Feature – Solvency II
While there is little data available on the asset allocation of the insurance sector as a whole, a survey of the insurers managing the 10 largest annuity books in the UK revealed that some 70% of the £320bn they collectively manage is invested in fixed income. A mere 4% are held in equities and property com- bined, while 16% is invested in loans and mortgages, according to a KPMG report commissioned by the Association of British Insurers (ABI).
The industry body predicts that if the Solvency II rules are eased, it could free up an additional £95bn to be invested in projects like renewable energy or social housing. Jacob Rees-Mogg, the minister for Brexit opportunities, has a good reason to speed up these reforms. The EU announced its proposals to reform Solvency II in September, which included a €90bn (£74bn) capital injection to bolster insurance invest- ment in illiquid assets, and Britain’s government is keen to ensure the competitiveness of its insurers. The UK’s reforms are expected to be part of the Financial Ser- vices Bill to be included in the Queen’s Speech in May. If the government wants to establish competitiveness with Europe’s insurers, it will need to crank up the pace of its reforms.
(Mis)matched adjustment For insurance investors, by far the biggest obstacle to greater investment in illiquid assets are the Matching Adjustment rules. The purpose of the rules is to ensure that long-term investments will meet long-term liabilities. But this effectively forces insurers to allocate most of their assets to investment- grade debt. In the current environment of low yields and rising inflation, this raises serious problems for investors. The Pen- sion Insurance Corporation (PIC), which specialises in de-risk- ing defined benefit (DB) pension schemes, describes Solvency II as “the economic equivalent of riding a bike wearing three helmets – extremely secure, but ultimately limiting to overall performance.” The Matching Adjustment also presents a challenge for ESG- focused investors. The ABI is one of the most vocal opponents of Solvency II believing that the rules are an obstacle to build- ing greener investment portfolios. “It is currently much easier to invest in a highly-rated mining company than it is to invest for 30 years in a wind farm,” the ABI said in a report. Allen Twyning, PIC’s head of affordable housing, argues that the Matching Adjustment rules are the biggest problem facing insurance investors, but they are also the easiest to address. “Matching Adjustment eligibility specifies which assets we can use to back our liabilities. At the moment, these assets are not callable or come with a pre-payment penalty. If a borrower wants to repay the debt early they have to pay us enough so we can buy another asset. “So, if we were to lend to a housing association and they wanted
56 | portfolio institutional | May 2022 | issue 113
We are big supporters of changing the rules to allow us to make power- ful investments, to allow us to think about social value, as well as economic value.
Tom Sumpster, Phoenix Group
to repay the money early, they would have to give us enough money that we could repay the cashflows with say government bonds. That is expensive for any borrower to take on,” he says. Add to that the fact that many infrastructure investors are struggling to find appropriate projects to invest in so insurers stand to lose out to the banks, which are not restricted by these lending rules. Compared to other insurers, PIC already has a significant allo- cation to infrastructure, which accounts for roughly a fifth of its £50bn of assets. But the buyout and buy-in provider expects its assets to double rapidly during the next decade, as DB schemes continue to mature. If Solvency II rules are relaxed, it expects to expand its infrastructure allocation by up to £50bn during the next eight years. Tom Sumpster, head of private markets at FTSE-listed insurer Phoenix, also sees the opportunity. “Solvency II is overly restrictive for the investments we would like to make. “There should be greater flexibility in terms of the capital that we have to apportion against our Solvency II investments,” he adds. “If we were given capital relief, there would be a greater potential to make investments in the markets where we want to do that, and where we can make a real difference, such as sup- porting social housing and the transition to renewable energy.” As long-term investors, life insurers, in particular, should be well placed to invest in illiquid assets. “The private market has now matured to a certain degree, providing us with an oppor- tunity to invest in real assets where we can make a difference to people’s lives,” Sumpster says.
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