This communication is for Institutional Investors, Professional Investors and Accredited Investors only and should not be distributed to or relied upon by retail clients. It is only intended for use in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Asian Insurance Investment Survey 2017
Introduction Standard Life Investments commissioned a survey to identify and understand the long-term impacts of historically low interest rates and the modernisation of regulatory regimes on insurers in Asia Pacific Research conducted in six countries across Asia Pacific to ensure coverage in market size and different stages of industry maturity One hour, face-to-face interviews with 51 senior investment professionals Respondents interviewed represented Over $4 trillion of assets under management An estimated 60% of total insurance assets within the region Interviews split by country Interviews split by role Interviews split by company type 5 China 11 Hong Kong 9 CFO/CRO/Chief Actuary 8 Life Insurer 12 7 8 8 Taiwan S. Korea Japan Australia 27 8 7 Portfolio Manager Head of Asset Class CIO/Investment Manager 37 6 GI & Health Insurer Investment Company & Other 2
Theme 1: Mind the gap? Target, current and expected returns for guaranteed saving products Many insurers in Japan, South Korea and Taiwan are experiencing return deficits in their guaranteed savings products The gap between current and target returns are modest, but the long term nature of these products means small gaps can generate big losses The low yield on these investments means expected return forecasts in line with historic returns are likely to prove too optimistic Target, current and expected returns for guaranteed savings products 4.9% 5.4% 5.4% 5.3% 5.6% 5.9% 4.4% 4.3% 4.5% 4.5% 5.7% 4.3% 3.3% 1.6% 1.1% 3.6% 3.5% 3.2% 2.2% 1.7% 1.5% 1.6% 2.7% 2.7% 3.3% 2.4% 1.5% China Hong Kong Taiwan South Korea Japan Australia Europe We allocate up to 50% to Japanese Government Bonds, so it has been a struggle to meet target returns and guarantees Japanese life insurer 0.1% Target Return Current Return Expected Return Risk-free Rate 3
Theme 1: Mind the gap? Asset liability mismatches Long duration products Lack of supply of long dated assets Risk of future return gap in China and Hong Kong due to the need to eliminate mismatch between assets and shorter duration liabilities Asia Pacific insurers told us they face asset liability mismatches in both directions: short duration liabilities backed by longer dated assets and vice versa Mainland Chinese insurers have generated abovetarget returns through investments in illiquid loans Insurers across the region have a limited universe of local long-dated bonds with which to match longer dated liabilities Short duration products Longer assets to pay for guarantees Insurers are aggressively offering shorter duration, high return products Mainland Chinese life insurer 4
Theme 1: Mind the gap? Shift in product mix from guaranteed savings to investment-linked Insurers in a number of markets are pursuing a shift away from guaranteed savings products towards investment-linked products Customers seeking higher returns are bearing the investment risk instead of the insurer Around half of insurer assets back guaranteed savings products Guaranteed savings products as % of current product mix 87% 45% 62% 31% 29% 51% 39% 13% China Hong Kong Taiwan South Korea Japan Australia Asia Europe Life - G. Savings Expected per annum product growth in the next three years 21.0% Despite the shift away from guaranteed savings products towards investment-linked products, growth still expected across all markets except Australia 8.6% 6.3% 6.0% 2.9% 1.3% 1.8% 2.0% 1.3% 2.5% 4.0% -1.7% GS IL GS IL GS IL GS IL GS IL GS IL China Hong Kong Taiwan South Korea Japan Australia The low return environment has reduced the attractiveness of guarantees and is forcing a shift to investment linked products Taiwanese life insurer 5
Theme 2: The dual role of alternatives Insurers are adapting their asset allocation strategies Insurers intend to increase allocations to alternative assets and global equities The survey revealed the drivers behind these intentions and the barriers they need to overcome in implementing this strategy 75% of total assets invested are made-up from allocations to cash and fixed income securities 78% of insurers intend to increase exposure to infrastructure 75% seek to increase private equity 64% are looking to add to real estate Current asset allocation 28% 7% 10% 31% 32% 22% 30% Domestic Sov. FI Domestic Corp. FI 18% 49% Oversea Sov. FI 25% 14% 30% 23% 16% 30% 18% 6% 10% 10% 7% 13% 9% 19% 9% 11% 4% 8% 13% 4% 26% 20% 8% 19% 4% 26% 15% 6% 8% 6% 6% 12% 8% 6% 8% China Hong Kong Taiwan S. Korea Japan Australia Asia Dev IG FI Other FI Equity LT Deposits & Cash Alternatives Other Meeting existing guarantees is not an issue, but pricing new guarantees competitively will be an issue going forward Mainland Chinese life insurer 6
