Increased overseas investments will raise Korean insurers’ foreign-exchange and liquidity risks, a credit negative, says Moody’s Investors Service. This comment follows the passing on 29 April by the Korean National Assembly of an amendment to the Insurance Business Act that will ease limits on Korean insurers’ overseas investment.
The revision, which will be effective by yearend, will allow insurers to invest up to 50% of the assets in both their general and separate accounts abroad, up from the current regulatory caps of 30% of their general account assets and 20% of their separate account assets.
In an article in the 6 May edition of “Moody’s Sector Comment”, Young Kim, analyst; Gil Jo, associate analyst; and Sally Yim, managing director, of Financial Institutions Group at Moody’s Investors Service, say that disruption caused by the coronavirus and lower-for-longer interest rates will encourage insurers to invest in higher-risk assets that offer higher expected returns, which are less liquid and more prone to mark-to-market valuations.
Although most insurers maintain fully hedged positions on their foreign investments with limited foreign-exchange risk, an increased investment cap will likely promote higher uptake of high-risk assets, in particular overseas non-traditional assets, thereby increasing liquidity risk.
However, increased overseas investment will also allow insurers to buy longer-dated assets, which are relatively scarce in Korea, and better manage asset-liability duration matching to prepare for the shift to tighter regulatory regimes, including International Financial Reporting Standard (IFRS) 17 and Korean Insurance Capital Standards (K-ICS) in 2022-23.
Life insurers have gradually expanded their overseas investments to 15% of their investment mix at year-end 2019, from 6% in 2014. For non-life insurers, overseas investments accounted for 14% of their investments at year-end 2019, up from 8% in 2014.
Some of the foreign investments include non-traditional assets including structured products, infrastructure or real-estate project finance loans and private equity, which tend to be risker because of their illiquid nature, particularly in times of stress.
Nonetheless, insurers have a generally conservative risk appetite with fixed-income comprising 48% of total investments and loans 19% at year-end 2019.
Because insurers measure their liabilities at fair market value and the liability duration will likely to increase under the IFRS 17 and K-ICS regulations, they are lengthening asset durations by buying longer-dated domestic and foreign bonds. More use of foreign bonds with maturities of 30 years or more, which are often highly liquid in developed economies such as the US and Europe, will promote better asset-liability duration matching.
The higher overseas investment cap addresses regulators’ concerns over widening negative interest rate spreads for insurers amid prolonged low interest rates and record low investment returns. The measure will encourage insurers to increase overseas investment for yield enhancement, which could partially offset their negative interest margin stemming from legacy products with high guaranteed interest rates.