The Malaysian life insurance sector is expected to remain resilient with the aggregate industry capital adequacy ratio (CAR) sustained above the prescribed regulatory level of 130%, even under a scenario of 200 bps parallel decline in interest rates, says Bank Negara Malaysia (BNM) in its 2H2019 financial stability report.
This conclusion was reached in a sensitivity analysis carried out by the central bank against the backdrop of the prolonged low interest rate environment.

Life insurance companies generally operate with a negative duration gap given the lack of long-term financial assets available to match the duration of their liabilities arising from products with much longer policy terms of more than 15 years. As a result, declining interest rates can have a bigger impact due to upward adjustments in the value of liabilities that exceed assets. This in turn will reduce a life insurer’s solvency position.

.Methodology and results

The sensitivity analysis assessed the change in value of life insurers’ assets and liabilities for each type of fund (i.e. participating, non-participating and investment-linked funds) following parallel declines in interest rates ranging from 50 basis points (bps) to 200 bps.

In assessing the impact on funds’ solvency positions, the assessment excludes additional buffers within shareholders’ funds and fungible surpluses from other funds that can typically be applied to offset any deficit that might arise.

The findings of the impact of interest rate reduction on insurance funds’ solvency are:












Interest Rate Reduction

 


Number of Funds Becoming Insolvent


Size of Insolvent Funds (% of Total Life Insurance Industry Fund)




Participating


Non-participating


Investment-linked




– 50 bps


-


-


-


-




-100 bps


-


-


-


-




-150 bps


-


2


1


0.8




-200 bps


-


3


1


1.3


Source: Bank Negara Malaysia

BNM says that the results reflect the favourable claims experience and relatively strong pricing power that life insurers have. Out of 42 funds offered by all 14 life insurers, only four insurance funds of three life insurers were insolvent under the different scenarios. In aggregate, these funds account for 1.5% of the total value of all life insurance funds. In each case, the insurance companies have adequate capital buffers to support the insolvent funds.

Type of fund

The impact of interest rate shocks on individual funds, largely depends on the type of fund, which influences the expected cash flows and discount rates applied.

Average Sensitivity of Insurance Funds to 100-bps reduction











Decline in Interest Rates


Participating


Non-participating


Investment-linked




Assets (%)


+8.0


+8.6


+5.9




Liabilities (%)


+12.4


+15.8


+7.4


Source: Bank Negara Malaysia

The impact on non-participating funds was the most pronounced relative to other funds given that their liabilities are all guaranteed and hence, are valued using risk-free discount rates i.e. MGS yields.

Participating funds on the other hand, were less sensitive to interest rate movements relative to non-participating funds. This reflects the nature of a participating policy, which comprises both guaranteed and non-guaranteed benefits. Non-guaranteed benefits represent the share of the insurer’s business profits attributable to the policyholders, which may vary over time depending on the fund’s business and investment performance. They are valued using a fund-based yield (FBY), which is more closely aligned to the risk profile and outlook of the participating fund, as the discount rate. The resulting valuation changes from a movement in the FBY therefore tends to be less sensitive to changes in interest rates compared to non-participating funds.

Investment-linked funds are also less sensitive to lower interest rates compared to non-participating funds. This reflects the feature of an investment-linked policy where any increase in the cost of insurance is borne by the policyholder’s unit investment fund. If the policyholder’s unit investment fund becomes depleted, the policy will lapse and the corresponding insurance liability of the insurer will cease. This reduces the expected amount of future net outflows and liabilities for the insurer.

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