Solvency II survey - Alfi

Solvency II - Impact on Asset ManagementWhat are the keyimpacts and challengesof Solvency II for assetmanagers?The main challenges for asset managers canbe summarised as follows:QQData management will be key for thesolvency capital requirements calculationof insurers and the reporting to thesupervisors. Market risk related toinvestments in collective investments fundswill have to be assessed based on a ‘lookthrough’approach, considering the risksrelated to each underlying asset.Any quality default in delivering requiredinformation may cause delays in thesolvency capital requirement calculation,even conflicts between the (re)insuranceundertaking and the supervisor.QQProduct analysis and investmentstrategies should be reviewed to includeconsiderations as:- Greater emphasis on Asset LiabilityManagement;- Central role for rating;- A measure of risks related to theinvestment strategies;- Solvency II capital requirement.QQService level agreement re-negotiation,to integrate additional services and newtypes of requirements from (re)insuranceundertakings to asset managers.Asset managers who will be able to developSolvency II ready offerings both in terms ofdata, governance and investment range willbenefit from a significant competitive advantage.European insurancesector: key factsAs at 31 December 2010, Europeaninsurance undertakings have been amongthe most important investors in the EU withmore than EUR 7.3 Trillion invested in theglobal economy including EUR 3.7 Trillionin debt assets, which represents about 50%of the total assets under management inEurope and 54% of the European GrossDomestic Product.Breakdown of assets under managementfor European institutional investors atthe end of 2010Shares held by insurers/Marketcapitalisation in Europe35%30%25%20%15%10%5%0%2000 2001 2002 2003 2004 2005 2006 2007 2008Source: CEA, European Insurance — Key Facts, September 20113%28%42%Consequently, the new EU Solvency Directiverelated to the (re)insurance sector will impactthe economy on a global level, and the relationsbetween (re)insurance undertakings andasset managers.27%n Insurance undertakingsn Bankn Pension fundsn other institutionalsSource: EFAMA « Asset Management in Europe, facts andfigures », May 20124

Solvency II principlesUnder the new solvency rules, Europeaninsurers and reinsurers are required toconsider all type of risks to which they areexposed and to manage those risks withmore transparency. The Solvency IIframework directive does not apply forthe moment to pension funds.Under Solvency II, (re)insurance undertakingsare required to own an amount of capital,also called the Solvency Capital Requirement(SCR) in order to face unexpected events inaddition to the technical provisions designedto cover all their obligations towardsthe policyholders.It is expected that the Solvency II directivewill be implemented in the Member Statesof the European Union at the earliest on1 January 2014.The implementation of Solvency II is basedon a “Three Pillar” approach, as shown inthe following table:Framework Directive – overviewPillar I QuantitativerequirementsPillar II SupervisoryreviewPillar III DisclosureQQAssets and Liabilities -market consistentvaluationQQInvestments rules:freedomQQSolvency CapitalRequirement (SCR):European StandardFormula; or InternalModelQQMinimum CapitalRequirement (MCR)QQOwn FundsQQSystem of governanceQQOwn Risk and SolvencyAssessment (ORSA)QQSupervisory reviewprocessQQSupervisory interventionincluding capital add-onQQPublic Disclosure - annualsolvency & financialcondition report (SFCR)QQInformation to beprovided for supervisorypurposes (RSR)QQQuantitative ReportTemplate (QRT)Asset Managers and services providers = Key data ownersUnlike the current regime, all the requirementsare now closely linked with the asset side ofthe (re)insurer’s balance sheet, that’s whyasset managers are directly and indirectlyimpacted by the three aspects of the newEU Directive.The Solvency Capital Requirement (SCR) isa risk responsive capital measure calibratedto ensure that each insurer will be able tomeet its obligations over the next 12 monthswith a probability of 99.5%.The risk modules which have to be consideredinclude: Market risk, Counterparty defaultrisk, Life, Non-life and Health underwritingrisks, Intangible assets risk and Operationalrisk. The capital requirement is based onsensitivity to all quantifiable risk factorsincluding market risk presented as riskmodule in the directive (risk-based approach).5

