Solvency II - Impacts on the Real Estate industry
Solvency II - Impacts on the Real Estate industry
Agenda 1. Solvency II overview 2. The property capital requirements under Solvency II 3. Key challenges and opportunities for asset managers PwC European RE Conference 2011 2
1. Solvency II overview What is Solvency II ? PwC European RE Conference 2011 3
Main features Solvency II will regulate the capital requirements of European insurance companies ; Capital requirement will be calculated to ensure, with 99.5 probability, that an insurer always has sufficient resources available to meet its obligations to its policyholders; What is Solvency II ? (1/7) PwC European RE Conference 2011 Economic risk-based requirements across all members States; total balance-sheet approach vs.
liability only (Solvency I); Scope: • insurance (life, non-life) and reinsurance companies ; • very small entities, public insurance systems and occupational pension funds are excluded.
Timeline to Solvency II Solvency II implementation date: 1 January 2013 Transposition of the directive into national law Adoption of the Directive text by the European Parliament on 22/04/2009 QIS 5 results March 2011 Omnibus II Directive Solvency II full implementation date if Omnibus II is voted: 1 January 2014 What is Solvency II ? (2/7) PwC European RE Conference 2011 2009 2010 2011 2012 2013 2014 Propositions / Adoption of level 2 and level 3 enforcements QIS 5 August - November 2010 Publication of accounts in Solvency II in 2013 Omnibus II Directive 5
Solvency II: a three-pillar approach Market consistent valuations • Investments / Prudent Risk management/ Supervisor review • Risk management Reporting • Solvency and Financial Pillar 1 Pillar 2 Pillar 3 What is Solvency II ? (3/7) PwC European RE Conference 2011 Data requirements Data requirements Person Principle • Solvency Capital Requirement (SCR) − Standard Formula or Internal Model • Minimum Capital Requirement (MCR) framework • Own risk and solvency assessment (ORSA) • Solvency and Financial Condition Report (SFCR) • Regular Supervisor Report (RSR) • Quantitative Reporting Templates (QRT) 6
Solvency Capital Requirement overview Market Non-Life Health Life EL BSCR SCR SCR cred SCRop SCR health EL Adj Interest Intangible Mortality Default Premium Reserve SLT Health CAT Non-SLT Health SCR: Solvency Capital Requirement BSCR: Basic SCR SCRop: SCR for operational risk requirement Adj: Adjustment for loss-absorbing capacity CAT: Catastrophe risk What is Solvency II ? (4/7) PwC European RE Conference 2011 Currency Property = Adjustment for the risk mitigating effect of future profit sharing and deferred tax Spread Interest rate Equity Concentrati on Illiquidity Expense Disabilty Morbidity Lapse Longevity Revision CAT CAT Lapse Expense Disability Morbidity Lapse Revision Mortality Longevity Health Lapse Premium Reserve 7
Calibration of market risk module by asset class under the standard formula (QIS 5) Assets class QIS 5 shocks Bonds Deformation of the risk free interest rate (upward and outward deformation) Consideration of the rating for the spread risk calculation “Global” equities (listed on regulated markets of the EEA or OECD member states) Instantaneous 30% decrease in the market value of equity Remark: base level of the shock of 39% and symmetric adjustment of -9% as at 31/12/2009 “Other” equities (listed only on emerging markets, non-listed equity, hedge fund ) Instantaneous 40% decrease in the market value of equity Remark: base level shock of the shock of 49 % and symmetric What is Solvency II ? (5/6) PwC European RE Conference 2011 markets, non-listed equity, hedge fund ) Remark: base level shock of the shock of 49 % and symmetric adjustment of -9% as at 31/12/2009 Property Instantaneous 25% decrease in the value of investment in real estate (land, buildings, direct and indirect participation in real estate undertakings) Investments in foreign currency Instantaneous 25% decrease in the value of the foreign currency against the local currency (upward and outward shock: maximum result is retained) Cash Loss of all cash in case of bank default Participation in financial and credit institutions Equity shock is nil Strategic participations Instantaneous 22% decrease in market value Intangible assets (transferable) Shocks of 80 % on economic value 8
Equity risk Equity risk Equity risk 60% 80% 100% 7.7% 23.7% 1.0% 0.0% 0.1% Intangible Non-Life Health Life undertakings (solo) 60% 80% 100% 7.0% 52.4% 0.4% Intangible Non-Life Health Non - Life undertakings (solo) QIS 5 results – Standard Formula Basic Solvency Capital Requirement - breakdown What is Solvency II ? (6/7) PwC European RE Conference 2011 Market risks represent 67.4% of the Basic Solvency Capital Requirement (BSCR) for life insurance undertakings and 32.8% of the Basic Solvency Capital Requirement (BSCR) for non-life insurance undertakings.
