Why UK Life Insurers’ Key Profit Engine Is Losing Steam

Britain's largest life insurance companies face a sharp slowdown in their most important profit measure as intensifying competition and razor-thin credit spreads squeeze margins in the lucrative pension buyout market.

The contractual service margin, a crucial metric that represents future profits locked into insurance contracts, is forecast to grow just 1% annually through 2028, down from 5% growth between 2022 and 2024, according to RBC Capital Markets in a recent note.

The CSM serves as a fundamental component of UK life insurers' valuations but often escapes investor scrutiny.

"The margin outlook for UK PRT remains challenged, driven by new competition, low returning insurer asset strategies, and potential regulatory interventions," the brokerage said

The pension risk transfer market, where insurers take on corporate pension obligations, has become a battleground.

A record 11 insurers competed for deals in 2025, even as total industry volumes fell to roughly £40 billion from £48 billion in 2024, according to figures cited in the report.

Legal & General Group faces the steepest headwinds. RBC forecasts the company's closing CSM will sit 5% below consensus estimates for 2025, with pension transfers contributing more than half of core operating profit through 2029. The company's shares trade at 265.10 pence, well below RBC's 205 pence price target.

Aviva's CSM projections trail consensus by 2%, while M&G and Phoenix Group have offsetting factors that cushion the blow. Chesnara doesn't write pension risk transfer business.

Profit margins on new pension buyout deals have deteriorated across the board. RBC expects margins around 2.5% for the current year, compared with historical levels above 3%.

The compression stems partly from what insurance executives described at an industry seminar as historically low liquid investment-grade credit spreads, the premium insurers earn over government bonds.

"With three PRT writers likely under new ownership this year, insurers have stretch capacity to £70bn," the brokerage said, citing consultant LCP. That capacity far exceeds the top-end industry projection of £55 billion in demand.

The Prudential Regulation Authority adds another complication. The UK banking regulator plans to increase capital requirements against offshore reinsurance counterparties, with an update scheduled for the second quarter of 2026. This move particularly affects UK-listed insurance companies.

Despite lower profit margins, capital strain on new deals remained modest in 2025 as companies continued using government bond-based investment strategies rather than riskier assets. Legal & General pioneered these "structured gilt" approaches, significantly reducing upfront capital requirements.

The slowdown carries direct implications for dividend capacity. Phoenix Group's operating cash generation, the company's preferred cash metric, is expected to grow 5% to £1.47 billion, supported by recurring management actions worth £548 million.

M&G's adjusted operating profit is forecast at £802 million, down 4% from the prior year and 4% below consensus.

RBC analysts suggested industry consolidation may emerge given the competitive pressures, though timing remains uncertain as companies report full-year results through late March.

Source: Investing