Asset managers which deliver timely and accurate position-level data to their insurance clients under Solvency II could see increased inflows of capital from insurers.
Solvency II, which will be implemented from January 1, 2016, subjects EU insurers to risk-weighted capital charges and additional reporting obligations. Insurers into hedge funds must hold 49% in capital of their investment. Those insurance companies with exposure to private equity and OECD listed equities must hold 39% in capital, while real estate commands a 25% capital charge. However, the capital charge for exposure to European Economic Area (EEA) sovereign debt stands at 0%. Given the recent bail-outs of several Eurozone members, the capital weighting for EEA sovereign debt has prompted much scorn from the industry.
The Solvency II capital requirements have already caused a handful of insurers to dis-invest from hedge funds, most notably Storebrand in Norway. However, hedge funds offering separately managed accounts can enable insurers to lower their capital charges. Nonetheless, separately managed accounts are expensive to operate so the investment mandate from the underlying insurance client would need to be sizeable for it to be justified. Those managers providing a complete look-thru on their investments could also help insurers lower their capital charges. It is these managers demonstrating complete transparency, which could see insurance capital inflows.
Some speculate funds of hedge funds (FOHFs) could struggle to maintain insurance clients if their own underlying hedge funds refuse to provide them with look-thru on their investments. “We obtain position-level data from our managers, and therefore we can supply more granular data to insurers. As such, we believe insurance companies will invest with FOHFs that can supply them with timely data and help them understand the inherent risks in the portfolio. This should provide the diversification they are looking for without necessarily increasing their capital charges,” said Melanie Rijkenberg, Associate Director at Pacific Alternative Asset Management Company (PAAMCO), a FOHF.
Several industry associations across the EU including the UK’s Investment Association (IA) have developed a standardized template for data reporting by managers to insurers as part of their Solvency Capital Requirement (SCR). Insurers, in turn, are obliged to report this data to national competent authorities. Some managers have expressed alarm that proprietary data could inadvertently be leaked, while others are worried they may struggle to deliver the data within the tight-frames.
A paper by J.P. Morgan in February 2015 highlighted that “relative to other institutional investor segments, insurance companies historically have had lower allocations to alternatives in general and to hedge funds in particular.” Insurers have traditionally been biased towards fixed income and credit, mainly due to the stringent risk based capital frameworks they must adhere to. However, the J.P. Morgan paper added that the low interest rates and depressed bond yields was leading to income problems for insurers. As such, many will be obliged to attain diversification by exposing themselves to other asset classes, including hedge funds.