UK: Solvency II impacts on Investment Managers

Last Updated: 30 November 2010
Article by Deloitte LLP

Solvency II is a new solvency regime for all EU insurers to be implemented by 2012. Similar to Basel II for banks, it is sets the capital requirements for insurers on a risk basis, and has a three-pillar structure covering quantitative requirements, supervisory review and market disclosure.

In the 2009 IMA survey, insurance assets accounted for 23% of the total assets managed in the UK. Investment managers owned by large insurance companies are beginning to be engaged in their Solvency II implementation projects and are identifying a number of key impacts on their investment management operations. However, it does not seem as though many other investment managers have started assessing the potential impact on their business. As such, this presents an opportunity for investment managers to be proactive and get on the front foot with their insurance clients and targets.

Solvency II presents investment managers with the opportunity to re-assess their strategy with respect to the insurance market. Certain managers will see this as an opportunity to provide their clients with bespoke Solvency II solutions whereas as others will determine that the costs of compliance mean they exit the market.

Pillar 1 Quantitative Capital Requirements

Pillar I sets out the minimum capital requirements and allows insurance companies to use a "Standard Formula" where capital charges are standardised by asset class or an "Internal Model" whereby insurers calculate their capital requirements using a bespoke model.

Currently the largest money managers are offering auxiliary services, such as advising the insurer's in-house portfolio managers and providing custom benchmarks to managing insurance company investments. These managers are currently attracting more insurance clients because their expertise offers risk mitigation whilst achieving a desired return on investments. It is likely that as Solvency II unfolds this trend is likely to continue.

The new capital requirements may change an insurer's asset allocation and investment managers should be discussing the potential opportunity to develop new products that more closely match the underlying cash flows associated with insurer's cash flow obligations.

An additional challenge for hedge fund managers is the capital charges that are required by insurers who invest into hedge funds and use the Standard Formula. Although we expect that only smaller insurance companies in the UK will adopt the standardised approach (although some larger European insurers may use this approach), investment managers with these clients will need to consider whether offering managed accounts is a better solution to offering pooled vehicles once the final rules on 'look through' have been settled. For large insurers that use the Internal Model under Solvency II, hedge fund managers will need to provide these clients with adequate information to calculate an appropriate capital charge. This is likely to include historical and current risk data.

Pillar II Supervisory Review

Pillar II sets out the qualitative requirements for insurance companies and defines both the principles of risk management and governance as well as the supervisory review.

As part of their ongoing risk assessment and monitoring, insurance companies are expecting there to be significantly more interaction between themselves and investment managers and an increased amount of oversight by the insurer. Therefore, insurers and investment managers will need to review and potentially update the terms of their SLA to ensure that the services provided are Solvency II compliant. It is likely that these discussions will take time to complete and they will need to be amended to reflect the latest guidance.

Insurers will need to be able to conclude that the controls operating at the investment manager are operating effectively through ongoing monitoring. Further guidance regarding the required oversight by insurers on service providers is expected out in early 2011, but a transparent approach to insurance clients is likely to be required.

Pillar III Market Disclosure

Pillar III sets out the market facing elements of Solvency II including transparency requirements, disclosure requirements and competition related elements.

There are significant additional disclosure requirements for insurers arising from Solvency II. There have been concerns raised by the insurance industry around the scope and the timetable of the reporting requirements. Under the current draft, quarterly reporting will be required by insurers within six weeks of the quarter end reducing to four weeks when the transitional period ends in 2015. This will require significant information to be provided by investment managers on a by security basis.

Insurance companies are currently lobbying against the proposed timeframes and the volume of information to be provided. One of the key considerations will be around what defines a "hard close" and the accuracy of data that needs to be provided for quarterly reporting. For certain classes of asset, information may only currently be provided on a six monthly basis and it remains to be determined what will be required.

With the current deadlines (namely quarterly reporting by insurers within four weeks of the quarter end), many insurers would need the data within one week of quarter end. This is likely to be a challenge for any asset manager to finalise data in that time frame, but is an even larger challenge for managers that outsource their back-office. This is likely to require a new SLA with the back office provider that will most likely come at additional cost.

Consideration will need to be given to roll forward techniques or potentially technology solutions to automate data provision.

Additionally, the specific types of data supplied by the investment manager will need to be reviewed both because of the need for detailed data to calculate the capital charge described under Pillar I, but also that Solvency II will require the insurer to disclosure far more detail about their investments. Simply the name of the investment, the amount owned and the current price is not likely to be sufficient under the new regime.

Next steps

The specific requirements for Solvency II are still evolving, but investment managers should begin to assess if their current operations can meet the future demands of insurance clients and whether there is a cost/benefit of changing their operating model to meet these demands. Given the implementation timeframe those firms that start earliest are likely to implement the most effective and cost efficient processes and be the ultimate winners.

How Deloitte can help

Deloitte is one of the leading advisors to insurers implementing Solvency II and therefore remains in the forefront of the evolving requirements and the needs of insurers. Whether the investment manager is part of an insurance group or independently provides or hopes to provide asset management services to insurance companies, we can help managers identify where they stand against the current Solvency II requirements and identify solutions to any gaps.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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