Life insurers are a key ingredient in the UK’s aims to become an investment showstopper, say Kyle Audley and Brandon Choong, as the Solvency UK reforms move closer.
The UK remains one of the world’s leading financial centres; having survived the thematic headwinds of global inflation and limited fiscal headroom, as well as systemic shocks brought on by geopolitical turmoil and the pandemic, it is looking to new opportunities.
The future presents its own challenges, such as the imperatives to reach net zero and mitigate climate change impacts, provide affordable homes for a growing population, and deliver progress so everyone can benefit from the opportunities created in a thriving economy. With this in mind, the UK government has outlined several objectives: reaching net zero by 2050; investing in infrastructure to ‘level up’ economic growth; and driving regeneration and housing delivery to create affordable homes.
Ambitious targets require commensurate capital, and meeting these objectives will depend, in part, on the government’s ability to access private long-term capital funding for large-scale underlying projects and initiatives that drive progress.
The UK life insurance industry could be the single biggest provider of long-term fixed capital. Key players, particularly the major bulk purchase annuity companies, manage liabilities and invest assets within their matching adjustment (MA) portfolios – a regulatory mechanism that recognises the positive risk-management effects of cashflow-matching illiquid, fixed and highly predictable liabilities with similar-natured assets. The annuity providers have long-term liabilities (in some cases beyond 50 years), so they need assets with similar time horizons to back these liabilities, and lend to a diverse set of high-credit, quality public and private borrowers that seek debt for their own long-term projects and obligations. As a result, annuity providers are suited to act as long-term senior debt finance providers.
The bulk purchase annuity market is thriving, buoyed by the higher interest rate environment, and is expected to increase further. Facing potentially significant flows of new liabilities, firms will need to find large amounts of long-term investments. However, the life industry’s role in supporting broader government objectives could be enhanced beyond long-term fixed debt through reforms on both the supply side and the demand side – after all, it takes two hands to clap.
Supply-side reform
Recognising this opportunity and seeking to secure the UK’s position as a global financial leader, the government unveiled the Edinburgh Reforms in December 2022. These included plans to reform Solvency II to unlock more than £100bn of long-term productive asset investments from UK insurers. Driven by collaboration between the government, the Prudential Regulation Authority (PRA) and the life industry, individuals and firms scrutinised how such advances could be realised while preserving policyholder security and the UK stability.
There is a role for the life sector in guiding harmonious reform across institutions, borrowers and advisers
This culminated in the release of a PRA consultation last September on reforms to the MA’s asset eligibility requirements. It built on the existing requirements of fixed and certain cashflow, and developed the wider regulatory and risk management framework around MA portfolios to make it consistent with this new flexibility. Many productive investments are not fixed and are not currently eligible for the MA – often because of their means of revenue generation, uncertainty around the timing of key events, or structural debt requirements that challenge the fixity requirements needed for annuity matching.
Current MA eligibility proposals broaden the assets eligible for inclusion within the MA portfolio to those with highly predictable cashflows. Per the PRA, “the proposals will allow the life sector to play a bigger role in productive investment in the UK economy”. This enhances annuity writers’ ability to provide senior fixed capital, and we hope to see more investment in real assets in the UK.
The government has also made reforms in pensions to stimulate growth and innovation in UK business and technology. The Mansion House Compact, launched in July, commits a major portion of the UK defined contribution workplace market to allocate at least 5% of its default funds to unlisted equities by 2030, increasing further investment flows into growth and productive assets. The Long-term Investment for Technology and Science initiative also seeks proposals for new vehicles to enable pension schemes to invest in UK science and technology companies.
Demand-side reform
Supply-side reforms may yield more flexible institutional investors with vast amounts of capital – but to unlock a new era of productivity, further reforms are required to provide a pipeline of suitable investment opportunities for this capital. And here we encounter the demand side of the UK investment solution: the perennial challenge for annuity writers to originate suitable private market investments capable of backing the annual volumes experienced in bulk annuity markets. These reforms cannot be implemented in isolation; there is a role for the life insurance sector in guiding harmonious reform across institutions, borrowers and advisers, spanning a diversity of UK opportunities, to realise potential.
Central government’s role
Attracting private investors is a key element of fiscal budgets and government spending plans, particularly as higher interest rates have increased the cost of government borrowing. However, there are risks that capital markets cannot efficiently digest, as they are beyond the expertise of investment professionals and/or exceed institutions’ risk limits and appetites. A fiscal budget limited in capital can support this investment by instead acting as an underwriter to those risks, insulating institutional lenders from tail risks and black swan events. Markets are familiar with the central bank as lender of last resort, and with other public institutions that provide specific risk facilities (such as Flood Re). A Treasury able to underwrite new risks until capital markets can accept and efficiently price those risks could catalyse many large-scale projects.
Local government’s role
Generation of productive assets is not limited to Westminster; local governments work to drive growth and opportunity in their regions. However, the scope and investment expertise of such borrowers often varies. Reforms to improve consistency and structure could lead to a more compelling landscape of empowered regional borrowers.
National institutions’ role
National institutions play a key role in mediating capital supply and demand – they can enhance borrowers’ capabilities, provide debt and equity capital, and coordinate institutional investors. Each institution has a specific focus, often aligned with a broader government objective, such as UK company growth, infrastructure development or affordable home provision. This fragmentation of purpose and capability is difficult to navigate. A cohesive single body could promote government objectives better, simplifying engagement for borrowers and investors and allowing expertise to be combined.
Two hands to clap
The impacts of the Solvency UK reforms on UK insurers’ overall investment profile are yet to be realised. The reforms could lead to a broader spectrum of productive assets eligible for the MA, unlocking more investment capital. However, the measurable success of these reforms will depend on the availability of projects in which to invest.
As we have said, it takes two hands to clap, and the case for insurance companies to support productive investments at an even larger scale can be made more compelling by demand-side reforms. Insurers and regulators can become a guiding influence in the future of UK investment by continuing their efforts here.
Kyle Audley is a senior investment manager in the asset management team at Phoenix
Brandon Choong is a senior manager in the actuarial insurance and banking team at Deloitte
