Public Policy Analysis & Opinion

By Kevin P. Hennosy

NAIC LAUNCHES STUDY OF INFRASTRUCTURE INVESTMENT

Researchers assume long-duration investments could fund projects

Have you heard the one about this being “Infrastructure Week?” Every smart-mouthed political talking head on television seems to offer the line for a cheap laugh. Enough with the cheap laughs. Infrastructure is important.

Sometime in the spring of 2020, two bureaucratic sub-nodes of the National Association of Insurance Commissioners (NAIC) want to launch an infrastructure week of their very own.

According to an NAIC-transmitted Request for Information (RFI): The NAIC Center for Insurance Policy and Research (CIPR) and the Capital Markets Bureau (CMB) are collaborating on a research study aimed at discussing and clarifying topics surrounding infrastructure investments and determining the role of U.S. insurance companies as a source of infrastructure financing … .

The purpose of the RFI is to gather information and input from market participants—including representatives from insurance companies, trade associations, statistical rating organizations, and other interested parties—to develop a better understanding of infrastructure investments and the dynamics of that market as it relates to the U.S. insurance industry as an institutional investor.

Professor Gomes seems convinced that infrastructure investment should follow a “maintenance-only” approach. In other words, fix old bridges, fill potholes, and wait in silence for the life actuarial tables to kick in and “thin the herd.”

This effort begins with defining infrastructure, so the NAIC RFI borrows a description from the American Society of Civil Engineers:

• Transportation—roads (streets and highways), bridges, tunnels, public transit, rail, airports, and maritime and inland waterway ports.
• Broadband—(and other high-speed data and communication conduits) for rural communities.
• Telecommunications—wireless towers.
• Waste Management—wastewater, storm water, solid waste, sewage, land revitalization, and brownfields.
• Power and Electric—generation, transmission, and distribution facilities.
• Water and Water Resources—drinking water, flood risk management (dams and levees), water supply, and waterways.

The investment instruments may include: “1) corporate debt, 2) structured debt, 3) municipal debt, and 4) equity.” That pretty much covers the proverbial waterfront. Do not be surprised if the NAIC finds out that there still is a significant market for the exchange of cattle for magic beans.

The RFI also raises issues needed to review how it treats infrastructure investment through financial reporting processes. “Currently, the accounting treatment, the assignment of NAIC designations and the risk-based capital charges for infrastructure investments are the same as other like-rated debt and equity.”

Based on responses to the NAIC RFI and other information sources, the NAIC’s CIPR and CMB will consider whether infrastructure investments should receive different treatment than other debt and equity instruments. The NAIC RFI asks: “Is the regulatory treatment of infrastructure assets an impediment to investing in them?”

Big issues

In addition to the nuts and bolts issues of insurance regulation, the RFI touches on high-level public policy issues. For example, the RFI makes the following observation related to risk arising from climate change: The long-term nature of infrastructure investments coincides with many of the predicted future impacts from a changing climate. Insurance in this space can play the dual role of providing incentives for climate risk reduction efforts to be undertaken as part of the infrastructure investment as well as providing direct resilience of infrastructure through increased insurance uptake.

To sate its curiosity about infrastructure resilience, the NAIC RFI requested the following:

• Should future climate impacts be considered as an infrastructure investment criterion?
• Is there an existing methodology to incorporate climate as an investment criterion?
• Should this also be included in the NAIC designation process?
• Would the lack of significant risk reduction action on climate impacts be a deterrent for insurers’ investment in infrastructure in the near term? Long term?

The RFI states the impetus for the study, which focuses on the infrastructure problem in the U.S.: The infrastructure in the U.S. is aging and in need of improvement and modernization—requiring a significant amount of capital and financing. U.S. insurance companies have participated in infrastructure investments as the long-dated terms match well with the long duration of their liabilities. But they have not been a leading provider of capital for infrastructure projects to date.

The insurance sector is not alone.

Wharton School Finance Professor Joao Gomes presented research on the topic of private infrastructure investment as part of the Penn Wharton Public Policy Initiative. Gomes’ research seeks to expand understanding of why private investments in public infrastructure did not rebound after the financial panic of 2007-2008.

