NOT FOR CIRCULATION Impacts of interest rate environment on Japanese insurance sector - From "negative spread" to "negative rate" - November 2016 Takashi HAMANO Deputy Commissioner for International Affairs Financial Services Agency of Japan (JFSA) * Any views expressed in this presentation are those of the author, and should not be considered as official views of the JFSA.
Contents I. Negative spread and its impact on Japanese insurers 1. Causes and consequences of negative spread problem 2. Mitigating the negative spread problem industry efforts and regulatory measures 3. Overcoming the negative spread problem II. Negative rate environment and its impact on Japanese insurers 1. What happens? 2. What we would expect? 1
I. Negative spread and its impact on Japanese insurers 1. Causes and consequences of negative spread problem 2
1. (1) Background After the bubble economy in 1980s, long persisting low interest environment since 1990s has caused a negative spread problem. Negative spread is an interest loss generated from the difference in the guaranteed (assumed) interest rate to policy holders and the actual investment yields. Several life insurance companies failed during 1997-2001. 3
9 (%) 1. (2) Assumed interest rates of life policies, 10-Year JGB yield and Nikkei Stock Index (JPY) 40,000 8 The negative spread issue has persisted since the 1990 s, due to the low interest rate environment 35,000 7 30,000 6 5 25,000 4 20,000 3 15,000 2 1 10,000 0 5,000 (year) 4
1.(3) Failure of Japanese life insurance companies 7 life insurers failed between 1997 and 2001. However, it should be noted that there were some specific risk factors behind the failures (e.g. deficient risk management, high-risk investment strategies etc.) in addition to an adverse market environment. (100 million Yen) The figures for total assets and excess liabilities are those at the time of failure 400 300 200 100 0 100 Nissan (Apr 97) Toho (Jun 99) Daihyaku (May 00) Liabilities in excess of assets Taisho (Aug 00) Chiyoda (Oct 00) Kyoei (Oct 00) Tokyo (Mar 01) 5
I. Negative spread and its impact on Japanese insurers 2. Mitigating the negative spread problem industry efforts and regulatory measures 6
2. (1) Industry efforts Even in a difficult business environment, life insurance companies in general are making profits even after offsetting of the negative spread. It is partly because mortality gains from death insurances tend to be significant. Cost savings also contributed to offsetting of the negative spread. N.B. Profit sources from basic insurance business (Core profits) of life insurance companies are classified into three categories. (a) Interest gains : Difference between the assumed interest and the actual interest (b) Mortality gains : Difference between the assumed mortality rate and the actual mortality rate (c) Cost savings : Difference between the assumed expenses in business operations and the actual expenses in business operations. 7
2. (2) Three profit sources of life insurance companies 4.0 Profits generated from lower-than-assumed mortality rates and cost savings had offset losses from negative spreads until recently 3.5 3.0 2.5 2.6 2.7 3.0 2.7 2.6 2.8 3.3 3.4 0.2 0.3 2.0 2.8 2.9 3.0 2.0 2.1 2.1 1.5 2.9 2.9 2.9 2.7 3.0 2.8 3.0 3.1 1.0 0.5 0.0 0.5 0.6 0.9 0.6 0.7 0.5 0.3 0.1 0.0 0.1 0.1 0.4 0.5 0.7 0.8 1.0 0.5 0.2 0.2 0.1-0.0 1.0 1.5 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Cost Profit Mortality Profit Interest Profit Total 3 ( Core Profit 8
