Southeast Asia's insurers have had to cope with shrinking debt yields across their region, courtesy of too much international liquidity and a global hunt for returns, as outlined in a recent article. A new issue is set to compound their problems – the looming introduction of a new set of capital regimes – and they are mulling how to address it.
Regulators across major countries in Southeast Asia have started to partially implement proposed solvency rules, called risk-based capital requirements (RBC 2). These are drawn at least in part from Europe's Solvency 2 regime.
Singapore is the lead mover, from which other regional jurisdictions are likely to take their cue. The Monetary Authority of Singapore (MAS) has published three rounds of consultative papers on its new rules, incorporating feedback from local insurers each time. The final version will update the calibration of the current risk charges and include operational risk within the calculation for 'total capital required'.
Insurers interviewed by AsianInvestor were unanimous in their view that the revised risk charges to certain asset classes were punitive. They argued the rules were likely to make it much more capital-intensive to run an insurance business.
For example, MAS has proposed that the risk charge – the amount of capital that must be set aside – for equity allocations rises from 16% to 40% of the allocation size. Increases in risk charges are also to be imposed on investments in private equity and hedge funds.
The proposed punitively high capital charges will discourage insurers from allocating to growth assets and instead push them into currently low-yielding bonds, said Serene Tan (pictured left), Singapore-based principal consultant at investment consultancy Mercer. They will suffer mark-to-market losses as a result of bond yields moving higher over the long run, she added.
MAS is pursuing the changes to bring Singapore in line with international standards, which are also becoming more stringent. The city state's RBC 2 requirements look set to be approved next year.
The new regime would likely act as the benchmark for other Southeast Asian countries' revised RBC requirements. Discussions are already taking place the Philippines and Thailand between the respective insurance industries and regulators about new rules.
Some markets, including the latter two, have started implementing a quantitative impact study (QIS) for RBC 2, which assesses the potential impact on the industry. Insurers will only know the optimal asset mix when this has been completed, potentially early next year.
Low bond yields and expected higher capital costs have led consultants and asset managers to recommend that Southeast Asian insurers increase their allocation to alpha-generating strategies, such as hedge funds, to garner higher yield.
“Hedge fund [investment] would be a good risk diversifier to their investment portfolio, but it would no doubt incur a higher risk charge than qualifying bonds,” said Mercer’s Tan.
“From the investment point of view, if the consideration for the risk charge is not part of the equation, a meaningful allocation to hedge funds should be around 10%,” she added, declining to comment on how much the risk charge could end up being.
That, again, leaves bonds. Tan recommends life insurers carve out a segment from their fixed income allocation for duration-matching debt and use the rest to target yield and value-adding strategies such as absolute-return mandates. For example companies could consider a fixed income mandate that is not benchmarked to any bond indices, but delivers returns 2% over the Singapore interbank offered rate.
The new rules might not be uniformly painful. Alan Yip, head of Asia insurance strategy at JP Morgan Asset Management, believes a more granular approach taken by RBC2 to the capital risk charge for alternatives would benefit insurers, as reported.
For example, infrastructure funds investing in brownfield assets (already established projects) should be seen as less risky, because they provide more predictable revenue streams than those offered by newly started projects.
“By putting different alternative assets into one category with a high capital charge, certain solvency capital regulations are effectively restricting the investment freedom of some insurance companies,” Yip added.
The ultimate goal of the regulators is to stop insurers recklessly taking risks. Sutee Mokkhavesa, senior executive vice-president of risk and strategy at Bangkok-based Muang Thai Life, believes this is possible, while still allowing them the freedom to buy into alternatives.
Mokkhavesa (pictured right) proposes that there be certain rules that are only applied to alternative assets. “This additional regulation will require insurers who wish to invest in these alternative assets to pass the regulator’s ‘fit and proper’ test, which will ensure that they are sufficiently equipped with the knowledge and skill to participate in these more complex asset classes.”
On the upside
It’s wise not to overstate the difficulties. Southeast Asia is comprised of growing markets, with expanding middle classes that are increasingly looking to take out insurance. Those are good dynamics, even in a tougher market environment.
One expert noted that life insurers had more options than just raising premium charges or offering fewer policies. They could, for example, seek to raise new capital to help ease financial pressure. “The insurance market will not fall apart just because of the regulations,” he said.
However, he admitted the region’s insurers faced a “very challenging” environment ahead, with costs likely to rise. To navigate these changes, insurance companies, regulators and product providers must be flexible and cooperative.
Tomorrow's life insurance investment portfolios in Southeast Asia may look rather different from today’s.
Click here to read part one of this feature.
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