Codan’s Credit Allocations – A broad spectrum of liquidity

By Hamlin Lovell, NordicInvestor

Insurance companies are subject to a regulatory framework, but within this they have freedom to allocate to a wide range of credit asset classes and strategies. Nordic Investor interviewed Jon Pommergard Lind, Investment Manager at Codan Forsikring, who explained how the firm needs to keep some assets highly liquid, but can also invest in vehicles with maturities as long as 20 years to harvest illiquidity premia from asset classes such as infrastructure debt. Codan is also looking at Green Bonds.

Codan is part of the UK’s RSA Insurance Group plc, which also owns insurance companies in the UK and Canada. The different companies’ investment teams share ideas, but each one needs to carefully tailor its portfolio to match liabilities of the relevant insurance entity. For instance, “Codan is invested mainly in Scandinavian and European credit to match the liabilities of our insurance companies. We have assets with between five and ten external managers, in liquid and illiquid credit, bonds and REITs”, says Lind. Codan’s liabilities are linked to the general insurance it sells including for cars, houses, travel, accidents, as well as pets and boats.

“Our first focus is capital preservation, which means we are generally in high credit quality assets, such as covered bonds, mortgage bonds and corporate bonds – these will be mainly investment grade. 

Codan’s annual financial reports show small allocations to cash, cash equivalents and equity funds, but the great majority is in bonds.

Liability matching

Yet very low and negative interest rates on some bonds are a challenge for unleveraged investors, who are increasingly looking at alternative credit to produce higher returns. “We also need to generate returns to match our liabilities. Therefore, in the current environment we need to have some illiquid investments to harvest illiquidity premia, which might perhaps be 2% yield pickup on infrastructure debt”, he says.

Infrastructure debt is perceived to be a low risk alternative credit asset class, because it is usually linked to essential services with revenues that are predictable due to regulation, long term contracts or power price agreements (PPAs). Pension funds in Denmark, including some interviewed by NordicInvestor, are big investors in infrastructure equity, but general insurers’ risk profile is better suited to the debt.

Each insurance company will have a different tolerance for longer dated debt. The exact risk budgets for illiquid credit will vary between the different insurance companies in the Codan group, and the wider RSA group, depending partly on the maturity of their liabilities. “Some have shorter dated liabilities and others have longer dated liabilities”, says Lind.

Internal solvency models

Insurers’ asset allocation will also depend on how they calculate their solvency capital requirements. Rather than using the standardized Solvency II capital charges, or “Standard Formula”,

It is not straightforward to indicate what the charge would be for any infrastructure debt fund, because it needs to be considered in the context of the overall portfolio to allow for diversification benefits.

Covid-19

The Covid-19 Pandemic did not change sector allocations, but did delay one external investment. “We did not know how severe the hit would be for both financial markets and our underlying insurance business, so had to maintain precautionary higher levels of cash in the short term, postponing one allocation”, explains Lind, who adds that the investment has now been made.

He does not have a macro view on the shape or speed of the recovery, but rather needs to ensure that the portfolio would be resilient enough to withstand any crisis, now or in the future, as part of the stress testing process.

Liquidity normalising

Liquidity risk management also needs to be stress tested by insurance companies. “Surplus cash can be used for dynamic and tactical allocations, but liability matching cash cannot. Liquidity is of course a moving target and at times in early 2020 liquidity did become stressed in some parts of the credit markets. Managers are now reporting that liquidity levels are back towards pre-Covid 19 levels”, says Lind.

ESG and Green Bonds

Codan is covered by RSA’s low carbon policy. RSA is a signatory to the United Nations Principles for Sustainable Insurance (UN PSI), which covers both its underwriting activity (which has significant exposure to renewable energy) and investments. UN PSI signatories need to integrate ESG into decision-making and ownership practices, and one way of doing so is by implementing the UN Principles for Responsible Investment (PRI). RSA’s 2019 CSR report shows that 90% of funds are managed by signatories to the UN PRI.

Focusing specifically on climate, RSA is also a member of the UK based group, ClimateWise, which helps insurers to manage and communicate their climate risk policies, again both for their underlying insurance business, and for their investments: “RSA’s Climate Change and Low Carbon Policy applies to relevant asset managers across the Group. Recently, the Swedish Government has started to issue “Green Bonds” and Codan has participated in them”, says Lind.

Yet ESG policies vary somewhat by the asset class. Lind “does not see much relevance for ESG in mortgage backed securities for example”, an important allocation for Codan.