Paragraph 7 of this article, describing the capital charges, was amended on 6 July following feedback from Eiopa. A new paragraph 8 was added to describe the broad change in capital charges.
European insurers appear to have won their battle to reduce the capital charges on infrastructure projects under Solvency II.
In a consultation paper published on 2 July, the European Insurance and Occupational Pensions Authority (Eiopa) proposed that investment-grade infrastructure projects should qualify for a lower risk charge.
However, the authority is still debating how the revised charges should be calibrated.
The paper rules out using the counterparty risk module to deal with infrastructure project debt, saying it would not capture the deterioration in credit quality over a one-year period, could underestimate own funds volatility, and is too different from the methodology for other bonds and loans.
Instead, Eiopa favours adjusting the spread risk charge to compensate for the illiquidity and high recovery rate of infrastructure debt compared to other bonds. "One possible approach is to derive a spread risk charge based on initial spreads for infrastructure project finance loans. The other approach is to use the existing spread risk charges for bonds and loans as a starting point and to adjust for differences in credit risk or the risk of forced sales," the paper says.
Eiopa described the first approach as "promising" but "is not yet at a stage to present results or methodologies."
On the second approach, Eiopa gave indicative spread risk charges based on consideration of the liquidity and credit risk. For example, debt for a BBB-rated project of seven years duration would incur a 13.25% charge under the liquidity analysis, or 11.78% under credit risk. This compares with approximately 15.5% in the current rules.
Under the liquidity approach, the risk charges are around 14.5% lower compared with the current rules. Under the credit risk approach, risk charges are only reduced for A and BBB-rated debt; for BBB the reduction is 24% while for A it is "somewhat less", according to Eiopa.
"The two approaches covering the liquidity and credit risk components of the spread both have their merits. Eiopa is still considering whether the two methods could also be combined," the paper says.
For the calibration of equity investment charges, Eiopa said the only workable method is to use prices for listed equities as a proxy. "While this method still has a number of limitations the available evidence provides some support for an equity risk charge between 30% and 39% for well-diversified portfolios of qualifying equity investments in operational infrastructure projects," the paper says.
This compares with 39% under the current rules, though including the maximum possible symmetrical adjustment (+10%) and the unlisted equity charge (+10%), it can be as high as 59%.
Projects with an investment-grade rating from a credit rating agency would qualify for the revised charges. For unrated projects, the paper describes the characteristics of a project that it considers equivalent to an investment-grade rating.
Eiopa's proposals also seek to ensure that insurers consider how each infrastructure project investment is compliant with the prudent person principle.
The paper was produced in response to a call from the European Commission to investigate the infrastructure charges. Eiopa's consultation will close on 9 August and final advice should be submitted to the Commission by the end of September.
The European Commission said it will amend the charges in the regulation in time for the start of Solvency II on 1 January 2016.
