Why are Asian insurers tapping into private debt

Low interest rates have become the new normal not just for European insurance companies but also for many insurers across Asia. While Japan has experienced low interest rates for decades, other Asian countries have seen rates drop significantly in recent years. This phenomenon, coupled with a lack of local assets, has compelled many Asian insurance companies to invest increasing proportions of their investment portfolios in overseas assets and substantial allocations to US corporate debt.

However, US interest rates have come under greater pressure more recently as a result of the Fed’s response to the COVID-19 economic dislocation. Additionally, tighter regulations, as well as increased hedging costs have made it less attractive for Asian insurance companies to continue allocating to publicly traded US corporate bonds. This has driven Asian insurers to hunt for additional sources of yield, which may be found in the illiquidity/complexity premium of private assets.

Among private assets, debt investments are the natural choice for liability-driven investors. Hence, many insurance companies in Asia have started tapping into private corporate direct lending, as well as lending backed by infrastructure and real estate assets. This trend will likely continue to be supported by:

Falling interest rates:

COVID-19 has derailed the hiking cycle that the market was expecting from the Fed. As the crisis persists and global central banks continue to embrace low interest rates policies, investors are mired in a lower-for-even-longer interest rate market. In addition, most Asian insurance markets suffer from negative net interest rate margin due to high legacy guaranteed rate policies, intensifying insurers’ hunt for yield.

Shallow domestic fixed income market:

Insurers have traditionally relied on the domestic fixed income market to match liabilities. However, the required assets for several Asian life insurance markets dwarf the size of its respective domestic corporate bond markets by several multiples. The Japanese insurance market has epitomized this phenomenon, with life insurance asset size nearly 25 times that of the domestic corporate bond market. Taiwanese and Korean life insurers face a similar challenge, with the life insurance industry assets between 10 to 15 times that of the domestic corporate bond market.[1] As a result, insurers are driven to source for quality yield and duration offshore and in private assets.

Higher USD hedging costs:

Strong demand for USD has driven up hedging costs for most APAC markets. At the height of market volatility, in March 2020, USD hedging costs rose as high as 4% and 2% for offshore TWD and KRW respectively. Growing demand for USD in these markets will further fuel negative basis in the FX swap market, keeping USD hedging costs high. As such, insurers would have a higher yield requirement to compensate for higher hedging costs when investing offshore.

Potentially high capital efficiency:

Unrated debt typically attracts a credit risk charge or credit shock spread in between that of investment grade and high yield in most Asian Risk Based Capital (RBC) frameworks. As such, a private debt investment could attract lower risk charges than a high yield corporate bond of the same yield, and could therefore be potentially more capital efficient. Private debt that is backed by real assets, i.e. infrastructure or real estate, may even receive a reduced capital charge reflecting potentially lower default rates and higher recovery rates in the event of default. There is typically no additional capital charge for the illiquidity/complexity risk associated with private debt transactions.

Cick here to read the full article

1. Source: International Monetary Fund, as of Oct 2019

font

This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.

DWS International GmbH as of 09/2020
CRC 078415 (09/2020)

CIO View