Japan’s Sumitomo Life Insurance expects currency hedging costs for foreign bond investments to remain elevated based on the interest rate outlook, putting a drag on earnings in the next three years, CEO Yukinori Takada said.
Life insurers are among Japan’s biggest institutional investors. Hedging costs eat into the higher yields that Sumitomo Life and its peers sought in U.S. government and corporate debt.
“With U.S. and European central banks tightening monetary policy to curb inflation, the interest rate differential between Japan and the U.S. will remain wide for at least the rest of 2023,” Takada said in a recent interview.
The company has set a conservative earnings target for the three years starting this month, aiming for a group core profit of 730 billion yen ($5.4 billion) in total, down about 14% compared to the three years through fiscal 2022.
Takada says a decline in investment income is the main factor pushing down core profit. Hedging costs are determined by short-term interest rate differentials between currencies.
Even if the U.S. and European economies enter a recession and central banks cut interest rates, reducing hedging costs, there would be a lag of about a year before any earnings benefit emerges.
In 2025, Japan will introduce new capital standards that are meant to give a more accurate picture of insurers’ financial strength. One focus will be duration risk.
The wider the gap in duration between assets and liabilities, the more sensitive insurers’ balance sheets are to interest rate volatility.
In general, life insurers have assets whose maturities do not match the length of the insurance policies they sell. The industry-wide duration gap was 0.9 years as of the end of September 2022, Goldman Sachs Securities in Japan estimates. Sumitomo Life does not disclose its duration figures.
The company will take a cautious approach to boosting investment returns over the coming three years, according to Takada.
“If you aggressively pursue returns, your risk weighting becomes very high,” he said.
Digital technology is a core component of the company’s three-year plan. Sumitomo Life is earmarking about 160 billion yen — an increase of about 20% over the previous three-year plan — for digital investments, including in systems and sales tool updates.
Sumitomo Life also plans to strengthen services in non-insurance areas, such as using customer data obtained from its Vitality insurance plan, which reduces premiums if a customer’s health figures improve, to analyze ways to prevent severe illnesses.
While Takada said he doesn’t focus on the company’s overseas revenue ratio in decision-making, he said Sumitomo Life has its eye on the U.S. market, which it entered by acquiring insurance company Symetra in 2016, and Asia.
“It is important not only to earn investment returns, but to be able to show synergies in terms of operations and product development,” Takada said, regarding the outlook for investments and acquisitions.