Two thirds (66%) of respondents said that reform of legislation, including the Solvency II directive, supports greater allocation to a wider range of secure-income assets. One third (33%) said the reforms will have no impact on allocation and 1% said that the changes would not be supportive.

The research showed nearly half (48%) of the insurers surveyed classify secure-income assets as alternatives; 44% describe them as real estate; and 8% categorise these as alternative credit.

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When investing in secure-income assets, 66% of respondents said they select AA-rated instruments; 49% choose A rated; 26% cited BBB grade; and 7% referred to BB. Nearly all (98%) European life insurers said they had been successful in integrating secure-income assets within a matching portfolio.

When asked about the impact of regulatory reforms on European life insurers’ investments in private markets, 88% said these would be supportive of allocations, while 12% said they will have no bearing.

The life-insurance companies surveyed typically focus their private-market allocation on Europe, the research found. Almost half (47%) invest Europe-wide with a home-country bias; 33% invest Europe-wide; 17% invest solely in their home country; and 3% have a global allocation.

Boris Mikhailov, head of client solutions at AlphaReal, said: “Since Solvency II came into force in 2016, insurers have been limited in their ability to hold long-term equity instruments.

“This is at odds with the European Union’s goal to drive investment in long-term, sustainable-investment projects and stifles life insurers’ ability to diversify across different asset classes including private markets, and secure long-term income funds that are well-suited to matching their liabilities.

“We welcome any reform that gives insurance companies the opportunity to invest strategically in these assets.”

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Ed Palmer, AlphaReal’s co-deputy chief executive and chief investment officer, added: “Insurance companies can provide the finance which is so critical in supporting growth in the real economy, by investing in sustainable infrastructure, real estate and other projects that will drive the green transition in Europe.

“It is clear from our research that life insurers acknowledge the importance of revising the qualifying criteria for secure long-income and private assets.”

Insurers’ business models have been hit hard in recent years by record low global interest rates eating into the margins between what insurers earn from investments and pay out to policyholders.

Coming into effect earlier this year, Solvency II sets out the level of capital insurers must hold in order to do business in the EU. The effectiveness of the rule is to be re-examined every five years.

Bernardino told Reuters that Eiopa plans to use the 2021 review to “integrate in Solvency II a macro-prudential framework for insurance”, aimed at looking at insurers’ funding models.

He explained that the macro-prudential operational objectives could include ensuring sufficient loss-absorption capacity and reserving, avoiding negative interconnections and excessive concentrations as well as avoiding excessive involvement in activities posing systemic risk.

Other measures could include limiting pro-cyclicality and risk behaviour as insurers collectively search for yield and avoiding moral hazard.

Recalculating UFR

The news comes as last month, Eiopa said it was considering whether to slash the benchmark used by insurers to calculate the value of billions of euros of liabilities – a move that would push up the cost of life insurance.

The regulator said it would reduce the “ultimate forward rate” or UFR, an interest rate of 4.2% that is used for discounting liabilities over a 20-year period, to 3.7% to better reflect the European Central Bank’s (ECB) ultra-low interest rate.

As a result, insurers will be forced to hold more capital, driving up the price of life insurance.

Solvency II criticism

Insurers have long-complained that Solvency II will make it harder for them to do business, demonstrated by a spate of consolidation within the industry.

In September, Ned Cazelet, chief executive of Cazalet Consulting, which provides strategic advice, market intelligence and support to financial institutions, told International Adviser accused some insurers of using the “transitional relief” clause in the legislation to hide “deep trouble” in their balance sheets.

The exemption gives companies 16 years to comply with Solvency II rules.

“The rules took years to be formulated. If it was so urgent, why did it take 10 or 15 years to bring it in? Also, now the rules have been brought in, you can ask for transitional relief.

“Some UK companies are making selective use of transitional relief but Germany is in particular. Parts of the French and Italian insurance industries would also be in deep trouble,” said Cazalet.

The founder and chief executive of Cazalet Consulting, which provides strategic advice, market intelligence and support to financial institutions, has serious concerns about the direction and speed of Solvency II and the life support it offers to companies he feels should be allowed to fail.

You see similarities between the UK 20 years ago and the situation in Europe today. Can you elaborate?

Twenty years ago in the UK you had lots of companies writing what I would call ‘risk business’. In particular, lots of with-profits business where guarantees were given to customers that the life companies were supposed to be able to pay.

However, a lot of these companies were blind to their liabilities and cruising for a bruising. Almost all of them now are either closed to new business or they no longer exist in their previous form.

We were in a world of fantasy financials 20-odd years ago, with our big, long-term insurance companies. In 1997, 10-year gilt yields were around 8%. Part of our thinking was that they were not going to stay there. We believed interest rates were going to come down, liabilities would go up and the companies would be in trouble.

In less than year they went from around 8% to 4%. Lots of life companies shut down and other people and companies waded in to mop them up, consolidate them and try to manage them as closed funds.

How did that affect the market?

The Financial Services Authority (FSA) had just come into existence around that time and I did some work with them. There were regulations and people passed the tests, except the tests were as much use as a paper parasol in a monsoon.

