ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD

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1 FOR PROFESSIONAL AND INSTITUTIONAL INVESTOR USE ONLY NOT FOR PUBLIC DISTRIBUTION (PLEASE READ IMPORTANT DISCLOSURES) ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD Based on a Global Insurance Survey from the Economist Intelligence Unit in Partnership with BlackRock

2 Asian Insurers: Adapting Investment Strategies to a Changing World Insurance companies globally are adopting new ways of thinking about their industry, as the markets in which they operate see significant long-term economic and regulatory changes, not to mention near-term volatility. BlackRock commissioned the Economist Intelligence Unit to survey more than 200 insurers around the world in May and July to find out more about the trends that are driving widespread change for our insurance clients, and what challenges they face in adapting their investment strategies. In addition to having case studies based on in-depth interviews with global insurers and perspectives from BlackRock investment specialists, the survey results included 40 insurers from Asia Pacific, including China, Korea, Malaysia, the Philippines, Singapore and Taiwan. Asian insurers are affected by the same market trends as their global counterparts, but their businesses are influenced by different domestic regulatory, cultural and economic factors. The summary below based on the global survey results reveals how actively Asian insurers have been preparing for change in their businesses, and indeed in several key respects, how they differ from insurance firms in other regions. Focused on Long-term Change, Cost of Capital: Similar to their global counterparts, a significant majority of Asian insurers said change within their businesses is needed to produce adequate shareholder returns in the next three years. However, one of the primary drivers of change in Asia has been the increasing cost of capital, unlike other parts of the world that cited low investment yields. Nevertheless, the need to generate higher absolute returns is present in Asia. About the Survey: In April and May 2013, the Economist Intelligence Unit surveyed 206 insurers worldwide, including 40 firms in Asia Pacific. Countries that were surveyed included Japan, China, Singapore, Taiwan, South Korea, Australia/New Zealand, Malaysia and the Philippines. Among the respondents in Asia, 13 were from life insurers, 9 from non-life insurers, 16 from composite firms and 2 from re-insurers. An additional survey was conducted in July 2013, of 100 respondents globally with a similar demographic to the main survey. Demand for Higher Yielding, Less Liquid Assets: Low rates are driving the majority of Asian insurers to increase exposure to high yield debt and allocating more to less liquid assets. Adoption of alternative investments by Asian insurers is at an early stage relative to many Western firms. Yet, compared with almost every other insurer in the survey, firms in China, Korea and Taiwan indicated the strongest demand for hedge fund and real estate strategies. Taking Action in the Near Term: Not only are Asian insurers ready to make strategic long-term changes to their investment strategies, they are also more willing than firms in the West to take near-term action tactically in the face of evolving market risks, such as the tapering of central bank asset purchases. In addition, Asian insurers are more active than insurers in the US and Europe in terms of altering their duration profile, adopting absolute return strategies and generally shifting exposure to risk assets. Firms in Asia generally believe QE will wind up more quickly than firms in other parts of the world are anticipating. Increasing Use of ETFs: Changing markets and regulations are also driving insurers to explore new tools such as ETFs. 74% of Asian firms said they will likely increase their use of ETFs over the next three years and a majority acknowledged the need to learn more about using the instruments as part of an investment strategy. Seeking Help on Risk Management: Asian insurers strongly believe that regulations are making them more risk averse and do not feel well-prepared, particularly in China and Southeast Asia. As a result, firms in the region are seeking more support from asset managers when it comes to risk management, investment strategy and product design. [2] ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD

