Taiwan’s insurers grapple with FX risk, as hedging costs remain high and RBC looms

The US$620 million loss that Taiwanese life insurers posted in April has focused attention on the need for better management of currency risk, while new risk-based capital rules could make unhedged FX exposure more costly. However, options for getting the risk off the books remain limited.

Some insurers attributed the losses to higher hedging costs following volatility caused by the imposition of US President Donald Trump’s trade tariffs. The losses preceded an even more dramatic currency move in the first week of May, with the US dollar falling nearly 10% against the Taiwanese dollar. Urgent hedging by life insurers may have contributed to the sudden rise in the value of the Taiwanese dollar, although it is unclear by how much.

Relatively low interest rates and a shallow domestic fixed income market mean that, for many Taiwanese life insurers, investing overseas is unavoidable.

According to the Taiwan Insurance Institute, as of the end of 2024, 70% of the segment’s US$1.2 trillion investment portfolio was allocated overseas, primarily in US Treasuries and corporate bonds.

At the same time, analysts suggest that only between 60-70% of this exposure is hedged, prompting calls for insurers to take a more proactive stance on their asset liability management (ALM).

“The recent appreciation of the Taiwan dollar against the US dollar underscores the importance of regularly reassessing asset-liability management strategies. Key considerations should include duration matching, FX exposure, investment yields, and liability funding costs,” says James Chan, a senior financial analyst at AM Best.

He insists that adequate hedging is an important part of this.

“Hedging, much like insurance, may appear to be a cost during stable periods but plays a critical role in protecting against adverse outcomes,” he said.

“Hedging, much like insurance, may appear to be a cost during stable periods but plays a critical role in protecting against adverse outcomes.”

James Chan

Senior Financial Analyst at AM Best

Limited instruments

The majority of Taiwanese life insurers hedge currency exposure using one-to-three-month rolling forwards. The key determinant of hedging cost is the interest rate differential between the US dollar and the Taiwanese dollar. When the Taiwanese currency strengthens, as it did in April and May, hedging US dollars back into the home currency becomes much more expensive.

Rolling forwards are an ill-fitting tool for managing the currency exposure of Taiwanese lifers, which typically purchase long-duration assets of between 10-30 years, and hold them to maturity. However, it is difficult to see what alternatives they have.

“The more effective tool for currency hedging is, in theory, a cross-currency swap, which can be tailored to match the duration of the investment,” says Max Davies, Head of APAC Insurance at Man Group.

“The problem is that the US dollar / Taiwan dollar swap market is far less liquid than the forwards market. Moreover, swaps are much more operationally complex to execute, requiring good relationships with banks, a robust ecosystem for the instrument and matching to the underlying bond level.”

Davies notes that the introduction of the Solvency II capital framework in Europe encouraged many insurers to switch their FX forward hedging over to the swap market, which allowed them greater certainty of returns. A few factors enabled them to do this: their relative sophistication, the highly liquid nature of the USDEUR swap market, and the support that many banks were prepared to provide. The situation is different in Taiwan, however.

“The more effective tool for currency hedging is, in theory, a cross-currency swap… The problem is that the US dollar / Taiwan dollar swap market is far less liquid than the forwards market.”

Max Davies

Head of APAC Insurance at Man Group

“Some banks don’t want to offer USDTWD cross-currency swaps for very long durations,” says Davies. “The problem is that the banks don’t really want to expose themselves to long duration risk of this nature, so for the insurers it’s about finding a counterparty that is happy to be on the other side of the trade.”

An alternative to the USDTWD swap market might be to use a proxy coupling, such as crossing the US dollar with the Korean won, the Singapore dollar, or the Malaysian ringgit.

“This would allow insurers to broaden their tools a little bit more, so that in times of volatility everyone doesn’t just congregate to the Taiwanese dollar and drive up hedging costs,” says Steven Lam, Senior Insurance Analyst at Bloomberg Intelligence.

However, proper management of proxy hedges would require a level of sophistication that some smaller players might not have.

“These currencies may not exhibit a one-to-one relationship with the Taiwan dollar, and insurers will have to make sure that they have teams of people who can monitor the markets closely so they can adjust positions dynamically,” says Lam.

Reinsurance could be another avenue for insurers to think about, but Davies says that this hasn’t really taken off in Taiwan yet – unlike in Japan, where life insurers face similar currency ALM challenges. Davies says that “practical challenges” have prevented the market from taking off in Taiwan so far.

“Policies are often complicated and the existence of the currency risk is a key driver of that, so for reinsurers, achieving the liability rate is not easy. However, life insurers could consider working with a reinsurer to take some legacy risks off their hands, in order to optimise their backbook. As such, the potential emergence of a life reinsurance market in Taiwan is something that is worth keeping an eye on.”

“This would allow insurers to broaden their tools a little bit more, so that in times of volatility everyone doesn’t just congregate to the Taiwanese dollar and drive up hedging costs.”

Steven Lam

Senior Insurance Analyst at Bloomberg Intelligence

Government support

One product structurer who works for an international bank says that Taiwanese life insurers need to stop “riding on the yield curve” for short-term gain and pay closer attention to the long-term risks that they face.

But he acknowledges that governments and policymakers also have a role to play in tackling this issue.

“From the regulator’s point of view, they could allow lifers to have greater flexibility and tools for FX hedging, make it easier for them to invest onshore (for example, easing collateral requirements when they lend money to local projects) and establish local currency fixed income product offerings so that life insurers have more investment instruments,” says the product structurer.

One suggestion finding some support at the moment is the idea that Taiwan’s central bank should step in to support the development of a domestic swap market. This would allow life insurers to put on more hedging by getting a favourable swap rate from the central bank.

While such a move may sit uncomfortably with those that favour more market-driven solutions, Davies points out that there is already the implicit understanding that the central bank offers a backstop against severe currency fluctuations between the US dollar and Taiwan dollar. It is this implicit backstop, according to Davies, that may be responsible for the current hedging gap.

Risk-based capital

One regulatory change that has the potential to impact hedging behaviour is the introduction of a new risk-based capital framework, due to enter into force from the start of next year.

“With this new generation of risk-based capital rules, insurers across the globe have recognised that currency risk is a really poor risk to have from a return-on-risk capital perspective, because it usually comes with high capital charges and is an asymmetric risk. From a capital perspective, insurers are much better off taking credit risk, where they can rely on good credit underwriting, either internally or via outsourced asset managers,” says Davies.

However, Davies’ comments come with an important caveat. Given the persistent difficulty of fully hedging currency exposure, Taiwan’s Financial Supervisory Commission may allow life insurers to park their hold-to-maturity assets (which is what their overseas bond portfolio is mostly made up of) in a separate account and utilise transitional measures. This would allow them to bypass mark-to-market valuation under the RBC framework, and could help them escape the worst of the capital charges for their currency risk exposure as they transition to the new framework.

Still, analysts think the direction of travel is clear. For long-term success in an increasingly uncertain world, insurers are going to have to stay on top of their ALM.

“We expect Taiwan life insurers’ earnings structure to remain sensitive to forex volatility. The still wide gap between the U.S. dollar and the NT$ interest rates will continue to complicate the insurers’ profit formula, particularly those associated with their foreign currency investments,” says Serene Hsieh, a Credit Analyst with S&P Global.

“From our observations, insurers with stronger talents, a track record of managing FX risk, effective risk monitoring mechanism to stress test and to calculate the potential costs of risk taking appear to experience less negative earnings shock from the adverse movement.”