balancing risk, return and capital requirements: the effect of solvency ii on asset allocation and...

Written by

Balancing Risk, Return and Capital RequirementsThe Effect of Solvency II on Asset Allocation and Investment Strategy

Balancing risk, return and capital requirements

Foreword:Beyond performance

despite several deferrals of the implementation deadline, solvency ii has already proved a major catalyst for change with insurers spending considerable time and resource on preparing for d-day. at Blackrock®, we share this focus as we help insurers meet the outcomes they need in this rapidly shifting environment. specifically, we are investing heavily in our infrastructure and people to help you navigate this crucial transition successfully.

Yet this tremendous effort by the industry masks significant uncertainty: be it in terms of the final shape of the directive or how solvency ii will affect asset allocation, investment strategies and capital markets – all against a backdrop of a continued sovereign debt crisis. Faced with this murky picture, insurers, not surprisingly, find it hard to have full confidence in their preparedness.

to help bring some clarity around the remaining key challenges, Blackrock has commissioned the economist intelligence unit to conduct a comprehensive study among european insurers. the findings offer a real insight into the challenges associated with each of the three pillars and the implications for insurers’ product offering and the wider capital markets. interestingly, the research highlights a degree of discrepancy between market perception and what your peers really think, particularly in relation to the use of alternatives and their levels of preparedness for solvency ii governance and disclosure requirements.

personally speaking, the most important finding was the need to move beyond performance and seek full alignment of investment expertise and enterprise risk management. in 2012 and beyond, we will work very closely with our clients to help them achieve that essential goal. i hope you find the report thought-provoking and, above all, beneficial, and look forward to hearing your views.

sincerely,

david lomas, ACIIHead of Global Financial Institutions Group, BlackRock email: [email protected]

Balancing risk, return and capital requirements [ 1 ]

contents

executive summary and key Findings 3

about this report 6

introduction 7

the Future for asset allocation 8

return-seeking assets 12

a demanding data management regime 18

shifting product ranges 22

consequences for capital markets 25

equity and debt markets 28

conclusion 32

Blackrock commentators 34

about Blackrock 35

appendix 36

[ 2 ] Balancing risk, return and capital requirements


executive summary

despite recent uncertainty about whether the implementation date of solvency ii will be pushed back a year, insurers are still working on the assumption that they have just one year to go, and therefore preparations for the new directive are well under way.

the europe-wide legislation will impose stringent new capital requirements across the insurance industry, creating a more risk-focused approach to better protect policy holders from future financial crises. data management will be overhauled, while many players will be forced to rethink their product range and investment strategies.

coinciding with this final phase of preparations for solvency ii are some of the most testing market conditions in living memory. the ongoing sovereign debt crisis has raised questions regarding the very foundations on which some pillars of solvency ii are built and as uncertainty over the final shape of the directive persists, insurers face notable challenges when building their strategies for the future.

the economist intelligence unit, on behalf of Blackrock, surveyed 223 insurers with operations in europe. With the survey sample representing at least half of the european market in terms of assets under management, the findings offer real insights into how insurers are managing solvency ii’s data management requirements; the impact of capital charges on their investment strategies, risk management and product ranges; and their views on the future for capital markets in a post-solvency ii world.


Asset Allocation Shifts have been Decided but Implementation is on Holdalmost half (46%) of survey respondents say they already know how they are likely to change their asset allocation, with just 4% saying they have not made plans. However, over half (53%) say they are waiting until closer to implementation of the directive before making changes to their asset allocation. most changes are as expected – away from equities and towards corporate bonds.

Allocations to Alternatives are set to Increasesome asset allocation changes are less expected. alternatives such as hedge funds and private equity will benefit from solvency ii, with 32% of survey respondents saying they will increase their allocations to these asset classes. Just 9% and 6% respectively say they will decrease allocations. these increases come despite the higher capital charges for these assets, with insurers betting that the higher charges will be worth the higher potential returns. almost three-quarters (70%) of survey respondents expect their asset allocation changes to result in higher returns.

Allocations to Derivatives will Increase Under Solvency IIOver half (60%) of survey respondents agree that the directive will result in greater use of derivatives to better match assets and liabilities. While some insurers say they are already confident in their derivative usage, as asset-liability management (alm) strategies become more complex and demanding in volatile markets, this will be an area on which many insurers will need to focus. Over one-third (37%) of insurers agree that solvency ii will make them more likely to use derivatives in the future, although only 18% currently use derivatives and just 23% have definite plans to increase their overall holdings.

Meeting Solvency II Data Requirements is a Major Concern, Whilst Pillar III Commands the Least BudgetOver 90% of survey respondents are very or somewhat concerned about meeting the requirements for the timeliness (96%) and completeness (94%) of data under solvency ii, as well as the quality of data from third parties (92%). in particular, pressure is on third parties to provide the ‘look-through’ on pooled funds required by insurers, with 92% of respondents concerned that they will have to limit their investment strategy as some assets demand more rigorous data requirements. Overall, survey respondents say they are most concerned about pillar iii, yet it is the pillar to which they are devoting the least budget.

key Findings

Insurers will Re-Examine Guaranteed Products, Which may Become Prohibitively Expensive For some insurers, the directive merely accelerates an ongoing trend away from guaranteed products, but for others it creates a whole new way of thinking about their business. two-thirds of life and composite insurer survey respondents say they will restructure in order to better manage their guaranteed funds in house, while almost half (49%) of life and composite respondents say they will seek advice on alm. as a result, insurers will be forced to more aggressively price their guaranteed products, which will likely drive consumers into other cheaper but less well-protected offerings. annuities too will become potentially more expensive, as insurers factor in the increased costs of managing solvency ii market risk into pricing.

Solvency II Could Increase Market VolatilityJust 5% of survey respondents disagree with the idea that there will be an increase in volatility in capital markets because of solvency ii. insurers are also anxious about the threat of pro-cyclicality. if capital requirements reduce when markets are benign and increase during periods of volatility, losses due to falls in market prices could lead to a wave of forced selling, which could create further losses. eiOpa plans to tackle this issue but insurers say the uncertainty makes planning, particularly at this late stage, a challenge.

Share Prices are Likely to be Hit by Solvency IIless than one in 10 (9%) of survey respondents disagree with the idea that, due to solvency ii, average share prices will be lower as demand for equities will be lower. and even fewer (3%) disagree that the equity risk premium will need to increase significantly to encourage investing in equities. However the overall supply of equities could be lower, as only 9% do not believe that companies will favour issuing debt rather than equity for their funding needs.

Regulators may Have to Rethink Approach to ‘Risk-Free’ Assetsas the security of government bonds is thrown into doubt, insurers believe the regulator may have to revisit the 0% capital charge for sovereign debt. insurers using their own internal models already factor in the ‘real’ risk presented by government debt, but organisations using the standard model may be exposed. planned changes to asset allocation, such as moves from government bonds into higher-rated corporate debt, support the view that insurers are assessing the risk and return trade off for themselves.

about this report

In October and November 2011, the Economist Intelligence Unit, on behalf of BlackRock, surveyed 223 insurers with operations in Europe to find out how they were handling the data management requirements of Solvency II, the impact of capital charges on investment strategies and product ranges, and their views on the future for capital markets in a post-Solvency II world.

