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I'm your host Zach Rifis, head of US investment grade and macro strategy. And joining me today to discuss APAC Insurance is Trung Tran. He's our senior analyst covering APAC Insurance and GCC banks. Broadly Trung, thanks so much for coming on the podcast.
Thank you, Zach, and hello, everyone. All right, I'm looking forward to a great discussion and learning a few things myself as I'm not as familiar as I'd like to be with either of these sectors. And I know you've recently put out some great pieces. So can you start by just taking us through our coverage in the APAC Insurance sector and maybe touch on some of the common themes that you see across geographies?
Sure. So we start to look into the APAC Insurance around early 2023. So it's about five years that we are looking to these sectors. So within this space, we look at different countries from the North Japan, Hong Kong, Korea, China, Taiwan, and then further down to Thailand and Australia.
So we look at those that we, the bottom issue was in this space, and most of them are actually life insurance. We have a couple of non-life insurance like in China as well in Australia, but most of the coverage that we have actually life insurance companies. I think some of the names that investors are very keen to know more are usually Japanese life insurance as well as the Hong Kong life insurance like AI, BLS, OPC, and FWVs. So yeah, that is our coverage at the moment.
We have about 17 names and our coverage. We may see as I went, there's more names, but of course it's depend on the size of the insurance as well as the client interest, which should be one to expand for those. But yeah, that is just a very brief description about our coverage. I think which regard to what do we see as the common teams in this space?
I guess there's a lot of changes happening right now, but if you filter the noise, you will see that ultimately there are still key driver for a lot of things that are happening in APA insurance. It is the change in the cryptocurrency regulations as well as the accounting change. So in the past, like maybe like four or five years and long before that, in APA insurance, we see a lot of differences in terms of the cryptocurrency regulations, the cryptocurrency models. So each country has their own models and these models are usually very, very different from each other.
We have these initiative to drive global insurance capital models. And at the end of last year, this model is called, or this framework or you call it blue print called insurance capital standard has been finalized. And this is where a lot of insurance companies in APA, a lot of countries are heading towards this new cryptocurrency regimes, which is much more sophisticated compared to a lot of existing cryptocurrency regimes that we have right now across the markets. Some of the countries has already adopted these models even before the finalizations of these ICS, just a couple of short words.
Like for example, like Korea, they have already adopted these regimes in 2023, Hong Kong last year, Japan starting from these years. And a lot of the markets will follow as well. China has actually also adopted these models, not the full models, but in the face, I mean, they adopt the model two phases. So they have adopted these models like a couple of years ago as well.
So this is the very big change that is happening right now in the insurance space impact. And because of this adoption of the new cryptocurrency regimes, it's just helped investors to look at the insurance companies in a more universal way perhaps. In a universal way, yes. And I mean, it's also helped to reflect the economic pictures of the insurance company betters because before that, you know, like under the old regimes and then this comes together with the companies that are two, under the old regimes, like the valuation of the reserve, the valuation of the asset investments are quite a lot of them actually is like on a book value basis.
So it does not really reflect the true pictures of the insurance companies as in when the interest rate change or even the assumption change to. So it was not a very good representative of the insurance company in the past, but the new some of the models and the new accounting system, it just helped the stakeholders to see the insurance companies through the economic lens betters. And of course, it's more updated than to do the latest accounting rates. And there's a lot of more stringent requirements in terms of their risk management.
So the risk trust in the model is much, much more, is much higher than compared to the models and the way that is closed, the data also have to be standardized. So these are the very big change that has been happening. And as a result of these change, some of the team's back to your questions that we are seeing now is changes in the regulations refinement which regard to these models. So the regulator may change some of the assumption rates for their labs for their accounting rates.
And this is a question that the insurers are waiting anticipating to adapt to. And then with the change of the sum of the models, there will be also a discussion about what are the relaxation measures that the insurance will have for a period of time because they when they move into this new regime, it doesn't mean that they will adopt it immediately 100%. The need times, so it's 10 years, it can take 15 years to adopt to these models. So yeah, this is another thing that we are seeing some relaxation measure for the companies from the regulators.
And of course, it's have a few different other implications as well. So yeah, I think for those who are new to this space or even those who have been looking into this space for a while, just keep in mind that the supersoncy regime change as well as accounting change that just happening since 2023 are still a very big driver on what has been happening in the market at the moment. That's interesting. And I think definitely helpful to have the more universal way to look at these insurance companies and their performance across geographies as opposed to having to just consider the different solvency regimes and accounting standards or the way they report.