3 FOCUSED ON LONG-TERM CHANGE, COST OF CAPITAL There was widespread agreement among insurers in Asia that they will need to implement changes internally in order to meet shareholder demand for returns over the next three years and to maintain investment contribution to ROE. The main drivers for change were seen as the rising cost of capital, a view likely exacerbated by changing market expectations on global interest rates. To achieve better returns, Asian insurers are depending primarily on investing more tactically across assets and diversifying their fixed income exposures. Seventy-percent of insurers in Asia said they are implementing a tactical asset allocation framework to generate higher returns for shareholders, higher than the 47% of insurers globally. Sixty-five percent of Asian firms said they were either investing in new fixed income asset classes or diversifying their portfolio compared with 52% of all insurers surveyed. Figure 1 - As an insurer in Asia, how much does your business need to change to produce adequate shareholder returns over the next three years? Large scale change No change A little change Some change 8% 25% 33% 34% Figure 2 - To produce adequate shareholder returns over the next three years, what are the key investment changes you are working on? Choose up to two answers. 8 65% 43% 59% 53% 45% 41%41% 15% 41% 31% 22% 14% Diversifying fixed income asset classes Seeking better diversification across all asset classes Source: Economist Intelligence Unit, July 2013 Implementing a tactical asset allocation framework Asia Pacific Taking more investment risk Europe Seeking illiquidity premia North America ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD [3]

4 TURNING TO HIGHER YIELDING, LESS LIQUID INVESTMENTS Though bond yields have been rising steadily in the past few months, they remain below average in the most liquid markets and duration risk remains near historic highs. Buy-and-hold investors of long maturity U.S. Treasuries for example still do not get adequately compensated for the interest rate risk they are taking on. As a result of these low rates, Asian insurers are making strategic changes to their portfolios, many are extending their reach into riskier assets and moving lower down the liquidity scale. Seventy-eight percent of Asian insurers said they are raising allocations to higher yielding fixed income and 58% said they are investing more in less liquid strategies. Insurers in China, Taiwan and Malaysia showed a particularly strong interest in shifting to assets in the higher yielding and less liquid spectrum. In addition, firms in China, South Korea and Taiwan indicated the strongest likelihood of increasing allocations to hedge funds and both real estate debt and equity, compared with nearly every other country surveyed. However, when asked what proportion of their portfolio would be allocated to less liquid investments over the next three years, the majority of insurers in China, South Korea and Taiwan indicated a relatively small allocation of 1-5%. Figure 3 - How are you adapting your investment strategies to low rates? % 67% Increasing allocations to higher yielding fixed income instruments 71% Allocating more to less liquid strategies China 10 43% Increasing duration Singapore 33% Taiwan 14% Reducing cash balances South Korea 29% 25% Reducing investment related costs by using beta products Malaysia Figure 4 - How likely are you to increase allocations to each of the following asset classes? % saying Very Likely or Moderately Likely to increase allocations Global 52% 55% Taiwan Korea China 86% 86% 86% Real Estate Debt Real Estate Equity Hedge Funds [4] ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD

5 TAKING ACTION IN THE NEAR TERM Expectations for the gradual withdrawal of QE are creating further complications for insurers in the near term and driving them to adjust their strategies accordingly. Asian insurers are more confident than insurers elsewhere that QE will end in 1-2 years. In addition, they have been more actively preparing for an end to easy money policies compared with insurers in other regions. For example, of insurers in Asia are cutting portfolio duration to reduce their interest rate risk versus 57% of European insurers and 55% of North American insurers, according to the July 2013 survey. Also, of Asian insurers are seeking more flexibility by using absolute return strategies and moving away benchmarks, compared with 53% of insurers in Europe and 45% in North America. A notable area where Asian insurers are steering clear though is derivatives. Only said they were increasing their use of derivatives ahead of the end of QE, much lower than the 37% in Europe and 35% in North America. Figure 5 - When do you believe QE will end? 8 52% 35% 13% 15% Within 1 year 1-2 years 2-3 years Global Asia Pacific Source: Economist Intelligence Unit, July 2013 Figure 6 - Which of the following is your organisation doing to prepare for the unwinding of QE by central banks? 8 57% 55% 53% 45% 37% 31% 35% 18% 21% 37% 35% Shorten duration Move away from benchmark to adopt more absolute return strategies Increase credit exposure Increase exposure to risk assets Increase use of derivatives Asia Pacific Europe North America Source: Economist Intelligence Unit, July 2013 ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD [5]

