Relative value is a concept which is familiar to investment professionals across all sectors. Generalist investors and asset allocators have a broad opportunity set into which they can deploy their capital and make relative value a part of each decision.
Sector specialists who focus on a narrower investment universe in private markets must be extra vigilant and keep perspective. In private debt, this means having the discipline and rigour to price bilateral transactions with reference to the returns available for comparable risk profiles both within your industry and across industries.
Insurance companies should represent a compelling investment for any allocator. An insurer pools the individual risks of its policyholders so that potentially large losses for each of them is mitigated. This creates a strong societal benefit. With products that clearly fulfil customer needs, it should be, and is, possible for insurers to provide products which customers value and thereby generate shareholder profits.
This is a good start for a lender as they think about the credit profile of their borrower – but how does that compare to other debt opportunities?
An insurer will have a relatively large balance sheet which it invests into high-quality, diversified investments so that when needed, they are available to pay policyholder claims. In addition, the insurer will hold extra financial assets – for regulatory reasons – which provide financial resilience against unexpectedly large losses.
The private debt market can provide insurers with finance for the more remote parts of these excess assets, which provides the lender with the protection of asset-backing. This contrasts with corporate credit where debt is measured relative to profits, with security and repayment of the debt being more reliant on the future sales and revenues of the borrower.
The purchase of many insurance policies is either long-term or repeated. On the life insurance side of the market, premiums are often a long-term commitment by the policyholder and are paid over many years. In the non-life corner, policies are more often annual purchases, but form a permanent feature of a customer’s financial planning; in both life and non-life, persistency with the incumbent insurer is high. When compared to some other sectors, the revenues, and profits, of an insurer should therefore be more consistent. Again, consistency in profits are credit positives for the sector.
The source of returns in the insurance sector are often differentiated from other debt. The insurer earns money from asset risk and from liability risk. Inherent within the liability risk is the premium for the insurance risk undertaken, but there are also excess risk-adjusted profits the insurer can earn from its balance sheet diversification. It is possible to charge policyholders an undiversified risk-premium, which reduces their risk, while adding those risks to a diversified balance sheet to lower total risk of the insurer.
Insurance debt has strong fundamentals and provides a good level of absolute return. On a relative value basis there are further considerations which make private insurance credit attractive. While the largest insurance groups can access financing from debt capital markets, there is a long tail of financially strong insurers who do not have the size necessary for the public markets.
This large group of insurers is underserved and may often be funded inefficiently – usually, purely with equity. Their options in the private debt markets may also be limited due to the need for a lender to have the sector expertise and insights to underwrite the business and its balance sheet but the credit quality of these counterparties can still be very high. Regulatory rules require these insurers to have balance sheet strength as good as, or perhaps greater, than their larger peers; in contrast to some other industries, a smaller business does not necessarily mean weaker credit.
The insurance industry as a whole continues to grow. In the non-life segment, secular trends are leading to more people having more possessions of greater value, which they need and want to insure. In the life segment, the accumulation of wealth and a desire to protect that wealth drives demand for asset-based life products. Leaning into these trends, insurance companies have opportunities to grow – which will require a larger capital base. For equity funded businesses, introducing a modest level of borrowing can facilitate that growth by bolstering the regulatory capital base of the business.
The demand for borrowing from insurance companies is, and looks set to continue to be, in excess of the level of supply. Capital allocators should find that now is an excellent time to consider the absolute and relative attractions of private insurance debt.
Dan Knipe is Chief Investment Officer at Kilter Finance
Any views expressed in this article are those of the author(s) and do not necessarily reflect the views of Life Risk News or its publisher, the European Life Settlement Association
