Property risk under solvency II: effects of different unsmoothing techniques
Abstract
Solvency II imposes risk-based capital requirements on EU insurance companies. This paper evaluates the property risk standard model proposed. The calibration was performed from the IPD UK monthly index total returns for the period between December 1986 and December 2009. In general, it is considered that returns derived from valuation-based indices are smoother than those derived from transaction-based indices. This paper contributes to the existing literature by applying various unsmoothing techniques to this index. The results show that the capital requirements, applying the same calculation method (historical value at risk at the 99.5% confidence level) as in the calibration of the standard model, are generally bigger than those proposed in the standard model of Solvency II.
Keyword : Solvency II, internal model, standard model, property risk, QIS5, unsmoothing returns, IPD UK index
How to Cite
Durán Santomil, P., Otero González, L., Martorell Cunill, O., & Gil-Lafuente, A. M. (2019). Property risk under solvency II: effects of different unsmoothing techniques. Technological and Economic Development of Economy, 25(1), 1-19. https://doi.org/10.3846/tede.2019.6213
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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BlackRock. (2012). Balacing risk, return and capital requirements; the effect of Solvency II on asset allocation and investment strategy. Economist Intelligence Unit.
Blundell, D. M., & Ward, C. W. R. (1987). Property portfolio allocation: a multi-factor model. Journal of Development Studies, 4(2), 145-156. https://doi.org/10.1080/02640828708723929
Booth, P. M., & Marcato, G. (2004). The measurement and modelling of commercial real estate performance. British Actuarial Journal, 10(1), 5-61. https://doi.org/10.1017/S1357321700004530
Braun, A., Schmeiser, H., & Schreiber, F. (2017). Portfolio optimization under Solvency II: implicit constraints imposed by the market risk standard formula. The Journal of Risk and Insurance, 84(1), 177-207. https://doi.org/10.1111/jori.12077
Brown, G. R., & Matysiak, G. A. (1998). Valuation smoothing without temporal aggregation. Journal of Property Research, 15(2), 89-103. https://doi.org/10.1080/095999198368419
Brown, G. R., & Matysiak, G. A. (2000). Real estate investment. Prentice Hall.
Butaci, C., Dzitac, S., Dzitac, I., & Bologa, G. (2017). Prudent decisions to estimate the risk of loss in insurance. Technological and Economic Development of Economy, 23(2), 428-440. https://doi.org/10.3846/20294913.2017.1285365
Committee of European Insurance and Occupational Pensions Supervisors. (2010a). QIS5 Technical Specifications. Retrieved from https://eiopa.europa.eu/publications/qis/insurance/insurance-quan-titative-impact-study-5/technical-specifications
Committee of European Insurance and Occupational Pensions Supervisors. (2010b). Solvency II Calibration Paper (CEIOPS-SEC-40-10). Retrieved from https://eiopa.europa.eu/ceiops-archive/documents/advices/ceiops-calibration-paper-solvency-ii.pdf
Chaplin, R. (1997). Unsmoothing valuation-based indices using multiple regimes. Journal of Property Research, 14(3), 189-210. https://doi.org/10.1080/095999197368609
Cho, H., Kawaguchi, Y., & Shilling, J. D. (2003). Unsmoothing commercial property returns: a revision to Fisher-Geltner-Webb᾽s unsmoothing methodology. The Journal of Real Estate Finance and Economics, 27(3), 393-405. https://doi.org/10.1023/A:1025898325952
Clayton, J., Geltner, D. M, & Hamilton, S. W. (2001). Smoothing in commercial property valuations: evidence from individual appraisals. Real Estate Economics, 29(3), 337-360. https://doi.org/10.1111/1080-8620.00014
Corgel, J., & DeRoss, J. (1999). Recovery of real estate returns for portfolio allocations. Journal of Real Estate Finance and Economics, 18(3), 279-296. https://doi.org/10.1023/A:1007728900308
Devaney, S., & Martinez, R. (2011). Transaction based indices for the UK commercial real estate market. Journal of Property Research, 28(4), 269-289. https://doi.org/10.1080/09599916.2011.601317
