As well as increased usage and demand for illiquid assets, insurers continue to adapt their allocations and matching adjustment (MA) applications in line with market conditions and regulatory reforms.
Introduction
Milliman has completed its fourth annual Illiquid Asset Survey, focusing on UK bulk purchase annuity (BPA) insurers. The confidential study explores current practice in sourcing and managing illiquid assets and captures responses from firms representing the majority of the market.
The survey has enabled us to explore the degree of consensus on several key topics which we summarise in the rest of this note.
Key observations
The survey was structured around three areas of particular interest:
- Insurers’ approaches to illiquid asset allocation and origination
- The appetite for assets with highly predictable cashflows (HPCs), sub-investment grade (SIG) assets and MA applications
- Economic impacts and target execution spreads for illiquid assets
We also extended the survey to cover insurers’ plans to use funded or asset-intensive reinsurance, given the recently published supervisory statement (SS5/24) from the Prudential Regulation Authority (PRA).
Illiquid asset allocation and origination
- Asset types: Similar to our finding in last year’s survey, while asset mixes varied considerably between participants, the overall picture continues to be of a relatively stable core group of asset types held broadly across the range of insurers. Moves into new asset classes are limited and focused on infrastructure debt (construction phase) only. Some insurers have holdings in USD- or EUR-denominated assets for certain illiquid asset classes, but investments remain predominantly GBP-denominated.
- Changes in asset allocation: Participants indicated an expected decrease in their allocation to equity release mortgages (ERMs) and a simultaneous increase in allocation to infrastructure debt over the next year. This shift is predominantly driven by origination constraints and less attractive spreads for ERM, while matching at longer durations is seen to be driving the expected increase in allocation to infrastructure debt.
- Allocation to illiquid assets: The general trend is an increase in the percentage of existing liabilities being backed by illiquid assets compared to last year. This trend is in line with insurers’ stated expectations last year as they planned to target higher new business allocations (predominantly via GBP-denominated assets). Similar to previous surveys, most participants generally aim to increase exposure in the future via a higher target allocation on new business (at least 40%). We also noted a slight increase in the appetite for non-GBP assets.
- Key investment drivers: Improving risk-adjusted investment returns remains the most important investment driver for all survey participants. This is followed by better duration matching, which has steadily increased in importance and is a key theme arising throughout this survey. Compared to our 2024 survey, using illiquid assets to improve inflation matching has become less important, despite the recent higher and more volatile inflation environment.
- Origination: There appears to be some appetite among firms to move closer to in-house, full end-to-end capacity origination approaches. There is overall a variety of approaches used by firms, even within the same asset class, speaking to the individual capabilities of firms.
- Constraints on investment: Supply side constraints may be particularly challenging as they largely lie outside the control of insurers. On the other hand, the range of assets permitted for the MA could potentially be broadened following changes introduced in PS10/24. Furthermore, the implementation of the MA Investment Accelerator has also received a cautious welcome from participants.
The appetite for assets with HPC, SIG assets and MA applications
- HPC assets: There currently appears to be limited appetite among participants to invest in HPC assets in the short term, although several firms expected to have a modest allocation over a three- to five-year horizon. In terms of the types of assets being contemplated, participants indicated callable bonds, long income real estate and assets with construction risk as candidates. Given this is a relatively new area, it is unsurprising that some insurers are adopting a wait-and-see approach. It will be interesting to revisit this topic in future surveys to explore how experience in this area evolves.
- SIG assets: There is currently a very limited appetite for direct investment into SIG assets. However, some participants indicated they were now more likely to retain some assets that have downgraded to SIG, at least for a period, to allow for potential recovery.
- MA applications: Firms plan to make use of recent regulatory changes and are actively engaging with the PRA to submit applications covering major changes in the next 3 years. All the survey participants expect to make resubmissions regarding the eligibility for new asset classes or types on a frequent basis – highlighting the continued evolution of eligible assets held in MA portfolios.
- Rating validation: There was broad alignment in practices around the validation of internally assigned ratings. Several firms internally validate the ratings across the vast majority of their book each year. Additionally, all firms had a portion of their book externally validated.
Economic impacts and target execution spreads
- Strategic asset allocation: Current economic conditions are seen to have an impact on the mix of assets insurers are finding attractive to purchase. There is an increased appetite for illiquid assets as well as gilts and inflation-linked products among participants.
- Inflation, interest rates and exchange rates: Current economic conditions around inflation and interest rates are having an effect on the nature and term of the finance that borrowers are seeking, with an increase in demand noted for short-/medium-term floating-rate finance. Thus far, the increased uncertainty around exchange rate behaviour has not impacted the appetite for non-GBP assets. However, this survey was conducted ahead of the implementation of US tariffs and hence the subsequent impact of this has not been accounted for in the results.
- Hedging: At the time of our survey (March 2025), economic conditions had not led participants to undertake significant changes to either the nature or scale of their hedging programmes. However, insurers have noted that there may be second-order impacts through pricing levels as well as an increased demand for inflation swaps given the reduced issuance of inflation-linked cash bonds.
- Execution spread: There is a wide variation in target execution spreads between firms both at short and long durations, while mid durations displayed a greater consensus between insurers. We interpret this as indicative of the varying risk appetite of participants at different terms.
Funded reinsurance and illiquid assets
- Funded reinsurance: Most participants indicated they remained open to the use of funded reinsurance in the near term. The key drivers for the use of funded reinsurance include improved pricing, access to additional asset sourcing capabilities, and capital management.
- SS5/24: Overall, participants considered there to be a relatively neutral impact arising out of SS5/24, though some negative impacts were expected in the form of increased implementation times and costs.
Conclusion
Across the BPA insurance sector in the UK, use of illiquid assets continues to remain a particular focus within the industry with participants indicating a general increase in target allocations to illiquid assets compared with prior years. Participants indicated that this momentum is principally driven by the pursuit of attractive risk-adjusted returns, in particular given the low spread environment prevailing in the UK public credit market. Illiquid assets are also being seen as increasingly useful to support the duration matching of liabilities as public credit issuance has moved shorter and liabilities have lengthened with the inclusion of deferred pensioners. However, participants noted concerns regarding the limited supply of illiquid assets. Recent initiatives from the PRA such as the ability to include assets with highly predictable cashflows in the MA received a cautious welcome, but their impact is not yet clear.
How Milliman can help
As the illiquid asset investment market continues to grow in scale and importance as a driver behind new business pricing, insurers must continue to develop their capability and frameworks for originating and managing these assets.
Milliman consultants have extensive market experience in these areas. We are well placed to help our clients address a broad range of questions and challenges, for example:
- Developing asset allocation strategies and investment risk management frameworks for illiquid assets
- Independently reviewing market risk and liquidity risk management frameworks
- Independently reviewing credit quality assessment frameworks and their application
- The potential treatment of novel assets within internal models and Standard Formula frameworks
- Modelling illiquid assets using stochastic techniques, including real-world stochastic investment return scenarios
To discuss this note or any related topics, please contact your usual Milliman consultants or the paper authors.