Respondents comprised of 75 life, 65 non-life, and 57 composite insurers, while 26 were reinsurance companies. Responses were collated from insurers with headquarters in all major EU countries.

Businesses were grouped by assets under management (AUM) covering 106 very large insurers with more than €25bn; 23 large insurers with €10bn-€25bn; 68 with €1bn-€10bn; and 26 with AUM of less than €1bn.

In addition, in-depth interviews were conducted with eight experts from insurance companies, regulators and trade bodies. Our thanks are due to the following for their time and insight (listed alphabetically):

Anders Brix, Risk management team, Danica Pension, Denmark.

Britta Burreau, Managing Director, Nordea Life, Sweden.

Frank Eijsink, Global Program Director for Solvency II, ING Life, Netherlands.

David Johnston, Senior Implementation Manager, Financial Services Authority, UK.

Olav Jones, Deputy Director-General, CEA, European insurance and reinsurance federation.

Isabella Mammerler, Head of European Regulatory Affairs, Swiss Re.

Carlos Montalvo, Executive Director, European Insurance and Occupational Pensions Authority (EIOPA).

Ann Muldoon, Solvency II Director, Friends Life, UK.

The report was written by Gill Wadsworth and edited by Monica Woodley of the Economist Intelligence Unit.

introduction

insurers racing to meet the 2013 implementation date for sweeping changes to solvency regulations were given a year’s grace in the autumn of 2011, with regulators setting a new deadline of January 2014.

delays to the implementation of solvency ii are nothing new – and a further delay may be in the works - but the insurance industry is unlikely to view the latest push back as much of a reprieve in their efforts to comply with the directive, particularly as by 2013 they will need to demonstrate how they will meet the final legislation.

the solvency ii directive imposes stringent new capital requirements, creating a more risk-focused approach designed to better protect policyholders from future financial crises. the legislation is far-reaching and complex, and has forced insurers to analyse everything from data management and risk analysis to asset allocation and product ranges.

as insurers continue with their preparations, the ongoing sovereign debt crisis has forced regulators back into negotiations to agree on a directive that can withstand such unexpected changes in fortune.

against this backdrop of uncertainty, insurers face notable challenges as they strive to formulate a successful strategy that will stand up to the rigours of a new regulatory regime and an unpredictable economic future.



now that insurers have the fundamental systems building blocks in place following the first stages of preparation for solvency ii, they are turning their attention to investment strategies and asset allocation. However, the survey reveals that insurers are not able to prepare to the extent that they would like as the directive itself is still being finalised.

almost half (46%) of respondents to the survey say they know how their asset allocations will change as a result of solvency ii, but more than half (53%) say they will wait until they are nearer to the final implementation date before effecting any change. non-life insurers are less confident than their life counterparts as to how their future asset allocations will look – 43% compared with 50% – and as such are more likely to wait until solvency ii is clearer before taking action.

David Johnston, senior implementation manager at the uk’s Financial services authority, explains: “Until the Solvency II rules come into force in 2014 the current rules still apply, so insurers are welcome to make any changes they want in the interim, within the context of those rules. But they might not be able to move to their ‘business-as-usual post-Solvency II’ end state just yet.”

Where insurers have examined the future for their investment strategies under the new regime, the overriding response is to keep asset allocations the same. this is partly explained by the already conservative asset allocations the survey respondents report.

What is Your Current Asset Allocation?

Corporate bonds 36%

Government bonds 28%

Cash 3%

Property 4%

Hedge funds 1%

Derivatives 1%

Other alternatives 5%

Total equities 15%

Other assets 7%

Base: all respondents (n=223)source: economist intelligence unit

Well before the advent of solvency ii, many insurers had started de-risking strategies – action which has since been accelerated by the difficult economic conditions. Ann Muldoon, solvency ii director at Friends life in the uk, says: “In the UK we already make an assessment of risk-based capital [Individual Capital Assessment] and provide this as a private submission to the regulator. This is already informing our strategic asset allocation decisions.” she adds that where solvency ii has the potential to change the individual capital assessment, the insurer will guide its strategic asset allocation studies accordingly.

nearly two-thirds (64%) of the survey respondents’ total asset allocations are to fixed income, with government debt accounting for 28% and corporate bonds 36%. equities account for 15% of total portfolios, while alternative assets including private equity, hedge funds and derivatives amount to 7%.

in the fixed income category, just under half (49%) of respondents plan to keep allocations to corporate bonds the same, although one-third expect to increase investment in this asset class. more than one-third (37%) of life companies say they will increase allocations to corporate bonds compared with 29% of non-life companies. Just 18% of respondents overall say they will decrease corporate bond allocations.

the Future for asset allocation


While solvency ii is set to favour european economic area (eea) sovereign debt with proposed 0% capital charges, government debt allocations look likely to remain static for 48% of insurers, while 27% expect to increase and the remaining quarter will decrease. this may be an indication that insurers expect regulators to rethink the 0% capital charge in light of the eurozone debt crisis (which is explored further on page 30).

many insurers operating in countries enduring the worse of the sovereign debt crisis are cautious about the future for their own region’s government bonds. none of the icelandic insurers and just 7% of italian respondents plan to increase allocations to government bonds.

in contrast, in the nordics where governments enjoy relatively healthy debt levels, conditions are stable and they are outside of the eurozone, insurers say they will increase investment in government bonds.

more than half (56%) of swedish insurers say they will increase sovereign debt allocations, with just over one-fifth (22%) expecting to decrease. respondents in denmark tell a similar story, with half saying they will increase domestic government bonds and just one-quarter expecting to decrease investment in this asset class.

Thinking About the Likely Effects Of Solvency II, in Light of the Regulation’s Capital Requirements, how are Your Holdings in Government Bonds Likely to Change?

Holdings will increaseHoldings will decrease

25%

Pan-Europe

27%

29%

0% 0%

Nordics

39%

36%

Italy

7%

France

21%

32%

Netherlands

21%

21%

Belgium

22%

UK

27%

28%

Germany

38%

16%

Switzerland

18%

35%

Iberia

46%


“Under Solvency II there is a possibility that a large number of insurers may be forced to sell assets in times of financial stress”Italian non-life insurer, AUM >€25bn


However scandinavian insurers face a supply constraint when increasing their government debt allocations as the region’s countries are small, relatively well off and do not need to issue large amounts of bonds.

Britta Burreau, managing director at nordea life in sweden says: “[Sweden] has a small economy and we are already experiencing a shortage of government bonds. The long 10-year interest rates have been forced down due to huge demand and this could worsen under Solvency II.”

Anders Brix, part of the risk management team at danica pension in denmark, shares nordea’s concerns and anticipates further problems with low interest rates as a result of solvency ii’s market-consistent economic valuation, which forces insurers to mark-to-market assets and liabilities. “Solvency II is generally good for risk management, but we are concerned about what can happen if or when all insurers will have to value their liabilities at market value, since the interest rate markets may not be able to supply enough interest rate sensitivity. This may depress interest rates further and hence create more demand for interest rate sensitivity,” mr Brix says.

the concern about availability of local bonds is highlighted in the survey with 55% of nordic insurers saying they will shift from local to global bonds, compared with an average of 40% for all respondents.

elsewhere in fixed income, the survey reveals an increased appetite for corporate bonds. One-third of respondents say they will increase investment in this asset class, with life insurers more likely to increase (37%) than non-life (29%). Just 18% of respondents overall say they will decrease corporate bond allocations.

the Future for asset allocation continued


Thinking About the Likely Effects of Solvency II, in Light of the Regulation’s Capital Requirements, how are Your Holdings in Corporate Bonds Likely to Change?


