By James Hughes, Head of Aberdeen Solutions and Matthew Smith, Head of Client Solutions
This was long enough for European insurers to have to meticulously plan for a new way of approaching assets and liabilities that was still evolving right up to the live date. Insurance chief investment officers (CIOs) are now looking at their investment portfolios through the same glasses that you're handed when you arrive at a 3D movie screening.
It's no longer the case that a portfolio can be evaluated using traditional ‘2D’ risk and return techniques; the CIO (and its asset manager) now needs to factor in a third dimension – the level of capital required to cover the invested assets, given the liability profile. In our view, this is one of the most disruptive aspects of Solvency II.
3D films are just an illusion, a bit of cinematic magic that give the impression of depth, even though the film itself is as flat as it ever was. The standard model under Solvency II affords insurers no room for the kind of trickery that could allow simple ‘optical’ treatment of capital requirements to appear smaller or larger.
The requirement to think in three dimensions arrives at an interesting time for insurance companies. There is something of a ‘perfect storm’ currently bearing down on insurers’ asset mix. Low interest rates, expensive risk assets and higher levels of currency volatility are all complicating investment strategy.
Add to the mix continued pressure on underwriting income from falling premiums. Then introduce new solvency and accounting requirements and you can begin to appreciate the problem. For many years, smart CIOs have looked to deliver higher returns through ‘sweating’ their asset book. In a low interest rate environment, an ‘every basis point’ mentality increasingly becomes the focus of investors. However, allocating capital to many of the asset classes that can actually deliver higher yields now carries a relatively unforgiving capital charge.
Modern 3D technology now feels a little like an attempt to revise a century-old proposition for an audience that expected something more thrilling when visiting the cinema. Simultaneously, it is propping up an industry that has been brought to its knees by piracy and streaming.
Having got 3D down to a fine art, the movie industry’s next big innovation was 4D, an immersive cinematic experience that makes watching a film feel like a wild theme park ride for the senses, but also makes the modern silver screen a considerably more complex proposition than ever before.
Solvency II was EIOPA’s attempt to take the best bits of various established global risk-based capital regimes and ensure that European insurers were in the best possible health to withstand another global financial crisis. For now at least, most European insurers only have to contend with Solvency II’s third dimension.
For those select large insurers that have been handed Systematically Important Financial Institution status or complicated ownership structures (e.g. certain bancassurers), however, a fourth is already a reality.
Regulation is inevitably becoming more complex, and plans are already in place for global capital standards to be implemented as early as 2018. In this environment, the need for sophisticated modelling and asset management solutions designed by businesses like Aberdeen will only become more important to the investment portfolios of insurance businesses.
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