A study released this week by the European Insurance and Occupational Pensions Authority (EIOPA) has confirmed the regulator's viewpoint that insurers need to set aside significant amounts of reserve capital to safely invest in private equity.
The European Commission directed the insurance watchdog to examine the suitability of regulatory capital requirements under the EU's planned Solvency II regime for insurers. EU member states must transpose the regime into national law by June, with the rules taking effect in 2014, though some suspect that timetable to be delayed as stakeholders continue to debate the impact of the regime.
EIOPA will take comments on its paper until 28 May, with the aim of producing a final report in July.
Solvency II requires insurers to hold €49 for every €100 invested in private equity under its “standard model” approach. EU insurers have the option of creating their own risk models, subject to EIOPA approval, however the study indicates the regulator may take a hard look at models which do not set aside sufficient emergency capital for private equity assets. A spokesperson for trade body Insurance Europe predicted most EU insurers will pursue a custom model approach.
The buyout industry has criticized the standard model's high capital requirements for private equity assets, arguing the long-term nature of the asset class helps reduce the volatility of insurers' investment portfolios.
Some in the industry have launched counter-studies that conclude EIOPA's standard model doesn't give private equity a fair shake. The European Private Equity and Venture Capital Association released studies that suggested a capital “shock buffer” around the 25 percent range was more appropriate for private equity holdings.
In similar effort LGT Capital Partners published a working paper last year that challenged the standard model’s effectiveness by calling into question its one year time horizon in interpreting private equity's risk and diversification attributes. Private equity commitments are typically locked in ten year closed-ended investment vehicles.
In its study EIOPA addresses some of the counter studies, saying arguments put forward supporting lower capital requirements for private equity and certain other asset classes suffer from “severe limitations”.
Specifically the regular said certain studies had limitations due to self-reporting or selection bias, which in effect skewed the risk/return profile of private equity funds. EIOPA argued that databases used in the studies were subject to a fund manager’s willingness to report performance, adding that voluntary reporting still dominates in the private equity industry and that poor performers may elect not to report.
The EVCA was not immediately available to respond to EIOPA's criticisms of its study.