APAC life insurers gear up to reposition fixed income
Asia’s life insurance companies' toolkit for fixed income strategies are now filled with more choices, as 2023 shapes up to be the year of fixed income under rising yields.
“Persistently high inflation, high rates, and high volatility created a new investment landscape insurers have not faced in decades,” said Rick Wei, head of Asia ex-Japan insurance strategy at JP Morgan Asset Management. “For 2023, Asia-Pacific insurers are showing a strong interest in overseas investments due to attractive fixed income yields, the need for duration matching, and diversification benefits. High-quality fixed income is on top of the list.”
With the Federal Reserve’s hiking cycle near its end, many Asia-Pacific insurers are taking advantage of the higher yields without adding unnecessary credit risk in the face of a looming recession, Wei noted.
For life insurers, this means investing in high-quality duration bonds such as US government bonds, which now offer the highest real yield since the financial crisis, as well as high-grade corporate bonds. Long-duration bonds also help more closely with liability duration match, he said.
“To better match their liability duration, we expect Asia-Pacific insurers to further expand the permissible investment universe to include US dollar T-Strips, long-duration investment-grade credit, agency collateralised mortgage obligations (CMOs), etc.
"Additionally, insurers could consider applying interest rate derivative overlays to enhance solvency capital and balance sheet management,” he told AsianInvestor.
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“As recession remains our base case scenario, it is important for insurers to remain stringent with credit surveillance and identify the most attractive parts of the investment grade market to take advantage of higher yields,” he added.
Echoing Wei’s remarks, Max Davies, insurance strategist at Wellington Management, also noted challenges for life insurers to change the asset mix of their fixed income portfolio.
With 2022 being a tough year for fixed income investments, some life insurers might have unrealised losses in their portfolio. But if they hold to maturity, provided no defaults, the returns should still be decent, Davies said.
“So, to reposition meaningfully in fixed income amidst this environment can mean crystallising a gain or a loss on the fixed income before its maturity,” he told AsianInvestor.
Long-term fixed income investors such as life insurers can see through volatility, but on the other hand, they can't be as nimble as they would want to be as a total return investor or in other asset classes.
Life insurance companies’ liability duration often exceeds 20 years.
With the introduction of more market-based capital regimes in many markets, including China, Korea, and Hong Kong, asset-liability duration mismatch will reduce the solvency capital ratio and cause volatility to insurers’ capital and balance sheets. The new accounting rules, IFRS 9 and 17, will crystallise the market value impact from interest rate changes, leading to unwanted profit and loss volatilities, JP Morgan’s Wei noted.
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But overall, Davies thought that rising yields are positive for life insurance companies in the long term, because they can generate more yields from safer instruments and don’t have to take illiquidity and equity risks, nor credit risks.
The extent to which a life insurer can reposition their fixed income portfolio depends on a variety of factors, including their liability and liquidity profile, and the implications for their balance sheet, he noted.
For markets that have a lower supply of government bonds, such as Hong Kong, life insurance companies are more reliant on corporate bonds.
“Credit is a big question mark within fixed income,” Davies said.
Unlike the benign market backdrop for credit downgrades and defaults of the past 10 years, 2023 poses great uncertainties around inflation, the path of interest rates, recession risk, and geopolitics, for example, he said.
“So with credit, I wouldn't necessarily say we are advocating for full offence or full defence, but it's, where possible, remaining nimble… and making sure your mandates have a bit more space to take advantage of certain dislocations when they occur.”
In certain areas of the credit market, extra due diligence would be prudent, such as the triple B bucket that has grown considerably in recent years, he added.