Pan-Europe

18%

Iberia

27%

0%

33%

Nordics

13%

48%

Italy

21%

43%

France

21%

37%

Netherlands

14%

36%

Belgium

22%

33%

UK

18%

33%

Germany

22%

31%

Switzerland

18%

29%


norwegian insurers exhibit the most interest in growing corporate bonds allocations. three-quarters say they will take this action. italian insurers also favour company debt under solvency ii, with more than two-fifths looking to increase investment.

the survey also highlights a shift from longer-term to shorter-term debt, as the former will be more expensive to hold under solvency ii. Forty-four percent of respondents say they will favour short-term debt under the directive, with more than half of uk insurers expecting to make this move.


twice as many respondents believe that solvency ii will ‘severely hamper their ability to take investment risk’ than those who do not. this is even more extreme among the largest insurers, with more than three times the number saying they will be restricted versus those who will not.

Solvency II will Severely Hamper our Ability to Take Investment Risk – Do you Agree or Disagree? (Responses by Assets Under Management)

Agree 41%

Neutral 46%

Disagree 13%

Agree 33%

Neutral 38%

Disagree 29%

Insurers with >€10bn AUM Insurers with <€10bn AUM

Base: all insurers with >€10bn (n=129) all insurers with <€10bn aum (n=94)source: economist intelligence unit

Carlos Montalvo, executive director of eiOpa, says solvency ii is not designed to hamper insurers’ ability to take investment risk, but rather to ensure a direct link between the assets in which they invest their underlying risks and the assigned capital charge.

He adds: “[Solvency II] may, therefore, have an impact on the investment policies and products offered by some insurers, but this change is to be encouraged where it promotes effectively managed insurance companies and improves policyholder protection.”

However, the extent to which insurers are concerned about restricted investment risk is reflected in their expected changes in investment strategy is limited. One-third of respondents say their investment risk budgets will increase under solvency ii, with only 15% actively disagreeing.

looking at assets that will carry a higher capital charge, as they are considered riskier, more than half of respondents to the survey say they will keep equity allocations the same across all regions, although us equities are the most likely (62%) to remain static. French and italian insurers are the most likely to increase allocations to european equities (37% and 39% respectively), while just over one-third (34%) of german insurers are set to decrease allocations to stock markets in this region.

allocations to alternatives, which also carry a high capital charge under solvency ii, actually look likely to increase once the directive is in place. Just under one-third (32%)

return-seeking assets


say they will increase allocations to private equity and hedge funds, with allocations expected to decrease at just 6% and 9% of insurers respectively. non-life companies had a slightly bigger appetite for hedge funds than life, with 46% saying they will increase investment compared with 33% of their life counterparts.

in terms of assets under management, the very largest insurers (with aum greater than €25bn) are the most likely to increase allocations to hedge funds (36%), with 26-27% of other insurers expecting to allocate more funds to this asset class under solvency ii.

French, nordic and iberian insurers are among the most likely to increase hedge fund allocations. italian respondents are the most likely (23%) to decrease investment in this asset class, while dutch insurers are the most likely (71%) to keep hedge fund allocations the same and are also among the highest number to keep private equity static.

BlackRock View: Matt Botein, Managing Director, BlackRock Alternative Investors (BAI)

The survey results show insurance companies are expecting to increase their usage of alternative investments strategies as they look to prudently improve diversification in their portfolios and meet their investment needs. Their implementation process involves balancing (and optimizing) the impact of potentially higher capital charges for certain asset classes with the economic benefits of superior risk adjusted returns. This is even more urgent today as the challenging market environment makes stable and uncorrelated returns increasingly appealing.

Transparency and a greater focus on risk management are key considerations insurers will take into account as they allocate capital to alternative asset classes under this new regulatory regime. Therefore, an attractive solution can be based on diversified hedge fund strategies that meet the disclosure and reporting requirements of Solvency II, while being a good complement to their existing portfolios. Also, strategies that generate transparent, long term stable cash flows with bond like characteristics and uncorrelated returns will be well received by those insurance companies planning to add or increase their allocation to alternatives.


return-seeking assets continued

Thinking About the Likely Effects of Solvency II, in Light of the Regulation’s Capital Requirements, how are Your Holdings in Each of the Asset Classes Below Likely to Change?

Private Equity


Pan-Europe

6%

Iberia

0%

0%

32%

Italy

0%

62%

Belgium

0%

56%

Germany

6%

38%

Netherlands

7%

36%

Nordics

0%

36%

France

5%

32%

Switzerland

18%

29%

UK

8%

27%

Hedge Funds


Pan-Europe

9%

32%

Italy

23%

31%

Belgium

11%

33%

Germany

13%

22%

Netherlands

14%

14%

Nordics

10%

39%

France

5%

42%

Switzerland

6%

29%

UK

5%

32%

Iberia

55%

0%



Frank Eijsink, global program director for solvency ii at ing life in the netherlands, says: “There are two aspects to consider: the capital that you need to set aside for investing in risky assets and the volatility of that asset price. Although hedge funds and private equity funds have low volatility in the asset price, you do have to set aside a significant amount of capital for those investments.”

the increase in risk budget, alongside greater allocations to alternatives, leaves respondents confident of higher investment returns post-solvency ii. seventy percent say returns will either significantly (23%) or slightly (47%) increase under the new regime, while no insurers say returns will significantly decrease.

How do you Expect the Changes to Your Asset Allocation to Affect the Overall Returns of your Portfolio?

0 10 20 30 40

23%

0%

47%

23%

6%

50

Returns are likely todecrease significantly

Returns are likely todecrease slightly

Returns are likely tostay the same

Returns are likely toslightly increase

Returns are likely tosignificantly increase

Base: all respondents (n=223)source: economist intelligence unitFigures do not add to 100% due to rounding

derivatives, too, are set to gain ground in the post-solvency ii world, with more than one-fifth (23%) of survey respondents saying they will increase derivative usage. However, given just 18% report current derivative investment (although we do not know what shape that derivative investment takes, and therefore its impact on portfolios), any rise is from a relative low starting point.


return-seeking assets continued

Thinking About the Likely Effects of Solvency II, in Light of the Regulation’s Capital Requirements, how are Your Holdings of Derivatives Likely to Change?


Pan-Europe

7%

23%

Italy

62%

0%

France

0%

37%

Switzerland18%

29%

Netherlands

14%

29%

Iberia

9%

27%

Nordics

3%

19%

Germany

13%

19%

UK

5%

13%

Belgium

0%

11%


Just 4% of respondents disagree that solvency ii will cause more insurers to use downside protection to mitigate capital charges, explaining some of the increase in derivative use.

danish insurers are the most likely to increase derivative use, with 75% saying they will invest in these instruments in the future. italian insurers also exhibit high levels of interest, with 62% expecting to increase derivative investment.

