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Mar 2021

Low interest rates suppress Korean, Chinese and Japanese insurers' operating margins in 2021

Source: Asia Insurance Review | Jan 2021

Terrence Wong

The credit profiles of the Asia-Pacific insurance sector are predominantly influenced by key factors including consistently low interest rates, the severity of a negative spread, risky assets exposure, pricing adequacy, a duration mismatch gap between assets and liabilities, growth dynamics and local regulatory initiatives. Fitch Ratings’ Mr Terrence Wong looks at three core markets.
While the 2021 outlook on the Korean life insurance sector is worsening, the outlook on the country’s non-life sector is stable. Fitch’s sector outlook for the Chinese and Japanese insurance markets is stable. The 2021 sector outlook is based on an updated definition by Fitch that takes into consideration the underlying fundamentals we expect in 2021 relative to the actual fundamentals in 2020.
South Korea – coronavirus pandemic continues to impair business stability
The worsening sector outlook for the Korean life insurance market reflects Fitch’s concerns on the escalating negative spread burden of major life insurers, about 100bp on average in 1H20, arising from legacy products with an average crediting rate of 6% or more, amid a prolonged low-interest-rate environment. On the other hand, Fitch’s stable sector outlook for Korea’s non-life insurance in 2021 recognises the favourable growth prospect of long-term medical indemnity and the general insurance segment while the industry should continue to be challenged in managing the loss ratio.
The coronavirus pandemic will continue to impair the overall business stability of Korean insurance. Restrictions on face-to-face distribution channels due to persisting social distancing measures and potential asset volatility associated with volatile movements in equity markets are likely to remain, depending on how the epidemic situation evolves.
The profitability of non-life insurers is likely to be less pressured, although underwriting margin should remain under pressure primarily because of high loss ratios in the motor and long-term medical indemnity business. Fitch expects the overall earnings of life insurers to shrink steadily in the near to medium term in light of a higher burden for reserving and lower investment yield.
The industry capital strength could come under further pressure once a new solvency regime, K-ICS, is introduced in 2023, although it would have a larger impact on the lifers that have a longer duration of insurance liabilities to be valued on a market-value basis. The local risk-based capital (RBC) ratio under the current regime is likely to increase marginally in the near term, supported by the supplementary capital issuance and thinner surplus margins.
China – capitalisation to remain healthy, supporting business expansion
The stable sector outlook on China’s insurance market factors in the expectation that Chinese insurance sector will have faster growth dynamics due to continued economic recovery from the coronavirus pandemic. Fitch expects insurers to maintain healthy capital strength to support business expansion and asset risks in both life and non-life sectors.
A growing ageing population and increase in risk awareness after the COVID-19 outbreak are likely to lead to a surge in the need for long-term health insurance and services, as well as demand for long-term saving products. The regulatory guidance on health insurance, which was announced by the China Banking and Insurance Regulatory Commission (CBIRC) in 2020, could encourage insurers to explore growth opportunities in this segment, particularly long-term medical insurance. However, limited historical data of long-term medical expenses and evolving morbidity rates may pose mispricing and reserving risks for insurers amid rapid healthcare market development.
Non-life premium growth will accelerate steadily, with a rising demand from the non-motor business due to regulatory initiatives. In July 2020, CBIRC has promoted disciplined and steady development of both the motor and non-motor insurance segments over the next three years. Agriculture, catastrophe insurance, liability, accident and health insurance will remain the growth drivers. The non-motor business grew by 13.8% on y-o-y basis in 3Q20, although the outbreak of COVID-19 greatly suppressed expansion in 1Q20.
While the implementation of comprehensive motor insurance pricing reform could undermine the margins of smaller non-life insurers, Fitch expects that economies-of-scale will still enable the larger motor insurers to sustain profitable underwriting results. The shift in insurers’ product focus to long-term products, regular-pay and wider-margin products with more protection features will continue to enhance the mortality and morbidity gains of the larger life players despite consistently low recurrent investment yield and a more competitive market landscape.
The agency expects insurers’ solvency position to remain sound. Lower bond yields along with relaxation of the cap of equity limit could prompt insurers to raise equity-type investments, making insurers more vulnerable to extreme equity market movements. However, we believe most of the insurers are unlikely to take an irrational approach to additional asset risk, with the resultant more stringent capital requirement under the coming implementation of the China Risk-Oriented Solvency System (C-ROSS) phase II.
Japan – underwriting fundamentals likely to stay resilient 
Fitch’s stable sector outlook on Japan’s life and non-life markets is based on Japanese insurers’ earning stability, which is backed by seasoned in-force policies, stable results and favourable pricing. The insurers’ underwriting fundamentals are likely to stay resilient overall despite the economic stress from the coronavirus pandemic.
Japanese life insurers’ underwriting profitability is likely to remain solid given their business focus on steady and profitable protection products, especially the most profitable and moderately growing ‘third’ (health) sector. Their earnings are sustained by policies which have been accumulated over recent decades. Fitch estimates that more than 95% of Japanese traditional life insurers’ underwriting profits are derived from their in-force book of businesses which have very low surrender and lapse rates. As a result, the negative impact from the slow pace of ongoing new business due to social distancing under the pandemic is likely to be minor.
While it is highly probable that Japanese non-life insurers will have to cope with rising natural catastrophe risks in Japan, they are likely to maintain decent underwriting profitability from the domestic market, due partly to continued premium rate hikes, reinforced by a virtual oligopoly.
Fitch expects continued accumulation of retained earnings and capital reserves to underpin the capital adequacy of Japanese insurers. The average statutory solvency margin ratio of the nine traditional life insurers stayed solid at 1,012% at end-September 2020, from 1,000% at end-March 2020, and that of the four major non-life insurers remained strong at 774%, from 747%. Insurers are also likely to keep strengthening their capital by issuing hybrid securities, especially when they undertook major M&A transactions. Hybrid securities are qualified as regulatory capital in Japanese insurers’ solvency margin calculation.
Most Japanese insurers, which include both life and non-life insurers, have substantial exposure to domestic equity, foreign credit and/or currency risks. The negative rating outlook on five out of 10 rated insurers reflects our concern that insurers’ capitalisation could be vulnerable to potential extreme capital market volatility amid the COVID-19 outbreak.
We expect low interest rates to suppress insurers’ operating margin in 2021 in South Korea, China and Japan. Non-life insurers’ growth dynamics are going to be underpinned by continued economic recovery in these three regions. In consideration of overall credit fundamentals, insurers’ flexibility to maintain adequate solvency to fund their growth, buffer assets risks, and to support M&A transactions is likely to remain largely intact in the region. A 
Mr Terrence Wong is senior director, insurance ratings with Fitch Ratings.
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