The implementation of new capital rules across much of Asia’s life insurance industry is set to redouble the desire of industry players to invest into alternative credit strategies, according to a global fixed income study released by Invesco on January 29
The study defined alternative credit strategies as emerging market debt, high yield corporate debt, structured credit, direct lending, bank loans, real estate debt and infrastructure debt. It surveyed 79 institutional investors, including 21 based in Asia Pacific, managing around $1.2 trillion in assets in total.
One of the key takeways was a growing concern among insurers in Asia about the impact of evolving regulations on their asset allocation decisions.
“We are in an era of increasing regulations and Asian insurers in particular face some unique regulatory challenges,” Terry Pan, chief executive officer for Greater China, Singapore and Korea at Invesco, told AsianInvestor.
Key regulations particularly in respondents’ minds included the China Risk Orientated Solvency System (C-Ross) regime in China and risk-based capital (RBC) regime changes in other regional markets, he said, adding that these regulations are encouraging insurers to use less risky debt instruments.
RBC requires that reporting entities (typically insurers) maintain stated levels of capital in reserve to offset potential losses from investments. The riskier the type of investment, the most capital the company is required to hold against it.
The likelihood of a change in capital rules has also been highlighted by Moody’s Investor Services. On December 11, 2017 it released an outlook report on the Asia Pacific insurance industry that noted that changing legislations are affecting the way insurers operate.
In Hong Kong, consultations to establish a new risk-based capital regime are inching closer to implementation; while consultations are already underway to introduce a more advanced RBC framework in Singapore, Taiwan and South Korea.
All of these new rules systems are set to tighten requirements on internal risk management frameworks and will prod insurers to re-assess asset risk, the report noted.
The Invesco survey respondents noted three main effects of the changing regulatory environment. First, they said the rules would likely reduce their appeal for traditional risk assets, while correspondingly raising their interest in quasi-matching assets. Plus they said they would need to diversify their investments more internationally, where possible.
The investors’ particular interest in alternative credit was very practical. The incoming rules look set to require less capital offsets than equities, while the assets are likely to provide higher yields than core fixed income.
A Moody’s report dated September 19, 2017 on the Chinese insurance sector, for instance, noted that the C-Ross regime looked set to apply capital charges of 31% to 48% for equity investments, versus 1.5% to 14.5% for bonds. Meanwhile fixed income alternatives such as a infrastructure debt hard capital charges varying between 1% and 13%.
New rules by China's Insurance Regulatory Commission that came into effect on January 5, are also likely to encourage insurers to more heavily enphasise debt within their alternative investment allocations, AsianInvestor has reported.
Insurance respondents to the Invesco survey said they believe the evolving regulatory environment will cause expected investment returns to further drop below investment targets, especially in the case of guaranteed insurance policies.
To address this, insurers are turning to quasi-matching assets such as real estate and infrastructure debt, where they can structure cashflows to appropriate liabilities, while achieving a higher yield than on traditional matching assets such as core fixed income,” Invesco’s survey noted.
Mary Leung, head of advocacy for Asia Pacific at the CFA Institute, told AsianInvestor there has been a big surge of interest in infrastructure debt in the past few years among pension funds and insurers.
“Infrastructure is attractive to them as their long-term investment horizon matches with their liability structures. Finding the right project to invest in is, however, crucial,” Leung told AsianInvestor.
Room to grow
There is certainly scope for Asian insurers to increase their allocations into alternative credit.
On average, institutional investors across the world allocate 19% of their fixed income portfolios to alternative credit strategies, according to the survey. European, Middle Eastern and African insurers said they invested 17% on average, while those in North America allocated 26%.
But regional respondents said they invest only 13% of fixed income portfolios into alternative credit strategies.
However, they appear open to raising this. On a 1 to 10 scale of rising importance, Asian investors rated alternative strategies the highest for improving diversification (7.1), while estimating their effectiveness in reducing risk and preserving capital at 4.5 and 4.4, respectively.
That trend is in line with global investor attitudes. North American investors rated alternative strategies 8.2 for improving diversification.
On a global basis, institutional investors appear to be cautiously interested in alternative credit opportunities over the next three years.
Twenty five percent of global respondents said they expect to increase allocations to direct lending, while 5% expected to make reductions. Similarly. One quarter of investors intend to raise allocations to real estate debt, versus 1% who planned to lower allocations.
The report noted that global investors consider certain segments of alternative credit to be expensive. They particularly identified high yield structured credit, and to a lesser extent, direct lending.
High yield bonds are also being viewed with increasing concern. While 13% of respondents said they intended to increase high yield bond allocations over the next three years, 21% said they would look to decrease allocations.