Regulation (EMIR) and the US Dodd-Frank Act. General insurers have historically been less active in using derivatives, so they must consider the potential cost implications and margin requirements of central clearing when implementing this type of strategy.”


A key aim of Solvency II is to increase the amount of transparency in the insurance industry, particularly in terms of providing faster data analysis of all asset valuations. However, many firms haven’t yet considered the substantial amount of data changes and transparency requirements that Solvency II will generate, argues Pears.


“Investors will require much more transparency for their portfolios and


a closer working relationship with their investment manager. BNY Mellon is well placed to handle this,” he says.


Paul Traynor, head of insurance, EMEA at BNY Mellon, agrees, adding that the bank has recently developed a service to provide Pillar 3 Quantitative Reporting Templates (QRT) reporting.


“It supports insurance companies as they negotiate the data governance and data quality hurdles imposed by the new regulations,” he says.


As well as requiring more transparency, Solvency II will encourage


insurers to reduce their exposure to long-duration corporate bonds and move towards shorter-dated fixed income. To some extent this pressure has already existed in the UK for some time, as spread stresses have a larger impact on longer-dated bonds.


“Whether this necessarily leads to a reduction in long-dated credit


depends on the shape of the credit curve and their cost of capital—are insurers being appropriately rewarded for taking long-dated credit risk? This may change in the future,” argues Pears.


“The elephant in the room is debt issued by the government of a European Economic Area (EEA) state which, under current Solvency II


proposals, is treated as credit risk-exempt. Yet there are clearly significant economic risks to investing in some European sovereign states. Solvency II says it is safe to invest, but is it? Arguably insurers would be expected to highlight any perceived additional risk as part of their Own Risk Solvency Assessment (ORSA).”


Also, given the current situation in Europe, Lewin doesn’t think that the


risk maths of Solvency II make any sense. He argues that insurers will be driven to buy shorter-dated credit and to sell longer-dated credit, because it carries a higher SCR charge under Solvency II than the yield compensation.


“Spreads on UK long-dated debt will end up wider than justified by


the fundamentals of those underlying corporates, and it could lead to dislocation in that market,” he says.


Pears believes that this has led to a transition towards more sophisticated


strategies. “If you’re underwriting long-dated insurance risk and holding long-


dated credit, this is less capital-efficient than holding credit exposure in shorter durations and matching the long-dated liabilities with debt issued by the government of an EEA state,” he says.


“Firms issuing credit might not know that Solvency II is happening,


and there is not enough well-priced debt to buy in durations attractive to insurers. Unless corporate issuers operate in the insurance sector they probably won’t be aware of the implications for credit buyers.”


Despite the challenges that insurers face with respect to their investments


because of Solvency II, there are still some asset classes that will generate efficiencies for them, such as asset-backed securities (ABS). However, insurers need managers who understand the legal structure of the individual securities, as this defines their true economic risk and therefore their capital charge for insurers operating an internal model under Solvency II, argues Pears.


Spring 2012 | INTELLIGENT INSURER | 35


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