Investment Activities of Polish Insurance Companies Before and After Solvency II

Conducting investment activity is one of the basic tasks of an insurance company. Investments are classified as value generators for an insurance institution because, thanks to the use of the financial market mechanism, insurers fill the gap between the present value of collected premiums and the value of future liabilities. Thanks to investments, it is possible to implement insurance protection at any time. Thus, insurance companies support effective risk management of other business entities. The funds invested affect the financial result achieved by the insurance institution.

The implementation of the assumptions of investment activity is, apart from collecting premiums and settling liabilities due to benefits and damages, the essence of insurance activity. One of the basic determinants of this activity is legal restrictions.

The aim of this article is to look for answers to the following research questions:

How Solvency II influenced the structure of the investment portfolio of domestic insurers?

The first part of the article discusses the most important assumptions of Solvency II, while the second part examines the structure of investment portfolios of Polish insurers. The structure of investments of insurance companies was examined over a time horizon from 2014, that is, 2 years before the entry into force of the Solvency II assumptions on the domestic insurance market, until the date on which the last available financial statements of insurance companies were prepared (2020).

The importance of the topic of managing the investment activities of insurers results from the position of insurance companies in the economy. The literature on the subject contains many studies discussing the theory and practice of investment management in insurance companies (Bac, 2004; Bożek, 2011; Czerwińska, 2009, 2013; Gąsiorkiewicz, 2014, 2019; Jonas, 2014; Marcinkowska, 1997; Parlińska, 2014; Soczewko, 2001; Wartini, 2009; Wasiak, 2018). However, these studies usually focus on only one selected branch of insurance – life or non-life insurance. They also do not cover the time frames discussed in this paper.

Starting in 2007 – although some authors refer to a date a year later – the economic crisis and its impact on the insurance market has been a subject of interest for many authors, and contributed to the revision of considerations on the safety of the insurance market, culminating in the Solvency II Directive (Bożek, 2011, pp.89–99; Gąsiorkiewicz, 2009, pp.196–197; Gąsiorkiewicz, 2019, pp.151–168; Ostrowska, 2014, pp.121–130; Parlińska, 2014, pp.97–114; Wartini, 2009, pp.17–28). This directive introduced many significant changes to the management of the investment activity of insurers. In terms of safety, insurance companies were obliged to follow the “prudent investor” principle. This rule states that insurance companies “may only invest in assets whose risks they can understand sufficiently to be able to identify, measure, monitor, manage, control, report and take into account in their assessment of their own solvency needs” (Directive, 2009). A system based on covering the solvency margin and guarantee capital with own funds has determined the activity of insurance companies for many years. However, with the development of the insurance market, the evolution of investment activity, and the identification of the catalog of risks, the Solvency I system ceased to fulfill its task. To quote Manikowski and Matuła, Solvency I “turned out to be inadequate and did not guarantee the desired level of insurance coverage” (Manikowski and Matuła, 2018, pp.205–224). The main objection to a system based on the solvency margin, as discussed in the literature on the subject, was the omission in its calculation of the exposure to risk of the investment activity of the insurance company – including risk measurement and management (cf. further Handschke and Monkiewicz, 2010, p.240). This problem was clearly presented by Bragt, Steehouwer, and Waalwijk in relation to the Dutch insurance market (Bragt, et al., 2010, pp.92–109). They found that the system operated on the basis of the risk embedded in the liabilities of the insurance company. Thus, the investment risk was completely ignored, as a result of which the capital requirement for an investment portfolio consisting of, for example, 80% shares and 20% bonds was the same as for a portfolio with the opposite ratio – 20% shares and 80% bonds – despite the fact that both portfolios faced completely different risks. In addition, the literature contains arguments about limiting the functioning of the single insurance market, the lack of proper supervision over insurance groups, and the inconsistency of systemic solutions implemented in the insurance sector and other financial sectors (cf. further Jędrzychowska, 2009, pp.29–42).

