Balancing risk, return and capital requirements: The effect of Solvency II on asset allocation and investment strategy
 

Balancing risk, return and capital requirements: The effect of Solvency II on asset allocation and investment strategy

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In October and November 2011, the Economist Intelligence Unit, sponsored by BlackRock, surveyed 223 insurers with operations in Europe to find out how they were handling the data management ...

In October and November 2011, the Economist Intelligence Unit, sponsored by BlackRock, surveyed 223 insurers with operations in Europe to find out how they were handling the data management requirements of Solvency II, the impact of capital charges on investment strategies and product ranges, and their views on the future for capital markets in a post-Solvency II world.

Respondents comprised of 75 life, 65 non-life, and 57 composite insurers, while 26 were reinsurance companies. Responses were collated from insurers with headquarters in all major EU countries.

Businesses were grouped by assets under management (AUM) covering 106 very large insurers with more than €25bn; 23 large insurers with €10bn-€25bn; 68 with €1bn-€10bn; and 26 with AUM of less than €1bn.

In addition, in-depth interviews were conducted with eight experts from insurance companies, regulators and trade bodies. Our thanks are due to the following for their time and insight (listed alphabetically):

Anders Brix, risk management team, Danica Pension, Denmark

Britta Burreau, managing director, Nordea Life, Sweden

Frank Eijsink, global program director for Solvency II, ING Life, Netherlands

David Johnston, senior implementation manager, Financial Services Authority, UK

Olav Jones, deputy director-general, CEA, European insurance and reinsurance federation

Isabella Mammerler, head of European regulatory affairs, Swiss Re

Carlos Montalvo, executive director, European Insurance and Occupational Pensions Authority (EIOPA)

Ann Muldoon, Solvency II director, Friends Life, UK

The report was written by Gill Wadsworth and edited by Monica Woodley of the Economist Intelligence Unit.

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Balancing risk, return and capital requirements: The effect of Solvency II on asset allocation and investment strategy Balancing risk, return and capital requirements: The effect of Solvency II on asset allocation and investment strategy Document Transcript