Equity risk Equity risk Equity risk Interest rate risk Interest rate risk Interest rate risk Diversification Diversification 0% 20% 40% 67.4% Health Life Counterparty Market Source : QIS 5 Final Report (EIOPA) 0% 20% 40% 32.8% 7.0% 0.5% 7.0% Life Counterparty Market Source : QIS 5 Final Report (EIOPA) 9
Equity risk Equity risk Equity risk 60% 80% 100% 120% 140% 28% 30% 12% 10% 6% 8% Diversification Illiquidity Concentration Currency Market risk breakdown (QIS 5) What is Solvency II ? (7/7) PwC European RE Conference 2011 Property risk represents 12% of the Market Risk Solvency Capital Requirement. Equity risk Equity risk Equity risk Interest rate risk Interest rate risk Interest rate risk Diversification Diversification Diversification -40% -20% 0% 20% 40% 60% 42% -36% Property Spread Interest rate Equity 10
1. Solvency II overview Solvency II and the real estate industry PwC European RE Conference 2011 11
Weight of insurers Insurers remain one of the largest investor group, accounting for 25% to 35% of the total European property investment market… … but real estate represents a small share of insurers’ total investments. Solvency II and the real estate industry (1/2) PwC European RE Conference 2011 Not surprisingly, real estate has received little attention in the Solvency II debate. 12
European insurers’ investment portfolio - 2009 Solvency II and the real estate industry (2/2) PwC European RE Conference 2011 (CEA - European Insurance Key facts - September 2011) 13
2. The property capital requirements under Solvency II The IPD Solvency II research report PwC European RE Conference 2011 14
The IPD Solvency II research report The IPD report offers a detailed review of the Solvency II regulatory framework and focuses specifically on real estate. The study (incl. a survey of 18 major European insurance players) was funded by seven key trade bodies (incl. INREV and EPRA) and PwC European RE Conference 2011 was funded by seven key trade bodies (incl. INREV and EPRA) and was published on 15 April 2011. On 2 September 2011, the IPD published an update of some key analyses which confirmed the findings of the original study.
2. The property capital requirements under Solvency II Standard model vs. internal model PwC European RE Conference 2011 16
Critics of the standard “Property” SCR IPD report observations The current Solvency II proposals do not mirror the full realities of the real estate market across Europe. In particular, the current proposals consider a property market shock factor based on data from the UK commercial property market only, and so provide an incomplete picture of risk. Standard model vs. Internal model (1/4) PwC European RE Conference 2011 market only, and so provide an incomplete picture of risk.
In addition, the way in which the current proposals reflect correlations between property and other asset classes, and property and interest rates, appear heavily weighted towards the UK, making them higher than might otherwise be.
IPD recommends refining the detail of the regulation in a way which takes account of the diversity of property investment practice and performance across Europe. 17
Current proposals vs. IPD report A step towards internal models Current proposals IPD report property market shock factor 25% no more than 15% property/equity correlation 0.75 0.39 to 0.5 Standard model vs. Internal model (2/4) PwC European RE Conference 2011 property/interest rate correlation 0(up)/0.5(down) negative Some other IPD report issues: • Impact of geographically diversified real estate portfolio • Impact of the residential sector in European portfolio diversification • … 18
Standard model vs. internal model A simplified example Standard model Assets under management (at fair value) • Bonds €700m • Listed stocks €200m Total €1,000m • Property €100m Internal model Standard model vs. Internal model (3/4) PwC European RE Conference 2011 Standard model • Equity shock 39% • Property shock 25% • Property/equity correlation 0.75 • Property/int. rate correlation 0.50 SCRstandard = €147m Internal model • Equity shock 39% • Property shock 15% • Property/equity correlation 0.39 • Property/int. rate correlation - 0.10 SCRInternal Model = €132m - 10% 19
Developing internal models Objectives & issues Objectives • To define an SCR which better corresponds to the company’s real risk exposure; • To lower the SCR, compared with an SCR calculated using the standard formula.
Standard model vs. Internal model (4/4) PwC European RE Conference 2011 standard formula. Issues • Existence (period, frequency) and accuracy of data supporting the internal model calculation; • Certification of the model by the insurance supervisory body; • Costs of developing and maintaining the internal model vs. SCR reduction.
