Allocating Overseas: What Asia Insurers Can Learn …...Allocating Overseas: What Asia Insurers Can...

Allocating Overseas:What Asia Insurers Can Learn From

Insurers in Developed Markets

May 2017

INSURANCE INVESTMENT INSIGHTS

Many insurers in Asia are thinking of expanding their portfolios overseas. They may benefit from a closer look at the composition of overseas portfolios of insurers in more mature markets, as well as from an examination of key considerations in pursuing this approach.

3ALLOCATING OVERSEAS

NANCY KONGVice PresidentInsurance Asset ManagementPineBridge Investments, Hong Kong

YONGHO LEE, CFAVice PresidentInsurance Asset ManagementPineBridge Investments, Hong Kong

Amid the prolonged low-interest-rate environment, insurance companies in Asia, some with historically small overseas investment allocations, are now actively seeking both yield enhancement and diversification through their overseas investment portfolios.

In mature markets such as the US, insurance companies have a long history of overseas investing, and the allocation percentage has been very stable. In other markets, such as China, the proportion of offshore investments has traditionally been low. Increasingly over the past two years, we have been witnessing a rapid change in offshore allocations, with some markets in the region moving aggressively in this direction.

However, when considering either moving into or expanding overseas allocations, insurers should not only consider the available instruments, yield differential, investment margin, and regulation/solvency, but they should also be aware of the additional risks involved.

Source: National Association of Insurance Commissioners, Taiwan Insurance Institute, Life Insurance Association of Japan, General Insurance Association of Japan, Korea Life Insurance Association, China Insurance Regulatory Commission, 21st Century Business Herald, PineBridge analysis. Note: US 2012 data refers to June 2012; all others refer to fiscal year end. Japan’s fiscal year end falls at the end of March in the next year, i.e., FY 2015 ends March 2016. Taiwan and Korea data include life insurance companies only, while US, Japan, and China data show the whole insurance industry level.

12.0%

57.0%

21.6%

8.3%

2.0%

0%

10%

20%

30%

40%

50%

60%

US Taiwan Japan Korea China

2012 2013 2014 2015

Insurance Allocation Percentage to Overseas Assets

4 PINEBRIDGE INVESTMENTS

Allocations by country: a snapshotThe United StatesAs expected in a mature market, the overall overseas allocation percentage has been very stable in the past few years, at around 12%. Within the overseas portfolio, the majority (93%) was invested in foreign bonds as of 2015, while the percentage differs between life insurers (98%) and property

and casualty (P&C) insurers (71%).

The majority of the foreign bond investments were in the corporate sector, although the actual percentage differs between life and P&C, with P&C insurers making a larger allocation to government and financial bonds compared with life insurers, as shown in the next chart. This reflects the higher liquidity required to cover P&C’s book of business, including events such as natural disasters.

US: Foreign Investment Asset Allocation

98%

71%

94% 93%

2%29%

6% 7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Life P/C Others Total

Foreign Stock Foreign Bond

Source: National Association of Insurance Commissioners. As of 2015.



15%

19%

8%15%

13%

28% 24%15%

72%53%

69% 70%

0%

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30%

40%

50%

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100%

Life P/C Others Total

OtherFinancial Government

US: Total Foreign Bond Exposure by Sector

The majority of the foreign bond investments are widely diversified among developed markets with limited exposures to emerging markets. With the recovery of commodity prices and geopolitical risks around the world, we would expect future changes to the mix of foreign bonds.


0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

Canada

United Kingdom

Australia

Netherlands

Japan

France

Luxembourg

Cayman Islands

Ireland

Mexico

US: 10 Largest Foreign Bond Exposures by Country


TaiwanThe overall overseas investment percentage of portfolios grew most aggressively in Taiwan to 57% as of 2015, compared with only 34% five years earlier in 2010. While industry level-disclosure of the details of the overseas portfolios is not available, we analyzed the top market players whose asset size represents about half of the industry total. We found similar results to their US peers, where close to 90% of overseas assets were in bonds.

Taking a closer look at the portfolios of Taiwan’s Fubon Life and Shin Kong Life in the next chart, which disclose sectors of overseas bonds, we see that more than half of their overseas exposure is to corporate bonds, while a very small allocation is to government bonds. Just eight years ago in 2009, about 70% of Taiwan’s top insurers’ overseas bond allocations were in government and agency bonds. This clearly shows an increased appetite for credit risk and the internal capability development to further enhance yield in the low-interest-rate environment.

