15 April 2024

Income strips for insurers - a natural fit?

Given their high quality and inflation-linked nature, income strips have always been a popular asset class with insurers but current market dynamics make the opportunity particularly attractive, in our view.

With many UK defined-benefit pension schemes considering de-risking options in the wake of higher interest rates, their appetite for private assets, such as Income strips, has reduced thus leaving significant opportunities for other institutional investors. Given their high quality and inflation-linked nature, income strips have always been a popular asset class with insurers but current market dynamics make the opportunity particularly attractive, in our opinion. Here, we explore how income strips – which are backed by prime real estate – could provide insurance companies access to an alternative source of credit risk and illiquidity premium, as well as the opportunity currently available.

What are Income strips?

As the name suggests, these transactions 'strip' or separate the stream of cash generated by a lease from the underlying real estate asset. This means that the income stream an investor receives represents 100% of the value of the investment.

In an income strip transaction, the owner sells the underlying real estate to the investor and enters into a lease agreement, with the option to buy the asset back for a nominal sum (e.g. £1) when the lease ends. This effectively means income strips have an amortising repayment profile of the underlying real estate where the remaining future cashflows are secured against the property.

For tenants, income strips offer the benefit of raising long-term affordable financing against their strategic real estate holdings, while retaining ownership of the freehold when the lease ends (so long as all lease payments are fulfilled).

For investors, income strips could provide long-dated (c.40 year), investment grade, inflation-linked cashflows with an attractive yield, secured against business-critical UK real estate. This investment profile can be attractive to different types of institutional clients such as pension funds and insurers seeking to generate long term inflation-linked cashflows.

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Christian Thompson
Director, Insurance Solutions, M&G Investments
christian.thompson@mandg.com

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