Where insurers are planning on increasing the use of derivatives, they will need to demonstrate they have the appropriate systems to be able to capture the impact on the business through their own risk and self assessment (Orsa) process under solvency ii. Ms Muldoon of Friends life is of the view that this poses no problem for uk firms that have been using derivatives for many years and already have systems in place to measure and monitor risks, such as counterparty exposure.

However, eiOpa is clear in its expectations when it comes to derivatives and all other ‘risky’ asset classes. Mr Montalvo of eOipa says: “Insurers will be required to have effective risk management systems enabling them to manage, inter alia, the counterparty risk presented by an exposure to derivatives. EIOPA will work closely with national competent authorities to ensure that the Directive is appropriately implemented and supervised.”


BlackRock View: Nigel Foster, Managing Director, Derivative Solutions Group

The findings point to a greater need for derivatives under Solvency II to better match liabilities, provide capital guarantees and manage volatility.

This increased use of derivatives is set against a background of higher standards of transparency and additional capital being deployed under Solvency II. Demanding as these requirements are on their own, the introduction of these standards comes at a point when derivative markets as a whole are in a state of flux, thus further increasing complexity.

A new derivative market infrastructure is coming into being driven in part by shortcomings identified in the financial crisis associated with the collapse of Lehman Brothers and the taxpayers’ rescue of AIG. Under legislation such as the US Dodd Frank Act derivatives are to be more closely controlled, in particular private OTC transactions. In addition, to counter the risk of default we have seen the introduction of mandatory standards in the form of counterparty and collateral arrangements. All of this is new, and in addition to the Solvency II requirements. Furthermore, the notion of default risk now plays a part in pricing that hitherto it did not.

What this means is that Solvency II is not alone in ‘raising the bar’ for derivatives. Taken together, the level of expertise and control required, call for a radical rethinking of derivative capabilities and practices. As a result, even the largest insurers will need to choose between ‘upping their game’, dropping out of the business lines that demand most derivative expertise or partnering with those providers that have the scale and resources to do the job properly.


a demanding data management regime

the comprehensive data management and governance regime imposed by solvency ii’s third pillar has proved one of the most controversial elements of the directive, and the survey reveals many insurers are struggling to come to terms with the requirements.

respondents claim high levels of readiness for all three pillars. When asked what they thought about the structure and requirements of each of the three pillars of the directive, 97% say they are very well or quite well prepared for pillar i, 95% feel the same about pillar ii and 89% for pillar iii.

Thinking About the Structure and Requirements of the Solvency II Directive, how Well Prepared do you Feel for Each of the Three Pillars?

0 20 40 60 80 100

Pillar 3: Reporting

Pillar 2: Governance & Risk

Pillar 1: Capital requirements

Not very prepared Not at all prepared

Quite well preparedVery well prepared

37%

41%

51%

51%

54%

46%

11%

5%

3% 1%


However, the confidence in preparations for pillar iii was not borne out by responses to more detailed questions on solvency ii’s data requirements.

in spite of more than half (55%) of respondents claiming to have the necessary data to meet the requirements of solvency ii, 97% say they are either ‘very’ or ‘somewhat concerned’ about meeting the requirements for quality of data; 96% say they have concerns about timeliness; and 94% say the completeness of data requirements are a cause of anxiety.


Thinking About Each of the Specific Reporting Requirements Under Pillar III, how Concerned are you About Each of the Following Areas?

0 20 40 60 80 100

Limiting my investment strategyas some assets will not adequately

meet data requirements

Data from third-partieswill not be sufficient

Meeting the requirementsfor timeliness of data

Meeting the requirementsfor completeness of data

Meeting the requirementsfor quality of data

Not concernedSomewhat concernedVery concerned

39%

46%

55%

58%

63%

54%

46%

40%

36%

34%

8%

8%

5%

6%

3%


among the concerns expressed by respondents to the survey, one large swiss insurer says: “The description and mitigation of risk exposure by risk category required under Pillar III…this is a time-consuming process.”

at the same time, survey respondents are dedicating the smallest amounts of their overall budgets to pillar iii, which accounts for less than one-third (30%) of resource dedicated to solvency ii.

“The biggest challenge is the development of IT architecture, processes and data, [which] may be required to gather the necessary information”spanish non-life insurer, aum >€25bn

“The biggest challenge is to plan how data will flow from internal reporting systems to the regulatory reporting system”uk non-life insurer, €1–10bn aum

BlackRock View: Coenraad Vrolijk, Managing Director, Financial Market Advisory Business & Co-Chair, BlackRock Solvency II initiative

With slowly moving portfolios, insurers have never had to provide this level of transparency, at such timely notice, on their assets in the past. The focus over the past years has been very much on the science of modelling risks. However, with deadlines drawing closer, attention has shifted to the operational challenges of making multiple managers across multiple jurisdictions and multiple legal entities all report accurately, consistently and quickly. Individual insurers who are unable to provide the required transparency and are still operating in excel spreadsheets may find their credibility severely challenged across the remainder of the pillars.


a demanding data management regime continued

What is your Overall Budget for Solvency II? How is your Budget for Solvency II Apportioned Between each of the Three Pillars?

Pillar I 36%

Pillar II 34%

Pillar III 30%

Overall Solvency II Spend Share by Pillar

€0-1 mn 16%

€1-5 mn 33%

€5-10 mn 23%

€10-25 mn 14%

€25-50 mn 5%

€50-75 mn 5%

€75-100 mn 1%

>€100 mn 1%

Don’t know 3%


One of the clearest examples of a mismatch between perceived readiness for pillar iii and actual understanding of the new requirements drawn out by the survey, relates to ‘look-through’. solvency ii introduces ‘look-through’ across all assets classes, which forces insurers to understand the risk of every investment they hold, even if it is a pooled vehicle. One French survey respondent says: “I think under Solvency II the main challenge will be on quality reporting to the individual line item in pooled investment funds.”

But only one-third of respondents are confident they understand how the relationship between pooled fund look-through and return will be altered under solvency ii. non-life insurers show below-average understanding of how look-through applies to pooled funds; just 22% agree they know how the relationships will work. meanwhile, just 42% of life companies agree they understand the relationship between look-through and pooled funds under solvency ii.

Ms Muldoon of Friends life says: “The main areas of look-through relate to unit-linked business and repackaged loans [asset-backed securities]. For unit-linked business, insurers should take steps to ensure that they understand the asset mix of their external fund links.”

the problem with the imposition of look-through lies where insurers employ fund management providers and third parties that may be unable to deliver adequate data for particular funds. ninety-two percent of respondents are very or somewhat concerned that data from third parties will be insufficient under solvency ii. the highest instances of concern are among the very largest insurers (with more than €25bn in aum), with 55% saying they are very concerned, as these are most likely to employ the largest number of third parties and use more complex investment strategies.

“Sometimes, it is difficult for an organisation to obtain data that is at the same time appropriate, complete, and accurate”norwegian life insurer, >€25bn aum


“The current wording [in the Directive] requires a look-through approach to reporting and solvency calculations which means that for any fund an insurer invests in - be it a credit default obligation, mutual fund or property fund - they should be able to list all the underlying assets one by one. Not many providers have systems that allow you to do that, and if that rule comes in, investors may have to go direct or just invest in funds that are less complicated to monitor,” says Mr Jones of the cea.