Taiwan: Asset Allocation of the Top Life Insurers

51% 55%49%

6%4%

7%

0%

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100%

Cathay Life Nan Shan Fubon Life

Others

Cash, Deposit, andShort-Term Investment

Policy loan

Mortgage & secured loan

Real estate

Domestic equity

Domestic bond

Overseas equity

Overseas bond

Source: Company websites, PineBridge analysis. As of 2015.


Source: Annual Reports of each company.

Taiwan: Total Overseas Bond Exposure by Sector

Fubon Life

6.0%

45.8% 44.0%

4.2%3.0%

39.2%

54.3%

3.5%

0%

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Gov't Bond FinancialBond

CorporateBond

Others

20142015

14.9%

54.6%

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12.7%

57.0%

21.4%

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0%

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Gov't Bond CorporateBond

Int'l Bonds Listedin Domestic OTC

Others

20142015

Shin Kong Life

Taking a deeper dive into the Cathay Life and Fubon Life portfolios, we can see the country allocation of overseas bonds is divided among North America (about half of the portfolio) and Europe (20%), with the rest in Asia and other regions.

About 80% of the foreign currency exposure is hedged, commonly using a short-term rolling hedge, according to company disclosure of the top insurers as of 2015. Hedging is much more important to countries such as Taiwan that have large foreign allocations, so they are able to hedge against holding assets in a foreign currency. Typically, there are two types of ways to hedge. The first is on a short-term rolling basis, as Taiwan does, which has the benefit of a lower hedging cost but the disadvantage of exposure to the uncertain hedge cost when rolling over in the future. The second is to hedge against the duration of the investment, which has the advantage of a locked-in hedge cost but the disadvantage of a high hedging cost or sometimes the possibility of the hedging instrument being unavailable.

Japan and KoreaInsurers in both Japan and Korea are increasing allocations to overseas investments, but less aggressively than insurers in Taiwan.

About 80% of Japan’s and 90% of Korea’s overseas investments are in foreign bonds. In Korea, about 40% of the overseas bonds are in Korea Paper, meaning foreign-currency-denominated bonds issued by Korean entities. Korea Paper has become an easy way for local insurers to start capturing the yield differential via the credit profiles they are familiar with.


If we review the top three insurers in Korea and Japan, we can see the typical country allocation to foreign bonds consists of around half in North America. Japan insurance companies invest a further 30% in Europe, and Korean insurers invest a further 2% in Europe. It is clear, therefore, that developed markets are the favored investment targets when going offshore.

Short-term rolling of foreign exchange (FX) forwards is common in Japan for hedging currency risk arising from investments to foreign bonds. This is due to Japan’s extreme low-interest-rate environment with a flat yield curve. Some companies keep certain “naked” (unhedged) positions, depending on the tactical short-term view of exchange rates.

In Korea, foreign bonds must be hedged back into local currency with an instrument that has a tenor of one year or longer to recognize the full duration of the bond for the calculation of interest rate risk under the local risk-based capital (RBC) framework. For example, if an insurer invested in a 10-year US-dollar-denominated bond and used a three-month FX derivative, it would only be recognized with a duration of three months. But if an insurer invested in a 10-year US-dollar bond and had a one-year FX derivative, it would be recognized as an investment with a duration of the full 10 years. This is key for life insurance companies that manage long duration liabilities and seek investments to match the duration.

The Korean regulator, however, recently has announced that it will amend this rule to recognize the actual duration of foreign bonds for the local RBC framework, which will give insurance companies more flexibility when managing FX risk.

Source: Report from Life Insurance Association of Japan issued on December 2nd, 2015. Report from Bank of Korea issued on December 4th, 2015. Japan as of FY 2014, Korea as of Q3 2015.

Japan and Korea: Foreign Investments Asset Allocation

Japan

Foreign Gov'tBonds 33%

Foreign Corp.Bonds 46%

ForeignStocks

8%

Other ForeignSecurities

13%

Korean Paper40%

Bond52%

Equity8%

Korea


ChinaThe overseas investments by China’s insurers differ quite substantially from their peers in Taiwan, Japan, and Korea.

China insurers’ overseas investments have accelerated since 2012 as regulatory authorities have released more details about rules for overseas investments. While the overseas allocation percentage increased from less than 1% in 2012 to above 2% in 2016, it’s still very low compared with other Asian countries. However, in assets allocated, the number is significant at US$49.21 billion. Most of the top insurers have aggressive plans to expand overseas investments in the near future, though we believe the pace at which insurers are able to invest will be governed by cross-border capital controls, such as the Qualified Domestic Institutional Investor (QDII) rules.

