INREV’s Internal Model Data Matrix hopes to soften the impact of Solvency II. Jeff Rupp looks at the initiative in detail

Even though the actual date of Solvency II implementation continues to be elusive, one thing is certain: the real estate investment industry isn’t going to sit around and wait until the European Commission makes its final decision.

There is recent news of the implementation date being shifted again but, in spite of that, the likelihood of the 25% standard capital requirement for real estate being reduced is, unfortunately, not high. Insurance companies, for which real estate is an important part of the investment mix, are now looking more seriously at developing internal models that, if approved by regulators, will result in a lower solvency capital requirement.

Developing an internal model to determine solvency capital requirements is a lengthy and complex process that requires specific expertise, which is costly in terms of time and resources.  To add to the challenge, there are currently no specific guidelines or well-established common practice for these models. Most large global insurance companies have already been developing internal models for some time.

However, for small or medium-sized firms the task of developing internal models might still require significant investment that they may be unwilling or unable to make. This could leave them very much in the grip of the unnecessarily high standard solvency capital requirement of 25%, significantly reducing (or eliminating altogether) the incentive for them to invest in real estate funds or even retain their current holdings.

The Internal Model Data Matrix is an attempt to make it easier for the industry to build and share knowledge of the data sources and calculations required for the effective creation of these models. Its primary aim is to gather information to enable all insurance companies, regardless of size, to benefit from the experience gained by their peers on the development and maintenance of internal models. This could prove to be a useful resource for smaller insurance companies as they seek to address the challenges that could lay ahead once the Solvency II measures are eventually implemented.

The success of the project will depend on the support it receives from insurance companies willing to provide information via INREV’s online questionnaire based on the information they have obtained while developing their own internal models. The information collected will be compiled for comparison purposes. Insurance companies will not be required to reveal figures resulting from their models but are encouraged to share main characteristics of the data and methodology that they’ve used in developing their own internal models at a country and sector level. Information including data sources, time periods that have been taken into account and calculation bases will form the basis of the Matrix. It will also include information about the progress these organisations are making in relation to obtaining regulatory approval for their internal models.

Of critical importance will be the quantity and quality of information that is shared; more data and insight will undoubtedly improve the usefulness of the Matrix. To this end, we are encouraging both members and non-members of INREV to get fully involved and contribute relevant information.

The Matrix will actually be a dual-purpose industry tool. In addition to providing essential information on where to find relevant data to develop internal models, the data and insight collected can also be used on behalf of the industry to show where data can be found that demonstrate how the standard solvency capital requirement for property investments in Europe should be more appropriately calculated. Although there has been extensive dialogue with EIOPA and the European Commission to highlight the fact that the current standard solvency capital charge is not based on the most representative data available, the message doesn’t seem to have resonated yet. We hope that the Matrix will help to strengthen the industry’s argument about the need for a more accurate and representative standard capital requirement for real estate.

The detailed evidence from the Matrix project will also be relevant for organisations likely to be caught up in the Institutions for Occupational Retirement Provision (IORP) Directive, which is currently working on setting the capital requirement for pension funds. At the moment, it looks likely that pension companies could be facing the same ill-conceived 25% standard solvency capital charge for property investments.

When Solvency II’s 25% solvency capital requirement for real estate was officially announced back in 2010, the decision by regulators to adopt it was partly the result of the limited amount of data available in Continental Europe. The charge was based on IPD monthly data from the UK, which was taken as a proxy for real estate volatility across all of Europe. This was an unhelpful starting point, of course, because it seriously misrepresented the true picture. The Matrix will identify data sources that capture a much more accurate snapshot across a far broader range of national jurisdictions. It is hoped that, in the future, this will give regulators the wherewithal to reach better evidence-based calculations that will result in fairer policy making.

As frustrating as they might have been for the Commission, the delays by the European Parliament over the vote on the Solvency II implementation timetable may arguably have been advantageous for the real estate industry. They have given us more time to develop the Matrix and prepare the evidence needed to encourage regulators to rethink the current standard capital requirement. An optimist might hope that these delays could suggest a more fundamental waning of enthusiasm for the Directive overall. But it’s probably too early to call. In the meantime, the introduction of the Internal Model Data Matrix will at least play a useful role in helping the industry prepare effectively for Solvency II and possibly IORP, if and when they come.

Jeff Rupp is public affairs director at INREV