Even in the depths of the 2008 financial crisis, Canada’s life and health insurers continued to be strong buyers of long-term assets in Canada and abroad. A stable supply of attractive infrastructure and other long-term assets is critical for long-term investors, such as Canada’s residents, governments, and life and health insurers and pension funds.
However, finding attractive long-term assets in Canada is proving to be more difficult than it should. This is forcing insurers and other long-term investors into shorter-term asset mix strategies than they would prefer. It is even resulting in insurers looking abroad in search of long-term assets. Reform is needed to increase the supply of long-term investments in Canada. Getting this right will help contribute to the continued success and growth of the Canadian economy. It also represents an opportunity to deepen and cultivate Canada’s investment markets for the benefit of our governments, businesses, and citizens.
With $540 billion, or roughly 90 per cent of their total domestic assets, invested for the long-term, Canada’s life and health insurers are one of the largest long-term investors in Canada. The industry’s demand is driven by the nature of the business itself. Life insurance often results in several decades—up to 50 years or more—where the insurer is receiving premiums prior to paying related claims. An insurer’s investment strategy is heavily influenced by the profile of its liabilities as they must invest the premiums collected to pay claims and benefits on policies. Therefore, insurers seek to match the term of their assets with their liabilities to the greatest extent possible. As a result, the industry has a strong demand for very long-term investments—including in a number of key asset classes that are critical for economic growth, such as infrastructure.
Minding the gap
Canada’s current infrastructure deficit has been estimated to be between $350 billion and $400 billion. The bulk of the need is at the municipal level, but there are also significant infrastructure gaps at the provincial and federal levels. It is somewhat counterintuitive, therefore, that insurers and other long-term institutional investors like pension funds, cannot find enough supply in Canada to meet their needs. In fact, insurers increasingly have to look abroad for suitable long-term assets. This represents a lost opportunity for the Canadian economy.
Canada can and definitely should do more to keep investment in country. Governments have a leadership role to play in this regard. At the most basic level, governments need to ensure that infrastructure projects are brought to market in a timely and predictable manner. Undue delays and uncertainty around decisions regarding whether a project will proceed hinder the private sector’s ability to play a strong partnership role in helping to finance infrastructure projects. Clear communication of the benefits, and ultimately championing, of private-sector participation in funding long-term infrastructure is an important foundation.
Canada’s public-private partnership (P3) market has evolved considerably over the years both in volume and capital size. The increased adoption of P3s can be attributed, in part, to the creation of dedicated agencies at the federal and provincial levels. The Government of Canada has made a strong commitment to P3s through its continued support of PPP Canada. The commitment to P3s in the provinces, however, is more variable. While P3s have become an alternative financing solution for many provinces, particularly in those that have created dedicated infrastructure agencies such as Ontario, British Columbia, and Alberta, many provinces do not have such infrastructure champions and have yet to conclude a P3 project.
The Canadian life and health insurance industry urges all provinces to develop an infrastructure agency to champion infrastructure renewals and P3s in particular. Such agencies not only provide momentum toward proactively managing a province’s infrastructure deficit, but also help to develop the local expertise required to leverage the full benefits of a P3 model.
In addition, all provinces should introduce a P3 screening requirement for potential deals—along the lines of what PPP Canada currently has in place. Canada’s life and health insurers have successfully completed P3 transactions with project sizes as low as $20 million. The industry has the capability and appetite to take on smaller deals going forward. As such, a screening threshold of $20 million would be appropriate.
Making P3s viable for smaller projects
Given the significant infrastructure deficit at the municipal level, this is ultimately where the greatest need is in Canada for P3s. However, one challenge with P3s is that they are not always well suited to smaller deal sizes. One key reason for this is that the complexity and lack of standardization of P3 project documentation limits the attractiveness of smaller P3 projects for potential investors because the size of the potential deal may not be adequate to compensate for the up-front and ongoing management costs that investors incur. The complexity of structuring smaller P3 deals is also a barrier to potential issuers. Currently, smaller provincial and municipal issuers struggle to issue P3s due to this complexity and lack of standardization. While some standardization has taken place—in particular in Ontario and British Columbia—there is room to do more, including bringing documents and processes into alignment between provinces.
PPP Canada should lead a collaborative effort with all key public and private stakeholders to develop a national standard for project documentation for P3s under $50 million. Standardization could include aligning contract terms with clear rules for amendments, consents and waivers, trust indentures, and service contracts. Not only would potential investors benefit from more standardized, and hence easier to assess project documentation, but issuers and other long-term investors would as well. Furthermore, once in place, governments should lead market adoption of these new standards by only investing in P3 projects under $50 million that are structured in alignment with the new standard.
Once such fundamental harmonization is accomplished, other potentially beneficial reforms become viable, such as pooling of smaller projects. Pools could potentially be developed for projects from similar industries or project phases as a means to attract institutional long-term investor groups. Importantly, any pooling of projects should be done in a manner that allows investors to understand the credit risk of any given project.
A 50-year bond market
The historically low, long-term interest rates in Canada present an opportunity for governments to secure long-term funding at attractive rates while reducing refinancing risk and promoting the stability of the market. As with other long-term asset classes, the key challenge facing Canadian life and health insurers is the relative lack of supply of ultra-long-dated (out past 30 years) government bonds.
There has been encouraging movement in this regard recently, as the federal government has followed the lead of several provincial governments and started to issue 50-year bonds. More needs to be done, however. Proof of the excess demand is demonstrated in the yields on such bonds. For example, the recent federal government issuances ultimately yielded roughly one basis point lower than the yield for its benchmark 30-year issue. Similarly, based on the industry’s experience, recent ultra-long-term bonds issued by Canadian provinces carry a yield that is lower than the corresponding 30-year benchmark issue by up to 0.5 basis points for each year past year 30.
Accordingly, there should be a sustained commitment by both federal and provincial governments in Canada to issue 50-year bonds and to increase the supply of these bonds to a benchmark level over the next five years. Building the stock of 50-year bonds to a benchmark level is important to meet market demand.
Canada’s life and health insurers have a stable and strong demand for long-term assets and the need to source attractive Canadian long-term infrastructure and bonds will remain indefinitely. Closing the gap between the market supply and demand for such assets should be a priority for all levels of government. Getting it right will help promote economic growth for the economy as well as a strong and efficient insurance and pension industry for all Canadians.
Stephen Frank is the VP of policy development and health with the Canadian Life and Health Insurance Association.