Solvency II - Impact on Asset ManagementThe key risks modules that impact the assetmanagers are the market risk and thecounterparty default risk.Many large insurers will develop their owninternal models to calculate the SCR, whilesmall and medium sized insurers are likely touse the standard formula provided by theEuropean Insurance and OccupationalPensions Authority (EIOPA).The (re)insurance undertaking will have toregularly conduct an Own Risk and SolvencyAssessment (ORSA).The (re)insurance undertaking will need toestablish an effective system of governanceincluding risk management, internal control,internal audit, actuarial function andoutsourcing (written policies).According to the fifth Quantitative ImpactStudy (QIS5), the Market risk represents67.4% of the Basic Solvency CapitalRequirement (BSCR) for life insuranceundertakings which are by far the largestinvestors on the stocks markets.The QIS5 exercise shows the followingresults as at 31 December 2009:Decomposition of the diversified BasicSolvency Capital Requirement (BSCR)for all European solo undertakings(life and non-life)16.80%15.30%n Marketn Non-life6.90%4.30% 0.20%n Counterpartyn Healthn Life56.50%n IntangibleSource: EIOPA Report on the fifth Quantitative Impact Study (QIS5)for Solvency II, 14 March 2011Market risks represents one third of the BSCR for non-life insurance undertakings which arethe second largest contributor.% of market risk160%140%120%100%80%42%12%30%10%6%8% -36%100%60%40%28%20%0%Interest rateEquityPropertySpreadCurrencyConcentrationIlliquidityDiversificationMarket riskEquity risk represents more than 42% of the Market Risk Solvency Capital Requirement.6

All investments held by (re)insuranceundertakings, fall under the Market Riskmodule and Default Risk module of theSolvency II framework. In order to measurethe market risk inherent to any collectiveinvestment vehicle, Solvency II requires theuse of a "look-through" methodology.(Re)insurersMUST starthereThe alternatives to the look-throughapproach are penalised in term of capitalcharge. So, Solvency II shocks will be appliedat the level of each underlying asset line.A security level look-through will give the mostaccurate representation of market risk andwill, in all likelihood, lead to a lower capitalcharge being applied to a collective investment.StandardMandateEquityQQLook-throught for direct &indirect exposuresQQMandate-based method(Maximum capital charge)QQEquity simplification(Global versus Other)Increase in capital charges7

Figure 3: Impacts of Solvency II on asset managers’ business – ProfitabilityWhat do you think will be the impact of Solvency II on your organisation in terms of profitability?50%40%30%20%10%0%27%13%13%47%Positive No Negative I don’timpact impact impact know27% of asset managers that respondedbelieve that Solvency II will help maketheir organisation more profitable, while47% of asset managers are still unsure and13% expect significant implementation cost.One of the participants commented: “Our view is that Solvency II will certainly havemultiple impacts on us, however, we cannot say today whether this will impact us positivelyor negatively in terms of profitability and investment strategy.IT developments and reporting are a cost and will have an immediate negative impact iftaken in isolation.”Figure 4: Impacts of Solvency II on asset managers’ business investment strategyWhat do you think will be the impact of Solvency II on your organisation in terms ofinvestment strategies?50%40%30%20%10%0%20%33%7%40%Positive No Negative I don’timpact impact impact knowOnly 20% of participants believe thatSolvency II will positively impact theirinvestment strategies, while 33% thinkthat there will be no impact and 40%are still unsure.One of the participants commented: “Asset managers will be impacted, as they are eitherpart of insurance undertakings or act as service providers to them. Moreover, they will needto review and adapt products to align with new investment strategies. New reporting may berequired by insurers.”9

