02 May 2019
With a lack of domestic long dated assets to match their long-term liabilities and some restrictions on overseas investments, Asian insurers' biggest risk exposure comes from their investments. In Hong Kong, Vincent Huck meets with regional and local stakeholders to understand how they are coping and their expectations for the upcoming changes in regulations.
There is no place like Asia.
It doesn’t matter if you ask a chief investment officer (CIO), a portfolio manager, an internal or external asset manager, a consultant or a rating agency. When asked what is on their minds, Asian insurance investment professionals, whatever their background and point of view, will respond with two points in the same breath: there is no place like Asia, and there is a lack of available assets to invest in.
Cap on overseas investments (% of total investments):
China - 15%
Hong Kong - no limit
Indonesia - 20%
Malaysia - 10%
Singapore - 20%
South Korea - 30%
Taiwan - 45%
Thailand - 20%
There is no such place as Asia because its countries are moving at different speeds, the regulatory environments are at different stages and evolving at different rates. A lack of available investments also creates challenges for certain territories, while the restriction to invest overseas (see box) presents challenges for others.
Mark Konyn, group CIO at AIA Group, summarises: “From an investment stand point, being in Asia is very different from being in Europe because there is no regulatory harmony. There is no single currency, and you have different capital markets in the different jurisdictions and various restrictions from working in these various regulatory regimes.”
Nevertheless, there are common threads, Chris Howells, head of insurance solutions Asia Pacific at Schroders, says. These revolve around the questions: how to access longer duration for managing assets when there aren’t long duration domestic bonds? How to access greater liquidity or complexity premia when it is not necessarily available domestically? How to cope with the challenges of IFRS and risk-based capital (RBC) regimes?
The rating agency assessment
As a result of the lack of available domestic long dated assets, investment risk is high up on the agenda of rating agencies such as Moody’s in their analysis of Asian insurers.
Sally Yim, Moody’s Investors Service associate managing director for financial institutions in Asia Pacific, says: “Asset risk is a very important part of our analysis because it is the biggest risk for insurers in this region.”
Asian insurers are a lot more exposed to alternatives, she explains. “[These assets] are not as transparent or as easy to understand because those usually will not have a secondary market, or the observable market price is not as easily available then in other part of the world.”
Currency risk is also an issue, she says, as insurers ramp up their overseas investments in their hunt for yields.
Although Yim says “there is no Asia as a whole” and every market is different, she and her colleague, Frank Yuen, vice president senior analyst financial institutions Asia pacific, say the lack of available assets is a challenge across Asia for insurers.
Even in larger economies like China, although the market is bigger, the number of issuers remains limited resulting in concentration risk, Yim explains.
“On a relative basis, indeed China is probably a bigger market, but the issuers on the fixed income side are still for a large part banks,” she says. “So, if you look at the fixed income portfolios of Chinese insurers they have a very high concentration in the banking sector.”
Chinese insurers have been more cautious than their counterparts in the region when it comes to investment, according to Yuen. This is due to the rising credit risk and being in the late stage of the credit cycle.
“But things have changed with the drop in Chinese government bonds and the central bank and regulators relaxing the investment rules,” he says. “That leave some room to pick up risky assets for Chinese insurers.”
Chinese insurers tend to hold simple structured wealth products with duration of two years issued by the big four commercial banks, which are relatively safe with little liquidity or credit risk, Yuen says.
But they also hold public infrastructure debt or complicated structured products where it is not easy to locate the underlying asset, giving rise to concentration and illiquidity risk, he continues.
Looking at Taiwan, Yuen says it is a prime example of a market's exposure to currency risk. Because of the lack of available assets to meet the cost of liabilities in the local market, insurers have been keen to increase exposure to foreign markets, mainly US corporates.
“The credit quality [of these bonds] is good,” Yuen says. “But the risk for the insurers is that they don’t fully hedge these exposures, so the rates differences between the US and Taiwan creates an increase in hedging cost to the portfolio.”
He estimates over 60% of Taiwanese insurers’ assets are in foreign currency that are not fully hedged.
South Korean insurers have also been expanding their overseas book, but have usually been more conservative in the hedging, according to Yuen.
In Japan, on the other hand, it is very much down to each individual insurance company’s hedging practices, and while some have been conservative others have been more opportunistic, he says.
However, there is a big difference in risk appetite between subsidiaries of western companies and local players, Yim warns.
