Key Takeaways
- New rules will give Taiwanese insurers more room to smooth the profit impact of foreign-exchange volatility.
- However, the increased flexibility also allows for weaker protection against forex shocks.
- Overall, we view the rules as a potential credit negative.
Upcoming rule changes will give Taiwan's insurers more flexibility to smooth earnings volatility caused by foreign-exchange (forex) movements. However, this could turn into a credit negative if insurers put more strategic emphasis on profit management than stemming forex risk.
Under the new rules, insurers will be allowed to release more of their forex reserves to offset hedging costs. At the same time, the basis to calculate mandatory provisions is likely to be lower. S&P Global Ratings believes this will give insurers more control in managing the income-statement hits from volatile hedging costs.
While the regulator has not yet disclosed the exact timeline for implementing the changes, we expect this to happen relatively soon.
The new rules come at a time when Taiwan life insurers face higher forex hedging costs due to a widening gap between the U.S. dollar and the new Taiwan dollar (NT) interest rates. Such a trend can hit profits and potentially lead to capital erosion for insurers.
Limited Exposure To Recent Global Banking Woes
Taiwan's life insurers have higher overseas investment than regional peers, and thus could be more exposed than peers' to recent global banking events. However, we see a limited credit impact for rated Taiwan insurers.
We estimate overseas financial debentures (i.e., senior financial bonds, subordinated bonds, etc.) account for 20%-30% of total invested assets for rated life insurers in Taiwan. In our view, this overseas portfolio is generally of good credit quality because of stringent regulation governing such investments. We estimate financial bonds with contingent conversion liabilities are very limited. As to foreign equities, they make up no more than 5% of total invested assets.
As such, we expect very limited exposures to the recent failures of the three U.S. banks (Silicon Valley Bank, Silvergate Bank, and Signature Bank). Nor do we expect a large reverberation from the Swiss National Bank's emergency brokerage of a rescue deal between UBS and Credit Suisse.
Rising Costs And Falling Hedge Ratios
Taiwan's life insurance industry managed to contain forex hedging costs in 2022, in part by reducing their hedged positions and adjusting the mix of their hedging tools. The industry's forex risk ratio--defined as net unhedged position over total assets--lowered to 11% as of 2022 from about 12% as of 2021 (see chart 1). In our view, increases in forex volatility reserve and slow investment growth more than offset the risk from the sector wide lower effective hedged position.
Chart 1
When we measure the forex risk exposure that the life insurers face, we take into account the offset effect of an insurer's forex volatility reserve. The potential offset benefit increased as the reserve jumped by NT$185 billion during 2022 (see chart 2). This reflects insurers' strong forex exchange gains of NT$1.2 trillion from the very strong U.S. dollar.
But we think this high balance of forex volatility reserve will start trending down as most insurers have now exceeded the maximum reserve level as defined by the new rules, and the strong exchange gains will not likely be duplicated in 2023. Under the proposed rules, the reserve could be depleted at a faster pace.
Chart 2
We View Risk-Protection As Paramount
We acknowledge benefits attached to flexibility in earnings management. Resilient, good quality earnings underpin capital generation and demonstrate management's ability to attain set goals.
Nonetheless, in our view, offsetting the accounting impact from hedging costs does not alter the intrinsic nature of foreign exchange risk Taiwan life insurers face. Particularly since Taiwan's life insurance sector carries much more foreign exchange risk than its close regional peer groups. In the unpredictable forex market, an overly profit-oriented mindset for forex risks could lead to earnings shocks and capital erosion.
This report does not constitute a rating action.
| Primary Credit Analyst: | Serene Y Hsieh, CPA, FRM, Taipei +886-2-2175-6820; serene.hsieh@spglobal.com |
| Secondary Contact: | Patty Wang, Taipei +886-2-2175-6823; patty.wang@spglobal.com |
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