FEATURE: The 25 percent rule

As is the habit nowadays, one of Europe’s regulations has managed to become controversial. The draft rules for Solvency II, which are designed to produce a better-regulated insurance market, currently dictate that insurance companies must attach a 25 percent “risk shock factor” charge to all property investments. In other words, insurers would need to hold capital reserves sufficient to withstand a potential 25 percent fall in the book value of such assets. 
The basis upon which this figure was arrived at has not been welcomed. The European Association for Investors in Non-Listed Real Estate Vehicles (INREV), for instance, argues that the 25 percent figure chosen by regulators was based exclusively on IPD data for the UK market – one of the “most volatile real estate markets in the EU” – and also effectively excluded residential real estate. 
Things got worse for the real estate industry at the start of 2013, when it emerged that the European Insurance and Occupational Pensions Authority (EIOPA) would look at whether to recalibrate capital requirements for various financial investment asset classes – all except real estate, that is. INREV wrote a letter to EIPOA, begging the organization to include real estate in the potential recalibration. In the meantime, IPD has come forward to argue that a 15 percent Europe-wide property shock would more fairly reflect the varying levels of downside risk.
Apart from the controversy over the 25 percent figure, the impact of Solvency II on insurers when it comes to investing in unlisted property funds is no clearer, says Marieke van Kemp, head of real estate for ING Insurance Benelux. That is because, according to her, local regulators are interpreting available Solvency II tests in different ways.
“Some suggest that non-listed funds should be treated as equity, while others propose they should be treated as property on a look-through basis,” van Kemp says. “This implies different Solvency II treatments of property funds depending upon the country where the investing insurer is based, which is likely to be advantageous for some but not for others.”
The potential impact


At one point, insurance companies thought they had spotted a real estate niche where they could flex their long-term investment muscles. Indeed, they grew excited about the prospects in Europe of becoming bigger players in real estate lending as traditional lenders exited. 
Under changes to the proposed Solvency II regulation, however, this has become less appealing. Because of this, one possible side effect is that reduced attractiveness of lending might lead to increased direct investment in property and possibly indirect investment via equity in real estate funds. 
Still, the impact upon investing in real estate funds is not yet known, as research to date has tended to focus mainly on mainstream private equity as opposed to private equity real estate. Indeed, when PEI’s Research & Analytics team approached insurance companies last year about their approach to private equity funds (not private equity real estate per se, but buyout and venture capital funds), it received a mixed reaction.
Suomi Mutual Life Assurance, for instance, reported it had sold its fund interests due to the regulation. The firm told the Research & Analytics team that it was the anticipated impact of Solvency II that forced it to sell some of its private equity fund interests, as well as other alternative investments. The insurer now has a zero percent target allocation to alternatives and is holding on to the rest of its fund interests until they mature.
Of course, not all insurers have been forced to dispose of fund interests, although their appetite for such investing has been severely hampered by the regulation. Aktia Life Insurance told the Research & Analytics team that Solvency II was the sole reason why it will not make any more investments into private equity. It will not sell its holdings, rather it will wait until they mature. 
The private equity program of Nordea Life and Pensions still will continue in the future, but it will reinvest at a much slower rate in order to reduce its overall exposure to private equity. The firm stated that stress tests on its private equity portfolio had been tough, although Nordea’s other alternative investments, such as closed-ended real estate funds, had been more adversely affected. 
At the same time, there were plenty of insurers that said Solvency II had not been a meaningful consideration. AEGON and The Royal London Group, which recently acquired the Co-operative Insurance Society, both stated that the small size of their private equity investments in relation to their total assets under management meant that Solvency II would not impact their strategy going forward. 
For other firms, Solvency II was a consideration, but their skills in risk management enabled them to continue with their private equity programs as normal. Skandia Life Insurance stated that it had done a lot of risk modelling and preparatory work well in advance of this proposed legislation and therefore could continue investing into private equity in the same manner as in the past.]
CNP Assurances of France, however, highlighted ongoing uncertainty. “As long as Solvency II is not in its definitive form, it is very difficult to anticipate the impact,” the firm stated. “Therefore, we never stopped our investment program and still are actively investing in the industry year-on-year.” 
Indeed, in research by BlackRock in November, more than half of the insurers surveyed expected to up their private equity commitments, despite the threat of strict capital buffer rules under Solvency II, which will impact larger insurers with any EU business. Some 54 percent of the 206 global insurers surveyed (including 103 European insurers) were either moderately or very likely to increase their investment in private equity.