Nicholas Hyett 8 April 2019
The 2015 pension reforms saw UK individual annuity sales collapse overnight.
The response from the UK’s big life insurers has been hugely varied. While some have looked for new markets, others have abandoned insurance altogether.
The sector now offers investors an interesting mix of investments – from impressive dividend yields to emerging market exposure.
Remember, the value of investments can fall as well as rise, so you could get back less than you put in. Yields are variable and not a reliable guide to future income.
Shifting life expectancy boosting profits
UK life expectancy has been ticking up for decades. If you’re expected to live longer, insurers will pay you less in any given year, making annuities more expensive.
However, life expectancy has recently started to plateau. That’s made existing annuities cheaper than expected, letting insurers release money earmarked for future payments, and bringing bumper profits.
These ‘mortality releases’ could have a few years to run yet – and aren’t confined to the UK either.
Annual change in life expectancy at birth in weeks
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Source: Office of National Statistics
Aviva – more of the same
In some ways Aviva has changed the least since the reforms were introduced.
Sizeable bolt-on deals have bulked up the life and general insurance businesses. And although there’s been some development of the asset management business, it’s still a small contributor to total profits.
That’s taken investors a bit by surprise. Former CEO Mark Wilson was widely expected to focus on significant expansion, possibly in Asia. Instead the group has narrowed in on a smaller number of core developed markets, and new CEO Maurice Tulloch looks like he’ll be sticking to the script.
So what is there to attract investors to Aviva? Well a 7.9% dividend yield has to be top of the list, but with the focus turning to debt reduction there’s limited scope for extra returns. And of course dividends aren’t guaranteed.
Still, with 33m customers, and by far the most diverse retail business in the game, there’s plenty of scope for cross selling. Relatively few Aviva customers hold more than one product – but the group’s increased digital spend is aiming to change that.
If it can cross-sell effectively, Aviva might not need overseas adventures to keep profits moving the right direction.
Legal & General – buying in bulk
Legal & General is the UK’s first £1trn investment manager. But while the investment management business attracts the headlines – and generates a healthy profit – the pensions business is still at the centre of the investment case.
L&G is a leading provider of pension de-risking and bulk annuities to corporate pension schemes. It takes on some or all of a pension scheme’s liabilities in return for an upfront payment. The group then uses its investment expertise to make a superior return.
It’s an attractive and growing market – worth around £2trn in the UK. L&G’s been expanding overseas as well. With the US final salary pension markets worth an estimated $3.5trn, there are plenty of opportunities.
One emerging area is the lifetime mortgage market. L&G’s gone from nothing to writing £1.2bn of these equity release products a year. That’s led to some concerns about mis-selling, although L&G think they manage this risk well.
Overall we think L&G’s adapted well to the new landscape, and offers a healthy 6.4% prospective yield. But like all asset managers, profits will rise and fall with the wider stock market.
Standard Life Aberdeen a life insurer in name only
These days Standard Life Aberdeen (SLA) is a life insurer in name only.
The UK annuities portfolio was sold to Phoenix in August. While SLA received a 20% stake in the business, which should give it some exposure to the mortality releases boosting profits across the board, it’s now firmly focused on asset management.
The sector’s been under pressure from passive tracker funds and increased regulatory scrutiny. Coming to terms with these challenges explains the Aberdeen and Standard Life merger.
The Aberdeen business worked closely with global institutional investors, while Standard Life has been reaching out to retail customers. Together with different areas of fund management expertise, this should help insulate the company from investing fashions.
Unfortunately it hasn’t stopped investors pulling billions of pounds from SLA’s funds – not helped by the fact they’ve struggled to beat benchmarks in recent years.
The new SLA is a potentially attractive business, but only if it can convince customers it has some very attractive funds. In the meantime, the group’s hoping to hold its dividend steady, implying a yield of something like 8.7%.
Prudential – stronger apart
Plans to demerge Pru's UK insurance and asset management arms mean shareholders will soon hold shares in two very different businesses.
The first is a rapidly growing insurer, with market leading positions in several Asian markets, a sizeable US business and an early foothold in Africa. Increasing wealth and growing populations in emerging markets mean the growth potential is considerable.
A focus on regular instalment policies, like health and life insurance, gives it some resilience. Most people pay their monthly premiums even if the economy falters, especially since government provision of safety nets, like healthcare, is low.
This part of Pru should bear some resemblance to emerging market banks like Standard Chartered and HSBC. If all goes well, the steadier income would make it less volatile, but emerging markets are still higher-risk, and the US has tripped up the group before.
On the other side of the split is a mature UK/European life insurer and asset manager.
The sale of £12bn of annuity assets suggests the group may be thinking of following Standard Life Aberdeen down the asset management route. If so, the pension scheme-focused 'PruFund', which saw £8.5bn of net inflows last year, will be crucial to future growth.
A solid base of recurring revenue should combine to deliver solid dividend potential – although growth will likely be slower.
Pru’s growth potential means its shares are more highly rated than those of its UK focused rivals. As a result the shares offer a yield of just 3.5% - although with the demerger on the horizon that could all change.
In it for the income
Dividend yield is clearly a major attraction of investing in the life sector, but the highest initial yield might not always make the most attractive investment. It’s important the dividend can be sustained over the long run, and ideally grown too.
Breakdown of operating profits
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Past performance isn't a guide to future returns. Source: Aviva, Legal & General, Standard Life Aberdeen, Prudential annual reports and full year results.
If dividends are kept the same, then over time inflation will eat into their value. In real terms, your dividend will be worth less.
Although their strategies are capitalising on very different trends we think Legal & General and Prudential have the clearest route to revenue, and ultimately profit, growth in the years ahead. All being well, those profits can underpin growing returns to shareholders in the years to come – although as ever there are no guarantees.
The author holds shares in Legal & General.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.
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