japan’s insurance market - トーア再保険 ... · trends in japanese non-life insurance ......

The Toa Reinsurance Company, Limited

Japan’s Insurance Market

To Our ClientsHiroshi Fukushima

President and Chief Executive, The Toa Reinsurance Company, Limited 1

1. Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance GroupMakoto Hyodo

President and Chief Executive Officer, NIPPONKOA Insurance Co., Ltd. 2

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan’s

Non-Life Insurance Industry Hideya Kubo

Professor, Graduate School of Economics, Shiga University 8

3. The Insurance Market in 2009: Changing Channels and MarketsHideki Ishii

Insurance Journalist and Editor Inswatch 19

4. A Review of Today’s Japanese Non-Life Reinsurance MarketEdward Fenton

Managing Director, Asia Pacific, Guy Carpenter & Company, LLC 26

5. Trends in Japan’s Non-Life Insurance IndustryUnderwriting & Planning Department

The Toa Reinsurance Company, Limited 32

6. Trends in Japan’s Life Insurance IndustryLife Underwriting & Planning Department

The Toa Reinsurance Company, Limited 36

Supplemental Data : Results of Japanese listed non-life insurance companies

for fiscal 2008, ended March 31, 2009 (Non-Consolidated Basis) 44

Japan’s Insurance Market 2009

Contents Page

©2009 The Toa Reinsurance Company, Limited. All rights reserved. The contents may be reproduced only with the written permis-sion of The Toa Reinsurance Company, Limited.

1

Hiroshi FukushimaPresident and Chief Executive,The Toa Reinsurance Company, Limited

To Our Clients

It gives me great pleasure to have the opportunity to welcome you to our 2009 brochure, “Japan’s

Insurance Market 2009.” It is encouraging to know that over the years our brochures have been well

received even beyond our own industry’s boundaries as a source of useful, up-to-date information about

Japan’s insurance market, as well as contributing to a wider interest in and understanding of our domes-

tic market.

During fiscal 2008, the year ended March 31, 2009, the Japanese economy rapidly deteriorated as

the global financial crisis and turmoil in foreign exchange markets infected the real economy, as indicat-

ed by sharp declines in exports and production and the adverse impact on corporate earnings and the

labor market.

In the non-life insurance industry in Japan, sluggish automobile sales and declines in exports and

imports reflecting the economic downturn led to lower premium income from motor insurance and

marine insurance, resulting in an overall decline in premium income.

In the life insurance industry in Japan, both the numbers of new contracts and in-force contracts

declined from the previous year, affected by the economic downturn coupled with the aging society and

a low birth rate.

In the reinsurance market, many reinsurance companies experienced significant deterioration of

their business results and financial positions owing to turmoil in financial markets.

The operating environment of the Toa Re Group is expected to remain harsh in view of social and

economic changes around the world, structural changes in the insurance industry, and the trend of the

international regulatory environment for reinsurance.

In order to respond to these changes in the business environment in a timely and effective manner,

and to achieve sustainable growth of the Toa Re Group, we recognize that the provision of high added

value to our customers and the reinforcement of risk management and other internal control systems

throughout the Group are important issues. With the aim of promoting the development of the entire

Group and enhancing our corporate value, we have formulated a new medium-term management plan,

“Crescendo 2011”, covering the three-year period from fiscal 2009 to 2011 and founded on three core

elements, namely Customer/Income, Management and Corporate Social Responsibility (CSR).

By endeavoring to act as an exemplary reinsurance company, we are resolved to fulfill our mission:

“Providing Peace of Mind.”

In conclusion, I hope that our brochure will provide a greater insight into the Japanese insurance

market and I would like to express my gratitude to all who kindly contributed so much time and effort

towards its making.

2

The past two to three years have been a time of great change for Japanese

non-life insurance industry, for several reasons.

First, the first revision of the Insurance Law in nearly 100 years was promul-

gated in 2008. Currently, the non-life insurance industry is conducting various

preparations for the enforcement of the law.

