Real estate has been disadvantaged compared with other asset classes in the Omnibus II agreement reached by EU institutions on Wednesday night because the solvency capital charge for insurers on property holdings is too high, according to INREV.

The Omnibus II directive, which updates and makes changes to the EU’s Solvency II risk-based regulatory regime for the union’s insurers, retains the standard model 25% charge for real estate holdings, said INREV, the European Association for Investors in Non-Listed Real Estate Vehicles.

Jeff Rupp, director of public affairs at INREV, said: “The bad news is the 25% standard change, which is supposed to reflect the volatility of portfolios across Europe – but which, research has shown, overstates it.”

The association has argued that the data used to come up with the figure of 25% to represent the volatility of real estate – the IPD UK monthly index – does not include data from Continental Europe or residential property, and so overstates the volatility of the asset class for Europe as a whole.

The true average volatility level for real estate across Europe is no more than 15%, he said.

According to the agreed text of the directive, the standard model charge can be substituted by an internal model based on the actual volatility of an insurer’s property portfolio after approval by national regulators.

But in practice, devising this tailored solvency requirement is a very expensive option only open for big insurers, according to Rupp.

“Large companies can do that to avoid the 25%, but smaller companies find that quite hard to do, and the cost is a deal breaker,” he said.

However, negotiators from the European Parliament, member states and the European Commission did strike a compromise that provides some flexibility in calculating how much capital insurers must hold to protect against market swings, INREV said.

The final agreement included a 65% across-the-board volatility dampener that takes account of the cash insurers need to set aside to meet their liquidity needs in case their portfolio value decreases.

The cash needed for the whole portfolio is calculated and then multiplied by 65%.

This dampener effectively reduces the 25% standard model charge for real estate, but Rupp pointed out it would also apply to other asset classes.

“At the end of the day, real estate is still in a relatively disadvantaged position,” he said.

John Forbes, an independent consultant specialising in real estate, said following the tripartite agreement on Omnibus II, there were still significant areas of uncertainty to be resolved in the Solvency II regime.

The European Insurance and Occupational Pensions Authority (EIOPA) now has the task of finalising the level 2 regulations that will implement Solvency II, he said.

“Apart from the uncertainty in the regulation itself, the real estate industry faces a lack of clarity as to how individual insurance companies will implement the changes necessary,” Forbes said.  

Investment managers now also need to establish what information their insurance clients need for their capital charge modelling, he said, adding that insurers were only just beginning to work out the answer to this question.

Melville Rodrigues, partner at CMS Cameron McKenna, said there were elements of the announcements that real estate fund managers would not welcome, and they should continue to monitor Solvency II developments.

“For instance, managers may need to adjust their reporting practices and comply with the look-through principle,” he said.

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