Strapline
BNY Mellon
MANOEUVRING IN CONSTRICTING CIRCUMSTANCES
The implementation of Solvency II will place restrictions on the investment strategies of many insurers. Intelligent Insurer speaks to the team at BNY Mellon about the investment options open to insurers facing tighter capital regulation.
T
he implementation of Solvency II will require insurers to understand their liabilities better, to take more focused investment risks and to hold additional capital against any mismatch with
their liabilities’ duration. This is the opinion of Charles Pears, head of insurance at Insight Investment, a subsidiary of BNY Mellon.
“It will be particularly difficult for general insurers because they typically
hold short-dated, fixed-income assets and are already struggling to generate a real return in a higher inflation, low interest rate environment,” he says.
For longer-term investments insurers have, in the past, relied on
traditional investment principles to deliver returns. But that was in a more liberal capital market environment. The new paradigm of tighter market regulation means insurers must reassess how they manage risk and generate investment returns, argues Jamie Lewin, head of asset allocation at BNY Mellon Asset Management.
“Insurers must review return expectations and rethink the business risks
they take,” he says. “There could be profound changes to asset allocation, as Solvency II will have an impact on each asset class. Insurers will have to de-risk and relinquish risk premium on higher volatility asset classes. This
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could generate interest in swaps against physicals within fixed income to dial down on duration exposure and increase credit quality.”
Besides managing risk and return, Solvency II is exerting additional
pressures on insurers. These include the possibility that, in order to meet their new Solvency Capital Requirements (SCR), insurers might have to sell risky assets cheaply and buy safe assets at high cost, argues Lewin.
“Creating a client-specific optimal portfolio is also a tactical decision
so insurers should not ignore the market environment and valuation opportunities at asset transition,” he says. “The knock-on effect of removing risk could be increased cost.”
Pears agrees, saying that as well as taking into account current valuations
for different asset classes, insurers will need to consider the cost of holding capital against higher risks before portfolio rebalancing can occur.
“Insurers with enough capital could overlay their asset allocation with
derivatives, to deliver a sensible transition and minimise the current costs of buying and selling in illiquid markets,” he says.
“An additional consideration is the move towards central clearing for many derivative products to meet the European Market Infrastructure
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