Solvency II rules could “dry up” long-term funding for the corporate sector by discouraging insurers from the longer-dated corporate bond market, particularly the high-yield segment, say academics.
The European Union’s Solvency II directive is intended to ensure that insurance companies stay solvent by imposing capital requirements on the assets they hold. Some insurers have already reduced their equity allocations as a result.
Allocations to long-term corporate bonds, particularly those that are not investment grade, are also likely to reduce, said the Edhec Financial Analysis and Accounting Research Centre. The returns these bonds offer would not compensate insurers for the additional marginal cost of owning them.
“Naturally, this raises many questions on the future financing of the economy by the insurance industry,” reads the report. “Solvency II could therefore dry up a major source of corporate funding and thus counter the growth and financing objectives of the economy.”
Edhec's research is based on analysing the way regulators calculate the solvency capital requirement for different asset classes. It found this measure underestimates the risk of losses for high-yield bonds during crisis years but overestimate the risks in crisis years. It also found the measure fails to reflect differing risk characteristics for different global regions.
Edhec suggested adjusting the calculations to take into account macroeconomic cycles and regional differences. It also concluded that the Solvency II formula tends to favour short-duration and particularly high-yield bonds.
Solvency II does not only affect insurances companies and corporates. Asset managers will need to respond to shifts in insurers' investment objectives and work more closely with insurers, for instance to offer products that help them comply with the regulations.
A recent report by consultancy KPMG warned that although Solvency II programmes have been running in insurers for the past two years, engagement between insurers and asset managers has been relatively slow.
“The detailed data requirements, together with the very short data delivery timescales, will require much greater interaction between asset managers and their insurance clients than is usually evident,” said the report.
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