Insurers see profitability decline amid increased forex hedging costs

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By Anna J. Park

A period of rising interest rates has normally been a boon for insurance companies, yet this long-held notion looks to be changing now. Increased market volatility, in addition to soaring foreign exchange (forex) rates, has been disrupting local insurers' efforts to hedge their assets, which are held in foreign currencies, projecting their declining profitability in the coming months.

According to the latest research report published by the Korea Deposit Insurance Corporation (KDIC), the increased financial and geopolitical risk factors stemming from the U.S.' quantitative tightening as well as Russia's invasion of Ukraine are likely to put a burden on local life insurers' hedging costs of their assets, which are held in foreign-currencies.

As of the end of last year, local life insurance companies' foreign assets stood at 129 trillion won ($99.3 billion), which is up by more than 100 trillion won from that of 2013. The amount accounts for about 13.3 percent of local life insurers' entire asset size. 127.5 trillion won worth of foreign assets are marketable securities denominated in foreign currencies, along with loan bonds and deposits. More than 70 percent of life insurers' foreign assets are denominated in U.S. dollars, followed by 12 percent in Euros and 4 percent in Australian dollars, among others.

Because of the huge assets in foreign currencies, hedging has been companies' core interest in order to reduce the risks of being exposed to volatile foreign exchange markets. While 81 percent of the foreign assets are proactively managed with hedging, such as cross-currency interest rate swaps (CIRS) and foreign exchange swaps (FX Swap), the rest are exposed to foreign exchange risks.

However, the current global macroeconomic conditions have become unfavorable to local insurers' foreign exchange hedging strategies, the report advises the companies to take flexible approaches so as to reduce risks related to hedging and foreign currency assets.

"Foreign exchange hedging is a tool to minimize risks from foreign exchange market volatility, yet the cost of it is highly variable, depending on market environment changes. Thus, the cost of forex hedging could sometimes offset the reduced foreign exchange risk efforts," Cha Ho-sung, senior researcher at the KDIC, said.

"The costs borne by local life insurers due to forex hedging is already considerable, but discussions about the optimal level of forex hedging strategies are rather lacking," Cha added, advising the firms to come up with proper hedging scenarios considering their thorough cost-profit analysis, debt portfolios and asset sizes.

Given that the major local life insurers posted year-on-year declines in their first quarter this year, due to increased capital costs against the backdrop of rising interest rates, their forex hedging strategies have now become much more significant in maintaining their revenues.

Actually, the life insurers logged a loss of 5 trillion won during the first quarter in their insurance sales alone. Their quarterly revenues could offset the loss, as the firms generated 5.8 trillion won worth of profits in their investment and 944 billion won worth of other profits.

In the first three months this year, SAMSUNG LIFE posted quarterly revenue showing a 75-percent fall from the same period last year, followed by HANWHA LIFE's year-on-year 74-percent fall and Kyobo Life's year-on-year 46-percent decline.

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