Most insurers began their foray into overseas investments with Hong Kong equity, as it is more familiar, or with alternatives such as private equity and real estate. Very recently, we have seen a number of insurers take a more systematic approach to plan their overseas portfolio, such as starting with a strategic asset allocation study. Multi-asset allocations have

been invested in or are being investigated by, a number of top insurers through partnerships with global asset managers. While overseas bonds have been unpopular due to the lack of yield attractiveness in the past couple of years, we think that is likely to change in the near future because of rising rates in the US.

We expect China insurers’ overseas asset allocation, which currently focuses quite aggressively on risky assets, to follow the lead of Japan and Korea and expand gradually to include less risky assets, such as bonds. At year-end 2016, 53.4% of Chinese foreign assets were invested in public assets (including deposits, bonds, equities, and funds) and 44.9% were in private equity and property, the majority of which are invested in developed countries, such as Hong Kong, the US, the UK, and Australia.

There is no public data on how much of the industry’s overseas investments are currency hedged. According to our discussions with the market players, we believe most of the investments are not hedged at the moment, which makes sense given China’s weak domestic currency.

Source: 21st Century Business Herald. As of 2015.

Korean Paper*40%

Bond52%

Equity8%

Equity46%

Private Equity25%

Real Estate12%

Deposit10%

Bond 4% Other 2%

China: Overseas Investments Asset Allocation


What to consider when allocating overseasInsurers in Asia often ask why Taiwan, Japan, and Korea have quite a different level of allocation percentage into overseas markets. The reason varies, depending on four key considerations we think every insurer should review before setting up an overseas allocation.

1. The local capital market and available instrumentsSince their portfolios are liability-driven investments, insurers, especially life insurers, have to commit the majority of their assets to fixed income assets. However, local fixed income markets are not always large enough to absorb insurance assets. For example, in Taiwan the insurance asset base is double the size of the local government and corporate bond markets combined. As such, Taiwanese insurers have had to go abroad to find fixed income assets to match their liabilities. While Japan has a large government bond market, it currently offers extremely low yields, and the local corporate bond market is relatively small.

Source: Taiwan Insurance Institute, The Life Insurance Association of Japan, The General Insurance Association of Japan, Korea Life Insurance Association, The General Insurance Association of Korea, Bloomberg, PineBridge analysis. Insurance asset size as of FY 2015. Local bond market size as of May 16, 2016.

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Insurance Assets Gov't bonds Corp. bonds

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Insurance Assets and Local Bond Market Size


2. Yield differentialYield differential is dynamic and can switch from positive to negative over time. In the past seven years, overseas bonds have, more often than not, helped enhance the yield for insurers in Taiwan, Japan, and Korea.

Adjusting the 10-year US Treasury yield with the FX hedge cost in each market can be an indicator of the US dollar bond yield in local currency terms. It has been higher than local government bond yields most of the time in each of the three countries and was one of the drivers for insurers to invest in US dollar-denominated bonds for yield enhancement.

The recent rally of the US Treasury yield has widened interest rate differentials of Asian countries, which contributed to higher FX hedge costs. Hence, Asian insurance companies are increasingly looking for opportunities in A-BBB rated credits, rather than sovereigns.

Source: Bloomberg, PineBridge analysis. Note: The FX hedge cost/premium is calculated assuming a three-month rolling of the FX forward for Taiwan and Japan and a 12-month rolling of the FX forward for Korea to reflect the market practice.

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2010 2011 2012 2013 2014 2015 2016

Korea - 10yr UST hedged yieldKorea - 10yr local Gov't bond yieldTaiwan - 10yr UST hedged yield

Taiwan - 10yr local Gov't bond yieldJapan - 10yr UST hedged yieldJapan - 10yr local Gov't bond yield

Yiel

d

The Yield Differential of Overseas Bonds Versus Local Bonds


3. Investment marginThe insurance industries in Japan, Taiwan, and Korea have experienced negative investment margins in the past few years. Recently, however, some positive signs have emerged in Taiwan and Japan, as liability costs are lower and investment returns are higher. Naturally, insurers running negative investment margins are more motivated to seek new investment ideas and in general are more willing to take extra risks.

Based on the public information available in each market, we can see that the major insurance companies in Taiwan have continuously improved their investment returns, which marginally cover their liability needs. Japan has also managed to overcome their negative investment margins since 2013. Korea, however, is still under pressure due to a sizeable portion of legacy insurance policies underwritten when the interest rate was high.

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2011 2012 2013 2014 2015

Portfolio returnLiability cost

Investment Margins - Taiwan

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Investment Margins - Japan


4. Regulation and solvencyRestrictions that may limit the level of overseas investment are the regulatory controls and caps on the maximum total percentage of a portfolio to be allocated abroad. Japan’s insurance industry does not have such restrictions, whereas Taiwan, Korea, and China have a 45%, 30%, and 15% cap, respectively. However, special waivers to further lift from 45% are common practice among top insurers in Taiwan.

