Japan’s major life insurers are preparing to adjust their investment strategies for the second half of the fiscal year, with a cautious eye on the central bank’s monetary policy and the movement of bond yields. Their decisions, expected to unfold over the next six months, could have significant implications for both domestic and global debt markets.
A Powerhouse of Japanese Finance
Japan’s life insurance sector is a colossal force within the nation’s financial landscape. With total combined invested assets of approximately ¥388 trillion ($2.6 trillion), the life insurers rank among Japan’s most influential institutional investors. According to data from the Life Insurance Association of Japan, these companies manage vast portfolios that include substantial stakes in both domestic and foreign securities.
As the fiscal second half, running from October 2024 through March 2025, begins, life insurers are poised to unveil their updated investment strategies. These strategies are highly anticipated given the scale of the insurers’ assets and their ability to influence domestic and international markets. Their investment plans hold particular weight in the bond market, as these firms traditionally favor long-term bonds to match the maturity of their insurance liabilities.
But as global financial conditions remain fluid, influenced by factors ranging from interest rate movements in Japan and the US to fluctuations in the value of the yen, life insurers face a complex environment for allocating their capital.
One of the primary focuses for Japan’s life insurers is the domestic bond market, particularly super-long Japanese government bonds (JGBs) with maturities of 20 years or more. These bonds serve a crucial role in matching the insurers’ long-term liabilities, but the current environment poses challenges. Yields on these bonds, while stable, have not risen enough to provide the attractive returns insurers are looking for.
For much of 2023, Japan’s 20-year JGB yield has hovered below 2%, while the 30-year yield has stayed under 2.3%. Although the latter briefly breached this level earlier in the year, it has since retreated, creating a cautious atmosphere for buyers of long-term government debt. The modest yields have led to hesitation among life insurers to increase their holdings of these bonds, despite their historical preference for them.
However, there are signals that a shift may be on the horizon. If the yield on 20-year government bonds climbs to 2%, many experts believe life insurers will be more inclined to increase their investments. Market strategist Ayako Sera of Sumitomo Mitsui Trust Bank Ltd. notes that such a rise would make 20-year bonds an appealing option once again. Similarly, if 30-year bond yields rise to around 2.2%, more life insurers may be tempted to return to these securities, according to Hideo Shimomura, a senior portfolio manager at Fivestar Asset Management Co. in Tokyo.
Despite the anticipation for higher yields, life insurers are taking a measured approach, keenly observing any indications of future interest rate adjustments by the Bank of Japan (BOJ). While the BOJ has taken gradual steps towards tightening its ultra-loose monetary policy, it has signaled that it is not in a rush to raise interest rates further. This uncertainty has kept many insurers in a holding pattern, reluctant to make aggressive moves in the bond market without clearer guidance from the central bank.
The BOJ’s approach to monetary tightening has been a key variable for Japan’s life insurers. The central bank has begun raising interest rates in small increments after years of a near-zero interest rate environment, but it remains cautious about moving too quickly. This hesitancy stems from concerns about potential disruptions to Japan’s fragile economic recovery, as well as uncertainty around global financial stability.
BOJ officials have signaled that they are unlikely to pursue aggressive rate hikes in the near term. This stance complicates life insurers’ decisions. While higher interest rates would improve the returns on bonds and make domestic bonds more attractive, the slow pace of rate increases has left yields relatively low. “People want to buy yen bonds again, but interest rate levels aren’t high enough, so if they buy it will only be reluctantly,” said Eiichiro Miura, head of the strategic investment department at Nissay Asset Management Corp.
Miura’s statement reflects the broader sentiment in the market: life insurers are willing to re-enter the domestic bond market, but they are waiting for yields to rise just a bit further to make the investment more compelling.
In addition to domestic bonds, Japanese life insurers have traditionally been significant players in international bond markets, particularly in the US. However, high hedging costs and currency risks are clouding the outlook for foreign bond investments, especially in US Treasuries.
Historically, US Treasuries have offered higher yields than their Japanese counterparts, providing an attractive opportunity for insurers seeking higher returns. As of October 2024, the yield on 10-year US Treasuries exceeds that of equivalent Japanese government bonds by about 3 percentage points. Despite this favorable yield differential, the cost of hedging currency risks—particularly against the yen—has risen significantly, making the net returns on these investments less appealing.
For yen-based investors, the strength of the yen relative to the dollar is a critical consideration. A stronger yen reduces the value of foreign-denominated assets when converted back into yen, leading to potential losses. In mid-2024, the yen fell to a 38-year low of 161.95 against the dollar, prompting concerns about exchange rate volatility. Although the yen has since recovered, rising to as strong as 139.58 in response to BOJ rate hikes, the potential for further fluctuations remains a risk that insurers must factor into their investment decisions.
“They are not going to buy Treasuries because the hedging cost is too expensive,” said Shoki Omori, chief desk strategist at Mizuho Securities Co. “In reality, what they’re going to buy is US equities and US credit.” This shift reflects a broader trend among institutional investors, who are increasingly turning to unhedged foreign equities and corporate debt in search of higher returns, despite the inherent risks.
Currency risk remains one of the most significant challenges facing Japanese life insurers as they contemplate foreign investments. The yen’s sharp fluctuations against the dollar in 2024 highlighted the vulnerability of unhedged foreign bonds, particularly for long-term investors like life insurers who must carefully manage risk over extended time horizons.
However, some market analysts believe the worst of the yen’s volatility may be over. With US interest rates expected to plateau or decline in the coming months, the yen is unlikely to experience another sharp depreciation. Additionally, the BOJ’s measured approach to raising interest rates has helped to stabilize the currency, reducing the likelihood of another major spike in volatility.
“The risk of a sharp rise in the yen has disappeared, with the lowering of US interest rates already factored in and the BOJ not likely to raise interest rates aggressively,” said Nissay’s Miura. This relative stability could lead to a slight increase in life insurers’ holdings of foreign bonds, particularly in cases where the yield differential between Japanese and foreign bonds remains attractive enough to offset the hedging costs.
As Japan’s life insurers navigate the evolving financial landscape, they are likely to make strategic adjustments in their asset allocation. While domestic bonds remain a cornerstone of their portfolios, the uncertain interest rate environment and low yields have led insurers to explore alternative investments.
In the near term, many insurers may continue to diversify into equities, both domestic and foreign, in search of higher returns. US equities and corporate credit have been identified as particularly attractive options, especially given the high cost of hedging foreign bond investments. By shifting more of their capital into these assets, insurers can potentially enhance their returns while managing the risks associated with low-yield bonds and currency fluctuations.
At the same time, insurers are likely to remain cautious about taking on too much risk, given the long-term nature of their liabilities. Matching the duration of their liabilities with appropriate assets remains a top priority, and this will continue to drive demand for super-long domestic bonds, particularly if yields rise to more attractive levels.
