Tuesday, January 16, 2018 Stamford, CT USA — One-third of continental European insurance companies expect to increase investment portfolio allocations to real estate and infrastructure in the next three years, according to a new report, Insurers Present Challenges and Opportunities for Asset Managers, from Greenwich Associates. 

This dramatic increase in demand for debt in these illiquid asset classes is being driven by the combination of low interest rates and the impact of Solvency II—the set of regulations dictating capital adequacy for insurers that took effect in January 2016.

Insurance companies represent the largest source of externally managed investment assets in continental Europe, and insurers allocate more than €1 trillion to “external” asset management firms. “A spike in demand among these investors is having a major impact on both the real estate and infrastructure markets and the businesses of asset managers competing in Europe,” says Markus Ohlig, Greenwich Associates Managing Director and author of the new report.

Solvency II, which sets capital reserve thresholds for insurance companies, gives relatively favorable treatment to illiquid bonds, such as those in real estate debt and infrastructure debt. Although this debt is often unrated, it has historically shown low default rates, due to factors such as asset-backed structures or implicit government guarantees in infrastructure debt. “The relatively favorable capital charges assigned to this type of debt explains why insurance company demand for infrastructure and real estate is through the roof, and why insurers are opting for debt investments over equity,” says Markus Ohlig.

Opportunity for Asset Managers
Strong demand from insurance companies represents a significant opportunity for asset managers. One major fixed-income manager estimated that the revenue margin in these asset classes is five to 10 times higher than that in plain-vanilla liquid fixed income. Managers also benefit from the fact that illiquid asset classes are “sticky,” meaning that investors must make a long-term commitment with the manager.

To win these mandates, asset managers will need a thorough understanding of the unique needs driven by Solvency II as well as  local insurance regulations. Specifically, capital charges under Solvency II are impacted by the volatility of an asset class, its correlation to other asset classes and—to add further complexity—to the liability side of insurers’ balance sheet. “Success will require managers to demonstrate deep knowledge of insurers’ asset allocation, risk management models and stress tests under Solvency II,” says Markus Ohlig.