Preparing for Solvency II is one thing, but living with it will involve further refinements in how insurers approach asset management, as participants in part one of this InsuranceERM/Standard Life Investments roundtable attest
Daniel Blamont, head of investment strategy & strategic asset allocation, Phoenix Group
Hugo Coelho, assistant editor, InsuranceERM
Iain Forrester, investment director – insurance Solutions, Standard Life Investments
Victoria Gibson, group head of fixed income, QBE
Emily Penn, head of ALM, LV=
Craig Turnbull, investment solutions director, Standard Life Investments
Chaired by Christopher Cundy, contributing editor, InsuranceERM
Chris Cundy: Are your Solvency II preparations all done? How much is going to change next year?
Emily Penn: Broadly, across the industry, people have been so focused on preparing for Solvency II from the regulatory reporting side, and submitting applications for internal models and adjustments, that their asset portfolios are not necessarily where they would like them to be. We will see more work on optimising for the Solvency II environment next year.
Victoria Gibson: I would second that observation. Apart from taking a preventative approach - so you do not end up with something that potentially is going to have a punitive effect - and the focus on asset backed securities, there has not been that deep look.
Hugo Coelho: How fast will it change? In 12 months, would you be able to say, 'we have done all we wanted to' in terms of the allocation?
Emily Penn: It will probably take two or three years, because it will take a while for firms to get a grip with how the balance sheet is working under Solvency II.
Craig Turnbull: It is not necessarily a static target, either. You might know where you want to get to today, but over of the next two or three years, undoubtedly economic reality will change, investment opportunities will change, and the Solvency II regime will change. So, in a sense, it will always be a moving target.
Hugo Coelho: Apart from the internal model and the adjustments to the risk-free curve, is there anything else that will have a big influence?
Emily Penn: Transitionals is the big uncertainty. Nobody really knows how that is going to work in terms of recalculation.
Iain Forrester: One area of potential change is in relation to market disclosure. When companies start reporting their Solvency II balance sheet and its sensitivity, analysts will begin to form a consensus view on appropriate Solvency II capital ratios across the industry. This might lead to further capital management and ALM activity.
Daniel Blamont: We achieved Solvency II compliance in 2015. Next year, the process of optimisation to new metrics can start. This is not just about the SCR: there is also scope for firms to re-think their embedded value-type metrics and re-align them to the new regulatory environment.
Governance and prudent person principle
Chris Cundy: What influence is Solvency II's prudent person principle (PPP) having on the governance of investment portfolios? Will it increase willingness to consider alternative investments, as the PRA said in a recent presentation?
Emily Penn: They are sensible risk management principles, but I do not think they will fundamentally change anything. On the second point, obviously we are moving away from Solvency I's strict rules around asset admissibility, but this new freedom will take time to evolve because of the desire to keep everything as vanilla as possible for day one.
Victoria Gibson: Many aspects of the PPP are just summarising the processes we already have. But they are perhaps helpful for board members who are concerned about their responsibilities around governance of the investment portfolio and how much they can rely on someone else's expertise. When you have a capital modelling team, an independent risk function, an investment committee... resolving the accountability and ownership of responsibilities is interesting.
Emily Penn: Yes, there is more onus on the senior management board to understand the risks they are running, and in some circumstances that can be quite difficult for them if they are trying to invest in a new asset class.
Craig Turnbull: As an asset manager, we increasingly have to think about where in the client organisation does the education about a new asset class have to happen, and therefore what sort of role should we play in supporting the client in that process. An insurance company's actuaries, regulators, consultants, investment professionals, senior managers and NEDs all bring their own particular perspective to bear and the PPP is a useful lens through which the asset manager can consider their needs.
Victoria Gibson: Has there been a broad reviewing and re writing of your investment mandates?
Craig Turnbull: The biggest example has been in the matching adjustment (MA) business. We have worked closely with clients to revise investment mandates so as to be consistent with the regulatory requirements. This focused on areas such as permitted assets, trading/turnover guidelines and management reporting.
Outside of MA business, our work has been less specifically focused on the mandate itself and more on the level of client servicing that insurers require in a Solvency II world – in areas such as granular asset data reporting and, analytics around the solvency capital treatment of different types of strategies or other support that the client needs in order to obtain the appropriate regulatory outcome. The oversight of internal ratings processes is a good example.
Emily Penn: Within MA portfolios, are you seeing firms put the onus on the investment manager to ensure eligibility of assets?
