Explanation of Sony Life's Loss and ALM

I will explain the situation regarding Sony Life Insurance incurring losses from the sale of domestic bonds. While I have previously explained the massive losses incurred by Norinchukin Bank, the case of Sony Life is not of such a massive scale, nor is it a story that will lead to a financial crisis.
However, it is very interesting in the sense that it highlights how the recent rise in domestic interest rates is affecting the management of financial institutions, and it serves as a reminder of the difficulty of managing assets and liabilities (ALM) for financial institutions.

The Current Situation of Sony Life

This matter has been covered by the Nikkei and other newspapers, but I would like to explain it from the perspective of an institutional investor who has long observed their asset management. First, I will explain the situation Sony Life is currently in.

Details of Sony Life's Sale Losses

In the April-June 2024 quarter, Sony Life sold domestic bonds that were carrying unrealized losses, resulting in capital losses of 51.3 billion yen, including losses from the sale of securities. On the other hand, the life insurance company's core profit (profit including interest and dividends) was 36.6 billion yen, resulting in a total deficit of 14.7 billion yen when combined with the capital losses.
As for the investment results of an insurance company, the accounting result is the sum of this core profit (income including interest and dividends) and the capital gains and losses arising from trading.Normally, they ensure this does not become negative, but for Sony Life, it did.This is the first time since 2007, when data became available.

Comparison with Other Insurance Companies

Other insurance companies adjust their capital gains and losses so they do not become negative by selling stocks, as they have large unrealized gains on stocks even if they incur losses from selling bonds.However, Sony Life could not do this because they held almost no stocks.
Sony Life's portfolio is about 11 trillion yen in total, of which 80% is domestic bonds, 20% is foreign bonds, and they held only 0.07% in stocks. In other words, because they held almost no stocks even if they wanted to sell them, they ended up selling domestic bonds that were carrying unrealized losses due to rising interest rates, which resulted in a loss..

Background of Sony Life's Domestic Bond Sales

So, why did Sony Life have to sell domestic bonds?It is because as interest rates rose, more people canceled their insurance policies, and as a result, they needed cash to handle the refunds..
When an insurance contract is signed, there is something called a planned interest rate, and insurance companies determine the insurance amount based on the premise that the premiums received will be invested at this planned interest rate. The higher the planned interest rate, the lower the insurance premium.
When interest rates rise, there are cases where one can switch to a contract with lower premiums for the same coverage, leading to an increase in cancellations. Since this is common across the industry, it is thought that the same thing is happening at other insurance companies.

Differences in Portfolios

However, in terms of portfolios, the so-called 'Big Four' life insurers and older Japanese insurance companies invest a large portion of their assets in stocks and real estate, so they have large unrealized gains on stocks, and even if cancellations increase, they do not end up with negative capital gains and losses because they can sell stocks to generate cash.
On the other hand, many 'Katakana' life insurers like Sony Life do not hold stocks in their portfolios, and those are the ones currently in a difficult situation.

Impact of Rising Domestic Interest Rates

It is clear that there are domestic financial institutions suffering negative impacts from the rise in domestic interest rates, especially among insurance companies that did not hold stocks and have been investing in domestic bonds, which are in a difficult situation. This was also covered in the Nikkei and other newspapers.
It might seem like those that invested in domestic bonds, like Sony Life, were wrong, but having watched this industry for a long time, my view is slightly different. It is true that Katakana life insurers like Sony Life are in a difficult situation right now, but it is the older Japanese insurance companies, including the Big Four, that have long been said to have a problem..

The Importance of ALM

The asset management portfolios of Katakana life insurers and the Big Four life insurers are completely different. Katakana life insurers like Sony Life are the ones that have been properly practicing so-called ALM (Asset Liability Management), while the Big Four life insurers are the ones that have been said not to have been doing it properly.
ALM is a concept of managing assets in line with liabilities (such as future insurance payouts). For example, if an insurance company is to pay out insurance money in yen 30 years from now, it invests in 30-year yen-denominated bonds. That way, they won't have trouble with future payments. That is the idea. If they were investing in foreign currency to pay out insurance money in yen 30 years later, that money might decrease due to a stronger yen. If they invest in stocks, the stock price might fall, and they might not be able to make future payments.ALM is the idea of trying to manage assets in line with future payments.

Problems with Older Japanese Insurance Companies

Many of the older Japanese insurance companies, including the Big Four, have been operating since before the war, and naturally, the concept of ALM did not exist back then.Since there was no bond market, insurance companies invested the premiums they collected in stocks and real estate.
However, situations occurred where US financial institutions that did not properly practice ALM went bankrupt, and the idea that it is better to practice ALM properly spread.Such ideas spread in the 1980s in the US, and in the 1990s in Japan, partly due to the collapse of the bubble economy.

Characteristics of Foreign-Affiliated Life Insurance Companies

Many foreign-affiliated life insurance companies are relatively new, and the concept of ALM existed from the time these companies were founded, so many have been practicing ALM thoroughly from the start. Regarding asset management at foreign-affiliated life insurance companies, insurance policies paid out in yen are managed with domestic bonds, while foreign currency insurance policies are managed strictly in foreign currency, and they have also been practicing ALM thoroughly.These insurance companies do not rely on asset management as their source of profit, but rather on cost reduction, and they do not take on much investment risk. For the past 30 years or so, they have been evaluated as companies that practice ALM thoroughly.

Issues at Sony Life

However, in reality, Sony Life is currently in a difficult situation, and it is an undeniable fact that they have been forced to sell domestic bonds, resulting in significant losses. So, what did Sony Life do wrong? You might think they were practicing ALM thoroughly, but I believe they likely misjudged the probability of existing insurance policies being surrendered when interest rates rise.
Japan has not experienced a period of rising interest rates for decades, and since there is no data, I believe this misjudgment occurred.

The Difficulty of Predicting Insurance Surrenders

Predicting the probability of insurance surrenders is extremely difficult. Insurance companies invest the premiums they receive for the future, but they must account for the possibility that some policies will be surrendered.
Therefore, it appears they needed to manage a portion of their assets with short-term bonds, but the amount was likely insufficient. This point will likely trigger a re-examination of how ALM is conducted.

The Importance of Portfolio Diversification

What I recognized once again through this issue is the importance of portfolio diversification. Instead of thoroughly practicing ALM and managing assets only with domestic bonds, holding foreign currency and stocks can sometimes mitigate partial losses like those seen this time.
Also, if a yen appreciation occurs where risk assets are sold off heavily, it is possible that older Japanese insurance companies, including the four major life insurers, could face management issues. While Sony Life had its problems, it is my understanding that older Japanese insurance companies, including the four major life insurers, are by no means excellent either.
Everyone should also diversify their portfolios a little.

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