26-03-2020
Life insurers could shelter-In-place their investments
Insurance AlertssLife insurers could "shelter-In-place" their investments
Life insurers and regulators have to think creatively of ways long-term money can ride out a crisis that by its nature will be relatively short-term, says Mr Brad W Setser, a senior fellow for international economics at the think tank Council on Foreign Relations.
In a blog on the Council's website, he notes that strategies that worked in normal times may not work in a financial market hit by the COVID-19 pandemic.
“And the kind of prudential regulation that is absolutely essential to build buffers in normal times now needs to be turned on its head. In good times, you build buffers. In the face of an unexpected shock, you draw down on those buffers,” he said.
He estimates that Asia’s life insurers could hold somewhere between $1.5tn and $2tn of foreign currency denominated bonds as part of their portfolio—mostly dollar denominated, but some in euros. Japanese life insurers report about $900bn in foreign securities. Taiwan’s lifers, counting their holdings of ETFs that are listed in Taiwan but invest abroad, are heading toward $600bn in foreign bonds. Korea’s insurers have done something similar, but on a smaller scale.
These holdings pose a problem right now—especially as a large portion of this book typically needs to be hedged against FX risk in the market more or less continuously.
Mr Setser says that there are at least three potential issues:
- currency mismatch or FX exposure on investments
- fall in value of bonds
- third party asset managers who face constraints as they may use leverage and may have promised to stay currency hedged.
Regulatory flexibility
Mr Setser says that in the face of a pandemic, it can make sense to loosen regulatory constraints—this is the time to make use of regulatory flexibility and existing buffers. And similarly, in normal times, it is risky for the government to enable these trades by providing the insurers with low cost hedges. But in times of crisis, the direct provision of hedges to regulated insurers who are in a bit of a pickle is a sensible use of reserves
The broad idea is the financial equivalent of sheltering-in-place—insurers have long-term liabilities, so they need not be forced sellers, or even forced hedgers. They can use their balance sheet to absorb short-run volatility—and if needed, they can draw on their capital (and potentially new capital from their home governments) to absorb losses, as their home governments effectively provide a form of portfolio insurance.
FX position
Mr Setser says that even an open FX position is ultimately a manageable short-term risk, so in his view existing open books don’t now suddenly need to be closed to “derisk.”
If insurers are worried about this, their home governments can directly provide portfolio insurance against extremely large FX moves (guaranteeing that the insurers wouldn’t lose money from a move bigger than a certain defined amount) while regulators relax prudential regulations and allow the lifers to temporarily run bigger open positions. Alternatively, the government can directly step in and provide the hedge.
So between the regulatory forbearance for open positions, government insurance against losses from big FX moves and the direct provision of hedges, the underlying currency mismatch among the big Asian insurers can be addressed. And it can be done in ways that put minimal stress on bank balance sheets.
Fall in bond values
Mr Setser says that the lower market value of investment grade bonds may reflect an overshoot, as there have been a lot of forced sellers in the market. Or it may reflect a real shock that really has reduced the expected return over time on these bonds.
He says that regulators can take steps to make sure the insurers aren’t forced sellers. The real losses from bond investments can be absorbed by the equity capital of the life insurers. “And if, over time, the losses exceed the insurers’ equity capital, the policyholders—who have been promised a fixed payoff over time—can be bailed out by a government capital injection.” Mr Setser says the long-term “home” currency liability structure of the lifer insurers allows them to be patient.
In normal times a regulator would worry whether the insurer’s capital fell, and likely encourage the insurer to sell its riskier assets and/or raise capital. But at a time when those who can shelter in place should, the regulators can simply allow the insurers to operate with less capital (or inject government capital if they want) while they hold on to their existing portfolio. He said, “That portfolio may well be a long-term problem. It doesn’t have to be a short-term problem.”
Third party managers
Mr Setser says that third party asset managers typically have to invest to achieve a certain mandate and thus don’t have the flexibility of inhouse portfolios. He says that it may make sense to shift some of those portfolios back inhouse (when possible), or to give the third party manager flexibility to essentially maintain a static portfolio even if it breaches some contractually agreed risk and volatility thresholds.
Source: Asia Insurance Review