Iain Forrester: We have worked closely with clients to revise investment mandates, which have become much more detailed. The investment manager must comply with the mandate, but it remains the responsibility of the insurer to ensure that the mandate they are setting meets the eligibility criteria and other regulatory requirements.
Daniel Blamont: Mandate requirements have not just changed because of Solvency II. We had already gone through the process of changing the investment philosophy according to the types of liabilities the assets are backing. For example, annuity funds need not invest in credit benchmarked to corporate bond indices. The mix of bonds across tenors, maturity and rating depends on the liability cash flows, return on capital and expected defaults. The matching adjustment has restricted the definition of eligible investments, but ridding ourselves of index benchmarking has expanded the investment set – private placements, for example – and produced better balance sheet outcomes.
Victoria Gibson: Does all this extra work for asset managers mean insurers are still an attractive client, or are we becoming too 'high maintenance'?
Craig Turnbull: The overall cost to asset managers of servicing insurance clients is certainly rising and asset management firms will have to make an active decision around whether to invest in the resources required to successfully deliver these services. For asset managers who do strategically commit to third-party insurance business, it will increasingly be a scale business.
Victoria Gibson: Is it getting harder for niche asset managers to service insurers?
Craig Turnbull: There is increasing interest from insurers in what might be called niche asset classes and that is part of what is driving the greater use of external managers. The successful asset manager will need to have the asset management skills in these niche asset classes, whilst being part of an organisation that has a broader commitment and infrastructure to service insurance clients.
Victoria Gibson: It introduces another aspect of due diligence on that external manager. Are they really fit for purpose?
Craig Turnbull: We see that every week in our discussions with clients, potential clients and investment consultants. They are very much looking at our capabilities in terms of servicing and supporting the specific needs of insurers, clearly as well as our ability to add value in the management of the funds.
Iain Forrester: We see one of the key differentiators being whether the asset manager is willing to provide the transparency that the insurer needs. Are they willing to provide full look-through information for these niche asset classes? Are they willing to support knowledge transfer into an insurer's capital modelling team?
Craig Turnbull: A lot of the newer asset classes for insurers can be very attractive on paper in terms of capital-efficient yield enhancement, but they only work if the insurer is able to obtain that capital treatment. Transparency, openness and proactive knowledge transfer by the asset manager are essential to achieving that outcome.
Emily Penn: The internal rating is a very relevant one in terms of the knowledge transfer between the asset manager and the insurer, because the insurer has to be able to understand that rating process in order to reflect it in the capital modelling.
Chris Cundy: Does this point to a consolidation in the number of investment managers that insurers have? Is a sole manager the way forward?
Emily Penn: Over time, a small number of asset managers will claim this space. But I do not see a reason why, as long as the asset managers are able to service your needs, you could not use a multi manager approach.
Daniel Blamont: The rise of alternative asset classes means that niche asset managers have a place, provided they can offer transparency and clarity on valuation and internal rating, in particular. It makes sense to adopt a core-satellite approach. Traditional core investments are likely to be concentrated among a small number of players. Insurers and asset managers need to be able to work with each other to facilitate access to alternative asset opportunities efficiently and in a timely fashion.
Chris Cundy: Getting hold of the necessary asset data has been a long-discussed problem. Are you happy with the situation today?
Emily Penn: From our perspective, it's pretty well sorted.
Victoria Gibson: Reporting is an ongoing challenge and it goes to the question of resourcing and skills that need to be developed, both on our side and the investment manager's side.
Emily Penn: Specifically for the matching adjustment investment portfolio, we have had to be a lot more disciplined about getting the right management information for business coming in and business going out. Previously we would just get net income and invest it accordingly.
Chris Cundy: Is the tripartite data exchange template proving useful, or have people come up with their own solutions?
Iain Forrester: We are using it for insurance investors in our pooled vehicles. For segregated accounts, it tends to be a more bespoke service.
Craig Turnbull: For asset managers it is not a simple process to make that happen. It requires a big data and IT investment that will take many months or quarters to implement.
Iain Forrester: One of the challenges is that, where you are providing this across all of your pooled funds, you need to implement an automated solution. There are not standard industry data sources for all the information that insurers need to report – in particular for the data that is specific to Solvency II. So it seems very likely that, at least on day one, there will be some variations in the asset data being provided across asset managers and insurers.
Daniel Blamont: We are continually improving our investment database with the aim of having a common data source for all of our activities to ensure consistent and timely delivery of management information across the business.