Effects of Solvency II on Portfolio Efficiency, The Case of Real Estate and Infrastructure Investments

Abstract

We examine the potential effects of Solvency II on general portfolio efficiency, and specifically on the allocation of alternative assets by European insurers. The paper starts with a brief introduction to the Solvency II Directive, focusing on the rules for calculating the Solvency capital requirements (SCR), according to the standard formula. The following empirical analysis entails several portfolio optimizations considering six relevant asset classes for the time period from 1993-2013. We derive optimal portfolios with respect to portfolio risk and capital requirements, and finally combine both optimization problems. Our results suggest that, although the capital charges for real estate and infrastructure assets are not adequately calibrated, a significant shift of portfolio weights is not expected for the majority of European insurers. However, after Solvency II comes into effect, undercapitalized insurers may often not be capable of holding risk-optimal allocations of alternative assets.