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A practical guide to addressing Asian insurers’ interest-rate risk

Max Davies, CFA, CAIA, Insurance Strategist
Francisco Sebastian, FIA, ALM & Regulatory Capital Strategist
2023-11-30
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

Key points

  • A lack of long-duration fixed income securities in Asia means that many life insurers in the region are operating with assets that have meaningfully shorter duration than their liabilities. A changing regulatory backdrop has heightened the need to address this mismatch. 
  • Diversifying into the non-domestic corporate bond market and investing in alternatives may offer insurers a solution to meet both their duration and yield objectives. 
  • Incorporating derivatives into an asset/liability matching (ALM) strategy may help to address insurers’ overexposure to interest-rate risk. 
  • Insurers may also wish to reconsider how to construct their equity exposure to supplement their ALM objectives, focusing on equity sectors that correlate favourably with their liabilities.

The Asian insurance landscape is heterogenous. The practical realities of each market vary significantly because of differences in the nature of the insurance products, the prevailing regulatory regime, the maturity of the industry and the level of market penetration, as well as the limited availability of suitable investments in the region’s domestic capital markets. 

Yet one common theme runs through the region: the strong demand from life insurers for investments to match their long-dated liabilities. Most of the region’s life insurers find themselves in a position where their asset exposures are meaningfully shorter duration than their liabilities, which makes interest rates one of the largest drivers of risk on Asian life insurers’ balance sheets, exposing them to the resultant economic and accounting risks arising from movements in rates. 

The problem is driven by the short-duration nature of much of Asia’s domestic capital market in comparison with the long duration of the life insurers’ historic guaranteed insurance products. The introduction of risk-based capital (RBC) regimes across the region and the new IFRS 9 and 17 accounting standards will make these duration mismatches both capital intensive and volatile for earnings.

Against this backdrop, there is an urgent need for improved asset/liability management (ALM) practices as insurers will be subject to more market-value-based accounting and regulatory frameworks. Here, we outline a number of approaches for insurers seeking to reduce the mismatch between their assets and liabilities and better manage their interest-rate exposure.

Why is there a duration mismatch? 

While government and domestic corporate bonds typically dominate the core ALM portfolios of life insurers in Asia, lack of supply of domestic fixed income assets, limited availability of long-duration bonds and unattractive yields have led to a significant duration mismatch between many insurers’ assets and liabilities. This mismatch makes interest rates one of the largest drivers of risk on life insurers’ balance sheets, and is most pronounced in Japan, Taiwan, South Korea and Hong Kong (Figure 1) because of the large proportion of long-dated guaranteed products sold in these markets. 

The demand for investments with longer duration is often accompanied by a demand for yield driven by the high guarantees associated with long-term policies that were written when interest rates were far higher. Balancing these goals is a core objective of any ALM programme.

Figure 1
solving-the-duration-mismatch-a-practical -guide-to-addressing-asian-insurers-interest-rate-risk-fig1

The introduction of RBC regimes across many Asian jurisdictions over the coming years (Figure 2) will exacerbate this challenge, as it introduces new capital considerations.

Figure 2
solving-the-duration-mismatch-a-practical -guide-to-addressing-asian-insurers-interest-rate-risk-fig2

Lack of supply of domestic fixed income assets

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 means that the supply of domestic fixed income assets fails to meet the needs of domestic insurance companies. 

While the bond markets in China and Japan are, by some margin, the largest in Asia and have plenty of fixed income assets available domestically for ALM, the value of the bond markets in some of the larger life insurance markets (notably Singapore, Thailand and Hong Kong) is below US$500 billion each (Figure 3). Equally problematic, the local currency bond markets across the region are dominated by government bonds, which offer comparatively less attractive yields than corporate bonds due to the lack of spreads.

Figure 3
solving-the-duration-mismatch-a-practical -guide-to-addressing-asian-insurers-interest-rate-risk-fig3

Limited availability of long-dated local-currency bonds 

Life insurers in Asia must also contend with the limited availability of long-dated bonds in local currency, which is particularly true for corporate bonds (Figure 4). 

This dearth of long-dated corporate bonds restricts insurers’ ability to develop products with a long horizon, entrenches their over-reliance on government bonds with less attractive yields than corporates and necessitates taking concentrated exposures in the few domestic corporate issuers with long-dated maturities.

Figure 4
solving-the-duration-mismatch-a-practical -guide-to-addressing-asian-insurers-interest-rate-risk-fig4

Diversifying to address the duration mismatch 

A number of diversification approaches across asset classes and regions could offer potentially compelling solutions to the duration mismatch problem. 

Go global with corporate bond exposure

Given the domestic supply constraints, exposure to non-domestic corporate bond markets is a necessity for many insurers in Asia. Nondomestic markets can offer duration extension, yield opportunities and potential diversification benefits, both from the domestic credit cycle and through broader sector coverage. Non-domestic fixed income has become an increasingly popular exposure for Asia’s insurers, particularly given its…

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