Taiwan’s financial regulator is mulling whether to install a mechanism that discourages insurers from selling equities when stock markets are slumping and makes them less willing to buy them in a bull market.

To help maintain market stability, the insurance bureau of the Financial Supervisory Commission (FSC) said last Thursday that it is proposing countercyclical mechanism that would see higher risk measure for equities when market sentiment is positive and the opposite when not. 

FSC chairman Wellington Koo said that with such a mechanism in place insurers would be less inclined to offload their stock holdings in a hurry when the market wasn't doing well. In contrast, with the cost of investment climbing in a bull market as the risk coefficient rose, they would be less inclined to rush to buy, he reportedly said.

The idea is that if the broad market index, say the Taiwan Composite Index, fell below its moving average of the past three years, then the risk coefficient applied to any company shares held by an insurer -- currently 21.65% -- would be adjusted lower. The change in risk coefficient will largely depend on how much the market has dropped. The reverse would happen if the market index moved above the three-year moving average. 

The regulator has commissioned the Taiwan Insurance Institute to study the feasibility of such a mechanism and it plans to announce the results before the end of this year.

Share price declines put pressure on the risk-based capital (RBC) ratios of insurers. With an adjusted mechanism, insurers would not have to immediately dispose off their stocks when share prices fell, Serene Hsieh, Taipei-based director for financial services ratings at S&P Global Ratings, told AsianInvestor.

Cathay Life, Fubon Life, Taiwan Life declined to comment on the potential regulatory change.

CAPITAL REQUIREMENT CONCERNS

An insurer's RBC ratio is its total capital divided by its risk-based capital. It measures the financial health of an insurer after taking into account the risk taken in its investments.

If the value of its shareholdings fell, so too would its total capital and to a larger extent than its risk-based capital. That in turn would bring its RBC ratio down, which could mean insurers having to sell some of their equity holdings, begetting yet more share price falls in the market.

Lowering the risk coefficient in the denominator can help to maintain the ratio, a Hong Kong-based insurance analyst who declined to be named told AsianInvestor. This would be especially beneficial for insurers if they thought the share price falls were temporary and that the stocks were set to rise in value in the long run, he said. 

The minimum regulatory RBC ratio, which is required for insurers to cover their obligations and remain solvent over a defined period, is 200%.

Although the regulator’s initiative is meant to help stabilise the Taiwanese stock market, less clear is whether it would encourage insurers to invest more in shares, which constituted 7.14% of Taiwan’s total assets of NT$26.15 trillion ($850 billion) as of July 2018.

A spokeswoman at the insurance bureau said that the regulator’s priority is to ensure insurance firms have high enough RBC ratios in different scenarios. Whether insurers end up investing more or less will largely depend on their own risk appetites.

In the view of S&P, the higher-risk nature of equities (as opposed to other asset classes) is the same no matter whether the stock market is doing well or not. So even if the regulator changed the risk coefficient, the rating agency would maintain the same thresholds when determining their capital positions, Hsieh said.

“We remain cautious. Equities have higher risks and [are] a type of investment that causes higher volatilities," she said. "If [some insurers] become very aggressive [in equity investments], we need to see whether their capital can absorb the additional capital risks because of rising equity stock [holdings].”

FIVE PLUS TWO

Taiwan’s regulator also announced late last month a drastic decrease in the risk coefficient assigned to insurance company investments into the so-called five plus two innovative industries through private equity funds.

Five plus two refers to five pillar industries – the internet of things, biomedical, green energy, smart machinery and defence, subsequently expanded to include new agriculture and the circular economy (which is related to the recycling of products).

The risk coefficient for these was cut from 26.38% to 3.19% in order to encourage insurers to invest more in these areas, according to the insurance bureau's spokeswoman.

The financial regulator has also been urged to assign a lower risk coefficient to public equities that are held for the medium-to-long-term, as well as equities that are bond-like in nature and have good environmental, social and governance (ESG) elements.

These proposals are still under consideration by the insurance bureau, the spokeswoman said.