Second, the economic environment surrounding the non-life insurance

industry is changing rapidly. Similar to the global economy, Japanese economy is

experiencing the kind of “once-in-a century” financial crisis. Since autumn 2008,

stock prices have remained at low levels, numerous manufacturers have been

forced to reduce production, and consumer sentiment for consumption has been

poor. Premium income has continued to trend downward at non-life insurance

companies, and they have been required to strengthen their financial foundation

based on appropriate risk management.

Japanese non-life insurance industry experienced several major problems

involving the very foundation of the insurance business, including incidental

unpaid insurance claims, inappropriate non-payment of third-sector products, and

incorrect setting of premiums for fire insurance and other products. Over the past

several years, the non-life insurance industry investigated the detailed causes of

these problems and then revised business processes from the ground up and for-

mulated countermeasures to make sure that they would not recur. Today, compa-

nies are working to raise the quality of their operations by implementing measures

to preclude recurrence.

I would like to cover trends in Japanese non-life insurance industry as it faces

these major changes, and then explain the business strategy of NIPPONKOA

Insurance Group.

(1) Revision of the Insurance Law

The first revision of the Insurance Law in nearly 100 years was promulgated

in June 2008. The main objectives of the revision are to adapt the rules of insur-

ance contracts to the needs of modern society, and to revise the content of the law

from the perspective of protecting policyholders. Currently, non-life insurance

companies are executing initiatives such as revising insurance products to conform

to the new Insurance Law, restructuring the system in terms of the insurance

claims payment, and revising forms for canvassing and claims payment as they pre-

pare for the enforcement of the new law.

1. Makoto Hyodo President and Chief Executive Officer, NIPPONKOA Insurance Co., Ltd.

Trends in Japanese Non-Life InsuranceIndustry and Business Strategy of NIPPONKOA Insurance Group

1. Trends in JapaneseNon-Life InsuranceIndustry

Introduction

3

The Toa Reinsurance Company, Limited — Japan’s Insurance Market 2009

(2) Overview of Results in the Non-Life Insurance Industry

The scale of premium income in Japanese non-life insurance market ranks

fourth following the United States, Germany and the United Kingdom. However,

difficult economic conditions have caused the reduction of premium income for

the past two years. According to aggregate performance data for its 26 member

companies prepared by The General Insurance Association of Japan (GIAJ), for

the nine months ended December 31, 2008, net premium income decreased by

3.5 percent, or ¥198.6 billion, compared with the same period of a year earlier to

¥5,435.9 billion due to factors including reduced premium rates for Compulsory

Automobile Liability Insurance and lower motor insurance premium income.

Moreover, net claims paid increased by 1.1 percent, or ¥37.0 billion, compared

with the same period of a year earlier to ¥3,258.9 billion due to an increase in

claims paid on personal accident insurance and casualty insurance.

The situations appear likely to remain difficult. The decrease in motor insur-

ance, a mainstay product, is due to the decline in the number of vehicles sold.

Moreover, fire insurance has failed to increase because of the decline in the num-

ber of housing starts.

As you are aware, the result of non-life insurance industry correlate closely

with the real economy. At its meeting in London in April 2009, the Group of 20

(G-20) announced economic stimulus packages totaling $5 trillion by the end of

2010 with the goal of a 4 percent economic growth rate. The Japanese govern-

ment as well has devised and implemented various measures to counter the eco-

nomic crisis. These policies are certainly expected to generate growth trajectories

for the global economy and the Japanese economy.

However, we, the non-life insurance industry, are not just passively looking

at economic trends. Non-life insurance is able to deal with a variety of risks. Non-

life insurance companies can provide brand-new products to respond to the new

risks that are arising because of various changes in consumer lifestyles and the

activities of corporations. Actually, there is an expanding range of products, such

as corporate liability insurance. Moreover, the rising age of society is also expected

to broaden the scope for insurance products.

