21 January 2015
Instilling fresh thinking into the asset strategies of legacy insurers while navigating the global financial crisis has occupied Vidur Bahree for the best part of a decade. He tells Christopher Cundy about the ups, downs and turnarounds.
In the course of almost two hours, there are several moments where Vidur Bahree raises his eyes to the ceiling and says 'gosh, those were tough times'. The decade he has spent at Phoenix, the consolidator of closed life insurance companies, has been a rollercoaster ride – though today the firm's share price is riding as high as it's ever been.
Bahree's role has shifted over the years but his most recent responsibility has been as head of the financial management group (FMG), bringing rigour to the company's investment strategy. He has built a team that developed new processes for asset-liability management (ALM) and asset allocation, which has helped to create a more resilient balance sheet.
One gets the feeling that anyone involved in managing Phoenix has to have M&A in their DNA - and Bahree certainly fits the type. A graduate in mechanical engineering and a qualified accountant, he joined Dresdner Kleinwort's corporate finance team in the late 1990s, where his clients latterly included Hugh Osmond's Sun Capital, backer of consolidation vehicle Pearl, which eventually acquired Clive Cowdery's Resolution and gave rise to Phoenix.
His initial work for the investment bank involved advising on M&A and capital raising for financial sector companies, but he drifted towards the capital markets side of the business and at one point was involved in setting up a Bermudian life reinsurance company, into which Dresdner invested some of its own capital.
Come 2003-04, Bahree found his experience in demand. A wave of restructuring and recapitalisations of closed life insurance businesses was under way following the dotcom crash.
"I got engaged in discussions because we had used Dresdner's capital in supporting insurance business previously. There was strong support from all quarters for new capital to be injected into the UK closed life fund sector – this was our proposition," Bahree says. "From there on I worked with Sun Capital and [private equity fund] TDR until they succeeded in acquiring Pearl."
About six months after the acquisition, in 2005, Bahree began thinking about his career and pondered a move into private equity. He floated the idea with his client, who suggested another option - joining the management team at Pearl. It was a chance to see through the plans for the company that he had envisioned while at Dresdner.
Turning a tanker
Phoenix's asset portfolio
(£bn as of 30 June 2014)
|Cash and cash equivalents||9|
"It was a fairly open remit and there was a lot to get done. I worked extensively with shareholders and Pearl management team to turn around what felt like a very big tanker. It was an intensely busy three years," he says.
One of his actions while at Pearl was to establish a Bermudian reinsurer, Opal, which would reinsure Pearl's annuity book. Opal was to be separate from Pearl and the decision was in part based on the theory that separating the management of the with-profits and annuities elements of the business would mean both could be appropriately capitalised and run. Bahree designed the structure and in 2007 Opal reinsured £3.5bn of Pearl's annuities.
With his M&A background, it was inevitable that Bahree would be involved in Pearl's acquisition of Resolution, the other main protagonist in the UK's closed life consolidation story.
Not long after the deal was concluded, the biggest crisis in 70 years engulfed the financial sector and early in 2009 Bahree found himself sitting with the regulator on a Sunday morning, trying to figure out how to keep the company afloat.
With the Resolution acquisition, "we never managed to get to a point where we did with Pearl," he reflects. "With Pearl, we had a few years of benign markets in which to construct our workshop and make it work. We didn't manage to get our arms around Resolution before markets turned down in a drastic way."
In March 2009, at the very bottom of the market, the company found £500m of capital and restructured its debt. "That was the start of the journey that we have been on since," he says.
Part of that journey was buying back a beleaguered Opal from its shareholders, bringing the risk in-house where it legitimately belonged. Opal's liabilities had been fixed by the reinsurance contract but its assets had crumbled in the crisis. With some fairly comprehensive work on the investment strategy and a following wind from the markets, Bahree got the job done and turned back to the UK business in 2010, eyeing his next move.
Another opportunity to leave the now-named Phoenix was scotched when Jonathan Yates, former CEO of Admin Re, was brought in as CFO. "I said, if he's here, there's a story," Bahree says. "We got along and he asked me to be part of his team."
Done with the firefighting, the company started thinking about 'the Phoenix way' of managing closed life insurers, and the asset side came under Bahree's scrutiny.
"We have a lot of skill on the liabilities side of the business, and we had a scattered set of expertise around the asset side," he says. "We needed a bridge between the life insurance companies and the asset manager: a group of people that looks after investment strategy, asset allocation and ALM on behalf of the life insurance companies - or at least gives them the advice, the knowledge and the conviction to do the job."
His inspirations included Mark Versey at Axa (subsequently Friends Life and now at Aviva) and Prudential's John Betteridge (who quit as CIO over a year ago) who set up a three-pronged process of strategic planning, execution of ALM and investment strategy, and managing the asset managers.
The project was kicked off in 2012 and Bahree created a six-strong team with the idea that they would develop the in-house expertise to be able to aid the group to properly think about ALM and asset management.
Post-crisis, he found the investment landscape had changed radically. "In 2007 when people were panicking about the state of the credit markets, they had nowhere to go. Some turned to absolute return or other such strategies, which were not regulatorily friendly for UK life insurers. In 2012, you had a whole range of what are now called alternative credit assets," he says.