Diaz III, J., & Wolverton, M. L. (1998). A longitudinal examination of the appraisal smoothing hypothesis. Real Estate Economics, 26(2), 349-358. https://doi.org/10.1111/1540-6229.00749
European Insurance and Occupational Pensions Authority. (2011a). EIOPA Report on the fifth Quantitative Impact Study (QIS5) for Solvency II (TFQIS5-11/001). Retrieved from https://eiopa.europa.eu/publications/reports/qis5_report_final.pdf
European Insurance and Occupational Pensions Authority. (2011b). Specifications for the 2011 EU-wide stress test in the insurance sector (FS-11/012). Retrieved from https://eiopa.europa.eu/Publications/Surveys/Stress-Test-Framework.pdf
European Insurance and Occupational Pensions Authority. (2012). Quantitative Impact Study (QIS) on Institutions for Occupational Retirement Provision (IORPs) – technical specifications (EIO-PA-BOS-12/085). Retrieved from https://eiopa.europa.eu/Publications/QIS/COM-TS-adapted-_20121008_.doc
European Insurance and Occupational Pensions Authority. (2013a). Technical specification on the long term guarantee assessment (Part I, EIOPA/13/061). Retrieved from https://eiopa.europa.eu/Publications/QIS/A_-_Technical_Specification_on_the_Long_Term_Guarantee_Assessment__Part_I_.pdf
European Insurance and Occupational Pensions Authority. (2013b). Technical specifications part II on the long-term guarantee assessment (EIOPA/12/307). Retrieved from https://eiopa.europa.eu/Publications/QIS/20130125_EIOPA_LTGA_Technical_Specifications_Part_II_final.pdf
European Insurance and Occupational Pensions Authority. (2014). EIOPA Stress Test 2014 (EIOPA-14-215). Retrieved from https://eiopa.europa.eu/Publications/Surveys/eiopa-14-215_stress_test_2014_specifications.pdf
European Insurance and Occupational Pensions Authority. (2016). 2016 EIOPA insurance stress test report (EIOPA 16/302). Retrieved from https://eiopa.europa.eu/publications/surveys/eiopa-bos-16-302%20insurance%20stress%20test%202016%20report.pdf
European Insurance and Occupational Pensions Authority. (2018). Insurance stress test 2018 technical specifications (EIOPA-BoS-18-189). Retrieved from https://eiopa.europa.eu/Publications/Surveys/EIOPA-BOS-18-189_Technical%20Specifications_v20180528_28_05.pdf
FINMA 2011. Guideline on the SST market risk standard model. Retrieved from http://www.finma.ch/e/beaufsichtigte/versicherungen/schweizer-solvenztest/Pages/default.aspx
Fisher, J., Miles, M., & Webb, R. B. (1999). How reliable are commercial property appraisals? Another look. Real Estate Finance, 16(3), 9-15.
Fisher, J., Gatzlaff, D., Geltner, D. M., & Haurin, D. (2003). Controlling for the impact of variable liquidity in commercial real estate price indices. Real Estate Economics, 31(2), 269-303. https://doi.org/10.1111/1540-6229.00066
Fisher, J. D., Geltner, D. M., & Webb, R. B. (1994). Value indices of commercial real estate: a comparison of index construction methods. Journal of Real Estate Finance and Economics, 9(2), 137-164. https://doi.org/10.1007/BF01099972
Focarelli, D. (2017). Why insurance regulation is crucial for long-term investment and economic growth (Working Paper No. 1). Retrieved from https://www.ivass.it/pubblicazioni-e-statistiche/pubblicazioni/att-sem-conv/2017/conf-131407/SEP-12017-Focarelli.pdf
Gatzert, N., & Martin, M. (2012). Quantifying credit and market risk under Solvency II: standard approach versus internal model. Insurance: Mathematics and Economics, 51(3), 649-666. https://doi.org/10.1016/j.insmatheco.2012.09.002
Geltner, D. M. (1991). Smoothing in appraisal-based returns. Journal of Real Estate Finance and Economics, 4(3), 327-345. https://doi.org/10.1007/BF00161933
Geltner, D. M. (1993a). Temporal aggregation in real estate return indices. Journal of the American Real Estate and Urban Economics Association, 21(2), 141-166. https://doi.org/10.1111/1540-6229.00605
Geltner, D. M. (1993b). Estimating market values from appraised values without assuming an efficient market. Journal of Real Estate Research, 8(3), 325-345.
