Falling yields pile pressure on China’s insurers

CHINA’S insurance companies reported higher investment returns in 2024 despite falling market interest rates and an economy flirting with deflation, as the bond market soared, the stock market took off in the latter part of the year, and companies increased their dividend payouts.

Insurance companies’ annualised total returns were 7.16 per cent in the first three quarters of 2024, compared with 3.28 per cent in the year-earlier period, according to data from the National Financial Regulatory Administration, the country’s top insurance watchdog.

But the outlook for 2025 is less certain, as insurers face headwinds in both their equity and bond market investments, and come under growing pressure to ensure they can maintain profitability in a low-interest-rate environment.

To protect insurers’ bottom line, regulators have already told companies to cut the costs of their liabilities. Since 2023, insurers have been told to lower the illustrated rates for participating and universal life insurance, reduce the cap on assumed interest rates, and decrease the settlement rates for universal life policies.

However, amid expectations the low interest rates and bond yields will persist in 2025, the pressure to honour rates on existing policies remains significant.

“Although the industry has actively reduced costs on the liability side, the pace of reduction in the short term still lags behind the speed of the decline in asset yields,” China Insurance Security Fund CISF), a state-run bailout company, wrote in its annual assessment of the industry’s risks. “Further precautions need to be taken to protect companies from the growing gap in interest rate spreads.”

Increasing investment in equity assets is one obvious option to enhance returns. One potential positive for insurers is a new initiative announced by regulators on Jan 22 to encourage medium- and long-term investment funds – such as commercial insurance funds, the national social security fund and pension funds – to boost their presence in the stock market.

The plan was jointly issued by the general office of the Central Financial Commission, the China Securities Regulatory Commission (CSRC), the Ministry of Finance, the Ministry of Human Resources and Social Security, the People’s Bank of China and the NFRA.

It is a response to calls for measures to stabilise the stock market and resolve bottlenecks hindering the entry of medium- and long-term capital into the market.

Under the plan, large state-owned insurance companies are told to allocate 30 per cent of their new premiums every year to investment in A-shares, starting this year. The market value of tradable A-shares held by mutual funds needs to increase by at least 10 per cent annually over the next three years.

“This means the A-share market will receive at least several hundred billion yuan of new long-term capital each year,” CSRC chairman Wu Qing told a press conference on Jan 23.

To accommodate the longer-term nature of the investments, the plan explicitly mandates that the performance of state-owned insurance companies, and insurance funds under the state-run public pension scheme should be assessed on a cycle of at least three years.

The Ministry of Finance had already adjusted the performance evaluation criteria for state-owned insurance companies in October 2023 after the CSRC set out a broad policy framework in August that year to encourage long-term equity investment by insurance funds.

The return on equity (ROE), a key metric to assess a company’s profitability, was broken down into two parts of equal weighting – the current year and a three-year period.

Investment bottleneck

The latest plan adjusts those parameters, stipulating that the weighting given to the annual ROE should be no more than 30 per cent, while the weighting for indicators over a three-to-five-year cycle should be no less than 60 per cent.

The performance of the national social security fund, one of the most active players in long-term investment in the domestic stock market, will be evaluated over a period of five years or longer.

“The short assessment cycle has long been a bottleneck restricting the expansion of A-share investments by commercial insurance funds, and other long-term capital,” Wu said. Implementing a longer assessment cycle can effectively smooth out the impact of short-term market fluctuations on performance and enhance the stability of long-term investment behavior, he added.

China has launched a pilot programme for insurance companies’ long-term investment in the stock market. The first investment funds were approved by the NFRA in October 2023 and a second batch of funds was approved in January this year involving 52 billion yuan (S$9.6 billion).

“We will continue to expand the number of pilot insurance companies and the scale of funds based on the wishes and needs of insurance companies,” said Xiao Yuanqi, a vice minister of the NFRA, noting that the second batch of pilot funds would offer insurers more flexibility than the first.

Yet, while the new plan aims to have large state-owned insurance companies put 30 per cent of their new premiums every year into the domestic stock market, they still haven’t fully utilised their existing allowances.

Insurance funds have 4.4 trillion yuan invested in stocks and equity funds, 12 per cent of their total assets, while their investments in unlisted company equities account for 9 per cent, giving a total of 21 per cent, just under half of the cap allowed by regulators.

Insurance companies in China have a relatively short history of equity participation as stock markets were considered too risky, and they were restricted to investing in safer assets, such as government bonds and bank deposits.

However, in order to boost their returns and support the domestic equity market, insurers were given the go-ahead in 2004 to directly invest in the Chinese mainland stock market. 

To diversify their portfolios and manage risks, insurers are also allowed to invest in unlisted equities such as private equity funds, venture capital, and direct stakes in private companies. But their total equity-related investments cannot exceed 45 per cent of their total assets.

Lack of quality

Insurance industry insiders said that asset allocation is not solely driven by policy initiatives. The quality of listed companies is the cornerstone of equity investment and only when the market has long-term investment value can insurance companies genuinely increase their investment in equities.

Many financial institutions have bemoaned the lack of high-quality listed companies to invest in, an issue the government has acknowledged and is seeking to address. It has unveiled a string of policies including stricter IPO rules, stronger corporate governance and compliance requirements, and supporting technology and innovation-driven companies.

Although small and midsized insurance companies with small and flexible funds can achieve higher returns through stock speculation, for large insurers with substantial capital, their primary strategy remains “long-term money for long-term investment”.

