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Learning how Japanese insurers manage low interest rates

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Japanese life insurance strategies on ultra-low interest rates could be a blueprint into the future of insurers elsewhere, as they enter an environment that Japanese insurers are used to coping with, Fitch Ratings said.

Ultra-low interest rates have affected Japanese life insurers for more than two decades.

In response to the economic stagnation that began in the early 1990s, the Bank of Japan lowered interest rates and they have remained low ever since, the US rating agency said in a report.

Japanese life insurers have adopted various product, investment and business strategies to mitigate the effects, while generally maintaining their credit ratings, the report noted.

This comes as the coronavirus pandemic will prolong a trend that life insurers’ margins are squeezed by low rates. Fairly narrow corporate bond spreads are increasing the pressure.

Similar patterns have evolved in other major insurance markets faced with persistently low interest rates – notably Germany and the US (see graph below).

The report writes that “low rates are a key driver of our negative outlooks for life sectors in the US, Germany and elsewhere, and companies that fail to adapt are likely to be taken over or put into run-off”.

Fitch Ratings named three investment strategies that Japanese life insurers have taken: shifting the product mix, raising investment risks and diversifying overseas.

Shifts in product mix

Japanese insurers steadily reduced guaranteed crediting rates on savings products, and shifted focus to protection-oriented products where earnings are driven by underwriting profitability rather than investment performance. These protection-oriented products include health insurance, which has strong margins and whose growth is supported by Japan’s ageing population.

Insurers also sold more savings products denominated in foreign currencies (mostly in US and Australian dollars), so that they could access the higher yields available on foreign-currency investments without running a currency mismatch. However, tighter regulation, combined with declining US and Australian interest rates, has resulted in a decline in foreign-currency denominated savings products in recent years.

Increased investment risk

Japan’s ultra-low interest rates and fairly small credit market drove the country’s insurers to invest in overseas assets for higher yields, despite the currency mismatch with most of their liabilities. They focused on US investment-grade corporate bonds – and the proportion of foreign securities in their investment portfolios steadily increased (see graph below).

Japanese life insurers’ general accounts have strong liquidity, with Japanese government bonds representing 33% of the sector’s general account assets, as at end of March 2020.

This allows the insurers to seek to invest significantly more in less-liquid assets, such as international private placements and infrastructure debt, so as to gain higher yields, the report said.

Japanese life insurers diversified overseas

In around 2008, Japanese life insurers began diversifying overseas to reduce their reliance on domestic markets.

Their acquisitions have been focused on markets with more favourable demographics, such as the US and Australia, where populations are still growing.

For instance, Dai-ichi Life’s overseas business now accounts for more than 20% of its total earnings, according to the report.

German life insurers

When interest rates in Germany began decreasing after the 2008 financial crisis, German life insurers started shifting new product offerings towards those with lower capital requirements, such as reduced guarantee, unit-linked and biometric risk products (see graph below).

German life insurers have increased the proportion of illiquid assets, equities and alternative investments in their portfolios, and increased the duration of their investments as they attempt to increase their yield, according to the report.

However, the shifts have been limited and the average ratio of risky investment assets to capital is modest.

“We do not expect allocations to higher-risk investments to increase significantly given the higher regulatory capital charges for such assets under Solvency II,” Fitch Ratings said.

It also does not expect German life insurers to follow their Japanese counterparts’ strategy of investing significantly in foreign currency assets.

German insurance law requires companies to currency-match assets with liabilities or to hedge currency mismatches. The latter is typically not value-enhancing due to the cost of hedging, the report explained.

Fitch has a negative sector outlook for the German life insurance industry, reflecting lower market interest rates on reinvestment yields and the knock-on effects on investment margins and capital.

Fitch told Expert Investor: “Going forward we think German insurers are likely to continue the incremental steps towards growing the less capital intensive portions of their product mixes such as reduced guarantee, unit-linked and biometric products and to focus on squeezing yield out of their investment portfolios without changing allocations such that there are meaningful Solvency II ratio implications.”

Elena Johansson

Senior Reporter

Part of the Bonhill Group.