Graff, R. A., Harrington, A., & Young, M. S. (1997). The shape of Australian real estate return distributions and comparisons to the United States. Journal of Real Estate Research, 14(3), 291-308.
Hoering, D. (2013). Will Solvency II market risk requirements bite? The impact of Solvency II on insurers’ asset allocation. The Geneva Papers on Risk and Insurance–Issues and Practice, 38(2), 250-273. https://doi.org/10.1057/gpp.2012.31
Hoesli, M., Lekander, J., & Witkiewicz, W. (2004). International evidence on real estate as a portfolio diversifier. The Journal of Real Estate Research, 26(2), 161-206.
Insurance Europe. (2016). European insurance – key facts. Retrieved from https://www.insuranceeurope.eu/sites/default/files/attachments/European%20Insurance%20-%20Key%20Facts%20-%20August%202016.pdf
Investment Property Databank. (2011). The IPD Solvency II review. Informing a new regulatory framework for real estate. Retrieved from http://www.europeanrealestateforum.eu/wp-content/uploads/2013/09/11-04-15-IPD-Solvency-II-Review.pdf
Investment Property Databank. (2012). IPD index guide. Edition six – January. Retrieved from http://ec.europa.eu/finance/consultations/2012/benchmarks/docs/contributions/individual-others/ipd-annex1_en.pdf
Key, T., & Marcato, G. (2007). Index smoothing and the volatility of UK commercial real estate. Report for the Investment Property Forum.
Lai, T. Y., & Wang, K. (1998). Appraisal smoothing: the other side of the story. Real Estate Economics, 26(3), 511-535. https://doi.org/10.1111/1540-6229.00755
Maitland-Smith, J., & Brooks, C. (1999). Threshold autoregressive and Markov Switching models: an application to commercial real estate. Journal of Property Research, 16(1), 1-19. https://doi.org/10.1080/095999199368238
Maurer, R., Reiner, F., & Sebastian, S. (2004). Characteristics of German real estate return distributions: evidence from Germany and comparison to the U.S. and U.K. Journal of Real Estate Portfolio Management, 10(1), 59-76.
Miles, M., & McCue, T. (1984). Commercial real estate returns. Journal of the American Real Estate and Urban Economics Association, 12(3), 335-377. https://doi.org/10.1111/1540-6229.00327
MSCI. (2017). MSCI real estate Solvency II 2017 update report. Retrieved from https://www.msci.com/documents/10199/239004/MSCI+Real+Estate+Solvency+II+2017+Update+Report/136d5292-c850-4485-b187-94b1218bc626
Myer, F. C. N., & Webb, J. R. (1994). Statistical properties of returns: financial assets versus commercial real estate. Journal of Real Estate Finance and Economics, 8(3), 267-282. https://doi.org/10.1007/BF01096997
Quan, D. C., & Quigley, J. M. (1989). Inferring an investment return series for real estate from observations on sales. Journal of the American Real Estate and Urban Economics Association, 17(2), 218-230. https://doi.org/10.1111/1540-6229.00487
Quan, D. C., & Quigley, J. M. (1991). Price Formation and the appraisal function in real estate markets. Journal of Real Estate Finance and Economics, 4(2), 127-146. https://doi.org/10.1007/BF00173120
Schlumpf, F., Tessera, G., & Martínez, C. (2013). Market risk of real estate: using indirect data to understand direct risks. Journal of Financial Perspectives, 1(3), 111-120.