The wrong things were being measured meaning people deluded themselves that everything was OK because they had passed the test. The regulator needed to come up with a proper, market-consistent and realistic solvency regime, in particular for with-profits business.

What emerged was a whole raft of changes to with-profit governance, in particular the solvency regime I call ‘Solvency 1.8’. This means people had to live in the real world, value their liabilities properly and use market-consistent pricing with proper stress-testing and modelling.

Given the UK life sector’s history, is it in a better position than other European companies to adopt Solvency II?

UK life companies are still going to have a heck of a job getting ready for Solvency II but I think the UK has started in quite a good place. Luckily, we got ourselves in shape and pulled ourselves back from the brink in the late 1990s, early 2000s.

You have been very critical of some aspects of Solvency II. Why?

The rules took years to be formulated. If it was so urgent, why did it take 10 or 15 years to bring it in? Also, now the rules have been brought in, you can ask for transitional relief. So after a 15-year argument about what the rules should be, when the rules finally hit you’ve got 16 years to comply.

Transitional relief was instigated on behalf of German insurers. If Solvency II was implemented in full strength on day one, not many of them would be left standing. Some UK companies are making selective use of transitional relief but Germany is in particular. Parts of the French and Italian insurance industries would also be in deep trouble.

Will German 10-year government bonds now in negative territory cause further problems?

Just because the new rules won’t bite for 16 years does not mean you are not exposed to the underlying economic realities. I am simplifying here, but if a company is guaranteeing 3% it will probably have to earn 5-6% to net off the 3%. But if the market is giving you 0%, things start to look more interesting.

Let’s say every year the company agrees to pay you an annuity. It will need some assets, probably some bonds and maybe some equities to generate the right amount of cashflow over that period.

When the company comes to do a valuation of its liabilities it needs to look at what yield it is getting on its assets. If the assets are yielding 5%, the company can discount its liabilities at that present value. Whatever the asset yield is, you can use that as a discount rate. The lower the yield, the higher your liabilities are. It is standard practice all around the world, not just for insurance.

With a raft of existing and upcoming regulation to address, many asset managers said that they are looking for ways to minimise the reporting burden associated with both pieces of regulation, with some looking to reuse reporting and regulatory data.

Mifid II

Adopted in 2007, the existing Markets in Financial Instruments Directive (Mifid) aims to improve the competitiveness of EU financial markets by creating a single market for investment services and activities, and ensuring a high degree of harmonised protection for investors in financial instruments, such as shares, bonds, derivatives and various structured products.

Mifid II, which was pushed back by one year, is expected to come into force in 2018.    

The updated regulation is intended to strengthen the protection of investors by introducing robust organisational and conduct requirements.

It also aims to ensure that trading takes place on regulated platforms; introduces new rules on high frequency trading; improves the transparency and oversight of financial markets and will strengthen competition in the trading and clearing of financial instruments.

Reporting overlap

Oonagh O’Mahoney, senior vice president at Accudelta, said: “It has become clear that a common regulatory language is beginning to emerge allowing asset managers to identify overlaps between a number of regulatory reporting regimes.

“There has been considerable discussion about the potential overlaps between areas of the Priips (packaged retail and insurance-based investment products) regulation and aspects of Mifid II. It’s logical therefore for asset managers to leverage their efforts and look for overlap and reusable reporting data.”

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‘Double-hit’ scenario

The test will focus on two major risks; the impact of prolonged low interest rates and a “double-hit scenario” combining a sudden drop in asset prices with rock-bottom interest rates.

In recent years, European insurers have seen their profits battered by low interest rates and the new Solvency II capital rules, forcing them to adjust their business models and offload less profitable units.

“Persistent low risk free rates and relevant volatility in equity markets characterise the current EU financial sector, making market risks the main source of concerns regarding the stability of the insurance industry,” said Eiopa on its website.

The last test in 2014 was conducted prior to the Solvency II legislation coming into effect.

75% market share

The trade body said that although no insurance groups will be included in the test, the number of small and medium-sized insurers has been increased from a 50% share of each national market in 2014 to a 75% share this year.

Set up in 2011, Eiopa’s mandate is to support and ensure the transparency of the EU’s financial system, as well as protect insurance policyholders, pension scheme members and beneficiaries.

To limit the burden on the insurance industry, the regulator said it will use the exercise to also collect information on the Solvency II equity and Long Term Guarantees (LTG) measures.

Gabriel Bernardino, chairman of Eiopa, said: “The current challenging macroeconomic environment has to be acknowledged in such a stress test exercise. Therefore, Eiopa decided to conduct severe stress scenarios. 

“I am confident that the results of the simulation of such shocks will provide us with a high-resolution picture of the European insurance sector and its most critical vulnerabilities.” 

Not a ‘pass-or-fail’ test

The organisation was keen to assure firms that the test was not a ‘pass-or-fail’ exercise and on completion would not require them to calculate their solvency position.

The deadline for submission is 15 July, with the results coming out in December this year.