Four years after specialist annuity provider Just Group's share price was sent tumbling off a cliff by a change in the law – the announcement by George Osborne of his pension freedom reforms – another regulatory change is doling out pain to its shareholders.
But a planned change to the rules covering lifetime mortgages will have a wider impact than just one company's share price. Costs will be passed onto clients and access to equity release products potentially constrained.
Since 1 January 2018, Just’s share price has fallen by just over 50%, more than on the day of the 2014 Budget. It has been the worst-performing European insurance stock of 2018 according to a Barclays analyst.
The cause is an exceptionally technical consultation paper about lifetime mortgages from the Prudential Regulation Authority (PRA), whose chief executive is Sam Woods (pictured below). This consultation, CP13/18, asks if lifetime mortgage providers, like Just, are setting aside enough capital to protect themselves from the risks of producing these loans.
Just is not the only provider affected, though it is less able to absorb its effects than other insurers with more diversified businesses. But it is clients who will end up worse off.
The reforms could severely disrupt the equity release mortgage (ERM) market, cut annuity rates and increase the costs of lifetime mortgages too.
Lifetime mortgages are a type of equity release product where someone is loaned money (either a lump sum or drawdown). They have to repay this, plus annual interest, through the value of their property at a later period, for example when they die.
The PRA consultation closed at the end of last month and the industry is waiting, with no shortage of nervousness, for the subsequent policy statement. The effects of that paper could be huge.
So much so that analysts are tipping Just for a rights issue or even a possible takeover. New Model Adviser® reported last month that insiders think Legal & General (L&G) is a likely suitor.
Fund managers are also taking a hit, though some are seeing opportunity – New Model Adviser® found one hedge fund has started shorting Just’s shares.
And consumers seem set to lose out too. An unintended consequence of the PRA paper is the public could end up paying more for both lifetime mortgages and annuities as insurers hike prices to cope with the increased capital requirements (something it seems is already happening).
Both these markets have enjoyed a resurgence in recent times, but this new paper could put an end to that revival.
Passing on the pain
If regulators apply increased capital requirements for a certain market, it is natural for prices to rise.
As Just and other insurers use lifetime mortgages to back up its annuity promises, both of these products will be affected by CP13/18.
Alan Devlin, an analyst at Barclays, said these price hikes have already begun.
‘The unintended consequence of the PRA’s actions is to further increase the imbalance. It allows the insurance companies to pass on the additional costs of the increased capital requirements to the consumer,’ he said in a note.
‘The Just management team have raised prices on individual annuities twice (in July and again in August). The market has absorbed the pricing, and competitors have also increased pricing.’
The Institute and Faculty of Actuaries said in its response to the PRA consultation that, if the new rules go too far, it could seriously damage the market.
‘ERMs have the backing of both the Treasury and the FCA, and the PRA’s proposals have the potential to severely disrupt the ERM market. Indeed, insurers have already increased pricing on both annuities (individual and bulk) and on lifetime mortgages to pass on the potential additional costs of the increased capital requirements, increasing the cost to the consumer.’
Four years after Osborne’s pension freedoms nearly killed off the annuity market, the government’s regulators are on the verge of dealing it another major blow.
Safe as houses?
In the post-pension freedoms world, Just had to find new markets following the collapse of annuity sales and, along with defined benefit buyouts, equity release was where it focused. ERMs make up 37% of Just’s balance sheet.
Just, whose group chief executive is Rodney Cook, offers ‘no negative equity guarantees’ (NNEG) on its lifetime mortgages. This means the value of the loan after interest payments will not exceed the value of the property – a guarantee protecting the borrower’s children from any debt being passed on if house prices fall.
This is one of the reasons why CP13/18 is hitting Just so hard. The PRA says insurers should be able to cope with a slump in house prices because, if they do drop, the NNEG could expose the insurers.
Like other insurers, Just uses lifetime mortgages as cover for annuity liabilities. Lifetime mortgages offer higher yields than bonds and provide security because they are property-backed.
But the PRA is also challenging this. Its consultation said: ‘The proposals are intended to ensure insurers investing in ERMs to match annuity liabilities can consistently assess whether they have appropriately allowed for the risks arising from those loans and have not understated their technical provisions or overstated their own funds.’
Depending on where the PRA consultation ends up, it could be Just has to raise some extra capital. Analysts have different ideas about how it may go about doing that.
Marcus Barnard, an analyst at Numis, said the PRA paper has been the driving force behind the crash in Just’s share price.
‘Since 2 July, when CP13/18 was announced and the company gave us guidance through its solvency and financial condition report, we have had an idea of what this could mean under varying scenarios. This has had a negative impact on the share price of Just.’
Barnard said the current Just share price is factoring in ‘a worse than worst case scenario from CP13/18’. He believes options such as reinsurance and issuing either tier 1 debt or upper tier 2 debt are much more likely than Just issuing equity through, for example, a rights issue.
Devlin at Barclays agrees that an equity raise is unlikely, although he thinks the market is already pricing one in.
‘Although an equity raise cannot be ruled out, this is the last resort in an extreme scenario,’ he said. ‘The company has a number of less onerous capital management tools at its disposal. In our view, the market is pricing in a probable rights issue for Just.’
Devlin added the 50% drop in share price means it is offering ‘significant upside potential’ and the analyst reiterated its overweight rating in a note last month.
Some analysts feel more drastic decisions may be taken by Just’s senior management, including a possible sale.
Barrie Cornes, an analyst at Panmure Gordon, said in a note last month: ‘We think nothing has been ruled out by the company. This includes the possibility that the best way forward would be for Just to be part of a bigger group, which might require lower regulatory capital than if it were to continue independently.’
A possible takeover of Just is being discussed because, although it is listed, it is not part of a huge insurer that has a wide range of business lines like asset management.
Two other insurers that have been active in the lifetime mortgage market and offer NNEGs are Aviva and Legal & General (L&G).
Although these insurers’ share prices have also struggled in 2018, both providers are much bigger beasts and their exposure to lifetime mortgages is not as high as Just’s. Lifetime mortgages make up 2% of Aviva’s total life assets, a spokeswoman said, while for L&G they make up less than 5% of its £60 billion annuity portfolio. Just was unavailable for comment.
Cornes said recent ‘downward pressure’ on the Just share price was further worsened by its decision not to pay a dividend last month. This in turn meant equity income funds were updating their view on the stock.
Equity income funds will take a dim view of a cancelled dividend and Just’s share price slump has been bad news for some fund managers that hold it, as well as its senior management.
One such fund is the Miton UK Value Opportunities fund, run by Andrew Jackson (pictured above), which has had a ‘frustrating’ year, in part because of its exposure to Just’s share price fall.
Jackson, who has ‘warily’ retained the Just holding, said he expects the PRA consultation to cause ‘some impact on the sector’. However he thinks the share price fall is ‘overdone’.
He noted specialist insurer Rothesay Life acquired an £860 million book of lifetime mortgages from the government in September, which to him suggests ‘sector insiders consider this niche [lifetime mortgages with NNEGs] to have a viable future’.
However, other funds are less optimistic about Just’s future. Hedge fund Lansdowne Partners took out a 1.9% net short position against Just on 1 October, according to the Financial Conduct Authority’s (FCA) latest listings. The hedge fund declined to comment.