(3) Initiatives to Enhance the Quality of Operations

I became the chairman of GIAJ on June 30, 2008. The occurrence of prob-

lems in the non-life insurance industry created opportunities for GIAJ to formu-

late various measures to enhance the quality of operations. GIAJ is now in the

process of promoting efforts to improve their practicality. Moreover, GIAJ is

employing a plan-do-check-act cycle centered on the perspective of consumers’

voices to formulate and enforce the improvements of measures if needed to further

improve the quality of operations. An overview of specific initiatives are as follows.

4

■ Holding an “Advisory Panel to Listen to Consumers’ Voices”

The “Advisory Panel to Listen to Consumers’ Voices” was established to sincerely

listen to consumer opinions so that the industry as a whole can reflect them in

operations management. More than half of the panel’s members are influential

people from outside the industry, and their opinions will lead to measures to

improve the quality of operations in various ways.

■ Establishment of Various Guidelines

GIAJ has established various guidelines such as canvassing, claims payment, insur-

ance policy provisions and sales literature. Member companies are working to

improve the quality of operations based on these guidelines.

■ Enhancing the Quality of Non-Life Insurance Agents and Solicitors

Non-life insurance solicitors are the primary point of direct contact with con-

sumers. GIAJ has introduced the qualification renewal system for non-life insur-

ance solicitors and an insurance product learning system in working to enhance

the quality of non-life insurance solicitors.

■ Strengthening Consultation and Complaint Resolution Systems

GIAJ is strengthening consultation and complaint resolution systems to properly

acknowledge the opinions of customers and use them in operational reforms. At

present, Japanese financial industry is setting up a new framework for alternative

dispute resolution (ADR), and GIAJ is also promoting required standards based

on these movements.

(4) Trends among Specific Companies in the Non-LifeInsurance Industry

NIPPONKOA Insurance Co., Ltd. and SOMPO JAPAN INSURANCE

INC. have reached an agreement to establish a joint holding company for business

integration in April 2010. In addition, the three companies of Mitsui Sumitomo

Insurance Co., Ltd., Aioi Insurance Co., Ltd. and Nissay Dowa General Insurance

Co., Ltd. have announced an agreement to commence discussions toward a busi-

ness combination and business alliance under a holding company structure in

April 2010.

Japanese non-life insurance industry experienced a period of consolidation

from 2001 to 2004. These two business integrations are a much more significant

development than that.

1. Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance Group


5

(1) Results of NIPPONKOA Insurance

For the nine months ended December 31, 2008, at NIPPONKOA Insurance

net premium income decreased by 4.6 percent, or ¥24.3 billion, compared with

the same period of a year earlier to ¥506.3 billion, due to factors including

reduced premium rates for Compulsory Automobile Liability Insurance. This

ranked fifth in Japanese non-life insurance industry. Net claims paid decreased by

3.3 percent, or ¥10.3 billion, to ¥303.9 billion.

For the nine months ended December 31, 2008, the seven listed companies

among GIAJ members recognized revaluation loss on securities totaling approxi-

mately ¥500 billion due to factors including the substantial decrease in the value

of their securities portfolios, and net loss for the seven companies totaled ¥19.5

billion. Among the seven companies, NIPPONKOA Insurance’s revaluation loss

was relatively low, and we recorded net income of ¥19.8 billion.

(2) Medium-Term Management Plan of NIPPONKOAInsurance Group

NIPPONKOA Insurance has formulated a medium-term management plan

for fiscal 2009 throughout 2010. NIPPONKOA Insurance Group is acutely aware

of the public responsibility of the insurance industry and aims to contribute to

society under the premise of substantial management. The medium-term manage-

ment plan, as explained below, basically entails executing the three main strategies

of “contributing to society”, “raising quality” and “increasing earnings” in working

to increase corporate value.

Contributing to Society

We will conduct all of our corporate activities to respond to social issues such as

environmental protection. In addition, we will also contribute broadly to society

by working to respond to social demands. Our main activities are as follows.