Western subsidiaries tend to be more conservative in their investments, she says. That’s because the subsidiary will have to follow the investment guidelines of the parent and if the parent is subject to a regulation such as Solvency II, it will usually have more stringent requirements on the asset risk than the local regulation.
“Some of the local players - while it is not one size fits all - have legacy high guarantees policies, like in Taiwan for example, so they need to invest in riskier assets to compensate or meet the cost of liability of the policy.”
Yuen also points at the background of the insurer as a factor. The subsidiary of a Chinese insurer in Hong Kong, for example, would be more comfortable with Chinese credit giving rise to a high exposure to some state own companies.
Also, the larger players tend to compete on life or long-term insurance products, he continues, they will be conservative trying to match the duration of their assets as closely as possible to the duration of their liabilities.
“So, you would see a higher percentage of bond holdings in those portfolios,” Yuen says. “But the smaller players tend to sell short term products which give them an opportunity to look at other asset classes such as equities.”
Risk appetite going forward
Asked if Asian insurers, like their counterparts in Europe, are in a 'risky mood' and if Moody’s expect them to make riskier investments going forward, Yuen dismisses the idea.
“If you look at the fixed income portfolio […] because of the regulatory changes many insurers go for more government bonds exposures,” he says referring to the upgrading of current, or introduction of new, regulatory framework across the region. (See table: Asian regulatory environment)
“You could see some movements in the ratings because of the downgrade of the sovereign ratings, but it is not an active change in the portfolio,” he says.
However, a recent survey by Goldman Sachs Asset Management’s (GSAM) of 307 chief investment officers (CIOs) and chief financial officers (CFOs) representing $13trn of balance sheet assets, found Asian insurers showed a greater risk appetite then counterparts in Europe and the Americas for the coming 12 months.
Respondents globally were split down the middle on whether to increase, or decrease levels of risk over the coming 12 months: 22% said ‘decrease’, and 23% said ‘increase’.
Amongst Asia Pacific respondents, those planning to increase risk (32%) clearly outnumbering those readying for a decrease (20%).
Neil Moge, head of EMEA insurance portfolio management at GSAM, said this might be an indication that RBC frameworks are forcing greater matching of assets to liabilities.
“The risk [insurers] have to take is to match those longer-dated liabilities, and do that with credit,” he said. “So maybe that risk-based capital regime is forcing more risk-taking, to align asset and liability durations.”
An increased risk appetite amongst Asian insurers is at odds with what all stakeholders met by Insurance Asset Risk said. For them the new or upgraded regulation will result in more conservatism in the investments across the region. Forcing insurers to think of their assets in the context of their liabilities, an exercise which might be completely new for some of the local players.
Mi Namkung, associate partner for actuarial and insurance advisory services at EY, says the outcome of the regulatory changes in Asia will be different from the outcome of Solvency II in Europe. Because while Asian regulator might be benchmarking their regulation on Europe, they need to base their final rules on the local context.
Table 1: Asian regulatory environment
|China||C-ROSS||01-Jan-16||C-Ross 2 expected to be finalised by 2020 with stronger focus on risk-based capital measurement.|
|Hong Kong||Solvency margin||30-Jun-97||Introduction of RBC in progress. Third impact study in 2019 with first draft of rules expected in Q4 of 2019. Rules to be finalised by 2021/2022, with a generous transition period.|
|Indonesia||RBC||21-Jan-09||Last updated in 2012, no current plans for further updates.|
|Malaysia||RBC||01-Jan-09||The regulator, Bank Negara Malaysia, has initiated last year a review of its current RBC framework, which is expected to be conducted over the next few years, to reflect the current insurance and takaful landscape, as well as any recent developments in the regulatory and accounting standards. The first phase will focus on reviewing the prudential limits on assets and counterparty exposures, followed by a review of the standards for the valuation of liabilities and capital adequacy components.|
|Singapore||RBC||23-Aug-04||The Monetary Authority of Singapore has been conducting impact studies and industry consultations to evaluate its proposed RBC II reform.|
|South Korea||RBC||01-Apr-11||Implementation of IFRS 17 and K-ICS by 2022. K-ICS is a principle-based risk capital framework which is similar to the International Capital Standard.|
|Taiwan||RBC||01-Jan-08||Preparing for IFRS 17 and tightening overseas investment cap. The current RBC approach is based on prescribed risk factors multiplied by risk exposures. Taiwan is expected to move to RBC II, although no timeline has been confirmed, which will require a shock test to be applied on the decrement rates used to calculate the risk capital.|
|Thailand||RBC||01-Sep-11||The RBC II development project has been ongoing since 2012. The latest draft of the framework was released in April 2016 following industry analysis and consultation. There has subsequently been further market testing carried out, including two industry-wide quantitative impact studies, in 2016 and 2017. The new framework is scheduled to be implemented in 2019, although the precise timing is not known as yet.|
|Japan||Solvency margin||Insurers have been producing voluntary economic solvency ratios since 1996. Since 2016, ORSA report submission to the Japanese Financial Services Agency has been mandatory. A mandatory economic value-based solvency regime is being developed with a target implementation by 2020. Field tests are expected to be conducted in parallel with ICS developments|
|India||The insurance regulator is contemplating the introduction of an RBC regime. However the exact framework to be adopted in the RBC is yet to be drafted|
The Asian context
Asia is a less mature market than Europe, and as such insurers tend to sell more savings-type products with long-term guarantees rather than protection products, according to Namkung.
