[Reuters Breakingviews] Taiwan insurers get a stern currency warning

HONG KONG, May 12 (Reuters Breakingviews) - The Taiwanese currency’s recent stunning rally against the U.S. dollar has highlighted a big risk in an unlikely area: the island’s insurers. The large swing against the greenback, if sustained, will hit earnings at Cathay Life and its peers, which between them hold some $760 billion of overseas investments, mostly of U.S. stock and bonds. Hedges and reserves will soften the blow. But the underlying mismatch of domestic policies funding overseas assets is an enduring problem.

It is hard to pinpoint what prompted the Taiwan dollar's TWD=TP overall 6% appreciation, per LSEG, against its U.S. counterpart on May 2 and May 5. A combination of capital inflows and expectations that authorities will allow a stronger currency to smooth trade talks with Washington were probably factors, although the central bank has denied the latter. In any event, local exporters rushing to convert U.S. dollars and investors scrambling to hedge their currency exposure exacerbated the situation. As of Friday's close, the Taiwan dollar was trading at 30.29 to the dollar - a near-9% appreciation since the start of April.

The island’s insurers have put an estimated 70% of their $1 trillion or so of investable assets as of January overseas, but 80% of their liabilities – the life insurance policies they have written – are in the local currency. When they prepare their earnings results each quarter, they have to convert their foreign holdings into Taiwanese dollars. On paper, the recent ructions mean – absent a reversal – that their bottom lines are in for a pummelling. Cathay Life disclosed last year that a 1% of currency appreciation against the U.S. dollar would translate to a T$7.6 billion ($251 million) hit to its bottom line, after hedging. Theoretically, a 10% appreciation would have wiped out its full-year profit.

The island's central bank supports local life insurers by funding a "decent chunk" of their hedging costs via FX swaps managed by local banks, according to Brad Setser, a Senior Fellow at the Council on Foreign Relations. That still leaves a significant portion of private market hedges exposed to global interest rates and price swings. All else being equal, a strengthening Taiwan dollar can quickly turn into a solvency nightmare: the local industry has a combined $86 billion in shareholders’ equity, representing 11.3% of its overseas holding.

Taiwanese lifers, though, have spent years managing currency fluctuations while remaining well capitalised. They have specific reserve funds that can offset up to 100% of foreign exchange losses; those reserves swelled on the back of a strong U.S dollar in 2024. They have also ramped up sales of foreign-denominated policies in recent years. All in, that means just 12% of total assets have none of those protections, per S&P Global analyst Serene Hsieh. That works out to $147 billion, using the latest government figures as of January - less than 18% of GDP.

That’s comforting from a systemic perspective. But it’s no excuse for complacency. Income statements will still bleed red ink. And U.S. President Donald Trump’s trade wars may yet cause further ructions that lead to long-term appreciation of the Taiwan dollar. Ultimately, so long as the export-dependent economy keeps running a massive account surplus - nearly 15% of GDP last year - life insurers will keep investing abroad. But now their balance sheet mismatch has been exposed, they will need to find new ways to mitigate it.

CONTEXT NEWS

Taiwan's Financial Supervisory Commission held meetings with three of the island's biggest insurers, Cathay Life, Fubon Life and Nanshan Life, local media reported on May 5. The three companies told the regulator that their risk-based capital ratios would remain within legal limits even if the Taiwan dollar strengthened below 30 per U.S. dollar, according to the report.

The Taiwan dollar's 6% rise against the U.S. dollar over May 2 and May 5 marked a record two-day appreciation.

On May 9, the currency closed at 30.29 to the U.S. dollar, per LSEG.

The Taiwan dollar's stunning rally has blindsided markets