Japanese life insurers' credit quality under pressure: Moody's

Blame it on an ultralow interest rate environment.

Moody's Japan K.K. has changed the outlook for the life insurance industry in Japan to negative from stable.

The change in outlook reflects Moody's expectation that the industry's credit profile over the next 12-18 months will be pressured by a persistent ultralow interest rate environment, following the introduction of a negative interest rate policy (NIRP) by the Bank of Japan in February 2016.

"While Japanese insurers have a long history of adapting to low interest rates, current developments in yields, particularly at the super-long end of the curve, will lead to the broad downward revision of return assumptions for new investments. This development could in turn trigger significant adjustments in business and product strategies that could hurt the insurers' sales and strain their underwriting and sales capacity," explained Moody's.

Moody's says that key credit pressure will come from potential reactions in anticipation of future profit declines.

Moody's points out that while the adoption of NIRP is a significant policy step in itself, the sharp drop in market interest rates that the policy has triggered will have only a limited direct impact on the insurers' existing book of business over the next 12-18 months.

Instead, Moody's negative outlook is driven by the potential reactions from the industry, in anticipation of a prolonged period of ultralow domestic interest rates.

According to Moody's ultralow interest rates on Japanese government bonds (JGBs) will encourage insurers to expand their purchases of riskier, non-JGB assets and raise asset risk.

It adds that the fall in investment return assumptions will prompt insurers to either lower the guaranteed rates on their savings-type products, or suspend sales of such products, to avoid negative spreads.

Moody's also notes that low JGB yields will discourage insurers from investing in super-long-term JGBs to match their super-long-tenor liabilities, leading to delays in their efforts to address the duration gaps between assets and liabilities, or even widening it, which exposes them in turn to rising interest rate risk.

Moody's says that the headline profit impact will not be felt immediately, but economic metrics will provide hints of future deterioration.