15 January 2014

Risk.net: Private equity funds set to enjoy insurer cash injection in 2014

Some insurers, such as Skandia, are looking to increase their private equity allocations to as much as 10 per cent of their investment portfolios. For an asset class that typically accounts for as little as one or two per cent of the portfolio, that’s a big shift.

This renewed interest is perhaps not surprising. Private equity can provide fat returns for yield-hungry insurers: as much as 500 basis points more than government bonds, and 300bp more than alternative investments such as mortgage-backed securities and property.

But there are downsides. One is irregular cashflows, as returns from private equity assets generally don’t arise until later in the investment period, making this class difficult to accommodate within an asset-liability management strategy.

European insurers also face a punitive 49 per cent capital charge for private equity investments under Solvency II’s standard formula, making it an expensive asset class from a solvency capital perspective.

There exist a number of issues that Dutch insurers are currently grappling with. One is the new theoretical solvency criterion – also known as Solvency 1.5 – which came into effect on January 1, 2014. This transitional regime will require insurers to apply stress scenarios similar to those set in Solvency II’s standard formula. Dutch insurers insist they should be able to weather the shock of potentially higher capital requirements, but experts predict the new rules will encourage insurers to adjust their asset mix and hedges as solvency ratios come under pressure.

The partial group disability market is also presenting Dutch insurers with problems. After an overhaul of welfare legislation in 2006, insurers eagerly tapped this market. But they grossly underestimated the risks and costs of providing cover and have been forced to increase their reserves in response to higher-than-expected payments. As a result, major insurers are withdrawing from this business line, and those that are still active are increasing premiums and taking radical measures to control the damage.

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