2. (3) Introduction of regulatory measures Japanese insurance regulatory regime was reinforced by the full revision of the Insurance Business Act (promulgated in 1995 and enforced in 1996). Some regulatory measures that helped to mitigate the problem were introduced. (a) Standard Policy Reserve System including the statutory defined standard assumed interest rate was introduced in 1995. (b) The statutory method for setting the standard assumed interest rate was amended in 2014 to make it more consistent with market rates. (c) A new accounting treatment for life insurers was introduced in 2000 to avoid fluctuation of insurers' net worth due to changes in interest rates. 9
2. (4) Method for setting the standard assumed interest rate The method for setting the standard assumed interest rate used for the calculation of the standard policy reserve requirements is based on JGB yields and hence it has also been in decline continuously. The standard assumed interest rate was reduced in 2013 from 1.5% to 1.0% for the first time since 2001. Assumed interest rate 1990 5.5% (more than 10Y), 5.75% (10Y or less) 1993 4.75% 1994 3.75% 1996 2.75% 1999 2.0% 2001 1.5% 2013 1.0% N.B. From 1990 until 1994, the most common assumed interest rates for endowment insurance contracts. From 1996, the statutory defined standard assumed interest rates. 10
2. (5) Amended method for setting the standard assumed interest rate The method for setting the standard assumed interest rate was amended in 2014 to be more consistent with market rates. The rates for some single-premium products were lowered in April 2015. Post-Amendment (Since June 2014) Pre-Amendment Others Single-premium saving types whole life, endowment, annuities etc. Benchmark yield 10 year JGB Same as before 10 year JGB Reference term of yield Lower of 3 years average or 10 years average Same as before Lower of 3 months average or 1 year average Reference yield Yield to subscribers Same as before Current yield Frequency of adjustment Once per year Same as before 4 times per year Trigger for adjustment 0.50% or more deviation Same as before 0.25% or more deviation Safety factor coefficient 90% confidence level 95% confidence level 11
2.(6) Transition of Standardized Assumed Interest Rate Standardized Assumed Interest Rate has continuously declined due to decrease in long-term interest rate Standardized Assumed Interest Rate : In order to ensure soundness of insurers and to protect policyholders, insurers are required to accumulate their policy reserves based on the "Standardized Assumed Interest Rate", which is set by a formula defined by the FSA regulation based on market interest rate. Decrease of Standardized Assumed Interest Rate means that life insurance companies must accumulate 12 more policy reserves. Life insurance companies, therefore, may have to raise insurance premium.
I. Negative spread and its impact on Japanese insurers 3. Overcoming the negative spread problem 13
3. (1) Background The negative spread problem mainly matters to insurance contracts entered into in the high interest rate environment until early 1990s. Those legacy insurance contracts have been decreasing in the last two decades. In addition, newly entered insurance contracts with lower assumed interest rate have increased in the same period. With a favourable investment environment (e.g., higher stock prices and increased return from foreign securities investment) in the last few years, major life insurance companies have recorded strong core business profits. Against these backdrops, the negative spread problem is being settled for many life insurance companies. 14
3. (2) Financial results of life insurers in Japan 40,000 35,000 100 billion yen Recent financial results of life insurance companies have been generally strong 30,000 Core Profit 25,000 20,000 Current Net Profit 15,000 10,000 5,000 0 FY90 FY95 FY00 FY05 FY10 5,000 (*) 42 life insurers 15
