Insurers are ramping up their investment in short-dated loans to small to medium-enterprises (SMEs) to take advantage of the expected delay to Solvency II.
Investment in loan portfolios has spiked in recent months as insurers look to avoid the high capital charges imposed on loan assets by Solvency II, according to asset managers.
Etienne Comon, head of European insurance strategies at Goldman Sachs Asset Management (GSAM) in London, explains: "We have seen strong interest in relatively short-dated loans. In the loan market there is an ample supply of three-to-four-year loans, which is useful for insurers who want to make sure that by the time Solvency II comes in they have the flexibility to adjust their investments."
Loans to SMEs are attractive to insurers because they offer higher yields than government bonds along with security in the form of physical collateral. However, under Solvency II, which is not expected to come into effect until at least 2015, they would typically attract a capital charge of 45 per cent as they would be treated as sub-investment grade.
Direct investment in longer-term loans is also becoming increasingly popular, as current market conditions mean insurers can use derivatives to lock-in fixed cashflows with very little risk.
John Whitworth, insurance partner at Oliver Wyman in London, says an insurance company investing heavily in these assets would typically have a swap strategy to fix the interest rate risk on its portfolio. "The thing that has really changed over the last five years is that because the spread is so high on loans, the risk that you can't cover that floating leg [on the swap] is much lower than it used to be", he says.
The yield pick-up available from loans will also soften the impact of any capital charges assigned to these assets when Solvency II is finally implemented, adds Whitworth.
The uncertainty over Solvency II is being exploited by those who want European policy-makers to adapt the regime to favour investment in long-term loans. Nigel Wilson, London-based group chief executive officer at Legal and General, said in a speech on February 6 that regulation had to help insurers make long-term investments, not hinder them. He cited a green paper soon to be published by European Commissioner Michel Barnier as evidence that the tide was turning against rules that penalised the holding of these assets.
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