Since 2016, insurance companies in the European Union have to comply with Solvency II regulation. This Directive imposes equity solvency capital requirements. This means that insurance companies have to hold a capital buffer to survive adverse shocks in financial markets. Most European pension funds are still subject to local regulation, but these local frameworks tend to resemble Solvency II.
Under Solvency II the standard solvency capital requirement (SCR) for a diversified equity portfolio is 39% for stocks listed in developed markets and 49% for those listed in emerging markets. This SCR is adjusted up or down with a maximum of 10 percentage points, depending on the equity market’s past three-year performance. The equity SCR is intended as a means to keep the probability of bankruptcy over the next twelve months below 0.5%.
Solvency II has a different equity solvency capital requirement for developed market stocks (39%) percent) and emerging market stocks (49%). This makes sense, as there is a difference in financial economic risk between the two types of markets. However, differences in financial economic risk within developed or emerging markets are not taken into account. This has two unintended, potentially detrimental consequences:
We will explain why. First of all, within developed or within emerging equity markets, the risk of each equity portfolio is assumed to be the same. If you assume that more risk should lead to more return, this regulation creates an incentive to buy more risky stocks. This can be seen in Figure 1, where we depict a low-risk (blue) and a high-risk (red) portfolio. Solvency II assumes the risk for each of these two portfolios to be the same as the market’s, as indicated by the blue and red circles. As a result, the Solvency II investor does not face a risk-return trade-off, but can choose the highest return regardless of financial economic risk. Instead of promoting prudency, Solvency II therefore encourages risk-seeking behavior.
This is linked to the second unintended consequence of Solvency II. If large enough pools of capital are exposed to Solvency II-type regulation, the price of high-risk stocks is driven up more than warranted by their economic risk, while the price of low-risk stocks is pushed down more than justified by their economic risk. This leads to lower future returns for high-risk stocks, and higher future returns for low-risk stocks. Investors only have an incentive to buy the low-risk stocks when their price has decreased so much that the relation between risk and return has become flat or inverse. Such a distortion between risk and return is indeed observed in practice, and is commonly referred to as the low-risk anomaly. Oversimplified regulation such as the crude Solvency II SCR framework may help create and sustain this anomaly.
We urge European regulators for institutional investors to improve Solvency II by aligning it with more sophisticated European regulation that is already in place for private investors in mutual funds. This would reduce the potential harmful unintended consequences from existing solvency regulation.
Specifically, we propose to multiply the standard solvency charge of 39% with the ratio of the company’s equity portfolio volatility to the broad equity market’s volatility. This is a way to capture a portfolio’s relative risk. The ratio will be above one for more risky portfolios and below one for less risky portfolios, meaning that high-risk stock portfolios require more solvency capital than the market, and low-risk stock portfolios less. In our proposal the distinction between developed (SCR of 39%) and emerging (SCR of 49%) stocks has disappeared. This is because our formula already accounts for this difference.
For the broad equity market we propose to use the MSCI World Index. For volatility, we propose to take the five-year volatility and review this on a quarterly basis. If the company’s equity strategy does not have a representative five-year history, we propose backfilling the equity return history with a representative alternative proxy return series, such as an index that follows a similar investment strategy.
Our proposed approach encompasses the existing distinction between emerging and developed markets, and also takes into account many other potential sources of risk. It is a straightforward and cost-efficient way for asset owners to assess risk, which is already used in regulation for European retail investors. It gives better incentives to institutional investors, contributes to market efficiency and is difficult to manipulate. In short, it reduces potentially harmful, unintended consequences of existing regulation for institutional investors.
当資料は情報提供を目的として、Robeco Institutional Asset Management B.V.が作成した英文資料、もしくはその英文資料をロベコ・ジャパン株式会社が翻訳したものです。資料中の個別の金融商品の売買の勧誘や推奨等を目的とするものではありません。記載された情報は十分信頼できるものであると考えておりますが、その正確性、完全性を保証するものではありません。意見や見通しはあくまで作成日における弊社の判断に基づくものであり、今後予告なしに変更されることがあります。運用状況、市場動向、意見等は、過去の一時点あるいは過去の一定期間についてのものであり、過去の実績は将来の運用成果を保証または示唆するものではありません。また、記載された投資方針・戦略等は全ての投資家の皆様に適合するとは限りません。当資料は法律、税務、会計面での助言の提供を意図するものではありません。
商号等： ロベコ・ジャパン株式会社 金融商品取引業者 関東財務局長（金商）第２７８０号
加入協会： 一般社団法人 日本投資顧問業協会