OREANDA-NEWS. Plans to create a new infrastructure asset class with lower capital requirements under the Solvency II regime should encourage investment in the sector by insurers, which see infrastructure assets as a good match for their long-term liabilities, Fitch Ratings says. Requirements that insurers demonstrate robust risk-management processes to take advantage of the lower charges are unlikely to be a significant hurdle for most firms as these systems are likely to be already in place.

The proposal is part of the technical advice on infrastructure investment risk provided to the European Commission on Tuesday by the European Insurance and Occupational Pensions Authority's (EIOPA). It would cut the risk charge for 'BBB'-rated infrastructure debt by around 30% compared to the original plan, under which charges on infrastructure were the same as on corporate bonds.

Our discussions with insurers suggest there is broad appetite to increase infrastructure investment, but this has been slow to take off for reasons that include uncertainty about capital requirements and political risk. EIOPA's recognition that these assets might merit lower charges could therefore increase demand. But we expect infrastructure will 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.

EIOPA had previously proposed a moderate reduction in charges to reflect the high recovery rates of infrastructure debt and the illiquid nature of these investments, but the latest proposals go further, following feedback from insurers. Many life insurers are well placed to invest in infrastructure as they can hold the assets to maturity to match their long illiquid liabilities, such as annuities. By doing this, insurers can access the extra yield available to compensate for the lack of liquidity, which can limit the attractiveness for other investors.

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 because most of them will be using the standard formula for calculating capital. 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 justify lower charges in that model.