Life insurers across Asia Pacific, but particularly in Taiwan and South Korea, will keep increasing their investments into international lower-rated investment grade bonds and private debt in an effort to meet their return needs. That is likely to lead them to invest more in internal risk analysis and could increasingly test financial regulators, said S&P Global Ratings in a new report released on Tuesday (February 23).

In the report, S&P noted that the risk of volatility in highly valued equity markets mark the top investing vulnerability for life insurers’ balance sheets.

“We did a number of stress tests and confirmed that market volatility was one of the highest levels of risk facing insurers in Asia Pacific,” said Craig Bennett, director of the financial services group at S&P Global Ratings and a co-author of the report, told AsianInvestor.

Life insurers across all markets are having to consider how best to meet often guaranteed policy returns at a time when interest rates in many home markets are at all-time lows. The Korean benchmark interest rate, for example, stands at 0.5%, while Taiwan’s policy rate is a historic low of 1.125%, with few signs it will rise soon.

The likelihood of equity volatility means the asset class, already a small area of life insurer investment, could decline further. Asia Pacific life insurers hold equity exposures of around 8%, versus nearly 80% in bonds.  

* Indicative based on company information. Source: S&P Global Ratings

Most of this bond exposure is in highly rated debt; around one third of regional life insurers’ bond exposures is rated ‘AAA’ or ‘AA’ and close to 50% is ‘A’ rated.

Eunice Tan, senior director for insurance ratings at S&P Global Ratings and the report's other co-author, predicts that Asian life insurers are likely to continue increasing their exposure to both lower-rated investment grade bonds and private debt in international markets.

The former offers a little more yield than higher-rate debt, albeit at slightly higher risk and increased capital cost, while the latter gives generally strong annual returns at the cost of liquidity. Life insurers in Taiwan and Korea have particularly looked at both areas for over two years, given that they offer higher return rates than local bonds.

“In a market that is very volatile the selection of assets will be a combination of art and science,” said Tan. “The science includes hard guarantees of what [liabilities] the insurer needs to meet, and the need to find higher yielding assets in a market where rates are trending low, there are highly volatile equity markets and even uncertain foreign exchange [rates].”

REGULATORY IMPLICATIONS

Insurers’ rising focus on private debt raises its own challenges for the insurers.

“While hard assets are less volatile, they are also less liquid, which has accounting and yield considerations, as well as [local] regulatory capital requirements,” said Tan. This includes the introduction of IFRS 17 accounting standards, which will require insurers to report their balance sheet liquidity on a daily basis.

Tan noted that several insurers are responding to that need by “strengthening their credit oversight and pouring in more resources to build their knowledge in that space. This was happening even pre-Covid”. She declined to offer specific examples.

The head of Asia insurance coverage at a US fund manager says this makes sense.

“Insurers should be conducting regular stress test scenarios to ensure they remain able to withstand downturns and remain within their risk appetites,” he told AsianInvestor. “Some may be taking views on where markets might be heading (rates trending upwards) and could be reacting or will react to that.”

However, he argues that it will be difficult for the insurers to add so many resources they can effectively insource their debt investing needs.

“Typically, core asset classes could be managed in-house and the satellite strategies/alternatives could be outsourced to more specialised managers,” he said. “ALM/scenario analysis would certainly become a more important part of the entire process.”

REGULATORY CHALLENGE

Monitoring the insurers’ continued advance into offshore and more illiquid assets will increasingly challenge the two markets’ financial regulators.

“The regulators will have to keep an eye on the rising investments into the unrated space, whether it’s in terms of ensuring insurers establish credit risk management capabilities internally or ascertaining a specific view,” said Tan.

In addition, “[the regulators] need to balance the risk of the insurers having very high foreign asset exposures and the FX risk this creates with the need of these insurers to cover their policies”.

Taiwan’s insurers have been at the spearhead of these concerns, courtesy of a relatively high exposure to guaranteed investment policies. Lacking sufficient local investment returns, the insurers have increasingly invested into offshore assets, either directly or via onshore funds that have underlying international debts.

As a result, they already have a lot of foreign exchange risk, and this is likely to rise further. They are also exposed to international bond markets that could face further downgrades as the impact of Covid-19 lingers.

However, Taiwan’s insurers’ focus on investing via exchange-traded funds might help inoculate them to some degree. “[The island’s] insurers were investing in foreign bond ETFs sometime back – so if there are a large number of downgrades, there may be no way to divest specific names and the entire portfolio gets impacted,” said the head of insurance coverage at the US fund manager.

The island’s regulator is having to monitor this, and others are likely to keep an eye on what it does. “Regional regulators are … watching Taiwan’s regulator and are being quite careful to ensure that FX issues do not become another area they need to fix,” noted Tan.

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