16 October 2012

Risk.net: Insurers 'must understand risk on non-traditional assets'

Incorporating new asset classes into existing investment portfolios could pose significant risks to firms that do not have a good knowledge of how they work, said speakers at a panel discussion at Insurance Risk's Solvency II & Insurance Risk conference in London. Insurers need to consider the modelling, data and regulatory implications of investing in new and potentially higher risk assets.

Emerging market debt, loans to small- and medium-sized enterprises (SMEs) and collateralised loan obligations (CLOs) were highlighted as potentially providing above-average yields in the current low interest rate environment.

Charles Pears, head of insurance products at asset manager Insight Investments in London, said: "We are really seeing insurance clients push away from their more traditional investment heartland and asking investment managers, ‘Can you deliver return without taking on undue risk?' And that is taking them into all sorts of new areas."

Insurers, Pears said, must consider the capital charge that will attach to assets under Solvency II, as well as the modelling requirements. "However well-rewarded an investment position may be, if the regulatory capital attached to that risk is such that you can't afford it, than that's it - you can't afford to take that risk", Pears said.

Having adequate data on asset risk will enable an insurer to determine how a certain investment will affect a firm's regulatory capital. At present, Solvency II's standard formula puts a punitive charge on structured products such as CDOs and CLOs.

Zurich views the regulatory charges as a constraint, but takes an economic view of the merits of an investment, said Tom Rogers, head of strategy implementation at Zurich Insurance. "We look at the problem [of low yields] in economic terms and we view the regulatory capital models as a constraint within that. So long as we can meet that restraint, we will go ahead and invest in asset classes that on a standalone basis would not look attractive, but on an aggregate basis fit into the overall portfolio and make the economics work", he said.

Many insurers' appetite for investment risk had so far not been curtailed by Solvency II, because of the levels of regulatory capital they hold, said Insight Investments' Pears.

While the risks associated with investing in new asset classes could be adequately managed by insurers, few have made substantial changes to their portfolios at present.

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