The insurers are coming! Recent research from Colonial First State Global Asset Management (CFSGAM) revealed that, up to now, pensions have accounted for around 70 percent of infrastructure funds under management. Going forward, however, it expected the proportion accounted for by insurance companies to move up from a historic 14 percent of the total to 44 percent.
This would be a dramatic shift but not a surprising one. After all, the same kinds of characteristics of infrastructure that have attracted pension funds – such as stable, long-term inflation-protected cash flows and attractive spreads – apply equally to insurers. Both types of organisation can use these characteristics to match liabilities. The only difference appears to be that pension funds have been quicker off the mark to embrace infrastructure.
But if insurers are to close the gap in the way envisaged by CFSGAM, they may need to mobilise themselves – or others on their behalf – to push back against draft Solvency II proposals which, in the words of a new report from JP Morgan Asset Management and actuarial firm Milliman, “paints infrastructure investing with an overly broad brush”.
Few would disagree that Solvency II arises from good intentions – a directive introduced in 2009, primarily to determine the amount of capital that insurers should hold in order to reduce the risk of insolvency. But, as we all know, the road to hell is paved with good intentions.
The problem in the case of infrastructure is that the European Insurance and Occupational Pensions Authority (EIOPA), which is advising the European Commission on the Solvency II project, has categorised “infrastructure equity” and “infrastructure debt” under the “type 2 equity” and “spread risk sub-module” standard formulae respectively.
In the view of the Milliman/JP Morgan report, this fails to acknowledge the very wide range of risk/return profiles within the infrastructure asset class. To give one obvious example, greenfield investment tends to come with a much higher level of risk than core, brownfield investment (with conservative insurers far more likely to weight allocations in favour the latter). But the Solvency II approach does not recognise this – or many other – types of differentiation within the asset class, and means insurers may have to set aside more capital than is really necessary given the risk being taken.
The report reaches the conclusion that “the draft proposal makes it more difficult for European insurers to access the stable and relatively predictable long term cash flows provided by infrastructure assets at the lower end of the risk spectrum”.
As governments hunt for long-term sources of finance to support their infrastructure plans, regulators appear – albeit with the laudable aim of a secure financial system – to be placing obstacles in the way. Let’s hope the insurers are indeed coming. The future without them will be a lot tougher for the infrastructure asset class.