Portfolio management is proving particularly difficult for Japan's huge life insurance firms right now. They must maintain sufficient duration in their portfolio and avoid asset-liability mismatches while at the same time seeking to obtain higher yields.
This is a problem common to many life insurers globally – but most do not have to cope with negative yields on their domestic government bonds. Those in Japan also face the nigh-impossible task of trying to predict how the yen will perform against the dollar given the huge uncertainty over US policy under Donald Trump.
Amid such challenges, Japanese firms such as Dai-ichi Life and Nippon Life – with ¥35 trillion ($309.4 billion) and ¥64 trillion, respectively, in general account assets as of end-2016 – are gradually raising their exposure to foreign, higher-yielding securities, noted Teruki Morinaga, a director in the insurance research division at Fitch Ratings in Tokyo.
Japanese traditional life insurers' allocation to domestic bonds fell to 42% as of end-December from 44% on March 31, while their exposure to overseas securities rose to 28% from 26% over the same period, according to Fitch.
Domestic v. offshore trade-off
Domestic insurers continue to buy local debt, especially long-duration Japanese government bonds (JGBs), Morinaga said, because they want to avoid widening of the mismatch between assets and liabilities. But since JGB yields are so low (or indeed negative), insurance firms are buying only as much of them as they need to to prevent the duration gap from widening, he told AsianInvestor.
Meanwhile, they steadily increasing their exposure to very high-grade (at least A-rated) foreign bonds, particularly US and to a smaller extent Australian debt, said Morinaga. “Japanese life insurers acknowledge that their foreign credit research capabilities are still limited, so they are focusing on safer assets,” he said.
In recognition of this, the biggest firms – such as Dai-ichi Life and Nippon Life – are beefing up their credit research capabilities, he added.
A few are also gradually accumulating alternative investments, including foreign infrastructure-related loans, like their European and US peers, said Morinaga. Moreover, Dai-ichi has started to raise its exposure to emerging markets, such as government bonds in Eastern Europe, he added.
On the equity side, Japanese life insurers appear to be maintaining their typical equity allocations of around 5%, said Morinaga. To increase this portion is difficult, he noted, because stock investments incur a high regulatory capital charge, yet to reduce them is tricky because they provide dividend yields and help diversify the portfolio.
Of course, Japanese insurers' challenges are compounded by the uncertainty around Trump's policies. That is leading them to invest in shorter-duration bonds than they normally would – around five or six years' tenor – as their average portfolio duration is around 10-15 years, noted Morinaga.
Some are also putting on more foreign-currency hedges. The most widely expected scenario is that the yen will weaken against the dollar, but because of the difficulty of predicting Trump's likely policies, some feel the yen may appreciate. Hence they are trying to minimise currency risk, he said.
There are no specific restrictions on foreign investments for Japanese insurers as such, noted Morinaga. But as they increase their allocation to foreign bonds, their ALM will become more difficult, which effectively means there is a limit at some level.
“I'm not sure where the limit is,” he said, “but I think the foreign securities allocation will increase to more than 30% of total portfolio – because at present they have no choice.”
However, some express concern that Japanese insurers' increasingly aggressive hunt for yield may land then in hot water.
“There is a lot more aggression out there, which last time brought me a lot of attractive M&A fees when I spent my time rescuing the people who had gone too far,” said Ian Brimecome, senior executive officer at Tokio Marine, Japan's biggest property-and-casualty insurer by revenue.
What the London-based veteran sees across the industry worries him. “The issue is a more indiscriminate chase for yield,” he told AsianInvestor in August.
Once again Japan’s insurers are venturing into foreign financial instruments ranging from fixed income private placements to high-dividend equities and collateralised loan obligations, noted Brimecome.
Elsewhere in Asia too insurance firms are seeking to expand their overseas portfolios, with China a notable example.
AsianInvestor's upcoming February/March issue will feature an article on how Asian insurers are responding to the current market environment.
AsianInvestor's annual Insurance Investment Forum will take place on March 1 at the Mandarin Oriental in Hong Kong and annual Japan Institutional Investment Forum on March 15 in Tokyo. Please click on the links above for more details.