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Insurers and infrastructure: More details required

Six major UK insurers are now expected to invest £25bn in infrastructure projects as part of plans unveiled by the government. Should their shareholders be pleased or concerned?

Garry white employee

by
Garry White

in Features

04.12.2013

Legal & General, Prudential, Aviva, Standard Life, Friends Life, the trading business of Friends Provident, and Scottish Widows, part of Lloyds Banking Group, have all signed up to the government’s plan.

The Treasury now plans to oversee £375bn of infrastructure investment over the next 20 years, up from the £309bn announced last year.
Insurers need steady sources of income over long periods of time – and infrastructure can provide this. It is this fact that has led to the proliferation of infrastructure investment funds in the FTSE 250 such as HICL, 3i Infrastructure and International Public Partnerships over the last few years. They offer long-term, above-inflation revenues that are underwritten by the government.

However, one thing common to all of these listed infrastructure funds is that they invest in mature assets. They do not take on “construction risk” and this is where the big problem lies.

Construction budgets can run away with themselves. There can also be delays in any building project that mean the piece of infrastructure is not put into service – and therefore generating revenues – until quite some time after it was originally planned.

All of this creates a risk in the investment that is outside the profile of a insurance group trying to maintain income for pensions. They are only likely to invest once the construction process is at, or very close to, completion. If they take on too much construction risk this would be bad for their income – and their balance sheets.

Indeed, there is a vague sense of déjà vu surrounding these proposals. A previous proposal to get £20bn of institutional investment in infrastructure resulted in just £1bn of pledges from such pension providers. The project risk was patently too high for the full £20bn to be met.

This is a good sign. Insurance groups are prudently managed and they won’t commit capital if the risk is too high. It will therefore be likely that when final plans are announced most of the risk will remain with the taxpayer – so the government will need to assess how much money the electorate is prepared to pay to make the plan a reality. Of course, that is if these investments materialise at all.

Nick Prior, head of infrastructure at Deloitte has described today’s proposals as “aspirational.” This is probably the best description that can be put on this mooted £25bn investment right now. For insurance company investors the devil will be in the detail. However, if the construction can be organised so the risk is palatable to insurers and pensions providers, then it could be a very positive development for shareholders in the sector.

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