Sponsored: Aon’s Gerard-Jan van Berckel unpicks some of the reasons behind re/insurers’ growing appetites for real estate investments
For centuries, insurance companies worldwide have been underwriting property risk. Insurance companies have an interesting history with respect to property risk and insurance. Insurance companies ran the first fire brigades and created the National Fire Protection Association (NFPA) in 1896, which remains the world’s leading advocate of fire prevention and public safety. Throughout history, insurers have been a safety beacon for governments, corporations and individuals owning and leasing property.
Today, these close ties between insurers and real estate continue, as insurers invest the premiums they acquire in real estate, whether equity or debt, and make informed investment decisions to maximise their portfolio yields. Eligible public bonds, often secured by real assets such as real estate itself, have been a staple of insurance company investment portfolios for many years.
However, as the capital markets have proven increasingly challenging, especially over the last decade, insurers and reinsurers have explored new approaches to maintain their investment returns and diversify their risk by considering new asset classes. European insurers have turned their attention to real assets, including direct and indirect real estate debt and infrastructure debt, investing by making secured loans to an owner or purchaser of these assets.
Investment grade real estate debt can be an attractive asset class for insurers as it offers:
• Higher rates of return than public debt (typically), and is more capital-efficient;
• Higher recovery rates than corporate bonds with investments secured against a named asset, giving the investor greater control, and
• Higher margins and lower loan-to-value levels than pre-Global Financial Crisis, further increasing the attractiveness of the assets.
Changes in asset liability matching
Often, insurers have capacity to take on liquidity risk, particularly those with liability profiles that exceed five years. Traditionally, life insurers target longer duration assets, in excess of seven years, while property and casualty (P&C) insurers tend to focus on short duration investments, due to their shorter liabilities.
However, changes in regulation over the last five years have seen Periodic Payment Order (PPO) liabilities for P&C insurers become more pronounced. Many P&C insurers see investment in real estate debt as a preferred solution to tackle longer-term liabilities, making real estate debt an increasingly suitable investment for all types of insurers that have to mitigate the duration gap.
Importantly for insurers, the market is large. In Europe, outstanding commercial real estate debt exceeded €978 bn at the end of 2014, with the amount of outstanding debt in the UK alone exceeding €183 billion (£160 billion) today. There is every expectation that the market for real estate and private debt investment will grow exponentially over the coming years, with the potential for investors to benefit increasing in tandem.
However, while there are numerous advantages for insurance and reinsurance companies to consider investing in real estate debt, there are also potential pitfalls. Key challenges include:
• Lack of specialist knowledge. Although many insurers underwrite property risk, investing in this asset class does require an in-depth investment knowledge. Much of the knowledge has traditionally been housed in banks and now increasingly sits within asset managers;
• Having access to deal flow and origination of attractive real asset opportunities can often only be found by dedicated managers and advisors with established teams and track records;
• Many insurers are seeking broader market exposure than has historically been available via third-party managers – in terms of both sector and geography. Many third-party managers, particularly in Europe, have typically been boutique, focusing only on certain sectors of the market or specific regions, and
• Many investors’ capital constraints have led to them seeking co-investment capabilities, which have historically been in short supply.
Today, with the clear and growing appetite for real estate debt investment from insurance and reinsurance investors, these challenges are being addressed through the creation of numerous real assets, real estate and private debt fund investment solutions. Co-investment capabilities are being developed to help investors to overcome their capital constraints, while delegated investment options enable insurers to realise the benefits of untapped asset classes in a compliant and efficient way.
Gerard-Jan van Berckel, head of delegated investment solutions for insurers at Aon.