Three key differences in investment strategies between Singaporean life insurers
The Singapore Life insurance industry is not only competitive and mature but is also bound by many rules and regulations that are largely driven by the different stakeholders. For the participating business, the investment portfolio plays a central role in being able to maintain a top position in this market. Given this multi-dimensional complexity, insurance companies use an array of quantitative models to support investment decisions. Qualitative aspects are also integrated into these models. Such as reputational risk, operational aspects, ESG criteria and peer group metrics, all of which can be taken into account when specifying realistic boundary conditions in ALM optimization.
A peer group analysis can enable insurers to spot differences in investment and overlay strategies and to uncover potential reasons for investing in a certain equity benchmark or asset class. This seems especially important in the competitive life insurance market in Singapore.
Ortec Finance has created an up-to-date database constructed from multiple sources including the latest insurance data published by the Monetary Authority of Singapore, which serves as the foundation for our industry comparison analysis. In this article we will focus on three key themes and highlight the differences seen throughout the Singaporean market.
The three themes are:
- Variation in equity allocations
- Interest rate risk management
- FX hedging
This article will be the first of a series linked to the Singaporean Industry. Future articles will touch upon duration hedging with swaps, hedging the overseas equity portfolio with equity options and look into Dynamic Asset Allocation strategies geared towards tail risk management.
Each year, around June, the Monetary Authority of Singapore (MAS) publishes Annual Reports for each individual insurance entity operating in Singapore. This includes information on the balance sheet, detailed liability information and solvency capital ratios for the different insurance products. The MAS database contains data since 1999 and hence captures three noteworthy historical events - the Nasdaq bubble, the global financial crisis and the European sovereign debt crisis.
We have analyzed investment allocations of the 9 largest life insurers and focused on extracting information on the decisions that underline the deterioration and recovery in capital. Overall we find consistency but there are interesting exceptions.
In Figure 1 you find an overview of the distribution of the overall business in 2017. The participating (Par) fund business is by far the largest product category compared to non-participating (Non Par) and Investment Linked Product (ILP) businesses. The top 9 Life Insurers command around 90 – 95% of the total market share.
Figure 1: Distribution of the overall business in 2017
1. Variation in equity allocation across the industry
In Figure 2 we provide an overview of the asset allocation of Equity, Government debt, Qualifying debt and Non-Qualifying debt in the period between 2013-2017 for the participating fund business. Across the industry, we find clear differences in these allocations and the deviations in Equity are the largest. In 2017, the Equity allocation accros the industry varies between 20% and 45% and the allocation of Government debt varies between 5% and 35%. For Qualifying Debt we observe a tighter range of allocations in 2017 compared to the period 2013-2016.
Analyzing the asset allocations through time more closely, we find that some insurers have applied dynamic rebalancing rules of the equity allocation and this was (not surprisingly) especially noticeble during the financial crisis when they de-risked the portfolio. Interesting enough however these strategies didn’t perform well compared to their peers, who applied a static approach, in the recovery period. To enhance these dynamic rebalancing rules from a risk and return perspective, quantitiative models are desired to refine the strategy and to consider the impact to all stakeholders.
Figure 2: Asset allocation across the industry focusing on Equity, Government debt, Qualifying debt, Non-Qualifying debt and Land & Build during the period 2013-2017.
2. Managing interest rate risk
Interest rate risk is typically the main market risk for life insurers, which is managed by investing in cash instruments and a range of derivatives (Swaps, Swaptions, Caps/Floors, Futures). Within the Enterprise Risk Management (ERM) framework, Insurers have set-up dedicated Interest Rate Risk policies governing the management of this risk.
Analyzing the historical data of the capital charges for Debt can reveal information about the interest rate hedging strategy of an insurer. In particular, the ratios between Debt Generic and Debt Specific is key to this analysis (important to note that cross-referencing this to additional analytics is required to come at this conclusion). The data shows that certain industry players have chosen to increase the duration gap anticipating future interest rate hikes, and an overall increase in the yield curve.
The policy framework mentioned earlier will also include quantitative models to test these strategies in a framework that manages all the relevant dimensions of the insurer. For sophisticated analysis, real world scenarios are used. These scenarios are calibrated against robust benchmarks to predict future development of the interest rates consistent with other economic variables. Through the use of such a scenario set, the policy committee will be able to capture the future balance sheet risks of deploying such a strategy and will be able to highlight the benefits of non-linear option strategies.
In Figure 3 we gain insight in the capital charges under the Risk Based Capital (RBC) framework in the period between 2009-2017.
Figure 3: Overview of capital charges for Debt Generic and Specific risks in the period between 2009-2017 under RBC.
3. FX hedging
Singaporean insurers invest a portion of their assets in overseas markets and in particular in the United States of America. Allocations to overseas investments for 2017 were in the range of 20% - 50% of Total Assets. It is a common industry practice to hedge the full FX exposure, leading to a combined SGD 40 Billion allocated to FX Derivatives. The data however shows that a limited number of Insurers maintain a small percentage of FX risk. Two common reasons are:
- given the complexity of hedging Equity FX Risk counterparts choose to keep this unhedged and
- benefits of diversification.
It is important to understand the benefits and risks that come with using different FX strategies, and the dynamics with other RBC drivers. Having a full picture provides the management with the necessary tools to steer the company through choppy waters when problems arise.
Ortec Finance has created an up-to-date database containing the latest insurance data published by the Monetary Authority of Singapore based on which we also have performed a thorough analysis across all businesses. In this article we focused on the participating fund business, and in particular the variation in equity allocations, Interest rate risk management and FX hedging. We observe clear differences across the industry leading to a better understanding of the historical investment returns for these funds.
Combining historical analysis with forward looking simulations is a powerful toolset and provides Life Insurers with an improved understanding of the risks they carry on their balance sheet. Incorporating this into the Enterprise Risk Management framework including policies that govern ALM strategies, such as Interest Rate Risk policy and Derivatives Use policy leads to an overall successful organization.