Theme 2: The dual role of alternatives In search of higher returns The fall in yields on fixed income securities has driven insurers to consider increasing allocations to equities and alternative assets Different alternative asset classes bring different benefits, but in all cases investors expect higher returns through the harvesting of illiquidity premiums Proportion of insurers expecting future allocation to increase minus proportion of insurers expecting future allocation to decrease for each asset class Domestic Sov. Fixed Income Domestic Corp Fixed Income Overseas Sov. Fixed Income Dev. IG Fixed Income EM Corp Fixed Income Regional Equity Global Equity Cash Infra. Real Estate Private Equity China -33% -33% 0% 0% 0% 36% -33% -17% 100% 67% 100% Hong Kong 0% -25% 0% 25% -100% 33% 0% 0% 75% 67% 80% Taiwan 0% -33% 33% 25% 0% 20% 60% 0% 50% 33% 50% South Korea -100% -100% 100% 0% 0% 0% 0% 0% 100% 100% 100% Japan -67% 50% 50% 67% 0% -50% 50% 0% 100% 0% 50% Australia -10% 20% 100% 100% 0% -14% 100% 0% 50% 50% 0% Within my alternatives portfolio, private equity will be the area of fastest growth in the next three to five years Mainland Chinese life insurer 7
Theme 2: The dual role of alternatives In search of longer dated assets 55% of insurers surveyed cited asset-liability mismatches as an issue Infrastructure debt is of interest as it offers both higher yields and longer duration assets to better match insurers liabilities Proportion of insurers citing asset-liability mismatch as an issue Net 0% 50% -33% 100% 70% -75% 21% 44% 67% 33% 100% 80% 55% Yes Neutral 1 2 3 4 5 6 7 11% 17% 0% 0% 10% 25% 11% No 44% 17% 10% 34% 67% 75% China Hong Kong Taiwan South Korea Japan Australia Total Asia The limited supply of longer dated Japanese Government Bonds is driving the shift into longer duration infrastructure debt investments Japanese life insurer 8
Theme 3: Global opportunities, local challenges International allocations to increase in response to investment challenges 78% of insurers surveyed intend to increase international investment over the next three to five years 61% of respondents cited currency hedging costs as a major barrier to increasing international allocation Regulation and lack of internal expertise also provide challenges Proportion of insurers citing intent to increase or decrease to international allocation over the next three to five years Net 36% 43% 88% 60% 83% 100% 65% 64% 71% 88% 80% 83% 100% 78% Yes Neutral 9% 0% 13% 0% 17% 0% 9% No 27% 29% 20% 13% China Hong Kong Taiwan South Korea Japan Australia Total Asia With the Hong Kong dollar pegged to the US Dollar, the Government effectively does our hedging for us. Furthermore, our liabilities can be in US Dollars too Hong Kong life insurer 9
Theme 3: Global opportunities, local challenges Drivers to going global: Returns, liability matching and diversification The survey identified three complementary drivers behind intentions to increase exposures to overseas market 1. International markets provide broader set of investment opportunities 2. They provide scope to increase diversification 3. Markets in Europe and the US offer greater depth and breadth than domestic markets and, crucially, offer longer dated bonds that allow better matching Q16. Are you actively allocating or do you intend to allocate more assets internationally? If so what do you believe are the drivers of increasing international allocations? Source: SLI Asian Insurer Study 2017 We think the Renminbi will further depreciate so offshore investments may be higher yielding, we will not hedge our exposures Mainland Chinese insurer 10
Theme 3: Global opportunities, local challenges Barriers to going global: Regulations and lack of in house expertise Regulatory barriers are a prominent feature, but differ across markets China has the toughest restrictions 15% cap on international allocations and insurer-specific quotas In Taiwan, insurers are permitted to invest up to 45% of assets overseas In South Korea, there is a 30% cap on international allocation Insurers in Japan, Hong Kong and Australia face fewer regulatory barriers Q15b. Increasing overseas allocation introduces a significant currency hedge issue, which offsets the benefits of investing o ffshore Source: SLI Asian Insurer Study 2017 We want to increase alternative allocations but lack capabilities to manage alternative assets in-house at the moment South Korean insurer 11
Theme 3: Global opportunities, local challenges Barriers to going global: Currency hedging issues Currency hedging issues were quoted as a significant barrier to overseas investment by 61% of insurers researched In Taiwan, the survey found that three quarters of international assets are being currency hedged Mainland Chinese insurers generally do not currency hedge their international investments Will currency hedging be a major barrier to international allocation in the next three to five years Net 11% 0% 71% 100% 100% -75% 43% 100% 100% 71% 61% 33% 38% Yes Neutral 44% 25% 29% 0% 0% 25% 20% No 22% 38% 18% 75% China Hong Kong Taiwan South Korea Japan Australia Total Asia 12
