Japan’s lifers gently diversifying as yield pressure grows

Japanese life insurers are still diversifying their investments away from the domestic market at a sedate pace but the incentive to do so more quickly and to take on more risk can only grow the longer yields on government bonds remain depressed.

And right now, that's exactly what appears to be on the cards with no interest rate hikes in sight in neither Japan nor Europe, where there are negligible and even negative risk-free returns, and rate cuts back on the agenda in the US where Treasury yields have turned south again.

Still, Japanese life insurers tend to make more money than their counterparts elsewhere, which affords them something of a cushion.

“The big difference between Japanese life insurers and European – and to a smaller extent US – life insurers is that the underwriting margins from protection life products are much thicker in Japan,” Teruki Morinaga, director of insurance at Fitch Ratings Japan, said. “That means Japanese life insurers are more resilient or will be able to endure the situation longer than their European peers.”

Japan's nine main traditional life insurers' core earnings grew by 5% year on year in the financial year to March-end 2019 (FY19), driven in part by the stable earnings in their underwriting businesses. Better investment returns also helped after they allocated a bigger share of their assets to foreign bonds.

But Japanese life insurers are also seen having to cast a wider net for their risk-adjusted returns, whether that means pushing out across more of the credit spectrum or looking to other asset types.

Much of their focus will remain on the US fixed income market due to its breadth and liquidity, according to Morinaga.

However, with dollar-hedging costs high, Japanese insurers are now either cutting back on US Treasuries and seeking opportunities among high-grade corporate bonds or looking more to the euro area, Australia, New Zealand, Canada, and Scandinavian countries, he said.

FURTHER DOWN THE LADDER

Although they have started to diversify, low bond yields in Japan remain the primary threat for Japanese life insurers, as they have to lengthen or at least maintain asset duration to avoid worsening asset and liability duration mismatches, according to Fitch Ratings.

Japanese life insurer results for FY19 showed their in-force business – calculated on a European Embedded Value basis – worsened compared with a year earlier. This was mainly due to the persistently low interest rates and further flattening of the yield curve in Japan.

A life insurance company's in-force business is the aggregate value of all the policies in its portfolio, whether paid up or in the process of being paid.

Fitch expects super-low bond yields to continue to restrain the economic capital of Japanese life insurers. Like their Korean peers, they need to meet the economic capital-based regulatory regime that is likely to be introduced in Japan in around 2025 and they will likely struggle to do so if super-low bond yields persist.

On Monday, another rating agency, Moody’s, issued a note on Japan's four largest life insurers: Dai-ichi Life, Meiji Yasuda Life, Nippon Life and Sumitomo Life.

It noted how their core profits benefited from higher interest margins but also warned that their rising overseas investments were a key source of asset risk for their credit profiles.

Insurers' foreign bond and equity holdings rose to 30.4% of general account assets at the end of March 2019, from 29.2% a year ago. Both Moody’s and Fitch expect this gentle upward trend to continue but are wary of the growing risks, especially if Japanese insurers are forced to venture into lower-rated markets in their quest for better yields.

“Until recently, I had heard, for example, countries such as France and Spain were relatively attractive,” Morinaga said. “However, even some middle-risk countries’ government bond yields have declined, so my latest impression is that more Japanese insurers are seeking opportunities in European high-grade corporate bonds market [in] alliance with European asset management companies, for instance.” 

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