Solvency II - Impacts on the Real Estate industry - European Real Estate Conference 2011
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www.pwc.com European Real Estate Conference 2011 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
What is Solvency II ? (1/7)
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;
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.
PwC European RE Conference 2011 4What is Solvency II ? (2/7)
Timeline to Solvency II
Adoption of the Directive text by Solvency II full
Solvency II
the European Parliament on implementation
implementation
22/04/2009 QIS 5 results date if Omnibus II
date: 1 January
March 2011 Transposition is voted: 1 January
2013
of the directive 2014
into national
law
Omnibus II Directive
2009 2010 2011 2012 2013 2014
QIS 5 Propositions / Adoption Publication of
August - November of level 2 and level 3 accounts in
2010 enforcements Solvency II in 2013
PwC European RE Conference 2011 5What is Solvency II ? (3/7)
Solvency II: a three-pillar approach
Pillar 1 Pillar 2 Pillar 3
Market consistent Risk management/ Reporting
valuations Supervisor review
• Investments / Prudent • Risk management • Solvency and Financial
Person Principle framework Condition Report (SFCR)
• Solvency Capital • Own risk and solvency • Regular Supervisor Report
Requirement (SCR) assessment (ORSA) (RSR)
− Standard Formula or • Quantitative Reporting
Internal Model Templates (QRT)
• Minimum Capital
Requirement (MCR)
Data
Data requirements
requirements
PwC European RE Conference 2011 6What is Solvency II ? (4/7)
Solvency Capital Requirement overview
SCR: Solvency Capital Requirement
SCR BSCR: Basic SCR
SCRop: SCR for operational risk
requirement
Adj: Adjustment for loss-absorbing
Adj capacity
EL BSCR SCR
SCRop
cred CAT: Catastrophe risk
Market SCR
Default Health Life Non-Life Intangible
health
Non-SLT Premium
SLT Health CAT Mortality Reserve
Interest Health
rate
Longevity
Equity Premium Lapse
Mortality Reserve Disabilty
Property Morbidity
Longevity CAT
Lapse
Lapse
Spread Disability
Morbidity
Expense
Currency Lapse = Adjustment for the
risk mitigating
Revision
Concentrati effect of future
on Expense
profit sharing and
CAT deferred tax
Illiquidity Revision
PwC European RE Conference 2011 7What is Solvency II ? (5/6)
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 Instantaneous 30% decrease in the market value of equity
markets of the EEA or OECD member Remark: base level of the shock of 39% and symmetric adjustment of
states) -9% as at 31/12/2009
“Other” equities (listed only on emerging Instantaneous 40% decrease in the market value of equity
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 Equity shock is nil
institutions
Strategic participations Instantaneous 22% decrease in market value
Intangible assets (transferable) Shocks of 80 % on economic value
PwC European RE Conference 2011 8What is Solvency II ? (6/7)
QIS 5 results – Standard Formula
Basic Solvency Capital Requirement - breakdown
Life undertakings (solo) Non - Life undertakings (solo)
100% 1.0% 0.0% 0.1% 100% 0.4%
23.7%
80% 80% Intangible
7.7% Intangible 52.4%
Non-Life Non-Life
60% Equity risk Health
60%
Equity risk Equity risk Health
Life 7.0% Life
40% 40% 7.0% 0.5%
Counterparty Counterparty
67.4%
Interest Market Interest Interest Market
20% rate risk 20%
rate risk 32.8% rate risk
0% Diversification
0% Diversification
Source : QIS 5 Final Report (EIOPA) Source : QIS 5 Final Report (EIOPA)
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.
PwC European RE Conference 2011 9What is Solvency II ? (7/7)
Market risk breakdown (QIS 5)
140% 8%
6%
120% 10%
Diversification
12%
100% Illiquidity
30%
80% Concentration
60% Equity28%
risk Equity risk Equity risk
Currency
Property
40%
42% Interest Interest Interest Spread
20% rate risk rate risk rate risk
Interest rate
0% Diversification Diversification Diversification Equity
-36%
-20%
-40%
Property risk represents 12% of the Market Risk Solvency Capital
Requirement.
PwC European RE Conference 2011 101. Solvency II overview Solvency II and the real estate industry PwC European RE Conference 2011 11
Solvency II and the real estate industry (1/2)
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.
Not surprisingly, real estate has received little attention in the
Solvency II debate.
