Is it a good idea to ease regulations on infrastructure investment?

Ear­li­er this year, Legal & Gen­er­al announced a pledge to invest £4bn into urban regen­er­a­tion and the con­struc­tion of new homes in the West Mid­lands. 

Work­ing in part­ner­ship with the West Mid­lands Com­bined Author­i­ty (WMCA), L&G, which man­ages £1.4tn as the UK’s largest investor, has financed more than £30bn of regen­er­a­tion projects in UK towns and cities out­side Lon­don. It has already invest­ed £2bn in the WMCA region, with the £210m Birm­ing­ham Health Inno­va­tion Cam­pus and hous­ing projects.

“The West Mid­lands eco­nom­ic plan, resources and skills make it an attrac­tive des­ti­na­tion for trade and invest­ment from across the world,” said Sir Nigel Wil­son, CEO of L&G at the time of the announce­ment. “Our role in this is to put UK funds, includ­ing pen­sion sav­ings, to work here so UK savers ben­e­fit from UK pros­per­i­ty.” 

The deal is one of a grow­ing num­ber of major infra­struc­ture projects financed by insur­ance com­pa­nies. In June, Aman­da Blanc, the group CEO of Avi­va, told the Finan­cial Times that the firm is con­sid­er­ing invest­ing funds from both pol­i­cy­hold­ers and share­hold­ers in infra­struc­ture. It’s thought a deal could be done as ear­ly as this year. Blanc has spo­ken else­where about using the fund­ing to pro­mote green, low-car­bon projects in par­tic­u­lar.  

The gov­ern­ment and insur­ance sec­tor believe that such announce­ments could her­ald the unleash­ing of bil­lions of pounds of invest­ment by insur­ance firms in cap­i­tal projects across the coun­try. The key to unlock­ing this poten­tial is to amend the Sol­ven­cy II require­ments.

Inher­it­ed from the UK’s mem­ber­ship of the EU, the reg­u­la­tion is under­go­ing a review, includ­ing a con­sul­ta­tion that clos­es in July. Insur­ers have long argued that this reg­u­la­tion requires them to hold too much cap­i­tal and applies too many restric­tions on the type of invest­ment they can make. The gov­ern­ment and for­mer prime min­is­ter Boris John­son have made it known that they’re impa­tient to make this reg­u­la­to­ry change.

The Pru­den­tial Reg­u­la­tion Author­i­ty (PRA), which over­sees the insur­ance sec­tor, is broad­ly in favour of mea­sures to pro­mote invest­ment by insur­ers. But it is con­cerned that exces­sive relax­ation of Sol­ven­cy II could put pol­i­cy­hold­ers at risk and dam­age the finan­cial sta­bil­i­ty of insur­ance firms.

Among indi­vid­ual insur­ance com­pa­nies argu­ing for change is Phoenix Group, the largest long-term sav­ings and retire­ment com­pa­ny in the UK with around £300bn in assets under invest­ment. “As an insur­er, we’re a long-term investor look­ing for sta­ble returns over decades,” says Andy Brig­gs, group CEO, Phoenix Group.

He points out that insur­ers are already some of the largest asset own­ers in the UK. “Sol­ven­cy II reforms could rep­re­sent a unique and sig­nif­i­cant oppor­tu­ni­ty to ensure more pri­vate-sec­tor cap­i­tal can be direct­ed by insur­ers into long-term infra­struc­ture assets in the UK,” he says. 

“Crit­i­cal­ly, these reforms can and should be made in a way that doesn’t com­pro­mise on pol­i­cy­hold­er pro­tec­tion – which remains the core pri­or­i­ty for us as a busi­ness. With the right reg­u­la­to­ry and pol­i­cy changes, Phoenix could poten­tial­ly invest up to £50bn in illiq­uid and sus­tain­able invest­ments in the UK, which will sup­port and accel­er­ate the decar­bon­i­sa­tion and lev­el­ling-up agen­das.”

How Solvency II reforms can unlock investment

The Pen­sion Insur­ance Cor­po­ra­tion spe­cialis­es in pen­sion insur­ance buy­outs and buy-ins to the trustees and spon­sors of UK defined-ben­e­fit pen­sion funds. In Jan­u­ary, it revealed that it could have almost dou­bled its infra­struc­ture invest­ment, from £10.9bn to £20.9bn, since 2016 if it hadn’t been for Sol­ven­cy II. Accord­ing to the cor­po­ra­tion, if the reg­u­la­tions were reformed then its planned invest­ment in what it calls pro­duc­tive finance could increase from £30bn to £50bn by 2030.

The Asso­ci­a­tion of British Insur­ers (ABI) recent­ly called on the insur­ance indus­try to strength­en its role as key investors in net-zero infra­struc­ture. The aim, accord­ing to the ABI, is to put more of insur­ers’ cap­i­tal into green invest­ments and ensure that they are “cen­tral to the con­ver­sa­tion about how green infra­struc­ture is devel­oped and fund­ed”.

It wants to “unlock the sig­nif­i­cant invest­ment poten­tial from the insur­ance and long-term sav­ings indus­try through mean­ing­ful reform of the Sol­ven­cy II reg­u­la­to­ry frame­work” while bring­ing investors into the “heart of the deci­sion-mak­ing process on green infra­struc­ture and tech­nol­o­gy devel­op­ment”.

Infra­struc­ture com­pa­nies and finance firms should note that insur­ers will require gran­u­lar detailed infor­ma­tion about the per­for­mance of the project in ques­tion. So says Bob Hak­en, cor­po­rate finance part­ner at law firm Nor­ton Rose Ful­bright. 

“Par­tic­u­lar to infra­struc­ture, insur­ers will also need to be sat­is­fied as to the expect­ed cash flows, espe­cial­ly any volatil­i­ty,” he says. “Depend­ing on the par­tic­u­lar struc­ture, it may also be nec­es­sary to obtain a rat­ing for the debt.”

He adds: “The regime is intend­ed to facil­i­tate and encour­age invest­ment in infra­struc­ture projects. If the qual­i­fy­ing cri­te­ria were to be relaxed, we may see much greater invest­ment by insur­ers, to the ben­e­fit of com­mu­ni­ties rely­ing on the infra­struc­ture. So far, the PRA has been reluc­tant to sin­gle out green projects for pref­er­en­tial treat­ment but pol­i­cy­mak­ers may see this as an oppor­tu­ni­ty.”

The gov­ern­ment is expect­ed to intro­duce changes to Sol­ven­cy II with a new finan­cial ser­vices bill to be brought for­ward in the autumn. The result­ing leg­is­la­tion could be intro­duced as ear­ly as next year. 

So far, the PRA’s sug­ges­tions have been rel­a­tive­ly mod­est. If, though, the Trea­sury and the insur­ance indus­try win the cur­rent argu­ment about the bal­ance between ensur­ing sol­id foun­da­tions for insur­ers on the one hand and allow­ing them to realise the full poten­tial of their con­sid­er­able finan­cial clout on the oth­er, infra­struc­ture across the UK might be on the verge of a new gold­en era.