Insurers are always vying for increased profitability, and low interest rates have been hampering their investments over the past few years. However, with interest rates climbing, insurers have a chance to recover some of the ground lost over the past few years. Asia Insurance Review spoke to experts from Fitch and HSBC Asset Management to find out more.
To most insurers, rising interest rates are both negative and positive: They tend to depress the value of assets and liabilities at the same time, and to make any mismatch between the two more visible, for good or bad.
IFRS17 and other reforms which generally push for more ‘mark to market’ of both assets and liabilities are, in this sense, pro-cyclical, and will push insurers in the region to adapt their portfolios accordingly.
This is happening already in Singapore, for instance, with Risk Based Capital II framework, according to HSBC Asset Management (Singapore) CEO and head of Southeast Asia Patrice Conxicoeur.
“In terms of investment strategies, this means that insurers will tend to prefer, even more than usual, strategies that will help them minimise asset liability gaps, and to build cushions, thanks to increased returns for instance with higher yielding strategies. Nonetheless preferences remain for investment grade, fixed income strategies, and more recently, an ever-increasing use of alternatives, particularly in the direct lending space, including infrastructure lending,” he said.
Fitch has observed such activity in Japan and China, with insurers being more cautious and waiting for the best timing to accumulate bonds aggressively. Japanese insurers want to avoid the situation where the bond yield continues to rise after they accumulate bond holdings aggressively.
“They are likely to buy more bonds aggressively when they think the bond yield is approaching nearly the peak for now, but the judgment on timing would be different, which depends on each Japanese insurer,” said Fitch Ratings director of insurance Teruki Morinaga.
According to the CBIRC’s statistics, Chinese insurance industry’s investment portfolio is composed of bonds (40% at end-May 2022 vs 39% at end-2021), alternative investments (36% vs 37%), stocks and funds (12% vs 13%) and cash and deposits (12 vs 11%). Insurers may gradually raise traditional bond investments and even cash and deposits, not purely responding to a potential rise in interest rates but considering own liability structures as well as their solvency positions under C-ROSS phase 2, which has stricter capital requirements for risky assets.
The need for sustainable investments
The most recent development within the industry lies in the need to ensure a carbon-neutral footprint, on both sides of the balance sheet. Many insurers across Asia have been exploring investments into ESG-related assets, which have less of an impact on ROI than would be expected.
“Our research shows no evidence that ESG investing would come at the expense of performance in any asset class, for instance bonds, equities or loans. On the contrary, we note that issuers (of debt or equity) with high ESG scores tend to display features that were historically associated with ‘quality’, ‘value’, or ‘lower risk’,” said Mr Conxicoeur.
“That being said, one must note that most investors that we work with, and this would include insurers, are reducing their carbon footprint and generally improve the ESG features of their investment portfolios. In the insurance sector, and particularly for life insurers, the nature of the investment portfolios means that these changes cannot be made overnight, and the transition is bound to take multiple years.”
He also noted that insurers generally do not make direct commodity investments, such as oil and gas. While undoubtedly most have indirect exposure via their fixed income and equity exposures, the clear trend at the moment is down, owing to the growing prevalence of ESG investment principles.
Japan and China seeing improved returns through ESG
Insurers in Japan, especially, are feeling increased pressure from investors/stakeholders that Japanese insurers have to invest in more ESG-related assets. According to Mr Morinaga, however, as most Japanese insurers want to accumulate more ‘ESG-related assets’ the investment yield of these assets tends to become compressed due to stronger demand than supply.
“As of now, Fitch observes that most Japanese insurers do not want decreasing investment performance because of ESG, so most Japanese insurers are investing in ESG-related assets only if the investment yield is about equivalent to other options (only if the investment yield from ESG related asset is acceptable) on the whole,” he said.
In China, ESG funds as a whole achieved better returns than the market average. According to Ping An’s ESG report in November 2020, investment in actively managed funds generally delivered better returns than passive index ESG funds. Top-tier insurers, such as Ping An, China Life, are committed to pursuing sustainable development and attaining healthy overall returns through diversified investment portfolio.
“Insurers with strong risk management introduced ESG evaluation into their decision-making process for investment projects, help them attaining favourable investment returns and reducing volatilities, particularly in light of current macroeconomic environment,” said Fitch Ratings director of insurance Stella Ng.
Battling ‘greenwashing’
Japanese insurers acknowledge that ‘consensus or definition on ‘what are ESG related assets’ is different between Europe and the US (and between Europe and Japan), and there is difference of opinion even within Europe. Therefore, Japanese insurers are expected to continue adjusting the definition of ESG-related assets in a flexible manner going forward.
“Also, we note that Japanese insures are strengthening the communication with relevant international organisations. For example, Mr Kimura (Nippon Life’s senior executive) has become one of the board members of United Nations’ Principles for Responsible Investment,” said Mr Morinaga.
In China, insurers’ ESG efforts are mainly driven by government-related initiatives and are still in the developing stage. Fitch believes that the ‘greenwashing’ effect is unlikely to affect insurers’ overall investment strategies at this stage.
Russia-Ukraine war has limited effect
Russia president Vladimir Putin’s invasion of Ukraine has exacerbated tensions which were already latent, be it in terms of inflation, associated monetary policies, and market volatility. As ever, in times of crisis, risk appetites tend to shrink, and overall, Mr Conxicoeur believes that the crisis compounds trends already highlighted above.
“The irony is that overall higher interest rates are a good thing for the insurance industry when they are stable. It’s the transition from ‘too low for too long’ to higher rates which is painful, especially when associated with so much macroeconomic and monetary variables.
Understandably, caution is therefore key, but this certainly doesn’t stop insurers from preparing for the future, specifically by doing their due diligence on new strategies, many of them in the alternative space, and with a clear ESG angle,” he said.
Fitch noted that the exposure to Russia/Eastern Europe is negligible for Japanese insurers, and Fitch has not observed any meaningful direct impact.
Further, based on its communication with rated issuers, investment exposure to Ukraine is very limited, with Fitch not seeing the war in Ukraine having significantly affected insurers’ investment strategies. A