Japanese life insurers’ derivative-related exposures are higher than those of other insurers in the region, primarily because of hedged foreign-exchange risks, mainly against the US dollar. Generally, 50%-90% of these currency risks are hedged and transactions are collateralised with Japanese government bonds (JGBs)
Hong Kong:
Life insurers in the Asia-Pacific (APAC) are unlikely to face liquidity risks from derivative exposures of the sort faced by UK pension funds in late September, says Fitch Ratings. We view the liquid assets of our rated issuers as sufficiently deep to cover associated liquidity pressures.
UK pension funds’ problems were largely driven by liability-driven investment (LDI) strategies, but the use of LDI to fully match asset investments to long-term liabilities is not common in APAC.
“Notably, our analysis and conversations with issuers indicate little, if any, exposure among Fitch-rated APAC insurers to leveraged derivative trades as part of such strategies,” said Fitch.
Nonetheless, life insurers in APAC still face challenges reconciling duration gaps between assets and liabilities in their portfolios, as well as a range of exchange-rate and interest-rate risks.
In some markets, derivative investments are used as part of policies to manage these risks, which could expose them to margin calls amid an environment of sharp interest-rate increases and exchange-rate movements.
Japanese life insurers’ derivative-related exposures are higher than those of other insurers in the region, primarily because of hedged foreign-exchange risks, mainly against the US dollar. Generally, 50%-90% of these currency risks are hedged and transactions are collateralised with Japanese government bonds (JGBs).
The lack of leverage and the large volume of JGBs on Japanese life insurers’ balance sheets mean that associated margin-call exposure is limited, even when the yen’s exchange rate moves sharply – as it has in 2022.
Meaningful levels of cash may be necessary when derivative trades are settled, but we expect the companies’ holdings of cash and highly liquid assets, such as JGBs, to be sufficient to meet these liquidity needs, even in volatile market conditions. Settlement dates are also generally spread widely over the year, further reducing risks.
Life insurers in Japan generally retain the majority of their interest-rate and equity-risk exposure, which can be considerable, on their own books.
“We expect that hedged positions on these exposures will remain limited in the next few years, reducing associated liquidity risks. Interest-rate and equity exposures are offset by excess capital buffers, with insurers’ stress tests indicating they should be able to maintain adequate capital even in the event of substantial adverse shifts in interest rates and equity markets.”
Korean life insurers have more limited exchange-rate exposure than their Japanese counterparts. Although they have a portion of assets in overseas investments to support and diversify yields, the share is generally below 15% of their total investments, by our estimates.
Some use interest-rate swaps or currency swaps to reduce risks associated with potential market volatility.
“However, we view these as unlikely to pose a threat to their existing liquidity buffers, in light of the limited volumes involved,” explain Fitch..
In Australia, one insurer uses swaps to reduce the need for frequent trades to match assets and liabilities on an underlying portfolio of government bonds. However, we view its liquidity support for these funds as high. Any margin calls are likely to be limited, given the availability of assets with sufficient duration to match the liabilities, which reduces the need to leverage a derivative strategy to achieve duration-matching.
Chinese life insurers face very little exchange-rate risk, as their investments in foreign currency-denominated assets are small relative to their overall invested portfolio or equity capital. They also tend to adopt a buy-and-hold approach in managing duration between assets and liabilities, and are not active users of hedging to manage interest-rate risk.