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One of the few constants in Asia’s diverse and dynamic life insurance landscape is the search for long-dated investments that hedge liabilities. By nature, the industry generates liabilities that tend to have a longer duration than the assets on life insurers’ balance sheets. The resulting duration gap exposes life insurers to changes in interest rates that will soon incur higher capital charges due to the new risk-based capital (RBC) regimes being introduced across Asia. In addition, insurers could face increased volatility in their balance sheets as the new accounting standards in IFRS 17 (and IFRS 9) come into effect on 1 January 2023.
Against this backdrop, there is an urgent need for improved asset/liability management (ALM) practices among the region’s insurers. Here, we outline potential approaches for insurers to reduce the mismatch between their assets and liabilities and to better manage their interest-rate exposure.
Domestic fixed income assets are the most obvious ALM tool because of the predictable nature of the cash flows and their likely alignment with the principal currency of the liability exposures. However, the lack of depth and maturity in many Asian markets (Figure 1) means that the supply of domestic fixed income assets often fails to meet the specific demands from domestic life insurance companies. Insurers must also contend with the limited availability of long-dated bonds in local currency, which is particularly true of the corporate sector.
A number of diversification approaches across asset classes and regions could offer potentially compelling solutions to the duration mismatch problem.
Diversifying across a varied mix of investment options is becoming increasingly important for Asia’s life insurers as they confront the new accounting and capital regimes across the region as well as an increasingly uncertain market backdrop. Implemented thoughtfully, with the attendant currency hedging and collateral management, the diversification approaches outlined above may go some way to addressing the challenges.
Read more in our latest paper, A practical guide to addressing Asian insurers' interest-rate risk.
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