Japan’s lifers see Covid-19 risks, limited opportunities
The biggest risks for Japanese life insurers posed by the coronavirus outbreak are likely to come from movements in financial markets such as interest rates, equities, credit-spread products or currencies, according to credit rating agency analysts.
The spread of Covid-19 from China and the fears of a global recession have led to volatility in global financial markets, which may have a meaningful negative impact on Japanese life insurers.
Throughout the global investment landscape, the coronavirus’ impact on the US would potentially have the biggest negative risk on Japanese life insurers’ investment portfolio performance, according to Soichiro Makimoto, vice-president and senior analyst at Moody’s Investors Service.
“Japanese life insurers have large investments in the US, hence the interest rate decline in the US will push down their income gain from new money,” he told AsianInvestor.
Which will be the biggest risk depends on each Japanese insurer, because they have different investment and ALM (asset liability management) risk profiles, according to Teruki Morinaga, director of insurance at Fitch Ratings Japan.
He lists four major investment and ALM risks for various Japanese insurers.
First and foremost, they are exposed if the Japanese government bond yield curve flattens further and shrinks economic capital due to the ALM duration mismatch of most Japanese life insurers. As some Japanese insurers have a heavy exposure to domestic equity, a further decline in the domestic stock market also poses a risk.
Another issue is the recent appreciation of the Japanese yen and the fact that this gives most Japanese life insurers an increased exposure to foreign bonds without sufficient currency hedging. An larger exposure to foreign credit products could risk further credit spread widening globally and thus shrinking capital.
“Declining US bond yields are currently working very positively for Japanese insurers by expanding their economic capital, while it is becoming more difficult for Japanese insurers to seek sufficient yields in US dollar credit markets going forward due to a yield that has already declined,” Morinaga said.
With market turbulence, opportune investors might be able to benefit. Morinaga points out that a global financial crisis similar to the one in 2008, means that investors such as Berkshire Hathaway’s famous chief executive Warren Buffet could pick up good assets at a relatively cheap price.
“I am not very sure whether the majority of Japanese insurers can do so or not. Maybe some Japanese insurers can buy good assets at a cheap price, but it depends on [the investment strategy of] each insurer,” Morinaga said.
“I think one important target could be foreign credit products including illiquid assets bought at a cheaper price than fair valuation, but it will most likely not be easy for most Japanese insurers to buy such assets adequately in the turbulence,” he added.
LONG-TERM EFFECTS
As the coronavirus spreads and more countries take precautions, the fear of a potential recession has risen. At a “normal level financial crisis”, such as that of 2008, Morinaga would expect a very limited number of downgrades among Japanese life insurers. The majority have been able to accumulate ample excess capital over the past five to 10 years.
“If an extremely severe financial crisis, much harsher than that in 2008, happens, it is more likely that a majority of Japanese insurers would avoid downgrade for the same reason," he said, arguing that the current situation (as of March 10) was not yet a financial crisis as the market had only reached mid-2016 levels.
Should the coronavirus turn out to be a long-term pandemic for the rest of the year and into 2021, Morinaga still believes that Japanese life insurers have sufficient substantial capital buffers to support their current ratings. As of now, the mortality losses due to the outbreak are likely to be small and manageable, especially considering Japan’s developed universal healthcare system and the society’s hygiene consciousness, he added.
“A meaningful downgrade due to pandemic is still unlikely based on the best guess at this stage. If more than 10,000 people die in Japan this year from Covid-19 – or much worse, at the levels of those who succumbed to Spanish flu at the time of World War I – then the underwriting results of life insurers will clearly worsen,” Morinaga said.
The latest field test conducted by a Japanese financial services agency shows that the average economic solvency ratio (ESR) for life insurers was 178% at the end of March last year, with 100% being the benchmark where capital equals risk with no buffers. Sensitivity analysis of the test shows that the average ESR would drop by 40 percentage points if the domestic interest rate drops 50 basis points, according to Makimoto.
He believes that a long-term pandemic would hurt life insurers in other ways, as insurance sales would be affected. In Japan, captive sales agents are the main distributors of life insurance products and, as a common practice, they regularly visit their clients to solicit new business.
“If the current remote working arrangements are prolonged, it would weaken the industry's new business growth. That said, the Japanese life insurers still have a strong premium base, as they have a large number of existing policies with long durations,” Makimoto said.