Solvency II - Impact on Asset ManagementFigure 5: Impacts of Solvency II on the asset classes allocationWhat do you think will be the impact of Solvency II for your organisation onthe investment strategies?negative Impactpositive ImpactEquity67%33%Real Estate67%Bonds100%Structured products and funds33%67%Money market products and funds67%Direct and positive impact expected for bonds, money market and structured productscompared to equity and real estate investment products. Some participants are unsure of whatthat impact will be.Figure 6: Impacts of Solvency II on asset managers’ business – other organisational impactsWhat do you think will be the impacts of Solvency II for your organisation?negative Impactspositive ImpactsRisk management/Reporting40%33%IT Development cost60%7%Development of new products7%53%Clear expectations of negative impacts of Solvency II regarding IT development costs andpositive impacts on the development of new products.There is still some confusion regarding the impacts on risk management and reportingrequirements.One of the participants commented: “Becoming a full partner for insurance undertakingswill help extend the scope of services offered to insurance undertakings beyond pure assetmanagement. Active role in ALM business involves additional responsibilities but alsoadditional vectors for profitability, service improvement and specialist expertise in the field.”10

Figure 7: Requests received by asset managers from their insurance clients in respectof Solvency IIDid you already receive requests from your insurance clients in respect of Solvency II?Percentage of asset managers that havereceived requests from their insurance clientsType of requests received frominsurance clients100%90%11%80%70%60%56%67% 67%40%60%50%40%89%30%20%10%44%33%33%0%n Yesn NoData RFP Reviewing Additionalrequirement including existing servicesSolvency II investmentcapabilities strategyData is the key concern in the vast majority of requests from insurers.Renegotiation of Actual Service Level Agreements even if arriving at the second position isexpected to increase in the coming months.One of the participants commented: “Solvency II will require upgrades to areas of datamanagement that will also be required to meet other regulations.”Figure 8: Key challenges identified by asset managersAt least 47% of the asset managers surveyed intend to launch a project regarding Solvency IIwithin their organisation.Key Challenges identified by asset managersIT DevelopmentNew servicesNew product development55%45%64%Investment strategy review9%Control environment27%TrainingData management9%82%0% 20% 40% 60% 80%11

Solvency II - Impact on Asset ManagementA majority of participants believe that Solvency II will require new services and new products.IT developments and data management will be the major challenges.Regarding data management, potential impacts reported by participants include:QQContent of data (granularity, look-through on underlying assets, etc.);QQFormat, frequency, classification of data;QQControl environment (new controls process), control report (certification);QQModification of actual reporting and/or the re-definition of mandates with (re)insurers;QQConfidentiality issue at the fund or sub-fund level.Participants believe that training, the review of their investment strategy and the controlenvironment will be minor challenges created by Solvency II.Figure 9: Expectations from ALFIDo you have specific expectations from ALFI in respect of Solvency II?13%0%87%87% of participants are interested by supportof the ALFI around the potential impacts ofSolvency II on the funds industry, especiallyas regards regulatory updates, guidelines andbest practices.n Yes n No n No answersExpectations of Guidelines/Best practicesExpectations in terms of regulatory updates20%20%7%73%7%73%n Yes n No n No answersn Yes n No n No answersALFI has a key role to play for funds industry in order to leverage the impacts of Solvency IIon the asset managers and service providers:One of the participants commented: “Solvency II might offer the opportunity to proposenew services. But this also requires being up to date on the regulation itself and thediscussions around. ALFI has a role to play in this field.”One of the participants commented: “Some of our clients have already started requestinganalyses. To be responsive and understand the requirements of Solvency II, we expect havingfrom ALFI best guidances and regulatory updates.”12

ConclusionSolvency II will increase data andgovernance requirements for insurersand will also cause them to rethink theirinvestment strategy. The findings from thefirst Solvency II survey conducted withLuxembourg asset managers show, amongother things, that a large number of playersare not yet fully aware of the impact thisnew regulation is going to have on theirbusiness. Continuous monitoring of thisimportant piece of legislation is key.13

June 2012Solvency II - Impact on Asset Management