Steffen, T. (2008). Solvency II and the work of CEIOPS. The Geneva Papers on Risk and Insurance – Issues and Practice, 33(1), 60-66. https://doi.org/10.1057/palgrave.gpp.2510162
Baum, A., Crosby, N., McAllister, P., Gallimore, P., & Gray, A. (2000). The influence of valuers and valuations on the workings of the commercial property investment market. Royal Institution of Chartered Surveyors/Investment Property Forum, London.
BlackRock. (2012). Balacing risk, return and capital requirements; the effect of Solvency II on asset allocation and investment strategy. Economist Intelligence Unit.
Blundell, D. M., & Ward, C. W. R. (1987). Property portfolio allocation: a multi-factor model. Journal of Development Studies, 4(2), 145-156. https://doi.org/10.1080/02640828708723929
Booth, P. M., & Marcato, G. (2004). The measurement and modelling of commercial real estate performance. British Actuarial Journal, 10(1), 5-61. https://doi.org/10.1017/S1357321700004530
Braun, A., Schmeiser, H., & Schreiber, F. (2017). Portfolio optimization under Solvency II: implicit constraints imposed by the market risk standard formula. The Journal of Risk and Insurance, 84(1), 177-207. https://doi.org/10.1111/jori.12077
Brown, G. R., & Matysiak, G. A. (1998). Valuation smoothing without temporal aggregation. Journal of Property Research, 15(2), 89-103. https://doi.org/10.1080/095999198368419
Brown, G. R., & Matysiak, G. A. (2000). Real estate investment. Prentice Hall.
Butaci, C., Dzitac, S., Dzitac, I., & Bologa, G. (2017). Prudent decisions to estimate the risk of loss in insurance. Technological and Economic Development of Economy, 23(2), 428-440. https://doi.org/10.3846/20294913.2017.1285365
Committee of European Insurance and Occupational Pensions Supervisors. (2010a). QIS5 Technical Specifications. Retrieved from https://eiopa.europa.eu/publications/qis/insurance/insurance-quan-titative-impact-study-5/technical-specifications
Committee of European Insurance and Occupational Pensions Supervisors. (2010b). Solvency II Calibration Paper (CEIOPS-SEC-40-10). Retrieved from https://eiopa.europa.eu/ceiops-archive/documents/advices/ceiops-calibration-paper-solvency-ii.pdf
Chaplin, R. (1997). Unsmoothing valuation-based indices using multiple regimes. Journal of Property Research, 14(3), 189-210. https://doi.org/10.1080/095999197368609
Cho, H., Kawaguchi, Y., & Shilling, J. D. (2003). Unsmoothing commercial property returns: a revision to Fisher-Geltner-Webb᾽s unsmoothing methodology. The Journal of Real Estate Finance and Economics, 27(3), 393-405. https://doi.org/10.1023/A:1025898325952
Clayton, J., Geltner, D. M, & Hamilton, S. W. (2001). Smoothing in commercial property valuations: evidence from individual appraisals. Real Estate Economics, 29(3), 337-360. https://doi.org/10.1111/1080-8620.00014
Corgel, J., & DeRoss, J. (1999). Recovery of real estate returns for portfolio allocations. Journal of Real Estate Finance and Economics, 18(3), 279-296. https://doi.org/10.1023/A:1007728900308
Devaney, S., & Martinez, R. (2011). Transaction based indices for the UK commercial real estate market. Journal of Property Research, 28(4), 269-289. https://doi.org/10.1080/09599916.2011.601317
Diaz III, J., & Wolverton, M. L. (1998). A longitudinal examination of the appraisal smoothing hypothesis. Real Estate Economics, 26(2), 349-358. https://doi.org/10.1111/1540-6229.00749
European Insurance and Occupational Pensions Authority. (2011a). EIOPA Report on the fifth Quantitative Impact Study (QIS5) for Solvency II (TFQIS5-11/001). Retrieved from https://eiopa.europa.eu/publications/reports/qis5_report_final.pdf
