Insurers in China, Hong Kong and Taiwan are reviewing their asset allocations and thinking about how they should optimise their portfolios as they brace for new solvency rules in their home regions.
The China Banking and Insurance Regulatory Commission (CBIRC) is expected to launch the second phase of China Risk-Oriented Solvency System (C-Ross II) in 2021 to create a more comprehensive regulatory capital regime and to improve the transparency of the risks embedded within insurers' investments.
Hong Kong’s Insurance Authority (HKIA) plans to implement a brand new risk-based capital framework in 2022. Under this new framework, Hong Kong licensed insurers will be required to factor in asset risks in their solvency computation in addition to risks from insurers’ underwriting activities.
Taiwan is also developing a solvency standard – Insurance Capital Standard 2 – that facilitates improvement in insurers’ asset and liability management (ALM). The Financial Supervisory Commission (FSC) plans to implement the new solvency rules in 2026.
As these important changes loom, AsianInvestor asked experts about the common features of these new rules in the three regions, the potential impact on their investment portfolios and how their internal teams might operate differently.
Their contributions have been edited for clarity and brevity.
Thibaut Ferret, senior solutions director for Asia Pacific
Aberdeen Standard Investments
The risk-based capital (RBC) frameworks in these three jurisdictions share similar principles, although their parameters differ. In general, insurers in Asia should prioritise reviewing their investments in light of the higher proportion that market risk plays in their overall capital requirements.
In Taiwan and Hong Kong specifically, we expect insurers to focus on interest rate risk, credit spread risk and equity risk capital charges, especially those not already subject to RBC standards, such as Solvency 2 in Europe or Canada's Life Insurance Capital Adequacy Test (LICAT).
We anticipate four main knock-on effects in these two markets. Firstly, there will be a restructuring of fixed income portfolios to better match assets and liabilities, while reducing the credit spread duration of lower-rated bonds.
Next, insurers will introduce liability and capital-aware multi-asset solutions that combine strategic asset allocation, portfolio construction and derivatives programmes. Thirdly, there will be a need to comply with matching adjustment (MA) requirements to benefit from additional capital relief. MA is an additional spread added to the liability discount rate based on stringent ALM requirements. It allows insurers to improve the solvency ratio by both reducing the liability value and lowering the credit spread capital charge.
Lastly, insurers will have increasing use of interest rate, foreign exchange and equity derivatives to hedge market risk and reduce related capital charges.
When it comes to China, it might be too early to draw conclusions on the impact of C-Ross II. Insurers there already operate under C-Ross, and changes in the new version may compensate for any increased charges.
As for risk-based capital overall, insurers will likely increase collaboration between investment, risk, finance and actuarial teams, and strengthen internal ALM capabilities. Additionally, external asset managers will be required to increasingly understand and integrate local RBC rules for delegated investment solutions.
Kevin Jeffrey, director of investments for Asia
Willis Towers Watson
In general, the change will bring a greater focus on the capital charge associated with investing in certain asset classes, largely reducing the ability of insurers to take substantial levels of risk relative to their liabilities. The systems are all designed to improve consumer protection and trust in the insurance market.
Depending on the specific nature of the insurer, you are likely to see less risk taking in terms of equity or credit risk exposure and any substantial liability duration mismatch. Against the wider backdrop of historically low bond yields, insurers will be forced to find yield in private markets, while gaining confidence that they are capital efficient investments. This will bring a continued focus on private debt and other forms of alternative credit – areas which are more likely to be outsourced than internally managed.
Regulatory treatment of niche asset classes, and the ability of the asset management community to support the needs of insurers – with sufficient portfolio look through, and appropriate credit ratings, for example, will all play a role in how this landscape evolves. Insurers in all markets will generally need to invest in their ability to monitor and report on the new regimes.
Rick Wei, head of Asia ex Japan insurance strategy
JP Morgan Asset Management
At a high level, the new solvency rules have the common objective of enhancing policyholder protection, improve risk-based supervision and alignment with international standards and best practices.
Compared with C-Ross, the key changes in the new framework include mandatory look-through regulations, stricter capital resources, updated risk factors and the introduction of concentration risk. The potential impact on asset risk includes higher capital requirements on fund investments, unlisted equity, and non-standard assets that cannot apply look-through analysis. Overseas investments will continue to look attractive under the new phase in terms of asset-liability matching and diversification benefits.
