09 July 2015

Fitch: Solvency II proposal may boost infrastructure investment

The latest proposals on capital charges for European insurance companies could encourage further investment in infrastructure assets, which insurers see as a good match for their long-term liabilities, Fitch Ratings says.

In a recent consultation paper the European Insurance and Occupational Pensions Authority proposed cutting the capital charges on investment-grade infrastructure projects to reflect the high recovery rates of infrastructure debt and the illiquid nature of these investments. Many life insurers are well placed to invest in these assets as they can hold them to maturity to match their long illiquid liabilities, such as annuities, without the need for liquidity - particularly if they are held as part of a diverse portfolio that has liquidity elsewhere. By doing this, insurers can access the extra yield available to compensate for the lack of liquidity that limits the attractiveness for other investors.

The examples provided by EIOPA for two potential approaches suggest the capital requirement for spread risk on a 'BBB' 10-year infrastructure bond could be 17.11% or 15.2%. The requirement would be 20% under the current Solvency II rules.

Fitch discussions with insurers suggest there is broad appetite to increase infrastructure investment, but this has been slow to take off for several reasons, including uncertainty about capital requirements and political risk. EIOPA's recognition that these assets might merit lower charges could therefore help increase demand. But Fitch expects infrastructure to remain a relatively small proportion of overall assets and believe the pace of investment will not accelerate rapidly as insurers will want to build their expertise in the sector.

Infrastructure debt's cash flow features and long duration means it will probably be most attractive to insurers that sell long-term financial products with guaranteed returns, including many firms in Germany and the UK.

The direct impact of the proposals in these two markets would probably be greater for German firms. This is because most German life insurers will be using the standard formula for calculating capital, while most UK firms with significant guarantee business will use their own internal models, which will already allow them to hold less capital if they can persuade regulators the level is appropriate. EIOPA's lower proposed capital charges would only apply directly to the standard formula, but insurers using an internal model could cite them to help justify lower charges in that model.

EIOPA expects to provide final advice on infrastructure capital charges to the European Commission by the end of September.

Press release

© Fitch, Inc.