Jacqueline Loh: Re-thinking investment strategies for growth
Keynote address by Ms Jacqueline Loh, Deputy Managing Director of the Monetary Authority
of Singapore, at the Asia Investment Management Summit, 25 November 2013.
* * *
Distinguished guests, ladies and gentlemen, a very good morning to all of you.
1. The global economic recovery remains uneven and fragile, five years after
Lehman's collapse. While there have been some encouraging signs over the past year, with
stronger jobs growth and the housing recovery in the US and the Euro area economies
stepping out of the recession zone, there continues to be heavy reliance on extraordinarily
loose monetary policy and low interest rates for life support.
2. Lean economic growth since the onset of the Global Financial Crisis, beset by bouts
of heightened volatility, present a challenging environment for investment managers. For the
insurance industry, higher payouts following natural disasters pose additional difficulties. Five
of the ten costliest natural disasters, in terms of money rather than lives, occured in the past
five years.1
3. As a result of economic, financial and environmental systems coming under stress
at the same time, insurance companies are now operating in extremely trying conditions.
Specifically, insurers' profitability is under pressure simultaneously from all 3 sources:
a. Firstly premium income, which is correlated to weak economic growth and excess
capacity;
b. Secondly investment income, amidst a low yield environment and higher market
volatility; and
c. And thirdly, claims and expenses, given increasing claims for natural
catastrophes.
4. In light of this unprecedented mix of challenges, the insurance industry is
responding as follows:
a. Firstly, focusing more on improving underwriting profitability. Against a
backdrop of low yields, insurers can no longer rely on investment income to
compensate for poor underwriting results. Insurers now recognize the need to
strengthen their underwriting capabilities, in order to improve underwriting
profitability. Following the spate of natural catastrophes in Asia-Pacific in 2011 for
instance, many insurers have imposed more stringent underwriting and risk controls
such as event limits and policy exclusions. Steps have also been taken to close data
and risk modelling gaps, which will enable more accurate measurement and in turn,
better management of risk exposures.
b. Second, optimizing investment and product portfolios. For in-force businesses
for which policy terms cannot be changed, insurers are primarily seeking to optimize
their investment and hedging strategies. For new products and policy renewals,
insurers are also looking to re-price their policies or adjust guarantee levels.
c. And third, enhancing operational efficiency. Apart from improving premium and
investment income, insurance companies are also streamlining processes to lower
operational and claims expenses.
5. Going forward, there is no doubt that
a longer-term and more sustainable
approach is needed to achieve long-term profitability. In keeping with the conference
theme of "Seeking Better Returns in the Current Volatile Climate" - I would like to discuss
the investment challenges facing insurers, as well as share my observations on key
issues that insurance companies would need to address in this new investment
landscape.
6. This is important because as many of you know, insurers operate in a
multistakeholder environment. They need to first offer competitive products to policyholders to
meet their needs, maintain adequate capital to meet regulatory requirements, as well as
provide adequate shareholder returns. The insurance industry's targeted return corridor to
policyholders can be at least 3-5%2 in order to maintain bonus payouts for participating
policies; whilst the ROE to shareholders have typically ranged between
10%-15%3. In the
case of life insurers, in particular, for which investment returns is a key source of income
given their focus on long-term and guaranteed savings products, lower returns will strain the
ability to meet both policyholders' and shareholders' expectations. Some insurers have
ventured to forecast that a 10% ROE for the industry will be a "best-case scenario", with
many more calling for the industry to be more realistic about its return expectations from their
investment portfolios.
Challenging investment landscape
7. Let me first discuss the investment headwinds facing insurers. Specifically, there are
3 key challenges that are driving insurers to undergo a fundamental rethink of their
investment approach:
a. One, lower returns in the new normal;
b. Two, lack of long duration assets; and
c. Three, regulatory reforms.
Lower returns in the new normal
8. First, lower returns in the new normal. There has been increasing acceptance that
the era of low yields is not just a cyclical phenomenon, but is in fact the New Normal. In
advanced economies, policymakers are faced with conflicting challenges as they seek to
maximise economic growth on the one hand; while having to pursue fiscal consolidation and
financial sector reform on the other. Meanwhile, emerging economies will grapple with tighter
financial conditions and by implication, slowing growth when unconventional monetary
policies are unwound. The outlook is highly uncertain as the normal cyclical recovery
template cannot be applied to structural deleveraging episodes such as the one we are
currently in. Although bond yields are expected to rise from their current low levels, it is likely
that insurers will have to settle for much lower returns from fixed income investing in the
years ahead than that achieved in the pre-crisis period. Over the next 20 years, the slowing
demographic outlook for the world will also exert pressure on economic growth and lower the
expected returns for most asset classes.