■ Carbon Neutral Declaration

We will achieve zero emissions of CO2 by reducing CO2 emissions by 15 percent

or more compared to the level of fiscal 2006 by fiscal 2012, and by purchasing car-

bon credits to offset the portion of emissions that are difficult to reduce.

■ Eco First Commitment

NIPPONKOA Insurance is the first company in the insurance industry to be cer-

tified as an “Eco-First Company” under the “Eco-First System” established by the

Ministry of the Environment of Japan. We have made the “Eco-First

Commitment” to the Minister of the Environment to undertake initiatives includ-

2. Business Strategy ofNIPPONKOAInsurance Group

6

ing the reduction of CO2 emissions.

NIPPONKOA Insurance is using the character “ECORaTTa” to represent these

environmental activities, and widely publicizes NIPPONKOA’s initiatives.

Raising Quality

As detailed below, we are raising quality throughout our operations, from product

development to sales and claims payment, to provide customers with safety and

security.

■ The Highest Quality of Claims Handling

We have implemented a system for rapid response to accidents 24 hours a day,

365 days a year. In addition, we aim to provide the highest level of service in ways

such as promoting the use of environmentally sound parts when repairing vehicles

that have been in an accident.

■ Raising Sales Quality

We aim to improve the quality of individual solicitors by conducting efficient and

effective education and training.

■ Raising Product and Administrative Quality

We are developing simple, easily understood products in ways such as consolidat-

ing products or endorsements, and using plain and clear language for policy condi-

tions. Moreover, we are upgrading our information technology base to simplify

and standardize the contract procedures and improve administrative quality.

Increasing Earnings

We will increase corporate value by balancing allocation of Group profit generated

through the measures to increase earnings between providing returns to all our

stakeholders and investing in growth areas. Main initiatives are as follows.

■ Measures to Strengthen Underwriting and Loss Prevention

We are strengthening underwriting and moving to prevent or alleviate losses.

■ Improving the Profitability of Business Units

We will work to improve profitability by grouping existing businesses in units

defined by products or sales channels and employing unique management indica-

tors to thoroughly analyze, formulate and execute concrete plans for improving

profitability.

■ Raising Operating Efficiency

We aim to reduce operating risk and achieve low-cost operations by raising operat-

ing efficiency.

1. Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance Group

“ECORaTTa”


7

(3) Business Integration of NIPPONKOA Insurance andSOMPO JAPAN INSURANCE

NIPPONKOA Insurance and SOMPO JAPAN INSURANCE have agreed

to establish a joint holding company for business integration in April 2010 for a

“new solution service group with the aim to provide customers with security and

service of the highest quality and contributes to social welfare.”

The new group aims to make all value judgements from the perspective of

customers and aims for enhancement of corporate value and contribution to social

welfare, by maximizing synergy effects by way of such measures as standardization

and sharing of functions and services.

Within the joint holding company, NIPPONKOA Insurance and SOMPO

JAPAN INSURANCE will diligently use the strengths of the existing brands and

sales channels of each company. At the same time, they will work to achieve

economies of scale by sharing IT systems and other resources to reduce the burden

of cost centers with the aim of enhancing competitiveness.

In Japanese non-life insurance industry, deregulation from 1996 liberalized

premiums on insurance products in the retail field, which had been uniform

throughout the industry up to that time. This engendered competition in the areas

of product development and premiums. Moreover, successive business integrations

and mergers took place with the primary aim of increasing scale.

Subsequently, as discussed earlier some major problems arose, however, over

the past two to three years the insurance industry has dealt with them. Moreover,

non-life insurance companies have restructured the way they do business from the

ground up, from headquarters to front-line sales and claims branches. As a result,

our industry has entered a new phase in which companies compete on the basis of

the quality of operations.

