Japan's insurers are ready to ride out market turmoil of the type seen recently.

S&P Global Ratings believes recent volatility in financial markets doesn't materially affect the financial soundness of rated Japanese insurers. Japanese insurers have strengthened controls they use to manage market risks through reduction of equity risk and interest rate risk. The insurers have reduced their sensitivities to financial market volatility, which will help them maintain solid capital levels even under a moderate market stress scenario, in our view.

Equity Price Sensitivity

Capital buffers and risk reductions could mitigate stress

Falling equity prices do not immediately affect Japanese insurers' financial soundness, in our view.  In Japan, some insurance companies have sizeable exposures to equities either for strategic reasons or for pure investment purposes. However, insurers generally have sufficient capital buffers and solid risk control frameworks. The major insurers have huge unrealized gains on their equity holdings. For example, unrealized gains on equities amounted to about 70% of net assets of major life insurers (Nippon Life Insurance Co., Dai-ichi Life Insurance Co. Ltd., Meiji Yasuda Life Insurance Co., and Sumitomo Life Insurance Co. on a stand-alone basis), as of the end of March 2024. The breakeven point at which major life insurers' unrealized gains on equities would be zero would be a level on the Nikkei index of about 10,000 to 17,000, far below the bourse's recent levels.

Chart 1

In addition, major non-life insurance groups have strengthened controls related to equity risk, in our view.  Major non-life insurers have gradually reduced their equity risks over more than a decade through sales of strategic equity holdings, which helped them lower sensitivity to fluctuations in equity prices. They plan to accelerate such sales in the next six to seven years. Cutting strategically held stocks will further reduce sensitivity to equity prices and stabilize their capital.

Chart 2

We don't expect to change our assessments of insurers' financial risk profiles based on short-term volatility in equity prices in early August.  We have sufficiently incorporated high equity risk into our proprietary capital model. In our capital model, declines in unrealized gains on equity holdings are largely offset by reductions in equity risk as a result of high risk charges on equities. Assuming a 99.99% confidence level, a 10% decline in unrealized gains on domestic equity holdings could shave about 0.6% from insurers' capital levels on a net basis. We expect rated insurers could maintain their strong capital positions even if we assume domestic equity prices deteriorate further, for example if the Nikkei 225 index falls to 30,000.

Interest Rate Sensitivity

Lower sensitivity to economic solvency ratios

We consider rising domestic interest rates to be generally positive for Japanese insurers' economic capital.  Major life insurers have reduced interest rate risk to prepare for new solvency regulation effective in fiscal 2025 (ending March 31, 2026). They have successfully lowered interest rate sensitivity, though some duration gap between yen denominated assets and liabilities continues to exist. Rising domestic interest rates could increase their economic capital because the duration of liabilities is relatively longer than the duration of assets.

We expect insurers to maintain high economic solvency ratios.  Insurers' calculations of the ratios could deteriorate slightly under the new solvency regulations despite the duration gap. This is because the new regulations assume lapse risk will rise with higher interest rates. However, even in this case we view the impact on their financial soundness as limited, given their low sensitivity to movements in interest rates. In addition, existing regulatory solvency margin ratios could decline as domestic interest rates increase. We don't anticipate insurers' ratios will decline to the minimum 200% threshold, given the gradual rise in interest rates in Japan and also assuming necessary management actions to maintain ratios above the minimum level.

Chart 3

Foreign Exchange Sensitivity

Solid risk controls despite higher hedging costs

Insurers have solid management of foreign exchange risks, in our view.  Japanese insurers reduced investments in overseas bonds that have foreign exchange hedges to mitigate hedging costs in 2022 and 2023. Major life insurers maintain a high level of foreign exchange hedging of about 80% of their remaining overseas bonds. Also, some Japanese insurance groups (both life and non-life) have overseas subsidiaries, creating some mismatch in currency flows on their balance sheets. However, they have maintained high hedging ratios to control foreign exchange risk. We do not expect insurers to increase foreign currency risk significantly. Major insurance groups with overseas subsidiaries have achieved low sensitivity to foreign exchange risk in their economic solvency ratios. Even if the yen appreciates 10%, their economic solvency ratios would drop only 1-4 percentage points.

Chart 4

Related Research

• Japanese Insurers Splash Cash As Performances Improve, June 28, 2024
• Japan Insurers: Scandals And Expansions In Focus, Feb. 8, 2024