Regulatory changes may encourage insurers to increase their investment in infrastructure projects
Up to now, European insurers have not invested heavily in infrastructure projects. This is somewhat counter-intuitive as many insurers, particularly life-assurance companies and pension funds, have long-term liabilities to policyholders. One would therefore expect that long-term assets could be matched with their liabilities.
Currently, however, EU insurers only have about €22 billion invested in infrastructure, representing less than 0.3% of their total assets.
What was the Issue?
The existing regulatory framework that applies to insurers restricts the types of investments which they can make. Until recently, it looked like the new regulatory regime for insurers, known as Solvency II, would continue the regulatory barrier to infrastructure investment. In particular, the impact of those investments on the capital requirements of insurers was seen as prohibitive. Without a change to the regime, infrastructure assets were therefore unlikely to be viewed by insurers as being an attractive asset class.
What is Changing?
There is a political will, at a European level (through the Juncker plan) and at a UK level (as evidenced by George Osborne's plans to set up a National Infrastructure Commission), to boost infrastructure investment. These plans include attracting investments from insurers and pension funds.
At the request of the European Commission, work has been done to reduce the regulatory barrier to investment by insurers. This work has resulted in the European Commission publishing proposals designed to encourage insurers large and small to invest in infrastructure.
The biggest barriers identified were the additional capital that insurers would have to hold if they were to invest in infrastructure. The Commission's proposals seek to address those barriers by doing the following:
- Applying a lower capital charge to insurers when they invest in infrastructure, subject to those investments meeting certain conditions; and
- With a view to it making it easier for smaller insurers to invest in
- infrastructure, allowing investments in European long-term investment funds (ELTIFs) to benefit from lower capital charges; and
- Reducing the effect of the Solvency II regime on certain unlisted equities in the infrastructure sector, with a view to avoiding a situation where insurers are forced to sell off those assets due to temporary valuation issues.
In order to benefit from the changes in the regulations, insurers will need to adhere to certain conditions. There will, for example, be certain risk-management and due-diligence requirements, and insurers will need to be able to show that the infrastructure project will generate predictable cash-flows and withstand stressed conditions.
Will the Changes Make a Difference?
An industry body for the insurance sector, Insurance Europe, has given the Commission's proposals a qualified welcome:
“We welcome that the European Commission has … taken steps to make swift changes in the Solvency II treatment of infrastructure. However, the capital charges … remain significantly in excess of the actual risks which these assets pose to insurers’ portfolios. There is also little or no recognition of the diversification benefits that infrastructure brings to insurers’ portfolios. Therefore, while they are a step in the right direction, these changes are not enough to remove the barriers to investment by insurers."
While these points need to be considered, insurers have shown recent interest in infrastructure investments even though the Commission's proposals have not yet taken effect. UK examples of note are:
- Prudential's £100m investment in the Swansea Bay Tidal Lagoon in October 2014;
- Legal and General's £6.3bn investment in UK property and infrastructure to date, with a view to supporting UK projects, with that commitment being part of an overall commitment of £15bn; and
- The investment by Allianz, as part of a £4.2bn consortium, in the Thames Tideway Tunnel in July 2015.
The proposals are not, however, limited to UK investments, nor even to investments in European infrastructure. Infrastructure projects worldwide stand to benefit from the proposals.
What Happens Next?
The European Parliament and the Council have up to three months to exercise their right of objection to the Commission's proposals. This period may be extended for another period of three months at their initiative. The proposals will therefore probably not be in force by January 2016, when Solvency II comes into effect. If Insurance Europe's points are taken on board, however, the final form of the proposals might further reduce the regulatory barrier to insurers investing in infrastructure projects.