FTSE 350 Review: The best yields on offer from life insurers

Large companies that do financially complex things and offer a solid dividend yield, rather than high growth, are hardly the stuff of which investors’ dreams are made. However, the life insurance industry has managed to make it through the premium renewal season without any adverse news, and companies this year are likely to generate capital well in excess of their statutory requirements.  

Life insurers can make a return from investment capital, which in some ways is easier than the business of tying up capital in writing policies, even if it makes some nervous about potential losses. Nowadays, the assets themselves are increasingly being deployed in private markets: Deloitte Consulting reports that more life insurance companies are deploying capital in the booming private credit market as an alternative to investing in volatile equities.

Investors should expect that trend to continue as life insurers look for stable (or, at least, less regularly marked to market) sources of income that will finance their push into the pensions transfer market. Taking on companies' pension liabilities has been big business for the sector in recent years, and there is little sign of that slowing down.

But the trauma of the liability-driven investment (LDI) crisis in the aftermath of the autumn 2022 mini-Budget chaos is still not far from the discussion for life insurers. While no large insurer was directly affected by the crisis, outside of concerns about the impact on future LDI business (which does not appear too substantial), investors’ wariness of unexpected events has carried over into significantly discounted share valuations. In other words, it seems the market is only prepared to accept the complicated nature of insurance risk in return for a hefty discount.

Whether this amounts to a fair assessment of individual company prospects is a moot point. However, in a sector where earnings growth without significant M&A is difficult to achieve and spare capital has generally favoured buybacks and enhanced dividends, investors could be forgiven for valuing life insurers at the same level as old smokestack industries. In this respect, Aviva (AV.), Phoenix (PHNX) and Legal & General (LGEN) all resemble each other to a greater or lesser degree in their ability to direct their corporate actions towards enhancing income for shareholders.  

Merger & acquisition activity has not been a topic in life insurance for at least a decade, but hardening rates this year mean that balance sheets are producing significant excess capital. This means there is the possibility of deal-making returning to the market. Yet consider Aviva that has spent most of the past half-decade unwinding mergers and acquisitions made in the previous decade, with the result that it can now probably sustain its share buyback programme for longer than its main rivals. That gives credence to the view that insurers will continue to finance payouts in preference to paying out for a rival company.   

As Berenberg analysts point out, it has been difficult to follow a consistent strategy when picking insurance shares. The best performers in the wider insurance market have tended to focus on pricing and revenue growth, meaning that life insurers' only real returns have come from income yields that have soared to 9 per cent. The strength and durability of these payouts will be key to how popular the shares are this year. UK base rate cuts are somewhere on the middle horizon, and that could be a good starting point for a re-rating. Berenberg reckons that rate cuts could favour UK life insurers, in particular, because of their greater exposure to different credit markets and large asset bases. On top of this, the boom in pension transfer business fuelled by rising gilt yields (which bring schemes into surplus, enabling companies to offload them to insurers) is unlikely to be materially affected so long as base rates remain well above zero.