Is Solvency II in fact a boon to PE?

Despite the higher capital charges, European insurers say they plan to increase their private equity investments under the Solvency II framework as a way of capturing yield.

Against a backdrop of low interest rates and anaemic growth, European insurers may look to alternative asset classes in their search for yield, according to a new study from investment management group BlackRock. 

For several months the private equity industry has feared that stringent capital requirements under Solvency II, a still-in-the-works pan-EU framework for insurers, would harm fundraising efforts. 

However, almost a third of European insurers said they would increase their allocations to private equity and hedge funds, despite the higher capital charges under the new rules. Only 6 percent of respondents said they would in fact decrease their exposure to alternatives. 

The Directive, expected to come into effect in 2014, requires European insurers to set aside a hefty €49 for every €100 invested under its default risk model. Insurance firms however have the option of formulating their own risk models, subject to the approval of regulators. 

David Lomas, head of Blackrock’s global financial institutions group, said insurers could reduce that private equity capital charge to as low as €25 under the right internal model. 

“Capital requirements under an internal model can be lower for strategies that adopt transparent and well diversified holdings. In addition, hedging potential volatility in these strategies can also have a positive impact under the internal model for insurance companies”, he explained.

“Key to this is the insurer’s ability to look through to the underlying holdings in each strategy, to understand the risk of each position and to be able to stress and report these under a variety of scenarios. 

“Government bonds are struggling to deliver the returns insurance firms have typically relied on”, he added. “It seems private equity can be a cure for part of that higher return requirement”.