Insurance industry experts have described the treatment of equity investments under Europe’s Solvency II regime as “harsh” and “punitive” and suggested that regulators should review their approach to private equity in particular.
This could have a knock-on impact in Asia. Insurance firms and watchdogs in the region will be monitoring the situation closely, as various jurisdictions in the region develop their own risk-based capital (RBC) regimes, in many cases taking cues from European regulation.
A regulatory review of Solvency II – which requires insurers to hold different amounts of capital against investments according to their perceived riskiness – is under way this year. There are hopes that risk charges for certain holdings will be reduced.
“If you look at the risk categorisation for equity under Solvency II, it’s certainly quite harsh at present; it doesn’t really make any sense,” said Hugh Savill, London-based director of regulation at the UK’s Association of British Insurers, speaking this month at an FT forum in London, Managing Assets for Insurers.
He told AsianInvestor by email that the 'base shock level' for OECD equities under Solvency II is 39% and for other types of equities (including unlisted equity) is 49%. He added that these figures are modulated by a symmetric adjustment mechanism of plus or minus 10 points.
UNLISTED EQUITY CHARGE
Savills suggested that the treatment of unlisted equity, in particular, "deserved a closer look", as the landscape has changed.
“It’s no longer evident now that if you are a company with ambition you must list,” he said. “The burdens of public listing are huge, and there’s a lot of attractive [stock] available through private equity. I don’t think the regulations reflect that properly any more, [in respect of] the balance of risk.”
Heneg Parthenay, head of insurance at Insight Investment, part of the BNY Mellon group, made similar points. Insurers were among the early investors in private equity, he noted, but Solvency II has had a negative impact on allocations to the asset class in UK and Europe.
“At the same time, Solvency II makes investment in private credit relatively more attractive,” said London-based Parthenay. “Capital charges are quite punitive on the equity side, but less so on the debt side.”
Hence, he added, there is a “disconnect” between the treatment of private debt and of private equity in the Solvency II framework.
Parthenay also suggested that the rules should incorporate specific treatment of inflation. “Currently each insurer has the discretion to decide how to treat, measure and reserve against inflation risk under Solvency II. That could be addressed in future changes to the Solvency II framework.”
Insurers in some Asian countries have voiced similar views on equity treatment under incoming RBC regimes in their own markets. Investment heads at Thai firms FWD Thailand and Krungthai Axa Life expressed concerns earlier this year about potential charges for equity holdings as they awaited confirmation of the details of pending rules.
The review of certain parts of Solvency II enables Asian watchdogs to learn and make their own adjustments, Andries Hoekema, global head of insurance segment at HSBC Global Asset Management, told AsianInvestor.
A number of Asian regulators are building risk-based capital regimes to implement the International Association of Insurance Supervisors' Core Principles, he noted. This includes Solvency II but also Australia's Life and General Insurance Capital Standards and China Risk Oriented Solvency System.
Taking the Solvency II regime as a whole, some insurers are relatively sanguine about its impact.
Jane Styles, chief investment officer at London-based property-and-casualty insurer MS Amlin, said during the panel: “Overall, Solvency II has not been as bad as some people think [in terms of its effect on investment portfolios]. I’ve had to make virtually no changes to my strategy because of Solvency II.
“The only thing is we’ve had to sell a few structured bonds that don’t meet the risk retention rules, which was a tiny amount anyway,” added Styles.
Ultimately, Solvency II is making the insurance industry more cautious and forcing it to ask what would happen in a crisis, said Guillermo Donadini, CIO for international (non-US) markets at property-and-casualty insurer AIG.
“We have to assume that if a crisis hits, we have no room for manoeuvre,” he noted during the same panel discussion. “That’s the best way to ensure you have enough buffers to face a credit crunch or market crisis.
“Hopefully insurers won’t be forced to sell, but they are not going to be there to buy stuff that others are selling. That’s what we have to assume,” added Donadini.
He also outlined during the discussion how AIG is rethinking its asset allocation framework in light of what it sees as a fundamental shift in the market environment, as reported by AsianInvestor last week.