Investment Highlights

• The 10-year MGS yield at 3.9% has risen by 60bps compared to 3.3% just before the pandemic, tracking closely to the movements of US Treasury yields. Aggressive rate hikes in US of 75bps were seen in each FOMC from June 2022 to Nov 2022.
  
  The hawkishness of US rate hikes has resulted in a surge in 2-year US Treasury yield to 5.1% while 10-year US treasury yield soared to 4% on 8 Mar 2023. This was prior to the crisis of 2 US banks ,Silicon Valley Bank (SVB) and Signature Bank (SB), which faced liquidity woes on 10 March 2023 as well as concerns on the financial health of Credit Suisse (CS) in Europe which then saw the yields easing substantially. The 2-year US Treasury yield fell to 3.9% while the 10-year US Treasury yield slid to 3.5% on 15 Mar 2023. With the US Federal Reserve stepping in to offer available funding to financial institutions to assure that banks have sufficient liquidity to meet the needs of depositors coupled with Swiss National Bank (SNB) providing liquidity support with lending USD54bil to CS to calm market jitters, we have seen yields climbing back up slightly.
   
• Arising from the recent liquidity troubles of SVB and SB, it is likely that the tightening of US monetary policy ahead could be less aggressive than before. Our economics team expects another 25bps increase in US Fed Funds rate at the next Federal Open Market Committee (FOMC) meeting on 21-22 Mar 2023. This will lift the US policy rate to range of 4.75-5.00%. All eyes will be on the FOMC’s DOTS plot for a clearer US policy rate direction in the upcoming meeting in Mar 2023.
   
• As uncertainties in the US policy rate may still cause swings in US Treasury yields, consequently impacting 10- year MGS yield, we see Allianz Malaysia (Allianz) to benefit the most from a reduced volatility of interest rate movements on earnings after adopting FRS 17 commencing 1 Jan 2023. The impact of accounting changes to FRS 17 on the recognition of changes to market value of securities portfolio will depend on insurers: i) mix and focus of insurance products, and ii) the measurement approach used to account for insurance contracts. Under FRS 17, changes in value of investment securities from movements in interest rate could either flow through the profit & loss (P&L) or other comprehensive income (OCI). Insurance companies can apply 3 approaches in measuring insurance contracts: i) General Measurement Model (GMM) or Building Block Approach (BBA), ii) Variable Fee Approach (VFA), and iii) Premium Allocation Approach (PAA)
  
  Based on the stocks under our coverage, Allianz focusses strongly on investment-linked (IL) products for their life business. This is evidenced by the group’s IL premiums which accounted for a substantial 59.7% of its life business’ total GWP in FY22. We gather that more than 90% of the group’s life insurance contracts will be measured under VFA with the remaining portion under BBA. Hence, the adoption of FRS 17 will see the movement in interest rates on the securities portfolio backing VFA contracts to have lesser volatility on their earnings under the P&L. This is due to interest rate impacts on securities portfolio under FRS 17 being now adjusted from contractual service margin (CSM), which will then be spread out over time through the contracted period of the IL policies. Prior to this under FRS 4, the full impact of fair value changes on securities or investments backing VFA contacts flows through the P&L of Allianz, hence impacting earnings.

• Maintain NEUTRAL on the sector and continue to be selective on insurance stocks. Our top pick for insurance is Allianz Malaysia (FV: RM16.50/share) with undemanding valuation trading at 0.6x P/BV and attractive dividend yield of 7.3% for FY23F.

Source: AmInvest Research - 20 Mar 2023