Even if market interest rates have risen of late: the low interest rate environment still has a firm grip on markets. Insurance companies are therefore increasingly trying to invest their funds profitably in assets outside the traditional investment spectrum – e.g. in infrastructure projects. Examples are renewable energy projects, such as wind and solar parks, or road construction, gas network and power grid projects.

Such investments offer features that are favourable for insurers, such as long terms and comparatively high yields. However, the investments are often highly complex and pose special challenges to risk management. In November and December 2021, BaFin held discussions with insurers showing high infrastructure volumes on their accounts and seeking to expand them. The objective of this exchange of views was to gain insight into different investment strategies and find out how companies plan to manage the risks associated with these investments. The idea for the talks was spurred in particular by the results of the “Search for Yield” survey carried out at the end of 2020 (see info box).

What makes infrastructure investments attractive for insurers

The survey revealed that infrastructure investments suit insurers’ needs in many ways. In times of low interest rates, they do more than stabilise earnings: they offer prospects of yields that exceed by far those of traditional investments with a comparable risk profile.

What is more, infrastructure projects frequently have very long terms and therefore fit in very well with the business models of life insurers in particular. The insurers benefit from an essentially crisis-resistant performance. Other advantages of this asset class over traditional investments include low volatility and the fact that the performance correlates less with market developments. Insurers prefer investments with limited risk and stable cash flows. For this, they are – at the moment – also willing to accept the increased illiquidity of these investments.

Types of investments with greatly differing risk profiles

An aspect that plays a key role in the risk assessment and the investment decision is the development stage of the infrastructure project being financed. The brownfield segment, i.e. infrastructure projects that are already operational and generating returns, accounts for by far the largest share of insurers’ investments in this area. Investments in greenfield projects, i.e. those still in the development phase, account for a lower share. These investments are subject to higher uncertainty. Risks can occur, for example, in the course of project development, during construction and as a result of demand uncertainty.

BaFin’s survey also revealed that particularly life insurers generally invest in “core” assets. These are often projects, mostly in the brownfield stage, with monopoly characteristics. In many cases they are state-regulated and feature very long terms. They can be found in particular in the utilities sector. In contrast, investments of the “core plus” segment – often “core” projects involving modernisation measures – are riskier and less common. “Opportunistic” investments that are even riskier can be found in only a few cases and make up only a small part of an insurer’s portfolio. In this case, the investments are not aimed at achieving stable incomes but rather at generating an increase in value.

For the most part, infrastructure investments are investments in debt instruments, but equity instruments now also account for a significant share of the investments. While larger (life) insurers invest both directly in infrastructure projects as well as via investment funds, smaller insurers focus their investments almost exclusively on investment funds. Given the increased complexity and higher risks, particularly in the case of equity investments, insurers gladly rely on the expertise of asset managers when making their choices. Even if companies were to continuously increase their staff capacities, they would barely be able to provide the required specialist knowledge. This is because the range of investment possibilities is becoming increasingly diversified in response to changes in technical and legal framework conditions.

New insights and forthcoming challenges

One insight reported by all surveyed companies is that the market for infrastructure investments is growing. The reason is that many companies from the energy, telecommunication, utility and road construction sectors require investor capital in order for them to realise their projects. However, demand is also rising – even more so than supply.

The situation is complicated by the fact that new projects tend to be less attractive and profitable. This is especially the case in the renewable energies sector because the top places for solar and wind energy are already occupied. As a consequence, issuers pay lower returns for the same risk profile. Investors must therefore – if they have exhausted the possibilities of investing in the German and Western European markets – shift their regional focus to include, for example, other European and North American projects. With investment funds, the investments are even more broadly allocated than with direct investments, and also include emerging markets, thereby ensuring greater diversification.

A further challenge: project providers are increasingly demanding higher minimum investment volumes. For many investors, this represents an ever greater entry barrier, especially in the “core” and “core plus” sector, making it difficult to invest in conservative strategies – specifically in regulated brownfield projects.

Demands on risk management

Due to their heterogeneity, complexity and illiquidity, infrastructure investments pose special challenges to risk management. It is important that the principle of corporate prudence under section 124 of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) is observed. This can only be done by carrying out a comprehensive assessment before making an investment and afterwards closely monitoring, continuously controlling and managing procedures in relation to the invested capital.

Amongst other things, insurers must observe Guideline 28 on the System of Governance (“Assessment of non-routine investment activities”) of the European Insurance and Occupational Pensions Authority (EIOPA). As infrastructure investments usually are complex products that are difficult to value within the meaning of EIOPA Guideline 33, insurers should implement appropriate procedures in order to manage, monitor and control them. BaFin has published an interpretative decision (only available in German) on the topic of infrastructure investments and dealing with the risks associated with them.

BaFin closely tracking developments

BaFin is tracking the development of the infrastructure market very closely. It plans to collect fresh data on infrastructure investments in the “Search for Yield” survey update due to take place in the second half of 2022. One aspect BaFin intends to examine is whether there is an increasing tendency among insurers to take greater risks.