Non-life insurance companies have changed their corporate cultures so that

they are better able to listen sincerely to customer opinions than they were in the

past. This has created the chance to discuss the risks surrounding customer thor-

oughly as well as to find links to new business opportunities. In other words, non-

life insurance is fulfilling its responsibility to provide customers with security,

which is enabling the industry to develop further.

Conclusion

8

2.Hideya Kubo Professor, Graduate School of Economics, Shiga University

Analysis of Long-Term Efficiency Gains andEvaluation of Large-Scale Consolidation inJapan’s Non-Life Insurance Industry

Japan’s non-life insurance industry generated stable, consistent growth without

price competition under the rating system of Property and Casualty Insurance

Rating Organization of Japan, which was established in 1948.

Even during the deflation of Japan’s bubble economy during the 1990s, in con-

trast to the negative spread of Japan’s life insurance industry, where actual invest-

ment returns were below projected investment returns, the non-life insurance indus-

try was only marginally affected by the issues of nonperforming loans, since its prod-

ucts, such as motor, fire and other types of insurance (excluding saving-type insur-

ance), are of shorter duration, and the scale of its assets was only about one-fifth that

of the life insurance industry.

In addition, major revisions to the Insurance Business Law to 1) ensure the

soundness of insurance companies; 2) promote the deregulation of insurance; and 3)

ensure fair business operations, took effect in April 1996. Along with the revised Law

Concerning Non-Life Insurance Rating Organizations (the “Rating Organization

Law”), these revisions served to promote deregulation, but the scope of liberalization

of insurance rates was small at first.

However, conditions dramatically changed as a result of the Japanese version of

“Big Bang” that the cabinet of Prime Minister Ryutaro Hashimoto began promoting

in November 1996. The U.S.-Japan Insurance Talks, which had previously made lit-

tle headway, reached their policy conclusions, and consequently the Rating

Organization’s compulsory rates based on the Rating Organization Law were abolished.

Property and Casualty Insurance Rating Organization of Japan issued regulated

rates based on the Law Concerning Non-Life Insurance Rating Organizations of

1948, and it initially provided suggested rates based on its statistical data. However,

a 1951 revision to the Rating Organization Law ended suggested rates in favor of

compulsory rates, and these regulated rates remained in effect for the next 45 years.

As a result of the U.S.-Japan Insurance Agreement in December 1996, the compul-

sory Rating Organization rates were abolished (Note 1) and regulations were main-

tained in the third sector. The Financial Reform Law of June 1998 and the revision

of the Rating Organization Law of July 1998 also liberalized insurance rates.

The liberalization of interest rates, which symbolized financial liberalization in

Japan, began in the 1970s. It took approximately 20 years until the 1994 liberaliza-

tion of interest rates on liquid deposits. In contrast, non-life insurance rates for all

main fire, personal accident and motor insurance products were liberalized over a

period of three years from 1995, when the revision of the Rating Organization Law

rendered the banded rate reporting unnecessary, and advisory rates were introduced

for fire insurance for industrial risks.

The Rating Organization reportedly set the expected loss ratio (net premium

component) lower, and set the additional rate component (premium accretion com-

ponent) higher. Reductions in this larger accretion rate component have accelerated

as a result of liberalization.

In general, price liberalization and other aspects of deregulation draw an

increased number of new market participants offering new products and services,

1. Market Changes Dueto CompleteLiberalization ofInsurance Rates


9

with a concomitant decrease in the market share of companies already in the market.

Beginning in 1996, non-life insurance subsidiaries of life insurance companies and

companies from other industries successively entered the market, which increased the

number of non-life insurance companies doing business in Japan from 23 in 1993 to

a peak of 34 in 2000. However, many of the new participants were unable to keep

up with the high pace of rate liberalization, and became engulfed in a trend toward

consolidation, mainly with existing non-life insurance companies.

