A mixture of low fixed income returns, dropping currency swap rates, a need to reduce duration gaps and regulatory changes are leading life insurance companies across Asia to reassess their investment portfolios, and could cause sizeable portfolio shifts.
An in-depth new report on Asia’s life insurers by Moody’s on Wednesday (July 29) noted that the likelihood of lower-for-longer interest rates after the coronavirus abates are set to make insurers change their investment allocations. The head of life insurance client coverage at a major US fund manager added that many insurers have begun discussing how best to diversify portfolios to respond to low rates and changing regulations.
“Many CIOs and investment committees are making or considering strategic asset allocation changes to incorporate new risk and capital metrics to overall line up their objectives at the highest level,” he told AsianInvestor, adding that many companies were seeking customised yield enhancement strategies.
How regional insurers do so will vary. Moody’s drew them into three broad buckets: insurers making more credit investments; the organisations opting not to raise long-dated local government bond investments; and a desire to raise equity and alternative asset exposures. But it said there are likely to be several exceptions (see chart below).
The rating agency predicted that some insurers would take advantage of a sizeable widening in credit spreads on highly rated US credits since the coronavirus began. The average credit spreads for single-A US corporate bonds, for example, stood just under 250 basis points (bp) over Treasuries on May 12, for example, versus 150bp in mid-January.
Such investments are particularly appealing for Japanese and Taiwanese insurers, which also need longer-dated debt to narrow their duration gaps or the average maturity of their liabilities versus their investment assets.
Signs of increased offshore investing has already emerged in Japan. The foreign bond allocations of Japan’s Meiji Yasuda for example, rose from 19% at the end of March 2019 to 22% a year later, while that of Sumitomo rose from 29% to 30% over the same period.
To finance this shift, the insurers have gradually decreased local government bond positions, a move that might be credit negative. However, Moody’s noted that it only expected a mild increase in credit risk given the insurers’ “focus on high-quality US papers (those rated Aaa to A) and the strong liquidity of the US credit market.”
SEEKING OTHER OPTIONS
Not all insurers are seeking US credit investments to ease their yield challenges.
A deterioration in China’s corporate sector and a need to reduce duration gaps (the difference between the average maturity of liabilities versus assets) has led the country’s insurers to start “focusing on long-term Treasury bonds and bonds issued by policy banks and state-owned banks,” said Moody’s.
Meanwhile, insurers based in Hong Kong have been moving credit allocations to investment-grade bonds from unrated bonds.
A number of insurers across the region, including “in Hong Kong, Japan and Korea are pursuing more active, non-traditional approaches, such as the use of swaps, swaptions and reinsurance transactions, to reduce duration gaps,” Moody’s added.
This included Dai-ichi Life, which Moody’s noted had used measures “including reinsurance transactions and derivatives” to reduce its duration gap to 1.9 years at the end of March.
Korean insurers will adopt similar measures in the second half of 2020, after the local regulator allowed them to use derivatives to lengthen asset duration in November 2019. It is also “amending rules to allow the use of reinsurance by life insurers to share interest rate risk with reinsurers to reduce the burden from negative spreads,” according to Moody’s.
Added to that, Korea’s insurance regulator raised the cap on local insurers’ foreign asset investments from 30% to 50% in May, something the insurance client coverage executive believes will entice more of them to invest overseas to gain higher returns. They need to do so, given that their average rate of return on investments reportedly fell from 5.6% percent in 2010 to 3.5% in 2019.
Equities are also gaining more interest, with Moody’s noting some Greater China companies would likely seek price drops “as opportunities to selectively increase their equity portfolios.”
Indeed, China’s regulator has just raised the level of permitted equity investment from 30% to 45%, subject to permission.
“The top five insurers in China are likely to raise their equity investment to 35% and PEVC (private equity and venture capital) investments into the primary market,” predicted the insurance client coverage executive.
Indeed, insurers across Asia are widely anticipated to seek more investments in private equity, private credit, infrastructure, real estate and hedge funds. However, areas of focus may broadly vary by country.
Moody’s said that “insurers in Hong Kong have been trying to source long-dated infrastructure deals for yield enhancement and asset-liability management, while Japanese and Korean insurers continue to focus on real estate, infrastructure and private equity to boost yield.”
These efforts are likely to continue, given the likelihood of the lower-for-longer rate environment continuing “to support insurers' incentives to seek viable projects that can enhance investment returns and lengthen asset durations,” the rating agency said.
The ability of more insurers to invest in alternative assets will also depend on their capital efficiency. As the insurance client coverage executive noted, the Monetary Authority of Singapore introduced new risk-based capital rules in the first quarter, which may well be emulated by other regimes in the region. However, the MAS has yet to finalise the treatment of infrastructure and structure products.
“We have no information when they will finalise the capital treatment, but we believe they are looking to learn from the European insurers’ experience of stricter standards under Solvency 2 to and adjust it to more local applications," said the insurance coverage executive.