The UK real estate investment industry is calling on the government to reform the country’s Solvency II insurance regulations and unlock more institutional capital to support its ‘levelling-up’ and net-zero objectives.
The British Property Federation (BPF), Association of Real Estate Funds (AREF), European Association for Investors in Non-Listed Real Estate Vehicles (INREV) and the Investment Property Forum (IPF) have submitted a joint response to the government’s consultation on Solvency II reforms, which closed last week.
It calls for a new way to calculate the volatility and risk of real estate and to reduce the amount of capital insurers need to put aside when investing in the asset class.
The European real estate industry has long argued that the EU’s Solvency II regulations overstate the volatility of insurers’ long-term real estate holdings. Now, following Brexit, domestic insurers and real estate fund managers hope the issue can be addressed in the UK.
The submission calls on the UK Treasury to introduce new methodology for the asset class that calculates volatility and risk based on a longer-term hold periods.
The organisations argue that real estate Solvency Capital Requirement (SCR) – the proportion of cash insurers need to hold in reserve for a given investment – should be reduced from 25% to 10% or lower.
The existing SCR of 25% was calculated using MSCI data on real estate valuations over a one-year period during the global financial crisis. The BPF and other associations argue that this period was marked by exceptional levels of volatility and cite European Insurance and Occupational Pensions Authority (EIOPA) data that shows insurers hold real estate assets for an average of 14 years and typically through market cycles.
In 2019, EIOPA introduced the long-term equity (LTE) category, which led to the SCR charge for certain equities investments being reduced from 39% (listed) and 49% (unlisted) to 22%. The real estate industry argues that a similar adjustment should be made to bring it in line with LTE.
“Life insurers invest in real estate through a variety of routes, including direct property, investment in funds, real estate debt and listed real estate companies, particularly REITs. We believe consideration should be given to changes to Solvency II in each of these areas,” the submission says.
“At one end of the range, highly leveraged investments in real estate with substantial operational element, for example hotels, would appear to be closer to private equity. At the other end of the range, property on a 25-year lease to the government, would appear to be closer to a bond eligible for the matching adjustment.”
The real estate organisations also stress that the such reforms would unlock billions of pounds of institutional capital that could be used to invest in infrastructure and regeneration, supporting the government’s levelling-up and decarbonisation agendas.
“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 Ion Fletcher, policy director at the BPF.
“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.”
Paul Richards, managing director at AREF, said: “AREF fully supports reforms to Solvency II and, along with other real estate associations, has proposed changes to enable the insurance sector to unlock substantial funds for investment in real estate and similar illiquid assets.
“Real estate is an attractive asset class for life insurers due to its liability-matching characteristics and predictable income streams in the form of rents. By enabling the insurance sector to invest more in these types of assets, this could attract much-needed additional capital for regeneration, infrastructure and housing which would assist the government in meeting its levelling-up agenda for the UK.”
Melville Rodrigues, head of real estate advisory at Apex Group and coordinator of the working group that included members from BPF, AREF, INREV and IPF, said: “I am delighted the real estate industry associations are aligned on this key issue. Their submissions send a powerful message that the industry is committed to driving long-term and sustainable growth in partnership with institutional investors.
“The proposed reforms to Solvency II can be a game changer in delivering ‘levelling up’ and the transition to a greener economy by releasing significant capital held by life insurers.”
Rodrigues, who has been calling for a swift reform of Solvency II, said: “I look forward to HM Treasury and the Prudential Regulation Authority engaging constructively with the associations to unleash our real estate’s entrepreneurial DNA. By doing so, we will enhance policyholder protection by increasing investment into productive capital and making opportunities more equal across the UK.”
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