Turning off the tap

Ed Collinge can credit his employment with JP Morgan Asset Management (JPMAM) in part to ‘Solvency II’.

Insurance professional Collinge cut his teeth with ill-fated Lehman Brothers before moving on to 177-year-old UK insurer Legal & General Group, where he headed capital management for its annuity business. In the middle of working for Lehman and L&G, he also became a fellow of the Institute and Faculty of Actuaries, the oldest professional actuarial association in the world.

By the time Collinge joined JP Morgan in the autumn of 2012, the financial services provider was in the thick of a global build-out of its insurance operation, having upped the headcount of staff dedicated to the industry to more than 30, adding personnel in Chicago and New York, as well as London, where Collinge is based.

Looming in the backdrop of the hiring spree that brought Collinge to JPMAM was the impending implementation of Solvency II, scheduled for January 2014. The press notice talking up his appointment was telling: in it, Solvency II was referenced twice.

For Collinge, the UK insurance professional, Solvency II is government business regulation writ large. The upshot of the European Union (EU) ‘Solvency II Directive’ is nothing short of a streamlining of continental insurance regulation, in effect creating a single insurance market in Europe.

But to hear Collinge tell it, the bill has a largely unanticipated downside for the future health of infrastructure in Europe. The insurance industry is potentially a white knight for sorely needed infrastructure investment on the continent, but in Solvency II, Collinge is looking at a potential deal-breaker.

“The typical balance sheet in European banking has become constrained, and the cost for banking to hold long-dated debt is considerably higher now,” says Collinge.

“Europe is in need of investment in infrastructure and banking, the original source of that investment, is no longer there to provide it at the same level it used to be,” he continues. “This is a great opportunity for insurance, people with long-dated capital that can invest for the long-term. There is a need for that investment in infrastructure and insurance has the ability to fill that gap, especially in infrastructure debt.”

But unless the EU can get the Solvency II Directive right, that might not happen.


On a London afternoon in October, Collinge is joined by fellow JP Morgan colleague Serkan Bahceci, vice president of research for infrastructure and real assets, to discuss the impact of Solvency II on insurance investment in infrastructure.

It was Collinge and Bahceci, together with William Coatesworth of actuarial and consulting firm Milliman, who authored a white paper for infrastructure under Solvency II, a draft proposal of which is currently being reworked by the EU.

In April, the European Insurance and Occupational Pension Authority (EIOPA) published a discussion paper on Solvency II that Collinge and Bahceci say inspired them to pen their own report.

“Europe is asking for feedback from the industry about Solvency II,” explains Bahceci. “This is the part of the policy that will affect insurance going forward. That is the point of our paper: this is the time when we can have a voice in the discussion.”

The arrival of Infrastructure investment for insurance companies under Solvency II, published in September, preceded an important announcement: in early October, the EU said Solvency II would not go into effect until 2016.

European Commissioner Michel Barnier called the January 2014 go-live date “simply no longer tenable” after meeting with the European Council and European Parliament. His pronouncement marked the latest postponement for the bill, which was first introduced in 2009 and has been much permutated.

Consumer protection is the intention of Solvency II, which is basically a risk management system requiring each insurer to hold a certain amount of capital based on the level of risk assigned to an asset. Setting aside money proportionate to the capital made in the investment, according to the rationale guiding the directive, would reduce the risk of default and also reduce potential policyholder loss.

For example, an insurance company with a private equity holding would under Solvency II be required to put €49 aside for every €100 put toward the investment (a point of contention in the private equity industry).

The problem, according to Collinge and Bahceci, is that private equity under the bill is not the only asset class getting short shrift. Infrastructure, “a new, complex asset class,” Bahceci stresses, is a square peg being forced into a round hole by Solvency II.


“Having just a single bucket for infrastructure [which is what the draft proposal of Solvency II has done], is not feasible,” says Bahceci.

The draft proposal has painted the asset class “with an overly broad brush,” according to the paper, using a “simplistic approach” to infrastructure, which can vary in its expected risk-return. Solvency II in its current incarnation is unable to take that into account, Bahceci says.

To start with, notes Collinge, the proposal is not sympathetic to the fact that infrastructure can be invested in directly, as well as through a general partner (GP), not to mention via listed infrastructure equity.

But for Collinge, not recognising the uniqueness of infrastructure debt is perhaps the most damming oversight of the bill.

“Basel III has prompted banking to sell off project finance debt on the secondary market at a substantial discount,” Collinge says. “Infrastructure debt is a good match for insurance.”

Prior to Basel III, the project finance department of a bank would make an infrastructure loan, keeping it on its balance sheet for a 30-to-40-year duration, he notes. Infrastructure debt is an “alternative” infrastructure investment, Collinge asserts, providing a high quality, fully amortising investment.

The stable long-term cash flow from infrastructure is akin to the stable long-term liability cash flow from annuity products, Collinge says. But to date, insurance has not emerged as a major investor in infrastructure in Europe. Collinge cites a recent Insurance Europe paper showing that infrastructure accounted for €12 billion out of the €3 trillion managed by the 13 largest insurance businesses in Europe.

Like private equity, infrastructure under Solvency II is regarded as ‘type 2 equity’. As a result, the capital requirement for an insurer investing in infrastructure is a 49 percent fall in market value.

Infrastructure debt, meanwhile, is measured under the spread risk sub-module, irrespective of whether the debt is held in bond form or a long-term loan, and is calculated in relation to the duration and credit rating of the instrument.

If infrastructure debt is unrated, the paper says, the spread risk change to be applied is between a bond rating of A and BBB.


“I would not say [the EU] failed with the Solvency II proposal,” Bahceci insists. “There is very little information available. We have given them information and data.”

He goes on to explain that JP Morgan has interacted with the EU about regulation. With the delay in the Solvency II schedule, Bahceci notes the industry is open to sharing its opinion.

“Infrastructure is a good asset class for insurance to invest in,” he says. “The ball is in their court right now.”