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

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.

Figure 1

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

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

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

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…