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Capital Markets

Japan's life insurers curb enthusiasm on foreign bonds

Low yields, hedging costs, yen risks erode their investment appetite

TOKYO -- Japanese life insurers have turned hesitant toward plans to invest heavily in foreign bonds this fiscal year, as yields remain limited while the costs of covering currency exchange risks have grown.

Net foreign securities purchases by life insurers slowed to about 960 billion yen ($8.55 billion) in the April-June quarter, the Finance Ministry says, down nearly 70% from the year-ago period, shortly after the Bank of Japan introduced its negative-rate policy.

Uneven impact of Fed hikes

Quite a few Japanese life insurers remain open to foreign bond investment, but note a lack of momentum. "We are stuck," an official at a major life insurance company lamented, noting an increasingly motionless market.

One major factor is that U.S. long-term interest rates have not risen as expected. The yield on 10-year Treasury bonds has fallen to the 2.3% range since reaching about 2.6% in March. The prospect that the Federal Reserve will slow the pace of rate hikes has prevented a full-fledged increase in the benchmark Treasury yield, weakening the appeal in terms of expected investment returns.

Higher costs of hedging against foreign exchange losses are also at play. Life insurers invest over the long haul while minimizing risks because they serve customers under long-term contracts. So when buying foreign bonds, they usually opt to pay a premium for those with a currency hedge.

Though long-term interest rates have risen little after Fed hikes, the hedging costs have climbed in sync with those hikes this year, said Masahiro Ichikawa, a senior strategist at Sumitomo Mitsui Asset Management.

Life insurers are trying to lower the hedging cost. This year, Japan Post Insurance started lending U.S. Treasurys to Japanese banks so they can procure funds in dollars without hedging by using the bonds as collateral. "We are trying to lower the cost" by reducing the demand for hedging, said Ryosuke Fukushima of Japan Post Insurance. Nippon Life Insurance also is lending U.S. bonds for similar reasons.

Factoring in hedging costs, the yield on 10-year Treasurys comes to around 0.5% -- lower than the yield of 30-year Japanese government bonds. And hedging costs could increase further with continued rate hikes by the Fed.

Yen risk, low urgency

The stalled forex market also hinders foreign bond investment by life insurers. With the yen remaining softer than 110 per dollar, many insurers worry that the Japanese currency could strengthen suddenly and spur losses on their investment.

Insurers also face less pressure over targeted returns, thanks to a reduction in the benchmark yield set by the Financial Services Agency that serves as a basis for the insurers to promise a certain return to customers.

A decrease in new insurance contracts has reduced inflows of funds as well. "We have no hurry to invest," an official of a major life insurer said.

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