Asia Pacific's increasing affluence and growing insurance markets continue to drive the region's
insurance markets. Premium growth outpaces global averages, especially for the region's emerging markets, attracting capital from global insurance groups, says S&P Global Ratings.
Trends in profitability, however, are weighed down by volatile underlying investment markets, mounting competition, and rising compliance costs. Furthermore, damages caused by Typhoon Jebi and Typhoon Mangkhut will dent the earnings of nonlife insurers and reinsurers.
S&P believes senior managers will reposition business strategies, and focus on improving asset-liability management, in order to steady profit prospects.
The credit outlook for the Asia-Pacific insurance sector remains stable. In the year to 31 August 2018, S&P's rating actions showed a net negative bias of -1% across the Asia Pacific portfolio of over 150 rated insurers. Most rating actions over the past years involved revisions to ratings outlooks.
However, the tide could change. Insurers could become secondary casualties to the credit cycle, given their fixed income holdings. The potential disorderly unwind of debt leveraged positions and elevated asset prices within the region's capital markets (built up over the past decade) exposes Asia Pacific insurers to heightening credit risk.
Investment market volatility is top risk
After a decade-long wait, Asia-Pacific insurers are finally seeing a turn in the monetary cycle. Higher interest rates generally benefit insurers and dilute the need for reserve provisioning, however there are risks during transitional periods, related to the pace of rate hikes and the maturity of the existing investment assets. Mismatched speeds of tightening cycles in local and overseas markets may result in volatility to the insurers' balance sheets.
Over the past few years, insurers have increased their exposure to less liquid and long-duration infrastructure and real estate assets to counter the impact of low interest rates. The revaluation of these assets could potentially result in capital losses. In addition, the potential credit cycle downturn may result in heightened defaults and increased sensitivities toward credit risk. In the case of Japan, declining domestic interest rates prompted insurers to increase their allocation to overseas investments.
As asset liability management takes centre stage, demand for longer-duration investments assets will likely grow. In China, for example, leading insurance groups are focusing more on protection policies than the savings-type policies, which dominated growth over the past few years. These protection policies tend to be higher margin, in part because there is less investment guarantee to meet; they also will increase the need for long-duration investment assets. In China, S&P additionally anticipates increasing allocation toward infrastructure projects, which are often longer in duration than typical corporate bonds. The recent US-China trade tensions have resulted in volatile emerging market currencies and equities.
While Asia Pacific insurers' unhedged foreign exchange exposure is limited, the sensitivities toward foreign exchange movements has increased, particularly those of Taiwanese and Japanese insurers which have had above regional peers' allocation toward foreign currency-denominated bonds.
Busy times ahead
On the regulatory front, processes for strengthening risk management and enhancing regulatory capital framework remain top of the agenda. Complying with updated standards, including refinements of capital risk weightings and intermittent QIS testing, is demanding of time and human resources. Increased investments in actuaries, financial reporting personnel, dedicated risk officers, and others should improve enterprise risk management and ultimately financial strength. However, they are costly and drive down profitability. For small and midsize insurers, increased regulatory reach can put a strain on existing resources.
While the implementation of International Financial Reporting Standard (IFRS) 17 by 2021 still seems far away, insurers have already stepped up their efforts to prepare for this major update on how insurance liabilities are valued. Volatility in capital assessments may increase after liabilities are discounted based on current market equivalent rates. In South Korea, insurers have been increasing hybrid and subordinated debt issuance to boost capital positions while repositioning their business strategies to focus on protection products.
Increasing frequency of weather-related claims
After a series of destructive typhoons, including Typhoon Jebi and Typhoon Mangkhut, property damage and auto insurance losses will likely lead to nonlife insurance underwriting losses in Japan, Hong Kong, and China.
While S&P expects the brunt of the claims to be borne by domestic insurers, some of the large exposures may be absorbed by the international reinsurance markets. These large exposures include business interruption and property damages caused by floods.
Consequently, S&P believes lines such as property damage and auto insurance will see moderate rate hikes.
The unprecedented strengths of this year's typhoons bring a timely reminder about unmodeled risk exposures. S&P continues to see risks over outdated catastrophe models. The limited loss data (particularly for emerging markets) had raised concerns over pricing inadequacy.
The international credit agency believes many insurers and reinsurers are still using less robust models to ascertain risk pricing and reinsurance covers. While there had been updates and new releases to various catastrophe perils, the still limited risk awareness by domestic insurers had resulted in slow uptake.
The previous influx of capital to the reinsurance sector globally and mostly benign catastrophe environment had kept prices low. However, the rapid urbanisation of emerging Asia (particularly populous southern China) introduces new risks (though also opportunities) for insurers and reinsurers. S&P anticipates awareness around flood risk to increase after record storm surges hit coastal cities (such as Hong Kong, Macau, Shenzhen, and Guangdong), prompting greater uptake of insurance and reinsurance coverage.