The Directive of 2009 did not change, but actually underlined the desirable features of investments of insurance companies – the assets at the disposal of the insurance company to cover the minimum capital requirement and the Solvency Capital Requirement (SCR) were to be invested in a manner ensuring safety, profitability, liquidity, and quality. In the literature on the subject, we can find a catalog of features extended by the principles of portfolio diversification and congruence (Jonas, 2014, pp.26–34; Marcinkowska, 1997, pp.71–87; cf. further Jończyk, et al., 2004). The former does not require any comment, while the latter requires that the same currency is maintained for investments in assets covering technical provisions and liabilities under insurance contracts from which technical provisions are established. The Minimum Capital Requirement and the SCR have replaced the solvency margin and its guarantee capital. The SCR is equivalent to the amount of capital that an insurance company has to maintain, so that the probability of its bankruptcy does not exceed 0.5%. By definition, the SCR regulations contained a general presentation of the new measure, a standard formula for estimating the SCR, and guidelines for the use of internal models for determining the solvency of an insurance company. The directive also drew attention to the assets covering technical provisions, which should be invested taking into account the structure, nature, and duration of the insurance company's liabilities, while investment activities should be carried out in a way that ensures the capital is invested in the best interests of policyholders and beneficiaries.

The most important and, at the same time, greatest change for the insurance sector is the freedom of investment that was to be granted to insurance institutions under the directive. The notion of freedom should be understood as the lack of investment limits that would restrict the decisions of the managers of the investment activity of the insurance company. A catalog of instruments in which insurance companies can invest was opened. In terms of formalities, the requirement to approve and inform the relevant supervisory authority about investment decisions made by the insurer was also abolished. The use of derivatives was sanctioned by their role in the portfolio – the directive allows only derivatives that reduce the risk or improve the management of the investment portfolio. Moreover, with the entry into force of the Solvency II assumptions in the Member States, insurance companies ceased to apply the requirement to pair the place of origin of the insurance risk with that part of the company's property that covers the relevant technical provisions.

The assumptions of the directive of the European Parliament were implemented in Poland by the Act on Insurance and Reinsurance Activity of 2015 (Act, 2015). Pursuant to the above-mentioned directive, the national legislator repealed the investment limits dictated by the Act of 2003 and they were replaced with the principle of prudent investment (Act, 2003). Nevertheless, investments of insurance companies should meet the following rules (Act, 2015):

The property covering technical provisions/reserves should, for solvency purposes, take into account the nature and duration of liabilities under concluded insurance contracts.

The main innovation of the introduced Act is the revolution in the approach to investment risk and the related sanctions (cf. further Gąsiorkiewicz, 2019, pp.151–168). The problem of the previously applied regulations was aptly summarized by Wasiak: "If we were to compare two insurance companies with the same business parameters, one of which pursued an investment policy taking into account the matching of the structure of assets and liabilities and a much greater degree of portfolio security, and the other a less safe policy with a mismatch of assets and liabilities, the solvency margin for both companies would be the same anyway" (Wasiak, 2018, p.83). Solvency II solved the above-mentioned problem by making the solvency of insurers dependent on the matching of assets to liabilities and the degree of security of the investment portfolio. The new regulations linked both of these issues with the SCR of an insurance company.

The greater an insurance company's appetite for risk in its investment activities, the higher its SCR becomes. Thus, the insurer must maintain a higher level of own funds. The introduction of new risk measures for the investment activity of insurance companies forced the managers of these assets to review their investment portfolios. The purpose of a review of insurers' investments should be to optimize the portfolio of financial instruments in order to maximize profit and minimize the cost of capital to cover the risk. The new regulations came into force in a period of relatively low interest rates in the economy. The change in approach to the issue of building the investment portfolio was all the more important in the face of the availability of relatively cheap money.