Ms Burreau of nordea life comments: “We share these concerns and we are working with our distributors and asset managers to improve processes, data quality and frequency.” She adds: “You have substantial insight in your own processes but when you outsource them you don’t have the same insight and control, so as long as certain elements of the process are outsourced, there will still be potential risks.”

a large number (92%) of respondents say they are very or somewhat concerned that the reporting requirements of pillar iii will limit their investment strategy as some assets will not adequately meet data requirements. this will be a particular concern for those insurers who have indicated they plan to increase holdings in assets such as hedge funds. these assets are traditionally more opaque than other pooled funds but investors will need to work with third-party providers to ensure they have a clear view of their holdings under solvency ii.

some large insurers have done substantial work to get their own houses in order. For example, danica, the danish life insurer, says it has “a good warehouse which can support the Pillar III requirements”, while Friends life says it is also developing a warehouse to meet the solvency ii demands.

While insurers have work to do to comply with pillar iii, they have dedicated significant time and resources to meeting the solvency ii demands as a whole. Over half of respondents have currently committed at least €5m to the project, while two respondents had allocated budgets of over €100m.

mr Jones of the cea believes that insurers’ preparedness for solvency ii has been reflected in the high level of responses to the european insurance and Occupational pensions authority (eiOpa) fifth quantitative impact study (qis5).

Mr Jones comments: “The industry has been working extremely hard to be ready for Solvency II and that is no mean feat. The level of participation [in QIS5] was almost 70% of all the companies expected to fall under the scope of Solvency II. They have shown their ability to do the calculations already and while there are other legislative requirements and an urgent need for final methodologies and reporting requirements, insurers do feel they are on track.”


shifting product ranges

as insurers plan for changes to investment strategies and data requirements as a result of solvency ii, so too must they come to terms with how the regulations will influence their product ranges. the directive is designed to weed out badly designed products or ones that fail to adequately price risk, yet at the same time this improved transparency incentivises insurers to transfer more expensive, long-term risk back to the policyholder – most likely not the intention of the regulator.

less than one-fifth (18%) disagree solvency ii will force them to review their product ranges, with life insurers more affected than non-life. two-fifths of life insurers strongly agree they will need to rethink their offerings, while just one-fifth of non-life feels the same.

Solvency II may Force us to Review our Product Range – do you Agree or Disagree?

0 20 40 60 80 100

Reinsurers

Non-Life

Composite

Life

Pan-Europe: All Insurers

DisagreeNeitherAgree

36%

20%

44%

39% 14%

34%

32%

57%

44%

47%

48%

32%

23%

12%

18%


the predominant concern is for life insurers offering long-term guaranteed products, since exposure to interest-rate risk makes these products expensive, unless they can reduce the asset liability mismatch. Just under two-thirds of life insurers say they will restructure to better manage asset and liabilities, while nearly half (49%) say they will seek external advice on alm.


How Will you Manage your Guaranteed Funds Business Under Solvency II?

0 20 40 60 80We will close to new business

We will look to sell this part of the business

We will close the business altogether

We will drop guarantees

We will outsource management of these mandates

We are still considering options

We will increase yields

We will continue as we are

We will seek advice on ALM

We will re-structure to better manage assets/liabilities of funds in-house

3%

4%

5%

13%

16%

17%

20%

22%

50%

65%

Base: all life or composite insurer respondents (n=149) (multi-code allowed)source: economist intelligence unit

the impact of the directive will vary between countries; in italy, for example, many insurers have a large number of unit-linked products or they tend to renew guarantees periodically. as such, their market risk does not seem as high as that of insurers in the uk or sweden, for example, where there are long-tail annuity products or guaranteed products that have higher capital requirements under solvency ii. consequently, almost two-thirds (63%) of italian life and composite insurers say they will continue to run their guaranteed products as they are, compared with 22% of life and composite respondents overall. However, there may be a mismatch between the market value of the guarantees provided on savings products and the book value at which assets are carried, and it is not clear at this point if solvency ii will allow insurers to continue to carry assets and liabilities at book value.

in markets where there are in-built buffers against higher capital requirements, such as the netherlands, insurers benefit from a reduction in interest-rate risk as guarantees are linked to government bond indices.

However, Mr Eijsink of ing says insurers will need to develop products that offer guarantees in a different way and see what works in their market. He points to examples including variable annuities: “These are not popular in Europe and I am not sure the market is ready for them yet. Insurers will have to be creative in finding several products and see what works best by experimenting.”

in sweden, the directive could see solvency ratios plummet with capital requirements rising sharply, and while the country’s insurers are generally well-funded, 44% say they will restructure to better manage assets and liabilities, and the same number will review their product ranges.


shifting product ranges continued

Ms Burreau of nordea life suggests the cost of guaranteed products will become prohibitively expensive, driving consumers towards unit-linked products. “The cost of capital will make guarantees more costly and the customer may see them as too expensive. Consequently they might move to cheaper products where the individual carries the risk such as in unit-linked insurance,” she says.

Olav Jones, deputy director-general at cea, the european insurance and reinsurance trade body, describes some of solvency ii’s impact on product ranges as an “unintended consequence”. He adds: “The industry has supported Solvency II strongly from the beginning because we agree with a risk-based approach to regulation and solvency. We continue to engage strongly to make sure the final outcome is one that works as intended. However, we can see there is a risk that there will be elements which are not right. If so [the industry] will adapt to what we have to do but we wouldn’t like Solvency II to lead to fundamental changes in our business models, which we think have served the economy and our consumers well over many years.”

BlackRock View: Mark Azzopardi, Managing Director, BlackRock Multi-Asset Client Solutions (Insurance)

A significant increase in the cost of guaranteed products is indeed a very likely outcome but the observation is driven more by a failure in the old regime than in Solvency II. With some notable exceptions, regulation to date has failed to appreciate the full extent of the risk inherent in writing guarantees. However, many life insurers have no choice but to write guarantees if they are to differentiate themselves from pure asset managers and build a sustainable business model. Fortunately, this fuller appreciation of risk under Solvency II need not spell the end of risk taking. Guarantees can be simpler and designed specifically with risk management in mind, thus allowing better risk mitigation through a combination of more professional hedging in capital markets and traditional reinsurance. Much financial risk is at least partially hedgeable. Insurers might be better served acting as

intermediators and managers, rather than takers, of financial risk.


consequences for capital markets

according to the cea, european insurers invested €7.3trn in the global economy in 2010, which equates to more than half (54%) of the total european union gdp. clearly then, any regulation which alters insurers’ behaviour has ramifications for the global capital markets.

insurers responding to the survey believe solvency ii will exacerbate the recent stormy economic conditions, with just 5% of respondents disagreeing that the directive will lead to greater market volatility.

the smaller insurers participating in the study are more pessimistic than their larger counterparts, with 69% of insurers with less than €1bn in assets under management expecting greater volatility as result of solvency ii compared with 44% of those with more than €1bn.

Ms Burreau of nordea life says: “While it is impossible to foresee what the Directive’s impact will be on the market in three years time, the fact it coincides with Basel III and we still have unstable markets, it could be a very nasty combination to manage.”

