Best consulting firm: EY

Consultancy advised on all five matching adjustment repacks in first wave

Gareth Mee, EY

Buy-side Awards 2016

You might say EY's work for insurers last year contributed to the survival of one business and the emergence of another: the survivor being the UK's equity release mortgage industry; the emerging business, the repackaging of assets for Solvency II's matching adjustment (MA).

From what started as a way to fix a problem, insurers are now looking to use the MA repack structures developed in 2015 to invest in "more interesting" assets, says Gareth Mee, executive director and global investment advisory lead at EY, based in London.

That means yields of up to 5% on investment-grade assets such as restructured US energy loans, insurance-linked securities, property, ground rents or collateralised loan obligations.

The first wave of repacks ended a three-year saga for UK life firms that reached its climax in December 2015 as firms worked to restructure assets to make them eligible for the MA before January 1.

Failure could have derailed the UK's £2 billion/year ($2.5 billion/year) equity release mortgage business, and would have left one UK insurer – Legal & General – facing big hedging costs on foreign currency bonds.

Instead, successful repacks have created a nascent industry around bundling other ineligible assets to create insurer-friendly notes. EY worked on all five of the repacks known to Risk.net.

These first transactions showed the breadth of asset types that could be repackaged – including callable bonds and real estate loans, for example, as well as the range of structures the UK regulator would accept. So much so that some firms were surprised when they saw what their peers had done, feeling they might have underestimated how accommodating the regulator would be.

Insurers now have multiple templates for future structures, ranging from multi-tranche approaches with liquidity support to Aviva's simple model-driven transaction with just one senior note.

Based on what the PRA has approved, asset managers such as Natixis, Partners Group, EIG, Securis Investment Partners and Freehold Investment Management are pitching pre-repackaged assets to insurers using similar special purpose vehicle (SPV)-based structures. Mee says his team is working with many asset managers investigating such structures.

Cultural exchange

More broadly, Solvency II requires insurers to think more like asset managers, and asset managers to think more like insurers, he says.

In a sense, the team at EY helps with the transition, acting as actuarial guns for hire to asset managers, and asset management guns for hire to insurers.

"Insurers now need to do things such as understand relative value, manage loans, execute deals in a way that is not phoning up their broker or asset manager to trade corporate bonds. Conversely, asset managers cannot just invest based on what looks cheap. They have to understand the implications of what they are doing for the insurance company portfolio," Mee says.

The aim is to help insurers spot where they are a better buyer of an asset than other types of investors – owing to insurers' long-dated liability profile or their different capital regime, or both. The team also helps sellers understand how to parcel assets so they suit insurance company balance sheets.

In the quest for yield, firms have been buying new asset types, Mee says, pointing out that banks used to have credit teams of maybe 50 people to make loans.

The PRA is understood to be concerned that insurers lack teams with scale or expertise to match. The UK's Institute and Faculty of Actuaries, meanwhile, is setting up a working party to help firms navigate the regulatory challenges of managing loans.

Understanding such investments comes down to sound modelling. To that end, EY helps validate internal models, but often winds up helping calibrate them, drawing on a depth of expertise – which the insurer might not have – in areas such as commercial lending or insurance-linked securities.

Insurers now need to do things such as understand relative value, manage loans, execute deals in a way that is not phoning up their broker or asset manager to trade corporate bonds. Conversely, asset managers cannot just invest based on what looks cheap. They have to understand the implications of what they are doing for the insurance company portfolio
Gareth Mee, EY

The challenge is understanding what can make an asset go bad, Mee says. Real-world experience is vital to earmark binary risks, such as building a power plant only to discover at completion the piping throughout the building is too narrow. (This is a real-world example, he says.)

"Models might say, for example, 1.7 projects go bad. But in the real world, that can't happen. It has to be one project or two," Mee says.

Risk management, therefore, calls for iterations of modelling coupled with educated guesses about possible glitches, followed by layering up capital in response.

Once bought, insurers need help owning assets, too. There can be a tendency to "throw new assets over the wall" once acquired, for someone else in the firm to administer, he says.

But real assets require real input. Loans to a school or a hospital are hard to track, Mee says: "Somebody has to get hold of their accounts, follow them in the press to make sure nothing is going wrong, that sort of thing."

On the asset management side, the team helps sellers pitch ideas tailored to insurers' constraints. Returning to repack transactions as an example, EY has worked on restructuring ground rents through an SPV to render them suitable for an insurer's MA portfolio.

On such transactions, the consultancy often takes a structuring role, drawing on expertise from its banking teams, he says.

Project teams might include, for example, experts from the consultancy's ratings advisory team, debt advisory team, accounting and tax professionals, actuaries, real estate specialists, and valuation specialists.

"The core team might be four or five people, but we might pull in up to 20 or 30 people from around the firm for specific tasks," Mee explains.