Hanwha Life to further tap into interest rate derivatives

Hanwha Life Insurance Co., South Korea’s No. 2 life insurer, will make active use of derivatives and structured products to hedge against interest rate fluctuations, on which regulators are expected to ease regulations, said its chief investment officer.

Under the new accounting standard of IFRS 17 effective from 2023, insurance companies in Korea will be required to measure both assets and liabilities at market price, instead of book value. That will lead to increased value in liabilities and more spending to cover the increased risk. 

“We need to use derivatives products to hedge the interest rate risk of liabilities and put the saved money into various better-yielding alternative investments,” Hanwha Life CIO Hahn Doohee told Market Insight, the capital news outlet of The Korea Economic Daily.

With 120 trillion won ($109 billion) in assets under management, Hanwha concentrates its asset management on improving its debt servicing capabilities, thereby raising the quality of its equity capital, rather than focusing on bolstering the capital adequacy ratio, Hahn said in a recent interview.

His strategy compares with other Korean insurers’ CIOs who put a priority on chasing higher-yielding assets with downside protection.

“When interest rates are falling, we can make money from investing in 10-year bonds. But considering that our liabilities with maturities of 20 and 30 years will continue to increase, we will be further exposed to interest rate risk,” said the 31-year insurance veteran.

Under the current accounting rule, liabilities in insurance companies’ contracts are measured by their book value, which is less than their market value. So there is little point hedging against them, not to mention regulatory restrictions on their derivatives trade.

Now Hanwha and other insurance companies in Korea are calling on regulators to loosen regulations on derivatives investment so they can cover a wider range of interest rate risk with minimum initial cash investments.

“We need to hedge interest rate risk by aggressively using interest rate derivative products. IFRS 17 will expedite such a discussion,” the Hanwha Life CIO said. Hahn began his career in insurance at Samsung Life Insurance Co. in 1989.

The following is a transcript of the interview:

▲ Hanwha Life’s asset management goals and challenges:

“Our top priority is on improving debt servicing capabilities, thereby raising the quality of our equity capital. We have a double target: generating higher investment returns than funding costs to boost our equity capital, and managing liability risk."

“To boost investment returns in a way that does not undermine our capital base, we will aggressively use interest rate derivatives. We will manage interest rate risk using interest rate derivatives, instead of bonds in spot markets and will put the saved money into various better-yielding alternative assets.”

▲ Why haven't other Korean life insurers used interest rate derivatives for risk management yet?:

“The regulatory authorities have tried to restrict our derivatives investment, citing their risk. The key to liability-driven investing is in taking advantage of interest rate derivatives. Under the current accounting standard, we are able to use derivatives only for asset hedging because only assets are valued at market prices in the books. Now that liabilities also will be assessed at market value under the IFRS 17, we expect further relaxation in our derivatives investment.”

(He added that foreign insurance firms such as Prudential Financial and ING have employed the approach of liability-driven investing.)

▲ Recent investment trends:

“As market volatility increases, there will be greater opportunities for opportunistic investments to proactively respond to various market opportunities, instead of market-tracking strategies.”

▲ Future investment strategy and focus sectors:

“We are expecting to raise exposure to private market (deals) and will increasingly use derivatives products and structured products to improve our debt servicing capabilities. We cannot differentiate ourself from others in public markets. To achieve higher yields, we have to give up liquidity. We will discuss deal sourcing with good partners.”

▲ Hanwha’s most important GP selection factors for global PE investment:

“We focus on their deal sourcing capabilities and whether they provide co-investment or other partnership opportunities.”

▲ Under the new accounting rule, how can insurance companies chase high returns? 

“We need to use derivatives products to hedge liabilities' interest rate risk and put the saved money into various better-yielding alternative investments.”

▲ On concerns about a shortage of longer-term domestic bonds to invest in:

“This year, the government issued 170 trillion won worth of treasuries, far above its earlier target of 130 trillion won and compared with last year’s 100 trillion won. Despite the government’s concern, they were all digested.

“Compared with overseas yield curves, the Korean bond yield curve is flattening. That indicates a supply shortage of longer-dated bonds. It is because of demand from insurance companies. So we need to buy foreign bonds to which, however, we are told to hedge our exposure. To save hedging costs, we hedge with short-term contracts which, however, incurs significant costs related to interest rate swap transactions and increases the risk due to interest rate differentials.

“We invest around 30 trillion won in overseas investments per year. Currency hedging costs are basically determined by the interest rate differential. But most Korean institutional investors are moving in the same direction for overseas investment, driving foreign currency funding costs sharply higher and subsequently incurring additional costs for currency hedging by 50 to 100 basis points per year in interest rate swaps.”

▲ Proportion of real estate and infrastructure in alternative investments:

“Infrastructure, which are long-term assets, make up a large proportion. Among them, we are now shifting into ESG (environmental, social and governance) and renewable energy sectors.”

▲ COVID-19 impact on commercial building investments:

“Prices in overseas commercial buildings have been declining at a faster rate than those at home. But we invested mainly in senior loans on commercial buildings, so we are less affected by the pandemic.”

▲ On the recent change in insurance business practices:

“From the funding side, Hanwha Life now refrains from cut-throat competition as when we used to offer higher rates than rivals on savings products. Now the consensus view is that if we do not secure funding with reasonable terms, we will all die.”

▲ On the stock markets:

“I don’t see a significant price bubble in won-denominated assets. But low-rated bonds such as those with triple B and single A ratings in Korea seem to be overvalued. Their spread with high-grade bonds needs to widen further because financial conditions at companies in distress are worsening further.”

▲ Interest rate outlook for the next few years:

"Because of the aging population and the lower productivity, real interest rates will remain at low levels. There should be inflationary pressure building on the back of increased money supply, but it will remain at a very low level. I closely monitor TIPS (treasury inflation-protected securities) and price indices. It seems premature to bet on interest rate rises now.”

▲ On human resources for the investment division:

“The people we want are not stock-picking nor market-timing experts for traditional listed markets, but those with various investment solutions to improve our debt servicing capabilities, along with the capability to build networks and source and structure deals in private markets.”

“Instead of those good at screen monitoring and financial analysis, we want people who will meet GPs and structure deals in our favor through negotiations with their counterparts. We have hired those professionals and they are growing professionally with us.”

▲ On Hanwha Life’s $400 mn commitment to KKR & Co.’s $12 bn Asia buyout fund:

“We made the private equity investment, while curtailing public equity investment for that amount. Given the importance of networking, we wanted to build a network with KKR and take co-investment opportunities. In that respect, we made a strategic alliance with KKR through the investment.”

(Note: The PE investment may force Hanwha to set aside $196 million in capital against the investment under the IFRS 17.)

Write to Sang-eun Lucia Lee at selee@hankyung.com
Yeonhee Kim edited this article.