EUROPE - The 25% capital adequacy requirement for insurance company real estate investments under Solvency II could prudently be reduced to 15%, according to research carried out by Investment Property Databank (IPD) and commissioned by the Association for Investors in Non-listed Real Estate Vehicles (INREV).

IPD said the finding was based on pan-European data and so differed from the approach used by the European Insurance and Occupational Pensions Authority (EIOPA), which focused primarily on real estate value movements in the UK.

One of the long-running criticisms of Solvency II proposals is that the 25% threshold for real estate is based on a disproportionate weighting to the UK market, which is known for its higher volatility compared with continental markets.

The 50-page report, 'The IPD Solvency II Review: Informing a New Regulatory Framework for Real Estate', provides evidence to support this criticism.

Expanding the analysis to a full European scale, deploying new data series and using methods developed specifically for the purpose, the study identified widely differing shock response patterns, particularly among the euro-zone markets - enough to warrant a cautious reconsideration of the specified capital requirements.

These results were also supported by a survey of 18 leading European insurance companies carried out by IPD, which found that all euro-zone domiciled insurers considered the 25% capital charge under the standard formula to be too high.

Ian Cullen, co-founder of IPD, said he supported EIOPA's aims, but said IPD's "intensive re-exploration of Europe's performance map over its most painful 10-year period exposes the need for a refinement to the regulation, which is sensitive to the complex diversity of property investment practice and performance".

He added: "If the broadest available pan-European property shock factor was requested now of IPD, this would be no higher than 15%."

This major research project was commissioned by seven European trade bodies, led by INREV and supported by the Association of British Insurers (ABI), the British Property Federation (BPF), Bundesverband Investment und Assetmanagement (BVI), the European Public Real Estate Association (EPRA), the Investment Property Forum (IPF) and the German Property Federation (ZIA).

Matthias Thomas, chief executive at INREV, said: "There seems to be consensus that a capital charge of 25% is too high. Arguably, this level of capital charge could end up influencing the market as opposed to reflecting its risks, which is contrary to the ambitions of Solvency II.

"The IPD research provides clear, independent evidence that the capital charge should be no more than 15%."

Axel von Goldbeck, managing director at ZIA, said: "The Solvency II approach discriminates against markets with relative stability. Markets with a higher risk/return profile will benefit from the need of insurance companies for high returns to pay the capital reserve costs.

"We don't think this is the signal the regulator should give to the markets and the consumers of insurance policies."

Michael Barrie, chair of the ABI Property Investment Committee and director for balanced funds at Legal & General, said: "This timely report makes clear that further work is needed on the appropriate capital charge for holding real estate under Solvency II. The report makes clear the current level seems unnecessarily high.

"This is an important issue for UK insurers, which are the largest institutional investors in UK commercial real estate and now also hold significant investments across Europe."

Alan Patterson, head of European research and strategy at AXA Real Estate and chairman of the IPF Solvency II Group, said: "The IPF is keen to see the wide dissemination of the analysis undertaken by IPD in this project in order to promote a wider understanding of the diverse performance and attributes of the different European real estate markets and their respective correlations with other asset classes.

"Although hampered by a lack of raw data, we now have the first basis of a quarterly pan-European performance index."

Ian Fletcher, director of policy at the BPF, said: "We welcome the new insights this report provides about the risk for insurers of investing in European property and hope this research will inform discussions about a more refined treatment of property investment under the Solvency II directive."