In September 2015, the European Commission created a new category of assets, namely "infrastructure projects" in the insurance prudential framework known as "Solvency II". On 8 June 2017, the Commission complemented this by introducing a further category of assets called "infrastructure corporates". Like infrastructure projects, they will benefit from a more favourable treatment so as to encourage insurance companies to invest in these corporates. Santosh Pandit, policy expert at the European Commission, explains the latest changes.

What are infrastructure projects and infrastructure corporates?

Investment in infrastructure such as transport, electricity generation and distribution or digital networks is extremely important for the functioning of businesses and public facilities and for economic growth in the European Union.  Infrastructure businesses can be broadly classified into two categories: "infrastructure projects" and "infrastructure corporates". The former category typically involves the construction of new infrastructure facilities. Infrastructure corporates on the other hand are infrastructure businesses that are already operational (though in some cases, even established infrastructure corporates can take up new projects for expansion or modernisation). For example, many existing airports in the European Union that have funding requirements for expansion or redevelopment would be classified as "infrastructure corporates".  The regulatory framework needs to address the specificities of infrastructure corporates as well as infrastructure projects in terms of the investment risk taken by insurance companies as investors.

What is so special about infrastructure investments?

Infrastructure investments are typically long term in nature. Companies building and running infrastructure often borrow money for 7 to 10 years or even much longer. Insurance companies, particularly long term insurance companies, are well-placed to make such investments. Given that the life or investment type insurance policies that they sell usually have a long duration, they are keen to invest in long-term and safe investments. Studies have shown that, especially over a longer period, investments in infrastructure can be much less risky than in some non-infrastructure alternatives. Of course, not every infrastructure investment has lower risk and therefore investors need to do their homework and make sure they understand the risks involved.

What are the main changes introduced by the Commission?

Solvency II prescribes how much capital should be held by insurance companies so that they can absorb losses should any of their investments default. This capital requirement is expected to be proportionate to the risk profile of the portfolio of all assets they hold. Depending on how much capital they have to hold for a specific category of investment, it will be more or less attractive for them to invest in that category. As infrastructure is generally speaking a safe asset class and to promote investments in infrastructure, the Commission has now proposed to reduce the risk calibrations for qualifying debt investments in infrastructure corporates by 25% on average and for equity investments by up to 27%. Insurance companies will therefore have to hold lower capital against less-risky investments than in other, more risky investments. Prudent qualifying criteria such as revenue predictability and due diligence to establish that the borrower has the ability to service debt ensure that only safer investments benefit from the lower risk calibration.

How does the change affect individuals and businesses in the European Union?

European citizens – as insurance policyholders and beneficiaries – need to be confident that their insurance companies are financially sound. The Commission is giving an incentive to insurance companies to invest in safer infrastructure opportunities, which is something that will benefit citizens in the long run.

Infrastructure businesses that need funding in the form of equity or debt will also benefit from this dedicated treatment. First of all, their ability to obtain funding from the insurance sector will improve as they become more attractive to insurances due to their more favourable risk calibration. Secondly, especially smaller or medium-sized infrastructure borrowers, which do not have a credit rating, will also have the ability to raise funding.  This is possible because prudent eligibility criteria have been introduced so that insurance companies can assess the safety of their investment without necessarily relying on a credit rating. Such unrated debt will be given the same treatment as BBB rated debt.

What overall impact will this have for the European Union?

The introduction of the infrastructure corporates asset category is one of several measures under the Capital Markets Union action plan and the overall Investment Plan for Europe. Over a 5-10 year period, assuming there will be good quality investment opportunities, the Commission anticipates that insurance companies can at least double their investment in infrastructure. The changes to the Solvency II regulation, as proposed and adopted, are subject to scrutiny by the European Parliament and Council. These changes will become effective upon the completion of the scrutiny period and publication in the EU journal.

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