This is done to grow the business, she says, but insurers need a good plan to manage these long-term guarantees.
The upcoming RBC regulations will certainly take into consideration this context, allowing for the market to mature, she says. This won’t impact consumer protection, as other set of regulations focus on this aspect are also expected to come through.
“In Asia a lot of the focus is on growth, you can’t just hold what you have and manage it,” Namkung says. “They will continue to look for ways to grow their business because there are less mature and there are more potential clients to reach.”
The snowball effect on the asset side of the balance sheet is that there are no long dated available assets to match these long-term guarantees.
“Also, in certain countries like Korea, if you want to get exposure to long duration fixed income, your company has to be big enough to access these assets,” she says. “For small players it’s tricky because there is a limited supply.”
Overseas assets are the only option they have at the moment, Namkung continues. For Hong Kong insures it works well because the HK$ is pegged to the US$ limiting the currency risk, but for others in the region, hedging strategies become crucial as previously highlighted by Yuen at Moody’s.
The introduction of new regulation will have an impact on the asset allocation, Namkung says. “Apart from the European or larger insurers, Asian insurers didn’t seem to have any asset strategy before, they didn’t have to think about what to do so they will definitely change that. Unless [they] want to put more capital in and don’t care if it’s expensive.”
But if there is a way to reduce the required capital by changing their asset allocation, companies will consider it, she continues.
“First they need to know what is going to be the impact of changing the asset allocation,” Namkung says. “[they] will need a platform to test it, and we are helping to build those models.”
The CIO perspective
Jaijit Kumar, CIO for Asia at Aviva, confirms the regulatory changes are on his mind to make sure the portfolio is well positioned so that the capital consumption is not abnormally high.
“You have a reasonable trade off between the capital and the returns,” he says. “We have long dated liabilities and there is a certain earn grade that [we] need to meet [those], so [we] always need to generate enough returns.”
Kumar continues: “We try to avoid good and bad years [by having] a steady base and try to build little increment of alpha generation.”
Unsurprisingly, the main challenge he faces is the lack of available assets. “It drives yields down and liquidity can sometime be an issue,” Kumar says. “That is why we started looking at the alternatives or private assets, [where] at least you are getting paid for the illiquidity component.”
Similarly, at AIA, Konyn says real estate is an important asset class in countries where the capital markets are less developed.
AIA has a combination of dollar assets invested globally, but also in the Asian dollar fixed income market, he says. “We have a very significant allocation to US corporate which provides enhanced diversification and also duration extension.”
AIA has also been involved with local governments and ministry of finance to help develop the term structure for debt.
Konyn says: “When we talk to governments, we [highlight] the restrictions such as the lack of available long-term assets, and we encourage the issuance of those benchmarks issued by the sovereigns and participate actively in them.”
He cites Thailand as an example, where AIA is helping to build the yield curve profile and where it holds a significant proportion of government debt.
“We recently put a greater emphasis on looking for opportunities in privately funded infrastructure,” he continues. “We are also looking at ways to increase our exposure to private debt more generally recognising that not all borrowers come to market.”
To that effect, in April, AIA appointed HSBC Global Asset Management to identify and provide access to infrastructure debt opportunities across the Asia Pacific region.
The partnership is a direct response to the lack of long-dated assets to match insurance liabilities in the region, and in particular to the fact that financing of Asian infrastructure projects has been nearly exclusively the remit of banks.
In partnering with HSBC Asset Management, AIA will be able to leverage expertise of the manager’s parent – HSBC, the bank – in issuing loans for infrastructure projects.
