solvency ii – investment implications
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Solvency II – Investment Implications
January 2011
FOR UK INSURANCE COMPANIES ONLY. NOT FOR PUBLIC DISTRIBUTION
Solvency II_0111_BC.ppt
Good returns from bond markets but yields are historically low
2
Source: J.P. Morgan UK Government Bond IndexLatest data as at December 2010. Source: Federal Reserve Bank of England, Barclays Capital, J.P. Morgan
Government Bond Yields
Solvency II_0111_BC.ppt
3
Extremes in the equity markets
35
30 20041998199219911988
25 1987 20061985 20051978 2003
1994 1965 19991981 1962 1997
20 1979 1961 19961976 1956 19951970 1955 19891966 1951 19861964 1945 1984
15 1960 1944 19831952 1927 19821948 1926 19801947 1925 19721940 1923 1963
10 1939 1917 19501938 1916 1946
2001 1921 1912 19432000 1915 1910 1942 19931957 1913 1909 1941 1971
5 2002 1949 1911 1908 1936 19531990 1937 1907 1906 1935 1933 19771969 1930 1903 1905 1934 1922 1967 1968
2008 1931 1929 1901 1904 1928 1919 1958 19591974 1973 1920 1914 1900 1902 1924 1918 1932 1954 1975
-50 -40 -30 -20 -10 0 10 20 30 40 50 60 70 80 90 100 >100
Source: Elroy Dimson, Paul Marsh and Mike Staunton, Credit Suisse Global Investment Returns Sourcebook 2010
UK equity risk premium relative to bills, 1900 - 2010
2009
2007
2010
2008 2009
Solvency II_0111_BC.ppt
Asset allocation
4
Source: Association of British Insurers, Swiss Re Economic Research & Consulting Source: CEA
0%
20%
40%
60%
80%
100%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Equities Fixed Income
Property, Alternatives, Other
UK Insurers European Insurers
0%
20%
40%
60%
80%
100%
Life Insurers Non-life Insurers
OtherCashReal EstateProperty-secured loansShares and equity trustsBonds, preferred shares and fixed-interest trustsGovernment securities
Solvency II_0111_BC.ppt
5
Solvency II
Changes the way:
Regulatory capital is calculated
Projected liability payments are discounted
Solvency II_0111_BC.ppt
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Solvency II – Implication for bonds / credit
* Notes: 1) Under Solvency II QIS5 2) Profile of liabilities may affect the impact 3) Using an internal model can alter the impact
Gilts More use of gilts at high duration where yield is above swaps.Less use at lower duration.
Corporate Bonds More use of corporate bonds at low duration where risk adjusted return is higher.
Less use at higher duration.
Structured Credit, ABS etc 3 Significantly curtailed use of structured credit unless Standard calculation is amended
Source: J.P. Morgan Asset Management - January 2011
Solvency II_0111_BC.ppt
7
Solvency II - Implication for other asset classes
Property 3 Lower allocation to propertyDue to higher capital charges, with no index based dampener
Issues with the treatment of property backed structures
Equity 3 Lower equity allocationDue to higher base charges that vary under a “symmetric adjustment” to levels
very much higher than currently appliedEEA/OECD listed preferred
Much higher charges will make “other” equity category unattractive.
Other, including: Hedge Funds, Private Equity, Commodity, Infrastructure 3
Lower allocationsThey are not well defined by QIS5
Unless they are sufficiently transparent to allow moving into another risk module (such as Global equity, property or spread (credit) risk), they are subject
to very high “other equity” charges.
Total Return 3 Wider use of total returnDue to investment mandates becoming less constrained with aims to “beat
cash” plus the illiquidity premium
Source: J.P. Morgan Asset Management - January 2011
* Notes: 1) Under Solvency II QIS5 2) Profile of liabilities may affect the impact 3) Using an internal model can alter the impact
Solvency II_0111_BC.ppt
8
Solvency II – Implications from liability discounting methodology
Swaps Greater use of swapsDue to the valuation interest rate curve for discounting liabilities is based on the
swap curve.
