Life insurance companies in Japan are stepping up their risk appetite for higher rewards as they seek to offset the impact of the global Covid-19 pandemic, which looks set to depress already low fixed income yields.

Three major life groups in Japan – Dai-chi Life, Japan Post Insurance and T&D Holdings, the latter of which respectively owns Taiyo Life, Daido Life and T&D Financial Life – posted their earnings for the financial year ending March 31, 2020 on May 15. 

The three groups reported mixed earnings. Japan Post's net profit was up 25.1% year-on-year to ¥150.69 billion ($1.4 billion) due to a decrease in operating expenses. However investment income declined by 5% to ¥1.14 trillion. Dai-chi Life's net profit was down 86% after its wrote-down the value of its holdings in New York-listed Janus Henderson. Its investment income was down about 2.6% or ¥28.9 billion. At T&D Holdings, net profit declined 8% while the value of its investment holdings fell about 10%.

The three life insurers carry a great deal of investment heft between them, with combined assets totalling about $1 trillion. However, at least 40% of that amount sits in low-yielding domestic bonds, based on the insurers’ most recent financial statements. Japanese Government Bonds offered a yield of -0.009% at close on Monday (May 18).

Dai-ichi Life, which has about ¥35 trillion ($325 billion) of assets under management, said in its earnings results that fixed-income investments, including government and corporate bonds, will continue to form the core of its asset portfolio, as is the case with the long-term investment return needs of all life insurers.

However, "in order to secure profitability and strengthen portfolio risk diversification, the company will expand investment mainly in the fields of credit investment, infrastructure, and alternative assets," it said in its earnings statement. It didn’t specify the type of credit investments, but Japanese insurers are active investors in US corporate bonds.

The insurer added that it expects to cut its 7.8% domestic stock holdings "for the purpose of risk control." Still, it said it intends "to proactively reallocate stocks and industries in consideration of competitiveness, growth potential, and undervalued stock prices." With regards to overseas bonds, which make up 25.5% of its portfolio, the insurer said it will adjust its exposure "depending on the  interest rate and exchange rate level."

CREDIT AND ALTERNATIVES 

Meanwhile Japan Post, which has about ¥73 trillion of assets, plans to promote alternative investments. In its financial statement for the year ended March 2020, the organisation said it intended to increase revenues through the investment of so-called "return-seeking assets," which it previously referred to as "risk assets," such as foreign securities and stocks.

The group had previously said in its Medium-Term Management Plan 2020 that it intends to increase the use of derivatives and raise its proportion of risk assets to ¥87 trillion by March 2021 from ¥79 trillion at the end of March 2018. It didn't offer any guidance on how much progress it had made. 

Japan Post’s move to raise ‘return-seeking assets’ was in line with the intentions set out last month by Takayuki Haruna, the head of the investment planning department. He noted then that Japan Post aims to foreign bond holdings, primarily US corporate debt, by March 2021. "When you consider dollar hedging costs, only credit products have a decent return," he said.

Similar to its two rivals, T&D Holdings also made its intentions clear to invest more in credit and alternative assets.

The insurer said it plans to expand such investments while it “controls its interest-rate risk through asset-liability management (ALM).” Looking ahead, the company said it would "adjust its portfolio flexibly according to the market outlook" while expecting "a decline in net investment income centred on interest income and dividends from securities.

NO CHOICE

Konosuke Kita, director of consulting at Russell Investments in Tokyo, said the insurers have little choice but to move towards alternative assets. “Life insurers are conservative, but under the low yield environment they cannot get enough return from bonds and have to invest in risky assets to seek a higher return.”

The yield on 10-year JGBs and shorter maturities has been almost constantly in negative territory since the beginning of 2019, except for a brief period in March. As Japan's government steps up its quantitative easing programme in response to the economic downturn caused by the spread of Covid-19, JGB yields look set to remain depressed, leaving the insurers with the headache of finding better returns elsewhere.

Offshore government debt, traditionally one obvious alternative, also offers very little by way of returns. The yields for US Treasuries have fallen below 1% following the recent interest rate cut by the Federal Reserve.

According one industry expert who declined to be named, insurers in current market conditions need to make at least a 1% annual return on their investments to cover the interest payments for recently sold insurance policies.

With slim pickings during the current volatile market, the insurers are holding a higher level of cash and deposit holdings. Japan Post, for instance, had ¥53.6 trillion ($496.66 billion) of cash and cash equivalents at the end of March, up from ¥52.16 trillion a year earlier. T&D’s cash and equivalents totalled ¥917.9 billion, ¥63.8 billion higher than the beginning of the fiscal year. 

Soichiro Makimoto, a Moody's vice president and senior analyst, told AsianInvestor the one likely option for the insurers was US high-quality corporate bonds. 

“There are three components in such investments: US interest rates, credit spreads and the cost of hedging the risk of currency fluctuation,” Makimoto explained. Currently, returns from rising credit spreads, supported by lower cost of hedging, have more than offset falling US interest rates.

Equities offer a less appealing option, he added. The insurers have “meaningful” exposure to domestic equities and unhedged foreign-currency positions, leaving them vulnerable to declines in the Japanese stock market and a sharp appreciation in the Japanese yen. 

MOODY’S DOWNGRADE

Despite seeing their investment incomes decline, Japan's insurers' financial health remains largely robust, according to Kita. However, trouble may be on the horizon.

On April 9, Moody's Japan changed its outlook for Japan's life insurance industry to negative from stable, reflecting the strain on insurers' capitalisation and profitability from growing uncertainties in the domestic and global capital markets amid coronavirus-related disruptions.

"The Japanese life insurers could see their otherwise strong capital position erode over the next 12-18 months amid increased capital market volatility," said Makimoto in the report. However, he noted that the insurers' premium base remains supported by their large number of existing policies with long durations, which will partially mitigate the impact of a sharp drop in new sales.

Moody's said it could change the industry outlook back to stable if the disruptions from the outbreak and capital markets start to stabilise, and the insurers maintain their strong financial and business profiles.

With a combined AUM of close to $3.6 trillion, Japan insurers are major institutional investors, and their investment strategies are closely watched.