  • Balancing Risk, Returnand Capital RequirementsThe Effect of Solvency II on Asset Allocationand Investment StrategyWritten by
  •   Balancing risk, return and capital requirements Foreword: Beyond Performance Despite several deferrals of the implementation deadline, Solvency II has already proved a major catalyst for change with insurers spending considerable time and resource on preparing for D-day. At BlackRock®, we share this focus as we help insurers meet the outcomes they need in this rapidly shifting environment. Specifically, we are investing heavily in our infrastructure and people to help you navigate this crucial transition successfully. Yet this tremendous effort by the industry masks significant uncertainty: be it in terms of the final shape of the directive or how Solvency II will affect asset allocation, investment strategies and capital markets – all against a backdrop of a continued sovereign debt crisis. Faced with this murky picture, insurers, not surprisingly, find it hard to have full confidence in their preparedness. To help bring some clarity around the remaining key challenges, BlackRock has commissioned the Economist Intelligence Unit to conduct a comprehensive study among European insurers. The findings offer a real insight into the challenges associated with each of the three pillars and the implications for insurers’ product offering and the wider capital markets. Interestingly, the research highlights a degree of discrepancy between market perception and what your peers really think, particularly in relation to the use of alternatives and their levels of preparedness for Solvency II governance and disclosure requirements. Personally speaking, the most important finding was the need to move beyond performance and seek full alignment of investment expertise and enterprise risk management. In 2012 and beyond, we will work very closely with our clients to help them achieve that essential goal. I hope you find the report thought-provoking and, above all, beneficial, and look forward to hearing your views. Sincerely, David Lomas, ACII Head of Global Financial Institutions Group, BlackRock email: solvency2@blackrock.com
  • Balancing risk, return and capital requirements  [ 1 ]ContentsExecutive Summary and Key Findings 3About this Report  6Introduction  7The Future for Asset Allocation  8Return-Seeking Assets  12A Demanding Data Management Regime  18Shifting Product Ranges  22Consequences for Capital Markets  25Equity and Debt Markets  28Conclusion  32BlackRock Commentators  34About BlackRock  35Appendix  36
  • [ 2 ]  Balancing risk, return and capital requirements
  • Balancing risk, return and capital requirements  [ 3 ]Executive SummaryDespite recent uncertainty about whether theimplementation date of Solvency II will be pushed backa year, insurers are still working on the assumption thatthey have just one year to go, and therefore preparationsfor the new Directive are well under way.The Europe-wide legislation will impose stringent new capital requirements across theinsurance industry, creating a more risk-focused approach to better protect policyholders from future financial crises. Data management will be overhauled, while manyplayers will be forced to rethink their product range and investment strategies.Coinciding with this final phase of preparations for Solvency II are some of the mosttesting market conditions in living memory. The ongoing sovereign debt crisis has raisedquestions regarding the very foundations on which some pillars of Solvency II are builtand as uncertainty over the final shape of the Directive persists, insurers face notablechallenges when building their strategies for the future.The Economist Intelligence Unit, on behalf of BlackRock, surveyed 223 insurers withoperations in Europe. With the survey sample representing at least half of the Europeanmarket in terms of assets under management, the findings offer real insights into howinsurers are managing Solvency II’s data management requirements; the impact of capitalcharges on their investment strategies, risk management and product ranges; and theirviews on the future for capital markets in a post-Solvency II world.
  • [ 4 ]  Balancing risk, return and capital requirementsKey FindingsAsset Allocation Shifts have been Allocations to Derivatives will IncreaseDecided but Implementation is on Hold Under Solvency IIAlmost half (46%) of survey respondents say they already Over half (60%) of survey respondents agree that theknow how they are likely to change their asset allocation, Directive will result in greater use of derivatives to betterwith just 4% saying they have not made plans. However, match assets and liabilities. While some insurers say theyover half (53%) say they are waiting until closer to are already confident in their derivative usage, as asset-implementation of the Directive before making changes to liability management (ALM) strategies become moretheir asset allocation. Most changes are as expected – complex and demanding in volatile markets, this will be anaway from equities and towards corporate bonds. area on which many insurers will need to focus. Over one- third (37%) of insurers agree that Solvency II will make them more likely to use derivatives in the future, althoughAllocations to Alternatives are set to only 18% currently use derivatives and just 23% haveIncrease definite plans to increase their overall holdings.Some asset allocation changes are less expected.Alternatives such as hedge funds and private equity will Meeting Solvency II Data Requirementsbenefit from Solvency II, with 32% of survey respondentssaying they will increase their allocations to these asset is a Major Concern, Whilst Pillar IIIclasses. Just 9% and 6% respectively say they will Commands the Least Budgetdecrease allocations. These increases come despite the Over 90% of survey respondents are very or somewhathigher capital charges for these assets, with insurers concerned about meeting the requirements for thebetting that the higher charges will be worth the higher timeliness (96%) and completeness (94%) of data underpotential returns. Almost three-quarters (70%) of survey Solvency II, as well as the quality of data from third partiesrespondents expect their asset allocation changes to (92%). In particular, pressure is on third parties to provideresult in higher returns. the ‘look-through’ on pooled funds required by insurers, with 92% of respondents concerned that they will have to limit their investment strategy as some assets demand more rigorous data requirements. Overall, survey respondents say they are most concerned about Pillar III, yet it is the pillar to which they are devoting the least budget.
  • Insurers will Re-Examine Guaranteed Share Prices are Likely to be Hit byProducts, Which may Become Solvency IIProhibitively Expensive Less than one in 10 (9%) of survey respondents disagree with the idea that, due to Solvency II, average share pricesFor some insurers, the Directive merely accelerates an will be lower as demand for equities will be lower. Andongoing trend away from guaranteed products, but for even fewer (3%) disagree that the equity risk premium willothers it creates a whole new way of thinking about their need to increase significantly to encourage investing inbusiness. Two-thirds of life and composite insurer survey equities. However the overall supply of equities could berespondents say they will restructure in order to better lower, as only 9% do not believe that companies will favourmanage their guaranteed funds in house, while almost half issuing debt rather than equity for their funding needs.(49%) of life and composite respondents say they will seekadvice on ALM. As a result, insurers will be forced to moreaggressively price their guaranteed products, which will Regulators may Have to Rethinklikely drive consumers into other cheaper but less well- Approach to ‘Risk-Free’ Assetsprotected offerings. Annuities too will become potentially As the security of government bonds is thrown into doubt,more expensive, as insurers factor in the increased costs insurers believe the regulator may have to revisit the 0%of managing Solvency II market risk into pricing. capital charge for sovereign debt. Insurers using their own internal models already factor in the ‘real’ risk presentedSolvency II Could Increase Market by government debt, but organisations using the standardVolatility model may be exposed. Planned changes to asset allocation, such as moves from government bonds intoJust 5% of survey respondents disagree with the idea that higher-rated corporate debt, support the view that insurersthere will be an increase in volatility in capital markets are assessing the risk and return trade off for themselves.because of Solvency II. Insurers are also anxious about thethreat of pro-cyclicality. If capital requirements reduce whenmarkets are benign and increase during periods of volatility,losses due to falls in market prices could lead to a wave offorced selling, which could create further losses. EIOPAplans to tackle this issue but insurers say the uncertaintymakes planning, particularly at this late stage, a challenge.