Generic Credit Unknown at presentCIOs will need to deal with some complex issues for benchmark setting or
asset allocation that arise from the use of an illiquidity premium which is based on a corporate bond index
Illiquidity premium varies by type of business (with-profits, annuities, all remainder)
At present this illiquidity premium is not ‘matched’ by any available investment
Source: J.P. Morgan Asset Management - January 2011
* Notes: 1) Under Solvency II QIS5 2) Profile of liabilities may affect the impact 3) Using an internal model can alter the impact
Solvency II_0111_BC.ppt
9
Solvency II - Transparency and ‘Look through’
Segregated Mandates Attraction of segregated mandates increasesEspecially if using an internal model due to the “look-through” requirements
Collective Investment Funds Transparent funds preferred to those that are notRequirement to apply “look-through” approach will raise a “hassle” factor
barrier that fund managers will have to address to retain insurance investors
Currency overlay mandates Attraction of currency overlay mandatesDue to advantage of hedging currency risk, otherwise currency risk carries a
25% charge
Source: J.P. Morgan Asset Management - January 2011
* Notes: 1) Under Solvency II QIS5 2) Profile of liabilities may affect the impact 3) Using an internal model can alter the impact
Solvency II_0111_BC.ppt
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Summary – attractiveness of asset classes under Solvency II QIS5 versus current position
Short Govts
Short Corp.
Long Govts
Long Corp.
EM Debt
Property
Total Return
Equities
Currency overlay
Swaps
Transparency
Segregated mandates
Generic credit
?
* Notes: 1) Under Solvency II QIS5 2) Profile of liabilities may affect the impact 3) Using an internal model can alter the impact 4) Not drawn to scale
Expected risk
Exp
ect
ed
re
turn
Source: J.P. Morgan Asset Management - January 2011
Solvency II_0111_BC.ppt
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Known Unknowns
Changes to Solvency II regulations
Changes to accounting standards
Markets ‘price-in’ Solvency II effects
Development of Solvency II ‘efficient’ investment products
Solvency II_0111_BC.ppt
Outlook for 2011-2012
12
Deflation Disinflation Inflation
Equities drift to new lows in 2011
Equities drift to new lows in 2012
Markets rerated towards new all-
time highs in 2011
Markets trend sideways to up
Bond yields soar, equities suffer,
new lows in 2010
Bonds plummet equities up but underperform commodities
15% 60% 25%
20% 80% 50% 50% 50% 50%
NEW LOWS NEW LOWSNEW HIGHSNEW LOWS NO EXTREMES NO EXTREMES
QE fails
Recovery stalls during 2010
Lost hope
Growth snuffed out by rising
yields in 2012
Dream ticket
Sub-par growth, easy policy
Party Pooped
Policy stimulus removed 2011/12
Stagflation
Yields rise, growth stalls
Fast & Loose
Rapid growth, surging inflation
Solvency II_0111_BC.ppt
Conclusion
What to consider:
Resources
Dialogue with asset manager
Investment strategy – including consideration of:
– Profile of liabilities
– Market environment and opportunities
13
Solvency II_0111_BC.ppt
14
Important Information
This material is for the use of UK insurance companies only – not for onward distribution
The value of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. Investing in alternative assets involves higher risks than traditional investments and investors should consult a professional adviser prior to investing. Alternative investments have higher fees than traditional investments, may not be tax efficient and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The information provided is for use by professional investors within UK insurance companies only and is not for public distribution.
It may include opinions based upon understanding of complex regulatory proposals that may well change or not be implemented at all. The services being promoted are not, are not intended to be and should not be construed as providing investment advice or advice on regulatory requirements or the law. Readers should take appropriate independent professional advice on such matters which is relevant to their particular situation before acting on anything contained in this document. This document is for informational purposes only and is intended solely for the person to whom it is delivered by J.P. Morgan Asset Management. This document is confidential and may not be reproduced or distributed in any jurisdiction without the express prior written consent of J.P. Morgan Asset Management.
The opinions expressed are those held by J.P. Morgan Asset Management at the time of publication and are subject to change. This material should not be considered by the recipient as a recommendation relation to the acquisition or disposal of investments. This material does not contain sufficient information to support an investment decision and investors should ensure they obtain all available relevant information before making any investment.
Issued in the UK by JPMorgan Asset Management Marketing Limited which is authorised and regulated in the UK by the Financial Services Authority. Registered in England No. 288553. Registered address: 125 London Wall, London EC2Y 5AJ.
J.P. Morgan Asset Management
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