Insurers who have been investing in risk management and optimisation in response to these regulatory changes are expected to have an edge in the years ahead. Asian insurance companies are well-positioned, having witnessed strong new business growth in the past years despite reduced margins from increasing competitive pressure.
The challenge now is to keep the momentum going. As insurers seek to preserve profitability and financial strength, they are realising that innovation – in the areas of product, distribution channels, customer centricity, the use of capital and expense savings – is essential. Taking strategic actions – such as the reallocation of capital, asset and capital optimisation, product innovation or refocusing and installing risk management systems to preserve shareholder value – will be key to a sustainable business model going forward.
Capital Optimisation and the Role of Treasury
Asian insurance companies have historically been flush with capital, but the changing economic and regulatory environment is putting pressure on their financial resources. In particular, subsidiaries of European multinational companies in Asia are facing additional pressure due to implications of the Solvency II regime.
In addition, the desire to grow continually in Asia through attractive products – which often involve offering guarantees – requires further additional capital under the new regulatory framework. For these reasons, capital management and optimisation is increasingly important. Companies are considering the solutions available, which typically include enhancing the investment returns or minimising capital requirements.
Due to the recent low-yield environment, insurance companies have started searching for higher yield assets. The duration of these assets has also become an issue, since the new regulations penalise more heavily for any mismatch between asset and liability risk profiles. Countries like Taiwan or Korea are struggling with negative spread issues, while others such as Singapore or China are looking for more attractive investments to underwrite suitable new products.
There is an increasing trend around insurers exploring alternative assets, such as foreign real estate, infrastructure bonds or emerging market bonds. However, there are issues on the supply side as these assets are primarily sourced outside of Asia and as a result carry currency risks. The treasury function has a role to play in sourcing these assets and working with the investment and actuarial teams to enhance the asset allocation. The development of hedging strategy is often part of the risk management agenda.
A bigger role for the treasury is in minimising capital requirements. Some of the avenues include managing asset and liability profile or looking at capital and legal entity structures more holistically. One of the key focus areas for large, listed insurance companies is to maintain the dividend-paying capacity and treasury can play a major role in managing cash and freeing up surplus in an insurance company. We see a rising trend around increasing the fungibility of capital and redeployment of capital based on risk-adjusted metrics.
Shareholder Value Management
The days of a two-digit return on equity are over. Companies need to focus on customer-centricity on one hand, and create value for the shareholder on the other. Traditional metrics, such as embedded value or current international financial reporting standards (IFRS), are less than adequate in helping investors to understand the profile of the undertakings, forecast results and value creation. The market expects more information around cash generation and sustainability of dividends.
Treasury has a key role to play in order to orchestrate the crystallisation of profits into real cash: they need to develop a strategy to upstream flows from subsidiaries to the head office, using various instruments (including inter-company loans, reinsurance or captives and dividends), considering strong regulatory pressures, liquidity coverage and foreign exchange (FX) risks. They also typically work on funding – seeking new forms of capital such as hybrid instruments, or insurance-linked securities (ILS). An example could be contingent capital, where additional shares would be issued depending on an insurance event trigger such as a natural catastrophe.
To be effective, treasurers need to develop a management information system that helps them to forecast cash in real time. Such reporting is a key support in their activities. However, most companies have not yet invested in this facility. Treasury needs to have access to detailed, structured and consolidated data in order to work on predictive modelling and sensitivity analyses. New technology and cloud can help to accelerate this activity, as treasury collaborates closely with the other finance and actuarial departments.
With the development of new technologies, there is a unique opportunity for insurance companies to enhance the customer experience. Most of them are on a digital journey spanning their operations from front to back – through underwriting and claims transformation programmes – to listen to and serve their clients more flexibly and efficiently; leveraging connected devices and using Big Data to improve segmentation and the customer journey. These are necessary steps when disruptive innovation could quickly transform new entrants into leaders in niche areas.
At the same time, innovation is also increasing risks such as cyber threats or technology costs of replacement. These insurable events provide opportunities for insurers to propose new products. It is important for them to properly assess the emerging risks and set the price at the right level.
From increasing solvency regulations, reducing return on equity (ROE) in a time of low interest yields, to continual innovation challenges and new competitors, the insurance sector is facing challenges on many fronts. Those that invest and adapt will seize the opportunities available – and the treasury department will need to ably advise on optimising capital and selective investments in order to help their company stay ahead of the curve.
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