Some of the opportunities were not new ground for insurers - commercial real estate loans or equity release mortgages, for example. Others, such as infrastructure lending, had become more available because the banks had reined-in their activity.
In late 2012, he put forward proposals to tweak the investment strategy of the annuity books. "It was not that difficult because these were asset classes that made good sense – and they have performed incredibly well," Bahree says.
For the following 12 months, the team focused on ALM for the annuity books. Bahree points to a table in the annual report showing how the company's market-consistent embedded value (MCEV) has become far less sensitive to a 1% decrease in risk-free rates.
In 2012, such a shift would have wiped £91m from the MCEV. "There was a lot of risk riding on that - and a lot of capital," he says. With some changes to the portfolio and derivatives contracts, by the end 2013 a 1% increase in rates would have reduced MCEV by only £11m instead.
This was no simple task: getting hold of the data to analyse the sensitivities was a challenge in itself, and Bahree's team had to develop an approach to manage risk tolerances and build the technology to support all this. "The fundamental principle is to get matched, but this is non-trivial; something as simple as consistent modelling of asset cash-flows can be incredibly difficult to get at. It requires quite a lot of sophisticated technology, intellectual rigour and working collaboratively to get effective results, which is what my colleagues in FMG are all about," he notes.
Battening the hatches
The team next set about "battening the hatches" in the credit space, to ensure that Phoenix Life would be better placed to navigate credit markets going forward. Having looked extensively at hedging credit risk, FMG concluded that at its core, the credit strategy for annuity business needed to be fundamentally different from either of the approaches that Phoenix Life had inherited. The strategy the team developed to run credit bond portfolios was called NSD – net spread times duration – which is similar to the 'buy and maintain' approach that has gained momentum in the rest of the industry.
The legacy index-benchmarked approach was just not right for annuity books, Bahree says. "With an annuity portfolio, you know your cost of funds, you know what risk capital you have to hold and the return this requires, so you need an investment mandate that marries the investment manager's stock-picking and portfolio construction skills to the insurer's balance sheet. The NSD approach does this, and delivers the objective of capturing a risk premium and running it off in a stable manner," he adds.
Bahree clearly has unfinished business with Phoenix's investment strategy. The 2012 strategy advocated a large-scale shift away from investment-grade bonds, whose volatility and dominance within the portfolio is a worry.
"Everyone has recognised the fact that you don't need a massive portfolio of liquid bonds backing them [annuities] because they are long-term liabilities. Credit markets have become increasingly illiquid as broker inventories have shrunk and prices tend to 'gap' if there is any sort of rush for the exit. Within reason, you should diversify into a wide range of less volatile illiquid assets and capture illiquidity premiums that can be run off more smoothly," he says.
Phoenix has other priorities right now, he says, but it's a strategy that he will continue working on. "If you do not recognise that the world offers you wider [credit investment] opportunities today than just credit bonds, you are doing all your stakeholders a disservice. Our role is to understand nature of changing markets and guide strategy accordingly," he says.
The impact of Solvency II
A lot in the investment world has changed in the last two years, he notes. "Of the three asset classes we looked at in 2012 – commercial real estate, infrastructure and equity release mortgages – the opportunity in the first two of those has diminished to a great extent.
"Equity release mortgages remain a strategic asset from an economic and political perspective, but from a Solvency II perspective they are very challenged. Fundamentally, these are assets that we would regard as part of the asset strategy for annuity business, supporting a moderate allocation."
In common with the rest of the UK annuities market, Bahree is wondering how equity release mortgages can be included in a Solvency II matching adjustment portfolio. The Prudential Regulation Authority (PRA) has said they are broadly incompatible with the matching adjustment, but insurers are considering securitisations to produce the steady cash-flows that the regulations require.
Bahree makes little protest about the impact of Solvency II on his work, taking a pragmatic approach of coping with the rules rather than railing against them.
Phoenix's objective is to be 100% compliant at 1 January 2016 and a lot of effort has been made to put together a Solvency II-compatible balance sheet, he says. Some of the bigger issues for the industry have been the matching adjustment, which impacts how an annuity portfolio is constructed, and the question of the discount rate – the disparity between swap rates and gilt yields and the volatility of the difference – which impacts the with-profits portfolio.
Happily, on the matching adjustment, the NSD process his team developed fitted well with the PRA's view on how these assets should be managed. "Our thinking was as sensible as the regulation turned out to be," he says.
He asserts that the regulations are not forcing the company out of specific asset classes. "Where you have matching adjustment problem you have to think of way of solving it, or determine that that asset class, from a capital risk versus return perspective, doesn't deliver for you. So you think about an alternative strategy."
The problem-solving extends to his life outside of work. Bahree is a committed family man and dedicated to his two children, and aside from the occasional round of golf, he and his wife have an interest in architecture and interior design. They are regularly called on by friends and family to help redesign their domestic spaces, he says.
His own home in south-west London is actually three houses consolidated into one. And what inspires the interiors? The Bauhaus movement, which embraces simplified forms, rationality and functionality. A better analogy for his work at Phoenix would be hard to find.