The tumult of the coronavirus outbreak is endangering the health of life insurance company balance sheets and could well cause them to accelerate plans to invest in private assets, say fund manager executives.
Others argue that life insurers should use derivatives when investing in stocks too, to reduce their downside risk.
As the partial closure of economies across the world continues, the economic impact has resulted in sharply lower stock valuations and the likelihood of a rising tide of investment-grade, high-yield bond and corporate loan downgrades and defaults.
The latter, in particular, is a worry for life insurers, which typically invest most of their assets under management in fixed income.
Add into this the danger of falling new policy sales. Insurers tend to rely primarily on huge sales teams to conduct person-to-person policy selling, but the lockdown of cities such as Hong Kong and Singapore has sharply diminishing such activity. A drop in asset inflows pose challenges for the companies, on top of falling investment returns.
“Insurers are facing a triple whammy in terms of declining asset prices, increases in their liabilities in some markets and volatility in, as well as a reduction of, their solvency ratio,” said Rick Wei, head of Asia ex-Japan insurance investment strategy at JP Morgan Asset Management.
S&P Global Ratings said that most Asia-Pacific life insurers should avoid downgrades because of their capital strength, but that the impact of Covid-19 would “test their resilience” and that it would likely drop certain companies in the coming weeks.
The insurers’ need to source better and reliable investment returns is likely to reinforce demand for alternative, or private assets. Asian insurers have already begun looking to invest in private equity, private debt, real estate and infrastructure debt, yet remain exposed at a far lower level than their peers in Europe or the US.
“From our discussions with European insurers, many of them have a target allocation of between 15% to 25% to real assets from their current [much lower] levels,” Wei told AsianInvestor. “Asian insurers currently have much lower allocations, around the low single digits, but we see that in a low yield environment alternative assets… [provide] diversification and stable income streams to increase risk-adjusted return and build portfolio resilience.”
He believes that level of exposure will change but declined to estimate by how much.
The head of Asia for an insurer-related asset manager concurred, noting that the interest of regional insurers in alternative assets had been growing for some time, but current conditions could help push through diversification into private assets.
“Investment teams haven’t really changed their level of interest in alternatives. But what might change is when they report to their boards and investment committees; they can put pressure on them by saying ‘we need to make a decision and now is the time to do it’. This period of time could really help their messaging.”
While the interest in alternative investments makes sense, there is less unanimity of opinion over insurers investing in structured equity products that use derivatives.
These sort of strategies are already in use in Europe. They typically consist of insurers, or external fund managers, buying put options to limit their exposure to drops in stock value and paying for it by selling calls that cap the amount they will benefit from equity rises. In effect, insurers would see the equity investment returns move within a band.
“In Europe, there are some proven equity hedging strategies and multi-asset hedging strategies that use derivatives to protect downside [risk]. These can lead to a reduction in the solvency capital charge,” said Wei.
A few fund manager executives told AsianInvestor that these strategies may become more appealing in Asia too, particularly given the introduction of new risk-based capital regimes that are less draconian about derivatives if they are used to hedge investment risk.
Large multinational life insurers in Asia often use derivatives to hedge their interest rate or foreign exchange risk already and note that doing so for equity exposures too could well make sense – provided local financial regulators are willing to countenance them.
The head of multi-asset solutions at an international fund house told AsianInvestor that he had had several conversations with insurers about such investment approaches.
“Many insurers are coming and asking us to infuse downside protection in their traditional portfolios. One-third of the conversations we have involves how to avoid big downside risk.”
“Derivatives got a bad rep 10 years ago, but people are increasingly willing to listen again,” he added.
The head of insurance client coverage at a major US fund manager agreed that such approaches made sense.
“Even if there is no immediate regulatory capital relief from such strategies, it makes sense to hedge some tail risks,” he said. “And as we have new capital regimes that are moving to a more economic basis when judging capital costs, so hedging on an economic basis offers more relief on a capital basis too.
“That is the direction in which we are moving and more insurers have started to look closely too,” he added.
Not everybody is as convinced that insurers will start to put money into hedged equity investments in the near term, however.
“We haven’t seen [such strategies] yet in Asia; it depends on the regulatory response. Also managing those derivative positions can be challenging,” is Wei’s verdict. “It’s an interesting area but a lot more work needs to be done for it to develop.”
The senior executive at the insurance-related asset manager was similarly cautious.
“Are such strategies a possibility? Yes. Do I think something will take place moving forward? I'm not so sure as there is inherent risk in them. You have insurer investment heads trying to understand the asset diversification and long-only side risks, and this [sort of strategy] is another level past that. I think it’s a step too far.”
Officials at AIA, FWD, Axa, Ageas and Allianz did not respond to AsianInvestor queries on their investment approaches.