  • About this ReportIn October and November 2011, the Economist Intelligence Unit, onbehalf of BlackRock, surveyed 223 insurers with operations in Europeto find out how they were handling the data management requirementsof Solvency II, the impact of capital charges on investment strategiesand product ranges, and their views on the future for capital marketsin a post-Solvency II world.Respondents comprised of 75 life, 65 non-life, and 57 compositeinsurers, while 26 were reinsurance companies. Responses werecollated from insurers with headquarters in all major EU countries.Businesses were grouped by assets under management (AUM) covering106 very large insurers with more than €25bn; 23 large insurers with€10bn-€25bn; 68 with €1bn-€10bn; and 26 with AUM of less than €1bn.In addition, in-depth interviews were conducted with eight experts from insurancecompanies, regulators and trade bodies. Our thanks are due to the following for theirtime and insight (listed alphabetically):Anders Brix, Risk management team, Danica Pension, Denmark.Britta Burreau, Managing Director, Nordea Life, Sweden.Frank Eijsink, Global Program Director for Solvency II, ING Life, Netherlands.David Johnston, Senior Implementation Manager, Financial Services Authority, UK.Olav Jones, Deputy Director-General, CEA, European insurance and reinsurancefederation.Isabella Mammerler, Head of European Regulatory Affairs, Swiss Re.Carlos Montalvo, Executive Director, European Insurance and Occupational PensionsAuthority (EIOPA).Ann Muldoon, Solvency II Director, Friends Life, UK.The report was written by Gill Wadsworth and edited by Monica Woodley of theEconomist Intelligence Unit.
  • Balancing risk, return and capital requirements  [ 7 ]IntroductionInsurers racing to meet the 2013 implementation date forsweeping changes to solvency regulations were given ayear’s grace in the autumn of 2011, with regulators settinga new deadline of January 2014.Delays to the implementation of Solvency II are nothing new – and a further delay may be inthe works - but the insurance industry is unlikely to view the latest push back as much of areprieve in their efforts to comply with the Directive, particularly as by 2013 they will needto demonstrate how they will meet the final legislation.The Solvency II Directive imposes stringent new capital requirements, creating a more risk-focused approach designed to better protect policyholders from future financial crises.The legislation is far-reaching and complex, and has forced insurers to analyse everythingfrom data management and risk analysis to asset allocation and product ranges.As insurers continue with their preparations, the ongoing sovereign debt crisis has forcedregulators back into negotiations to agree on a Directive that can withstand suchunexpected changes in fortune.Against this backdrop of uncertainty, insurers face notable challenges as they strive toformulate a successful strategy that will stand up to the rigours of a new regulatory regimeand an unpredictable economic future.
  • [ 8 ]  Balancing risk, return and capital requirementsThe Future for Asset AllocationNow that insurers have the fundamental systems building What is Your Current Asset Allocation?blocks in place following the first stages of preparation forSolvency II, they are turning their attention to investmentstrategies and asset allocation. However, the survey revealsthat insurers are not able to prepare to the extent that they Corporate bonds 36%would like as the Directive itself is still being finalised. Government bonds 28% Cash 3% Property 4%Almost half (46%) of respondents to the survey say they Hedge funds 1%know how their asset allocations will change as a result of Derivatives 1%Solvency II, but more than half (53%) say they will wait until Other alternatives 5% Total equities 15%they are nearer to the final implementation date before Other assets 7%effecting any change. Non-life insurers are less confidentthan their life counterparts as to how their future asset Base: All respondents (n=223) Source: Economist Intelligence Unitallocations will look – 43% compared with 50% – and assuch are more likely to wait until Solvency II is clearerbefore taking action. Well before the advent of Solvency II, many insurers hadDavid Johnston, Senior Implementation Manager at the started de-risking strategies – action which has sinceUK’s Financial Services Authority, explains: “Until the been accelerated by the difficult economic conditions.Solvency II rules come into force in 2014 the current rules Ann Muldoon, Solvency II Director at Friends Life in thestill apply, so insurers are welcome to make any changes UK, says: “In the UK we already make an assessment ofthey want in the interim, within the context of those rules. risk-based capital [Individual Capital Assessment] andBut they might not be able to move to their ‘business-as- provide this as a private submission to the regulator. This isusual post-Solvency II’ end state just yet.” already informing our strategic asset allocation decisions.” She adds that where Solvency II has the potential toWhere insurers have examined the future for their change the individual capital assessment, the insurer willinvestment strategies under the new regime, the overriding guide its strategic asset allocation studies accordingly.response is to keep asset allocations the same. This ispartly explained by the already conservative asset Nearly two-thirds (64%) of the survey respondents’ totalallocations the survey respondents report. asset allocations are to fixed income, with government debt accounting for 28% and corporate bonds 36%. Equities account for 15% of total portfolios, while alternative assets including private equity, hedge funds and derivatives amount to 7%. In the fixed income category, just under half (49%) of respondents plan to keep allocations to corporate bonds the same, although one-third expect to increase investment in this asset class. More than one-third (37%) of life companies say they will increase allocations to corporate bonds compared with 29% of non-life companies. Just 18% of respondents overall say they will decrease corporate bond allocations.
  • Balancing risk, return and capital requirements  [ 9 ]While Solvency II is set to favour European Economic Area (EEA) sovereign debt withproposed 0% capital charges, government debt allocations look likely to remain static for “Under48% of insurers, while 27% expect to increase and the remaining quarter will decrease.This may be an indication that insurers expect regulators to rethink the 0% capital charge Solvency IIin light of the eurozone debt crisis (which is explored further on page 30). there is a possibility thatMany insurers operating in countries enduring the worse of the sovereign debt crisis are a large numbercautious about the future for their own region’s government bonds. None of theIcelandic insurers and just 7% of Italian respondents plan to increase allocations to of insurers maygovernment bonds. be forced to sell assets inIn contrast, in the Nordics where governments enjoy relatively healthy debt levels,conditions are stable and they are outside of the eurozone, insurers say they will increase times ofinvestment in government bonds. financial stress” Italian non-lifeMore than half (56%) of Swedish insurers say they will increase sovereign debt insurer,allocations, with just over one-fifth (22%) expecting to decrease. Respondents in AUM >€25bnDenmark tell a similar story, with half saying they will increase domestic governmentbonds and just one-quarter expecting to decrease investment in this asset class.Thinking About the Likely Effects Of Solvency II, in Light of the Regulation’s CapitalRequirements, how are Your Holdings in Government Bonds Likely to Change? 46% 39% 35% 32% 27% 28% 22% 21% 16% 7% 0% 0% 18% 21% 21% 25% 27% 29% 38% 36% Pan-Europe Iberia Nordics Switzerland France UK Belgium Netherlands Germany Italy Holdings will decrease Holdings will increaseBase: All respondents (n=223)Source: Economist Intelligence Unit
  • [ 10 ]  Balancing risk, return and capital requirementsThe Future for Asset Allocation Continued However Scandinavian insurers face a supply constraint when increasing their government debt allocations as the region’s countries are small, relatively well off and do not need to issue large amounts of bonds. Britta Burreau, Managing Director at Nordea Life in Sweden says: “[Sweden] has a small economy and we are already experiencing a shortage of government bonds. The long 10-year interest rates have been forced down due to huge demand and this could worsen under Solvency II.” Anders Brix, part of the Risk Management team at Danica Pension in Denmark, shares Nordea’s concerns and anticipates further problems with low interest rates as a result of Solvency II’s market-consistent economic valuation, which forces insurers to mark-to- market assets and liabilities. “Solvency II is generally good for risk management, but we are concerned about what can happen if or when all insurers will have to value their liabilities at market value, since the interest rate markets may not be able to supply enough interest rate sensitivity. This may depress interest rates further and hence create more demand for interest rate sensitivity,” Mr Brix says. The concern about availability of local bonds is highlighted in the survey with 55% of Nordic insurers saying they will shift from local to global bonds, compared with an average of 40% for all respondents. Elsewhere in fixed income, the survey reveals an increased appetite for corporate bonds. One-third of respondents say they will increase investment in this asset class, with life insurers more likely to increase (37%) than non-life (29%). Just 18% of respondents overall say they will decrease corporate bond allocations.
  • Balancing risk, return and capital requirements  [ 11 ]Thinking About the Likely Effects of Solvency II, in Light of the Regulation’s CapitalRequirements, how are Your Holdings in Corporate Bonds Likely to Change? 48% 43% 37% 36% 33% 33% 33% 29% 31% 0% 13% 14% 18% 18% 18% 21% 22% 22% 21% 27% Pan-Europe Iberia Nordics Switzerland France UK Belgium Netherlands Germany Italy Holdings will decrease Holdings will increaseBase: All respondents (n=223)Source: Economist Intelligence UnitNorwegian insurers exhibit the most interest in growing corporate bonds allocations.Three-quarters say they will take this action. Italian insurers also favour company debtunder Solvency II, with more than two-fifths looking to increase investment.The survey also highlights a shift from longer-term to shorter-term debt, as the formerwill be more expensive to hold under Solvency II. Forty-four percent of respondents saythey will favour short-term debt under the Directive, with more than half of UK insurersexpecting to make this move.
