EUROPE - Solvency II is expected to influence asset allocation by European insurers and may lead to shifts in demand and pricing for several asset classes.

According to a new report called 'Solvency II Set to Reshape Asset Allocation and Capital Markets' and published by Fitch Ratings, new rules imposed by Solvency II will require insurers to value asset and liabilities at market value in determining their solvency position.

Clara Hughes, director in Fitch's insurance team, said: "Insurers' asset allocations will be heavily influenced by these capital charges, which vary significantly by asset class, quality and duration.

"This is a fundamental change from current asset allocations, which are driven by expected long-term investment returns."

The report reveals that the main impacts will be a shift from long-term debt to shorter-term debt, as well as an increase in the attractiveness of higher-rated corporate debt and government bonds.

According to the study published by Fitch, the capital requirement imposed by Solvency II will also lead to a diversification of large asset holdings, an increase in the attractiveness of covered bonds and a preference for assets based on the long-term swap rate and a shift from short-dated paper to deposits.

As a result, better duration matching with derivatives such as swaps and floors could be seen in the future, as well as an increase in downside protection to mitigate the impact of the new capital charges.

The rating agency also anticipates an increase in financial engineering to create Solvency II-friendly assets such as reverse repos and structured notes, which can optimise return on capital.

However, Fitch said it was unlikely that large-scale reallocations would occur in the short term, as transitional arrangements were likely to phase in implementation of Solvency II over several years.