Theme 4: Trust in external managers? Real and perceived challenges to employing external managers The insurers surveyed indicated intentions to increase strategic asset allocations to those asset classes where the use of external managers is highest: alternatives and international equities 75% of insurers surveyed expect the trend to increase alternative assets to drive more use of external manager 20% of assets in Asia Pacific are managed by external managers, compared to 29% for their European peers Proportion of insurers intending to increase or decrease their use of external managers in the next three to five years Net -6% 0% 5% 7% 7% 11% 17% 19% 21% Yes 0% 6% 10% 7% 21% 11% 17% 19% 21% Neutral 94% 88% 86% 93% 64% 89% 83% 81% 79% No 6% 6% 5% 14% Regional Equity Domestic Sov. FI Infrastructure Oversea Sov. FI Real Estate Domestic Corp. FI Global Equity Private Equity Oversea Corp FI 13
Theme 4: Trust in external managers? Drivers of external manager use Insurers look to external managers to fill the gaps in their own investment expertise. The more experienced investment teams may even look for input on individual transactions External managers are also used when investment management is not seen as a core area of expertise by the insurer Proportion of assets managed by external asset managers 67% 59% 48% 36% 33% 15% 20% 4% 6% 6% Domestic Sov. FI Domestic Corp. FI Oversea Sov. FI Oversea Corp FI Regional Equity Global Equity LT Deposits Infrastructure Real Estate Private Equity Asset managers bring ideas from overseas, which are not new for them but are new for us Mainland Chinese life insurer 14
Theme 4: Trust in external managers? Barriers to external manager use Interviews with participants revealed two types of barriers to the use of external managers 1) Structural challenges 1) Incentives to build in-house capabilities 2) Affiliated asset management companies External managers know very little about regulation and we need to teach them instead of the other way around Mainland Chinese life insurer 2) Performance, value for money and lack of understanding regarding local issues Understanding performance is the biggest barrier to using external managers Hong Kong life insurer Q29. Where there is a desire to increase allocation to external managers, what are the main challenges that need to be overcome? Source: SLI Asian Insurer Study 2017 15
Theme 5: Investment risk exposed Investment implications of regulatory change The consequences of investing in risk assets will become transparent as accounting and solvency regimes become more risk sensitive and market based The challenge increases when there is a disconnect between accounting and solvency standards: as they transition from bookbased to market-based regimes Solvency regulation challenges investment strategy Accounting regulation challenges investment strategy Net -25% 17% 40% 100% 50% -50% 22% Net 63% 17% 0% 100% -10% 75% 32% 100% 100% Yes 38% 33% 60% 60% 25% 51% Yes 75% 33% 20% 10% 75% 46% Neutral 0% 50% 20% 0% 30% 0% 19% Neutral 13% 50% 60% 0% 70% 25% 41% No 17% 20% 10% 30% No 13% 17% 20% 20% 14% 63% 75% China Hong Kong Taiwan South Korea Japan Australia Total Asia China Hong Kong Taiwan South Korea Japan Australia Total Asia Accounting regulation is a major and continuing source of headache Mainland Chinese life insurer 16
Theme 5: Investment risk exposed Driving a fundamental move to risk aware investing 89% of insurers surveyed indicated the need for closer collaboration between actuarial and investment teams 51% told us that solvency regulations challenge their investment strategy 46% told us that accountancy regulations challenge their investment strategy Clear trend towards greater transparency on risk; this is driving a move towards more risk aware investment and collaboration Proportion of insurers indicating the need for closer collaboration between actuarial and investment teams Net 100% 80% 67% 100% 90% 67% 86% Yes 100% 80% 83% 100% 90% 67% 89% Neutral 0% 20% 0% 0% 10% 33% 8% No 17% 3% China Hong Kong Taiwan South Korea Japan Australia Total Asia IFRS will bring in mark-to-market, which will have a major impact on our P&L, and may mean we will not be able to invest in as risky assets South Korean non-life insurer 17
Asian Insurer Survey 2017 conclusion The twin forces reshaping the industry Five themes, one story Insurers face an increasingly difficult investment challenges: seeking higher returns, business model pressure, regulatory changes, greater transparency on risk and the need for greater collaboration between actuarial and investment teams Industry in transformation Greater transparency on risk has implications for both the investment approach and the business models of insurers. Reality gap on return gap? Insurers recognise the challenge of generating returns in a world of low bond yields and the increased chance that returns will fall short Solving the outsourcing puzzle? The shape of the industry will depend on whether insurers decide to outsource more, build their own teams or forego the opportunities in alternatives and global assets The missing link? By linking investment teams and actuaries, internally and externally, insurers are more likely to arrive at the right solution to manage risk and meet their investment challenges We see these themes as one story that will shape the industry over the coming years 18
Insurance solution case studies Private market assets and the illiquidity premium
