On July 8 2015, the Swiss Financial Market Supervisory Authority (FINMA) put out a revised package of circulars for consultation. One of these circulars concerns the investment guidelines for insurers, which has been completely revised since the 2008 version.
The regulatory environment for insurer investment strategy
In Switzerland, insurers are subject to a reasonably detailed and widespread set of investment restrictions. In theory, these guidelines and restrictions could considerably limit the investment freedom and the perceived risk of the block of assets, which are set aside to directly back insurance liabilities (known as the Tied Assets). The extent to which these guidelines have an impact on insurers of course depends on:
- The composition of their (minimum risk) replicating portfolio i.e. the portfolio of assets which best replicates the cashflows and other characteristics of their liabilities.
- The risk appetite of the insurer as it applies to market and credit risk, as well as the individual limits and tolerances and investment mandates.
In general, the specific limits within the investment guidelines are not restrictive for insurers writing domestic traditional business backed by traditional asset classes. However, in the current low yield environment insurers often look for increased yield or diversification by investing in assets denominated in foreign currencies (for example USD bonds offer a longer duration than CHF bonds, making them relatively more attractive for life insurers) or other asset classes. Such alternative assets include infrastructure investments, insurance linked securities and corporate debt.
The circular that has been out for consultation contains a number of key alterations, which generally serve to further facilitate such investment decisions. These include:
- the extension of the universe of alternative investments deemed admissible with the Tied Assets
- the requirement for insurer to assess the credit worthiness of investments themselves and no longer rely solely on rating agencies
- the removal of the current inadmissibility of investments with a direct link to insurance risk (e.g. insurance linked securities)
We consider each of these points and their possible implications for Swiss insurers in the following sections:
The most substantial change is the extension of the investment opportunities arising from alternative investments. It is proposed in the circular that private debt (including senior secured loans) and commodities become admissible as alternative investments within the Tied Asset fund. Infrastructure investments are now explicitly mentioned and assigned to private equity respectively private debt asset classes.
In the wider context in Europe there have been a number of investigations recently, including a report from the European Regulator EIOPA, with a view to making insurer investment into infrastructure more attractive. Specifically they aim to find a more appropriate treatment of infrastructure investments within Solvency II and provide incentives for insurers to increase investments into this asset class, which is often viewed as socially beneficial.
The proposals in the draft circular are consistent with this trend and the investment opportunities for insurers would be considerably widened. Under the current regime, investments into private debt would only be allowed through hedge funds and investment in commodities is generally limited to indices and baskets.
Nevertheless for admissibility, investments still need to be held indirectly i.e. through a fund structure.
Further, to reflect the enlarged investment universe, the limit on the asset allocation for alternative investments would be increased from 10% to 15%.
At the end of 2013, Swiss life insurers invested roughly 2/3 of their tied assets into core low-risk investments (such as bonds, cash, derivatives for hedging and participations in Group companies). Of the remainder, 14% was invested in real estate, 12% in mortgages and other loans, 4% in equities and other collective investments and a mere 2% in alternative investments. The extremely low allocation to alternative investments and in particular infrastructure investments was perhaps not surprising given the regulator constraints arising from the Tied Asset regime combined with the current treatment in the standard model of the Swiss Solvency Test (SST), which is relatively unfavorable compared to other asset classes.
We belief insurers will welcome the relief that would be provided by this circular but that further changes to the regulatory environment, in particular the SST treatment, would be required to enable insurer investment in this class on a larger scale than is currently practicable.
Own credit ratings
The proposed circular would require the use of own credit ratings for all investment classified as tied assets. External ratings could only be used as a source of information to determine the own credit ratings and at a very minimum would need to be plausibilized by the insurer. Further only external ratings from recognized rating agencies (i.e. primarily the big three agencies defined in circular 2012/1) would be allowed.
Since the credit crunch of 2008, regulators and financial institutions are acutely aware of the risk of over-reliance on rating agencies. By requiring the insurers to form their own views on credit worthiness, we believe this reliance will decrease. However, some insurers may see this credit assessment as a “tick box exercise” or lack the necessary expertise. Further as use of external ratings within the SST is already limited to primarily the big three agencies, we do not expect this change to have a large impact on the investment decisions of insurers unless the internal views they form in the future significantly differ from that of the rating agencies.
Insurance linked securities (ILS)
The proposed admissibility of “investments with a direct link to insurance risk” i.e. insurance linked securities in the tied assets would allow insurers to invest into ILS given that the securities were not positively correlated to their own insurance risk. Given that the current volume invested into ILS is very limited in Switzerland, we do not expect that this change would have a significant impact. Further careful consideration to links between the asset and liabilities sides of the balance sheet would need to be considered as well as any possible decrease in overall diversification.