Hundreds of billions of dollars in insurance assets could be up for grabs in the next several years because of a set of new regulations in Europe that likely will lead insurers to rely more on external money managers.
More insurance assets may need homes
Solvency II likely will lead insurers to rely more on external money managers
Combined with an already challenging market environment, the new regulations — which are known as Solvency II and are scheduled to be in effect on Jan. 1, 2013 — are set to dramatically change insurance investment portfolios in Europe, said Dirk Popielas, Frankfurt-based managing director and head of Europe insurance solutions at J.P. Morgan Asset Management.
“Nothing will be as it was in the past,” Mr. Popielas added.
According to Comite Europeen des Assurances, a Brussels-based federation of insurance trade associations, European insurance assets total about e6.8 trillion ($9.6 trillion). The vast majority are managed internally, but sources say the move to hire external money managers is expected to grow at an accelerated level as insurance portfolio management becomes more complex under Solvency II.
Globally, about $1.03 trillion in insurance assets are managed by non-affiliated managers, of which about a third is sourced from Europe, estimated David F. Holmes, partner at manager consultant Eager, Davis & Holmes LLC, Louisville, Ky.
The global total represents an annualized increase of about 20% over the past 10 years, estimated Etienne Comon, managing director and head of insurance strategy in Europe at Goldman Sachs Asset Management based in London. Assuming a double-digit rate of growth industrywide, with “a lot of that coming from Europe,” the firm is ramping up its insurance asset management team, Mr. Comon said. In June, GSAM added two key roles in the region, including Mr. Comon's own appointment.
Large-scale reallocations by insurance companies have not yet occurred, partly because of an expected transition period allowed under the new rules, sources said. However insurers are “actively looking at their asset allocations to figure out whether they can improve returns vs. the capital implications,” said Christopher Price, head of insurance advisory services at Deutsche Insurance Asset Management, London, with about $200 billion of external insurance assets globally. Partly because of the additional complexity in insurance asset management under Solvency II, DIAM added a team of insurance asset management specialists from Sal. Oppenheim Group as part of a larger acquisition by parent company Deutsche Bank AG in 2010, substantially increasing its quantitative analysis skills, Mr. Price said.
“We expect that (the total assets to be outsourced by insurance companies) will grow dramatically over the next five years by another $1 trillion in absolute terms” in Europe, J.P. Morgan's Mr. Popielas added. J.P. Morgan began building a distinct global insurance analytics team several months ago, adding expertise in quantitative analysis, asset-liability studies and enterprise risk management as related to insurance companies.
Meanwhile, managers affiliated with insurance companies that have been strengthening their European capabilities include Pacific Investment Management Co., Legal & General Investment Management and Aviva Investors.
Matthieu Louanges, executive vice president and head of PIMCO's European insurance business based in Munich, said the firm has been enhancing capabilities in “many different departments since Solvency II will impact several facets of asset management, including analytics, risk management and portfolio management.” PIMCO has about e280 billion in assets managed for insurance companies, including assets sourced from its parent company, Allianz SE.
One key change under Solvency II is that insurance companies' capital requirements will vary to reflect the volatility of the investment portfolio measured against the volatility of the liabilities. Furthermore, valuations must be on a mark-to-market basis, rather than the previous fixed book-value approach.
“Insurers will look to managers to integrate portfolio management with the capital charge dimension” of Solvency II, Mr. Louanges said.
For example, a typical European life insurance portfolio with 45% government bonds, 45% A rated corporate bonds, 7% equity and 3% real estate would be required to hold capital around 6.3% of the total assets' market value, according to “Solvency II Set to Reshape Asset Allocation and Capital Markets,” a report published by Fitch Ratings in June. Assuming similar liabilities, adding one percentage point to the equity weighting and increasing the mismatch of assets and liabilities to two years from one year could lead to capital requirements about 50% higher, depending on other factors such as portfolio diversification, according to the report.
“One of the things Solvency II does is challenge the old model of investment for insurers,” said Mr. Comon of GSAM, As a result, insurers are looking to external managers who can “integrate capital efficiency in the investment process as well as portfolio management and risk assessment,” he said. GSAM has about $115 billion in assets under management from insurance companies.
Insurers also are putting more emphasis on stable income ahead of alpha generation, said John Roe, head of strategic investment and risk management at Legal & General Investment Management London. LGIM is the fund management subsidiary of insurer Legal & General Group.
“What is needed is a strategy that is quite resilient to changes,” Mr. Roe added. “For example, there will be much more interest in tail-risk management.”
The new rules appear to encourage a higher allocation to government bonds issued in the European Economic Area because they will escape a capital charge, regardless of the bond rating. Therefore, long-dated government bonds will be popular, helping increase the bond duration of the portfolio, said Ravi Rastogi, senior investment consultant at Towers Watson & Co. London, who advises insurance companies. However, because of volatile bond markets within the EEA, insurers will likely turn to lower-returning but higher-rated bonds issued by countries such as Germany and France.
Sorca Kelly-Scholte, London-based managing director of the consulting and advisory services division at Russell Investments, said: “The regulatory changes in Europe may lead many (insurance companies) to upgrade the management of their growth assets,” making them work harder “to compensate for lower overall allocations to growth assets.”
According to data from Russell using information from 24 European insurers, the average allocation to fixed income is about 75% of total assets. Equities average about 4.5%; real estate, 3.8%; cash, 5.1%; with the remainder in ‘other' investments.
“Diversification will clearly be beneficial under Solvency II, and that perhaps hasn't been the case in the past,” said Richard Field, director of global investment solutions at Aviva Investors, London.
“Insurers will need to diversify risk exposures and access asset classes that they haven't had to do before. Some have no existing capabilities to manage the new asset classes.”