As darkness fell one cold November evening in 1817, the citizens of Newcastle upon Tyne witnessed what must have seemed like a miracle — the city’s main streets were some of the first in the UK to be illuminated by gas, with the finance, and indeed management, provided by a local insurer, the Newcastle upon Tyne Fire Office.
UK life insurers and pension funds, which today manage nearly £3tn of assets, have been investing in the real economy for centuries. Insurers — with their need to match illiquid long term liabilities, such as annuities, with investments in corresponding long term illiquid assets — have long been attracted to investing in infrastructure. And in recent years persistently low interest rates have made infrastructure potentially even more attractive as insurers intensify the search for good returns for customers.
The appetite is certainly there. And so, it appears, is the demand. It is a rare point of agreement in post-referendum Britain that the country needs a new deal for greater infrastructure investment — whether in mega-projects such as extra airport capacity, further investment in schools, hospitals and medical centres, or investment in the renewables sector.
But insurers can only invest if the conditions are right. It is no good asking us, as stewards of our customers’ pensions and savings, to invest unless we can get an appropriate return for them. And at the moment a series of policy and regulatory own goals are stopping the UK from entering a new era of major infrastructure investment.
How have we reached such an impasse? First, the emerging regulatory environment does not support insurers’ critical role as long-term investors. Regulation has created perverse incentives for companies to become highly conservative, cautious and bureaucratic in where they invest, shifting from equity to sovereign debt and corporate bonds. We are being forced to invest in monochrome and not in technicolour. The excessively rigid new Europe-wide insurance capital regime, “Solvency II”, is a case in point. And the significant flow of investment into so-called lower risk assets potentially creates an asset bubble — and bubbles inevitably burst.
Moreover, overseas investors have greater freedom to invest in the UK than we do. Imagine I want to make a $100m investment in a 20-year bond backing a wind farm. Canadian regulators, for example, would make a Canadian insurance company hold additional capital of $3m. But to make the same investment under the Solvency II rules a British company would need to hold capital of above $10m. Where is the sense in that — especially when, if the conditions were right, UK insurers could make the investment, contribute to Britain’s infrastructure and British pensioners could enjoy the investment returns?
Governments have tried to encourage private sector investment in infrastructure. But if the projects are not there and take too long, companies will not come on board. For example, the Roskill Commission was set up nearly half a century ago to look at a third airport for London. We have only just made a decision on a third runway at Heathrow and not even broken soil yet. In contrast, Beijing’s second international airport is scheduled for completion in June 2019, only six years after approval was granted.
Here are two ways to encourage insurers to invest in infrastructure. First, lighten the regulatory burden that unduly limits how insurers invest and establish a principles-based regime that leaves greater room for the exercise of judgment and allows for well-managed risk taking. Second, government must be more consistent in how it structures the finance for major infrastructure projects — for example, by taking on unusual planning or unproven technology risks. These are simple remedies to a longstanding problem, but they could generate a great dividend for the UK.
The writer is group chief executive of Aviva