The non-life insurance market was strongly affected by the liberalization of the

price of main products over a short period. Graph 1 shows long-term changes in

Japan’s non-life insurance market over the past 30 years or so. This time frame is

broadly divided into three periods. The first period includes the era of stable growth

under regulation and the growth of the bubble in the 1980s. The second period

includes the protracted period of low growth in the 1990s as the bubble deflated.

The third period includes the period of deregulation beginning in 1999 when premi-

ums were completely liberalized.

First, let’s consider market change from the perspective of market consolidation

as measured by the Herfindahl Index (HI). Here, the HI is calculated using direct

premium income, which constitutes revenues for typical companies, and core earn-

ings. Core earnings are calculated by subtracting one-time gains and losses from asset

sales; valuation gains and losses; and foreign exchange gains and losses from ordinary

income as reported on the income statement, and reflecting provisions to and rever-

sals of the catastrophe loss reserve. In other words, this calculation expresses the pri-

mary income for a non-life insurance company.

Prior to rate liberalization in fiscal 1998, both versions of the HI are uneventful

and show little variation. They clearly show a market structure with little change in

share, which is typical of a regulated industry. The HI using direct premium income

(the graph with the solid line) stays at about 0.09. At the peak of the bubble, when

10

market concentration was generally considered to be low, the HI does not change

(direct premium income increased 8 percent annually in 1989 and 1990).

Incidentally, with the advent of the second period, the HI using direct premium

income does not change, but the HI using core earnings (the graph with the dashed

line) gradually rises. The profitability differential between companies widens, and

the bar graph shows that among non-life insurance companies core earnings per unit

of business expenses including personnel, non-personnel, and operating expenses

decreased by half from about ¥0.2 to nearly ¥0.1. The non-life insurance industry

took no drastic action to address decreasing profitability up to the complete liberal-

ization of rates in 1998.

The HI begins to change substantially in the third period. Admittedly, there

were numerous extraordinary factors including 1) the occurrence of E. coli O157 food

poisoning in 2001 that resulted in provisions to the reserve for outstanding losses

(ordinary profit for the industry as a whole decreased ¥128.9 billion); 2) a 7.0 percent

increase in direct premium income (transitional revenue) as a result of the abolish-

ment of government reinsurance of Compulsory Automobile Liability Insurance in

fiscal 2002; and 3) the impact of a string of typhoons in fiscal 2004 (claims paid

increased 16.1 percent compared with the previous fiscal year because of Typhoons

16 (Chaba), 18 (Songda) and 23 (Tokage)). Nevertheless, their influence on industry

concentration could be considered neutral. The HI rose mainly because of the follow-

ing two points. First, a flight to quality was evident among consumers in their swift

reaction to the order to suspend operations given to The Daiichi Mutual Fire and

Marine Insurance Company in May 2000 and the petition for corporate rehabilita-

tion filed by The Taisei Fire and Marine Insurance Company, Limited in November

2001. Subsequently, competition intensified as a result of rate liberalization and large-

scale consolidation took place among existing insurance companies.

Features unique to the non-life insurance industry also influenced the progress

of large-scale consolidation. In general, deregulation attracts new entrants to a mar-

ket, and the HI falls. However, the non-life insurance industry requires a large initial

investment and the period until new entrants become profitable is long, which serves

to limit market entry. Moreover, the non-life insurance industry provides similar

products, and so the liberalization of premiums on main products put pressure on

companies with weaker sales capabilities to reduce fixed expenses more substantially

than the industries in general. Added to the longstanding horizontal structure of the

industry, these factors led numerous companies toward consolidation.

Domestic non-life insurance companies shortly aggregated into six groups. The

HI using premium income from direct underwriting rose to the 0.15 level in fiscal

2004 from the 0.09 level in fiscal 1998. While factors such as the widely varying out-

comes of industry consolidation, market concentration as evidenced by revenues

accelerated, resulted in pronounced variation along a rising trend line in the HI

using core earnings.

