Japan Top Life Insurer Taps Derivatives to Fight Low Yields

(Bloomberg) -- In a world of falling bond yields and rising hedging costs, Japan’s leading life insurer is increasingly turning to derivatives in a bid to bolster returns.

Nippon Life Insurance Co. has expanded its use of currency swaps, dollar-yen options, equity and interest rate derivatives in particular since October to boost income and offset the impact of hedging costs, said Toshinori Kurisu, deputy general manager at the firm’s finance and investment planning department.

Japan Top Life Insurer Taps Derivatives to Fight Low Yields

“We are coming up with ideas on how to efficiently hedge risks and as a result enhance returns, not just take risk for the sake of returns,” said Kurisu in an interview last week. “We aim to ride out the low-yield environment with a globally diversified allocation and by using derivatives to enhance our risk-return efficiency.”

Japan’s life insurers are increasingly getting creative as global bond yields slide with slowing economic growth. Currency hedging expenses, a pivotal factor for some of the world’s biggest holders of debt, add to that predicament with the costs for dollar protection near the highest since 2008.

Among the Nippon Life strategies:
  • Currency swaps to convert some foreign cash flows to yen, to avoid the risk hedging costs wipe out income earned from international holdings
  • Sale of dollar-yen call options, using the premiums earned to offset the cost of purchasing puts -- the insurer expects the currency pair to trend lower
  • Purchase of equity and interest-rate derivatives, such as long-term interest rate swaps to fix yields and match longer liabilities
  • Cap or cut its overall currency-hedged allocations -- currently hedges about 60 percent of investments

The layered approach reflects Nippon Life’s exposure to overseas debt markets, which account for a fifth of its 65.5 trillion yen ($590 billion) in assets. Of those, almost half are in the U.S., with 40 percent in Europe, Kurisu said.

“We will keep expanding overseas credit investment by picking issues individually,” Kurisu said. The focus is on maturities of around 10 years, where there is spread of around 1 percent after hedging costs, he said.

Other Japanese life insurers have also gone off the beaten path to drive gains or protect capital. Dai-Ichi Life Insurance Co. said last month it’s turning to real estate, project financing, and private equity.

The plan to reduce currency hedging does bring risks. Mizuho Financial Group Inc. announced another round of losses on its foreign-bond holdings earlier this month. Fukoku Mutual Life Insurance Co. said in February it plans to ramp up hedging as it sees a yen surge as the number one danger.

Japan Top Life Insurer Taps Derivatives to Fight Low Yields

Nippon Life expects the dollar-yen to trade in a 10-yen range around the 110 level this year, with a bias to the downside, according to Kurisu.

The yield on the Bloomberg Barclays Global Aggregate Bond Index has fallen from 2.27 percent in November to 1.90 percent Tuesday, the lowest in almost a year. The cost to hedge dollar-yen currency risk for three months has risen 40 basis points to 2.88 percent from a year ago, according to data compiled by Bloomberg.

“We are taking any steps however small so that they culminate in a diversified portfolio,” Kurisu said.

©2019 Bloomberg L.P.