European Insurance and Occupational Pensions Authority. (2011b). Specifications for the 2011 EU-wide stress test in the insurance sector (FS-11/012). Retrieved from https://eiopa.europa.eu/Publications/Surveys/Stress-Test-Framework.pdf
European Insurance and Occupational Pensions Authority. (2012). Quantitative Impact Study (QIS) on Institutions for Occupational Retirement Provision (IORPs) – technical specifications (EIO-PA-BOS-12/085). Retrieved from https://eiopa.europa.eu/Publications/QIS/COM-TS-adapted-_20121008_.doc
European Insurance and Occupational Pensions Authority. (2013a). Technical specification on the long term guarantee assessment (Part I, EIOPA/13/061). Retrieved from https://eiopa.europa.eu/Publications/QIS/A_-_Technical_Specification_on_the_Long_Term_Guarantee_Assessment__Part_I_.pdf
European Insurance and Occupational Pensions Authority. (2013b). Technical specifications part II on the long-term guarantee assessment (EIOPA/12/307). Retrieved from https://eiopa.europa.eu/Publications/QIS/20130125_EIOPA_LTGA_Technical_Specifications_Part_II_final.pdf
European Insurance and Occupational Pensions Authority. (2014). EIOPA Stress Test 2014 (EIOPA-14-215). Retrieved from https://eiopa.europa.eu/Publications/Surveys/eiopa-14-215_stress_test_2014_specifications.pdf
European Insurance and Occupational Pensions Authority. (2016). 2016 EIOPA insurance stress test report (EIOPA 16/302). Retrieved from https://eiopa.europa.eu/publications/surveys/eiopa-bos-16-302%20insurance%20stress%20test%202016%20report.pdf
European Insurance and Occupational Pensions Authority. (2018). Insurance stress test 2018 technical specifications (EIOPA-BoS-18-189). Retrieved from https://eiopa.europa.eu/Publications/Surveys/EIOPA-BOS-18-189_Technical%20Specifications_v20180528_28_05.pdf
FINMA 2011. Guideline on the SST market risk standard model. Retrieved from http://www.finma.ch/e/beaufsichtigte/versicherungen/schweizer-solvenztest/Pages/default.aspx
Fisher, J., Miles, M., & Webb, R. B. (1999). How reliable are commercial property appraisals? Another look. Real Estate Finance, 16(3), 9-15.
Fisher, J., Gatzlaff, D., Geltner, D. M., & Haurin, D. (2003). Controlling for the impact of variable liquidity in commercial real estate price indices. Real Estate Economics, 31(2), 269-303. https://doi.org/10.1111/1540-6229.00066
Fisher, J. D., Geltner, D. M., & Webb, R. B. (1994). Value indices of commercial real estate: a comparison of index construction methods. Journal of Real Estate Finance and Economics, 9(2), 137-164. https://doi.org/10.1007/BF01099972
Focarelli, D. (2017). Why insurance regulation is crucial for long-term investment and economic growth (Working Paper No. 1). Retrieved from https://www.ivass.it/pubblicazioni-e-statistiche/pubblicazioni/att-sem-conv/2017/conf-131407/SEP-12017-Focarelli.pdf
Gatzert, N., & Martin, M. (2012). Quantifying credit and market risk under Solvency II: standard approach versus internal model. Insurance: Mathematics and Economics, 51(3), 649-666. https://doi.org/10.1016/j.insmatheco.2012.09.002
Geltner, D. M. (1991). Smoothing in appraisal-based returns. Journal of Real Estate Finance and Economics, 4(3), 327-345. https://doi.org/10.1007/BF00161933
Geltner, D. M. (1993a). Temporal aggregation in real estate return indices. Journal of the American Real Estate and Urban Economics Association, 21(2), 141-166. https://doi.org/10.1111/1540-6229.00605
Geltner, D. M. (1993b). Estimating market values from appraised values without assuming an efficient market. Journal of Real Estate Research, 8(3), 325-345.
