In times of increasingly strict product and governance regulation, asset management has become one of the main drivers for the business profitability of insurers all over the world. In their quest for long-term stable returns that match their insurance obligations, insurers are increasingly open-minded to new asset classes and willing to take more risk, leaving behind traditional bond-based investment strategies.
Surprisingly, the overall outlook is not as negative as it was last year. When insurers globally were asked to identify the macro concerns for their portfolios in two recent surveys by Goldman Sachs and BlackRock,2 geo-political risks, recession and regulatory risks no longer dominated. Instead, they were more concerned about inflation, deflation and environmental risks. Moreover, insurance investments are becoming more and more diversified, crossing borders both geographically and in terms of asset classes, fuelled by more fluid regulatory frameworks, such as the European Solvency II framework. Although insurers' risk appetites differ significantly among regions, insurers all over the world are currently focusing on private markets, in particular private equity and private lending. Nevertheless, the bulk of their investment portfolios is still constituted by government and corporate bonds, explaining the insurers' preoccupation with rising interest rates.
Accordingly, the current environment is characterized by a multitude of activities and trends, some more mainstream and some very individual, but all with the goal to define a sustainable investment strategy that will allow insurers to survive and thrive in an increasingly complex environment. In this article we turn the spotlight on two such global trends, one very new and one very old:
- Responsible investing has only very recently moved into the focus of many insurers but is, for a multitude of reasons, on the verge of becoming mainstream in Europe and the Asia Pacific region.
- Real estate is and has always been a preferred asset class for insurers, demonstrated by insurers' logos on buildings all over the world. There is, however, strong competition for real estate investments in the classical real estate markets in Europe and the US. It is therefore worthwhile having a look at the very promising real estate market down under.
The term "responsible investing" has become a buzzword for investors of all types and while the traditional "hard" investment criteria continue to play an important role, insurers increasingly include "soft" criteria in their investment process, looking at the environmental, social and/or governance (ESG) impact of their investments. In the latest BlackRock survey, 83 percent of the interviewed senior executives stated that integrating such criteria is important to their organization.3 According to the Goldman Sachs survey, 56 percent of the interviewed senior executives from European and Asian insurance companies confirmed they are already using ESG criteria as an investment consideration.4 The same survey revealed, however, that ESG is much less in vogue in the Americas, with a share of only 28 percent of insurers using ESG criteria.
What's in it for insurers?
What drives insurers to limit themselves and potentially abandon additional returns? Importantly, committing to ESG criteria and ensuring long-term returns are not mutually exclusive and UBS have commented that sustainable investment returns are comparable to conventional ones.5 Furthermore, ESG criteria can be helpful to identify additional long-term risks associated with an investment. For example, climate change has been identified as one of the key macro risks to portfolios globally in the BlackRock survey. Investments in areas with negative environmental impact may suffer from regulatory intervention or the costs associated with environmental damage. Moreover, climate change also affects the insurers' core business, e.g. by increasing risks for P&C insurance or reinsurance costs. Finally but importantly, being associated with the violation of social or governance issues may lead to considerable reputational damage. Insurers are experiencing a stronger demand for ethical investments, in particular from Millenials. By investing responsibly, insurers do not just want to be "good" − they are targeting sustainable long-term returns, reducing risks for their core business and improving their public reputation.
Responsible investing and renewable energy
One area of investment which clearly demonstrates the above benefits for insurers is renewable energy. Renewable projects do not only fulfil the relevant ESG criteria, but can also provide long-term stable returns which tie in with the profile of long-term insurance liabilities. Moreover, the technology associated with renewable investments tends to become increasingly reliable while costs decrease over time.
Despite the pulling back or withdrawal of government subsidies on renewable projects, particularly in Europe (e.g. via reduction of feed-in-tariffs in the UK, Germany, France and Finland), the market continues to be buoyant partly through the emergence of Corporate Power Purchase Agreements (PPAs) where an off-taker agrees to purchase electricity from renewable projects on a long-term predictable pricing model which helps underpin the investment case for a project. Growing demand for renewable energy means growing opportunities for investments. As an example, DLA Piper recently advised AB-In Bev (the parent company of Budweiser) on its PPA to purchase 100 percent renewable electricity for all of its UK operations from Lightsource, a renewables developer in which BP has invested heavily.