Strictly speaking, with regard to the investment activity of insurers, Solvency II changed the requirements regarding (Gąsiorkiewicz, 2019, pp.151–168):

the management of a portfolio of financial instruments, with special attention to be paid to the relationship between the products offered and the structure of the liabilities they cause and the investment strategy,

For the purposes of calculating market risk in Solvency II, two approaches to the estimation of individual components of risk have been adopted – a standard formula and a calculation based on an internal model. In Poland, no insurer has received the appropriate consent from the supervisory authority to use the internal model. Hence, the rules dictated by the standard formula determine the method of calculating capital requirements for domestic insurance institutions. From January 01, 2016, the SCR comprised the Basic SCR, the capital requirement related to operational risk, and the adjustment reflecting the loss-absorbing capacity of provisions and taxes (cf. further Ringwelska-Ładak, 2017, pp.137–148).

The calculation of the basic capital requirement takes into account the following risk modules:

market risk,

These modules are used to describe dependency structures at a later stage of capital requirement estimation, with each module being further divided into submodules. From the perspective of investment activity, the most important module is the market risk module, which distinguishes the following risk submodules: interest rate, share prices, real estate prices, credit spread, asset concentration, and currency risk.

One of the main objections to the standard formula concerns the use of linear correlation to describe the dependency structures. The literature underlines that the aggregated risk factors do not always have a normal distribution, which, in the opinion of some authors, undermines the validity of the standard approach described in the formula (cf. further Wanat, 2014, pp.207–215). Another argument against Solvency II is the specific privileging of some issuers. For the purposes of calculating the capital requirement, the legislator provided for different weights for different categories of financial instruments. However, bonds issued by one of the European Union Member States, a local government unit, or a central bank were given weights equal to 0. The same weight also applies to instruments endorsed and guaranteed by the indicated entities. In other words, the aforementioned financial instruments do not generate a capital burden for the insurance company. Thus, they become the leitmotif of the insurance company's investment strategy for the investment portfolio managers.

One of the consequences of the prudent investment principle is the need to develop risk measures that affect the insurance company. These measures must be consistent with the principles that guide the insurance institution in managing investment risk and business strategy. This requirement naturally leads to a new challenge faced by insurance companies – collecting and processing financial data. This issue was also discussed in the Act on Insurance and Reinsurance Activity. The relevant provisions relating to the monitoring of the correctness and timeliness of the data used in investment activities have been significantly tightened in relation to the previously binding legal act. In view of the multitude of categories of financial instruments that can be purchased, information processing is possible only in the presence of specialized IT systems aimed at supporting consistent property management and risk management of an insurance company. The consequence of changes in the field of data collection and processing is a significant increase in the costs of servicing the management of the insurance company's investment portfolio. In the face of Solvency II, both when building an investment strategy and when making decisions regarding the investment of an insurance company's funds, the portfolio manager must remember about:

the rate of return on the investment,

In the context of the Solvency II Directive itself, it is difficult to argue with the statement that it imposed many new requirements on insurance companies. Nevertheless, it did not define a single correct approach to investment activity or the investment risk management system. The burden of developing an investment strategy, taking into account a policy of tolerable risk limits, remains on the shoulders of insurance companies.

The investments of life insurance companies are summarized in Table 1 and illustrated in Fig. 1.

Figure 1

The value of investments of life insurance companies showed a downward trend from the beginning of the study until 2018 (from PLN 45,182 million to PLN 39,550 million). In 2019 and 2020, the capital involved in investments increased to PLN 40,333 million and PLN 41,241 million, respectively. Throughout all the years of the study, real estate investments showed a similar downward trend – in 2014, the value of these investments amounted to PLN 321 million and in 2020, it was PLN 231 million. Their share in the total portfolio remained approximately constant and fluctuated at around 0.6%–0.7%.

Similarly, the value of investments in subordinated entities and their share in total investments did not change significantly during the study period. In 2014, life insurance companies showed investments in subsidiaries at the level of PLN 2,080 million (4.6% of total investments), while at the end of the analysis, this value had decreased to PLN 1,886 million. Due to a decline in the value of the entire portfolio, however, its share in total investments remained unchanged at 4.6%.