There Will be an Increase in Volatility in Capital Markets Because of Solvency II – do you Agree or Disagree?

Agree 69%

Neutral 27%

Disagee 4%

Agree 44%

Neutral 51%

Disagee 5%

Insurers with >€1bn AUM Insurers with <€1bn AUM

Base: all insurers with >€1bn (n=196) all insurers with <€1bn aum (n=26)source: economist intelligence unit

Mr Montalvo of eiOpa says solvency ii does not introduce volatility, but rather simply provides a clearer picture of an insurer’s financial position, which is in turn properly reflected in the market. He says: “The volatility will be the same... You don’t reduce or increase [volatility] with Solvency II, you just reflect it as it really is.” mr montalvo also notes the directive introduces measures to limit market volatility, but the final mechanics of such devices are still on the drawing board.

“It will increase the risks associated with cross-holding of securities between the banking and insurance sector”spanish life insurer, >€25bn aum


the importance of any measure that counters market volatility is seen as critical to solvency ii’s success. countering the effects of pro-cyclicality is of particular importance. this is where regulations encourage insurers to sell assets in a market downturn, thereby worsening the economic conditions.

Ms Muldoon of Friends life says: “Solvency II includes an equity dampener and a matching premium which are designed to limit the capital impact following equity market falls and credit spread widening respectively. However, under the latest proposals these only apply to a restrictive set of assets. Although the draft regulations make provision for the regulator to apply an industry-wide countercyclical premium, there is a lack of clarity on when it would apply in practice and its extent in the event it is applied.” she adds: “This uncertainty makes planning for and managing risk in a downturn difficult, and increases the risk of forced selling if the countercyclical premium is not invoked or is less than anticipated.”

Mr Jones of the cea is particularly concerned about the design of the package of tools created to avoid artificial volatility and pro-cyclicality, and notes that the implications of a failure in this field will have far-reaching implications for the insurance industry and the capital markets.

He says: “There is a package of measures under discussion to ensure Solvency II does not create artificial volatility and force pro-cyclicality. If done properly, these measures can really address this issue. If not, Solvency II could have serious unintended consequences, including forcing the insurance industry away from offering long-term guarantees and a long-term investment horizon. This would be bad for the consumers, the economy and the industry.” For mr Jones, the key to effective countercyclical measures is to ensure insurers are not forced to sell assets simply because regulation encourages them to do so under certain economic conditions.

consequences for capital markets continued

“The public disclosure requirement under Pillar III will improve the comparability of firms for investors”uk life insurer, >€25bn aum


BlackRock View: Mark Azzopardi, Managing Director, BlackRock Multi-Asset Client Solutions (Insurance)

Insurance companies themselves will not actually be any riskier or more volatile as a result of Solvency II. It is simply that the way in which they are measured will change to one which is much more sensitive to market values. In theory, this added transparency should reduce the risk of owning an insurance stock and therefore reduce its volatility. However, at least in the short term it is quite possible that a fuller appreciation of the risk inherent in insurance stocks, in particular through the volatility of reported solvency ratios, will shock investors.

More broadly, there is some merit in the argument that pro-cyclicity will increase volatility by forcing insurers to sell risk assets in bear markets. There are some proposed measures such as the countercyclical premium, the matching premium and the equity dampener that partially mitigate this pro-cyclicity. Equally, there are limits to how far EIOPA can go without effectively condoning insolvency. After all, at the point where an insurer runs out of capital it is reasonable to expect it to have sold down all its excess risk assets relative to the regulatory least-risk position.


equity and debt markets

BlackRock View: Richard Turnill, Managing Director, Global Equity Team

A crucial impact of Solvency II will be the creation of a more risk-focused approach, where the analysis of investment risk versus expected returns becomes the most important factor. This focus will be especially pertinent considering the expected increase in equity market volatility. Therefore, a low beta, high quality equity income strategy is likely to feature heavily within insurers’ equity allocation.

Research conducted by our Risk and Quantitative Analysis area shows that low volatility (high quality) equities outperform high volatility equities over the long-term. This turns the well-established assumption of being paid to take more risk upside down. The survey findings also indicate a consensus move away from equities and towards corporate bonds. The resulting increase in demand will further depress already low fixed income yields, so re-allocating from broad equities towards high quality

equities, with the much stronger risk/return profile, seems a better solution.

equity markets look the most likely to be negatively affected by solvency ii. Only 9% of survey respondents disagree that share prices will fall, as demand for equities will be lower due to solvency ii. an even smaller number (3%) disagree that the equity risk premium will have to increase in order to encourage investment in this area.

smaller insurers with less than €1bn in assets are more likely to expect share prices to fall than their larger counterparts, with 62% expecting them to be hit compared with 43%.

dutch and nordic respondents show most concern about the directive’s impact on equity markets, with 64% of insurers in the netherlands believing share prices will fall, while 55% of nordic respondents agree.


Due to Solvency II, Average Share Prices will be Lower as Demand for Equities will be Lower – do you Agree or Disagree?

Agree 46%

Neutral 45%

Disagree 9%


Due to Solvency II, the Equity Risk Premium will Need to Increase Significantly to Encourage Investing in Equities – do you Agree or Disagree?

Agree 49%

Neutral 48%

Disagree 3%


However Ms Muldoon of Friends life says: “Although equities attract a relatively high capital charge under the Solvency II standard formula, this has been known for quite some time and we would expect the market to have already priced this in.”


equity and debt markets continued

the lower demand for equities may also be balanced out by a lower supply. Forty percent of respondents believe that, due to solvency ii, companies will favour issuing debt rather than equity for their funding needs. the subsequent increased supply of debt will be useful as nearly half (45%) of respondents say they expect high-rated corporate and government debt to become more attractive as a consequence of solvency ii.

Regulators may have to Rethink Approach to ‘Risk-Free’ Assetsunder current proposals, the regulator attributes eea sovereign debt a 0% capital charge, so for insurers able to use the asset class as a suitable matching proponent in a long-term investment strategy, this looks attractive. However, the recent eurozone debt crisis has thrown the very inclusion of a ‘risk-free’ asset in the standard capital model into doubt.

Mr Eijsink of ing comments: “ING had already taken the opinion that it was a grave omission in the standard model and we can see that government bonds are not risk-free. What we dearly miss is a real risk-free asset since we have a risk-free definition on the liability side of the balance sheet but we don’t have a risk-free asset on the asset side.”

although it is unclear as to whether eiOpa will revise the 0% capital charge, this seems unlikely since the european commission will wish to avoid any potential market disruption any rethink might cause. ultimately, insurers are responsible for understanding the real risks posed by any asset class in which they invest under the Orsa process.