Some of the key emerging trends for renewable projects and potential investment opportunities we currently see include:
- Offshore wind in new markets
- Floating technology
- Battery storage
The offshore wind sector has traditionally been strongest in Europe (and the UK, in particular), and while Europe continues to provide opportunities, some of the most interesting and exciting developments appear to be in countries where offshore wind has not had much historical precedent, notably the US, Taiwan and Japan.
Most market experts agree that US offshore wind represents some of the most exciting and large-scale opportunities for renewable energy in the world. Surprisingly for a country with such massive potential in this area, there is only one US operational offshore wind project, which is the relatively modest-sized 30 MW Block Island Wind Farm. However, according to the Department of Energy, the US has a total project pipeline of 25,434 MW of offshore wind energy as of June 2018. In particular, some of the East Coast states have been the most focused on pushing this program, with several states committing to minimum targets for offshore energy production, such as New York (2,400 MW by 2030), New Jersey (3,500 MW by 2030) and Massachusetts (3,500 MW by 2035). DLA Piper is advising bidders in several of these projects. Each of these programmed projects will require extensive capital commitments and fund raising, providing a huge pool of investment opportunities in a country most insurers are familiar with.
Taiwan has seen some of the most rapid execution of a concerted offshore wind policy. In 2018, Taiwan’s Ministry of Economic Affairs awarded grid capacity of a total of 5,500 MW to 16 offshore wind projects under the first process of its kind in Taiwan. While this represents an impressive level of progress, there have been a number of recent issues relating to how the Taiwanese government subsidies may operate in respect of offshore wind. At the very start of 2019, Ørsted, the major Danish offshore wind developer, announced that it was pausing its activities on the two Taiwanese projects it had won exclusivity for lack of certainty on this very issue. Developers and investors alike will be keen to monitor developments in Taiwan to understand whether the projects can be structured to entice third party investors such as insurance companies.
Some of the key challenges that have long faced Japan's attempts at building an offshore wind capability have included the climatic and topographic conditions, grid capacity and legal and regulatory complexities. The Japanese government has, however, committed to decarbonising its economy by 2050 and as such it has also sought to reduce some of the lead-time and complexity around permitting to encourage development. At the same time, many industry experts believe that the evolution of floating offshore wind technology (see below) could be the key to unlocking Japan's offshore wind potential as many of the identified sites are in deep waters where it may otherwise be prohibitively expensive to build fixed turbines. There will be more clarity by the northern spring / summer 2019 when the Japanese government is expected to release invitations for tenders to the market for the development of offshore wind sites.
Floating offshore wind and floating solar are two key areas which are expected to grow in the coming years. In short, this is the use of wind turbines or solar panels on floating platforms to take advantage of favorable climatic conditions or lack of land. Some commentators are describing floating offshore wind as a potential game-changer for those countries where the waters are too deep to be able to accommodate fixed bottom turbines. Currently, there are only two operational offshore wind projects (Hywind Scotland and the much smaller Floatgen wind turbine off the French coast). 2018 saw, however, a number of noteworthy deals advance, among them a 25 MW project off the coast of Portugal and a Norwegian project being developed by Innogy SE, Shell, and Stiesdal Offshore Technologies A/S.
In 2018, the World Bank produced an in-depth report on floating solar and flagged that the market is where the land-based solar market was in 2000 with a similar potential for growth. While a large number of countries across the globe have floating solar facilities, China has become the biggest player and the only country to deliver large scale projects (with capacity over 100 MW) with parts of south and south-east Asia being identified as being key opportunities. For example, in January 2019, Bangladesh announced two floating solar plants (including one with a grid capacity of 50 MW) with the backing of the Asian Development Fund.
While the technological advancements in floating projects are exciting, the sector remains relatively young with a number of issues that will need to be overcome: lack of track record (in the case of floating wind), the projects being in countries which would be novel for the typical renewable energy investor and the smaller scale of the projects (in the case of floating solar) might make them unattractive unless they were bundled up into larger portfolios.
For the last few years, battery storage has been heralded as a turning point in the energy sector. Battery storage creates the ability to store power at times of excess and release it at times of deficit and high demand, which is critical to balancing supply and demand in the power system. As renewable energy can be varying and intermittent at different times, battery storage has the potential for allowing a more graduated and controlled release of the energy produced. Although the development of the market has been patchy across the globe, some countries have been at the forefront of sector, most notably the US and Australia.