Private credit: Insurer allocations Insurers are increasingly making significant allocations to private credit asset classes Commercial real estate debt Private placements Infrastructure debt Key benefits for insurers include the expected illiquidity premium: Which is particularly attractive with annuity portfolios And the diversification of credit exposure And duration lengthening Source: Standard Life Investments 20
Credit universe Return Traditional Alternative Niche Distressed Debt Secondary Bank Loans/Pools Real Estate Loans Regulated and Social Infrastructure Syndicated Corporate Loans Emerging Market Debt High Yield Debt Specialised Finance Aviation Shipping Leasing Niche Bank Financing SME Loans Consumer Loans Real Estate Loans Real Asset Private Debt Asset Backed Securities Direct Lending G7 Treasuries UK Investment Grade Credit Non G7 Sovereign Debt Global Investment Grade Credit Commercial Real Estate (CMBS) Residential Real Estate (RMBS) Collateralised Loan Obligations (CLOs) Asset-backed Consumer Loan Pools (ABS) Real Estate Subordinated Lending Junior Debt/Mezzanine Cash Low Loss Severity Capital Preservation Higher Loss Severity Alpha Seeking Credit Source: Standard Life Investments 21
Relative value of Commercial Real Estate Loans Estimating the Illiquidity premium Commercial Real Estate Debt can offer an attractive illiquidity premium Source: Standard Life Investments, January 2017 22
Private market assets: Case study Capital efficient asset allocation to generate attractive yields What were the insurer s requirements? Increased risk-adjusted return on assets backing annuity business Had capacity to increase allocation to illiquid asset classes Investment solution and outcome Allocations to Commercial Real Estate Loans and Infrastructure Debt Risk-adjusted returns greatly improved and IFRS profits boosted Investment manager support Investment mandate tailored to meet Solvency II Matching Adjustment regulations Accredited Internal Credit Rating Framework Source: Standard Life Investments 23
Case study 2: Secure Income Real Estate
Secure Income Real Estate Insurers are also looking for alternative sources of yield Secure Income Real Estate investment is focused on properties with: High-quality tenants, on Long-dated leases These assets can provide sustainable income for insurers, with strong indexation benefits for Continental European properties These assets are expected to have lower volatility (than core Real Estate), which can reduce the Solvency Capital Requirement for insurers Source: Standard Life Investments 25
What is a secure income real estate fund? Traditional pan-european real estate funds Illustrative secure income real estate funds Value driver Majority in building Majority in lease Lease types Mixture of leases Index-linked Portfolio lease length 3-7 years on average >15 years Vacancy risk Average risk - tenants can go bust and leases expire Minimal risk focus on tenants with very strong covenants Asset management Active to generate added value More limited. Focus is on maintaining secure income characteristics of the portfolio Volatility of capital values Higher Lower Effect of lease events on returns Affected by lease events Minimal exposure to lease events Institutional investors see secure income real estate as alternative to matching asset classes Source: Standard Life Investments 26
Absolute Return for Insurers case study
Absolute Return Illustrative funds by risk expectation Low risk expectation Medium risk expectation Return target Cash + 3% Cash + 5% Risk expectation 2% 4% 4% 8% Ideas universe Bonds and FX Macro Multi-Asset Macro Current availability Global Global Institutional SICAV fee 45bps* 85bps Broad investment freedom enables return to be generated irrespective of the environment Risk-based portfolio construction to ensure a robust portfolio Longer investment time horizon exploits established inefficiencies * After institutional fee rebate. Return expectations gross of fees annualised over rolling 3 year periods. Risk measure is annualised volatility. Source: Standard Life Investments 28
Standard Formula SCR Medium risk fund Solvency II SF SCR End-March 2017 35% 30% 25% 20% 15% 10% 5% 0% Interest Rate Equity Property Credit Currency Diversification TOTAL 3.5% 10.6% 3.7% 15.1% 9.2% 23.7% Source: Standard Life Investments 29
Standard Formula SCR Low risk fund Solvency II SF SCR End-March 2017 14% 12% 10% 8% 6% 4% 2% 0% Interest Rate Equity Property Credit Currency Diversification TOTAL 0.0% 2.4% 3.5% 7.0% 2.9% 10.0% Source: Standard Life Investments 30
Absolute return: Case study Capital efficient asset allocation to generate attractive yields What were the insurer s requirements? Increased yield on shareholder assets held at the group level Group assets will be subject to Solvency II capital charges Investment solution and outcome Allocation to absolute return funds The selected fund mix achieved the insurer s risk-return objectives Investment solution and outcome Capital assessment of the absolute return funds under Solvency II Full look through asset reporting to underlying asset holdings Calculated on standard formula SCR and internal model Source: Standard Life Investments 31
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