Proposed derivative restrictions for Singapore insurers to have a limited impact

New MAS proposals to unify investment guidelines for all insurers, and in doing so limit derivatives usage, will not affect existing investment policies for insurance firms

A Monetary Authority of Singapore (MAS) proposal to limit the use of derivatives for investment purposes by insurance companies and to bring the investment activities of general insurers and reinsurers in line with those of life insurance companies will not pose problems, say local market participants.

On January 23, the MAS released a consultation paper, 'Review of requirements on investment activities of insurers' proposing to extend MAS Notice 317 to general insurers and reinsurers. MAS Notice 317 sets out the basic principles that govern the oversight of investment activities of life insurance companies. There is no corresponding notice currently for general insurers and reinsurers. Key requirements of the proposal would include the implementation of an investment policy and an investment committee for general insurers and reinsurers.

Additionally, under Paragraph 23, the proposal prohibits insurers from taking uncovered positions in derivative transactions. The MAS will require insurers that use derivatives to hold liquid assets sufficient to cover their exposure in the case of cash-settled transactions or enough of the underlying asset should physical delivery be required. The use of derivatives for hedging purposes is still permitted.

Hussain Ahmad, director of general insurance, South-east Asia at Towers Watson, says the proposed changes will not alter the investment activities of general insurers significantly.

"What the regulation is saying is do not use derivatives specifically for speculative purposes or to gain leverage as unhedged bets using derivatives will not be allowed. At this point I don't think this will have a massive impact on what insurers are doing as they are not investing in highly speculative instruments, so it is more of a pre-emptive measure," he says.

Insurers that use derivatives for hedging purposes will have to make sure they are compliant with MAS regulations but are still free to use derivatives for hedging purposes, says Ahmad.

In addition the proposal requires insurers to have a specified investment policy and an investment committee. However Ahmad questions the need for these measures for some of the smaller players. According to Ahmad, smaller general insurance companies would have over 50% invested in cash, with the remainder in short tenor bonds.

"Most of the smaller general insurers are investing in highly liquid instruments such as cash, cash equivalents and short-term bonds. They don't have significant investment in equity or long-term bonds. Is there a need to have a 20-page investment policy for these insurers? Probably not," he says.

Russel Lok, advisory services partner at Ernst & Young in Singapore, agrees that the proposal will not significantly alter investment policies of general insurers and reinsurers.

"We don't believe this proposal will change investment policy radically. Investment policy will be down to market sentiment which is still quite cautious following the global financial crisis. Not all insurers use derivatives and many of them don't have the operational capability to do so, or simply don't understand them. The more sophisticated insurers will use derivatives but mainly for hedging purposes in the form of interest rate swaps to manage their duration gap and forex derivatives to hedge forex exposure," he says.

Don Guo, chief investment officer of Asia Capital Re (ACR), a Singapore-headquartered reinsurer, welcomes the move to extend the oversight of investment activities to reinsurers but says its impact, especially around the use of derivatives for investment, will be limited.

"In our portfolio we have investments in 16 currencies all over Asia, mainly in local currency government bonds. Our investment portfolio is a combination of around 90% fixed income, 5% cash and 3–5% equities. We mainly maintain high quality fixed income with short duration. Our liability duration is quite short – less than three years," says Guo.

Guo says ACR uses derivatives for hedging purposes but not as an investments tool.

"We don't use derivatives for investment schemes – that is not in our mandate. We use derivatives for two purposes: to hedge downside risk where we buy protection on our credit portfolio to hedge against tail risk, and to manage our forex exposure where we use non-deliverable forwards to hedge our exposure to some currencies in Asia that are difficult to access," he says.

Additionally with a low interest rate environment likely to persist, the reinsurer has not used derivatives to hedge interest rate risk.

"We have not used interest rate swaps to hedge interest rate risk, the reason being the Fed and local Asian governments have kept interest rates quite low. In the future, if we see a danger of rising rates, we may then look to hedge our interest rate risk," Guo says.