  • [ 12 ]  Balancing risk, return and capital requirementsReturn-Seeking Assets Twice as many respondents believe that Solvency II will ‘severely hamper their ability to take investment risk’ than those who do not. This is even more extreme among the largest insurers, with more than three times the number saying they will be restricted versus those who will not. Solvency II will Severely Hamper our Ability to Take Investment Risk – Do you Agree or Disagree? (Responses by Assets Under Management) Insurers with >€10bn AUM Insurers with <€10bn AUM Agree 41% Agree 33% Neutral 46% Neutral 38% Disagree 13% Disagree 29% Base: All insurers with >€10bn (n=129) All insurers with <€10bn AUM (n=94) Source: Economist Intelligence Unit Carlos Montalvo, Executive Director of EIOPA, says Solvency II is not designed to hamper insurers’ ability to take investment risk, but rather to ensure a direct link between the assets in which they invest their underlying risks and the assigned capital charge. He adds: “[Solvency II] may, therefore, have an impact on the investment policies and products offered by some insurers, but this change is to be encouraged where it promotes effectively managed insurance companies and improves policyholder protection.” However, the extent to which insurers are concerned about restricted investment risk is reflected in their expected changes in investment strategy is limited. One-third of respondents say their investment risk budgets will increase under Solvency II, with only 15% actively disagreeing. Looking at assets that will carry a higher capital charge, as they are considered riskier, more than half of respondents to the survey say they will keep equity allocations the same across all regions, although US equities are the most likely (62%) to remain static. French and Italian insurers are the most likely to increase allocations to European equities (37% and 39% respectively), while just over one-third (34%) of German insurers are set to decrease allocations to stock markets in this region. Allocations to alternatives, which also carry a high capital charge under Solvency II, actually look likely to increase once the Directive is in place. Just under one‑third (32%)
  • Balancing risk, return and capital requirements  [ 13 ] BlackRock View: Matt Botein, Managing Director, BlackRock Alternative Investors (BAI) The survey results show insurance companies are expecting to increase their usage of alternative investments strategies as they look to prudently improve diversification in their portfolios and meet their investment needs. Their implementation process involves balancing (and optimizing) the impact of potentially higher capital charges for certain asset classes with the economic benefits of superior risk adjusted returns. This is even more urgent today as the challenging market environment makes stable and uncorrelated returns increasingly appealing. Transparency and a greater focus on risk management are key considerations insurers will take into account as they allocate capital to alternative asset classes under this new regulatory regime. Therefore, an attractive solution can be based on diversified hedge fund strategies that meet the disclosure and reporting requirements of Solvency II, while being a good complement to their existing portfolios. Also, strategies that generate transparent, long term stable cash flows with bond like characteristics and uncorrelated returns will be well received by those insurance companies planning to add or increase their allocation to alternatives.say they will increase allocations to private equity and hedge funds, with allocationsexpected to decrease at just 6% and 9% of insurers respectively. Non-life companies hada slightly bigger appetite for hedge funds than life, with 46% saying they will increaseinvestment compared with 33% of their life counterparts.In terms of assets under management, the very largest insurers (with AUM greater than€25bn) are the most likely to increase allocations to hedge funds (36%), with 26-27% ofother insurers expecting to allocate more funds to this asset class under Solvency II.French, Nordic and Iberian insurers are among the most likely to increase hedge fundallocations. Italian respondents are the most likely (23%) to decrease investment in thisasset class, while Dutch insurers are the most likely (71%) to keep hedge fund allocationsthe same and are also among the highest number to keep private equity static.
  • [ 14 ]  Balancing risk, return and capital requirementsReturn-Seeking Assets Continued Thinking About the Likely Effects of Solvency II, in Light of the Regulation’s Capital Requirements, how are Your Holdings in Each of the Asset Classes Below Likely to Change? Private Equity 62% 56% 36% 38% 36% 32% 32% 29% 27% 0% 0% 0% 0% 0% 6% 5% 6% 8% 7% 18% Pan-Europe Iberia Nordics Switzerland France UK Belgium Netherlands Germany Italy Holdings will decrease Holdings will increase Hedge Funds 55% 42% 39% 32% 32% 33% 31% 29% 22% 14% 0% 6% 5% 5% 9% 10% 11% 13% 14% 23% Pan-Europe Iberia Nordics Switzerland France UK Belgium Netherlands Germany Italy Holdings will decrease Holdings will increase Base: All respondents (n=223) Source: Economist Intelligence Unit
  • Balancing risk, return and capital requirements  [ 15 ]Frank Eijsink, Global Program Director for Solvency II at ING Life in the Netherlands, says:“There are two aspects to consider: the capital that you need to set aside for investing inrisky assets and the volatility of that asset price. Although hedge funds and private equityfunds have low volatility in the asset price, you do have to set aside a significant amount ofcapital for those investments.”The increase in risk budget, alongside greater allocations to alternatives, leavesrespondents confident of higher investment returns post-Solvency II. Seventy percent sayreturns will either significantly (23%) or slightly (47%) increase under the new regime,while no insurers say returns will significantly decrease.How do you Expect the Changes to Your Asset Allocation to Affect the OverallReturns of your Portfolio? Returns are likely to 23% significantly increase Returns are likely to 47% slightly increase Returns are likely to 23% stay the same Returns are likely to 6% decrease slightly Returns are likely to 0% decrease significantly 0 10 20 30 40 50Base: All respondents (n=223)Source: Economist Intelligence UnitFigures do not add to 100% due to roundingDerivatives, too, are set to gain ground in the post-Solvency II world, with more thanone‑fifth (23%) of survey respondents saying they will increase derivative usage.However, given just 18% report current derivative investment (although we do not knowwhat shape that derivative investment takes, and therefore its impact on portfolios), anyrise is from a relative low starting point.
  • [ 16 ]  Balancing risk, return and capital requirementsReturn-Seeking Assets Continued Thinking About the Likely Effects of Solvency II, in Light of the Regulation’s Capital Requirements, how are Your Holdings of Derivatives Likely to Change? 62% 37% 27% 29% 29% 23% 19% 19% 13% 11% 0% 0% 0% 3% 5% 7% 9% 14% 13% 18% Pan-Europe Iberia Nordics Switzerland France UK Belgium Netherlands Germany Italy Holdings will decrease Holdings will increase Base: All respondents (n=223) Source: Economist Intelligence Unit Just 4% of respondents disagree that Solvency II will cause more insurers to use downside protection to mitigate capital charges, explaining some of the increase in derivative use. Danish insurers are the most likely to increase derivative use, with 75% saying they will invest in these instruments in the future. Italian insurers also exhibit high levels of interest, with 62% expecting to increase derivative investment. Where insurers are planning on increasing the use of derivatives, they will need to demonstrate they have the appropriate systems to be able to capture the impact on the business through their own risk and self assessment (ORSA) process under Solvency II. Ms Muldoon of Friends Life is of the view that this poses no problem for UK firms that have been using derivatives for many years and already have systems in place to measure and monitor risks, such as counterparty exposure. However, EIOPA is clear in its expectations when it comes to derivatives and all other ‘risky’ asset classes. Mr Montalvo of EOIPA says: “Insurers will be required to have effective risk management systems enabling them to manage, inter alia, the counterparty risk presented by an exposure to derivatives. EIOPA will work closely with national competent authorities to ensure that the Directive is appropriately implemented and supervised.”
  • Balancing risk, return and capital requirements  [ 17 ]BlackRock View: Nigel Foster, Managing Director,Derivative Solutions GroupThe findings point to a greater need for derivatives under Solvency II tobetter match liabilities, provide capital guarantees and manage volatility.This increased use of derivatives is set against a background of higherstandards of transparency and additional capital being deployed underSolvency II. Demanding as these requirements are on their own, theintroduction of these standards comes at a point when derivative marketsas a whole are in a state of flux, thus further increasing complexity.A new derivative market infrastructure is coming into being driven in part byshortcomings identified in the financial crisis associated with the collapseof Lehman Brothers and the taxpayers’ rescue of AIG. Under legislation suchas the US Dodd Frank Act derivatives are to be more closely controlled, inparticular private OTC transactions. In addition, to counter the risk ofdefault we have seen the introduction of mandatory standards in the form ofcounterparty and collateral arrangements. All of this is new, and in additionto the Solvency II requirements. Furthermore, the notion of default risk nowplays a part in pricing that hitherto it did not.What this means is that Solvency II is not alone in‘raising the bar’ for derivatives. Taken together, thelevel of expertise and control required, call for aradical rethinking of derivative capabilities andpractices. As a result, even the largest insurers willneed to choose between ‘upping their game’, droppingout of the business lines that demand most derivativeexpertise or partnering with those providersthat have the scale and resources to do thejob properly.
