Life insurers have not escaped the market volatility that characterised the first quarter of the year – the FTSE 350 composite Life Insurers index ended the period down almost 10 per cent. But the fall in share prices enhances the sector’s appeal for total cash payouts, which this year are forecast to average over 8.8 per cent. Considering this, investors with an eye on income cannot afford to ignore the sector merely due to short-term volatility, particularly when companies can provide a natural inflation hedge through the types of assets in which they invest.
In fact, for most of the UK’s life insurers, the cash yield is now higher than their price/earnings ratio. In some cases, the difference is extreme. At M&G (MNG), for instance, analysts at Berenberg now calculate that the combined cash returns via dividends and buybacks have reached a yield of 19 per cent. And M&G isn’t alone. Berenberg reckons that all of the UK’s life assurers are currently yielding more than their valuations, although the difference is not quite as extreme at the likes of Aviva (AV.) and Phoenix Group (PHNX). Notably, much of the capital generation the sector is currently experiencing is through organic growth. Overall, other than in the case of Aviva, very little of that cash has come from book run-offs or disposals, and it therefore represents strong capital generation by the underlying business.
Bulking up on annuities
The pandemic had a counterintuitive impact on the life insurance industry in that the main effects were delays in decisions on new business, which have now started to normalise. Decisions on de-risking balance sheets by transferring defined-benefit pension fund liabilities to the life sector lie with the trustees of pension funds – and the signs are that this year the normal flow of business will return for the bulk annuities market, rather than the lumpy deals that meant the second half of 2021 saw a rush of delayed business being transacted. Although taking on pension liability risk is capital intensive, the sheer volume of business emerging as more baby boomer cohorts retire has been simply too great for life insurers to ignore, which in itself must represent a profound demographic shift as the UK’s population ages.
According to consultancy LCP, annuity buy-ins could reach more than £30bn this year, with Aviva, Standard Life and Legal & General (LGEN) all taking significant portions of business. LCP predicts £30bn-£50bn of annualised de-risking business between now and 2025, with about £650bn over the next decade. Despite the dominance of the big four, smaller niche players are also expected to win significant business this year in the sub-£50mn bulk deal market. Phoenix has also established itself as a key player in the annuities market through a series of well-timed acquisitions.
The inflation hedge
The other attraction this year for investors is that life insurance companies have a natural inflation hedge. While premiums can be raised to protect underlying income, the churn in customers makes this a limited tool for protecting earnings. On the other hand, the projects in which life companies can invest, which include property and infrastructure, mean their invested capital has a natural income uplift as such investments usually come with 'plus CPI/RPI' clauses in their contracts.
In addition, the variety of investments permited to UK-based insurers is likely to increase as part of the reforms to Solvency II rules, broadening the base of allowed investments to include areas such as renewable energy and largescale infrastructure projects. Insurers should also benefit from a 60-70 per cent reduction in their risk margin. Whether that will immediately flow through to profits is difficult to tell, but it should at least give them more flexibility as to how they deploy their capital.
| NAME | Price (p) | Market cap (£mn) | 12-month (%) | Fwd PE | Yield (%) | Last IC View |
| Aviva | 444 | 16,372 | 11.0% | 10 | 6.8 | Buy, 414p, 2 Mar 2022 |
| Just Group | 91 | 941 | -13.0% | 5 | 2.1 | Buy, 86p, 3 Feb 2022 |
| Legal & General Group | 265 | 15,834 | -2.0% | 8 | 7.4 | Buy, 253p, 9 Mar 2022 |
| Phoenix Group | 626 | 6,259 | -14.0% | 8 | 8.0 | Buy, 635p, 14 Mar 2022 |
| Prudential | 1,072 | 29,459 | -26.0% | 12 | 1.3 | Buy, 1,095p, 9 Mar 2022 |
| Source: FactSet |
