Japanese life insurers are facing a new economic value-based solvency regime in 2025, and one of the major issues leading up to this change is their relatively large investments in domestic equities.
With the new regulatory regime, the risk charge for equity may become harsher. The detailed calculations have not been disclosed, but the regime is expected to be heavily inspired by EU’s Solvency II directive, where the risk charges for equity is much higher than in Japan currently.
“In the US, where the regulation is not as developed as in Europe, the US insurers think about the capital efficiency very seriously, so they don’t allocate to high capital charge assets like equity. So right now Japan stands alone in the developed world with insurers having a noteworthy allocation to equities because of the super low bond yields. That may become tougher with the higher risk charge,” Teruki Morinaga, director of insurance at Fitch Ratings Japan, told AsianInvestor.
Domestic equities made up between 7% and 14% of total investment portfolios across the four largest life insurers – Dai-ichi Life, Meiji Yasuda Life, Nippon Life, and Sumitomo Life – as the fiscal year ended March 31, 2022.
LEADING THE WAY
In order to strengthen their capital adequacy, life insurers have reduced their equity positions since the global financial crisis in 2009. However, since the Bank of Japan adopted a zero to negative interest rate policy around 2016 and 2017, the lifers retained their remaining positions, given the Japanese stock market’s relatively decent performance. Dividends from equities in Japan are also relatively high at typically 2% or more.
“With the bond yield almost zero, they want some investment income. Also, from finance theory, diversification matters, so some small allocation to both public and private equity makes sense for portfolio management,” Morinaga said.
Dai-ichi Life has explicitly mentioned it is trying to further reduce their equity risk as well as interest rate risk to cope with the new regulatory regime from 2025 onwards. To make such a move, Dai-ichi Life and its peers will be waiting for the right time to execute.
In case the stock market crashes in the near future, exposure will automatically decline, at the expense of capital. If the stock market declines slower than expected, Dai-ichi Life will be able to reduce its positions while taking in profits and accumulating retained earnings.
“A successful sale of domestic equities all depends on timing, but theoretically Dai-ichi Life is doing the right thing to cope with the new regulatory regime effectively and to reduce the balance sheet risk. Other companies are not as clear as Dai-ichi Life, but some companies are saying similar things to a smaller extent while others are retaining their equity exposure,” Morinaga said.
Under the new regulatory regime, a large duration gap — or mismatch between the life insurers' long yen-dominated liability duration and relatively short asset duration — can lead to higher risk charges.
Japanese life insurers have been selling long-duration products, with payouts over 20 to 30 years in case of death or illness. However, the asset duration is typically 12 to 13 years, resulting in a mismatch of several years.
Furthermore, there are limited investment opportunities in Japan since corporate bonds typically have under 10-year durations. Some companies issue 20 to 30 year bonds but the supply is much smaller than the corporate bond market in the US.
“The new regulatory regime by the Financial Services Agency of Japan requires insurance companies to calculate all risks in a more stringent manner than the current capital regime due to the shift to a more conservative confidence level. In addition, the new regime will capture the interest rate risk stemming from a duration gap more appropriately,” Soichiro Makimoto, VP Senior Analyst at Moody’s Japan, told AsianInvestor.