The Financial Supervisory Commission’s (FSC) decision to ease foreign exchange reserve requirements for local life insurers is unfavorable to their credit profiles as the move could lead them to lower hedge ratios, making their profitability more sensitive to foreign exchange movements, Moody’s Investors Service said yesterday.
The commission on Jan. 30 raised the monthly foreign exchange reserve ratio from 0.05 percent to 0.06 percent of insurers’ foreign currency positions.
Insurers can use the reserve to offset up to 60 percent of their foreign exchange gains or losses, up from the previous 50 percent, when hedging costs exceeds 2 percent, the commission added.
The move is a credit negative for Taiwanese insurers, because it would incentivize them to lower their hedge ratios against New Taiwan dollar movements, Moody’s said.
It also allows insurers to reserve part of their retained profits to absorb potential foreign exchange losses, it said.
“The increased flexibility to shield accounting earnings from foreign exchange volatility will reduce insurers’ incentive to hedge their overseas investments amid rising hedging costs,” Moody’s analysts Kelvin Kwok (郭嘉銘) and Sally Yim (嚴溢敏) said in a report.
This would result in higher earnings sensitivity to foreign exchange rate movements, they said.
The insurance sector saw foreign exchange losses soar to a record NT$230.9 billion (US$7.5 billion at the current exchange rate) last year when the NT dollar weakened 2.97 percent against the US dollar.
Taiwanese insurers have accumulated foreign exchange risks from rising overseas investments, a substantial portion of which are not backed by foreign currency insurance policies, Kwok and Yim said.
Overseas investments comprised 67.9 percent of insurers’ investments as of September last year, up from 57.6 percent in 2015.
“The foreign exchange reserve is not a good substitute for hedging arrangements even from an accounting perspective because the reserve could be quickly depleted in the event of wild foreign exchange rate swings,” they said.
The revisions would mitigate, but not eliminate, the reserve depletion risks, because the monthly addition is small, compared with insurers’ overseas investments of NT$16.1 trillion, they said.
Still, lower hedge ratios would reduce insurers’ hedging costs and boost their short-term profitability if currency rates hold stable, they said.
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