The lack of available assets combined with restrictions on overseas investments has meant insurers in the region sometimes need to be creative to unlock opportunities.
Prudential, for example, launched a consumer finance company in 2006, Prudential Vietnam Finance Company Limited. It was reportedly the first foreign, non-bank financial institution licensed for consumer finance lending in Vietnam.
Twelve years later, it was the fourth largest consumer finance company by outstanding loan balance in Vietnam, and Prudential sold it for $151m to Korean group Shinhan Financial Group.
In the process, Prudential and Shinhan agreed a new long-term bancassurance partnership in Vietnam and Indonesia.
External asset manager perspective
Another way to tackle the lack of assets is to look at derivative strategies, according to Howells at Schroders.
“Futures for example, or interest rates swaps to manage the interest rates mismatch or the problems arising from the mismatch of the availability of longer dated cash flow to meet your liabilities,” he says. “But that can be hampered by some regimes not allowing the use of derivatives or even the firm’s own ability to manage the operational complexity of derivatives.”
Arnaud Mounier, managing director for insurance business development at AllianceBernstein, also points out a change in products sold as a potential solution.
CIOs might tell the insurance team to stop selling high guarantees liabilities as there is no assets to match those, he says. “And that is one of the reasons you see a higher demand for unit-linked products.”
From an asset manager perspective, Mounier who used to be regional CIO for Axa across Asia ex Japan, says Asia is a demanding region.
“It is such a heterogenous region, you can’t do the same pitch to all the players in all the different markets, you have to go in with a specialised targeted pitch. You can’t sell the same thing and with the same arguments [to all],” he explains. “For example, private debt in Asia is seen as alternative so something that yield at 10% and above, so if you don’t sell it with leverage it will not work.”
“You have to understand the level of expectation and how they classify the assets,” Mounier says.
Namkung at EY, says third party asset managers have been struggling in the region. Mainly because the larger companies have their investment affiliates or internal departments but also because Asian insurers’ investments were not very complex so there was no need for a third party.
Howells, however, says he sees no difference from other regions. The less complex assets, such as vanilla bonds or domestic equities, would tend to be dealt with in-house.
“But once you start going out to global markets and to more esoteric assets such as alternatives,” he says. “For the smaller to medium size insurers there is less capability to be able to access the market or understand the drivers behind the value or the performance of those assets.”
Asset gold rush?
The roll out of RBC frameworks across the region raises the question on whether the new regulations will benefit external asset managers, with some expecting something akin to a gold rush.
Guy Mills, chief executive officer of Manulife Hong Kong & Macau, says it could create more opportunities. “The smaller local players really have no choice, it is not an option to develop that in-house capability,” he says. “so, the thesis is right.”
But not everyone is entirely convinced. Namkung says at the local market level it is unlikely to make a massive difference, but aggregated across the region as whole it could be an opportunity for external asset managers.
Kumar says the current level of AuM combined with the expertise of the in-house asset manager, Aviva Investors, means there isn’t much sense in looking for external managers at this point.
“As the portfolio grows in size you can diversify further then it makes sense to start looking at different strategies and managers who specialise in those,” he says. “At this point we wouldn’t necessarily outsource with a mandate to an external asset manager, it is more about looking at funds a manager has, like real estate funds for example.”
It will be easier for the asset managers to relate with the insurers, the same way as they are relating in Europe because ALM considerations are going to become more prominent, Mounier says. “But will they outsource more? I’m not sure. They will probably try to do it themselves or develop affiliated asset managers. It will depend how punitive some of the asset classes are under the new framework.”
If there is one consensus amongst interviewed stakeholders, it is that the future holds many opportunities for insurance investment professionals.
Insurance companies’ assets across Asia Pacific (Apac) are expected to grow from $10.5trn in 2017 to $13.7trn in 2025, up 30.5%, according to a PwC report.
“In Asia it is pretty clear that with the positive demographic profile there is going to be an increasing need for long term solutions for financial planning and making sure that individuals have significant protections,” Konyn at AIA says. “It is pretty clear as well that governments want to see the private sector really dominate the provision of those services over and beyond a minimum social welfare safety-net, so the opportunity is there in the region for continued aggregation of financial resources through the medium of life insurance.”
Aviva’s Kumar shares the analysis, saying the current growth and under-penetration in the market are signs of great potential. But he warns: “We are in a competitive market environment and so execution is key.”