6 INCREASING USE OF ETFS In addition to looking to illiquid assets for higher returns, insurers are also using exchange traded funds (ETFs) to diversify out of cash and access certain asset classes, while remaining liquid. ETFs may also be attractive as both a tool to gain access to new markets as well as for portfolio transitions, allowing insurers keen on shifting allocations to gain beta exposure while a mandate is funded. In Asia, 74% of insurers said they are likely to increase their use of ETFs over the next three years. However, further education on how to use these tools will have to accompany growth in the ETF market. Three quarters of Asian insurers said they need to know more about how to use ETFs as part of an investment strategy. Figure 7 Do you agree or disagree with these statements on ETFs? % saying they agree % 81% 85% 77% 67% 71% 72% 68% 71% Insurers are likely to increase their use of ETFs over the next 3years I need to know more about howto use ETFs as part of an investment strategy ETFs are suitable as a long-term strategic holding for both core and satellite asset allocation Asia Pacific North America Europe [6] ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD

7 SEEKING HELP ON RISK MANAGEMENT ETFs is not the only area where Asian insurers may desire additional knowledge. As firms consider more tactical allocations and shift into new areas of the market, risk management will increase in importance. Thirty-eight percent of firms in Asia said that the main challenges they face when assessing where risks lie in their portfolios was a lack of sufficient expertise. That was considerably higher than Europe (26%) and North America (16%). In addition, 55% of firms in the region said not being able to use risk factors to model risk was a challenge. Risk management was an area where Asian insurers said they were seeking business partners, particularly in China. Sixty-five percent of firms in the region said risk management/governance was an area where they needed to work more closely with third parties such as asset managers to evolve their businesses. Among this group, China s needs were the strongest, with 86% of Chinese insurers saying they were in need of help when it came to risk management. Asian insurers also cited relative strong needs in other areas. Seventy-percent said they needed assistance from asset managers on investment strategy design, compared with 61% in Europe and less than half in North America. Also, 63% of firms in Asia said they were looking to work more closely with managers on product design, much more than the in Europe and 27% in North America. Figure 8 What are your main challenges when assessing where risks lie across all asset classes in your organization s investment portfolio? 55% 51% 47% 33% 41% 52% 48% 38% 45% 35% 24% 38% 26% 16% 23% 23% 13% Access to risk factors to be able to model risk Achieving lookthrough to underlying holdings Lack of data Lack of resource Lack of sufficient expertise Lack of adequate systems/ infrastructure Asia Pacific Europe North America Figure 9 - In which areas will insurers need to work more closely with third parties such as asset managers to evolve their businesses? 8 65% 69% 71% 61% 48% 63% 27% Risk Management/ Governance Investment strategy design Product design Asia Pacific Europe North America ASIAN INSURERS: ADAPTING INVESTMENT STRATEGIES TO A CHANGING WORLD [7]

8 IN SUMMARY Global insurers are acutely aware that they must adapt to survive in today s challenging marketplace. Low investment yields, reduced liquidity and financial regulation have prompted a greater focus by insurers all over the world on diversification, liquidity and risk management. What this survey underscored is how committed insurers in Asia are to implementing change in their businesses and the different tactics they are taking compared with firms elsewhere. Some of these differences were in terms of degree, such as how strong the demand for less liquid alternative investments such as hedge funds and real estate were in some Asian countries relative to firms elsewhere. Other differences were based on approach. For example, most insurers in the survey felt they needed to change in order to boost returns, but Asian firms were much more willing to use a tactical asset allocation framework compared with other regions. They were also more active than firms in the West in preparing for the end of quantitative easing policies, which they strongly felt would end in one to two years. Asian insurers also understood that adapting to change in their industry not only calls for different investment strategies, but also requires external partners, particularly in the areas of risk management and product design. The picture of Asian insurers painted by the research results was an industry largely embracing change and ready to find partners who can help them evolve their businesses for the long term. About BlackRock s Financial Institutions Group As one of the industry s largest managers of insurance company assets, the insurance practice is a strategic focus for BlackRock. We serve over 149 insurance clients in 23 countries. Our insurance portfolios span a wide range of requirements, ranging from actively managed to buy-and-hold. 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