Life companies could increase allocations to commercial real estate next year, following a regulatory body action to reduce risk-based capital requirements for property investments.
Reducing these requirements frees up capital for life companies to invest in commercial properties and boosts the effective returns of investing in the sector. As a practical matter, the amount of capital involved is small relative to the total size of most life companies, but it makes commercial real estate a more competitive alternative.
“Life companies can now get a better return on risk-based capital than before, which makes commercial real estate more attractive relative to other investments than it was before the change,” said Bruce Oliver, an associate vice president of commercial and multifamily policy at the Washington, D.C.-based Mortgage Bankers Association.
The changes come after actions by the Life Risk-Based Capital Working Group of the National Association of Insurance Commissioners, an organization of state insurance commissioners that sets regulatory requirements for life insurers.
The new capital rules require that life companies hold 11% capital for commercial property equity investments, down from 15% before the regulations were revamped. For real estate equity investments that life companies hold in joint ventures, limited liability companies, or a similar structure, the amount of risk-based capital required to be held was reduced to 13%, down from 23%. The new regulations go into effect for life company 2021 year-end risk-based capital reporting.
Life companies and industry trade groups including the MBA and American Council of Life Insurers (ACLI) initiated discussions with the NAIC working group in 2017 to reduce the capital requirements. Industry representatives contended that the previous requirements reflected a higher degree of risk for commercial real estate investments than is warranted by the sector’s historical performance.
In a letter of support for the proposal dated May 21, the MBA wrote that there was little data available on the performance of real estate when the current risk-based capital requirements were adopted in 2000. “(T)he proposal is based on analysis of historical real estate investment performance data from the NCREIF Property Index (NPI), supplemented by further data … through earlier years of 1961-1977,” the letter stated.
The life company coalition is also lobbying the life RBC working group on behalf of a proposal that would further reduce risk-based capital requirements for properties that are valued on the books at less than market value. The proposal would enable life companies to recognize a portion of unrealized gains on properties that, for example, appreciate over time.
The actions taken by the NAIC only impact commercial real estate equity, not debt investments. Separately, NAIC working groups are listening to similar proposals to update risk-based capital requirements for CMBS. These updates also would involve reducing capital requirements that would make it less onerous for life companies to invest in bonds backed by commercial mortgages and REITs.
The rationale for the changes would be to put the capital charges for CMBS more in line with the actual risk posed by the security. As with the changes in the equity capital requirements, that could make CMBS more attractive to life companies relative to competing investment products. The CMBS proposal is being heard by the NAIC’s Valuation Securities Task Force.
For a full analysis, please see: Analysis: A Rule Change Could Fuel LifeCo CRE Investment