Use of energy storage in the US is growing quickly and Reuters reported the battery storage sector was expected to expand by 186 percent in 2018. This can be partly explained by the fact that funding (whether from venture capitalists, bond placements or bank debt) is considered to be less of a challenge. For example, DLA Piper advised on a deal in which Macquarie Group secured funding from CIT Bank to partly fund a $200 million portfolio of storage systems in California − the largest battery project to get bank financing in the US, which came to financial close in 2017.
Batteries have started to play a key role supporting the growth of renewables in Australia. Significantly, the Australian Renewable Energy Agency (ARENA), a government agency, is providing subsidies for storage facility projects, making Australia a prime and attractive market. In 2018, DLA Piper advised ARENA on the funding of two battery projects which will together deliver 55 MW of power and can provide approximately 80 MW of energy storage capacity.
There has not been much activity involving insurers investing directly into battery storage projects yet. With costs in battery storage expected to continue to fall, particularly with the electric vehicle market growing, the battery storage market could make renewable energy investments even more attractive by reducing overall costs and giving more flexibility as to when energy is deployed.
Future opportunities and challenges
As the demand for responsible investing is higher than ever, the market for third-party investors is extremely competitive. This means there is a lot of money chasing a relatively small number of investments, particularly in mature markets such as Europe. This situation leaves many investors empty-handed or, at the very least, left with smaller renewables portfolios than they would like. Solutions for investors may come from making investments that may carry more risk, eg, due to new geographies or technologies or because the investor is willing to invest already during development and construction. For example, DLA Piper recently advised Credit Suisse on two deals in which Credit Suisse took the construction risk: in 2016, Credit Suisse acquired a minority stake in the 1,000 MW Fosen Wind in Norway, which will be the largest onshore wind project in Europe once completed, followed by a fund managed by Credit Suisse investing as an 80 percent stakeholder in the 475 MW Nysäter wind farm in Sweden which was the largest onshore wind deal to close in 2018.
These market conditions clearly favor larger investors, and another emerging trend may be that smaller insurers will increasingly invest in specialist renewable energy funds managed by global insurers or asset managers having more experience in acquiring and managing renewable projects (for example, the Allianz specialist fund). There is a huge appetite for investing responsibly in renewable energy and a strong pipeline of deals worldwide but the market conditions are favoring larger investors (or pooled smaller investors) or asset managers with specialist expertise that can truly capitalise on some of the new market developments happening across the globe.
Real estate investments down under
In the period immediately following late 2008, real estate markets globally had been severely affected by unprecedented economic turmoil, particularly in Europe and the United States. While Australia's real estate vehicles were not immune, the underlying real estate remained relatively stable when compared to other developed western real estate markets. This led to a growing awareness of the resilient nature of the Australian real estate market in particular and the Australian economy more broadly for all types of investors all over the world. Since 2015, following the lead of the private equity groups, fund managers, sovereign and pension funds, a number of globally focussed insurance companies from Europe, Asia and the US have entered the Australian and some Asian markets, seeking currency and geographic diversification and as well as better risk adjusted returns by investing mainly into core real estate via direct acquisition or real estate lending.
Having avoided a recession, Australia, with a AAA rating, has performed well in the last years to the point that foreign-sourced capital is now the dominant source for Australian real estate investment. Insurers now account for 21 percent of the “billion-dollar club” in terms of real estate allocations, making them the second-largest group after public pension funds. Along with New York Life, two other insurers ranked among the top ten in terms of allocations to real estate: Swiss Life, the sixth-biggest investor with AU$40.7 billion committed, and Italy’s Generali, whose AU$32.3 billion allocation was the ninth largest.
Australia readily accommodates new foreign investors, embracing the globalization of real estate capital and allowing the most conservative of investors to deploy capital with confidence in a politically and economically stable environment. In addition, the Australian real estate lending market offers particular opportunities since the Australian Prudential Regulatory Authority has forced Australia’s four major banks to reduce their commercial real estate exposures. This has created an AU$50 billion funding gap for non-bank lenders to capture since only limited liquidity is available from the domestic Australian banks. The insurers have recognised this unprecedented opportunity to finance high quality Australian real estate projects offering attractive risk adjusted returns.
Early movers among the foreign insurers into direct investment in the Australian real estate market have included some of the South Korean insurance companies. Since 2015, there have been numerous investments into core commercial office real estate investments by the likes of Lotte Life Insurance, Samsung Life and M&G Life, typically tenanted by the Australian government or investment grade rated corporate entities under long term (often 12-15 years plus) leases with fixed annual increases between 3 percent and 4 percent. DLA Piper has handled several of these transactions including the acquisitions of several Australian Tax Offices in markets across Australia as well as facilities occupied by the University of New South Wales and the Australian Red Cross, being entities that are either guaranteed by, or receive, Australian Federal Government support.