So given this move toward a more universal, perhaps look at, you know, way to look at, these companies across regions of a better economic lens, which credits do currently prefer in the APAC insurance market and maybe just take us through a couple of key reasons why those are your preferred names. Yeah, sure. So before that, I must also make a claim here is that it does help to make it easier for investors to compare. But at the end of the day, there's still a lot of new answers and differences across models.
So when you look into the supersoncy models as well as compare across different geographies in terms of performance as well as the solvency, there's still a lot of work to be done that you have to really look into that book and compare within the industry to get a rough idea on what is a good credit, what is not so good. And within this, so after we have done all these analyses, we compare across the board in different markets. Some of the names that I think we really stand out and we like them so a lot. I think the most outstanding one is really the Japanese life insurers.
They are like, you know, a lot of excellence, credit qualities. They are like, they are usually like the top players within the industries like one, two, three, four, five, so the top five, uses the top five players. And they have a very, very high level of solvency ratios, whether in all regimes or in the new regimes compared to the industry average compared to the minimum requirements. They have tested this solvency ratios through a lot of stress as well.
So basically, when you look at the balance sheets, the capital equity ratio, there's a lot of work that has been built into their financials. And in terms of the performance, the performance is not like so great. I mean, the return equity is usually about three percent, which you might find a little bit low, but if you look at the nature of the business, which is mutual insurance, they're not really like, they have to maximize their profit. They just need to earn enough profit to continue because even that they are mutual insurance, they're not like fighting for commercial reasons, the return equity is enough to be the inflation as well as the government bond.
I think that is a very appropriate level of performance already. And as I mentioned earlier, in terms of their brandings, they are very well known industries. They're total assets, like a few hundred billion US dollars. So they are huge and humongous.
They have been in operations for a very long time, like up to 100 years or even more. So this institution is established institution in Japan. And they're one of the largest investors there, and even non-global skills as well. So when we look at this financial condition of these Japanese life insurers, as well as their brandings, the way they manage their business, we just find that this is a very, very well-ranked companies with excellent numbers across different metrics.
And they spread out pretty wide, which you may read the question why. It's such a strong name. They're still trading very wide. Like they are 10 years.
Some can be trading, I think as a result of the recent tariff as well. Can be trading on the spread of like T plus 200 people and above and their U2 companies about 6.6%. So like, which I find is just very unreasonable. There's been a period where the spread is much tighter, where we even see that, okay, now it's about time for us to change from our platform to market platform.
But recently it has been become wide against. So when we talk to investors on their views about the markets, Japanese life insurers for example, so what we do see is that there's still quite a lot of misunderstanding about the business. A lot of investors are still not very familiar with this space, even though these are very well-known names. And I mean, I'm happy in that sense that because we are contributing to the communities through our analysis of these Japanese life insurers.
There can be some concerns about equity investments, the investment portfolios, investment strategies. But that says the regulators have done a lot of stress on some of these risks and the Japanese life insurers are very well positioned for this kind of risk. Some ask the question about the bond structures, whether there's any extension risk or not. And to this we say that there's really minimal concerns about the cause with event here.
There has been no track record of these Japanese life insurers who are not calling their bond. So all in all, we just find that there is a mispricing for these Japanese life insurers and we like many of them. And three of them are like Newborn Life, Dijilive and Beijis, that's the one that we like the most and we have an upper form of recognition of this. So yeah, what we like, I think the Japanese life insurers are the one that on the top of my head.
Some of the others like Hong Kong, here, which is actually the best credit that we see in this space, but they are also trading quite tight. But that's fine. I mean, I think we find that the trading level is still acceptable. And the last one that I think was highlighting in these policies, perhaps QBE, non-life insurance in Australia, it has a very high-capy kind of situation and investment portfolio is just very very conservative.
Not to mention that performance is really one of the best that we have seen so far. So yeah, these are the names that we like in this space. Yeah, sounds like pretty incredible opportunity to pick up some nice spread and good businesses, especially in those Japanese lifers. So I'm sure that clients certainly appreciate highlighting that and that perspective.
I'd imagine there's plenty of risks out there not to mention the risks kind of facing the global financial markets and global economy in terms of some of the policies we have coming out of Washington here over the past couple weeks. What would you say the biggest risk that investors in the APAC insurance sector should be aware of? I'm sure there's some comments there in terms of policy out of the US, but what else is top of mind for you as you're going through your analysis of these companies? Usually for the life insurance industries, the common top risk that we have in mind is that interest rate risk.
