Shaken and stirred

These are seismic times for Japan and not only geologically, although that is an ever-present threat, but politically.

After winning landslide election victory in August 2009 - ending almost 50 years of unbroken Liberal Democratic Party rule - Yukio Hatoyama's Democratic Party of Japan and his untested government now control the world's second biggest economy. Hatoyama has publicly pledged a major shake-up of both the Japanese economy and society that has strong implications for the financial sector including (re)insurance, such as the restructuring of the public medical insurance systems for the elderly.

The Financial Services Agency, a government body affiliated to the Ministry of Finance is also tightening solvency requirements for life and non-life insurers. The new solvency rules are seen by informed sources as affecting reinsurance demand to the benefit of the international reinsurers and broking partners.

Japan has always had and will continue to have strong support from the international market due to the exceptionally high level of catastrophe risk exposure which it faces.

Ed Fenton, managing director at Guy Carpenter characterises the Japanese primary market as inherently stable and says that catastrophe reinsurance demand among business buyers is also stable and it has not been adversely impacted by the recession in Japan.

"Japan is not immune from what is going on in the rest of the world, but essentially it is a mature market and just as there has not been a huge growth phase in the recent past neither have we been seeing a contraction in demand. The amount of cover provided by the international market to Japanese non-life companies on behalf of their core industrial/business clients has not substantially altered.

"In the latest April renewals, the level of catastrophe reinsurance cover to the Japanese market was stable. Reinsurance, which is done on a pro rata and excess of loss basis in Japan, in fact showed some small growth in April for both windstorm and earthquake.

"Capacity has however become fairly tight and a few issues became apparent in the renewals, notably the strength of the yen against all currencies: most severely affected were the sterling-based reinsurers in Lloyd's," explains Fenton.

At Lloyd's the capacity of syndicates is defined by its yearly business plan in pounds sterling, which suffered huge devaluation against the yen.

For pricing trends at the last renewals some markets saw decent rate increases, according to Reina Tanaka, associate director, Standard & Poor's Japan.

"Some reinsurance rate increase was observed in catastrophe lines of business - windstorm and earthquake, due to reinsurers' loss of capital from the global financial crisis and their restricted capacities partly due to the yen appreciation. But as most companies' reinsurance treaties results for all lines, including natural catastrophe perils in 2008 were good, the price increases were relatively modest," she says.

On the windstorm side, for the past four years there has been a push from Japan to buy more cover, driven by enhanced internal risk management and ERM considerations, though over-placement was virtually non-existent.

Claudia Buholzer, president of Munich Re Japan, says: "Japan is an economy that has suffered from recession, but when you look at demand for international reinsurance it has been growing consistently.

"Due to the slump in the equity market, Japanese insurers have experienced losses in their security holdings; valuation losses have been substantial and increased more than sevenfold per end of fiscal year 2008, which in turn affects solvency margin calculations, because of company assets going into the calculations. Solvency margins have declined for 22 out of the 26 most important Japanese non-life insurers and this had two main effects.

"The first being that the insurers bought, and will continue to buy more catastrophe reinsurance cover to increase their solvency.

"The second effect which we are going to see is that the Financial Services Agency has a plan to revise the asset factor in the solvency margin calculation. Due to this it can be expected that insurers' solvency margin decreases by circa 30% on average and as a consequence, we will see more demand for catastrophe protection in the future."

Japan is also increasingly recognising the importance of enterprise risk management and capital management. In that context the past year showed well that traditional reinsurance can serve as a capital substitute," explains Buholzer.

Further consolidation

The Japanese primary non-life market is going through a further stage of consolidation and once this process is completed much of the meaningful reinsurance transaction volume will be concentrated among four insurance group giants.

Tokio Marine Holdings is Japan's largest non-life insurer and in December 2008 it acquired US non-life insurance group Philadelphia Consolidated.

Domestically over the past year, Tokio Marine had a decline in its insurance premiums in most sectors, including its mainline automotive insurance business, as did all its competitors. The second-ranked player after Tokio is Mitsui Sumitomo Insurance, followed by Sompo Japan Insurance and in fourth place Aioi Insurance.

