UK life insurers as a sector are a likely beneficiary of powerful macro trends that will augment free cashflow and lift dividends.
Accordingly, recent share price weakness can be seen as an attractive opportunity to buy key income names.
From their March peak, UK lifes have underperformed the FTSE All-Share by more than 6 per cent on a total return basis, with commentators citing the January 2016 introduction of Solvency II as the underlying cause.
Aside from garnishing the EU’s reputation for snappily named legislation, Solvency II has the serious purpose of harmonising European insurance regulation. As with Basel III, Solvency II is a risk-based capital framework conceived in the wake of the credit crunch.
The aim is to make certain that insurers have sufficient capital to satisfy claims in the event of an extreme financial shock. For life insurer detractors, Solvency II is merely a regulatory pretext to mandate higher capital ratios and portends fund raisings and dividend cuts.
This seems wrong. As recently as July 9, Sam Woods, the Prudential Regulatory Authority’s executive director of insurance supervision, discussed the need to “bust the myth” that Solvency II was a backdoor means of hiking capital requirements across the sector. Further, the life insurers’ August interims evidenced the substantive progress made in preparation for Solvency II.
Notwithstanding investors’ present fixation with Solvency II, there is a sense in which it represents something of a red herring. From a macro-thematic viewpoint, life insurers are clear winners from the ineluctable forces of demographic change.
It is well documented that the UK, along with most developed countries, is aging as healthcare innovations increase longevity and contraception curtails births. In recognition of this trend and the associated cost of providing for an expanding elderly cohort, both business and government have sought to mitigate their obligations by shifting responsibility to the individual; the government’s current consultation on pensions tax relief is merely the latest instance of this.
It seems obvious that life insurers are positioned to facilitate such change. From burgeoning bulk annuity volumes to the proliferation of self-invested personal pensions, and the nascent workplace pension offering, UK life insurers are busy gathering sticky, remunerative, long-term assets.
In this way, demographic change is the dynamic driving rising free cashflow and a parallel growth in dividends.
Correspondingly, investor anxiety over Solvency II is an opportunity to buy modestly-rated companies with attractive dividend yields and compelling macro-thematic underpinnings.
Jamie Clark is co-manager of the Liontrust Macro UK Growth and Macro Equity Income funds