BlackRock View: Scott Thiel, Deputy Chief Investment Officer, Fixed Income

The continued stress in segments of the Eurozone government bond market certainly merits reconsideration of the current proposal that these assets should carry a 0% risk charge under the Solvency II standard model. Indeed, as risk management practice continues to develop at European insurance companies and the use of internal models becomes more prevalent, it is possible that recent events will lead some companies to take more conservative capital charges in respect of this asset class, irrespective of the standard model. In such cases, it is conceivable that the capital charges used could be lower than those for corporate bonds of equivalent credit rating. The asset class may then remain more attractive than corporate bonds to the insurance sector, but this would be based upon an assessment of expected return versus capital requirement, which is part of a wider trend we expect as a consequence of the introduction of specific asset charges under Solvency II. In any case, we continue to see Government bonds as a very important part of the asset portfolios of European insurers given our expectation that, in the long term, these instruments will still be considered a very low risk asset class, not to mention their role in matching the liability profile of an insurance portfolio.

conclusionconclusion

While EIOPA and the relevant national regulators thrash out the final elements of the Directive and attempt to tackle the challenging issues of managing volatility, pro-cyclicality and risk-free assets, insurers should use the time to identify any mismatches between their perception of readiness and the reality.

Insurers’ anxieties about data management must be tackled if they are to achieve the optimum investment strategy and asset allocations to deliver superior returns, and they may need to revisit the amount of time and resource they invest in this area.

A disconnect persists between the perception of Solvency II limiting investment strategies and the reality, which actually opens the door to a wider field of asset classes via the ‘prudent person’ principle. While insurers are concerned that they will be penalised for investing in ‘riskier’ asset classes including derivatives and alternatives, they are still set to increase their risk budgets in the pursuit of higher returns. These final stages of implementation need to include effective measures to ensure insurers are allowed to invest in the strategies most suited to their business needs, and in turn, insurers and third parties must make certain they have robust reporting platforms to manage investment in these assets.

At the same time, insurers must wait and see how EIOPA and domestic regulators deal with concerns about systemic risk and market volatility and whether Solvency II will ultimately meet its aims – to protect consumers from future financial crises.

The survey data shows insurers still see the Directive as a useful tool in better managing risk. But if it forces them to excessively limit product ranges, then it may be consumers who inadvertently fall foul of the very legislation designed to protect them. As the cost of guaranteed products becomes prohibitively expensive, it could force consumers into other products where they shoulder the investment risk.

Just 13% of respondents disagree that Solvency II will be positive for insurers, but everything now hinges on ironing out the detail, particularly in Pillar I and ensuring the Directive allows insurers to function effectively in benign markets and be better prepared and protected in times of crisis. Timely action is also needed – earlier delays in implementation were greeted with relief by many insurers as it gave them more time for preparation but at this stage further delays in clarity of rules will only frustrate the industry.


“A large number of financial institutions will adopt a common risk modelling framework, which will help ensure stability in financial markets”uk non-life insurer, <€10bn


Blackrock commentators

David A. Lomas, acii, managing director, is head of Blackrock’s global Financial institutions group. this global business is focused on managing balance sheet and subadvisory assets, and providing risk management services to financial institutions. mr lomas is responsible for Blackrock’s strategy, service offering, client strategy and client proposition. He sits on Blackrock’s global Operating committee.

Matthew Botein, managing director, is head of Blackrock alternative investors (Bai). Bai includes Blackrock’s hedge funds and opportunistic funds, funds of hedge funds, private equity, private equity funds of funds, real estate and real assets.

Nigel Foster, managing director, heads the derivative solutions group within the Blackrock multi-asset client solutions (Bmacs) group, which is responsible for implementing bespoke portfolio solutions. mr Foster is a member of the Bmacs management team, counterparty Oversight committee (cpOc), Operating committee (eOc) and chairs the international derivatives Oversight committee (dOc).

Coenraad Vrolijk, managing director, leads our Financial market advisory business in emea within Blackrock solutions. the Financial markets advisory group advises clients in managing their capital markets exposure and businesses. mr Vrolijk is a senior advisor with specialization in insurance, central banks and financial market regulators. in addition, he co-chairs Blackrock’s solvency ii initiative.

Mark Azzopardi, managing director, is a member of the Blackrock multi-asset client solutions (Bmacs) group, which is responsible for developing, assembling and managing investment solutions involving multiple strategies and asset classes. Within Bmacs, he is part of the client strategy team where he provides strategic advice to institutional clients, focusing on insurance companies and on pension funds with a strong liability-driven philosophy.

Richard Turnill, managing director, and portfolio manager, is a member of the global equity team within the Fundamental equity division of Blackrock’s portfolio management group. He is responsible for leading the team which manages large cap global equity portfolios.

Scott Thiel, managing director, is Blackrock’s deputy chief investment Officer of Fixed income, Fundamental portfolios, and Head of european and global Bonds. He is a member of the Fixed income executive committee and the emea executive committee. mr thiel is a member of Blackrock’s leadership committee.


about Blackrock

BlackRock Financial Institutions GroupBlackrock has unrivalled insights into the management of insurance company assets. its Financial institutions group managed $204 billion in unaffiliated general account assets for 127 insurers in 23 countries as at the end of december 2011. in addition to these asset management relationships, Blackrock also provides risk management services to 75 insurers through Blackrock solutions.

For more information or to share your views, please contact us:

email: [email protected]

in a world that is shifting and changing faster than ever before, investors who want answers that unlock opportunity and uncover risk entrust their assets to Blackrock. as an independent, global investment manager, Blackrock has no greater responsibility than to its clients.

it’s why many of the world’s largest pension funds and insurance companies trust Blackrock to understand their unique objectives and why financial advisers and investors partner with Blackrock to help them build the more dynamic, diverse portfolios these times require.

Blackrock has built its offering around its clients’ greatest needs: providing breadth of capabilities and depth of knowledge – across active and passive strategies, including ishares® etFs. this is combined with a singular focus on delivering strong, consistent performance and an ability to look across asset classes, geographies and investment strategies to find the right solutions.

With deep roots in every region across the globe, some 100 investment teams in 27 countries share their best thinking to gain the insights that can change outcomes. and, with a passion to understand risk in all its forms, Blackrock’s 1,000+ risk professionals dig deep to find the numbers behind the numbers and bring clarity to the most daunting financial challenges. that shapes and strengthens the investment decisions that Blackrock and its clients are making to deliver better, more consistent returns through time.

BlackRock. Investing for a new world.


appendix

Company Headquarters

UK 27%

Germany 14%

France 9%

Switzerland 8%

Italy 6%

Netherlands 6%

Belgium 4%

Sweden 4%

Luxembourg 4%

Norway 4%

Finland 3%

Spain 3%

Bermuda 3%

Denmark 2%

Portugal 2%

Iceland 1%


Insurer Type

Life 34%

Non-life 29%

Composite 26%

Reinsurer 12%



Group AUM

€10bn-€25bn 10%

€500m-€1bn 9%

<€500m 3%

>€25bn 47%

€1bn-€10bn 31%


Job Title

CFO/Treasurer 22%

CEO/President MD 8%

Other 6%

SVP/VP/Director 41%

Other C-level Exec 23%



appendix continued

Frequency of Tactical and Strategic Reviews of Asset Allocation

Quarterly 37%

Monthly 53%

Weekly 3%

Annually 1%

Biannually 7%

Quarterly 42%

Monthly 25%

Weekly 1%

Annually 11%

Biannually 22%

Tactical Strategic


Agreement with Pillar I Statements

Our investment risk budget willincrease under Solvency II

Solvency II will make me more likelyto use derivatives in the future

Solvency II will severly hamperour ability to take investment risk

I expect the effect of Solvency IIon life insurers to be mainly positive

We already know how we arelikely to change our asset allocation

We are waiting until implementationof Solvency II is closer before making

changes to our asset allocation 53%

46%

40%

38%

37%

33%

38%

51%

47%

42%

49%

51%

9%

4%

13%

20%

15%

15%




Level of Confidence in own Investment Governance and Risk Management Under Solvency II