Gomes observes that material portions of the American population suffered significant losses to their financial well-being. In a podcast available on the Wharton School website, Gomes explains: While maybe 15% of average Americans are worse off relative to some sort of hypothetical alternative world that would have taken place if the crisis didn’t exist, corporate investments may be 25% or 30% below what they would have been in that alternative universe. So, it’s quite significant.

To build on the professor’s observation, Rough Notes readers may remember that both the Obama Administration and Congress blanched at a right-sized fiscal stimulus package to fund infrastructure projects. Instead, the administration and legislators followed a “centrist” approach, which provided a restrained spending package and depended on Federal Reserve policymakers. The method assumed that reducing interest rates to foster private sector borrowing would inevitably spur investment, including infrastructure investment.

Certainly, business investors took advantage of low-interest-rate borrowing; however, very little of that borrowing funded infrastructure investment. Instead, those borrowed funds appear to have fueled stock and commodity speculation as well as “workforce” investment—which often equates to accelerating compensation to senior executives.

Gomes recognizes that if not for a surge of information systems infrastructure investment around the Year 2000 (Y2K) scare, the American private sector has not spent heavily on infrastructure for 35 years.

The professor also cautions that the public-private partnership model for infrastructure investment underperformed in Southern European countries. This “third way” approach promised a win-win for the public and private sectors, but too often the arrangements transferred responsibility for funding to taxpayers.

Gomes seems to be convinced that infrastructure investment should follow a “maintenance-only” approach. In other words, fix old bridges, fill potholes, and wait in silence for the life actuarial tables to kick in and “thin the herd.”

Long duration?

Should the insurance sector become a center for capital formation aimed at infrastructure? We shall see.

The NAIC’s general statement about the insurance sector’s long-duration investments may not go unchallenged as insurers respond to the NAIC RFI.

Thinking back to bygone days when the NAIC received testimony from property/casualty insurance trade association executives who argued against the NAIC’s inclusion of investment income for profitability reporting, those executives offered a very different description of the insurers’ portfolios.

The execs told the NAIC that claims come at P-C insurers with the force and volume of a firehose; therefore, these insurers make only short-term, highly liquid, and essentially inconsequential investments. In other words, “Move along … nothing to see here.”

If these executives were not lying through their teeth, the short-term nature of property/casualty insurers’ investments would not match well with the long-dated terms of infrastructure investment instruments.

What about the life insurance subsector? The traditional perspective held that the life insurance subsector produced what professors called “patient capital” necessary for long-term investment. Those investments supported products that offered both fixed premiums and fixed benefits—the very kind of capital commitment required to fund infrastructure projects as noted in the NAIC RFI.

However, the contemporary life insurance subsector sells products that compete on investment returns shared in part with policyholders and annuitants. In the last half century, those “investment-oriented” products changed the nature of the subsector’s portfolios. Furthermore, the repeal of Glass-Steagall allowed financiers to take control of life insurers and siphon away capital for speculative purposes unrelated to mortality losses. These changes in the life insurance sector combine to materially diminish the patience of investment officers.

It will be interesting to see what the NAIC learns about the duration of insurers’ investments.

Internal improvements

Apart from the 50 years after the New Deal, American prosperity was dogged by an inability to secure private funding for infrastructure, including public infrastructure. Too often in American history, such as in 1857 when Ohio Life Insurance and Trust made risky investments in railroad infrastructure, such private investments ended in economic disruption.

More recently, state and local governments have sold public infrastructure to private investors, along with fee revenue generated by those assets. A notorious example of this approach comes from Chicago.

In Griftopia, journalist Matt Taibbi recounts the example of Chicago’s sale of its parking meters, garages, and lots to overseas investors. The investors made a single payment to the city, which Mayor Daley the Younger used to plug a budget shortfall. In return, the investors seized control of parking fees and fee revenue for the next 75 years. City officials found that under the sale agreement, the city could not close streets for neighborhood block parties, and the investors could set fees with impunity.

So much for that “self-government thing,” when a group of investors removed from controls can raise fees and define the usage of public assets.

The NAIC has selected an intriguing exercise in studying infrastructure investment.

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.