Other financial investments in each period accounted for approximately 95% of total investments, reaching the maximum level in 2015 (95.2%) and the minimum in 2017 and 2018 (94.6%). The value of this item decreased from PLN 42,781 million in 2014 to PLN 37,399 million in 2018. In the last 2 years of the analysis, a slight increase in the value of other financial investments was observed – up to PLN 39,124 million. Life insurance companies did not report any investment receivables from cedants in the analyzed period.

The structure of investments in real estate by life insurance companies is shown in Fig. 2.

Figure 2

The value of land and perpetual usufruct rights during the 7-year audit decreased by approximately 10% (from PLN 95 million in 2014 to PLN 84 million in 2020). The share of land and perpetual usufruct rights in the total real estate increased in all years of the study, apart from 2018 – from 29.7% in 2014 to 36.4% in 2020. This increase took place at the expense of investments in buildings, structures, and cooperative ownership rights to premises, which accounted for over 60% of total real estate investments. The value of this item decreased in each year of the analysis, from PLN 218 million in 2014 to PLN 145 million at the end of the study, recording a total decrease of approximately 30%. The share of construction investments and advances for these investments in the 7 years did not exceed 3% of the total real estate.

Investments in subordinated entities are shown in Fig. 3. Only in 2014 did life insurance companies show the marginal involvement of equity in loans granted to subsidiaries.

Figure 3

From 2015 to 2020, investments in subordinated entities consisted exclusively of shares and stocks of these entities.

Fig. 4, presenting the structure of other financial investments of life insurance companies, does not show the third item – shares in joint investment ventures. The value of this item in each year was equal to 0. Both the value of the item of equity instruments, participation units, and investment certificates, as well as its share in total other financial investments, increased in the period 2014–2016. The value of the item increased from PLN 7,117 million to PLN 8,455 million, while its share increased from 16.6% to 21.8%. In the period 2017–2019, the reverse trend was visible, with both the value and share of equity instruments decreasing to PLN 6,328 million and 16.5%, respectively. In 2020, life insurance companies returned to this form of capital investment, as a result of which the value of investments in the last year of the study amounted to PLN 6,556 million and its share in total other financial investments increased to 16.8%.

Figure 4

Investments in debt securities and fixed-income instruments showed similar fluctuations. The value of this item during the entire period of the analysis did not change significantly: in 2014, the value of debt securities amounted to PLN 29,672 million, while in 2020, it was PLN 29,739 million. During the entire period of the study, however, the share of this item in other financial investments increased, caused mainly by the transfer of capital employed in equity instruments to debt instruments. At the end of the study, the item representing debt securities and other fixed-income instruments accounted for 76.0% of total other financial investments. The value of term investments decreased almost fourfold over the course of the 7 years, from PLN 4,328 million at the beginning of the study to PLN 1,336 million in 2020.

The decrease in the value of term investments is also reflected in the gradual decrease in the share of this item in other financial investments, from 10.1% in 2014 to 3.4% in 2020. The value of other loans decreased from PLN 1,077 million in 2014 to PLN 332 million in 2016 and then increased to PLN 1,472 million in 2020. The share of this item in total other financial investments did not exceed 3.8%. Throughout the entire study period, a marginal share in the portfolio of life insurance companies was displayed by mortgage-backed loans and other investments. The shares of these two items at the end of the study were 0.0% and 0.1%, respectively.

The investments of non-life insurance companies are shown in Table 2. The overall structure of the portfolio is presented in the Fig. 5. The individual groups of instruments are presented in Figs 6–8.

Figure 5

Throughout all the years covered by the study, the total value of investments of insurance companies increased from year to year. The value and share of real estate in the investment portfolio decreased in each reporting period, however, from PLN 967 million in 2014 to PLN 804 million in 2019. From year to year, insurers increased their capital involvement in related entities. Investments in related entities until 2017 grew faster than the total value of investments, as a result of which their percentage share in portfolios increased on average from 14.3% to 25.8%. In the last 3 years of the analysis, the share of investments in subsidiaries in total investments decreased to 20.4%.