“Life insurance funds are not short-term capital and will not participate in market speculation,” an executive with the investment department of an insurance company said.

“Therefore, their main investment targets are high-quality companies with high dividends and stable performance. They won’t buy trendy stocks because, leaving aside the share price volatility, there’s a risk their operating performance will deteriorate to the extent that they will be delisted.”

The search for income amid low bond yields was one reason why China’s insurance companies homed in on mainland-listed bank stocks last year, as they were widely seen as relatively safe equity investments and were offering yields double or triple those of Chinese government bonds (CGBs).

Insurers, however, still need to invest a chunk of their money in low-risk fixed-income securities. The bull run in the bond market over the past two years, which has pushed CGB yields to record lows, has created new challenges.

The yield on the benchmark 10-year CGB fell to as low as 1.6 per cent on Feb 5, continuing a slide that saw the yield plummet 88 basis points over the course of 2024 to around 1.7 per cent by the end of the year. Yields on other maturities have also dropped sharply, leaving insurers in a dilemma.

“I hate long-term bonds now, because as soon as you buy them, you make a loss on the interest rate spread, but insurance companies have no choice but to buy them to protect their net assets,” said the chief actuary of a midsized insurer.

“Right now, if we assume the average cost of liabilities in the insurance industry is 4 per cent, with such low fixed-income yields, just how high do equity returns need to be for us to break even?”

Insurance companies around the world invest the majority of their funds in bonds, especially government bonds, because they are required to be risk-averse and invest prudently in securities that provide stable, predictable returns and a steady stream of income to meet current and future obligations to policyholders.

China’s regulators have in recent years put increasing focus on risk management by insurers and on ensuring that their assets – including investments such as bonds, stocks, property, and private equity – match the duration of their liabilities – including unearned premiums (the portion of a policyholder’s premium that has already been paid but where coverage has not yet been provided), reserves (funds set aside to cover future claims and obligations to policyholders), claims payable, and debt. 

New global accounting standards have also changed the way insurers measure their liabilities and how they value and classify their assets, making them more sensitive to market ups and downs.

China’s insurance companies have boosted their holdings of bonds, especially long-term bonds, to minimize volatility in their financial statements and to ensure they meet the new asset-liability duration requirements.

Investment dilemma

As of September 2024, bonds accounted for some 49.2 per cent of Chinese life insurers’ combined 28.9 trillion yuan of investment, a significant increase on the 41.8 per cent reported two years ago, despite the decline in yields, NFRA data show.

“We’ve done the math. After switching to the new accounting standards, to truly achieve asset-liability matching, we would need to allocate half of our funds to long-term bonds,” said an executive in the fixed-income department of a life insurer.

“This presents a dilemma: if we allocate them and interest rates do not continue to decline, we can’t meet our yield targets; if we don’t allocate them, we can’t fulfill the requirements for asset-liability matching.”

The chief actuary of the midsize insurer said that duration matching is now more important than generating investment returns.

“Assuming an insurer’s liability cost is 3 per cent and the asset yield is 2 per cent, then the gap for one year is 1 per cent,” he said. “But if there is an error in duration matching, and interest rate fluctuations are multiplied by duration, liabilities would need to increase by 10 per cent immediately, and the mismatch would directly lead to a 10 per cent decline in net assets.”

He illustrated the problem with an analogy. “If your spending is 10,000 yuan a month, you need to find a job that pays more than 10,000 yuan. But following the logic of the current accounting standards, you should find a stable job that you can keep for 30 years, even if your monthly salary is only 5,000 yuan.”

Many insurance companies are increasingly turning to hedging to manage their interest-rate risks, and industry insiders hope the government will increase the number and types of derivative tools available to them so they can better hedge against volatility.

There are also growing calls for insurance companies to be allowed to increase their overseas investments to boost returns. Chinese insurance companies had only 1.9 per cent of their investments overseas as of the end of 2023, way below the regulatory cap of 15 per cent.

More overseas investment

CISF’s latest annual assessment of the industry’s risks pointed to how China could learn from the experience of Japan, which has suffered from low interest rates for many years.

From 2008 to 2022, the Japanese life insurance industry’s allocation of assets to domestic government bonds was stable at around 40 per cent and that to domestic stocks fluctuated between 4.5 per cent and 6.1 per cent. Over the period, the percentage of overseas investment doubled to 24 per cent, nearly all of which went into bonds.

Japanese life insurers also used financial derivatives, such as foreign exchange forwards, swaps and options, to hedge risks associated with overseas investments to ensure the stability of their investment returns.

The industry’s total returns have consistently outperformed those on government bonds by an average spread of about 200 basis points a year from 2014 to 2022, CISF’s report said.

Industry experts said regulators should increase the investment quotas for insurance companies through the Qualified Domestic Institutional Investor programme, which allows eligible institutional investors to trade offshore securities.

The government could also prioritise connections to overseas markets through the Bond Connect, which allows mainland institutional investors to access the Hong Kong bond market, and encourage investments by insurance companies in long-term US dollar bonds issued in Hong Kong by high-quality domestic enterprises, they said.

They are also calling on the authorities to allow insurers to use derivatives to hedge against fluctuations in interest rates, foreign exchange and equity assets.

Although China’s yuan is currently facing depreciation pressure, such investment outflows should not be viewed over the short term, an investment professional in the insurance sector told Caixin.

“There will be both inflows and outflows, and overall it will balance out and won’t have a long-term impact on the exchange rate,” he said. CAIXIN GLOBAL