On 19 January 2024, the Council of the European Union published the final compromise containing amendments to Directive 2009/138/EC (Solvency II). The text contains details of the modified “Long-term equity investments” (LTE) sub-model (with a favourable 22% capital charge) and a specific treatment for Eltifs and other “low risk” AIFs. This contribution sheds some light on the implications of these amendments for insurers in the fund context.
The issue of long-term equity investments has been on the radar of the European Commission for several years. Despite the policymakers’ objective to support these, over the past few years, insurers’ investments in equities have been modest.
Giving long-term equity exposures a separate treatment from daily traded equities was the very objective of the creation of a LTE category upon the introduction of Solvency II in 2016. The category essentially acts as a “safe-haven” within the Solvency II framework for long-term investments, i.e. for any equities where it has been established that insurers can avoid being forced sellers of their equity holdings.
Less attractive
The relevance of such “safe-haven” cannot be overstated. Without the LTE category, Solvency II simply makes long-term illiquid equities less attractive for insurers. The LTE category is particularly relevant for exposures to private equity and venture capital funds. As Solvency II only looks at the equity risk from a volatility angle, the category is an essential element of the framework to ensure characteristics of insurers’ long-term investments are taken into consideration in the solvency risk assessment.
Despite the regulatory efforts to make long-term equity investments attractive by the European regulator, statistics published by EIOPA in its European Insurance Overview (2018) show that less than 1% of insurers’ investments are made in private equity funds. Furthermore, insurers make up less than 10% of the total investor base in all private equity – 3 times less than pension funds - despite insurers’ investment portfolio assets representing 58% of the EU GDP.
Perceived as overly prescriptive
The reason for this is that the current requirements have been perceived by insurers as overly prescriptive and difficult to apply in practice. Furthermore, insurers investing in funds are required to adopt the “look through approach” in calculating their Solvency Capital Requirement (SCR). This means that the SCR will generally need to be calculated on the basis of the underlying assets in a fund structure and this approach will need to be applied a sufficient number of times to capture all material risk. This also means that where an insurer invests in a fund-of-funds or a feeder/master fund structure, it will need to “look-through” each (target/master) fund so that the SCR is calculated on the ultimate underlying assets in so far as possible.
To encourage investments in long-term investments that recognizes the need for insurance companies to invest more robustly and strategically in long-term projects, the amended LTE regime reduces the capital requirements for specific long-term equity investments from 39% to 22%. In addition, the eligibility requirements with respect to the LTE regime under the amended Solvency II regime have been made more flexible.
Important in the fund context, is that the amended Solvency II regime allows ELTIFs to assess the eligibility requirements at the fund-level only and, thereby does away with the current “look-through approach”. The amended Solvency II regime also grants the “no look-through” benefit to specific low risk-profile AIFs. However, the criteria defining these funds as lower risk-profile AIF still have to be formulated in the delegated acts to be adopted pursuant to the amended Solvency II regime.
Complex exercise
Albeit the to be contemplated amendments are going in the right direction, as the absence of a “look-through assessment”, as well as the relaxation of the eligibility criteria are helpful, compliance with the requirements may still be a complex exercise and it will remain to be seen whether the new LTE regime and the role of (low-risk) AIFs and ELTIFs will make the use of this category more economic and attractive.
Marc Meyers is co-managing partner of Loyens & Loeff Luxembourg and heads its investment management practice Group. Sebastiaan Hooghiemstra is a senior associate in the investment management practice group of Loyens & Loeff Luxembourg and senior fellow/guest lecturer of the International Center for Financial Law & Governance at the Erasmus University Rotterdam. The law firm is a Knowledge Partner of Investment Officer.