2. The property capital requirements under Solvency II Treatment of direct vs. indirect investments PwC European RE Conference 2011 21
Treatment of direct vs. indirect investments One of the key concepts of Solvency II consists in following a look-through approach for direct and indirect exposures. A question has emerged for geared RE vehicles under the standard formula: Treatment of direct vs. indirect investments (1/3) PwC European RE Conference 2011 formula: • Does the look-through approach apply (25% capital charge on RE assets + capital charge on the debt)? or • Does the vehicle immediately attract a 49% capital charge on its net assets (non-listed equity)?
Treatment of direct vs. indirect investments Example with Fund A (30% leverage) and Fund B (70% leverage) both unlisted and having a NAV of €100m. Solvency Capital Requirement (“SCR”)? If look-through approach If 49% shock • Fund A • Fund A Treatment of direct vs. indirect investments (2/3) PwC European RE Conference 2011 • Fund A GAV = €141m (leverage 30%) SCR = [€141m X 25 [ € 41m X 7%] = €38m • Fund A NAV = €100m SCR = [€100m X 49%] = €49m • Fund B GAV = €333m (leverage 70%) SCR = [€333m X 25 [ € 233m X 7%] = €100m • Fund B NAV = €100m SCR = [€100m X 49%] = €49m 23
Treatment of direct vs. indirect investments Urgent clarification is needed, as the use of indirect investment in insurance fund portfolios accounts for instance for 23% of UK portfolios. Suggestion from IPD (Sept. 2011 update paper): Treatment of direct vs. indirect investments (3/3) PwC European RE Conference 2011 Suggestion from IPD (Sept. 2011 update paper): Considering the variety of RE vehicles, the most sensible option would be to allow insurers to decide a consistent treatment on a case- by-case basis.
2. The property capital requirements under Solvency II Absence of a dampener PwC European RE Conference 2011 25
Absence of a dampener For equities, a dampener applied for adjusting the equity SCR to reflect the state of the market (49 - 10% for type 1 equities and 39 - 10% for type 2 equities). No such adjustment is planned for property and would result in PwC European RE Conference 2011 No such adjustment is planned for property and would result in applying the highest SCR value at peaks in the real estate cycle and the lowest SCR value at the lowest point in the real estate cycle. 26
3. Key challenges and opportunities for asset managers PwC European RE Conference 2011 27
Key concepts & impacts Data and reporting requirements (1/2) • Reporting required within 14-16 weeks of year end and 4-6 weeks of quarter end New reporting (SFCR/QRT/RTS) • Data requirements in order to capture capital charges (Calculations/Reporting) Look-through to underlying assets PwC European RE Conference 2011 28 capital charges (Calculations/Reporting) assets • Need assurance from asset managers that the provided data is of the right quality Data must be suitably accurate, complete and appropriate • Different level of granularity for calculations and reporting Standard formula vs internal model
Solvency II: examples of specific reporting for (re)insurer Solvency II qualitative and quantitative reportings Property (land, building, direct, immovable property right • Identifying • Address • Acquisition value • Acquisition during the exercise (Y/N) • Return • Market value of the real estate investment Data and reporting requirements (2/2) PwC European RE Conference 2011 property right or indirect exposure) Specific Reporting for structured product (CDO) and credit derivative (CLN, CDS, TRS)… • Market value of the real estate investment • Currency ) of total value of the fund (if applicable) • Currency of the property (by location) • ...
Asset managers new offers Provide insurers with dashboards on their portfolio including qualitative information : exposition to credit risk by rating (tenants), exposition by currency… Services and products opportunities (1/2) PwC European RE Conference 2011 Provide insurers with quantitative reports: capital charges by asset classes and adjusted return of their assets, sensitivities on complex assets…Reporting on the biggest concentrations exposures… 30
Asset managers products offers Risk of fly-to-quality to reduce assets capital charges: -Use of UE government bonds because they are not charged for credit risk.
- Preference for short-dated corporate bonds. - Less incentive to own equities - Diversification between asset classes Services and products opportunities (2/2) PwC European RE Conference 2011 Reducing the SCR by shortening long term corporate bonds or equity positions also reduce asset returns. - Diversification between asset classes and geographically is key Ex: Use of OPCI (10% of liquid assets property, 60% of OECD property assets, 30% of equities), emerging funds -Need of assets with good risk/performance compromise: public sector bonds, absolute return funds… - Need of more innovative products: ex investment in mortgage loans portfolio 31
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