Encouraging Insurers To Invest For The Long Term

On 23 April 2023, the EU Parliament adopted the text of the political agreement reached with the Council of the EU on the Directive amending Directive (EU) 2009/138/EC that regulates the EU's prudential regime for insurance and reinsurance undertakings, also known as Solvency II. This adopted text contains targeted amendments to the Solvency II framework. An important aspect of these amendments is that they aim to free up large sums of money that (re)insurance companies had to keep in reserve, thus allowing the sector to channel more funds into the real economy. Considering that (re)insurance companies are major investors and their decisions on where to invest have a significant impact, this reform is also of interest for long-term investments in ELTIFs by (re)insurance companies.

What will change for long-term investments?

The Solvency II framework introduced risk-based capital requirements for investments by (re)insurance companies. It involves, among other things, calculating their solvency capital requirements (also known as the SCR) via a number of risk modules, including an equity risk sub-module. As a result, (re)insurers are required to apply the "prudent person" principle and thus maintain a portfolio of assets that meets their insurance liabilities. They must also have additional capital to cover the risks of adverse events, often referred to as a "capital charge". Therefore, when selecting their investments, (re)insurers have to consider the appropriate capital charges that apply to them under Solvency II.

Recognising that capital charges of around 39% were an obstacle to long-term equity (LTE) investments by (re)insurance companies, a Delegated Regulation introduced a more substantial regime for the preferential treatment of LTE investments, including investments in ELTIFs. As a result, LTE investments, including investments in ELTIFs, were eligible to benefit from a reduced capital charge of 22%, if the (re)insurance company met certain conditions.

In 2021, to further incentivise (re)insurance companies to invest long term as private investors, the EU Commission proposed the (now adopted) targeted amendments to the Solvency II regime. To emphasise the importance of freeing up funds kept in reserve and channelling them into the real economy, the EU Parliament voted to raise the allowance for LTEs from the level of a delegated act to the level of the Solvency II Directive. In addition, the adopted amendments further relax the regime for the preferential treatment of LTE investments, including investments in ELTIFs, to the extent that:

• The subset of equities is clearly defined and managed separately from the (re)insurer's other activities.
  
  
• A policy for long-term investment management is set up for each LTE portfolio and reflects the (re)insurer's commitment to hold these LTE investments for a period in excess of five years, on average.
  
  
• The investments consist only of equities listed in EEA or OECD member countries or unlisted equities of companies with their head office in EEA or OECD countries.
  
  
• The (re)insurer demonstrates to the relevant supervisory authority that it can maintain an LTE investment on an ongoing basis and under stressed conditions, and is able to avoid forced selling of equity investments within the subset for five years.
  
  
• The risk management, asset-liability management and investment policies of the (re)insurer reflect the intention to hold the long-term equity investments for a period of five years or more.
  
  
• The subset of equity investments is appropriately diversified so as to avoid excessive reliance on any particular issuer or group of undertakings and excessive accumulation of risk in the portfolio of LTE investments as a whole with the same risk profile.
  
  
• The subset of equity investments does not include participations.
  
  

With regard to investments in ELTIFs, the adopted amendments clarify that where equities are held within ELTIFs, the above conditions may be assessed at the level of the fund and not the underlying assets held within this fund (that is, no look-through as required in principle for any investment by (re)insurers). The adopted amendments also state that investments in AIFs with a lower risk profile may benefit from the same preferential treatment as investments in ELTIFs. A delegated act will specify the types of AIFs with a lower risk profile.

The capital charge for LTEs must be equal to the loss in the basic own funds that would result from an instantaneous decrease equal to 22% in the value of LTE investments. However, it should be noted that (re)insurers who adopt this approach may not revert to an approach that does not include LTE investments in case the (re)insurer is no longer able to comply with the above conditions.

Next steps

The adopted text is now subject to formal adoption by the Council of the EU, which should be a formality. The adopted amendments to Solvency II will enter into force 20 days following publication in the Official Journal of the EU. Member States will have 24 months to implement and apply the amended rules, which we expect will be the case by the end of Q2 2026.

For a period of four years from the entry into force of the amending Directive, the EU Commission is empowered to prepare and adopt a delegated act to provide further details.

What do we expect?

It is expected that the adopted amendments will lower the cost-of-capital rate from the current 6% to 4.75%, thus potentially stimulating LTE investments, including investments in ELTIFs and AIFs with a lower risk profile. Abandoning the look-through approach will facilitate LTEs in these investment funds. The adopted reform under Solvency II has the potential to further stimulate investments in ELTIFs and therefore interest in setting up ELTIFs. The redesigned ELTIF framework, also known as ELTIF 2.0, which entered into application in January 2024, significantly broadened the investment universe and removed obstacles to investment by professional and institutional investors.

ELTIFs have recently experienced an increase in demand, as 101 ELTIFs have been launched as of March 2024. These authorised ELTIFs are domiciled in only four Member States: Luxembourg (65), France (21), Italy (13) and Spain (2).

To access to the adopted text, click here_

For more information about the ELTIF 2.0 regime, please click here and here_

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.