So if interest rate decline, actually that's not good for the life insurance companies, because it can affect their sales perspective, can affect their services ratios in a negative way. Their business is operating in a way that their liabilities duration is much, much longer than their assets duration. So interest rate decline is actually not good for them. The other risk that is also very important is equity risk, because the life insurance companies, the one that we cover, have not too small an exposure to equity investment.
So this is another risk that investors have to keep monitoring for the life insurance company as well. And lastly, the reserving risk, which is commonly one of the biggest reasons for any default that you may see in an insurance company. So these are the big reasons that the insurance company face. To your questions about the recent policy change coming up from the US, I think, yes, we are still in a period, I think it's about two weeks already.
So we are still in a period of adjusting these information and anticipating what will come. I have received quite a lot of questions about our thoughts on these implications. And my response is that the most immediate impact I can see is really on the investment, particularly the equity investment. Let me think that Japanese life insurance for an illustration, which I think can also apply to a lot of the other life insurance as well.
But so far, we see that for the Japanese life insurers, they have about 10 to 15% of their investments in equity investments. And because of their new changes, it has triggered quite a lot of volatility in the equity markets globally, as well as domestically in Japan as well. We have seen quite a sharp decline in the equity valuations. There's some recovery, but it's still quite below the recent highs.
And that, of course, we'll have implications to their pharmacy level if this continues to be highly volatile or even like trending downward. So that is the risk that we are seeing for the insurance companies. The other thing is, I think, maybe in a medium to a longer terms, we have to really seize the impact on the investment as well. Because for those companies that are invested in, the earning capability can be quite effective for some industry, like trading, shipping, manufacturing, these industries can be quite affected by the changes.
And that means that the valuation on this investment can be under quite a lot of pressures. The dividend income that you might expect to get from this investment can also decline as well. So their profit and loss, the income will be highly affected because of these changes in a medium to a long term. So that is another trend that I can anticipate that will happen.
And if there is a long term decline in the valuations of the equity portfolios, that will mean that the available capital for the insurance company will also be further decreased. And this, as I mentioned at the beginning, will cause some financial to decline. So this is a risk that we are very careful when we are very conscious about. So that is the first immediate risk that I can think of.
The second one will be more of like the secondary effects. The question will come, what would be the prospect of the GDP growth? What would be the consumer sentiment and the purchasing powers? And this will also affect the sales for the Japanese life insurers.
And as a result, it can cause some slowdown. I mean, the growth has not been that fast anyway, but the growth will not be as white as you may see in the past. So the sales prospect can also be affected as a result of the recent change as well. And because of that, there can be changes in actual assumptions.
And then it will create a lot of the other reactionary change in the estimation of the liabilities, in the estimation of the embedded value. So there's a lot of changes that I think that can be that we may start to see over the medium to slightly longer terms. But for now, we are still pretty comfortable with the credits, most of the company that we see in the market right now, because they have been quite a lot of buffer against this type of risk that has just mentioned equity risk and resolving risk. So we have not changed really changed our positions of view on the credit fundamentals of a lot of the life insurers in the next.
That makes sense. And just to clarify for our listeners, the 10 to 15% of investments in equities that you highlight, I think, for the Japanese lifers, are those all domestic equities? Oh, these include domestic and international as well. You can expect maybe two-third domestic or half-half.
Yeah, he's a very big company. And when you think about the recent move lower inequities, I'd say in general, it hasn't been accompanied by a move lower in sovereign yields really across geographies, as we have a bit of a reassessment of, I'd say, term premium here in the US, among other things, with the big shift in our foreign policy, mostly through trade so far. Are you expecting any big shifts in investment portfolio allocations? Let's say for the Japanese lifers, Taiwanese lifers, anything like that in response to the market moves we've seen thus far not trying to extrapolate too much about what we'll see, but even the re-price we've had up to this.
Okay, you just pointed out about Taiwan's... Well, okay, this is interesting. A little bit more unique market, but I'll talk about that later. But if you ask me about any expectation for any shift to the investment strategies allocations, I think first we need to be aware that for the insurance companies, usually the investment strategies are pretty stable.
So you don't really expect a drastic change in the allocation investment allocation in the book. Some drastic change, I mean, some of the bigger change that at least we have seen recently is on the Japanese life insurers. So the past two years they have cut their exposure to foreign securities quite substantially, and they shifted back to domestic investments. And most of the investment has been always a majority of 60% of it is usually fixed income.
And government bonds are the dominance allocations to do this fixed income investment. So these will not change. I mean, the investment principles for fixed income, I mean, the preference for fixed income book and very high qualities type of investments are there to remain the same because they need to make sure that they have a low risk for their investment risk for their credit risk, and they need to make sure that the the duration of their investments are long as long as they can. So these strategies will not change.
