Report Summary

Insurers have just one year until the proposed implementation date for Solvency II and preparations for the new Directive are well under way.

The Europe-wide legislation will impose stringent new capital requirements across the insurance industry, creating a more risk-focused approach to better protect policy holders and investors from future financial crises. Data management will be overhauled, while many players 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 most testing market conditions in living memory. The ongoing sovereign debt crisis has raised questions regarding the very foundations on which some pillars of Solvency II are built, and as uncertainty over the final shape of the Directive persists insurers face notable challenges when building their strategies for the future.

The Economist Intelligence Unit, sponsored by BlackRock, surveyed 223 insurers with operations in Europe. With the survey sample representing at least half of the European market, the findings offer real insights into how insurers are managing Solvency II’s data management requirements; the impact of capital charges on their investment strategies, risk management and product ranges; and their views on the future for capital markets in a post-Solvency II world.

Key findings include:

• Asset allocation shifts have been decided but implementation is on hold

Almost half (46%) of survey respondents say they already know how they are likely to change their asset allocation, with just 4% saying they have not made plans. However, over half (53%) say they are waiting until closer to implementation of the Directive before making changes to their asset allocation. Most changes are as expected – away from equities and towards corporate bonds.

• Allocations to alternatives are set to increase

Some asset allocation changes are less expected. Alternatives such as hedge funds and private equity will benefit from Solvency II, with 32% of survey respondents saying they will increase their allocations to these asset classes. Just 9% and 6% respectively say they will decrease allocations. These increases come despite the higher capital charges for these assets, with insurers betting that the higher charges will be worth the higher potential returns. Almost three-quarters (70%) of survey respondents expect their asset allocation changes to result in higher returns.

• Allocations to derivatives will increase under Solvency II

Over half (60%) of survey respondents agree that the Directive will result in greater use of derivatives to better match assets and liabilities. While some insurers say they are already confident in their derivative usage, as asset-liability management (ALM) strategies become more complex and demanding in volatile markets, this will be an 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, although only 18% currently use derivatives and just 23% have definite plans to increase their overall holdings.

• Meeting Solvency II data requirements is a major concern

Over 90% of survey respondents are very or somewhat concerned about meeting the requirements for the timeliness (96%) and completeness (94%) of data under Solvency II, as well as the quality of data from third parties (92%). In particular, pressure is on third parties to provide the ‘look-throughs’ on pooled funds required by insurers. 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 products, which may become prohibitively expensive

For some insurers, the Directive merely accelerates an ongoing trend away from guaranteed products, but for others it creates a whole new way of thinking about their business. Two-thirds of life and composite insurer survey respondents say they will restructure in order to better manage their guaranteed funds in house, while almost half (49%) of life and composite respondents say they will seek advice on ALM. As a result, insurers will be forced to more aggressively price their guaranteed products, which will likely drive consumers into other cheaper but less well-protected offerings. Annuities, too, will become more expensive as insurers build in the increased costs of managing risk into premiums.

• Solvency II could increase systemic risk

Just 5% of survey respondents disagree with the idea that there will be an increase in volatility in capital markets because of Solvency II. Insurers are also anxious about the threat of pro-cyclicality. If capital requirements reduce when markets are benign and increase during periods of volatility, losses due to falls in market prices could lead to a wave of forced selling, which could create further losses. EIOPA plans to tackle this issue but insurers say the uncertainty makes planning, particularly at this late stage, a challenge.

• Share prices are likely to be hit by Solvency II

Less than one in 10 (9%) of survey respondents disagree with the idea that, due to Solvency II, average share prices will be lower as demand for equities will be lower. And even fewer (3%) disagree that the equity risk premium will need to increase significantly to encourage investing in equities. However, the overall supply of equities could be lower, as only 9% do not believe that companies will favour issuing debt rather than equity for their funding needs.

• Regulators may have to rethink approach ’risk-free’ assets

As the security of government bonds is thrown into doubt, insurers believe the regulator may have to revisit the 0% capital charge for sovereign debt. Insurers using their own internal models already factor in the ‘real’ risk presented by government debt, but organisations using the standard model may be exposed. Planned changes to asset allocation, such as moves from government bonds into higher-rated corporate debt, support the view that insurers are assessing the risk level of assets for themselves.