PRA: UK insurers free to invest in infrastructure provided that they understand the risks

Out-Law News | 08 Jul 2014 | 12:22 pm | 2 min. read

UK insurers should feel as free to invest in infrastructure as in any other asset class, provided that they are able to understand the risks of that type of investment, according to the industry regulator.

Andrew Bulley, director of life insurance at the Prudential Regulation Authority (PRA), was speaking to a committee of MPs about the regulator's position on recent insurance developments. He said that the type of investments made by firms was a commercial consideration, as long as investments were properly managed and avoided "substantial concentrations" of investment in particular asset classes.

"Conceptually, the PRA recognises that investment in long-term infrastructure assets, if managed appropriately, can hold out significant advantages for annuity writers," he said. "But from a supervisory perspective the most important point to emphasise is that, as long as insurers are able to understand and control the risks, and hold capital commensurate with those risks, the PRA does not take a view about the intrinsic and relative merits of individual asset classes."

"What a firm invests in is for that firm's management to decide; the PRA does not promote one asset class over another. What is important from the PRA's perspective is that a firm holds sufficient capital against the risks of its investments and that it has the right expertise, information and systems to be able to manage the risks of those investments both at the underwriting stage and in its subsequent monitoring of the exposure. In this regard, infrastructure is treated the same as any other asset class," he said.

Infrastructure finance expert Stephen Tobin of Pinsent Masons, the law firm behind Out-Law.com, said that insurers keen to diversify their investment portfolios in this way should seek appropriate advice to help them understand the risk profiles of different assets.

"Infrastructure can be a complex area with different assets having quite different risk profiles," he said. "Liability matching with infrastructure assets will need careful analysis, but there are plenty of assets that would work well in constructing a portfolio - the key is to understand the risks."

The UK government has been keen to encourage more investment in infrastructure by institutional investors, including insurers and pension funds. In 2013, six major insurers announced plans to collectively invest £25 bullion in UK infrastructure over the next five years, after late amendments to the upcoming Solvency II risk management framework removed barriers to longer-term investment from the final legislation. However, changes to the at-retirement market announced at this year's Budget are expected to have a major impact on sales of annuities, reducing the funds available to invest in infrastructure projects.

From April 2015, the government intends that members of UK defined contribution (DC) pension schemes would have the freedom to access their pension savings in any way that they wished without facing heavy tax penalties or having to buy an annuity. Bulley said that although some of the early projections floated by market commentators after the announcements were wide of the mark, the annuities market would likely be "permanently and significantly reduced" as a result of the changes.

"Insurers and the PRA are currently assessing the likely impact of the changes – we are having many conversations with insurers on this," he said.

"It is a commercial matter for firms to determine whether they will change their business mix and the extent to which product innovation is needed. However, such changes will undoubtedly give rise to a fresh set of prudential regulatory issues and so we will be considering how the changed environment will affect firms and what actions are needed to mitigate the risks that arise," he said.