Business / Financial Markets

Negative yields will punish insurer profits, ex-Bank of Japan official says

by Chikako Mogi and Masahiro Hidaka

Bloomberg

Miyako Suda, who opposed the Bank of Japan’s ultraloose monetary policy as a member of its Policy Board, has a warning for the nation’s life insurers as bond yields sink ever lower.

This prolonged period of ultralow rates will pressure profits as sovereign debt matures and has to be replaced with lower-yielding bonds, said Suda, who is now an external board member at Meiji Yasuda Life Insurance Co.

“As the duration of their JGB holdings shortens, insurers’ profitability will worsen if yields stay below zero,” the 71-year-old said in an interview in Tokyo. “If they don’t change direction now, they will become poorer and poorer. The negative impact will become evident.”

While Japanese life insurers have sought to diversify away from Japanese government bonds by buying overseas debt, the cost of hedging against foreign-exchange volatility and a collapse in global yields have crimped their progress. Domestic sovereign bonds still make up almost 40 percent of the ¥3.5 trillion of assets they manage, little changed from two years ago.

Insurers are currently in the process of announcing their investment plans for the second half of the fiscal year, with most attention focused on the nation’s largest, Nippon Life Insurance Co.

With the BOJ holding down its policy rate at negative 0.1 percent and suppressing bond yields through record asset purchases, the coupons on long-term debt have plunged. The most recent sale of 30-year bonds in October carried a coupon of 0.4 percent, compared with 2.80 percent for similar-maturity debt maturing in 2029.

Life insurers typically invest in longer-dated securities to match the liabilities on the policies they sell. JGBs with maturities of more than 10 years make up 74 percent of their domestic debt holdings, according to the Financial Services Agency.

About ¥40 trillion of 20-year government bonds will mature in the next five to six years, according to data from the Finance Ministry.

“There is a huge gap between the potential risks that await insurers and the sound profitability they are enjoying now,” Suda said, likening the life insurer industry to the Titanic.

An evaluation of insurers by the FSA last year showed that the average economic solvency ratio would drop to 100 percent, the minimum required to cover capital needs, if the yield on 20-year JGBs fell to 0.051 percent. The yield closed Friday at 0.245 percent.

The ESR ratio, which measures whether life insurers have enough capital to meet their commitments, averaged 141 percent for the industry in March 2018, according to the FSA.

“The 100 percent solvency ratio serves as a threshold, a drop below which will severely limit their risk taking,” said Suda, who sat on the BOJ Policy Board from 2001 to 2011.

The bank shouldn’t deepen negative rates unless it can also prevent bond yields from sliding, Suda said. The decline in benchmark 10-year yields to the brink of a record low last month indicates the challenge for the BOJ, she added.

One option that could help insurers would be for the BOJ to do a so-called reverse operation twist wherein it buys shorter-term bonds and sells longer-maturity ones, she said.

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