Aviva, L&G and other life insurers ‘attractive’ says broker due to property exposure protections

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UK life insurers have underperformed the wider sector and the market so far this year due to investor concerns that commercial real estate (CRE) exposure will negatively affect capital positions, but analysts at RBC Capital Markets presented 10 reasons why this was wrong.

While being sympathetic to the view that there “could be complications on the horizon” for commercial real estate investors, the UK life insurers have “a number of underappreciated protections in place”, the analysts said.

As a result, they believe the sector’s current average 2024 dividend yield of 9.3% is “an attractive entry point” and so reiterated ‘outperform’ ratings on Aviva PLC (LSE:AV.), Chesnara PLC (LSE:CSN), Just Group PLC (LSE:JUST), Legal & General Group PLC (LSE:LGEN), M&G PLC (LSE:MNG) and Phoenix Group Holdings PLC (LSE:PHNX).

The pushback from investors has been “particularly acute” for UK life insurers given the higher asset leverage in the sector versus other subsectors.

“However, the approach of just focusing on gross exposure (i.e. total CRE assets) lacks nuance as it fails to consider a number of key characteristics of the sector’s CRE strategies which provide a more defensive nature than gross exposure suggests,” the analysts said.  

1. CRE “accounts for only 6% of asset portfolios”. UK life insurer asset portfolios are diversified, including corporate bonds, infrastructure, ERM and CRE, the analysts said. Gross potential CRE exposure is 6% of total shareholder assets, and ranges from 3% of assets (Phoenix) to 9% (Aviva). While this gross exposure may screen as high versus shareholder equity at 54%, “we believe simply looking at total exposure is too simplistic”.

2. European offices are in higher demand vs US. While office vacancy rates around the globe have increased since Covid, experience has varied materially by geography, with vacancy rates with European offices at 7.5% versus 20% for the US. Moreover UK life CRE allocations are to the UK, with a regional bias, where RBC noted demand is more buoyant, with minimal exposure to the US.

3. Investor concern and scrutiny has focused on office space, however, UK life CRE exposure is invested across multiple subsectors, including industrial, retail, leisure, healthcare and science & technology. Office accounts for 36% for Aviva, 29% for Just Group and 43% for L&G of their total commercial mortgages/property investment.

4. UK life insurers actively concentrate on properties outside of London, where office vacancy rates remain low. Benefits also include lower competition, and the opportunity to partner with local councils for flagship developments, it was noted. Non-London commercial mortgage exposure is 44% and 90% for Just and Aviva respectively. L&G is involved in urban regeneration in circa 20 UK towns and cities.

5. “Conservative lending approach”, is next, as commercial mortgages are the single largest CRE asset class, with £9.7bn invested, with the analysts noting that lending standards have tightened considerably in the last decade. For example, Aviva’s average LTV down from 95% to 49% and interest cover increasing from 1.4x to 2.6x. Just’s average LTV is 51% and interest cover 2.4x, and Phoenix has 92% of its book at less than 60% LTV.

6. “The key concern for mortgage lenders is the ability of the borrower to pay interest and capital, and therefore counterparty risk is more significant than property valuation risk. Counterparties are overwhelmingly investment grade (Just 98%, L&G, 89% and Phoenix avg rating BBB).

7. Remediation actions are available and CRE is not a new asset class for the UK life sector. “Insurers have internal expertise and/or appointing specialist asset managers, and have navigated previous market turmoil. Insurers/managers are able to provide support to borrowers who are unable to pay, as happened during COVID with some payments being deferred.”

8. As RBC has noted in a recent note, insurers are not banks. As the duration of the liabilities is known exactly, “insurers will not be required to sell assets that have unrealised losses to cover withdrawals/lapses/ surrenders”.

9. The resilience of the residential market was highlighted too, as insurers have “material exposure” to the residential property market, with L&G owning housebuilder Cala. UK housebuilder shares are up on average and house prices have continued to trend upward despite higher mortgage rates.

10. Solvency II positions are at or near record highs, too, helped by rising rates and ongoing capital generation. “The excess capital provides a buffer for adverse market to market movements, as well as, any potential downgrades and defaults with the asset portfolios.”