Solvency regulations and low-risk investing: comparing the Nordics with the Netherlands
Pension regulations in the Nordic countries and the Netherlands are similar to insurance regulation in the European Union. Solvency capital (SC) required for credit risk in corporate bond portfolios is close to its economic risk, while solvency capital for equity risk does not distinguish at all between low-risk and high-risk equity portfolios.
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- SC required for credit risk is close to its economic risk
- SC required for equity risk does not distinguish between low and high risk
- This may contribute to the existence of the low-risk anomaly in equities
This shortcoming in the regulation encourages risk-seeking behavior by pension funds and insurance companies in their equity portfolios, and may contribute to the existence of the low-risk anomaly documented in the equity literature. Solvency regulation does not seem to discourage allocating to low-risk corporate bonds. However, other market frictions may cause the anomaly to persist in corporate bond markets.
In this paper1, we start by describing the regulatory frameworks in the Nordic countries and the Netherlands. We then continue with a more in-depth discussion of the possible reasons why low-risk investment strategies have a higher return-to-risk ratio, and apply this specifically to corporate bonds and equities from the perspective of insurance companies and pension funds.
1Houweling, P. and Swinkels, L., 2020, ‘Pension and Insurance Solvency Regulations and Low-Risk Investing: A Comparative Analysis of the Nordic Countries and the Netherlands’, Nordic Journal of Business.
