With Japanese bonds in freefall every day, pushing yields on 10Y JGBs to a 3 decade high, just shy of 3%...
... the time to pay the piper is fast approaching as unrealized losses on domestic bonds at Japan's major life insurers have soared to 30.86 trillion yen ($194 billion) as of the end of June, up 60% year-on-year, and trillions more since then, revealing the downside of the rising interest rates that have lifted investment income.
The total - which was compiled by Nikkei Asia from the 13 respondents out of 14 major life insurers surveyed - surpassed their unrealized gains on domestic stocks, which were up 48% to 30.03 trillion yen.
The main driver is obviously the one thing that is destroying Japan's entire financial system, rising Japanese government bond yields. Yields on 30-year JGBs, a key investment target for life insurers, climbed to the 3.9% range at the end of June, up about 2.7% points from the end of July 2023, before the combined unrealized gains among these companies flipped to losses.
The upward trend in yields has continued beyond June on expectations of further Bank of Japan rate hikes and concerns about fiscal expansion.
As the Nikkei reports, life insurers traditionally invest in ultralong-term JGBs to prepare for their future obligations to policyholders. In principle, unrealized losses disappear if the bonds are held to maturity. But under certain circumstances, they risk straining finances.
As we discussed last year, if the market value of a bond falls 50% below its acquisition cost, insurers may be required to recognize an impairment loss. Nippon Life Insurance recorded 44 billion yen in impairment losses for the April-June quarter, while Meiji Yasuda Life Insurance booked 25.3 billion yen. Some bonds purchased during the ultralow interest rate environment of the late 2010s have fallen far enough in value to reach the impairment loss threshold.
It gets far worse when instead of holding the worthless paper to maturity, insurers need to sell the bonds before maturity. Life insurers manage assets and liabilities seeking to align the duration of investment assets with the duration of future insurance obligations. When successful, rising interest rates reduce the market value of both assets and liabilities, limiting the net impact on financial strength.
But when assets have longer maturities than liabilities, rising rates can reduce net assets and increase the risk of deteriorating financial health. Insurers then may need to shorten asset duration by selling bonds, turning unrealized losses into realized ones.
Sony Life Insurance's policy lapse and surrender rate in April-June rose 0.2 points year-on-year to 1.4%, partly because a rapid depreciation in the yen prompted more customers to cancel policies denominated in foreign currency. The figure for T&D Financial Life Insurance, which has a strong presence in bank channel sales, climbed 0.88 points to 1.56%.
A surge in policy cancellations represents the greatest concern. As rates rise and stock prices climb, if many customers shift into insurance products or investment trusts offering higher yields, insurers may need to liquidate assets to fund surrender payments. Read: sell those bonds which are supposedly "held to maturity."
Though most insurers think current lapse and surrender levels can be handled with cash on hand, demand trends are difficult to forecast because they are tied closely to interest rate movements.
"Policy cancellation trends require closer monitoring than ever before," said Sadahiko Hayakawa, chief financial officer of Sony Financial Group.
The good news for now is that insurers' earnings remain strong. Core operating profit for the 14 major insurers, a measure of underlying earnings, reached 951.8 billion yen in April-June, up 37% year-on-year, with 12 of the companies reporting profit growth. Higher interest rates increased interest income from bondholdings, while dividend income from equities also rose.
To expand investment returns further, insurers are rotating into higher-yielding bonds, which however is a two-edged sword as those are the bonds who price is falling the fastest... and keeps falling every day.