High yielding private assets are attracting many asset owners as they seek higher returns amid a persistently low interest rate environment. Many are piling into the assets, and intend to bring exposures up to 15% of even higher. 

Life insurers are the big exception. The asset owners are traditionally some of the biggest traditional investors into fixed income, but their ability to add illiquid investments is being highly constrained by punitive capital charges and potential threats to their credit ratings. That is forcing them to cap their exposure to private assets and instead head up the fixed income risk curve.

The longstanding low interest rate environment has only added pressure to the constant tug of war between risk charges and investment returns in which life insurers are always engaged.

Clement Bonnet, Milliman
“On the one side capital regimes tell you that the more fixed income assets you have, the better, and on the other side the low interest rate environment and the competition and customer pressure, which still forces you to invest in high yield assets, are inferior from an RBC (risk-based capital) and capital point of view,” said Clement Bonnet, principal and consulting actuary at Milliman.

To differentiate themselves from competitors, he believes insurers need to become more sophisticated and diversify both their assets and liabilities, through the policies and products that they offer. This includes offering policies in foreign-denominated currencies or offering products with different risk limits, as well as more systematically assessing opportunities to hedge risk.

FIXED INCOME TINKERING

It also requires insurers to invest into longer-duration bonds, shifting some of their government bond investments into corporate bonds, or moving from domestic into offshore bonds and fixed income as they seek better returns from their fixed income portfolios.

They are particularly adding to positions in riskier grade corporate bonds, such as 'BBB' and 'BBB-' rated investment grade or even junk bonds, said a senior investment executive at a multinational insurer.

“At the most they get into private debt but this is not the cup of tea of many insurers, and those that do so need the capabilities to do it carefully," he told AsianInvestor.

Denis Resovac, Robeco
The desire of the lifers to do so is understandable. Whereas the average bond yield for 'AA' rated US corporates stood at 1.8% on May 24, 'BB' rated US corporate debt offered 3.47%, according to Y Charts
 
Denis Resovac, head of insurance strategy for Asia Pacific at Robeco, says insurers are increasingly offering more external mandates to fund managers for corporate bond investments.

“They might also consider allocating part of their liquid credit into illiquid credit such as private debt, infrastructure debt, real estate debt and structured [credit],” he added.

Even here there are limits. Many insurers face challenges when investing into offshore fixed income assets, including the ability to assess their risk. Plus they have to manage foreign exchange exposure, as the investment proceeds typically need to be converted back into the currency of their liabilities.

The life insurers need sophisticated hedging policies to avoid currency mismatch between their assets and liabilities, and those that cannot do so might be well advised not to get too much exposure, suggested Siew Wai Wan, senior director of insurance at Fitch Ratings.

Foreign exchange risks due to lifers investing heavily overseas would negatively influence credit assessments for S&P Global Ratings subsidiary Taiwan Ratings, added senior director Andy Chang.

PRIVATE ASSET CAUTION

Meanwhile, a combination of concerns over risk, punitive capital charges and credit rating implications is serving to limit the amount insurers invest into private assets .
 
Siew Wai Wan, Fitch
While there are exceptions - Cathay Life has just put money into private equity funds - illiquid investments such as real estate, private equity and some forms of infrastructure often comprises 10% or less of insurers' overall investment portfolios.  
 
The exact maximum level of private or alternative assets that an insurer can hold before ratings and capital concerns grow too high is largely subject to shareholders’ risk appetite, the senior insurance executive noted. It also depends on the country’s regulation, including risk charges and the economic environment.
 
Private equity investments in particular typically carry the most punitive capital charges, rising as high as 60% of the market value of the asset, according to Resovac.

The net effect is that, whereas many other forms of asset owner are diversifying their portfolios into more illiquid, private assets, life insurers have only done so to a limited degree.

“At best, regulators view [diversification into private assets] as neutral; in the extreme case, regulators frown upon diversification through requiring additional risk charges,” said the regional insurance executive. 

The difficulties of investing offshore and sourcing yield within fixed income is leading some industry players to call regulators to loosen capital requirements of some illiquid assets. However, Bonnet believes such aspirations are unlikely.

“In the long term there will be convergence towards RBC. Insurers will just need to live with whatever regime is in place,” he said.

For Asia’s life insurers, the need to balance investment returns against capital costs looks set to remain a headache for some time to come.

RATINGS IN THE FRAME

In addition to the attentions of insurance regulators and capital regimes, life insurers also have to consider how their portfolios are viewed by credit rating agencies.

People familiar with insurer practices say the attentions of the agencies do matter, but they play less importance to insurer investment departments than the need to stay on the right side of capital rules.

“Insurers are generally influenced by the perspectives of what rating agencies believe and will diversify to the extent possible to ensure they don’t fall off the cliff into a lower rating,” a senior executive at a multinational insurer told AsianInvestor.

He added that he is not aware of rating agencies having explicitly disincentivised diversification. But he said there is something of a disconnect between the asset correlation or risk-return assumptions of rating agencies and those of insurers. Those pressures do not always tally with the assumptions of regulators, which can add additional pressures to insurer investment decisions, he added.

Certainly, the focus of life insurers on fixed income is viewed positively by credit rating agencies.

“A 95% portfolio in fixed income is not prima facie bad,” said Jeffrey Liew, head of Asia-Pacific insurance at Fitch Ratings. “We have to look deeper into the fundamentals, the decision-making process and what's available in the market.”

The long-term liabilities of life insurers are well balanced against bonds with lengthy maturities, not least because they are (defaults aside) guaranteed to pay out their principals at the end of their tenures. In contrast, the rating agency hinted that insurers who invest too much into risky assets might face rating concerns.