De-risking report 2025
An increasing number of pension schemes are looking to “invest like an insurer” – be that as they prepare to approach the insurance market or as they think about how to invest their assets for a run-on strategy.
Whilst insurers’ investment strategies vary between them, there are some general principles that hold for all, which is not surprising given the heavily regulated environment in which they operate. These are:
Let’s look at each of these topics in more detail.
In the current markets, insurers are typically seeking to generate a return of around Gilts + 1.5% p.a. on their portfolios. You may be thinking that this is a lot higher than they give pension schemes credit for when setting premiums – and you’d be right, but of course they need to deduct from this return the cost of the capital they hold to protect policyholders from risk, their profits, the cost of longevity hedging, an allowance for defaults and also expenses.
So how do they generate the Gilts +1.5%? Well historically corporate bonds have formed a major part of insurers’ investment strategies. Typically, these are:
With credit spreads (the additional yield above risk free achieved by investing in a corporate bond) currently at very low levels, insurers are using corporate bonds less in their portfolios at this time. Instead, some insurers regard investing in gilts as attractive at the moment, given the current spread of gilt yields above swap yields. This approach benefits from a lower capital requirement initially, whilst giving them the flexibility to invest in something more attractive in the future should spreads widen.
Each insurer’s credit portfolio is a work of art, furthermore, for new business the assets an insurer chooses to invest in will constantly vary to reflect changes in investment conditions. This often means that the in-specie transfer of a pension scheme’s assets as part of premium payment can be harder than may be expected, even where the scheme is invested consistently with the principles typically used by insurers.
Investing in illiquids and benefiting from the illiquidity premium makes complete sense for a long-term investor like an insurer, and is another mainstay of return generation for bulk annuity providers. Solvency UK, the insurance regulatory regime, sets high standards if an insurer wishes to include illiquid asset returns in their expected investment returns, requiring them to be Matching Adjustment eligible, with requirements such as the liabilities and assets being very closely matched and the cashflows on the assets needing to be fixed (or “highly predictable” for up to 10% of the portfolio). These requirements mean that typically insurers must invest in higher quality illiquid assets than a pension scheme and that it is generally difficult to transfer illiquids to insurers as part of premium payment.
So what kind of illiquids do insurers invest in? Increasingly over recent years they’ve seen this as a way to also achieve their sustainability goals and invest in “productive finance”. These are typically large-scale infrastructure projects – such as social housing and renewable energy – providing financing to companies across the UK and contributing to future UK economic growth. Below we’ve set out some examples of recent insurer investments.
Insurers are required to take a more exact approach to hedging than a typical pension scheme, with more emphasis on the accuracy of the hedge and more frequent rebalancing. The fact insurers have longevity swaps for much of their liabilities also means they have more certainty about the cashflows that need to be hedged. It’s worth noting that any liabilities that are not hedged are subject to additional capital requirements.
In terms of whether insurers hedge using gilts or swaps, that can change over time depending on their relative attractiveness. As noted above, at the moment insurers are investing significantly in gilts.
One thing pension schemes should bear in mind if they’re trying to match how an insurer invests is that insurers don’t hedge to 100% of the buyout premium – they are hedging 100% of their best estimate liabilities plus capital requirements. Typically, this works out to be about c. 90-95% of the buyout premium, so pension schemes should be careful not to over hedge relative to an insurer.
As Remi Warren notes in his article: Sustainability in the pension de-risking market - increased focus over 2024, insurers’ approaches to sustainability is increasingly important to trustees and sponsors. Insurers are also keen to demonstrate they are playing their part in investing in productive finance and UK projects. As can be seen from the unlock more box above, there are lots of examples of this, with insurers having the scale to make meaningful investments.
Insurers are risk averse, long-term investors who have huge teams of investment professionals helping them to build secure, diverse portfolios. Whilst most pension schemes do not have the size or sophistication of the insurers, they can still learn from their approach to risk management and focus on sustainability.