In January this year, Mitsui Sumitomo, Aioi and sixth-ranked Nissay Dowa agreed to merge in April 2010 to form the country's largest non-life insurer.

So does consolidation mean the prospect of less reinsurance demand as a total? Buholzer does not believe this is the case.

"For example, the Japanese insurers buy relatively less windstorm/typhoon catastrophe reinsurance than other international markets with similar levels of exposure.

"We are seeing trends that insurance companies adopt the Standard & Poor's requirement to cover up to 250-years' return periods."

Also, she says natural catastrophe risks are peak risks and will add up in the combined companies' balance sheets, that is the merged entities will need similar levels of protection in the future. As already outlined, solvency margins are the greater priority now and will positively affect demand from the reinsurance provider's point of view.

Standard & Poor's in a recent published report Weathering the Storm states in the context of the series of merger and consolidation announcements by Japanese insurers in the first quarter of 2009: "We believe that competition is likely to intensify amid declining growth in the Japanese non-life insurance market. This may also alter the reinsurance landscape, as the newly formed insurance groups will likely redesign their retention and reinsurance strategies, potentially resulting in fewer and larger reinsurance programmes being placed in the market."

Buholzer also highlights the new government's policies to change the government's financing and spending plans. This could include the local earthquake pool which reinsures household earthquake risks and it may affect the contribution of primary insurers to the earthquake fund. Such changes have the potential to affect solvency, which in turn may further drive a need for reinsurance from the international market.

Standard & Poor's Tanaka is looking ahead, stating that it is too soon to say with conviction what will take place. "We do not foresee any major changes in demands and supplies regarding catastrophe covers of Japanese non-life insurers for the coming renewal in 2010."

Tanaka concluded: "The market does not foresee any significant changes in demand and supply regarding catastrophe reinsurance; There were no significant insurance losses from natural catastrophe in Japan during the first half of fiscal 2009 neither were there major catastrophe insurance losses outside Japan. Reinsurers' balance sheets have been recovering, but this will be partly offset by the continuous yen appreciation. Non-life insurers' underwritten risk exposures regarding windstorm/earthquake seem to remain stable or slightly lessen by the economic downturn and price and terms are not likely to be softened at 2010 renewal."

Buholzer believes there are strong opportunities for growth in the technological and health arena. She stresses that Japan is a very sophisticated market and that non-life insurers are servicing Japanese corporations well.

However there are important gaps to be addressed and reinsurers like Munich Re can intervene, notably for business interruption as a result of an earthquake where there has not been any physical property damage but business disrupted. Here catastrophe bonds have proved particularly successful.

International expansion

Other areas with growth potential for international reinsurance include liability. Looking at the international environment the penetration rate for liability (re)insurance in Japan is still low, but it is changing with the internationalisation of Japanese manufacturers and increasing exposure to litigation in the US, China and other major production centres. The Japanese insurance strategy is for international expansion, meaning following its corporate clients globally and so they are seeking reinsurance support for product liability, product recall and other classes.

This trend is given impetus by Japan's shrinking population, which has limited growth prospects in the domestic market and so non-life insurers are trying to survive through overseas expansion.

"The revamping of the social welfare system to address the urgent needs of a rapidly ageing demographic in Japan have become a key area of policy by the new government and improvements in healthcare provisions for the elderly is key and potentially a real growth area for Munich Re, such as reinsurance cover for critical illness," explains Buholzer.

Primary insurers are also looking to provide cover for the so-called new industries/technologies, including the burgeoning renewals energy industry notably solar and wind power. This has real relevance as the new government announced plans to cut CO2 levels by a huge 25% and with Japan being one of the largest solar photovoltaic installation producers worldwide, alternative energy reinsurance offers enormous growth potential.

With all these changes taking place, it is unsurprising that the Japanese market is often criticised, even by supporters, as being 'stable, insular and slow to innovate'. However, maybe it is also living up to its huge potential to become more receptive to international (re)insurance than ever before.