  • [ 18 ]  Balancing risk, return and capital requirementsA Demanding Data Management Regime The comprehensive data management and governance regime imposed by Solvency II’s third pillar has proved one of the most controversial elements of the Directive, and the survey reveals many insurers are struggling to come to terms with the requirements. Respondents claim high levels of readiness for all three pillars. When asked what they thought about the structure and requirements of each of the three Pillars of the Directive, 97% say they are very well or quite well prepared for Pillar I, 95% feel the same about Pillar II and 89% for Pillar III. Thinking About the Structure and Requirements of the Solvency II Directive, how Well Prepared do you Feel for Each of the Three Pillars? Pillar 1: Capital requirements 51% 46% 3% 1% Pillar 2: Governance & Risk 41% 54% 5% Pillar 3: Reporting 37% 51% 11% 0 20 40 60 80 100 Very well prepared Quite well prepared Not very prepared Not at all prepared Base: All respondents (n=223) Source: Economist Intelligence Unit Figures do not add to 100% due to rounding However, the confidence in preparations for Pillar III was not borne out by responses to more detailed questions on Solvency II’s data requirements. In spite of more than half (55%) of respondents claiming to have the necessary data to meet the requirements of Solvency II, 97% say they are either ‘very’ or ‘somewhat concerned’ about meeting the requirements for quality of data; 96% say they have concerns about timeliness; and 94% say the completeness of data requirements are a cause of anxiety.
  • Balancing risk, return and capital requirements  [ 19 ]Thinking About Each of the Specific Reporting Requirements Under Pillar III, “The biggesthow Concerned are you About Each of the Following Areas? challenge is the Meeting the requirements 63% 34% 3% development of IT for quality of data Meeting the requirements architecture, for completeness of data 58% 36% 6% processes and data, Meeting the requirements 55% 40% 5% for timeliness of data [which] may be Data from third-parties will not be sufficient 46% 46% 8% required to gather Limiting my investment strategy as some assets will not adequately 39% 54% 8% the necessary meet data requirements 0 20 40 60 80 100 information” Very concerned Somewhat concerned Not concerned Spanish non-lifeBase: All respondents (n=223) insurer, AUM >€25bnSource: Economist Intelligence UnitFigures do not add to 100% due to roundingAmong the concerns expressed by respondents to the survey, one large Swiss insurersays: “The description and mitigation of risk exposure by risk category required under Pillar “The biggestIII…this is a time-consuming process.” challenge is to planAt the same time, survey respondents are dedicating the smallest amounts of their how data will flowoverall budgets to Pillar III, which accounts for less than one-third (30%) of resource from internaldedicated to Solvency II. reporting systems to the regulatory reporting system” BlackRock View: Coenraad Vrolijk, Managing Director, UK non-life insurer, Financial Market Advisory Business & Co-Chair, BlackRock €1–10bn AUM Solvency II initiative With slowly moving portfolios, insurers have never had to provide this level of transparency, at such timely notice, on their assets in the past. The focus over the past years has been very much on the science of modelling risks. However, with deadlines drawing closer, attention has shifted to the operational challenges of making multiple managers across multiple jurisdictions and multiple legal entities all report accurately, consistently and quickly. Individual insurers who are unable to provide the required transparency and are still operating in excel spreadsheets may find their credibility severely challenged across the remainder of the pillars.
  • [ 20 ]  Balancing risk, return and capital requirementsA DemandingData Management Regime Continued“Sometimes, it What is your Overall Budget for Solvency II? How is your Budget for Solvency II is difficult for an Apportioned Between each of the Three Pillars? organisation to Overall Solvency II Spend Share by Pillar obtain data that is €0-1 mn 16% at the same time €1-5 mn 33% appropriate, €5-10 mn 23% €10-25 mn 14% complete, and €25-50 mn 5% €50-75 mn 5% accurate” €75-100 mn 1% Pillar I 36%Norwegian life insurer, >€100 mn 1% Pillar II 34% Don’t know 3% Pillar III 30%>€25bn AUM Base: All respondents (n=223) Source: Economist Intelligence Unit Figures do not add to 100% due to rounding One of the clearest examples of a mismatch between perceived readiness for Pillar III and actual understanding of the new requirements drawn out by the survey, relates to ‘look- through’. Solvency II introduces ‘look-through’ across all assets classes, which forces insurers to understand the risk of every investment they hold, even if it is a pooled vehicle. One French survey respondent says: “I think under Solvency II the main challenge will be on quality reporting to the individual line item in pooled investment funds.” But only one-third of respondents are confident they understand how the relationship between pooled fund look-through and return will be altered under Solvency II. Non‑life insurers show below-average understanding of how look-through applies to pooled funds; just 22% agree they know how the relationships will work. Meanwhile, just 42% of life companies agree they understand the relationship between look-through and pooled funds under Solvency II. Ms Muldoon of Friends Life says: “The main areas of look-through relate to unit-linked business and repackaged loans [asset-backed securities]. For unit-linked business, insurers should take steps to ensure that they understand the asset mix of their external fund links.” The problem with the imposition of look-through lies where insurers employ fund management providers and third parties that may be unable to deliver adequate data for particular funds. Ninety-two percent of respondents are very or somewhat concerned that data from third parties will be insufficient under Solvency II. The highest instances of concern are among the very largest insurers (with more than €25bn in AUM), with 55% saying they are very concerned, as these are most likely to employ the largest number of third parties and use more complex investment strategies.
  • Balancing risk, return and capital requirements  [ 21 ]“The current wording [in the Directive] requires a look-through approach to reporting andsolvency calculations which means that for any fund an insurer invests in - be it a creditdefault obligation, mutual fund or property fund - they should be able to list all theunderlying assets one by one. Not many providers have systems that allow you to do that,and if that rule comes in, investors may have to go direct or just invest in funds that are lesscomplicated to monitor,” says Mr Jones of the CEA.Ms Burreau of Nordea Life comments: “We share these concerns and we are working withour distributors and asset managers to improve processes, data quality and frequency.”She adds: “You have substantial insight in your own processes but when you outsourcethem you don’t have the same insight and control, so as long as certain elements of theprocess are outsourced, there will still be potential risks.”A large number (92%) of respondents say they are very or somewhat concerned that thereporting requirements of Pillar III will limit their investment strategy as some assets willnot adequately meet data requirements. This will be a particular concern for thoseinsurers who have indicated they plan to increase holdings in assets such as hedge funds.These assets are traditionally more opaque than other pooled funds but investors willneed to work with third-party providers to ensure they have a clear view of their holdingsunder Solvency II.Some large insurers have done substantial work to get their own houses in order. Forexample, Danica, the Danish life insurer, says it has “a good warehouse which can supportthe Pillar III requirements”, while Friends Life says it is also developing a warehouse tomeet the Solvency II demands.While insurers have work to do to comply with Pillar III, they have dedicated significanttime and resources to meeting the Solvency II demands as a whole. Over half ofrespondents have currently committed at least €5m to the project, while two respondentshad allocated budgets of over €100m.Mr Jones of the CEA believes that insurers’ preparedness for Solvency II has beenreflected in the high level of responses to the European Insurance and OccupationalPensions Authority (EIOPA) fifth quantitative impact study (QIS5).Mr Jones comments: “The industry has been working extremely hard to be ready forSolvency II and that is no mean feat. The level of participation [in QIS5] was almost 70% ofall the companies expected to fall under the scope of Solvency II. They have shown theirability to do the calculations already and while there are other legislative requirements andan urgent need for final methodologies and reporting requirements, insurers do feel theyare on track.”
