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Opportunities for investment growth amidst a regulatory power up

Source: Asia Insurance Review | Aug 2017

As the market dynamics in the West continue to shift, Asia is finding its own way towards sustained growth, market liberalisation and cross-border collaboration. Supporting the growth in demand for investable assets is going to be a high priority and this will have to come from a combination of domestic investment innovation and pragmatic foreign asset class integration. In this article, Mr Paul Sandhu of Conning Asia Pacific Limited, outlines some of the new and evolving market dynamics facing insurers in Asia, specifically in China, and possible solutions to support the upward momentum of Asia’s insurance market.

Asia’s insurance market has expanded substantially over the last few decades, purely fuelled by increased market penetration. A new phase of opportunities has now emerged; coming from investment/technology innovation, regulatory/accounting reform and changing distribution models.
   Insurance assets under management in Asia stand at US$10 trillion at the end of 2016, with Japan and China contributing around 75%. However, while Japan has been in single digit growth, China continues to grow its insurance AUM at ~20% a year on average. Given the current estimates, Chinese insurance AUM could top $6 trillion by 2022, overtaking Japan as the largest insurance market in terms of AUM in Asia. Figure 1 shows the annual growth of insurance AUM in China.
Total Insurance Assets for Companies operating within China
   This significant expansion creates a need for nearly $3.5 trillion of new assets over the course of the next five years. 
   As Chinese domestic investment returns decline, many companies are currently seeking alternative and foreign asset exposure to support the expansion of their portfolio. The China bond market is projected to be the second largest in the world, overtaking Japan in the next five years. That contributes to $3-4 trillion of new available debt in the market. However, China’s non-financial sector credit already hovers at roughly 200% of GDP, which is 25% higher than many advanced economies. This could lead to a slower expansion of the debt market. 
   Expanding insurance portfolio needs, coupled with non-insurance investment market needs could result in a highly correlated and unbuffered powder keg of significant tail events.
Silver lining
In Asia, many markets have either direct or indirect cross-border investment constraints, which together with high issuer concentration, leads to highly sensitive markets exhibiting hard and quick drawdowns. Investors with a long-term, strategic perspective are left with an investment conundrum. 
   Yet, there happens to be a silver lining. The characteristics that make the domestic markets highly-correlated and prone to significant drawdowns are also the same characteristics that contribute to a lower correlation when investing across markets. Having the ability to invest in foreign markets could yield not only exposure to asset classes with beneficial risk adjusted return attributes, but also ones with significantly lower correlations. 
Potential of foreign investment for Chinese insurers
The China Securities Regulatory Commission (CSRC) is currently not approving any further quota under their Qualified Domestic Institutional Investor (QDII) programme. However, the Chinese Insurance Regulatory Commission (CIRC) has an upper limit of 15% for foreign investment even though currently the average across insurers sits at roughly 2%. This potentially gives insurers the ability to pursue a significant amount of uncorrelated foreign assets once the QDII programme is back online. 
   Given this potential of added foreign investment in pursuit of diversification, the regulators are preparing insurers by moving ahead with reforms around solvency capital and asset-liability management. 
Setting up the future of investing through evolving regulations
Since the introduction of a risk-oriented solvency framework (C-ROSS) last year, the CIRC has been continuously reviewing the requirements. While insurers wait for further revisions to C-ROSS, the CIRC will be unveiling new ALM regulations which may require new infrastructure, including tools, processes and resources to be added within insurance companies. The result of which will be stronger ALM governance, a longer-term investment focus, and more robust decision making, underpinned by analytical modelling. The new ALM regulation is expected to be released this September or October.
   Those insurers who fully embrace ALM best practices will also be best placed to reap more flexibility in investable asset classes, including oversea investment. A robust ALM/SAA process will be a pre-requisite before insurers decide how to allocate their investments across different economies and asset classes. 
Portfolio optimisation across the globe
To take full advantage of the new CIRC requirements, a well-developed and robust ALM/SAA framework utilising stochastic projections that effectively project tail stress scenarios will be of increasing importance. Using this advanced decision making framework, insurance companies can effectively optimise their portfolios to minimise drawdowns. 
   The example in Figure 2 shows the economic value projections for a Chinese insurer utilising stochastic modelling in order to calculate tail risk for varying portfolio strategies with a focus on foreign equity allocation. Increasing the portion of foreign equity decreases the tail risk, while lowering returns. The optimal allocation can be determined by setting a risk budget and optimising the equity allocation against it.
Distribution of Economic Value over different investment strategies
Allocation to equites under different investment strategy
Asia shifts from sky high growth to building a robust foundation of stable growth and balance
The global market continues to shift, fuelled by expansion, disruption and politics. In parallel, and as a consequence, we are seeing an extensive “re-pricing” of risk through regulatory reform and cross-border experimentation. 
   In China, the most advanced solvency framework in Asia has been running for two years, but has already led to significant changes to insurers’ portfolios, and more importantly fundamental changes to the investment decision making process. Two key consequences of the regulatory reform are: 1) a stronger link across the balance sheet and through to shareholders’ capital and 2) a longer term strategic perspective focused on mitigating drawdowns through enhanced 
   Insurers in Asia stand at the top of a major fundamental regime shift, that has the potential of pushing a new growth cycle, fuelled by investment and technological innovation, regulatory/accounting alignment and expanded distribution. The incorporation of advanced modelling techniques and sophisticated frameworks capable of connecting these dynamics is increasingly necessary and will allow senior management to make the critical decisions to achieve success in this evolving market. A 
Mr Paul Sandhu is Head of Investment Solutions at Conning Asia Pacific Limited. 

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