Japan's insurers are increasing their investment risk, with larger players allocating more to offshore assets – often on an unhedged basis – while mid-tier companies seek out alliances and make tactical offshore bets to keep pace with their larger peers, according to analysts at Fitch and Moody’s.
On June 3, US rating agency Moody’s released a commentary looking at Japan’s four largest life insurers: Dai-ichi Life, Meiji Yasuda Life, Nippon Life and Sumitomo Life. It noted that their combined foreign bonds and foreign equity holdings rose to 30.4% of general account assets at the end of March 2019, up from 29.2% a year ago.
Moody’s expects this trend to continue as the insurers look to pursue higher yields and secure better investment returns amid Japan’s ongoing zero-interest rate environment. That is set to add risk to their balance sheets.
Meanwhile, smaller insurers are trying to compensate for their smaller investment divisions by seeking out international partners and looking to time the markets with specific investments.
“The larger life insurers have more diversified foreign asset profiles, because of their investments in sovereign bonds in multiple currencies and countries, as well as foreign credit instruments. By contrast, the smaller insurers have limited capacity to achieve such asset diversity,” said Soichiro Makimoto, a senior analyst in the financial institutions group at Moody's.
He added that Japan’s leading lifers look set to raise their exposure to shifting foreign exchange rates and varying yields as they raise their offshore investments.
“We expect that large Japanese insurers will continue to allocate their investments into unhedged foreign bonds – depending on the on currency rates – given the higher cost of currency hedging,” he said.
The cost of hedging US dollar-denominated assets back into yen has become particularly costly. At the end of April Japanese investors wanting to purchase a three-month dollar-yen forward contract would see a 10-year Treasury yield about negative 0.4%, versus the 2.53% yield it offered on an unhedged basis, according to Bloomberg.
Making unhedged dollar investments will inevitably raise the risks on the insurers’ balance sheets, added Teruki Morinaga, director of insurance coverage at Fitch Ratings Japan.
“Japanese traditional lifers’ foreign bond assets are already nearly 30% of their assets under management, which is already somewhat too high from the standpoint of robust ALM (asset-liability management),” he told AsianInvestor.
The extent to which Japanese insurers diversify their assets is directly linked to the size of their balance sheets. But there’s a downside to their size too.
AIMING TO ADAPT
The largest insurers in the country have a balance sheet size of around $400 billion to $800 billion or so, which is large enough to employ internal and external professional teams to diversify credit investments worldwide, Morinaga pointed out.
However, “as they are a sort of ‘big battleships’, they cannot change allocations in an agile manner,” he added.
Smaller Japanese life insurers lack the resources of their larger peers, and are looking to a variety of investment strategies to make up for the shortfall. For example, some medium sized insurers are trying to make up their limited resources via partnerships with US and European asset management firms.
Morinaga noted that Fukoku Life is one such example. Its internal global credit research capabilities are smaller than those of Dai-ichi Life or Nippon Life, but in September 2017 it signed a memorandum of understanding with US asset manager Payden & Rygel. The Los Angeles-based fund house is investing some of Fukoku Life’s assets while teaching some its trainees about international credit investment, he noted.
Other mid-tier Japanese insurers are trying to use their smaller asset sizes to more actively shift positions on foreign bonds and exposure to currency risks, in an active effort to improve their returns. It plays to a strength of the smaller insurers – their nimbleness – and done correctly it could improve returns. But it also raises their risk of ending up on the wrong side of a market bet, thus increasing their market risk.
“They argue they can do so because they are not too big. Therefore, if smaller companies’ external alliance strategies and/or agile asset allocation tactics turn out to be successful, then they will not be hit harder. But if not successful then they will be hit harder,” Morinaga said.
The shift in market conditions have also affected the investment strategies of Japan’s insurers. Moody’s Makimoto said that the companies mainly used to invest overseas in currency-risk-hedged foreign sovereign bonds, and in particular US sovereign bonds.
But the cost of hedging US dollar debts have meant that the most attractive investment targets in recent months have been FX-hedged sovereign bonds and corporate debt based outside the US, in particular Europe. These assets are far cheaper to hedge and allow the insurers to diversify their foreign currency mix. In addition, some insurers have sought to invest in unhedged sovereign bonds to gain exposure to currency risk.
The larger life insurers have also started dipping their toes in alternative assets such as private debt, private equity and real estate. Morinaga thinks the insurers won’t add large exposures in these asset classes for some time to come.
“Alternative markets are still small in the world, and especially in Japan, compared to Japanese major life insurers’ significant balance sheet size, and Japanese life insurers will continue to be rather prudent in due diligence process on foreign alternative investment projects,” he said.
The desire of some large insurers to get better returns has led them to seek out more credit risk in both vanilla and alternative debt, Morinaga added. They have put more money in high-grade corporate bonds in developed markets and, to a smaller extent, illiquid alternative investments such as infrastructure debt.
While Japan’s top-nine insurers may be adding overseas risk to their books, their overall financial health remains strong. Their statutory solvency margin ratio continued to improve to hit a weighted average of 967% by end-March 2019 from 922% a year earlier, according to Fitch.
The agency said it expects Japanese life insurers to maintain strong capital adequacy for their credit ratings, supported by steady accumulation of retained earnings and solid financial flexibility, which will be helped by hybrid debt issuance.
Investors interested in the strategies of Japan's asset owners can learn more at AsianInvestor's 8th Institutional Investment Forum Japan, to be held on June 18 in Tokyo. Please click here for more details.