Insurance par funds hold steady in 2020, but policyholders should reset expectations

LIFE insurers generally posted lower investment returns in their life funds in 2020. Most, however, are opting to maintain bonus rates for participating (or par) policies, providing yet another instance of the "smoothing'' process at work in traditional par insurance.

The compilation for this column is based on returns filed by five insurers. Others such as Manulife and TM Asia were not available as at press time.

Based on available disclosures so far, Prudential has indicated a reduction in terminal bonus rates for "some'' whole life policies. In 2020 its life fund reported returns of 5.65 per cent, compared to 12.26 per cent in 2019.

AXA also says it has revised reversionary or annual bonus rates for about 2 per cent of par policies for the first time "to ensure the long-term sustainability of the fund''. Based on our compilation, AXA's life fund outperformed others with a 10.18 per cent return in 2020.

In their reviews, the insurers also referred to the challenges of a low-rate environment. Earlier this month the Life Insurance Association announced a downward revision of the caps applied to par policy projected returns, to take effect in July. At the moment, the two illustrative rates are 3.25 and 4.75 per cent. In July the new rates will be 3 and 4.25 per cent.

The LIA emphasised that the rates are for illustration only and have nothing to do with the actual returns of life funds. Nor will they affect the benefits that policies will eventually deliver to policyholders.

The rates are used in policy or benefit illustrations handed to clients at point of sale, to illustrate a number of items, such as the death benefit over time, surrender values and effects of deductions. They are gross rates of return and do not include insurers' total expense ratios.

Still, this columnist expects that there are certain implications on policies going forward. Policyholders, for one, should brace for lower returns. But more on that in a while.

To recap, participating or par policies are those where insurers pool together premiums to invest collectively in the life fund. Returns to policyholders comprise guaranteed and non-guaranteed components. Non-guaranteed returns are in the form of the annual bonus or dividend, and sometimes a terminal bonus which rewards policyholders for staying invested over the long term. Bonuses once declared form part of guaranteed returns.

Insurers apply a smoothing mechanism to ensure that returns are stable. This means that in a good year they retain some surplus in reserve to pay out when returns are poor. In a poor year they may continue to pay the annual bonus in full.

The biggest allocation of life funds - about 55 to as much as 70 per cent - is invested in fixed income assets, and equities' share ranges between 25 and 30 per cent.

With a largely fixed income portfolio, life funds grapple not only with interest rate risk, but also the perennial risk of a mismatch between assets and long-term liabilities. The dearth of long-term bonds means insurers incur reinvestment risk as assets are reinvested in ever-lower yields.

The Singapore government does issue bonds of up to 30 years, but the yield curve flattens out at around 15 years, which means that after a certain point, insurers get no compensation for taking on the risk of a long-term bond.

For background, the practice of setting an industry cap on policy projections began in the 1990s, partly to restrain insurers from over-promising returns for the sake of attracting business. Since 1994, when a cap of 7 per cent was set, the illustrative rates have been adjusted about five times, and always downwards. Adjustments appear to coincide with market crises, such as 2002 in the aftermath of the bursting of the tech bubble and in 2008 in the great financial crisis.

Implications

What does this development mean for policyholders? One, you're likely to have to reset your expectations. While life funds and your own policy may well deliver returns in excess of the caps, reducing the caps suggests that insurers anticipate challenges in meeting the current return projections.

Paul Brenchley, KPMG Singapore partner, financial services advisory, says the cut in the illustrative rates "indicates the industry view that we are entering a world of lower investment returns''. "Bonds make up a large part of par fund investments and hence, the expected low future bond yields would have played a role in this decision to offer a more realistic expected future view of investment returns.''

Two, policies' breakeven points are set to extend further out into the future. The breakeven point is the point at which your policy can generate a surrender value that matches or exceeds the premiums paid so far. Today, for a whole life plan for a 35-year-old male, the breakeven point is around 20 years under the gross return assumption rate of 4.75 per cent. Under the scenario of 3.25 per cent, it is longer at around 25 to 30 years.

Three, insurers' expense ratios matter, particularly in the context of a largely fixed income portfolio where yields are under pressure. The expenses include not just the life fund's investment management fee which is generally relatively modest, but also items external to the life fund such as distribution costs. The higher the expense ratio, the lower your policy's effective return.

On the investment outlook, Income's par fund review says risk assets are favoured in 2021. "However, equity markets are trading at rich valuations, making them vulnerable to short-term corrections. This, coupled with the persistently low interest rate environment, may present challenges to the fund's investment return over the years.''

Sustainability lens

Meanwhile, insurers are mindful of environmental, social and governance (ESG) factors in the life fund investments. For most insurers, external managers are required to be Principles of Responsible Investment signatories.

Insurers that are part of multinational groups take the cue from their parent groups. Prudential, for example, aims to decarbonise its portfolio of assets held on behalf of insurers, and aims to be net-zero by 2050. The group's immediate goal includes a 25 per cent reduction of carbon emissions of shareholder and policy assets by 2025. It also aims to divest from investments in businesses that derive over 30 per cent of income from coal; equities are to be fully divested by end-2021 and fixed income by end-2022.

AIA Singapore said its par fund excludes certain sectors such as tobacco and cluster munitions. It will also exit directly managed coal mining and coal-fired power sectors by 2028.

AXA said its par fund investments are in line with the AXA Group's responsible investment policy which specifies exclusion of certain sectors, including coal mining and coal power generation, palm oil and controversial weapons. The group's climate strategy aims to fully exit from coal by 2040 and cap the 'warming potential'' of investments under 1.5 degree Celsius by 2050.

It said as at December 2020, its Singapore par fund has achieved 90 per cent ESG coverage, with over 3 per cent of the fund invested in green assets. It has also invested in private equity impact funds that address climate change, financial inclusion and access to healthcare.

Income's chief investment officer Mark Shi said: "While simple exclusions or elimination of investments based on ESG factors alone may unduly limit opportunities and curtail investment performance, our fund managers should demonstrate their commitment to promote improved management of ESG issues over time.''

Great Eastern last year said it has incorporated ESG factors in its manager evaluation and selection, and prefers external managers who incorporate ESG principles in their investment analyses and decision-making process.

READ MORE

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