PwC European RE Conference 2011 12Solvency II and the real estate industry (2/2)
European insurers’ investment portfolio - 2009
(CEA - European Insurance Key facts -
September 2011)
PwC European RE Conference 2011 132. 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 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. PwC European RE Conference 2011 15
2. The property capital requirements under Solvency II Standard model vs. internal model PwC European RE Conference 2011 16
Standard model vs. Internal model (1/4) 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. 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. PwC European RE Conference 2011 17
Standard model vs. Internal model (2/4)
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
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
• …
PwC European RE Conference 2011 18Standard model vs. Internal model (3/4)
Standard model vs. internal model
A simplified example
Assets under management (at fair value)
• Bonds €700m
• Listed stocks €200m Total €1,000m
• Property €100m
Standard model Internal model
• Equity shock 39% • Equity shock 39%
• Property shock 25% • Property shock 15%
• Property/equity correlation 0.75 • Property/equity correlation 0.39
• Property/int. rate correlation 0.50 • Property/int. rate correlation - 0.10
SCRstandard = €147m SCRInternal Model = €132m
- 10%
PwC European RE Conference 2011 19Standard model vs. Internal model (4/4) 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. 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. PwC European RE Conference 2011 20
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 (1/3)
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:
• 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)?
PwC European RE Conference 2011 22Treatment of direct vs. indirect investments (2/3)
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
GAV = €141m (leverage 30%) NAV = €100m
SCR = [€141m X 25%] + [€41m X 7%] SCR = [€100m X 49%]
= €38m = €49m
• Fund B • Fund B
GAV = €333m (leverage 70%) NAV = €100m
SCR = [€333m X 25%] + [€233m X 7%] SCR = [€100m X 49%]
= €100m = €49m
PwC European RE Conference 2011 23Treatment of direct vs. indirect investments (3/3)
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):
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.
PwC European RE Conference 2011 242. 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 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. PwC European RE Conference 2011 26
3. Key challenges and opportunities for asset managers PwC European RE Conference 2011 27
Data and reporting requirements (1/2)
Key concepts & impacts
New reporting
• Reporting required within 14-16 weeks of
(SFCR/QRT/RTS) year end and 4-6 weeks of quarter end
Look-through to underlying • Data requirements in order to capture
assets capital charges (Calculations/Reporting)
• Need assurance from asset managers
Data must be suitably accurate, that the provided data is of the right
complete and appropriate quality
Standard formula vs internal • Different level of granularity for
model calculations and reporting
PwC European RE Conference 2011 28Data and reporting requirements (2/2)
Solvency II: examples of specific reporting for
(re)insurer
Solvency II qualitative and quantitative reportings
Property • Identifying
• Address
(land, building, • Acquisition value
direct, • Acquisition during the exercise (Y/N)
immovable • Return
property right • Market value of the real estate investment
or indirect • Currency
exposure) • (%) of total value of the fund (if applicable)
• Currency of the property (by location)
• ...
Specific Reporting for structured product (CDO) and credit derivative (CLN, CDS, TRS)…
PwC European RE Conference 2011 29Services and products opportunities (1/2)
Asset managers new offers
Provide insurers with dashboards on
their portfolio including qualitative
information :
exposition to credit risk by rating (tenants),
exposition by currency…
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…
PwC European RE Conference 2011 30Services and products opportunities (2/2)
Asset managers products offers
-Use of UE government bonds because they
Risk of fly-to-quality are not charged for credit risk.
to reduce assets - Preference for short-dated corporate
capital charges: bonds.
- Less incentive to own equities
- Diversification between asset classes
and geographically is key
Ex: Use of OPCI (10% of liquid assets
Reducing the SCR by property, 60% of OECD property assets,
shortening long term 30% of equities), emerging funds
corporate bonds or
equity positions also
reduce asset returns. -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
PwC European RE Conference 2011 31Thank you! © 2011 PwC. All rights reserved. Not for further distribution without the permission of PwC. "PwC" refers to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL), or, as the context requires, individual member firms of the PwC network. Each member firm is a separate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL does not provide any services to clients. PwCIL is not responsible or liable for the acts or omissions of any of its member firms nor can it control the exercise of their professional judgment or bind them in any way. No member firm is responsible or liable for the acts or omissions of any other member firm nor can it control the exercise of another member firm's professional judgment or bind another member firm or PwCIL in any way.
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