Somewhat confident 55%

Extremely confident 42%

Not at all confident 1%

Not very confident 2%


Agreement with Pillar II Statements

We are confident we know how the relationshipbetween pooled fund 'look-through' and

return will be altered under Solvency II

Solvency II may force usto review our product range

We are confident we have the necessarydata to meet the requirements of Solvency II

We are confident we have the necessary resourcesin terms of asset liabilty management to

meet the requirements of Solvency II

We are confident that we can consistentlycapture the interaction between

assets and liabilities with our chosen model(ie, internal, partial internal)

67%

58%

55%

34%

34%

33%

39%

40%

48%

62%

1%

3%

5%

18%

4%




appendix continued

Agreement with Pillar III Statements

I expect the pricing of buyouts to get moreexpensive as a result of Solvency II

There will be increased usage of passivefunds due to Solvency II requirements

There will be increased usage ofactive funds due to Solvency II requirements

I would like to see an increase in the creation SolvencyII-friendly assets, which can optimise return on capital

Solvency II will result in insurers increasinglyusing downside protection to mitigate the

impact of new capital charges

The requirments of Solvency II will result ininsurers using better liabilty matching

techniques including the use of derivatives 60%

51%

39%

34%

34%

33%

37%

45%

55%

59%

59%

63%

4%

4%

6%

8%

8%

4%



Global Capital Markets: Effect of Solvency II on Fixed Income

An increase in demand forhigher-quality government bonds

A preference for assets basedon the long-term swap rate

An increase in use of emerging market debt

An increase in theattractiveness of covered bonds

A shift from short-dated paper to deposits

A shift from local to global bonds

An increase in use of ALM derivatives

A shift from long-term to shorter-term debt

An increase in the attractiveness ofhigher-rated corporate debt and govt bonds 45%

44%

40%

40%

30%

28%

26%

25%

22%



Global Capital Markets: Effect of Solvency II

Banks will struggle to sell the long-dated bonds required byBasel III as Solvency II makes holding long-dated

corporate bonds more expensive for insurers

Due to Solvency II, companies will favour issuingdebt rather than equity for their funding needs

Due to Solvency II, average share priceswill be lower as demand for equities will be lower

There will be an increase in volatility incapital markets because of Solvency II

Due to Solvency II, the equity risk premium will need toincrease significantly to encourage investing in equities 50%

47%

45%

40%

39%

48%

49%

45%

51%

48%

3%

5%

9%

9%

14%



Overall View of the Effect of Solvency II on Capital Markets

Reinsurer

Non-life

Composite

Life

Pan-Europe 58%

57%

72%

49%

50%

23%

21%

21%

29%

23%

19%

22%

8%

22%

27%

NegativeUndedcided/NeutralPositive


FOR MORE INFORMATION Tel: +44 (0)20 7743 3000Email: [email protected] Website: blackrock.com/international

002618–12 Feb12

Important information

1. this material is for distribution only to those types of recipients as provided below and should not be relied upon by any other persons. circulation must be restricted accordingly. this material is provided for information purposes only and does not constitute a solicitation in any jurisdiction in which such solicitation is unlawful or to any person to whom it is unlawful. moreover, it neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to it by making an offer to enter into an investment agreement.

2. this material may contain forward-looking information that is not purely historical in nature. such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. moreover, certain historical performance information other investment vehicles or composite accounts managed by Blackrock have been included in this material and such performance information is presented by way of example only. no representation is made that the performance presented will be achieved by any Blackrock funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

3. this material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. the opinions expressed are as of 1 February 2012 and may change as subsequent conditions vary. the information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Blackrock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. there is no guarantee that any forecasts made will come to pass. any investments named with this material may not necessarily be held in any accounts managed by Blackrock. reliance upon information in this material is at the sole discretion of the reader. past performances is no guarantee to future results.

4. this material is issued in the uk by Blackrock investment management (uk) limited (authorised and regulated by the uk Financial services authority). registered office: 12 throgmorton avenue, london, ec2n 2dl. registered in england no. 2020394. tel: +44 20 7743 3000. For your protection, telephone calls are usually recorded. Blackrock is the trading name of Blackrock investment management (uk) limited and Blackrock advisors (uk) limited. in Hong kong, the information provided is issued by Blackrock (Hong kong) limited and is only for distribution to professional investors (as defined in the securities and Futures Ordinance [cap. 571 of the laws of Hong kong and any rules made under the Ordinance]). in singapore, the information provided is distributed by Blackrock (singapore) limited (company registration no. 200010143n) and is for distribution to institutional investors (as defined in section 4a of the securities and Future act, chapter

289 of singapore (the sFa) and accredited investors (as defined in section 4a of the sFa) only). in Brunei, malaysia and thailand, this document is provided in a private and confidential manner to institutional investors only. this material is issued in the united arab emirates by Blackrock advisors (uk) limited – dubai Branch which is regulated in the uae by the dubai Financial services authority (dFsa). it is directed at professional clients only within the meaning of the rules of the dFsa and no other person should rely upon the information contained within it. For distribution in emea, korea and taiwan for professional investors only (or professional clients, as such term may apply in the relevant jurisdictions). Blackrock investment management (taiwan) limited is an independent legal entity, which is located at 28F, 95 tun Hwa south road, section 2, taipei, taiwan. tel (02)23261600. in Japan, this material is not for use with individual investors. this material may be distributed/issued in canada, australia and new Zealand by Blackrock Financial management inc. (BFm), which is registered as an international advisor with the Ontario securities commission. in australia, BFm is exempted under asic class Order 03/1100 from the requirement to hold an australian Financial services licence and is regulated by the securities and exchange commission under us laws, which differ from australian laws. in new Zealand, this presentation is offered to institutional and wholesale clients only. it does not constitute an offer of securities to the public in new Zealand for the purpose of new Zealand securities law. BFm believes that the information in this document is correct at the time of compilation, but no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BFm, its officers, employees or agents. this document contains general information only and is not intended to represent general or specific investment advice. the information does not take into account your financial circumstances. an assessment should be made as to whether the information is appropriate for you having regard to your objectives, financial situation and needs.

in latin america, for institutional investors only. it is possible that some of the funds mentioned or inferred to in this material have not been registered with the securities regulator of argentina, Brazil, chile, colombia, mexico, peru, uruguay or any other securities regulator in any latin american country, and thus, might not be publicly offered within any such country. the securities regulators of such countries have not confirmed the accuracy of any information contained herein. no information discussed herein can be provided to the general public in latin america.

Blackrock® is a registered trademark of Blackrock, inc.

© 2012 Blackrock, inc. all rights reserved. BlackrOck, BlackrOck sOlutiOns, aladdin, isHares, liFepatH, sO WHat dO i dO WitH mY mOneY, inVesting FOr a neW WOrld, and Built FOr tHese times are registered and unregistered trademarks of Blackrock, inc. or its subsidiaries in the united states and elsewhere. all other trademarks are those of their respective owners.

For institutional use only – not for public distribution.