South Korean life insurers’ near-term financial performance and business growth are likely to be constrained by the coronavirus pandemic, and they face rising investment risk if the pandemic escalates, sources told AsianInvestor.
The key reasons are higher financial-market volatility and the expected interest-rate cuts by many central banks, including Korea's own, to shore up the global economy. Covid-19 has also hampered investment decisions and strategies.
“Currently, all business trips have been cancelled, and that gives us trouble in the due diligence process. We are therefore focused on investing in commingled funds which invest in relatively safer assets, as the local asset managers can then do the due diligence on-site,” one alternative investment professional at a major Korea life insurer told AsianInvestor on condition of anonymity.
A senior investment professional at another Korean life insurer agreed that it has become harder to travel overseas for due diligence and other business purposes. Still, he sees a different approach on how to carry out alternative investments.
“We will invest in specific assets rather than blind funds or fund of funds where we can’t assess the underlying assets,” the senior investment professional spoke to AsianInvestor on condition of anonymity. “Macroeconomics and industry research will now become essential. Energy, retail, oil and travel industries will be in danger, so exposure to those industries should be minimised.”
The overarching push for direct investments comes from two upcoming regulatory changes in Korea: the Financial Reporting Standard 17 (IFRS 17) and K-Insurance Capital Standard (K-ICS). The projected consequences have led to a surge in the sourcing of overseas real assets by Korean securities companies who then sell them to syndicates of Korean asset owners, as AsianInvestor has covered extensively.
Regulators have somewhat mitigated the short-term disruptions of investment activities and strategies. On March 17, the International Accounting Standards Board (IASB) decided to delay the IFRS 17 by another year until January 1, 2023. This will also likely delay the start of the K-ICS to 2023, giving the insurers an additional year to get prepared, sources assessed.
The potential impact on Korean life insurers will depend on how well they’re capitalised. Those struggling to raise capital to improve their risked-based capital (RBC) ratio in the short term may well find it difficult and costlier to do so. There are also concerns that the corporate bond market will face a much higher rate when mature issuances are rolled over this year.
NEGATIVE SPREAD BURDEN
Korean life insurers are more likely to be affected by current market disruptions than non-life insurers. This is because major life insurers have a negative spread burden – the deficit created by the difference in the policyholder guaranteed interest rate and the actual investment yields. This remains one of major challenges to bottom-line profitability.
According to data from Korea’s Financial Supervisory Service (FSS) on November 13, 2019, life insurance companies have recorded a negative spread of 0.2 percentage points as at the end of June 2019. It was the first time that local life insurers have suffered a minus margin over the industry’s 70-year history.
A sharp decline in interest rates has put further pressure on capitalisation as profit deteriorates, especially for those exposed to relatively large negative spreads, according to a Hong Kong-based investment adviser familiar with Korean life insurers.
“As they need to consider both profitability and asset/liability management (ALM) at the same time, each insurer’s risk appetite would be different,” the adviser told AsianInvestor.
Under current investment allocations, however, immediate investment strategy changes may not come about due to different duration gaps of fixed income assets. Some life insurers may focus on stabilising capitalisation from an ALM standpoint under present market conditions while seeking to increase profitability, the adviser explained.
Uncertainties facing Korean life insurers have risen a great deal in recent months. These include material disruptions in financial markets, which may last for an extended period, and a potential spike in mortality risk, the severity of which is highly uncertain at this point.
In the near term, the deterioration in global equity markets and the decline in interest rates will put pressure on life insurers' earnings, reserves and capital, according to Siew Wai Wan, senior director of Asia Pacific insurance at Fitch Ratings.
“Therefore, the life insurers would take a more conservative approach on their investment portfolio by increasing more fixed-income securities. This is also to narrow the duration gap as their duration liability would go up due to the interest-rate decline,” Wan told AsianInvestor.
BINNING 2020 PLANS
In the short term, Korean life insurers are no longer able to deploy capital according to their 2020 plan made late last year, especially due to restricted travels. The life insurers are now busy assessing the implications and how they could re-adjust their business planning in response to the market sell-off and the repricing of risk premia, according to one Seoul-based adviser.
“In the mid-to-long term, as the market stabilises, many will be clearer on the market price from which they can revisit their strategy along with a better idea of the long-term performances of asset classes,” the adviser told AsianInvestor.
As interest-rate adjustments and volatility are primary concerns, it has become crucial to avoid investing in risky assets now, the senior investment professional at a life insurer reiterated. And although it will become harder to construct solid portfolios, he has his eyes set on at least one solution for the problem.
“Investments in infrastructure assets will now be re-evaluated after the virus outbreak. It is a very stable, long-term asset class and acts like fixed income securities,” he said.