Shortage of long duration assets
9. Next, a shortage of long duration assets. Asia has often been singled out as the
bright spot in the global insurance industry, as rising incomes and lower than average
insurance penetration in many markets offer rosy opportunities for growth. However, in terms
of seeking investment returns, Asian insurers are operating within similar market trends as
their global counterparts. To illustrate, long-term government bond yields in the US and Euro
area have declined an average of 200 to 300 bps compared to the 10-year average
prevailing before the Global Financial Crisis. In Asia, long-term government bond yields are,
on average, 50 to 300bps lower than pre-crisis levels. Asian insurers also have to face
increasing costs of capital4, compounding the pressure to generate higher returns.
10. Addressing the duration mismatch between assets and liabilities has been a
persistent challenge for insurers in Asia, due to a shortage of long-dated instruments as well
as restrictions on investments in some jurisdictions. A number of governments in Asia,
including Korea, Taiwan, China and Singapore, have responded by issuing long-dated
bonds; and easing restrictions on specific assets classes that insurers can hold.
Notwithstanding this, the supply of high quality government and corporate bonds remains
limited relative to the strong demand from a wide spectrum of investors for these "safe
haven" assets, such that insurers can be crowded out.
Regulatory reforms
11. Finally, let me touch on the oncoming regulatory reforms, such as Solvency II, which
will also play a significant role in shaping insurers' investment strategies. Almost 80% of the
respondents to a recent Goldman Sachs survey listed regulatory capital treatment as the
predominant non-market related concern.
12. Insurance regulatory reforms are converging towards a principles-based and fair
value approach for the total balance sheet. This will enable a more accurate assessment of
an insurer's financial and capital strength, even in times of stress. However, this can increase
volatility in an insurers' balance sheet, and raise overall risk charges and capital
requirements on long-term assets. In order not to disincentivise insurers from investing in
longer maturity instruments, it is therefore critical for regulators to continue to calibrate their
solvency regimes carefully. We do note however, that some regulators have or are
introducing into their capital frameworks, mechanisms to smooth out the effects of market
volatility, such as the illiquidity premium in Australia and the matching adjustment & volatility
balancer in Europe. These mechanisms recognize the long term and illiquid nature of
insurance liabilities, where insurers are able to hold assets to maturity.
Increasing Importance of Risk Management
13. So let me now move on to talk about the increasing importance of risk management
in these challenging times. The forces I have mentioned earlier, have triggered an
investment mindset shift, particularly in the last 6 to 12 months amongst insurers - from
conservative asset allocation strategies and matching of liabilities - to reaching for yield.
14. In their search for returns, many Asian insurers are investing more tactically across
asset classes and diversifying their fixed income portfolios. In addition, many are thinking
outside the low yield box and considering an extension of the investment universe
parameter. This would encompass non-traditional asset classes, such as emerging markets,
infrastructure, trade finance, structured credit, and alternatives such as hedge funds, real
estate and private equity. In the alternatives space alone, the average allocation by
insurance companies, as a percentage of their assets under management, has in fact
already increased from 10% to 15% between 2011 and 20135.
15. A recent Goldman Sachs Insurance Asset Management survey reports that nearly
half of Asian insurers are looking to raise their allocation to higher yielding assets. Like
expected returns, risks - market, credit, liquidity, and legal to name a few - from investing in
these newer asset classes will also be higher. There is no free lunch. Insurers' risk profiles
will be distributed across a wider and more complex spectrum of asset classes. This will call
for more sophisticated and robust management of individual investment risks, as well as the
correlation between the range of investment risks within a more diversified and complex
portfolio.
16. The risk management deficiencies highlighted by the global financial crisis and
recent tail events, have raised the bar in all areas of risk management. As a result, risk
management has now been elevated from a mere control function under the responsibility of
the Chief Risk Officer, to a strategic role that comes under the direct oversight of the
insurer's Board and senior management.
17. Similarly, the investment decision is not an isolated one, but one that has to be
made in view of the firm's overall business goals, business strategies, capital needs,
liabilities structure and risk appetite. Insurers would gain from establishing a robust
Enterprise Risk Management (ERM) framework to manage these factors holistically. Good
execution on this front will entail close coordination and communication between the
investment function and other key functions, including actuarial, risk and finance, to ensure
that dynamic trends on both investment assets and insurance liabilities, as well as the
resulting impact on earnings and balance sheet volatility, continues to be monitored and
managed dynamically.
Asia driving global insurance growth
18. The ability to manage investment risks skillfully is even more essential in the
Asian context, due to its rapidly growing share of insurance business and attendant
risk exposures.