  • [ 22 ]  Balancing risk, return and capital requirementsShifting Product Ranges As insurers plan for changes to investment strategies and data requirements as a result of Solvency II, so too must they come to terms with how the regulations will influence their product ranges. The Directive is designed to weed out badly designed products or ones that fail to adequately price risk, yet at the same time this improved transparency incentivises insurers to transfer more expensive, long-term risk back to the policyholder – most likely not the intention of the regulator. Less than one-fifth (18%) disagree Solvency II will force them to review their product ranges, with life insurers more affected than non-life. Two-fifths of life insurers strongly agree they will need to rethink their offerings, while just one-fifth of non-life feels the same. Solvency II may Force us to Review our Product Range – do you Agree or Disagree? Pan-Europe: All Insurers 34% 48% 18% Life 39% 47% 14% Composite 44% 44% 12% Non-Life 20% 57% 23% Reinsurers 36% 32% 32% 0 20 40 60 80 100 Agree Neither Disagree Base: All respondents (n=223) Source: Economist Intelligence Unit The predominant concern is for life insurers offering long-term guaranteed products, since exposure to interest-rate risk makes these products expensive, unless they can reduce the asset liability mismatch. Just under two-thirds of life insurers say they will restructure to better manage asset and liabilities, while nearly half (49%) say they will seek external advice on ALM.
  • Balancing risk, return and capital requirements  [ 23 ]How Will you Manage your Guaranteed Funds Business Under Solvency II? We will re-structure to better manage assets/ liabilities of funds in-house 65% We will seek advice on ALM 50% We will continue as we are 22% We will increase yields 20% We are still considering options 17%We will outsource management of these mandates 16% We will drop guarantees 13% We will close the business altogether 5% We will look to sell this part of the business 4% We will close to new business 3% 0 20 40 60 80Base: All Life or Composite Insurer respondents (n=149) (Multi-code allowed)Source: Economist Intelligence UnitThe impact of the Directive will vary between countries; in Italy, for example, manyinsurers have a large number of unit-linked products or they tend to renew guaranteesperiodically. As such, their market risk does not seem as high as that of insurers in the UKor Sweden, for example, where there are long-tail annuity products or guaranteedproducts that have higher capital requirements under Solvency II. Consequently, almosttwo-thirds (63%) of Italian life and composite insurers say they will continue to run theirguaranteed products as they are, compared with 22% of life and composite respondentsoverall. However, there may be a mismatch between the market value of the guaranteesprovided on savings products and the book value at which assets are carried, and it is notclear at this point if Solvency II will allow insurers to continue to carry assets andliabilities at book value.In markets where there are in-built buffers against higher capital requirements, such asthe Netherlands, insurers benefit from a reduction in interest-rate risk as guarantees arelinked to government bond indices.However, Mr Eijsink of ING says insurers will need to develop products that offerguarantees in a different way and see what works in their market. He points to examplesincluding variable annuities: “These are not popular in Europe and I am not sure the marketis ready for them yet. Insurers will have to be creative in finding several products and seewhat works best by experimenting.”In Sweden, the Directive could see solvency ratios plummet with capital requirementsrising sharply, and while the country’s insurers are generally well-funded, 44% say theywill restructure to better manage assets and liabilities, and the same number will reviewtheir product ranges.
  • [ 24 ]  Balancing risk, return and capital requirementsShifting Product Ranges Continued Ms Burreau of Nordea Life suggests the cost of guaranteed products will become prohibitively expensive, driving consumers towards unit-linked products. “The cost of capital will make guarantees more costly and the customer may see them as too expensive. Consequently they might move to cheaper products where the individual carries the risk such as in unit-linked insurance,” she says. Olav Jones, deputy director-general at CEA, the European insurance and reinsurance trade body, describes some of Solvency II’s impact on product ranges as an “unintended consequence”. He adds: “The industry has supported Solvency II strongly from the beginning because we agree with a risk-based approach to regulation and solvency. We continue to engage strongly to make sure the final outcome is one that works as intended. However, we can see there is a risk that there will be elements which are not right. If so [the industry] will adapt to what we have to do but we wouldn’t like Solvency II to lead to fundamental changes in our business models, which we think have served the economy and our consumers well over many years.” BlackRock View: Mark Azzopardi, Managing Director, BlackRock Multi-Asset Client Solutions (Insurance) A significant increase in the cost of guaranteed products is indeed a very likely outcome but the observation is driven more by a failure in the old regime than in Solvency II. With some notable exceptions, regulation to date has failed to appreciate the full extent of the risk inherent in writing guarantees. However, many life insurers have no choice but to write guarantees if they are to differentiate themselves from pure asset managers and build a sustainable business model. Fortunately, this fuller appreciation of risk under Solvency II need not spell the end of risk taking. Guarantees can be simpler and designed specifically with risk management in mind, thus allowing better risk mitigation through a combination of more professional hedging in capital markets and traditional reinsurance. Much financial risk is at least partially hedgeable. Insurers might be better served acting as intermediators and managers, rather than takers, of financial risk.
  • Balancing risk, return and capital requirements  [ 25 ]Consequences for Capital MarketsAccording to the CEA, European insurers invested €7.3trn in the global economy in 2010, “It will increase thewhich equates to more than half (54%) of the total European Union GDP. Clearly then, any risks associatedregulation which alters insurers’ behaviour has ramifications for the global capital markets. with cross-holdingInsurers responding to the survey believe Solvency II will exacerbate the recent stormy of securitieseconomic conditions, with just 5% of respondents disagreeing that the Directive will lead between theto greater market volatility. banking andThe smaller insurers participating in the study are more pessimistic than their larger insurance sector”counterparts, with 69% of insurers with less than €1bn in assets under management Spanish life insurer,expecting greater volatility as result of Solvency II compared with 44% of those with more >€25bn AUMthan €1bn.Ms Burreau of Nordea Life says: “While it is impossible to foresee what the Directive’simpact will be on the market in three years time, the fact it coincides with Basel III and westill have unstable markets, it could be a very nasty combination to manage.”There Will be an Increase in Volatility in Capital Markets Because of Solvency II –do you Agree or Disagree? Insurers with >€1bn AUM Insurers with <€1bn AUM Agree 44% Agree 69% Neutral 51% Neutral 27% Disagee 5% Disagee 4%Base: All insurers with >€1bn (n=196) All insurers with <€1bn AUM (n=26)Source: Economist Intelligence UnitMr Montalvo of EIOPA says Solvency II does not introduce volatility, but rather simplyprovides a clearer picture of an insurer’s financial position, which is in turn properlyreflected in the market. He says: “The volatility will be the same... You don’t reduce orincrease [volatility] with Solvency II, you just reflect it as it really is.” Mr Montalvo alsonotes the Directive introduces measures to limit market volatility, but the final mechanicsof such devices are still on the drawing board.
  • [ 26 ]  Balancing risk, return and capital requirementsConsequences for Capital Markets Continued“The public The importance of any measure that counters market volatility is seen as critical to disclosure Solvency II’s success. Countering the effects of pro-cyclicality is of particular importance. This is where regulations encourage insurers to sell assets in a market downturn, thereby requirement under worsening the economic conditions. Pillar III will improve the comparability Ms Muldoon of Friends Life says: “Solvency II includes an equity dampener and a matching premium which are designed to limit the capital impact following equity market falls and of firms for credit spread widening respectively. However, under the latest proposals these only apply investors” to a restrictive set of assets. Although the draft regulations make provision for the regulatorUK life insurer, to apply an industry-wide countercyclical premium, there is a lack of clarity on when it>€25bn AUM would apply in practice and its extent in the event it is applied.” She adds: “This uncertainty makes planning for and managing risk in a downturn difficult, and increases the risk of forced selling if the countercyclical premium is not invoked or is less than anticipated.” Mr Jones of the CEA is particularly concerned about the design of the package of tools created to avoid artificial volatility and pro-cyclicality, and notes that the implications of a failure in this field will have far-reaching implications for the insurance industry and the capital markets. He says: “There is a package of measures under discussion to ensure Solvency II does not create artificial volatility and force pro-cyclicality. If done properly, these measures can really address this issue. If not, Solvency II could have serious unintended consequences, including forcing the insurance industry away from offering long-term guarantees and a long-term investment horizon. This would be bad for the consumers, the economy and the industry.” For Mr Jones, the key to effective countercyclical measures is to ensure insurers are not forced to sell assets simply because regulation encourages them to do so under certain economic conditions.
