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UK life insurers exposed to no-deal Brexit house-price falls

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UK life insurers exposed to no-deal Brexit house-price falls

U.K. life insurers could be hit in several parts of their asset portfolios if the U.K. leaves the EU without a deal. But ratings analysts say they are well insulated from potential losses, and their business models overall are resilient to shocks.

Insurers invest the premiums they collect to boost profit and capital. Their investment portfolios are typically conservative, consisting mainly of government and highly rated corporate bonds. But life insurers in particular are increasingly taking on long-term, illiquid assets, such as corporate loans, that could be exposed to the effects of Brexit.

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A growing part of life insurers' investment portfolios is equity release mortgages, also known as lifetime mortgages. Insurers consider them a good match to their growing books of pensions liabilities from bulk annuity transactions, but they expose the insurers to falls in house prices.

Equity release mortgages pay homeowners a loan, which is then repaid by the sale of the house after their death. The mortgages typically contain a no negative equity guarantee, or NNEG, which means the provider, rather than the homeowners, will be on the hook if the sale of the house does not cover the loan plus interest.

If the U.K. leaves the European Union without an agreement on Oct. 31, house prices are expected to drop. Accounting firm KPMG predicted in a Sept. 2, 2019, report that U.K. house prices would decline on average by 6.2% in 2020 if there was a no-deal Brexit, compared with a rise of 1.3% if the U.K. leaves with a deal. In a report published in October 2018, S&P Global Ratings predicted that house prices could fall by 6.2% in 2019 and a further 3.3% in 2020, followed by growth of 3.8% in 2021.

'Incremental risk'

Insurers' saving grace is that, thanks to their more recent entry into the market, loan-to-value ratios on equity release mortgages are still relatively low. The interest on the loans rolls up over time and is paid off, along with the loan amount, when the house is sold, and so the loan-to-value ratio increases over time.

But David Masters, a director at S&P Global Ratings, said in an interview that loan-to-value ratios on average "are still typically substantially below 50% across portfolios." As a result, he said, there is an "incremental risk" to insurers "but it is not a massively heightened risk at this point." However, he added: "It brings it closer to a point where it becomes an increasing concern for us."

Benjamin Serra, senior vice president at Moody's, said in an interview that the low loan-to-value ratios meant "the risk is still relatively limited for the companies we rate."

Equity release mortgages typically do not need to be repaid for tens of years, which also insulates insurers from short-term house price fluctuations. Even if prices do fall sharply after a no-deal Brexit, there is time for them to recover and regain their previous growth trajectory before insurers need to worry about losses under the NNEG.

Willem Loots, senior director at Fitch Ratings, said that because of the duration of the loans, "it will take an extended period in terms of years of adverse house price movements ... for the losses on the no negative equity guarantee to become significant."

Also, while popular with U.K. annuity writers, equity release mortgages typically make up a small part of the overall portfolio. S&P Global Ratings said in an October 2018 report that the ratio of equity release mortgages to non-linked financial assets was 3% for Aviva PLC, the same for Legal & General Group PLC, and 7% for Liverpool Victoria Friendly Society Ltd.

Capital buffer

Equity release mortgages are not the only areas of insurers' investment portfolios exposed to falling property prices. Life insurers have been increasingly offering other mortgage loans and also have direct investments in real estate. Serra said that when combined with equity release mortgages, close to 15% of U.K. life insurers' portfolios has some link to real estate, meaning there was "a risk of correlation."

While there are risks, ratings analysts believe life insurers are well insulated from the effects of a no-deal Brexit on their investment portfolios, mainly because of their strong capitalization. Serra noted that, thanks to Europe's Solvency II capital regime, "at least you have some capital to withstand the decreasing real estate market and other risks as well."

Loots said while Fitch does not have a view on how asset prices and investments would respond to Brexit scenarios, more generally "we believe insurers' balance sheets are conservatively capitalized, such that quite significant market dislocations will not cause them trouble."