19. Over the next decade, Asia will continue to rise in importance in the global insurance
arena. Munich Re for example, estimates that Asian premiums can register healthy growth of
about 8% per annum, and account for almost 40%6
of global premiums by 2020. This is
underpinned by positive structural factors such as a growing middle-class and rising
affluence, aging demographics, and the continued industrialisation, trade and infrastructure
development in emerging Asia.
20. In particular, I would like to focus now on how insurers can play a long-term role in
Asian society and economies in two pertinent areas: one, financing Asia's retirement funding
gap; and two, financing Asia's long-term investment needs.
Financing Asia's retirement funding gap
21. Firstly, financing Asia's retirement funding gap. Asia is experiencing declining fertility
rates, increasing life expectancy, and a rapidly aging population. Between 2011 and 2030,
Asia's share of population aged 60 and above will increase from 40% to almost 50%,
compared to the global average of 20%7. At the same time, public retirement and pension
systems remain inadequate, and the retirement funding gap is estimated to be up to 13 years
of retirement savings8. Insurers can play a pivotal role in financing individuals' retirement
security through pension, annuity and saving products, complementing public pensions.
22. Insurers in Asia stand to benefit from robust premium growth on the one hand; but
will also be subject to greater volatility from fluctuations in the economic and financial market
cycles on the other. The low-interest rate environment is likely to magnify the present value
of future increases in longevity, which will in turn, affect the solvency position of annuity
providers and pension funds. While this can have unintended consequences on insurers' role
in supporting retirement adequacy, it can provide the impetus for product innovation and
alignment with the new investment and regulatory climate. Indeed, insurers have begun to
redesign their products such that interest rate risks remain manageable; while offering
guarantees that are valuable to policyholders at the same time.
Financing Asia's long-term growth
23. Next, financing Asia's long-term growth. Insurers are one of the world's largest
institutional investors, managing almost $25 trillion or a third of the world's professionally
managed assets9. Due to the nature of their liabilities, insurers are an ideal source of
longterm funding to finance economic growth. They have the ability to invest in long-term and
less liquid assets, such as infrastructure investments and clean energy. This role has never
been more critical; at a time when banking regulatory reforms have crimped banks' appetite
and ability to play a long-term financing role. We are already seeing encouraging signs of
insurers collaborating with banks to provide debt financing for infrastructure projects
together. Allianz, Ageas and Swiss Re are just a few examples of insurance companies
which have explored such moves. Zurich Insurance Group also recently made its single
largest investment in green bonds, which fund projects that help mitigate climate change in
local communities.
Singapore - a key hub to capture Asian premiums and intermediate global-Asia
investments
24. Singapore is now recognized as the leading insurance hub in Asia-Pacific. We are
home to many top global insurance players, and an ecosystem comprising a strong brokers'
cluster, the largest captive community in Asia Pacific, a growing cluster of specialty players
and the largest grouping of Lloyd's syndicates outside of London. This ecosystem is
selfreinforcing, creating a strong "clustering" effect that has been a key growth driver for
Singapore's insurance market.
25. As Singapore continues to develop itself as a global insurance market with the
ability to write not just Asian risks but global risks, many insurers are also making plans to
set-up their fund management arms to manage their growing investment portfolios in the
region. In addition to honing investment skills, there is also a general consensus on the need
to strengthen internal risk management expertise, as well as deepen data and modeling
capabilities, so as to attain a strong understanding of local market risks. To better manage
the risks of more complex products, as well as aggregate portfolio risks, many are also
increasingly leveraging on the external expertise of the sell-side bank and capital market
players, as well as fund managers in Singapore.
26. Singapore is also highly committed to research and development, and is
establishing itself as an innovation centre of excellence. To respond to the challenges of an
ageing Asia, it is imperative for Singapore to be at the forefront and lead the development of
retirement financing solutions for individuals, businesses and governments in Asia. Research
is an upstream activity preceding product development. To differentiate yourselves through
innovation, we would strongly encourage the industry to continue to conduct Asian-focused
retirement security research in collaboration with research institutes in Singapore, such as
the SMU Centre for Silver Security and EDHEC Risk Institute-Asia. The SMU Centre for
Silver Security for instance, is conducting applied research on financial products and markets
for the silver industry, which would allow insurers to develop and commercialise products for
the at-retirement market.
Conclusion
27. Let me conclude. The insurance industry will encounter significant headwinds in the
years ahead. I understand that the conference speakers will be touching on many pertinent
topics, including the macroeconomic outlook and investment implications, asset allocation
strategies in a world of low bond yields, and whether there is a right level of asset risks that
insurers should assume.
28. The inaugural Asia Investment Management Summit for insurers, organized by Asia
Insurance Review here in Singapore, is very timely. It will be an extremely useful platform for
all stakeholders to engage in constructive dialogue on how we can navigate the current
environment successfully. On this note, I wish all of you a rewarding and fruitful conference.
Thank you.