The largest increase in investments in related entities took place 1 year after the entry into force of Solvency II, that is, in 2017. At the same time, the involvement of insurers in other financial investments was increasing – the value of these investments showed an upward trend in all years, except for 2016. The dynamic of this trend until 2017 was lower than the growth rate of total investments. In the period 2018–2020, the share of other financial investments in total investments increased. The last item, investment receivables from ceding companies, played a marginal role in the average portfolio of Polish non-life insurance companies.

The capital commitment of insurers in land, perpetual usufruct rights, and buildings decreased from year to year (see Fig. 6). The value of the investments of the first of these items decreased over the 7 years by approximately one third – from PLN 92 million to PLN 57 million. In the same period, the valuation of investments in buildings, structures, and cooperative ownership rights to premises decreased by approximately PLN 170 million.

Figure 6

The significant increase in investments in subsidiaries was caused by investments in the shares or stocks of subsidiaries (see Fig. 7). In each year of the study, this subgroup accounted for over 90% of the total value of investments in subordinated entities. In terms of value, over the 7 years of the study, the value of equity instruments in subordinated entities more than doubled, from PLN 8,234 million to PLN 17,460 million.

Figure 7

Fig. 8, showing the structure of other financial investments of non-life insurers, does not show the third item – shares in joint investment ventures – because the value of this item was equal to 0 in each year.

Figure 8

The value of investments in equity instruments, participation units, and investment certificates before the entry into force of Solvency II exceeded PLN 15 million. This item accounted for over 30% of other financial investments of non-life insurance companies. In 2016, the value of investments in shares, stocks, and other securities, as well as participation units and investment certificates, decreased by over 40% (from PLN 16,414 million to PLN 9,046 million). Thus, their share in total investments decreased to around 18%. Last year, the value of this item reached PLN 10,107 million, which accounted for 14.4% of total other financial investments. Debt instruments throughout the analysis period showed an upward trend – both in terms of value (from PLN 26,141 million in 2014 to PLN 57,597 million in 2020) and share in other financial investments (from 52.6% to 82.3%).

This trend is understandable due to the preferential approach of the legislator with regard to the SCR to instruments considered safe, and in particular to debt securities issued, endorsed, or guaranteed by the State Treasury or local government units.

In 2014, other loans accounted for 6% of other financial investments and their share decreased from year to year until 2017. In 2018, the value of this item approximately doubled in comparison to the previous reporting period (from PLN 890 million to PLN 1,856 million) and its share increased to 3.2%, as can be seen in Fig. 8.

Until the end of the study, the value of other loans showed a downward trend. A similar trend was observed in term investments with credit institutions – a decrease in the value of this item (from PLN 3,694 million to PLN 1,762 million) and a decrease in the share of total other financial investments (from 7.4% to 3.3%) can be observed until 2017. In 2018, the value of term investments increased by approximately one third, to PLN 2,326 million, and then showed a downward trend until the end of the study. Throughout the entire study period, a marginal share in the portfolio of non-life insurance companies was displayed by mortgage-backed loans and other investments.

The Solvency II Directive and the legal act that implemented its assumptions on the Polish insurance market – the Act on Insurance and Reinsurance Activity dated September 11, 2015 – resulted in a shift of insurance companies' investments toward debt instruments. This action was aimed at reducing the capital requirement of insurers. It can be said that domestic insurance companies primarily aimed to have a safe structure of their portfolio, which included instruments with defined future cash flows. The aversion to risk of domestic insurers was also visible in the decline in interest in investments in the form of shares, stocks, participation units, and investment certificates. Insurers preferred a certain benefit of lower capital requirement over potentially more profitable, but also riskier investment portfolios. Estimating the scale of this phenomenon requires further research, especially in terms of return on assets and equity before and after Solvency II and the impact of the Covid-19 pandemic on the structure of insurers' portfolios.