3. (3)Nikkei Stock Index and JPY/USD exchange rate in recent years (pt) The market environment has improved since the launch of so-called Abenomics (JPY/USD) 20,000 Start of the Abe Administration (Dec 2012) Start of BOJ s QQE (Apr 2013) JPY/USD exchange rate (Right-hand scale) 140 120 15,000 100 10,000 Nikkei 225 Stock Price Index (Left-hand scale) 80 60 5,000 40 20 0 0 (year) 16
II. Negative rate environment and its impact on Japanese insurers 1. What happens? 2. What we would expect? 17
II. Negative rate environment and its impact on Japanese insurers 1. What happens? 18
1. (1) Background Bank of Japan s negative rate regime (on central bank deposits) was announced on January 29 and applied from February 16. Negative rate (- 0.1%) only applies to a small portion of banks deposits with the central bank (central bank deposits). Since end-february, JGB yields up to 10 year have turned into negative. Although the amount of central bank deposits in total remained almost the same, there are significant changes in money flow in the Japanese financial markets. 19
1. (2) Low/Negative interest policies of BOJ April 2013 : QQE ( Quantitative and Qualitative Monetary Easing ) January 2016 : QQE with a Negative Interest Rate September 2016 : QQE with Yield Curve Control 20
1. (3) How negative rate regime works Three-tier system of BOJ s current account balance (Since Feb 2016) Name of Tiers Applied Rate Basic Balance +0.1% Average outstanding balance from January 2015 to December 2015 (Benchmark reserve maintenance periods) Macro Add-on Balance 0% Outstanding amount of required reserves, outstanding amount related to the Loan Support Program etc. + Addition based on Basic Balance Policy-Rate Balance 0.1% Outstanding balance in excess of the amounts outstanding of and combined 21
1. (4) BOJ s QQE with Yield Curve Control (Introduced in Sep 2016) Yield Curve Control Inflation-Overshooting Commitment Short-term Long-term Observed CPI inflation rate exceeds the price stability target of 2% and stays above in a stable manner Negative rate (currently 0.1%) applicable to a portion of central bank deposits JGB purchase to keep 10 year JGB yield at around 0% Monetary base continues to expand until the above-mentioned condition is fulfilled 22
1. (5) 10/40 year JGB yields 1.6 1.4 (%) Application of negative rate (Feb 16, 2016) 10 year 40 year 1.2 1 0.8 BOJ's Monetary Policy Meeting (Sep 21, 2016) 0.6 0.4 0.229 (1/28) 0.2 0-0.2 BOJ's Monetary Policy Meeting (Jan 29, 2016) 0.104 (1/29) 0.052 (2/16) -0.03 (9/21) -0.049 (10/31) 4-Jan 11-Jan 18-Jan 25-Jan 1-Feb 8-Feb 15-Feb 22-Feb 29-Feb 7-Mar 14-Mar 21-Mar 28-Mar 4-Apr 11-Apr 18-Apr 25-Apr 2-May 9-May 16-May 23-May 30-May 6-Jun 13-Jun 20-Jun 27-Jun 4-Jul 11-Jul 18-Jul 25-Jul 1-Aug 8-Aug 15-Aug 22-Aug 29-Aug 5-Sep 12-Sep 19-Sep 26-Sep 3-Oct 10-Oct 17-Oct 24-Oct 31-Oct -0.4 (Source) Ministry of Finance, Japan 23
1. (6) JGB yields by maturity End-Dec 2015 Jan 29 2016 End-Feb 2016 End-Mar 2016 End-Jun 2016 End-Jul 2016 End-Aug 2016 End-Sep 2016 End-Oct 2016 5y 7y 10y 15y 20y 30y 40y 0.032 0.064 0.267 0.603 0.997 1.282 1.406-0.071-0.055 0.104 0.436 0.833 1.103 1.235-0.228-0.217-0.055 0.216 0.573 0.902 1.034-0.19-0.183-0.049 0.176 0.441 0.547 0.632-0.317-0.331-0.237-0.094 0.067 0.128 0.157-0.261-0.292-0.178-0.002 0.184 0.263 0.328-0.18-0.186-0.058 0.114 0.334 0.41 0.479-0.249-0.241-0.084 0.118 0.361 0.457 0.522-0.193-0.177-0.049 0.127 0.384 0.505 0.574 (%) (Source) Ministry of Finance, Japan 24
1. (7) Changes in money flows Pension funds Investment funds Major banks Deposits Trust bank Trust Account Banking Account Market funding Insurers Investment of surplus funds Short-term money market (e.g. uncollateralized call loans) Investment of surplus funds 25
II. Negative rate environment and its impact on Japanese insurers 2. What we would expect? 26