The impact on solvency is also something of a concern. For example, the solvency capital charge ratio for unhedged currency risk is below 5% in Taiwan and China, while it is 8% in Korea and 10% in Japan. The other less explicit solvency concern surrounds the duration of overseas bonds and whether overseas bonds are treated the same as local bonds. If they are not, an additional solvency capital requirement may be triggered due to the duration gap.

This is indeed a concern in China under the C-ROSS regulations. Chinese insurers will need to measure the solvency impact when their overseas bond allocations rise materially in the future. In Korea, as long as there is at least a one-year currency hedge arrangement, the duration of the invested foreign bond would count in full. In Taiwan and Japan, there is no explicit link between the duration gap and the solvency charge, so it is not as big of a concern. Taiwan insurers are required to hold capital against a negative investment margin, which provides the incentive to seek higher returns abroad.

Source: Company disclosures of Cathay Life, Fubon Life, Shin Kong Life; Taiwan Insurance Institute; PineBridge Analysis; HSBC Research dated 26 June 2014; the report from Life Insurance Association of Japan issued 2 December 2015; and the report from Financial Supervisory Services published in September 2015 in Korea.

4.0%

4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

5.4%

Dec. 2013 Jun. 2014 Dec. 2014 Jun. 2015

Reserve Rate

Investment Yield

Investment Margins - Korea


Overseas investing boils down to risk and ALM appetiteAlthough overseas investments can enhance yield and diversify the risk of the overall portfolio, they introduce additional risks that insurers may or may not be comfortable with.

Rollover risk of a currency hedge is a good example of this: Under a rolling hedge program, it appears that the currency risk is hedged, and it normally does not trigger any solvency capital requirement under most solvency schemes. But the rollover risk is a real economic risk. Also questionable is whether the duration of overseas bonds should be counted as a match for the duration of local liabilities, since the foreign and local rates can sometimes move in different directions. Eventually, it will be a tradeoff of yield enhancement needs versus risk and asset/liability management (ALM) appetite.

The paths the insurers in these advanced economies have taken toward expanding their overseas allocations can serve as a guide for other Asian insurers looking to invest offshore. By examining these developed insurance market portfolios, less developed markets can take these lessons into account as they begin to address the pressing need to diversify and manage risk over the long term.

About the Authors

NANCY KONGVice President, Insurance Asset ManagementPineBridge Investments, Hong Kong

Ms. Kong joined PineBridge in 2014 and is responsible for providing tailored investor solutions, asset and liability management advice, as well as developing the firm’s business with insurance firms globally. Prior to joining the firm, she was Deputy Chief Investment Officer at ING-BOB Life Insurance for over 2 years where she was responsible for strategic asset allocation, macro economy research and government/financial bond portfolio. Before that, she spent 3 years at ING Insurance and ING Investment Management (Hong Kong & the Netherlands) in several functions including investments, asset & liability management and investment risk management. Ms. Kong holds both a Master’s and a Bachelor’s degree in Economics from Fudan University and the Northeastern University in China, respectively.

YONGHO LEE, CFAVice President, Insurance Asset ManagementPineBridge Investments, Hong Kong

Mr. Lee joined the firm in 2014 and is responsible for providing tailored investor solutions and, asset and liability management advice, as well as developing business with insurance firms globally. As Head of Investment Planning at ING Life Insurance Korea, he was responsible for setting and reviewing liability driven asset allocation strategy for the General Account, as well as performing investment analysis and due diligence on new investment opportunities. Prior to that, he worked in the Treasury Department of Industrial Bank of Korea. Mr. Lee holds a Bachelor’s degree of Commerce in Finance from The University of New South Wales. He is also a CFA (Chartered Financial Analyst) Charter Holder, and has the CCIM (Certified Collective Investment Manager) qualification granted by the Korea Financial Investment Association.

PineBridge Investments is a global asset manager with experience in emerging and developed markets,and investment capabilities in multi-asset, fixed income, equities and alternatives. Our firm is differentiated by the integration of on-the-ground investment teams of more than 200 professionals, providing investors with the combined benefits of global fundamental perspectives and analytical insights. We manage over US$82 billion as of 31 December 2016 for a global client base that includes institutions, insurance companies, and intermediaries.

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Last updated 6 March 2017.

Allocating Overseas: What Asia Insurers Can Learn …...Allocating Overseas: What Asia Insurers Can...

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