23.6.2011
By Simon Miller
European insurance regulatory regime Solvency II is set to change how insurers allocate their assets according to a report from Fitch Ratings.
The report, Solvency II Set to Reshape Asset Allocation and Capital Markets, highlighted that the new rules required insurers to value asset and liabilities at market value in determining their solvency position.
As a result, Fitch claimed that there would be a shift from long-term to shorter-term debt. In addition, Fitch expects an increase in the attractiveness of higher-rated corporate debt and government bonds; an increase in the attractiveness of covered bonds; and a preference for assets based on the long-term swap rate and a shift from short-dated paper to deposits.
"Solvency II will force insurers to set aside explicit capital to reflect short-term volatility in the market value of the assets they hold," said Clara Hughes, director in Fitch's Insurance team. "Insurers' asset allocations will be heavily influenced by these capital charges, which vary significantly by asset class, quality and duration. This is a fundamental change from current asset allocations, which are driven by expected long-term investment returns."
European insurers are the largest investors in the European financial markets, holding €6.7trn (£5.9trn) of assets including more than €3trn of government and corporate debt.
Fitch expects to see better duration matching with derivatives such as swaps and floors and an increase in downside protection to mitigate the impact of the new capital charges. The ratings agency also anticipates an increase in financial engineering to create Solvency II-friendly assets such as reverse repos and structured notes, which can optimise return on capital
However, Fitch considers it unlikely that large-scale reallocations will happen in the short term as transitional arrangements are likely to phase in implementation of Solvency II over several years.
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