On January 1, 2016 Solvency II became fully applicable to European insurers and reinsurers. The 2,000-page framework covers three main areas: capital requirements, risk management and supervisory rules. The risk-based capital requirements part requires insurance companies to hold their own eligible funds in relation to their risk profiles to guarantee they have enough financial resources to withstand financial difficulties.
Capital requirements for investments in real estate or companies operating in the real estate sector are calculated in the property and equity risk modules. Investments in listed real estate companies are treated as equity investments, leading to a capital charge of 39%. In contrast, the risk charge for investments in direct property, which is based on the risk of a change in the level or the volatility of real estate market prices, is just 25%.
How is it that, listed real estate (LRE) – an asset class that invests in the same underlying assets, provides the same income and grants its investors greater liquidity and transparency – should be subject to almost double the capital requirement?
Even with the best intentions, these conditions are harsh. It was no surprise that, as EPRA, we, in alignment with our insurer members, decided around two years ago to get active on the advocacy side to identify possibilities to improve the situation and push for them at EU level.
A study by Insurance Europe found that almost half (48%) of insurers cited Solvency II capital requirements as the reason they have invested a sub-optimal amount in equities and LRE. This is strong evidence that the rules were ultimately inhibiting the best interests of end-investors, savers and pensioners.
In the last two years, the EPRA public affairs team has been working with the EU Commission, the European Parliament and the European Insurance Regulator EIOPA for the improvement of the Solvency II framework. Surrounded by public consultations, bilateral meetings and coalition building with partner associations, we’ve covered every aspect: from the responsible EU Commissioner and EIOPA Chairman to the technical level and back again.
On March 8, 2019, the Commission’s Vice-President announced changes to Solvency II capital requirements that mark significant progress for the LRE sector. The requirements, which demanded that insurers allocate an eye-watering 39% of capital invested in equities – including LRE – to liquidity reserves, have almost halved to 22% for a new sub-category of ‘long-term investments in equities’. With this, a new Solvency II sub-category has been achieved: Article 171a of the Solvency II-Delegated Regulation. The rules became applicable on June 8, 2019.
The capital rule changes, though, have one stipulation that holds the LRE sector back: the rules apply only to LRE investments held for five years or more. While a 12-year period initially proposed by the European Commission was beaten down, a five-year holding period might still be considered as too restrictive by certain insurance companies.
The changes to capital requirement rules mark significant progress for listed real estate and are a strong step towards an investment regime where the asset class is treated fairly by regulators, as a long-term investment. We appreciate the Commission’s recognition that equity capital charges were too high for insurers taking a long-term approach to investment.
For those not in the know, insurer capital in Europe is no small market and totals approximately EUR 12 trillion. This is around twice the size of pension funds in Europe and a phenomenal pool of capital to have unlocked.
This is why EPRA will focus its advocacy efforts on a general Solvency II review, foreseen for 2020/2021, to further improve the terms and achieve a positive, common-sense investment framework that strengthens our industry.