(February 13, 2012) — Hedge funds and private equity companies stand to gather billions of dollars in assets as European insurance companies shift their investment portfolios in advance of Solvency II regulation, BlackRock has found.
Almost a third of European Insurance investors, controlling around 62% of worldwide sector assets that total $7.4 trillion, told the asset manager they would up their allocation to hedge funds and private equity to position themselves and still be ready for the incoming Solvency II regulation.
The average allocation to hedge funds by the insurance industry is around 1%, BlackRock said, with a further 5% allocated to other alternatives, not including property.
David Lomas, Global Head of BlackRock’s Financial Institutions Group, said: “We are in a low yield environment and if insurers are offering guaranteed products to policy holders or if they have higher hurdle rates of returns for shareholders than current bond indices provide then they will be searching for yield.”
Lomas said that if insurance companies were following the strict model set by Solvency II regulations – which compels insurance companies to match their liabilities with assets, while holding low-risk securities – they may not automatically opt for alternatives, but there were several reasons why they might allocate to alternatives if using their own internal model. He said that if insurers could demonstrate that they understand the asset class, have transparency of look through to the underlying holdings and could model the market risk of the strategy at a more granular level, then they would be in a strong position to lower the current capital charge applied to the asset class.
He said if investors could display the risk of their assets was matched to the higher returns of their alternative holdings, they would be able to satisfy the regulator. Better data would avoid insurers accepting a 49% solvency requirement that is currently set to be levied on ‘riskier’ assets.
However, Lomas added that the quality of data available from alternative asset managers would be paramount for insurers to up their allocation to the asset class.
He said: “If insurers cannot get access to data in a timely and accurate manner there will be problems. Insurers need to interrogate data on assets in the same way they interrogate data on their liabilities, for example, looking at disaster scenarios or certain market events and understading how their assets would perform in those instances and the impact this would have on the balance sheet.”
This clarity on data is the largest stumbling block for alternative asset managers at the moment.
Some 92% of insurers told BlackRock that they were concerned that poor investment reporting and lack of clarity into underlying assets would limit their investment strategy.
Lomas said that BlackRock has more than $1.5 trillion of Insurance Company assets on it’s BlackRock Solutions platform. This platform provides insurers with the ability to assess their assets on a daily basis. It also provides them with the flexibility to stress their portfolios on a daily basis against a series of pre-determined risks, such as those envisaged by Solvency II.
He said: “Insurers have to acknowledge that they may have to do business with investment managers that are of a sufficient scale to be able to supply clear information in a timely manner, but it is also up to the alternative investment industry to provide the information…”
For an in-depth interview with Towers Watson’s Co-Head of Insurance Advisory click here.