Regulations on the amount of cash European insurance companies with real estate exposure need to hold are too stringent even in the most extreme market conditions, according to MSCI.
The European Union’s 2009 Solvency II Directive imposes a 25% capital requirement on insurance companies on top of the value of their direct real estate investments.
MSCI’s European property data over 15 years showed that the worst average total returns in a 12-month period were -11.2%. Excluding the UK – the most volatile major real estate market in Europe – that figure was -7.1%.
In the UK the worst performing 12-month period led to returns of -24.6% across the industry.
As a result, MSCI recommended a capital threshold of 15% for pan-European portfolios and 12% for ones without any UK property exposure.
The main reason for the difference was that, even though the Solvency II Directive and MSCI used similar methods, the EU’s conclusion was based on the UK’s performance (as the most volatile market) while MSCI’s was based on average figures.
MSCI suggested that insurance companies could be discouraged from investing in real estate if faced with strict capital requirements,
Long-term institutional investors look for real estate exposure for stable long-term income. However, property could become less useful for them if they decide the amount of cash they need to hold in reserves outweighs the benefits.
Ian Cullen, real estate advisory director at MSCI, said: “The new data reinforces the conclusion, reached in our 2011 study, that a 15% solvency capital requirement is a more accurate reflection of the available evidence of extreme downside risk across a broad geographical spread of European real estate investment markets over the past 15 years.”
At the moment, insurance companies account for between 25% and 35% of the investment market in Europe.
Comment: Jeff Rupp as Director of Public Affairs and Professional Standards, INREV
The solvency capital requirements (SCRs) used in Solvency II determine how much money insurers need to set aside in cash or highly liquid assets in case the value of their portfolios fall dramatically. This set-aside cash does not generate income, so SCRs reduce the amount of income that insurers can generate to meet their obligations to policyholders. SCRs that are unnecessarily high because they overstate even the most extreme downside risks, reduce insurers’ revenue streams.
The recently updated independent report on the SCR is important because, with even more data than the first study, it shows that the most accurate SCR for real estate investment across Europe is 15%. This data is not publicly available, so the European real estate investment industry hopes to bring it to policymakers’ attention.
There’s an opportunity to do this as part of the industry’s response to the European Commission’s Capital Markets Union Mid-Term Review consultation – which focuses on issues such as impediments to long-term investments – the deadline for which is 17 March. In addition to written responses, the industry will seek face-to-face meetings with policymakers to further the arguments on the SCR.
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