Beyond capital adequacy: Four insights from Europe for Apac insurers

Having operated under Solvency II for more than a decade, Europe provides a useful case study in how insurers adapt once a risk-based framework matures. The initial focus was understandably on compliance and capital adequacy. Over time, however, attention shifted towards a broader objective: constructing balance sheets capable of generating sustainable free capital while remaining resilient through market and liquidity stresses.

This evolution offers four important insights for Apac insurers:

1. Balancing short-term capital effects with long-term earnings generation.
2. Managing spread risk across assets and liabilities together
3. Building private asset exposure progressively
4. Embedding liquidity resilience considerations as private asset allocations increase

Insight 1: Focus on the immediate capital cost and beyond

An investment decision can affect an insurer’s balance sheet in two distinct ways.

Firstly, the immediate – or ‘stock’ – effect reflects the impact on its own funds, capital requirements and solvency ratios. Higher-yielding assets such as private credit may consume additional regulatory capital, while reinsurance can improve solvency metrics by reducing capital requirements. Both can create a meaningful short-term impact on free capital.

Secondly, the longer-term – or ‘flow – effect is the investment’s ongoing contribution to future earnings and organic capital generation. Assets that generate returns above the rate at which liabilities accrue can produce spread income that replenishes and grows free capital over time.

As risk-based capital frameworks mature, insurers increasingly assess investments through both lenses. The relevant question is not simply how much capital an asset consumes today, but how quickly its earnings can repay that initial capital cost. Assets delivering stronger default-adjusted carry for each unit of regulatory capital typically offer a shorter payback period and support more sustainable capital generation.

Europe’s experience therefore suggests that balance-sheet optimisation should extend beyond maximising the headline solvency ratio. Insurers may instead seek stable and repeatable free capital generation by reducing unrewarded risks or difficult to capture risk premia, such as interest-rate and currency exposures, and directing more risk budget towards compensated credit and selective equity risks.

Private assets can play an important role by providing access to illiquidity and complexity premia. Their value can be judged against both the capital they consume and the sustainable earnings they can generate.

Insight 2: Manage spread risk across the balance sheet

Once interest-rate and currency exposures are substantially hedged, credit spreads can become a major source of balance-sheet volatility.

On the asset side, default-adjusted spread carry provides a buffer against market movements. During periods of stress, income already earned may partly offset mark-to-market losses caused by spread widening. Private assets may potentially strengthen this protection by adding illiquidity and complexity premia.

But the asset portfolio represents only one side of the equation. Many risk-based regimes contain mechanisms that allow higher liability discount rates to offset part of the spread-driven decline in asset values. Examples include the Solvency II Volatility Adjustment and Matching Adjustment, the ICS Middle and General Buckets, and Singapore RBC2’s Illiquidity Premium.

This makes it important to assess spread exposure on a net balance-sheet basis. Outside Matching Adjustment portfolios, Duration Times Spread, or DTS, can help insurers compare the sensitivity of assets and liabilities to credit-spread movements. Volatility is determined less by asset exposure alone than by the mismatch between the spread sensitivities on the two sides of the balance sheet.

For Apac insurers, operating increasingly sophisticated capital frameworks, the takeaway is that the liability valuation framework should be integral to the investment strategy. The amount of spread risk a balance-sheet can sustainably support may depend not only on the asset portfolio, but also on the extent to which liability valuation mechanisms offset spread-driven volatility. Understanding this interaction can potentially allow insurers to capture more spread and illiquidity premium without undermining solvency resilience.

Insight 3: Expand private asset exposure progressively as capabilities develop

European insurers have generally built their private asset portfolios incrementally, entering more complex markets as their credit, governance and risk management capabilities developed.

Real estate debt was often an early allocation. It offered contracted income, collateral protection, additional spread and potentially useful duration for liability matching, either through favourable treatment of qualifying collateralised exposures under the Solvency II Standard Formula or, for larger insurers, through the development of internal credit assessment capabilities leading to an investment-grade capital treatment.

Insurers subsequently expanded into infrastructure debt and corporate direct lending, where stronger lender protections and enhanced spreads could support both free capital generation and liability matching.

Infrastructure equity also became part of some portfolios, particularly where qualifying assets received differentiated capital treatment. Although eligibility rules vary by jurisdiction, the underlying principle is relevant across markets: long-term assets must be appropriately structured, governed and managed if they are to receive favourable regulatory recognition.

Insight 4: As allocations to private assets grow, liquidity resilience becomes an important consideration

The same illiquidity premium that can enhance long-term returns also reduces balance-sheet flexibility, making liquidity management an increasingly important counterpart to capital management as allocations grow.

European regulators are placing greater emphasis on insurers' ability to meet liquidity demands under severe stress scenarios. In the life sector, in particular, mass lapse events, collateral calls and derivative settlements can create substantial cash requirements.

For some life insurers, liquidity considerations under stress may ultimately become a more binding balance-sheet constraint than capital adequacy itself over time.

Within the private equity/private real estate space, this may increase the appeal of assets that combine long-term return potential with predictable and stable cashflows both through cycle but also under stress.

Examples could include GP stakes supported by recurring management-fee revenues derives from established underlying funds, or long-lease real estate strategies backed by high-quality tenants. Such assets are not liquid, but their cash-flow characteristics may help support portfolio resilience under stress.

From solvency to resilience

Europe’s experience suggests capital adequacy is the beginning of the journey, rather than the final objective.

As Apac’s risk-based capital regimes evolve and mature, insurers may increasingly need to balance three related priorities:

• Generate sustainable free capital
• Limit balance-sheet volatility through market cycles
• Preserve sufficient liquidity under stress

This requires insurers to assess investment decisions not only by their immediate effect on solvency ratios, but also by their earnings potential, interaction with liability valuations and behaviour during stressed conditions.

The long-term objective is therefore not simply to maximise a regulatory capital ratio; it is to build a balance sheet capable of generating capital, absorbing volatility and meeting liquidity needs across different market environments.

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