Hong Kong’s new RBC regime is broadly similar to Europe’s Solvency II. Compared with Solvency II, the regime relaxes the eligibility criteria and product scope when applying the matching adjustment (MA). Given the significant benefits offered by matching adjustment, we expect more companies will take advantage of this effective RBC tool. Nevertheless, MA portfolio construction is complex and challenging, such as screening for eligible assets, achieving the right balance between higher spread and capital charge, as well as ongoing governance requirements.
As many Hong Kong insurers take more risks to maintain yield in a global zero-rate environment, insurers will need to design and implement customised alternative portfolios that will produce better risk-adjusted returns and that are also more capital efficient under the new RBC.
Terrence Wong, senior director for insurance
China, Taiwan and Hong Kong are going to launch either an enhanced version of the RBC system or a brand new capital regime. The purposes of the changes are mainly to align their solvency framework more closely with international practices as well as to strengthen the sophistication of insurers’ risk management in these regions.
The new capital rules are likely to drive insurers to review their investment approaches and guidelines, given the potential change in risk charges of investments. It will not be surprising if some insurers seek to achieve better capital efficiency by re-balancing their asset composition after the adoption of the new capital standards.
Investment assets will be subject to capital charges when the Hong Kong market shifts to the new RBC regime. Currently, insurers’ asset risks are not included as part of capital requirement calculation in Hong Kong. Additionally, in an attempt to strengthen the capital adequacy standard, CBIRC is likely to impose more stringent capital requirements on some investments where underlying assets are less transparent.
In view of these changes, we believe insurers need to determine whether the return they are able to obtain will exceed the cost of solvency capital. Insurers will certainly revise their asset allocations if the additional cost of solvency capital from the investments undermines their solvency stability.
Paul Sandhu, head of multi-asset quant solutions
BNP Paribas Asset Management
Over the past several years, ignited by the global financial crisis, there has been a regulatory push towards a more market consistent valuation of risk and capital for insurance companies. Europe was first to adopt a standard, called Solvency II, which became a guidepost for the rest of the world. This standard along with establishing a governance and assessment framework also provided guidance on capital valuation across market risk, insurance risk and various operational risks.
In Asia, the adoption of a similar standard has varied. The most notable was in 2016 with the C-Ross adoption in China and now with the new phase in consultation, we will see an added level of complexity for insurers. One key difference in the evolution of China’s solvency framework versus all other markets is simply that no other market looking to make this change in the near term is growing at the same speed as China, where AUM growth is still over 10% a year.
The regulator needs to balance the scope and depth of the new requirements with sustained growth in the market. Part of the growth will be contingent on the consistent performance of investment portfolios, and so this too will need to be assessed.
I believe that in China and other markets participating in this ongoing evolution of the solvency mechanism, we will not only see more numbers being crunched within insurance companies, but we will also see insurers pursuing more efficient investment strategies optimised around the new solvency standards.
Janet Li, wealth business leader
The impending regulatory changes across Mainland China, Hong Kong and Taiwan have slightly different focuses, albeit all pointing to better management of assets with reference to liabilities. Some general key considerations behind these initiatives are prudence and transparency of investment.
One critical factor affecting the insurance industry is the low-yield investment environment globally, where older policies issued in times of high interest rates are creating challenges. The next phase of China’s C-Ross regime again looks closely at the risks of the various asset classes and is expected to be key in driving future investment trends. The good news is diversified investments are encouraged, which reaffirms this golden rule of investment.
The risk-based capital regime in Hong Kong allows more qualitative assessment. This is consistent with the worldwide approach over the past 20 years away from a rules-based approach towards a principles-based one. This trend allows for better capturing of unique risks and risks pertaining to firm-specific circumstances.
Taiwan is in preparation to gradually adopt IFRS 17 and the Insurance Capital Standard 2 to align with international norms. At the same time, Taipei is promoting green finance and higher standards for reviewing insurers’ investments.
A lot is happening in the insurance industry, and investment portfolios will be driven by these winds of change. Perhaps ironically, the increased flexibility of principles-based governance may potentially be conflicted with the additional requirements regulators are imposing. This means that insurers have a greater need than ever for investment talents.