2. (1) Current status Impacts will be more gradual and creeping than sudden and abrupt. Impacts may differ by firms depending on their business model and balance sheet structure. However, some harbingers have been observed Changes in investment behaviors Suspension of or limitation on provision of certain life products 27
2. (2) Assets of life insurers (As of end Mar 2015) Cash / Deposits (1.5%) Loans (10.0%) JGB (49.7%) Securities (81.5%) Others (6.9%) Municipal bond (4.6%) Corporate bond (8.3%) Stock (7.6%) Foreign securities (24.5%) Other (5.3%) (Source) Life Insurance Association of Japan 28
2. (3) Insurers foreign investment (Net Basis. Billion JPY) Life insurers Non-life insurers 2015 Jan 159 11 Feb -283 1 Mar -512 0 Apr 654 8 May 839-1 Jun 55-16 Jul 70-8 Aug 64 3 Sep 215 14 Oct 505-6 Nov 321-4 Dec 318-8 2016 Jan 159-9 Feb 1,075-3 Mar 1,503 3 Apr 986-44 May 813 10 Jun 1,054-14 July 1,957 21 Aug 1,149 2 Sep 1,029 0 (Source) Ministry of Finance, Japan 29
100 2. (4) Changes in investment behaviors Japan USA 80 60 30.1 29.7 12.2 11.8 19.7 18.6 18.8 19.7 19.0 20.7 22.0 6.4 6.1 7.0 5.5 4.9 4.4 4.2 16.2 17.8 17.2 16.7 16.2 15.5 15.1 24.5 3.9 14.6 26.6 4.0 14.2 2.5 3.0 19.4 19.1 77.6 40 54.4 57.0 57.7 58.0 59.5 58.9 58.1 56.1 54.0 20 36.3 37.5 10.9 0 06/3 07/3 08/3 09/3 10/3 11/3 12/3 13/3 14/3 15/3 16/3 14/12 Domestic Gov. Bonds (JP/US) Domestic Bonds (JP) Bonds including Foreign Bonds (US) Domestic Stocks (JP) Stocks including Foreign Stocks (US) Foreign Stocks (JP) Foreign Gov. Bonds (US) Others 30
2. (5) Impacts on provision of life products Some insurers have either suspended in part or in full or otherwise increased premiums of certain long-term products. Some insurers are more inclined to sell purely protection-type products such as health insurance. Examples of insurers suspended in part or in full provision of single premium whole life insurance and/or single premium personal annuity insurance (as of April 2016) Fukoku Life, Asahi Life, Taiyo Life, Daido Life, Daiichi Frontier Life etc. Examples of insurers that lowered the assumed interest rate (i.e., increased premiums) of single premium whole life insurance (as of April 2016) Nippon Life, Daiichi Life, Meiji-Yasuda Life, Sumitomo Life 31
2. (6) Considerations for insurance supervision As the continued low/negative interest rate environment could negatively affect financial results of insurers in the long-term, JFSA conducts in-depth monitoring through ORSA reporting and ERM hearings regarding. One of the main focus is upgrading of asset management capacity. 32
2. (7) Upgrade of asset management capacity Diversification of investment portfolios (such as investment in foreign securities) with appropriate risk management is a key. JFSA monitors the development of asset management sophistication by life insurance companies. Excerpt from JFSA s Progress and Assessment of the Strategic Directions and Priorities 2015-2016 (Sep 2016) Looking at asset management of life insurance companies, global diversification of investments (such as investment towards foreign corporate bond market, growth market, hedge transaction using derivatives) has continued, as domestic interest rate decreased and management of JGBs became more and more difficult. One cannot foresee the future interest rate environment, but it is expected for life insurance companies to contribute to nation s assets formation and promote initiatives for upgrading asset management capacity. 33
2. (8) Challenges and way forward Exploration of alternative investment asset allocation for higher returns Robust risk management and proper cash management will be needed Control of duration mismatch could become more challenging Asset management with long-term perspective is crucial for life insurers 34
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