BNY Mellon


“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.”


“Under the standard formula, the approach for ABS is a very broad brush and treats all underlying risks the same, regardless of their expected loss characteristics,” he says. “This leads to some strange anomalies and capital inefficiencies for what are, otherwise, economically attractive assets. Under the current proposals, a carefully constructed portfolio could achieve attractive ‘LIBOR+’ returns with very low capital requirements (less than 7 percent).


“Absolute returns aim to deliver low volatility and an attractive return


profile. I believe this will grow in popularity where insurers have access to a ‘look-through’ analysis to understand fully the underlying risks and exposures.


“Annuity providers are using interest rate swaps as they are sensitive to


interest rate movement and mismatches in duration. We think more insurers will use interest rate swaps and swap-spread overlays as they can help them eliminate the gaps between the asset portfolio and the liabilities,” says Pears.


Lewin adds that the duration and yield characteristics of emerging


markets’ sovereign debt also look attractive under Solvency II. “Even after the SCR capital charge, there is a nice yield pick-up if you


don’t already have exposure. Funds must provide a ‘look-through’ to the underlying securities otherwise the fund will be exposed to a prohibitive capital charge,” he says.


Another asset class that is gaining interest from insurers is Diversified


Growth Funds (DGFs), says Lewin. “However, these are only attractive if the DGF has an absolute return


objective with genuine absolute return credentials in its construct, its risk management methodology, its returns capture and risk management philosophy,” he says.


Pears agrees, saying that the BNY Mellon team has interest in and experience


of diversified growth thanks to its broad set of investment products. “Insight builds highly bespoke benchmarks reflecting insurers’ appetite


for equities and other instruments based on their return objectives and capital position,” he says. “These bespoke boundaries offer maximum exposures and predictability about their capital position. Insurers are recognising that a static asset allocation approach to risk assets is likely to produce volatile outcomes and to be capital-inefficient.”


Despite offering attractive income levels, the high capital charge under


Solvency II makes assets like infrastructure and property less attractive to insurers as they are often fairly illiquid assets.


“The regulations differentiate between lending to property companies,


direct property and property vehicles versus an investment in an investment company engaging in real estate management and project development, with the latter potentially requiring twice as much capital,” says Pears.


Lewin also points out that real estate investment trusts (REITs) attract a 36 | INTELLIGENT INSURER | Spring 2012


high Other Equity capital charge under Solvency II—similar to frontier equity markets.


“Their yield characteristics look attractive if treated as developed equity


or local market equity. But it depends how the regulator decides to treat REITs within your overall equity portfolio,” he says.


Solvency II will also mean that insurers have to consider their counterparty risk exposure and the duration of cash held, argues Pears.


“Direct counterparty risk exposure, such as insurers holding 30-day


cash with anyone other than AAA-rated counterparties, is capital- intensive, compared with the fund alternatives. Our analysis suggests well- diversified money market funds, with a bias towards high quality debt, are more capital-efficient than a small portfolio of directly held deposits, while providing higher expected returns,” he says.


Tobias Mensing of BNY Mellon Asset Management Product


Development says that the bank’s insurance clients are demanding more transparency and guidance on their assets, ahead of Solvency II implementation.


“Emerging markets’ debt of investment grade quality is definitely of


interest to insurers,” he says. “This asset class provides good returns for a relatively low capital charge. We have Emerging Markets Local Currency Investment Grade Debt Funds holding at least 90 percent investment grade debt and will be able to provide the required security level reporting and currency hedged share classes in the future to minimise the capital charge.


“In general, clients are asking for full ‘look-through’ to the holdings level


for all our products. We can deliver the required information, according to individual client needs. We have open ears and our attention is directed


Paul Traynor can be contacted at: paul.traynor@bnymellon.com


The views expressed herein are those of the contributors only and may not reflect the views of BNY Mellon. This does not constitute business or legal advice, and it should not be relied upon as such.


BNY Mellon is a corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the corporation as a whole or its various subsidiaries. Products and services may be provided by various subsidiaries and joint ventures of The Bank of New York Mellon Corporation, which may include The Bank of New York Mellon (each, the “Bank”), a banking corporation organised and existing pursuant to the laws of the State of New York and operating through its branch at One Canada Square, London E14 5AL, England. Registered in England and Wales with FC005522 and BR000818 and authorised and regulated in the UK by the Financial Services Authority.© 2012 The Bank of New York Mellon Corporation. All rights reserved.


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