The expansionist era is over for Taiwan’s $1.1 trillion life insurance industry after the steepest Federal Reserve interest hikes in 40 years pushed it to the brink of a liquidity crisis.
Over the past year, local regulators have repeatedly loosened operating rules after a cocktail of unrealized investment losses, falling income and increased payouts saw companies struggle to meet required financial standards.
The combination of a concerted push to shore up capital buffers and the introduction of new rules allowing companies to reclassify assets means analysts now believe the worst of the crisis is over. However, there are still concerns over some operators and even the biggest players face years of crimped profitability and far slower asset growth.
The sector’s combined pretax profits were down 76 percent in the first half of 2023 compared to the previous year. In May, the central bank sounded a rare alarm, warning the stresses meant Taiwan’s financial system was “not 100 percent stable”.
“The central bank is an early warning system: it’s reminding you to watch out,” said Chang Shih-chieh, a former member of Taiwan’s Financial Supervisory Commission. “You need to be careful of liquidity issues or else accumulated minor losses could eventually get out of control.”
Rebuilding challenges
Getting back on track will mean painful changes. The sector has already embarked on a substantial capital raise and is under pressure from the financial services regulator to fundamentally overhaul its product mix.
The industry’s assets have increased more than two-fold since 2009 to $1.1 trillion—about equivalent to the GDP of the Netherlands—after an aggressive expansion strategy focused on financial instruments beyond classic insurance. Key among these were long-run savings products that offered a higher return than Taiwanese dollar bank deposits.
With no local bond market of sufficient size to absorb this money, it piled into overseas assets. Approximately 60 percent of its holdings are in US dollar-denominated bonds, mostly long-dated credit, necessitating a huge hedging operation.
This left the industry exposed when the US started raising rates, sending the values of such holdings plummeting and the cost of hedging rising. Unlike Silicon Valley Bank, which collapsed after being forced to liquidate similar holdings at a loss, the lifers don’t have to refund redeemed policies immediately, given them time to work out a strategy.
Still, they were sitting on huge paper losses.
Simultaneously, as consumers sought higher yielding investments, annual premiums fell 21 percent in 2022. Payouts jumped as property and casualty insurers faced a huge bill after misjudging the prevalence of Covid-19.
By October 2022, the net worth ratio of seven companies had dropped below the 3 percent regulatory minimum. As the situation deteriorated, Taiwan’s Financial Supervisory Commission stepped in. They allowed the reclassification of loss-making bonds as assets measured at amortized cost, and relaxed rules around hedging, bond trades and debt issuance.
Their actions “helped us make it through safely,” said Lin Chao-ting, deputy chief executive officer of Cathay Life Insurance Co Ltd, Taiwan’s largest life insurer by asset value, in an interview.
As well as raising capital, Cathay is focusing on overhauling its product offerings, Lin said. Key changes include cutting the number of investment offerings with a guaranteed return rate and trying to reduce exposure to currency fluctuations. That means selling more of its insurance policies in US dollars rather than local currency, and focusing its Taiwan dollar products on more classic protection-style policies, Lin said.
Wider consequences
With income still subdued and pressure to rethink their exposures, less cash means the industry—which includes the likes of Fubon Life Co. and Nan Shan Life Insurance Co.—may not be the heavyweight investors they were. Issuance of Formosa bonds, foreign-currency notes sold on the island in the first-half were down about 70 percent from last year as the market, which once lured the likes of Apple Inc., sinks into near irrelevance.
One Wall Street banker, who asked not to be named discussing internal trading flows, said participation from Taiwanese lifers is down materially in both primary and secondary markets. While other buyers have filled the void, the lifers’ absence is still felt.
“Their day-to-day activity may not dictate what spreads do in aggregate,” said Winnie Cisar, global head of credit strategy at CreditSights. “But at the margin they’re very important for absorbing incremental supply and just being one of those extra buyers of corporate credit that keep things relatively stable.”
And in Taiwan’s domestic market, when the biggest buyers become sellers, that can upend conditions. The lifers had to pay out yields of nearly 4 percent on their recent issues of subordinated bonds, well in excess of the 2 percent paid by local banks.
While the situation has stabilized, the pain isn’t over. According to a report sent to legislators by Taiwan’s FSC in May, there are still two life insurance companies whose financial ratios do not meet legal standards. Both plan to sell property assets to raise funds.
In a worst-case scenario, if a company fails to raise enough capital and falls below regulatory minimum ratios, the authorities could be forced to step in.
Three lifers are on negative credit outlook, according to S&P’s Taiwan Ratings. Two are small, but the other is Shin Kong Life, one of Taiwan’s top six life insurers. In the first half of 2023, Shin Kong’s after-tax losses jumped to NT$11.2 billion ($359 million). The company is also facing capital pressure, as it only just cleared regulatory minimums in March.
“In the short term, Shin Kong’s first priority is to raise capital,” said new chairman Wei Pao-Sheng at a product launch event last Thursday. Longer term, the company will focus on restructuring its product line, he added.
Cocktail of issues
While classically higher rates should be good for life insurers in the long term, the sector’s US dollar exposure means higher hedging costs that will limit profits. Right now, hedging costs are at approximately 4 percent implied yield for 12 months, roughly double last year.
Customers are also being slow to return, with consumers favoring bonds and term deposits. Even though premiums have recovered a little, in the first five months of 2023, the lifers still paid out NT$44.3 billion more than they took in, according to data from the Taiwan Insurance Institute.
Plus there are long-term consequences from the decision to reclassify so many assets as amortized costs. If and when the US starts to cut rates, lifers won’t be able to profit as most assets in that category must be held to maturity, said Chang.
And the capital-build process is probably just starting. From 2026, the industry will adopt IFRS 17 global accountancy standards, bringing broad changes to financial reporting. For example, insurance profit will be separated from investment returns and liabilities valued at current interest rates rather than initial rates.
Andy Chang, analyst at Taiwan Ratings, said the changes will likely require more capital, though how much is unknown until the regulator releases details of the local implementation.
“It is going to be a difficult and painful process to bridge the next accounting standards,” said Cathay’s Lin. “Slower asset growth will be the new norm.” With assistance from Argin Chang/Bloomberg
