Group says cut Solvency II capital requirements to 10%

A working group comprising leading property sector associations has called for significant reform of the Solvency II regulations.

The group, which comprises the British Property Federation (BPF), the Association of Real Estate Funds (AREF), the European Association for Investors in Non-Listed Real Estate Vehicles (INREV) and the Investment Property Forum (IPF), said it wants institutions to be able to release the capital needed to drive levelling up and to fund decarbonisation of the built environment

The EU Solvency II Directive came into force in 2016 and introduced capital requirements for insurers and reinsurers to protect beneficiaries from the risk of insolvency.

In its response to an HM Treasury consultation, the BPF argued that the current solvency capital requirement (SCR) for investment in property is based on a worst-case short-term downside scenario and overstates the potential risk for long-term life insurers. 

The working group said there should be a new methodology for calculating real estate volatility and risk, based on a long-term rather than short-term holding. It also said that a cut in UK insurers’ property SCR from 25% to 10% or lower is needed to reflecting the long-term horizon of real assets investment.

Insurers should have the flexibility to decide on a case-by-case basis whether a fund should be treated for Solvency II purposes as property or as long-term equity, it said.

The BPF pointed out that the current SCR of 25% was based on MSCI data on real estate valuations over a one-year period during the Global Financial Crisis, when there were exceptional  levels of volatility.

It also cited evidence from the European Insurance and Occupational Pensions Authority (EIOPA), indicating that on average insurers hold property assets for 14 years, typically spanning market cycles or a short term crash. Valuations data for a 10 or 15-year period should therefore be used as a basis for calculating the SCR.

BPF said that this more nuanced approach would mean a significant reduction in the SCR to 10% or lower, adding that this would make it more attractive for insurers to fund long-term regeneration.

“One of the flaws of the Solvency II regulation is that by treating property as a short-term asset, it overstates the risks of property investment for long-term owners,” said BPF policy director Ion Fletcher.

“A new methodology, which takes into account the long-term, sometimes generational nature of insurer investment into real assets and infrastructure, would not only more closely reflect reality, but could also unlock billions of pounds of investment to transform UK towns and cities.

“Government has talked about unleashing private capital for levelling up; a full examination of the Solvency II is one such opportunity.”

Melville Rodrigues, head of real estate advisory at Apex Group, coordinator of the working group that included members from BPF, AREF, INREV and IPF said: “The proposed reforms to Solvency II can be a gamechanger in delivering levelling up and the transition to a greener economy by releasing significant capital held by life insurers.”