How insurers are addressing the industry-wide illiquid asset challenge

James Fermont discusses how there has been a step-change in insurers’ engagement and willingness to take on illiquid assets from DB schemes —and why this trend is likely to continue.

As UK defined benefit (DB) pension scheme funding levels rose significantly following the gilts crisis, many trustees found themselves in the unexpected, but welcome, position of being able to insure their liabilities in full many years ahead of plan.

However, that scenario was somewhat theoretical for a meaningful proportion of schemes, due to having invested in illiquid investments, the value of which could not easily be realised to pay the buy-in price.

In many cases, trustee boards seeking to move to insurance have focused on a sale of such assets on the secondary market. However, insurers have recognised that they are in strong positions to provide an alternative solution, by accepting illiquid assets as part of a portfolio of assets used to pay the buy-in price.

LCP has surveyed all of the major UK bulk purchase annuity (BPA) insurers and found that over the last two years:

• Four insurers have accepted illiquid assets totalling approximately £3.1bn as part payment of insurance premiums – representing around c4% of the total premiums paid in that period.
• There has been a wide spread of the types of illiquid assets accepted, covering private credit, infrastructure debt and equity, real estate debt and equity, and even private equity.

The above graph demonstrates that there has been a step change in engagement by insurers in their approach to dealing with illiquid assets.

However, we estimate that passing assets to insurers has only been used on less than 25% of deals where an illiquid asset sale was needed – ie on more than 75% of transactions trustees have sold these assets to an unconnected party on the secondary market.

In our view, there is potential for a greater share of illiquid assets to go to insurers, given:

• Insurers are motivated buyers – in some cases, the wider insurance transaction hinges on a solution being found for the illiquid assets. One of the reasons that schemes have passed assets to insurers is because they offer a greater certainty of transaction completion, as compared to a sale to an unconnected party, which might take longer than expected (therefore potentially jeopardising the timing of the insurance transaction) or, in extremis, may not complete at all.
• Insurers have appetite for these assets - indeed all of the insurers in the market, including new entrants, indicated to us that they have appetite to accept illiquid assets in future.
• Given current low levels of spreads on corporate bonds, the additional yield offered by illiquid assets can be attractive. Solvency UK has widened the range of illiquid assets that insurers can hold and, although many illiquid assets held by schemes remain in a form that it is not efficient for insurers to hold long-term, innovation and focus in this area may lead to solutions that ease this barrier.
• Based on our experience, for at least some funds, insurers can match or beat the pricing that can be found on the secondary market.

The above highlights the importance of taking a holistic approach to considering illiquid asset solutions in the context of an insurance transaction. A well-run process should consider the full spectrum of options, and then seek to optimise against value achieved and certainty of completion.

At LCP, our illiquid asset solutions group has had significant success at passing illiquid assets to insurers. Since 2021, we have overseen sales of more than £5bn of illiquid and semi-liquid assets – around half of which have been sales to insurers as part of a buy-in – as well as structuring other innovative solutions such as sales to sponsors and loans secured on buy-ins to maximise the value available from illiquid assets.

Whilst a transfer to an insurer will not be appropriate for every asset – insurer capacity for these assets is finite, and they are selective in where they deploy it – we do believe that going forwards it will be the most optimal approach in more than 25% of cases.

This article that was originally published in Professional Pensions.