Asian insurance companies are looking to recalibrate their risk management models and seeking more alternative sources of return, as part of an effort to adjust their businesses to the impact of the Covid-19 pandemic, market experts tell AsianInvestor.
The sharp decline in equities during March has only been partly offset by more recent stock market rallies. Meanwhile many countries have dropped their interest rates to historical lows, while bond spreads have widened. This combination of financial market changes is forcing insurers to rethink their asset allocations and risk management.
Jaijit Kumar, head of Asian insurance solutions at Invesco, told AsianInvestor that insurers typically perform a variety of stress tests – typically assessing one-in-10 year or one-in-20 market events. However, “these may need to recalibrated, given we appear to be seeing these events more frequently than what is implied by the probabilities”.
In particular, insurers are having to consider making reallocations of their investment portfolios, given the declining return trend of traditional assets.
“For example, perhaps divesting high capital charge assets (i.e. public equities) to relieve capital requirements or increasing allocations to longer term bonds to manage duration and stabilise solvency against a further drop in rates,” Kumar told AsianInvestor.
Life insurers are often keen to buy long-term bonds, but Kumar's comments indicate the fact that the companies may need to raise such investments over a neutral portfolio allocation. He declined to offer portfolio percentage targets, noting it is very company-specific.
As reported, insurers across the region are facing this pressure on returns. In Japan, Dai-ichi Life, which has about ¥35 trillion ($325 billion) of assets under management, is looking at investing more in credit, infrastructure and alternative assets in order to improve profitability and better diversify portfolio risk.
Life insurer portfolios are typically designed to offset long-term liabilities and are generally quite resilient in the face of short term market shocks. However, Kumar noted it’s vital that they can weather stresses in their short-term investing strategy as well.
“Given the magnitude and speed of some of the recent moves in the markets, one area of focus going forward could be around more efficient management of tail risk,” he said.
Insurers that do so will need take into account the adoption of a variety of new risk based capital regimes across Asia. These new rules are magnifying the need for life insurance companies to run their portfolios as efficiently as possible.
One way the companies can try to better manage their risk in a capital efficient manner is to adopt managed volatility or systematic equity hedging strategies, said Kumar. The former aim to keep portfolio volatility under a certain level by shifting allocations between stocks, bonds and cash as market conditions change. The latter strategies typically use derivatives such as out-of-the-money put options to hedge against extreme market stresses for relatively little cost.
The new capital rules are also likely to hasten the push of insurers to consider more illiquid alternative asset investments. The need to lock up investments into private equity, private debt and real estate over long periods for chunky returns is seen as a good fit with the horizon-focused needs of life insurers.
Indeed, that appeal has led an increasing number of institutional investors to put capital to work to chase such assets. That is increasing competition among alternative asset managers, and is beginning to reduce the potential returns on offer.
Despite this, Andries Hoekema, global head of insurance solutions at HSBC Global Asset Management, believes alternative credit-type investments and private equity offer a decent amount of relative value to be had.
“We have seen certain insurance companies in Asia more or less going all-in on private equity, at the expense of public because there is more equity risk premium; maybe a bit of complexity premium and a bit of illiquidity premium as well,” Hoekema told AsianInvestor.
MANAGING RISK PREMIA
Insurers are also increasingly looking to use derivatives to take advantage of the risk premia available in equities, credit and multi-asset classes, such as volatility.
“Selling options to generate risk premium from implied volatility - because realised volatility tends to be lower than implied volatility – is a trick employed in reasonable amounts by multi-asset strategies. That should be coming to Asian balance sheets in a more structured form, especially if you have to activate asset liability management in the future,” said Hoekema.
“Then you can start looking at volatility as an asset class, not just buying it at the lowest level for your hedging, but selling it where it is too high.”
He noted that some insurers in China and North Asia are looking seriously at this approach.
Another potential strategy is for insurers to manage their insurance risk premium. This requires an insurance company to show that they have some risk budget available in their regulatory calculation in specific areas of insurance risk.
“You can add a little of an insurance risk you don’t have and diversify returns on that basis.” He noted that one example is an insurer buying insurance-linked securities.
"It may be that you are getting a completely uncorrelated investment compared to the rest of your portfolio, including liability risk. And [you could potentially] put that onto the books at very low additional regulatory capital, because there are diversification effects using in the aggregation of risks."
Hoekema said some Asian insurance company investment teams will have studied the way Solvency II has impacted insurance investing in Europe.
"They are saying to themselves ‘it looks like the European insurance companies are no longer buying this particular type of asset, maybe we can have a look, maybe some competition will disappear’.
“We’ve seen some anecdotal evidence of that in the infrastructure debt space, where ideally for a European insurance company, a loan does not contain prepayment risk. But certain Asian investors are happy to take that risk and get a little bit more spread.”
However, insurers will have to consider the impact of regulatory changes such as the new global accounting rules under IFRS 17 as they consider using such approaches to shift their asset allocations, added Hoekema.
“In order to generate those returns you are going to have to take advantage of this push that IFRS 17 is creating towards more active, more marked to market based accounting,” he said.