Asset allocation in a post-Solvency II world

Marco Diolosa, Head of Rates and Derivatives with Pension Insurance Corporation and Daniel Blamont, Head of Investment Strategy at Phoenix Group discuss how diversification and asset allocation have changed in response to Solvency II.

Insurance Insight Editorposted on Thursday, September 12, 2019

This excerpt is taken from a roundtable: ‘What strategies are proving successful in driving returns from an asset allocation strategy and achieving diversification at the lowest capital cost?.’

You can read the full roundtable in the research report Insurance Asset Management – Europe 2019, which can be downloaded here.

Insurance Investor: How has Solvency II and other regulations changed the way you invest?

Marco Diolosa: Asset allocation has changed somewhat in the post-Solvency II world. Before that there was more freedom to use a broader universe of assets to match liabilities than there is today.

Being an annuity provider, we use the matching adjustment to discount our liabilities, this means we can only invest in assets that are deemed “MA eligible” from a regulatory standpoint.

"Before Solvency II there was more freedom to use a broader universe of assets to match liabilities than there is today"

The matching adjustment eligibility criteria is quite restrictive and reduces the universe of assets we can invest into.

So yes, there are more asset classes or asset types available, but this availability of assets is counterbalanced by more stringent regulation.

This makes asset allocation and diversification more difficult on balance in our view.

Daniel Blamont: There is this prescriptive or reduced universe of assets you can invest in, within matching adjustment.

Also, within non-matching adjustment liability pools that an insurer may have, not necessarily restrictions on the investments themselves, there may be capital needs that mean that you are also restricted to some extent.

One new market development that we’re seeing, with Legal & General at the forefront of it, is the actual creation of an asset.

"A lot of insurers are looking to go further upstream in order to shape investments"

They are building houses for the rental market, long term leases, ground rents, and so forth. They are going all the way to the source and creating different catch flow streams, to then distribute them to different parts of their book.

We aren’t necessarily going to do this ourselves, but a lot of insurers are looking to go further upstream in order to shape investments or financing that suits the different parts of the book.

Marco: We have indeed seen that it is possible to manufacture eligible matching assets under Solvency II through structuring.

Many of our peers are securitising equity release mortgages into a junior and senior note. The senior note goes into the matching adjustment fund and backs liabilities and the junior note is either held somewhere else on balance sheet or sold in the market.

This could potentially be extended in the future into other types of asset classes, and so asset types that aren’t eligible today could become so in the future.

"It is possible to manufacture eligible matching assets under Solvency II through structuring"

Investors shouldn’t underestimate the amount of work required to securitise assets, and the need for the regulator to approve such structures.

Daniel: We have third-party managers who are investing in securitised assets on our behalf, a good example being student loans.

The UK government is trying to sell a chunky stake in student loans. They have sliced up their loan book into different parts with some going to annuity funds, pension funds and private equity type of investment strategies.

The other side is realising the needs of the different investor types out there, so there is hope that we won’t need to do all of the securitisation ourselves.

II: Solvency II is clearly one of the major issues that is impacting asset allocation. Are there any other major issues at the moment or is it mainly Solvency II?

Daniel: We prefer to see Solvency II more as a constraint.

We have a top down view of building a portfolio and still want good returns versus economic risk.

What we avoid at all costs is building a portfolio that is solely optimised versus capital, because we know that if you have a downgrade then your capital jumps up and if you build something with say bonds that are single A-, AA-, BBB-, which looks very good on your balance sheet on day one but overtime you are just kidding yourself.

"What we avoid at all costs is building a portfolio that is solely optimised versus capital"

We are aware of this and so the way that we have designed the mandates and where we externalised our investment decisions, are in Solvency II aware investments but not Solvency II optimised.

This excerpt is taken from a roundtable: ‘What strategies are proving successful in driving returns from an asset allocation strategy and achieving diversification at the lowest capital cost?.’

You can read the full roundtable in the research report Insurance Asset Management – Europe 2019, which can be downloaded here.