Private markets, along with multi-credit funds, were the two most mentioned buzz words amongst investment officers at UK and continental European insurers we surveyed in 2017. However, the on-going excitement for illiquid investments has been both tempered and supported by regulators. Yet, it has not led to ‘significant’ capital allocation activity from insurance risk carriers, despite the continued low interest rate environment we still find ourselves in. 2018 may see a change in this position as regulatory backing for private markets leaves the door open for insurers to up their allocations.
The UK’s Prudential Regulatory Authority (PRA) and European Insurance & Occupational Pensions Authority (EIOPA) has not let talk about investing in illiquid securities go un-noticed. Since March 1st, 2010, when EIOPA announced their Task Force report on the Liquidity Premium generated from illiquid investments, insurers have been aware of the parameters placed on the proposed use of property, infrastructure, private placement debt and other illiquid assets in their portfolio.
Since then, developments have been made. The European Commission requested that EIOPA look at simplifying and making proportional the capital requirements for investing in illiquid assets to that of other asset classes such as corporate bonds. Secondly, they asked that they review the removal of unjustified constraints to financing of infrastructure and other public-private projects, to enable insurers to participate in funding where banks no longer could or would.
EIOPA has duly responded by reviewing Solvency II’s Solvency Capital Requirement (SCR) rules, clarifying the capital charge placed on private assets. Additionally, the European Commission has established the so-called ‘European Fund for Strategic Investments’, which is basically a €16 billion guarantee funded by the EU budget, complemented by €5 billion from the European Investment Bank. The idea has been to have these funds available to help stimulate private sector investment.
On a UK level, the PRA has been busy implementing the rules for UK regulated insurers, ensuring that long dated liabilities like annuities can be matched with illiquid securities like commercial real estate mortgages, private market corporate loans and infrastructure debt within a Matching Adjustment portfolio. Greater trust is being placed in insurers internally assigned credit ratings. Although it is acknowledged this creates operational risk from any failure of those internal models, the channels of communication between regulator and insurance entity are such that trust does exist.
The PRA has also acknowledged the important role insurers have to play in the bulk annuity sector allowing Defined Benefit pension sponsors to act on desires to rid themselves of guaranteed pay-outs to retirees.
In summary, the outlook for private market investments has the regulatory structural support in place. The appetite for private markets appears to now be simply held back by confidence in the investments themselves.
In our December 2017 released study of insurers investment appetite – Insurance Asset Management – Industry Insight – we found that 22% of insurers were seeking to increase allocations to asset backed debt and 21% were looking to do the same specifically for private debt.
Further to this, 44% stated they would increase allocations to infrastructure and 29% were seeking out suitable SME financing opportunities and venture capital investment opportunities, a trend that would undoubtedly have not been seen just a few years ago.
However, holding back many from acting on these intentions was the understanding required to get involved. Over one-third (36%) stated ‘investment complexity’ was the main driver to allocating, with 30% highlighting the ‘due diligence’ challenges of employing new asset classes they were looking at.
It therefore appears that the move from pure asset allocation considerations to investment risk and operation factors is paramount, if insurers are to get on board with illiquid securities whole heartedly.
So, could 2018 be the year of the private investment? It isn't entirely clear but the trend is certainly favouring such an outcome. Education, understanding and clarity of opportunity are the key to unlocking the market’s potential.
Post by Noel Hillmann, Founder & Managing Director, Clear Path Analysis