Updated with clarification
European insurers are turning their attention to the U.S. market to make their infrastructure investment plays, with the municipal bond market a particular focus.
Capital charges in the new Solvency II rules, a continued low-interest-rate environment, and the European Central Bank's decision to expand its asset purchase program to European corporate bonds are pushing insurers in Europe to cast their nets wider for returns.
“We have seen significant interest by European insurance companies in infrastructure,” said Kathleen Hughes, London-based head of European institutional sales at Goldman Sachs Asset Management. These investors are looking at taxable municipal bonds — which non-domestic players are able to access — the majority of which finance infrastructure projects in the U.S., such as toll roads, water facilities, hospitals and schools, she said.
Taxable municipal bonds make up $300 billion — about 20% — of the overall $1.4 trillion municipal bonds market, sources said.
In terms of performance, the attraction is clear. In 2015, the non-tax-adjusted S&P Municipal Bond Total Return index gained 3.3%, outperforming the S&P Treasury index's 0.8% gain; the Barclays U.S. Aggregate Corporate Total Return Value index at -0.7%; the Bank of America Merrill Lynch U.S. High Yield index's -4.6% performance; and the S&P 500 Total Return index's 1.4% gain.
But, sources said, there are additional reasons for U.S. municipal bonds' attractiveness: treatment under Solvency II - which came into effect Jan. 1; diversification of insurers' investments; and the macro environment.
Solvency II was designed to improve insurers' financial stability and protect policyholders — the ultimate buyers of their products.
Moves to reduce risk charges on infrastructure investments will enable insurers to better match long-term liabilities with long-term assets, experts say. And this is where municipal bonds come into play.
Last month, tweaks to Solvency II came into force that reduce the risk charges imposed on insurers' equity and debt investments in infrastructure. These changes regarding infrastructure treatment “were very much welcomed by the (insurance) industry,” said Cristina Mihai, head of international affairs and investments at Insurance Europe, the Brussels-based body that represents insurers and reinsurers in Europe.
“The previous capital approach was not tailored to infrastructure investments, as there was no recognition as infrastructure as a separate asset class,” she said. “This made the capital requirements unnecessarily high and extremely penalizing, and so it disincentivized insurers from investing in this asset class,” she explained.
More needs to be done, however, according to Ms. Mihai. She said Insurance Europe supports current efforts to include infrastructure corporate bonds in the scope of Solvency II's tailored treatment as well as the Juncker Investment Plan, which aims to remove obstacles to certain types of investment.
“Conceptually, it is very sensible to support the idea that those with long-term liabilities invest in long-term assets,” said Stuart Shipperlee, managing director at Litmus Analysis Ltd. in London.