trading at 10 times forward earning – inexpensive for the income on offer.

Outsiders

The life assurance sector is largely made up of high-quality income plays. However, Just has the greatest exposure to the UK annuity market and is less diverse than other insurers in the FTSE 350. That said, we reckon the group should continue to benefit from the trend towards companies wanting to de-risk their pension schemes.