Many Japanese insurance companies failed in the 1990s as a result of over-ambitious investments made to offset negative spreads, the gap between income and returns on guaranteed insurance policies.
They may be set for a re-run today, warns Ian Brimecome of Tokio Marine Holdings, the country's biggest property-and-casualty insurer by revenue.
As senior managing executive officer the 63-year-old oversees Tokio Marine's European business and international business strategies. An M&A banker in the 1990s, he advised on numerous takeovers of bankrupt Japanese insurers.
Déjà vu is now setting in.
Indiscriminate yield hunt
“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,” Brimecome told AsianInvestor.
What the London-based veteran sees across the industry worries him. “The issue is a more indiscriminate chase for yield.”
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.
The industry’s forage for higher returns became frenzied when yields on domestic government bonds turned negative, after the Bank of Japan shocked the market with record dollops of quantitative easing and cut its deposit rate in January to -0.1% for the first time in its history.
Life insurers’ exposure to foreign securities stood at ¥77.53 trillion ($699.47 billion), or 21.7% of their portfolios, by the end of August. That compared to ¥45.27 trillion, or 14.2%, in 2011, according to the Life Insurance Association of Japan.
Japanese insurers, including Tokio Marine, have also sought to achieve asset diversification by buying foreign peers (see box below)
To minimise risks of a blow-up, Tokio Marine employs foreigners to manage overseas assets and is striving to become a more global company. It made Delphi’s president Don Sherman an executive officer and co-chief investment officer on August 1.
“I’m not the only foreigner in Tokio Marine senior management any more,” said UK-born Brimecome, who was the company’s first foreign executive officer. “It was sort of a lonely-ish place for a while.”
Like its peers, Tokio Marine is increasing its ¥4.5 trillion worth of holdings in foreign securities. It mainly intends to do so by buying bonds in the US and Europe via domestic subsidiaries and by expanding assets at the companies it has bought.
As a result of the rapid geographic diversification, the insurer has managed to keep the yield on its ¥21.8 trillion ($197 billion) of assets under management at around 2.2%.
But while foreign forays help boost income, they come with their own risks. Currency fluctuations make profits more volatile as Japanese life insurers generally do not hedge overseas investment income.
“All the ones that got into trouble [in the 1990s] tried to be very clever in making unhedged foreign currency bond investments, too much equity investment, too much real estate,” said Brimecome.
Each went under as a result of investments made to offset negative spreads, the gap between income and returns on guaranteed insurance policies, said Brimecome who advised Axa on its acquisition of failed Nippon Dantai Life Insurance in 1999 and AIG on its takeover of bankrupt Chiyoda Mutual Life Insurance in 2001.
He sees parallels from the 1990s with Japanese insurers' behaviour in the current low interest rate environment.
“Now even the riskiest investments are beginning to be very richly-priced and consequently I really question whether now is the time to be aggressive [when investing],” said Brimecome [pictured below]. “It’s probably a little bit late or very much too early [to be aggressively buying assets].”
Today the larger concerns lie around debt levels amid a shifting rate environment. US corporate leverage, debt to Ebitda, now stands at least as high on a nominal basis as in 2007. Of course, interest rates today are far lower, but signs are this will begin to change.
The Federal Reserve has signalled a rate hike is likely in December, and the consensus is that US president-elect Donald Trump’s economic policies will fuel inflation and lead to more rate hikes. That’s led US bond yields to rise to one-year highs, while 10-year gilts in the UK are at pre-Brexit levels.
Tokio Marine’s domestic units have kept hedging foreign security purchases, despite relatively high costs.
Yet opportunities remain, one area being illiquid assets. Richard Sega, chief investment officer at Conning, which specialises in asset management for insurers, said his group has helped Japanese insurers invest in US collateralised loan obligations. Such instruments offer a yield premium over high-grade corporates up to about eight years of duration, he noted.
Brimecome agrees illiquid instruments can be rewarding – if investors buy with their eyes wide open.
“If you don’t need to sell them urgently because you have a 15-to-20-year liability, like we have in some of our US businesses – that’s fine,” he said. “The issue is not knowing what the risk is, or not being paid for it.”
M&A moves to diversify
In addition to raising their offshore exposure, Japanese insurers have also turbo-charged asset diversification by buying foreign peers.
In October Sompo agreed to buy US insurer Endurance Specialty for $6.3 billion; Mitsui Sumitomo Insurance completed the acquitision of British reinsurer Amlin for $5.3 billion; and Meiji Yasuda Life Insurance wrapped up a $5 billion purchase of StanCorp Financial on March 7.
Financial sources in Tokyo say the Financial Services Agency, Japan’s powerful regulator, is worried some of Tokio Marine’s peers may struggle to manage these new insurance subsidiaries and is starting to apply the brake on further deal-making.
Tokio Marine has not stood apart from this offshore investing drive. In fact Brimecome has led a series of high-profile acquisitions for the group, but these are widely seen as well managed.
In 2008 the insurer snapped up the UK’s Kiln for $899 million and Philadelphia Consolidated for $4.7 billion. It bought Delphi Financial Group in 2012 for $2.7 billion and in 2015 it made the biggest ever purchase by a Japanese insurer, that of Houston-based HCC for $7.5 billion.