  • Balancing risk, return and capital requirements  [ 27 ]BlackRock View: Mark Azzopardi, Managing Director, BlackRockMulti-Asset Client Solutions (Insurance)Insurance companies themselves will not actually be any riskier or morevolatile as a result of Solvency II. It is simply that the way in which they aremeasured will change to one which is much more sensitive to market values.In theory, this added transparency should reduce the risk of owning aninsurance stock and therefore reduce its volatility. However, at least in theshort term it is quite possible that a fuller appreciation of the risk inherent ininsurance stocks, in particular through the volatility of reported solvencyratios, will shock investors.More broadly, there is some merit in the argument that pro-cyclicity willincrease volatility by forcing insurers to sell risk assets inbear markets. There are some proposed measures suchas the countercyclical premium, the matching premiumand the equity dampener that partially mitigate thispro‑cyclicity. Equally, there are limits to how far EIOPAcan go without effectively condoning insolvency. Afterall, at the point where an insurer runs out of capital it isreasonable to expect it to have sold down all itsexcess risk assets relative to the regulatoryleast-risk position.
  • [ 28 ]  Balancing risk, return and capital requirementsEquity and Debt Markets Equity markets look the most likely to be negatively affected by Solvency II. Only 9% of survey respondents disagree that share prices will fall, as demand for equities will be lower due to Solvency II. An even smaller number (3%) disagree that the equity risk premium will have to increase in order to encourage investment in this area. Smaller insurers with less than €1bn in assets are more likely to expect share prices to fall than their larger counterparts, with 62% expecting them to be hit compared with 43%. Dutch and Nordic respondents show most concern about the Directive’s impact on equity markets, with 64% of insurers in the Netherlands believing share prices will fall, while 55% of Nordic respondents agree. BlackRock View: Richard Turnill, Managing Director, Global Equity Team A crucial impact of Solvency II will be the creation of a more risk-focused approach, where the analysis of investment risk versus expected returns becomes the most important factor. This focus will be especially pertinent considering the expected increase in equity market volatility. Therefore, a low beta, high quality equity income strategy is likely to feature heavily within insurers’ equity allocation. Research conducted by our Risk and Quantitative Analysis area shows that low volatility (high quality) equities outperform high volatility equities over the long-term. This turns the well-established assumption of being paid to take more risk upside down. The survey findings also indicate a consensus move away from equities and towards corporate bonds. The resulting increase in demand will further depress already low fixed income yields, so re-allocating from broad equities towards high quality equities, with the much stronger risk/return profile, seems a better solution.
  • Balancing risk, return and capital requirements  [ 29 ]Due to Solvency II, Average Share Prices will be Lower as Demand for Equities willbe Lower – do you Agree or Disagree? Agree 46% Neutral 45% Disagree 9%Base: All respondents (n=223)Source: Economist Intelligence UnitDue to Solvency II, the Equity Risk Premium will Need to Increase Significantly toEncourage Investing in Equities – do you Agree or Disagree? Agree 49% Neutral 48% Disagree 3%Base: All respondents (n=223)Source: Economist Intelligence UnitHowever Ms Muldoon of Friends Life says: “Although equities attract a relatively highcapital charge under the Solvency II standard formula, this has been known for quite sometime and we would expect the market to have already priced this in.”
  • [ 30 ]  Balancing risk, return and capital requirementsEquity and Debt Markets Continued The lower demand for equities may also be balanced out by a lower supply. Forty percent of respondents believe that, due to Solvency II, companies will favour issuing debt rather than equity for their funding needs. The subsequent increased supply of debt will be useful as nearly half (45%) of respondents say they expect high-rated corporate and government debt to become more attractive as a consequence of Solvency II. Regulators may have to Rethink Approach to ‘Risk-Free’ Assets Under current proposals, the regulator attributes EEA sovereign debt a 0% capital charge, so for insurers able to use the asset class as a suitable matching proponent in a long-term investment strategy, this looks attractive. However, the recent eurozone debt crisis has thrown the very inclusion of a ‘risk-free’ asset in the standard capital model into doubt. Mr Eijsink of ING comments: “ING had already taken the opinion that it was a grave omission in the standard model and we can see that government bonds are not risk‑free. What we dearly miss is a real risk-free asset since we have a risk-free definition on the liability side of the balance sheet but we don’t have a risk-free asset on the asset side.” Although it is unclear as to whether EIOPA will revise the 0% capital charge, this seems unlikely since the European Commission will wish to avoid any potential market disruption any rethink might cause. Ultimately, insurers are responsible for understanding the real risks posed by any asset class in which they invest under the ORSA process.
  • Balancing risk, return and capital requirements  [ 31 ]BlackRock View: Scott Thiel, Deputy Chief Investment Officer,Fixed IncomeThe continued stress in segments of the Eurozone government bond marketcertainly merits reconsideration of the current proposal that these assetsshould carry a 0% risk charge under the Solvency II standard model. Indeed,as risk management practice continues to develop at European insurancecompanies and the use of internal models becomes more prevalent, it ispossible that recent events will lead some companies to take moreconservative capital charges in respect of this asset class, irrespective ofthe standard model. In such cases, it is conceivable that the capital chargesused could be lower than those for corporate bonds of equivalent creditrating. The asset class may then remain more attractive than corporatebonds to the insurance sector, but this would be based upon an assessmentof expected return versus capital requirement, which ispart of a wider trend we expect as a consequence ofthe introduction of specific asset charges underSolvency II. In any case, we continue to seeGovernment bonds as a very important part of theasset portfolios of European insurers given ourexpectation that, in the long term, these instrumentswill still be considered a very low risk asset class,not to mention their role in matching the liabilityprofile of an insurance portfolio.
  • Conclusion Conclusion While EIOPA and the relevant national regulators thrash out the final elements of the Directive and attempt to tackle the challenging issues of managing volatility, pro-cyclicality and risk-free assets, insurers should use the time to identify any mismatches between their perception of readiness and the reality. Insurers’ anxieties about data management must be tackled if they are to achieve the optimum investment strategy and asset allocations to deliver superior returns, and they may need to revisit the amount of time and resource they invest in this area. A disconnect persists between the perception of Solvency II limiting investment strategies and the reality, which actually opens the door to a wider field of asset classes via the ‘prudent person’ principle. While insurers are concerned that they will be penalised for investing in ‘riskier’ asset classes including derivatives and alternatives, they are still set to increase their risk budgets in the pursuit of higher returns. These final stages of implementation need to include effective measures to ensure insurers are allowed to invest in the strategies most suited to their business needs, and in turn, insurers and third parties must make certain they have robust reporting platforms to manage investment in these assets. At the same time, insurers must wait and see how EIOPA and domestic regulators deal with concerns about systemic risk and market volatility and whether Solvency II will ultimately meet its aims – to protect consumers from future financial crises. The survey data shows insurers still see the Directive as a useful tool in better managing risk. But if it forces them to excessively limit product ranges, then it may be consumers who inadvertently fall foul of the very legislation designed to protect them. As the cost of guaranteed products becomes prohibitively expensive, it could force consumers into other products where they shoulder the investment risk. Just 13% of respondents disagree that Solvency II will be positive for insurers, but everything now hinges on ironing out the detail, particularly in Pillar I and ensuring the Directive allows insurers to function effectively in benign markets and be better prepared and protected in times of crisis. Timely action is also needed – earlier delays in implementation were greeted with relief by many insurers as it gave them more time for preparation but at this stage further delays in clarity of rules will only frustrate the industry.
  • Balancing risk, return and capital requirements  [ 33 ]“A large number of financial institutions will adopt a common risk modelling framework, which will help ensure stability in financial markets”UK non-life insurer, <€10bn
