L&G: Solvency II reform would hurt as well as help

So much for the insurers’ Brexit dividend. The overhaul of EU solvency rules was expected to free up tens of billions of pounds. But the latest proposals could hurt companies such as FTSE 100-listed L&G, which published a strong set of interim results on Tuesday.

L&G boss Nigel Wilson has been lobbying for an overhaul of the Solvency II rules that would unlock capital to invest in levelling-up projects, infrastructure and green assets. Less than half of the L&G annuity portfolio is at present invested in the UK. He wants that to increase.

But as things stand, the revision of the rules would have a negative impact on L&G’s solvency ratio of 5 percentage points, according to UBS. It is particularly affected because of its large annuity business.

To be sure, that hit would not be huge. Higher interest rates have pushed up the ratio by five times that this year to 212 per cent in June, though it has fallen slightly since then.

Insurers’ solvency ratios are high enough for them to consider M&A, deleveraging and increasing returns to shareholders. Aviva earlier this year said it would return £4.75bn to investors.

L&G could use its excess capacity to take on more bulk annuities, given increased demand. Pension deficits fall as interest rates rise, making it easier for companies to transfer the risks.

Caution is in order. A recession would bring interest rates — and the solvency ratio — back down. It might also result in defaults and downgrades in L&G’s annuity book. Concern about credit risk has weighed on the shares, which underperformed most of this year compared with the European sector. The shares, on a price/earnings ratio of 8, sit a fifth below their 10-year average.

The stock has recently caught up with European peers, helped by an encouraging update last month. The company on Tuesday sought to reassure markets about its credit risk, emphasising the high quality of its bond portfolio. Fair enough, but L&G’s large annuity business means it has a higher exposure than peers to credit risk. In a really bad downturn, its shareholders would then need to take cover.