Solvency II Review and Long-Term Equity Investments: A New Era for Private Equity and Infrastructure Investments?

In January 2024 the final draft of Solvency II Review was agreed between EU Commission, EU Council and EU Parliament. The following analysis discusses the potential implications for public and private equity investments, focusing on capital-efficiency and ALM considerations.

Introduction

The January 2024 compromise between the EU Commission, EU Council and EU Parliament on the reform of the Solvency Directive (“Solvency II Review”)¹ contains material changes in the way Continental insurers will be allowed to operate in coming years, particularly with regards to rules surrounding long-term equity investments (or “LTEI”).

The latter has always been a “sore point” for EIOPA (the European Insurance and Occupational Pensions Authority). In a 2021 paper² the regulator highlighted how only 17 insurers (less than 4% of regulated insurers) were using LTEI, and infrastructure assets, in particular, have been singled out by the EU Commission as an area where insurer capital should be incentivized.

If we compare the average European insurer and pension fund exposures to equity and infrastructure funds, the difference is staggering: at the end of September 2023, only 3.4% of general account (i.e. non unit-linked) insurance assets were invested in equity strategies, vs 15.5% for defined benefit pension funds, and infrastructure funds represented only 1.5% of insurers allocation (vs 2.7% for pension funds)³. As a theoretical exercise, if insurers filled the equity and infrastructure allocation gap with pension funds, the potential money in motion would be a very large EUR 850bn.

This paper analyzes the two main changes affecting the insurance capital treatment of equity investments: amended criteria for the Long-Term Equity Investment (LTEI) classification, and tweaks to the “symmetric adjustment” (i.e. the regulatory capital add-on based on cyclical factors). This analysis also discusses the likely effect of these changes, and is structured as follows: initially touch on the regulatory capital treatment of equity investments under Solvency II and proposed changes; then analyze the capital efficiency and ALM implications of the Solvency II LTEI reform. We will then conclude with some key takeaways for Life and Health, and Non-Life insurers.

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1 Proposal (published on 19th January 2024) for a Directive of the European Parliament and of the Council, amending Directives 2009/138/EC, 2002/87/EC and 2013/34/EU  
2 EIOPA: “Background document on the opinion on the 2020 Review of Solvency II” published in June 2021  
3 Based on EIOPA’s SQ asset exposures for Q3 2023 for insurers (non-unit linked) and defined pension funds, using the following CIC4 categories: equity funds, private equity funds, infrastructure funds. Private equity differences are particularly large: only 0.5% of the insurer balance sheet is allocated to these strategies, vs 4.8% for pension funds.