  • [ 34 ]  Balancing risk, return and capital requirementsBlackRock Commentators David A. Lomas, ACII, Managing Director, is head of BlackRock’s Global Financial Institutions Group. This global business is focused on managing balance sheet and subadvisory assets, and providing risk management services to financial institutions. Mr Lomas is responsible for BlackRock’s strategy, service offering, client strategy and client proposition. He sits on BlackRock’s Global Operating Committee. Matthew Botein, Managing Director, is head of BlackRock Alternative Investors (BAI). BAI includes BlackRock’s hedge funds and opportunistic funds, funds of hedge funds, private equity, private equity funds of funds, real estate and real assets. Nigel Foster, Managing Director, heads the Derivative Solutions Group within the BlackRock Multi-Asset Client Solutions (BMACS) group, which is responsible for implementing bespoke portfolio solutions. Mr Foster is a member of the BMACS management team, Counterparty Oversight Committee (CPOC), Operating Committee (EOC) and chairs the International Derivatives Oversight Committee (DOC). Coenraad Vrolijk, Managing Director, leads our Financial Market Advisory business in EMEA within BlackRock Solutions. The Financial Markets Advisory Group advises clients in managing their capital markets exposure and businesses. Mr Vrolijk is a senior advisor with specialization in insurance, central banks and financial market regulators. In addition, he co-chairs BlackRock’s Solvency II initiative. Mark Azzopardi, Managing Director, is a member of the BlackRock Multi-Asset Client Solutions (BMACS) group, which is responsible for developing, assembling and managing investment solutions involving multiple strategies and asset classes. Within BMACS, he is part of the Client Strategy team where he provides strategic advice to Institutional clients, focusing on insurance companies and on pension funds with a strong liability- driven philosophy. Richard Turnill, Managing Director, and portfolio manager, is a member of the Global Equity team within the Fundamental Equity division of BlackRock’s Portfolio Management Group. He is responsible for leading the team which manages large cap global equity portfolios. Scott Thiel, Managing Director, is BlackRock’s Deputy Chief Investment Officer of Fixed Income, Fundamental Portfolios, and Head of European and Global Bonds. He is a member of the Fixed Income Executive Committee and the EMEA Executive Committee. Mr Thiel is a member of BlackRock’s Leadership Committee.
  • Balancing risk, return and capital requirements  [ 35 ]About BlackRockIn a world that is shifting and changing faster than ever before, investors who wantanswers that unlock opportunity and uncover risk entrust their assets to BlackRock. As anindependent, global investment manager, BlackRock has no greater responsibility than toits clients.It’s why many of the world’s largest pension funds and insurance companies trust BlackRockto understand their unique objectives and why financial advisers and investors partner withBlackRock to help them build the more dynamic, diverse portfolios these times require.BlackRock has built its offering around its clients’ greatest needs: providing breadth ofcapabilities and depth of knowledge – across active and passive strategies, includingiShares® ETFs. This is combined with a singular focus on delivering strong, consistentperformance and an ability to look across asset classes, geographies and investmentstrategies to find the right solutions.With deep roots in every region across the globe, some 100 investment teams in 27 countriesshare their best thinking to gain the insights that can change outcomes. And, with a passionto understand risk in all its forms, BlackRock’s 1,000+ risk professionals dig deep to find thenumbers behind the numbers and bring clarity to the most daunting financial challenges.That shapes and strengthens the investment decisions that BlackRock and its clients aremaking to deliver better, more consistent returns through time.BlackRock. Investing for a new world.BlackRock Financial Institutions GroupBlackRock has unrivalled insights into the management of insurance company assets. ItsFinancial Institutions Group managed $204 billion in unaffiliated general account assets for127 insurers in 23 countries as at the end of December 2011. In addition to these assetmanagement relationships, BlackRock also provides risk management services to75 insurers through BlackRock Solutions. For more information or to share your views, please contact us: email: solvency2@blackrock.com www.blackrock.com
  • [ 36 ]  Balancing risk, return and capital requirementsAppendix Company Headquarters UK 27% Germany 14% France 9% Switzerland 8% Italy 6% Netherlands 6% Belgium 4% Sweden 4% Luxembourg 4% Norway 4% Finland 3% Spain 3% Bermuda 3% Denmark 2% Portugal 2% Iceland 1% Base: All respondents (n=223) Source: Economist Intelligence Unit Insurer Type Life 34% Non-life 29% Composite 26% Reinsurer 12% Base: All respondents (n=223) Source: Economist Intelligence Unit
  • Balancing risk, return and capital requirements  [ 37 ]Group AUM <€500m 3% €500m-€1bn 9% €1bn-€10bn 31% €10bn-€25bn 10% >€25bn 47%Base: All respondents (n=223)Source: Economist Intelligence UnitJob Title CEO/President MD 8% CFO/Treasurer 22% Other C-level Exec 23% SVP/VP/Director 41% Other 6%Base: All respondents (n=223)Source: Economist Intelligence Unit
  • [ 38 ]  Balancing risk, return and capital requirementsAppendix Continued Frequency of Tactical and Strategic Reviews of Asset Allocation Tactical Strategic Weekly 3% Weekly 1% Monthly 53% Monthly 25% Quarterly 37% Quarterly 42% Biannually 7% Biannually 22% Annually 1% Annually 11% Base: All respondents (n=223) Source: Economist Intelligence Unit Figures do not add to 100% due to rounding Agreement with Pillar I Statements We are waiting until implementation of Solvency II is closer before making changes to our asset allocation 53% 38% 9% We already know how we are likely to change our asset allocation 46% 51% 4% I expect the effect of Solvency II 40% 47% 13% on life insurers to be mainly positive Solvency II will severly hamper 38% 42% 20% our ability to take investment risk Solvency II will make me more likely 37% 49% 15% to use derivatives in the future Our investment risk budget will 33% 51% 15% increase under Solvency II Agree Neither Disagree Base: All respondents (n=223) Source: Economist Intelligence Unit Figures do not add to 100% due to rounding
  • Balancing risk, return and capital requirements  [ 39 ]Level of Confidence in own Investment Governance and Risk ManagementUnder Solvency II Extremely confident 42% Somewhat confident 55% Not very confident 2% Not at all confident 1%Base: All respondents (n=223)Source: Economist Intelligence UnitAgreement with Pillar II Statements We are confident that we can consistently capture the interaction between assets and liabilities with our chosen model 67% 33% 1% (ie, internal, partial internal)We are confident we have the necessary resources in terms of asset liabilty management to 58% 39% 3% meet the requirements of Solvency II We are confident we have the necessary 55% 40% 5% data to meet the requirements of Solvency II Solvency II may force us 34% 48% 18% to review our product range We are confident we know how the relationship between pooled fund look-through and 34% 62% 4% return will be altered under Solvency II Agree Neither DisagreeBase: All respondents (n=223)Source: Economist Intelligence UnitFigures do not add to 100% due to rounding
  • [ 40 ]  Balancing risk, return and capital requirementsAppendix Continued Agreement with Pillar III Statements The requirments of Solvency II will result in insurers using better liabilty matching techniques including the use of derivatives 60% 37% 4% Solvency II will result in insurers increasingly using downside protection to mitigate the 51% 45% 4% impact of new capital charges I would like to see an increase in the creation Solvency 39% 55% 6% II-friendly assets, which can optimise return on capital There will be increased usage of 34% 59% 8% active funds due to Solvency II requirements There will be increased usage of passive 34% 59% 8% funds due to Solvency II requirements I expect the pricing of buyouts to get more 33% 63% 4% expensive as a result of Solvency II Agree Neither Disagree Base: All respondents (n=223) Source: Economist Intelligence Unit Figures do not add to 100% due to rounding Global Capital Markets: Effect of Solvency II on Fixed Income An increase in the attractiveness of higher-rated corporate debt and govt bonds 45% A shift from long-term to shorter-term debt 44% An increase in use of ALM derivatives 40% A shift from local to global bonds 40% A shift from short-dated paper to deposits 30% An increase in the 28% attractiveness of covered bonds An increase in use of emerging market debt 26% A preference for assets based 25% on the long-term swap rate An increase in demand for 22% higher-quality government bonds Base: All respondents (n=223) Source: Economist Intelligence Unit
  • Balancing risk, return and capital requirements  [ 41 ]Global Capital Markets: Effect of Solvency II Due to Solvency II, the equity risk premium will need to increase significantly to encourage investing in equities 50% 48% 3% There will be an increase in volatility in capital markets because of Solvency II 47% 49% 5% Due to Solvency II, average share prices will be lower as demand for equities will be lower 45% 45% 9% Due to Solvency II, companies will favour issuing 40% 51% 9% debt rather than equity for their funding needsBanks will struggle to sell the long-dated bonds required by Basel III as Solvency II makes holding long-dated 39% 48% 14% corporate bonds more expensive for insurers Agree Neither DisagreeBase: All respondents (n=223)Source: Economist Intelligence UnitFigures do not add to 100% due to roundingOverall View of the Effect of Solvency II on Capital Markets Pan-Europe 58% 23% 19% Life 57% 21% 22% Composite 72% 21% 8% Non-life 49% 29% 22% Reinsurer 50% 23% 27% Positive Undedcided/Neutral NegativeBase: All respondents (n=202)Source: Economist Intelligence UnitFigures do not add to 100% due to rounding
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