And on top of this, then we may expect to see some small change. And despite this smaller change, I think so for the insurance company when they try to improve their yield in a pretty low interest rate environment for some of the markets, they may start to increase their investment into let's say alternative investments, it can be markets, secularizations, it can be private equities. But usually this proportion, even though they're trying to expand these portfolios, is usually less than 5% of their book. So it's still pretty manageable.
The majority of their investment are still like fixed income, like triple A, where things are type of like investments. And if they're moving out of foreign securities in general, so is that kind of triggered by, I don't know if going back two years, it would really come up with the slow increase in interest rates we're seeing from the Bank of Japan and so kind of a slow lift higher. There's a couple of reasons for this change, two years back. Number one is the hedging cost.
So they expose that because of the overseas investment aspect, and usually they use hedging, so they buy a different type of swap forward to protect their overseas portfolios. But the hedging cost becomes very expensive at the point in times like 5% each. So it's like can just wipe out all the difference in the return that they have compared to the domestic market. So the hedging cost is not very reasonable.
So either they have to cut it in the hedging allocation or they just cut the overseas as well. And during the periods, there has been an anticipation of increasing the rate in the domestic market, which at the first place was the reason making the Japanese life insurance to go overseas. But now the domestic rates improve. That is also another factor that pulled the investment back to the Japanese domestic market.
So high hedging costs and increased interest rates domestically are some of the two reasons that have created such a shift. Going forward, now we are actually seeing a very high likelihood of actually a pause in rate heights in Japan now. So these can have a different result. I mean, some expect that there can be some further increase in alternative investments in terms of hedging.
I doubt that they probably going back to the hedging tool as we used to see. But it still depends on what the level will be as well as the actual outcome of the change in the rates in Japan as well. So the approach towards the hedging for the Japanese life insurance is still very much weight and sees. It's pretty dynamic.
There's no fixed rule for the hedging tool for the moment. But there's one more thing that I think is quite expected. And some of them are already making the move is the reductions in equity investment exposure. What we see is that July actually is very clear about that.
They are trying to reduce exposure to equity investment by a very big way. They're trying to cut almost half of their equity investment exposure going forward over the medium like two to three years. And they're making a progress on that. And this is a trend that we may start to see for some of the other insurance companies as well because they're trying to reduce their risk on their book.
Yeah, so that is some of the key things that I have. See, as you can see, there may be a shift, but it is just like a small, small change over time to the investment strategies for a number of insurance companies that we have here. Great. And there's certainly plenty to talk about in financial markets broadly right now.
But what are some of the common questions investors have for you in the APAC insurance sector? And what are your key responses as kind of providing a quick hit as to what the investment community is interested in and your views on those topics? Yes. So most recently, of course, the last question is on the effect of the tariff changes.
And I have just my response earlier. It's about equity investments as well as the sales prospect. Some of the other questions that we usually receive from the investor, let's say the question about the extension risk for the Japanese life insurers, to which we say that it's almost non-existence. And then there's a lot of questions about the nuances in terms of the bond structures for a life insurance in in ages whether it's deferral, whether it's what is the when is it going to be called, what is the probability of the call.
And for this question, usually, they are like our response is usually that the call risk for the insurance that we see in APAC are very, very low. There's some incidents of non-call but eventually after that they still call. Then there's some questions about the JAGANS, some accounting JAGANS for foreign insurance companies, which I think investors usually feel very upset about this industry in a way that there's just too many JAGANS and it's just very hard to understand. It just needs time.
So those are some of the questions that we usually receive from investors. Well, thanks, Trung. This was a very interesting episode for me. I learned a lot.
I'd love to have you back on the podcast to discuss some of this in more detail. I do think that it'll be a very interesting landscape over the next couple of months thinking about how foreign investors broadly shift their portfolios. And I know you mentioned especially with these big insurance companies, I think this goes globally that any shifts in asset allocation are pretty gradual and takes some time. But I think some of those timelines might get accelerated with the big shift that we're seeing in foreign relationships globally.
So I hope to have you back on in the future. And then thank you so much for coming on the podcast today. Great. Yes.
Definitely. I think I'm still trying to learn on what's happening next because of what's going on now. We start to see if there's more discussion from these insurance companies and you updates our talk on their investment strategies as well. That's more meaningful change that is happening.
So yeah, I hope that I can put out more on these fronts too. Great. Well, we will stay in touch. And in the meantime, thank you all for tuning in.
We will catch you next time on No More Risk Better.