Solvency II shake-up: are insurance executives ready for a wave of post-Brexit investment? This Opinion article by Gayatri Raman, President Europe and Asia, Clearwater Analytics takes a look.
They say good things come to those who wait. The governments proposed post-Brexit reforms to the EU’s Solvency II requirements finally incentivises UK insurers to put their excess cash to better use with lower capital charges. There is no doubt that Solvency II has proved to be overkill in the eyes of numerous insurers. Originally brought in to reduce any possible risk of an insurer becoming insolvent, the rules are the housing equivalent of needing to earn a £200,000 salary to cover a £200,000 mortgage, as opposed to applying a normal four times multiple.
This basically means that the insurance industry has been forced to hold a huge pile of cash which, until now, has been unable to put to work elsewhere. It is, however, important to note that the UK government is not getting rid of the need to hold a certain amount of capital in reserve to meet liability requirements, they are simply saying that insurers do not need all this excess cash. Particularly given the fact that, by definition, insurers already hold a high percentage of safe assets. A typical insurance portfolio, as a case in point, is largely made up of straightforward and relatively low risk fixed income assets such as long-dated government bonds or high-grade corporate bonds.
However, with bond yields at record lows, and with insurance companies committed to written guarantees to deliver some level of returns to investors, the reforms come at the ideal time. Many are already looking to invest in private market assets that can produce a higher yield. Some are considering infrastructure bonds issued, or even futures and other forms of derivatives. The smaller to medium sized insurance companies in particular are currently looking for all sorts of ways to better understand the risks in investing in these asset types, in the hope they can ultimately deliver stronger returns.
This is all well and good if insurers have the capabilities in place to support alternative asset classes and complex investment strategies in the search for higher yields. This includes having a complete understanding of the investments, their potential, and the market and global dynamics affecting them at your fingertips daily. Real-time information is the only way to predict performance, manage risk, and ensure compliance. Having the ability to diversify means insurers also need to invest cash or cash equivalents confidently by ensuring there are up-to-date positions and risk statements each day. This single view of the truth is mandatory in the search for greater returns. Given the proposed Solvency II changes and the current investment environment, insurers will need to evaluate different investment strategies relative to where they are today.
This is the only way they will be able to truly understand the impact of those investment strategies across a range of metrics relevant to their business. For example, what impact could an increase mid-market loan exposure by 10% really have on their non-EU regulatory capital over the next five years? Yes, a more relaxed regulatory insurance regime opens up opportunity, but only if insurers can find the answers to questions such as this. Those that find answers are set to gain the most from these reforms whenever the legislation is passed. Ultimately, it will be these firms that can use the capital released to invest in infrastructure and drive the UK forward in delivering a dynamic post-Brexit financial services market.