The plans of major Japanese life insurers for a modest increase in their allocation to foreign bonds – at the expense of Japanese government bonds (JGBs) – will help them bridge the period of low yields, says Fitch Ratings. We expect the change to continue until either the average interest rate on their guaranteed-return savings products falls or JGB yields rise. However, low long-term JGB yields will still hold back insurers’ progress in resolving what may be their most critical challenge this year – the mismatch between the duration of their assets and liabilities.
Fitch expects the average guaranteed interest rate on savings products to fall in line with current yields of around 1.5%-2% on 20- to 30-year JGBs in the next three to 10 years for ‘A’ rated and above companies, and over a period of longer than 10 years for ‘BBB’ rated and below companies. Any rise in JGB yields as a result of Prime Minister Shinzo Abe’s attempts to boost growth and inflation would shorten this timeframe.
The switch to foreign-currency-denominated bonds is likely to be modest because of more stringent regulation aimed at preventing insurers from taking on too much foreign-currency risk, as well as the yen-dominated profile of most insurers’ liabilities.
The Japanese Financial Services Agency tightened its solvency margin regulation for FY11, and now Japanese insurers’ exposure to foreign currency requires a higher capital charge (10% of FX exposure). Most insurers are likely to hedge the foreign-exchange risk, which will reduce the capital charge but also the yield enhancement.
The lack of JGB supply and low yields will also slow the pace at which insurers raise their exposure to long-term JGBs to cut the duration gap between assets and liabilities. Fitch estimates this gap to be approximately five years. The sensitivity to interest rates which the gap produces makes this a major risk.