By Thao Hua
New insurance regulations in Europe are expected to create a windfall for investment consultants as insurers look for capital-efficient ways to manage assets that will need to be more closely linked to liabilities under Solvency II.
In preparation for the potential growth, some firms such as Towers Watson & Co., Aon Corp., Russell Investments and PricewaterhouseCoopers International Ltd. have been building their insurance advisory teams over the past 12 to 18 months. The latest is P-Solve, which on Sept. 27 announced the acquisition of Meridian Consultancy to create P-Solve Meridian, which has £6 billion ($9.4 billion) in insurance assets under advisement.
"Similar to what has been happening in the pensions industry in the past several years—during which (plan sponsors) have been looking more closely at where the investment risks are and how they relate to the liabilities on the balance sheet—insurers are now moving in that direction," said Alasdair Macdonald, senior investment consultant and head of the U.K. investment strategy team at Towers Watson in Reigate, England.
A key consideration under Solvency III is the capital requirements that could substantially differ depending on whether firms opt to build an internal model to assess their asset-liability profile more precisely, or follow a standard formula as an alternative, sources said. While large insurance companies usually have the necessary internal resources to manage their own modeling under Solvency II, small to midsize companies will likely need to outsource some or all of the expertise.
Solvency II was originally to become effective on Jan. 1, 2013, but the start date likely will be postponed at least until 2014, sources said.
"Not all insurers will move to building their own models, of course, but we believe a lot (of companies) in the industry will be doing so in the long term," Mr. Macdonald said. "What gets measured gets managed, and this is where we see opportunities" for investment consultants.
Earlier this year, Towers Watson acquired EMB Consultancy L.L.P., a software and advisory business targeting non-life insurers. The move will help Towers Watson broaden its footprint in the sector, adding between 50 and 75 insurance clients as a result, Mr. Macdonald said.
There are 5,000 insurance companies with aggregate assets of about €7.3 trillion ($9.9 trillion) operating in the European Union, according to data from the Comite Europeen des Assurances, a Brussels-based federation of European national insurance trade associations. Of those 5,000, about 77% will be affected by Solvency II, the introduction of which is being closely watched by several other nations, including Japan, Switzerland and Bermuda, which have started discussions to introduce equivalent platforms. The United States also is considering similar regulations.
Historically, European insurance companies—particularly nonlife insurers—manage their assets and liabilities through completely separate divisions, often without any effort at integration, said Gareth Haslip, London-based head of risk and capital strategy for the U.K. and Europe, Middle East and Africa at Aon Benfield Analytics, a division of Aon Corp. that advises clients in the insurance sector.
In addition to the new regulations, recent investment conditions are forcing insurers globally to reconsider their investment portfolios. Most insurance portfolios are dominated by simple fixed-income assets, which in the near-zero interest rate environment has resulted in returns "that are nowhere near what is needed," said David Osborne, founder of Meridian who will be a consultant in the new P-Solve Meridian, a division of the Punter Southall Group in London. "It has been a bit of a culture shock for insurers."
"Solvency II is a real game changer," Mr. Haslip added. "People are thinking very actively about the investment question today, and it's a difficult process because they (previously) haven't had to link up the investment strategy of the assets with the liabilities side."
Aon Benfield is working with Aon Hewitt, the investment consultant subsidiary of Aon Corp., to help insurance clients "design investment strategies that are both economic and capital efficient under Solvency II," Mr. Haslip said. For example, although certain risky asset strategies such as hedge funds are penalized with a 49% capital charge under the standard formula, they can provide "additional yield that more than compensates" under certain circumstances, he added. "On the other hand, BBB corporate bonds with a 10-year duration, which has a 25% capital charge, may not be as efficient a way to deploy capital."
"Insurers now have to look at the overall asset allocation, and take the appropriate risk relative to the capital they need to set aside," Mr. Haslip said. "They will need more help getting the right investment strategy."
Carlos Montalvo Rebuelta, executive director of the European Insurance and Occupational Pensions Authority, said more insurers are expected to adopt an internal model—either in part or completely—over the long term, mainly because it could better align risk management with the company's business strategy. "An internal model must be seen as part of a risk management tool kit rather than a way to reduce capital requirements," he added. The EIOPA is a Frankfurt-based supervisory organization that advises on insurance and pensions issues.
Bruce Porteous, Edinburgh-based head of Solvency II and regulatory development at Standard Life P.L.C., said most large insurers are developing internal models under Solvency II, although "a lot will depend on where Solvency II lands and the market environment." The new regulatory framework has not been finalized.
Under current U.K. regulations, many insurers already submit an individual capital assessment, which has some of the same requirements as Solvency II, Mr. Porteous said. "For big companies like ourselves, we already use an internal model that's consistent with the risk profile of our business," he added. Standard Life has about £200 billion ($313.33 billion) in assets under management, a majority of which are assets managed for the company's insurance business.
While many of the large insurers "are in the advance stages in terms of developing internal models, small and medium-size companies are struggling," said Michael Sfez, managing director for France at Russell Investments based in Paris. "Many do not have the capabilities and are coming to us for help in implementing the models, which is clearly quite a burden for them."
Beyond building models, Russell also is expecting to help firms on implementation, monitoring and reporting, because requirements under Solvency II will be much more stringent and detailed, Mr. Sfez added. "The scope of assets is significantly wider," he said. In the short term, Russell is planning to hire at least two additional product specialists dedicated to Solvency II, he added.
PwC, which advises several hundred insurance companies across Europe on various aspects of Solvency II, also has been building its team, which now numbers "hundreds, approaching 1,000," said Paul Clarke, partner and global Solvency II leader based in London. He added the company is continuing to recruit.
"Solvency II is an absolute priority for our clients at the moment," Mr. Clarke said. "Many insurance companies have been pursuing sophisticated strategies in order to maximize returns achieved through a combination of asset allocation relative to risk. That's always been around. But the introduction of Solvency II adds a new dimension, requiring a much better understanding of the asset mix, asset prices, the volatility over time in respect to liabilities and the consequent impact on regulatory capital. That's new, and hence, that's where we would expect more insurance companies to reappraise their position as to whether to use an internal model or the standard formula."
Source Business Insurance
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