The European Union’s proposed implementation delay for Solvency II will provide regulators and insurers with much-needed breathing space, but is unlikely to boost lobbyists’ efforts to reduce the overly prudent 25% capital charge.
Solvency II includes new rules which define the level of capital insurers have to set aside to cover their investment risks. They are scheduled to come into force in exactly 18 months’ time – January 1, 2013.
But the European Union, mindful of the scale of work in advance of this deadline, is considering seeking a 12-month extension to the turn of the following year. Europe’s insurers and regulators are expected to find out if the extension request has been accepted after the EU, which transitions to Poland’s presidency tomorrow, has bedded in. Expectations are that the delay will be granted once the European Parliament returns after summer recess.
The work ahead is significant. In the UK property market alone, around 80 insurers have made an application to the Financial Services Authority to develop internal models, which is an insurance company’s best estimate of the capital required to cover its risks, to proportionally apply the 25% capital charge by asset volatility.
This risk-weighted modelling, currently in development by insurers will for property predominantly focused on market risk by key property variables: such as sector, region, yield profile, lease length, covenant strength, leverage and even counter party risk.
While most insurers are expected to design bespoke models, the big insurers with dominant UK property market share – Aviva, Legal & General Property, Prudential, Standard Life and AEGON – are likely to collaborate to some extent, which would aid the FSA which has to review, assess and stress-test insurers’ internal models.
Rob Martin, head of research at Legal & General Property, said: “The FSA will be at full stretch assessing and stress testing insurers’ internal models, so from their point of view, the more shared ground, the easier for them. But these models will contain big differences. The onus will be on insurers to determine how the risk weighting across property type will work – there is a lot to balance to get this right. But in the UK, insurers have been operating in risk-based framework for more than a decade, so the FSA is comfortable with the internal model approach.”
INREV, the European association for unlisted property funds, has led the lobbying effort to reduce the capital charge for insurers’ direct real east estate holdings, arguing that the 25% figure proposed by the European Commission and the European Insurance and Occupational Pensions Authority (EIOPA) is overly prudent.
INREV, along with six key European real estate and insurance trade associations, including the British Property Federation, the Association of British Insurers and the Investment Property Forum , commissioned IPD to write a research paper examining the validity of the 25% Europe-wide capital charge. The central criticism is that EIOPA’s calculations are entirely based upon the UK market, historically Europe’s most volatile property market.
The IPD Solvency II research project, published in April and its authors included co-founding director Ian Cullen, research director Malcolm Frodsham and professor Tony Key of the Cass Business School.
In it, IPD concluded: “Adopting the longest and most frequent property return history available (that of the IPD UK Monthly Index) as the baseline for all European portfolios no matter what their mix of market exposures, appears to us as an intermediate position which can be refined without sacrificing or even diluting the prudential aims of Solvency ll.”
IPD recommended a capital charge of “no higher than 15% allowing modest company mode flexibility”.
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