The period 2016 to 2018 saw the emergence of Chinese insurance companies into global real estate markets, including Australia. DLA Piper advised Ping An as one of the major investors on the formation of several residential joint ventures with leading ASX (Australia Stock Exchange) listed Australian real estate developer Mirvac Group as well as on a significant commercial office joint venture in Sydney with ASX listed global developer Lend Lease. Other significant transactions by Chinese insurers included several resort and hotel investments by Sunshine Insurance Group. An insatiable appetite for Australian real estate investment by Chinese insurance companies was expected to continue until Chinese regulatory changes hindered the overseas expansionary ambitions of these investors, curtailing further investments in 2018 and for the foreseeable future.
The Australian and Asian markets have seen the recent entrance of several US insurers. The investment arm of Manulife listed its US commercial office portfolio on the SGX (Singapore Stock Exchange), soon followed by further significant direct investment into Australian commercial office assets with its acquisition of the Myer headquarter in Melbourne.
Indeed the two biggest holdings of US insurers are bonds (#1) and real estate (#2). The majority of their real estate exposure comes in the form of financing commercial real estate investments. The AAA-rated life insurance companies do carry a small percentage of stock holdings in their portfolios but it is insignificant in comparison to their real estate exposure. For them, commercial real estate represents a scenario in which they can target better returns than their traditional bond holdings without having to take on the significantly greater risk of the stock market. (Source: Mortgage Bankers Association).
Significantly, both Prudential Life Insurance and MetLife, each a US-based company, have entered the commercial real estate lending market in Australia. While insurers have featured prominently as part of an established non-bank real estate lending sector in the US and Europe, the entry of US insurers is new. With DLA Piper having represented US Prudential on the set up of its commercial real estate lending program in Australia, both MetLife and Prudential have already deployed several billions of dollars into Australian commercial real estate first mortgage investments.
In line with the move of insurers into global real estate, 2018 has seen DLA Piper client Allianz emerge as the third largest global real estate investor and Axa as the fourth largest global real estate investor in 2018, a trend that is set to continue. Both Allianz and Axa have established significant real estate platforms in Asia and Australia as springboards into the Australian and Asian markets with Allianz announcing plans to double investments in Asia over three years with funds drawing in more money from its insurance operations in the region. (Source: The Business Times).
Currently Allianz's Asian exposure is still relatively small, accounting for only about 3 percent of Allianz's global real estate portfolio centred on the US and Europe, but this is bound to change: In 2018 DLA Piper has represented Allianz across Australia and Asia in a range of projects including student housing in Australia and logistics investments in China. Other global insurers are also expected to become more active in the Asia and Australia, with Zurich developing a major commercial office building in Australia.
The outlook for 2019 remains positive for the Australian real estate market and for continued investment. We expect direct investments from global insurers to increase, both for insurers already present on the Australian market and for newcomers. We also expect that the number of insurers entering the commercial real estate lending market will increase significantly due to the forced ease back of the four major Australian banks.
So let us take a look into the crystal ball: how will insurance asset management look like at the end of 2019? This will of course depend on market developments which are not easy to predict even for the most experienced asset managers. It is very likely that the current movements of diversification, focus on alternative asset classes and willingness to increase risks will continue. Real estate as one of our spotlight trends will continue to play an important role, but maybe with a focus on countries like Australia that until now were outside the scope of insurers. We believe that responsible investing and ESG will move to centre stage for European and Asian insurers, driving a need for responsible investments in particular in the area of clean energy and making use of the new technologies entering the renewable markets.
Moreover, new strategies also require new know-how and technologies, not only for renewable projects. Insurers will increasingly look for specialised know-how, building it up internally or acquiring or cooperating with specialised asset managers. Artificial intelligence and blockchain technology also play an increasing role in asset management and insurers will need to integrate these technologies in their investment processes. Consolidation will therefore be one of the main trends in insurance asset management in 2019. Sophisticated global players in insurance asset management, like Aviva or Axa, will be able to strengthen their position through acquisitions and development of know-how and new technologies. At the same time, smaller insurers will be cut off from these developments, having to procure the required know-how from the global players or specialised service providers via outsourcing, service relationships or co-investments.