Local private loans are the potential hair in the soup for Korean insurers and merit close watching even as they push to diversify their holdings beyond their shores and into new asset classes, a major credit agency has warned.

Comprising 20% of their aggregate holdings as of the end of 2018, loan holdings come second only to bonds, official industry data shows.

“Compared with other regions, Korean insurers have a relatively large exposure to loans,” Jeffrey Liew, head of Asia-Pacific Insurance at Fitch Ratings, told AsianInvestor.

What's more, household loans account for more than half of this total loan exposure.
Jeffrey Liew

On the plus side, the industry’s ratio of non-performing assets remains low – below 0.5% as of end-2018, which is consistent with the past five years.

“Despite the low NPL ratios under these loan portfolios, they are subject to the local economic environment. Under an economic downward scenario, Korean insurers can investigate whether the existing loan exposure is still tolerable with their internal risk management limit.”

Total investment assets of Korean life insurers amounted to W687 trillion ($578 billion) at end-2018. Domestic fixed-income securities accounted for 49% of the investment portfolios of Korean life insurers in 2018.

That is lower than the 57% three years ago, as shares of loans, overseas investments and alternative investments – mostly held as beneficiary certificates – have increased in proportion.

DIVERSIFYING ABROAD

Like their Japanese peers, Korean insurers are increasingly diversifying into overseas investments. Overseas investments nearly doubled from ‎W66 trillion by 2015 to W129 trillion at the end of 2018, according to the Korean regulator, the Financial Supervisory Service (FSS).

The overseas share of investments has climbed to 14% and 13% of life and non-life insurers’ investment portfolios, respectively, up from 8% and 10% three years ago. Nevertheless, Fitch points out that insurers’ allocation strategies remain prudent, with fixed income as the key component of overseas assets. These bonds are predominantly rated A and above on the international scale by Fitch and are denominated in US dollars or euros.

The FSS allows up to 30% of insurer assets to be invested overseas.

As insurers would have to take on additional currency risks, higher hedging costs could dampen efforts to make up the difference, even if FSS regulations increase the desire of Korean insurers to diversify into overseas alternative investments in years to come.

The need to diversify overseas comes at a time where it is becoming more challenging. In January 2019, for instance, FSS announced a requirement for insurers with significant maturity differences between overseas securities and the FX hedges to hold additional capital.

Fitch believes this is a prudent step from a risk-management perspective, particularly with the increasing allocation to overseas assets. It also prepares insurers for the new solvency standard  called K-Insurance Capital Standard, or K-ICS, that was slated to come into force in 2021 but has so far been postponed to 2022.

With the higher solvency standards in mind, Liew expects Korean insurers to move into less risky asset classes, notably fixed income investments.

“We expect the fixed income investment would remain as the major asset class given the liability structure in the local market, thus lengthening liability duration under the new capital regime. We have also seen a more cautious approach by Korean insurers in managing overseas investments due to rising hedging costs,” Liew said.

A more defensive strategy in overseas fixed income markets has been observed among Korean and Japanese asset owners alike.

But, according to Fitch, Korean insurers are more diversified compared with their peers in Japan as well as China, Singapore and Malaysia, and adopt more cautious asset risk management with effective hedging strategies on their overseas asset investments.