Aitken Ross

The case for sustainable insurance

Aitken Ross

Although a long-term favourite in our Sustainable Future bond funds, it is fair to say insurance is hardly the first sector that comes to mind when thinking about sustainability or positive environmental, social and governance (ESG) characteristics.

Yet in focusing on three pillars when analysing companies for inclusion in our funds sustainable credentials, fundamentals and valuations insurance companies score well across all of these. Insurance is a hedge against financial loss and such a simple concept can have many positive impacts for society, business and the broader economy.

Sustainability

From an individual perspective, general insurance protects our homes and possessions and provides an economic safety net; it affords people the confidence to invest, which in turn contributes to broader economic growth and development. Life insurance and income protection, meanwhile, give families financial security should the worst happen. As for businesses, their assets are protected against catastrophe, and credit and cashflows can be underwritten and secured, while also hedging out potential future liabilities. Again, this gives them confidence to invest and grow, which can lead to further employment and economic development.

Insurance companies also allow people to provide for their future and improve their financial security through pensions, savings and investment products; combining the premiums earned on policies with consumer assets, the Bank of England calculates the sector in the UK alone manages roughly £2 trillion. The second order impact of this is that capital is invested in, or lent to, corporations, which provides funding for these to grow. In cases such as Legal & General, for example, capital is injected into real assets such as infrastructure, helping communities to prosper.

Looking beyond such a broadly net positive impact, we believe the leading insurance companies contribute in a more sustainable way by devoting capital to researching ESG aspects. The best companies in the sector research specific sustainability, environmental and social risks, for example, and are therefore able to better understand and price these and help clients protect against them. Not only does this make them better underwriters, greater understanding of such issues also turns these companies into more prudent investors through the inclusion and adoption of responsible practices. This will ultimately create more stable and sustainable companies and, from our perspective, more stable and sustainable investments opportunities.

Fundamentals

European insurance companies are generally highly rated institutions with a parent credit rating of single A and above, and this is evidence of underlying quality and strength of balance sheet. A recent note by Moody’s highlighted that, on average, leverage within the insurance sector is at or below levels commensurate with current ratings, implying these companies have capacity to issue further bonds to retain capital strength without impacting their balance sheet strength.

Combine this with highly cash-generative business models, strong levels of capitalisation and a creditor-friendly regulator that prioritises capital and cash retention over dividend distribution, and we have a sector that is fundamentally stable and robust.

Valuations

We can see from the chart below that the sector, despite these positives, still trades at a discount to the broader market. Some of this is explained by the subordinate nature of many of these bonds, which carry a higher level of volatility; fair value for the insurance sector overall should therefore naturally be wider than the benchmark average. When we factor in the underlying credit quality, however, this spread differential should be much less than the market is currently pricing. We are therefore happy to maintain an overweight position on the basis that we believe investors are more than compensated for the risks.

Index spreads

Looking more closely at individual names we hold, the following table shows three bonds from insurers versus the iBoxx Sterling Corporate Index.

The case for sustainable insurance

The companies above operate in different sub-sectors: Rothesay specialises in pensions, Legal & General is the UK’s largest provider of life insurance while Swiss Re is one of the world’s leading providers of reinsurance (insuring the insurers). But while sitting in slightly different areas, there is clear commonality: all three bring security and resilience to clients, they are high-quality companies with parent credit ratings of single A and higher, and they offer a significant spread pick-up when compared to the benchmark average.

As outlined above, all the bonds mentioned are subordinated Tier 2 so a notch below senior but we are happy to move down the capital structure in such high-quality organisations and believe there is significant compensation for doing so.

Insurance provides a number of benefits to society, giving an economic safety net to millions, facilitating economic development and growth, and also researching and furthering our knowledge of sustainability and key environmental and social issues. It is a sector that has robust fundamentals and strong solvency on average and, most importantly, continues to offer long-term value to bond investors, demanding its core position across our SF Corporate Bond and Monthly Income Bond Funds.

For a comprehensive list of common financial words and terms, see our glossary here.

Liontrust Insights



Key Risks


Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well-regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Tuesday, November 24, 2020, 11:47 AM