Graff, R. A., Harrington, A., & Young, M. S. (1997). The shape of Australian real estate return distributions and comparisons to the United States. Journal of Real Estate Research, 14(3), 291-308.
Hoering, D. (2013). Will Solvency II market risk requirements bite? The impact of Solvency II on insurers’ asset allocation. The Geneva Papers on Risk and Insurance–Issues and Practice, 38(2), 250-273. https://doi.org/10.1057/gpp.2012.31
Hoesli, M., Lekander, J., & Witkiewicz, W. (2004). International evidence on real estate as a portfolio diversifier. The Journal of Real Estate Research, 26(2), 161-206.
Insurance Europe. (2016). European insurance – key facts. Retrieved from https://www.insuranceeurope.eu/sites/default/files/attachments/European%20Insurance%20-%20Key%20Facts%20-%20August%202016.pdf
Investment Property Databank. (2011). The IPD Solvency II review. Informing a new regulatory framework for real estate. Retrieved from http://www.europeanrealestateforum.eu/wp-content/uploads/2013/09/11-04-15-IPD-Solvency-II-Review.pdf
Investment Property Databank. (2012). IPD index guide. Edition six – January. Retrieved from http://ec.europa.eu/finance/consultations/2012/benchmarks/docs/contributions/individual-others/ipd-annex1_en.pdf
Key, T., & Marcato, G. (2007). Index smoothing and the volatility of UK commercial real estate. Report for the Investment Property Forum.
Lai, T. Y., & Wang, K. (1998). Appraisal smoothing: the other side of the story. Real Estate Economics, 26(3), 511-535. https://doi.org/10.1111/1540-6229.00755
Maitland-Smith, J., & Brooks, C. (1999). Threshold autoregressive and Markov Switching models: an application to commercial real estate. Journal of Property Research, 16(1), 1-19. https://doi.org/10.1080/095999199368238
Maurer, R., Reiner, F., & Sebastian, S. (2004). Characteristics of German real estate return distributions: evidence from Germany and comparison to the U.S. and U.K. Journal of Real Estate Portfolio Management, 10(1), 59-76.
Miles, M., & McCue, T. (1984). Commercial real estate returns. Journal of the American Real Estate and Urban Economics Association, 12(3), 335-377. https://doi.org/10.1111/1540-6229.00327
MSCI. (2017). MSCI real estate Solvency II 2017 update report. Retrieved from https://www.msci.com/documents/10199/239004/MSCI+Real+Estate+Solvency+II+2017+Update+Report/136d5292-c850-4485-b187-94b1218bc626
Myer, F. C. N., & Webb, J. R. (1994). Statistical properties of returns: financial assets versus commercial real estate. Journal of Real Estate Finance and Economics, 8(3), 267-282. https://doi.org/10.1007/BF01096997
Quan, D. C., & Quigley, J. M. (1989). Inferring an investment return series for real estate from observations on sales. Journal of the American Real Estate and Urban Economics Association, 17(2), 218-230. https://doi.org/10.1111/1540-6229.00487
Quan, D. C., & Quigley, J. M. (1991). Price Formation and the appraisal function in real estate markets. Journal of Real Estate Finance and Economics, 4(2), 127-146. https://doi.org/10.1007/BF00173120
Schlumpf, F., Tessera, G., & Martínez, C. (2013). Market risk of real estate: using indirect data to understand direct risks. Journal of Financial Perspectives, 1(3), 111-120.
Steffen, T. (2008). Solvency II and the work of CEIOPS. The Geneva Papers on Risk and Insurance – Issues and Practice, 33(1), 60-66. https://doi.org/10.1057/palgrave.gpp.2510162