For many investors, the market turmoil triggered by the Covid pandemic in March was one of the worst in their lifetime. A crash in US stock markets, a plunge in Treasuries and a massive selloff across the globe played havoc with market confidence. Financial markets only started to stabilise after major central banks, including the Bank of Japan, led global efforts in unveiling asset purchase programs and lending facilities of unprecedented scale.
Like many other investors, portfolio managers of the Japanese life insurers were left with a bittersweet moment. Encouraged by the market rebounding, Japanese lifers became optimistic to recover some of the losses on their foreign securities investments for the fiscal year.
But they will soon have to worry again, as they seek to devise a longer-term strategy for their US$3.6 trillion in assets and the $910 billion currently invested overseas.
Challenges here to stay
Before the pandemic, a prolonged low-interest-rate environment posed many challenges to the Japanese life insurance industry. With the pandemic, these challenges can be expected to stay for even longer. The interest margin of the lifers contributed little to their profits. The fall in market interest rates domestically over the years failed to meet guaranteed returns offered by the majority of policies, and in the case of legacy contracts, higher returns.
Weakening solvency is another consequence. As lifers have longer-term liabilities than assets, falling interest rates boost the market value of the former more than the latter, which ultimately impairs the lifers’ capital strength.
In AMRO’s 2019 Annual Consultation Report on Japan, a stress test on a hypothetical balance sheet shows that the capital position of the sector could shrink from 5% to 2.82% and 0.55% if the prevailing market interest rates fall from 1.5% to 0.5% and -0.5%, respectively.
Ultra-low policy rates and the liquidity provision globally kept yields low for market securities in Japan (Figure 1). And in the future, with global negative-yielding debts approaching a record high yet again, the Japanese lifers will have little choice but to purchase riskier assets and continue their investment exodus more boldly to seek profits (Figure 2).
Figure 1. Japanese Government Bonds and Global Negative-Yielding Debts
Note: QQE=Quantitative and Qualitative Monetary Easing; NIRP=Net Interest Rate Policy; YCC=Yield Curve Control
Figure 2. Asset Allocation of Japanese Life Insurers
Search for profitable investments
The challenge is that finding positive-yielding securities after hedging expenses will not be an easy task in the “lower-for-much-longer” environment.
Euro area treasuries, US corporate bonds, emerging market bonds and collateralised loan obligations are among the few popular options. Unfortunately, Japanese lifers have to face fierce competition from wealthy investors and other financial institutions, for example hedge funds, who are also yield hungry and can move faster (Figure 3).
As a result, Japanese insurers will have to be constantly on the lookout for new profitable investment opportunities and possibly venture into even riskier or more unfamiliar investment territory, while reducing hedging positions.
To do that, they need strategies to cope with the increasing complexities of credit, liquidity and market risks.
Figure 3. Foreign Securities held by Japanese Financial Institutions Relative to Market Capitalisation of Various Positive-Yielding Asset Classes after Hedging for Yen-based Investors
Sources: Bank of Japan; Bloomberg Finance LP; Life Insurance Association of Japan; JPMorgan; Scope Ratings and AMRO staff calculations.
Note: data are as of March 2020, except for CLOs, which are 2019 estimates. Calculations assume that the investment securities of JP banks’ foreign branches are foreign currency denominated. CLO = collateralised debt obligations; EM = emerging market; FI = financial institution; GPIF = Government Pension Investment Fund; JP = Japan; US = United States.
Digitalisation the way forward in distribution
Nonetheless, the Covid pandemic may prove to be an opportunity for the Japanese life insurers to innovate their businesses.
With over 70% of their products sold through agents and sales representatives, the lifers should revamp their distribution channels by deploying more digital solutions in view of observing social distancing measures. Moving businesses online could help reduce operational costs and boost profitability.
The future for the Japanese life insurers depends on how the strategies they implement under the post-Covid reality. This time, the inherently conservative and prudent sector may be poised to change its traditional way of doing business and become a pioneer in deploying state-of-the-art technologies to manage its costs.
Such changes are spreading into the trading area. As remote as it once seemed, some portfolio managers are already placing their bets from their suburban homes other than Tokyo offices.
# Wei Sun is a financial sector specialist at the ASEAN+3 Macroeconomic Research Office (AMRO)