Signs of distress are emerging in high-risk overseas alternative investments held by Korean insurers, including foreign real estate and private credit, but their complex structures make early detection difficult, analysts said. Concerns have been raised that if distress in overseas alternative investments hurts profitability, it could affect capital soundness.
According to S&P Global Ratings, Korean insurers’ exposure to high-risk overseas alternative investments stood at $35 billion at the end of last year, comprising $21 billion (about 31 trillion won) in overseas real estate funds and $14 billion in overseas private credit funds. While this accounts for about 5% of total assets under management, it is the largest among Korea’s financial sectors.
Korean insurers actively expanded overseas alternative investments amid the ultra-low interest rate environment following the 2020 pandemic. In major countries such as the United States and Europe, alternative investments are conducted on a limited basis, mainly by life insurers. In Korea, however, property and casualty insurers have also significantly increased alternative investments based on long-term insurance products. As a result, the share of alternative investments in Korean insurers’ asset composition expanded from 15% in 2015 to 21% at the end of last year.
S&P warned that signs of distress are recently emerging in overseas real estate funds held by Korean insurers. They mainly hold commercial real estate in North America and Europe as collateral, and collateral values are declining due to the spread of remote work and the prolonged high interest rate environment. Some overseas real estate funds have already recorded valuation losses.
Overseas private credit is equally unstable. The private credit funds held by Korean insurers mostly consist of senior direct loans to mid-sized U.S. companies. While losses have not yet occurred, distress could emerge in private credit funds if artificial intelligence (AI) affects the revenue of software companies.
The problem is that detecting distress in high-risk overseas alternative investments such as real estate and private credit is not easy. Most Korean insurers invest through feeder funds, which invest in other funds, creating information asymmetry due to the complex multi-layered structure. It is difficult to obtain immediate information on the underlying assets invested in, leaving insurers structurally bound to recognize problems a step late even when they arise.
S&P conducted a stress test in which real estate and private credit experience distress simultaneously, and found that it would negatively affect insurers’ average return on average assets (ROAA). The impact on capital buffers is limited, but if profitability declines, insurers cannot increase dividends and their capacity to accumulate capital may also weaken.
S&P projected that Korean insurers will reduce their share of alternative investments going forward. Expectations for risk-adjusted returns on overseas alternative investments are falling, while domestic bond yields are also rising rapidly. On the 23rd of this month, the 10-year government bond yield stood at 4.2%, up 1.3 percentage points in one year. “If U.S. private credit and commercial real estate are hit simultaneously, insurers’ profitability will be negatively affected,” said Emily Yi, an analyst at S&P. “Korean insurers appear likely to continue strengthening risk management of overseas alternative investments.”