EUROPE - European insurance companies will be forced to slash their exposure to real estate if the proposed Solvency II regulatory framework continues in its current form, industry experts have warned.
Speaking at the recent Expo Real event in Munich, Marieke van Kamp, head of real estate investments at ING Insurance Benelux, said the insurance company would have to reduce its real estate exposure if it applied the standard risk model.
Current Solvency II proposals incur a 25% capital charge for holding direct real estate. Critics complain this is based on the volatility of the UK market, and research from Investment Property Databank (IPD) argues that the capital charge for a pan-European property exposure should be closer to 15%.
Van Kamp said: "Our main concern is that the current model is calibrated to the UK real estate market, which is quite volatile. So the capital reserves [a company has] to hold for real estate assets are quite high, and an awful lot of return is needed to offset this.
"As an insurance company, if we calculate our asset allocation, taking into account the Solvency II modelling as it now stands, then real estate is not really profitable - it would be better to put our money in other types of assets."
ING Insurance Benelux is planning to use an internal risk model to prove to regulators that it can justify using a lower capital reserve threshold for real estate, allowing it to maintain its current 5% property exposure.
However, there is still uncertainty over whether internal risk models will be fully accepted by the European Insurance and Occupational Pensions Authority (EIOPA), which has advocated risk-based regulations.
When asked by IP Real Estate editor Richard Lowe about the impact of Solvency II on the industry, Michael Morgenroth, member of the board at German insurer Gothaer - said his biggest concern was the treatment of "so-called riskier assets" in relation to bonds, especially for real estate.
"A shock factor of 25% would lead to the results Van Kamp has mentioned," he said. "Insurance companies would shift their asset allocation toward bonds - that's my biggest concern from a real estate investor's point of view."
Morgenroth, who took over as chairman of the European Association for Investors in Non-listed Real Estate Funds (INREV) in June and has already claimed the SCR should be closer to 15%, also questioned Solvency II's impact on smaller insurers.
"The model is dubious in terms of competition because it really favours the bigger insurance companies, as they will be able to apply internal models, whereas the smaller companies will have to stick with the standard model for a number of reasons," he said.
He said this would lead to sharp differences in capital requirements for companies depending on their size, which in turn could lead to consolidation.
Laurent Lavergne, head of fund management at AXA Real Estate, argued that the current framework was too focused on "short-term views, short-term valuations and short-term risks".
"With Solvency II, the spirit of the law no longer takes into account the long-term view," he said. "It focuses on what you can lose over a 12-month period, with no care about the recovery you can expect if you are holding assets for a longer period of time.
"My concern involves having to match long-term assets with short-term views of the market, specifically with real estate, which is not very liquid. You cannot hedge property today, and it has a derivatives market that is fairly limited."
Paul Rivlin, joint chief executive at Palatium Investment Management, said: "The biggest problem is that Solvency II is so uncertain. The last thing we need in today's markets are more uncertainties."
IPD published a second update to its Solvency II research report in September, highlighting the uncertainty over the treatment of pooled fund structures under the regulations.
The research update calls for clarification over whether real estate funds will be treated as direct property, whereby the 25% capital charge is applied to the gross asset value (GAV) of underlying real estate assets, or if they will be treated as an equity investment with a higher capital charge (39% for listed, 49% for unlisted) applied to the fund's net asset value (NAV).
IPD said: "The uncertainty as to which treatment is envisaged under Solvency II arises from comments regarding companies that suggest geared vehicles should follow the equity treatment.
"In practice, pooled funds and other vehicles cover a broad and complex spectrum in terms of the vehicles themselves."
For this reason, IPD proposed that the "most sensible" option would be to allow insurers to decide on a case-by-case basis whether they thought an investment in a real estate vehicle should be treated as transparent or equity.