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan’s Non-Life Insurance Industry

11

(1) Frontier Production Functions as an Indicator of InsuranceCompany Efficiency

The large-scale reorganization of Japan’s non-life insurance industry has greatly

influenced the efficiency of each company in the industry. Careful consideration is

required to determine if conventional financial indicators such as the growth rate of

ordinary profit and the ratio of operating income to revenue are viable for measuring

the efficiency of non-life insurance companies. For example, the disposal of real estate

used for operations and the integration of computer systems during an analogous

period of large-scale industry reorganization would increase earnings by reducing

depreciation expenses but would have little impact on cash flow. In addition, in many

cases a corporation that consolidates factories and sells real estate it owns as a result of

mergers and acquisitions generally increases return on assets (ROA) and return on

equity (ROE; ROA multiplied by leverage). However, a majority of the assets of non-

life insurance companies are managed in underwriting reserves as financial resources

for the payment of future claims. The types of insurance products sold determine how

a company will fund these reserves, and the level of underwriting risk varies among

insurance companies. Consequently, ROA lacks validity as an evaluation tool. Low

ROE due to low leverage does not necessarily equate to inefficiency because sound-

ness of an insurance company is more important than for corporations in general.

Insurance company efficiency therefore requires a different approach to meas-

urement. In general, corporations are independent economic entities that produce

using resources such as capital, technology, human resources and raw materials.

Output is determined by the type and volume of inputs and the firm’s efficiency.

The production function is a simplified relationship between outputs and inputs,

and is suitable for measuring the efficiency of non-life insurance companies. The fol-

lowing expresses the production function:

Output = f (input a [e.g., capital], input b [e.g., labor], input c [e.g., overhead]. . . )

However, many of the firms in the current competitive market are inefficient.

Therefore, setting the production function of the most efficient firms as F yields the

following production function for all other firms:

Output = F (input a, input b, input c….) + Inefficiency

Moreover, the function should include a margin of error to reflect the use of

estimates. Therefore, the function becomes the following:

Output = F (input a, input b, input c….) + Inefficiency + Margin of error

Various assumptions are available for function F. However, the Cobb-Douglas

production function with its highly stable parameters is used here because it is sim-

plest. Moreover, the inefficiency component assumes a half-normal distribution, and

the margin of error assumes a normal distribution. The parameters expressing ineffi-

ciency are then estimated using the maximum-likelihood method. This methodology

for estimating efficiency is known as a stochastic frontier production function (Note

2). The algorithm for this function is detailed in “The Restructuring Strategies of

Japanese Life and Non-Life Insurance Groups” (2008)(Note 3).

2. Analysis of EfficiencyUsing Stochastic Frontier ProductionFunctions


12

For productivity derived from the frontier production function, the efficiency

of the subject firm is measured by the degree to which it deviates from the line calcu-

lated for the most efficient production of goods given capital and labor inputs.

Consequently, the higher the number, the higher the productivity.

With goods produced as a dependent variable for the production function, the

estimates here have five components: 1) direct premium income as a proxy for the total

turnover of a typical corporation; 2) ordinary income as reported on the income state-

ment; 3) core earnings that exclude extraordinary gains and losses related to capital from

ordinary income and reflect the increase or decrease in the catastrophe loss reserve; 4)

core earnings including depreciation (cash flow); and 5) the sum of core earnings and

business expenses to represent added value under the concept of gross profit.

On the other hand, the independent variable for the production function

involves inputs of capital stock and labor, which are defined as follows. Capital stock

is net depreciation expense as reported by each company in the statement of depreci-

ation and amortization in its financial statements for the most recently ended fiscal

year. For those insurance companies that do not report net depreciation expense in a

statement of depreciation and amortization, capital stock is calculated by discounting

reported depreciation expense by the average depreciation rate for the industry.

Labor inputs consist of 1) total expenses for both sales and internal administra-

tive personnel; and 2) related business expenses other than personnel expenses. Sales

personnel expense is the total of agency commissions and brokerage and customer

acquisition costs (fees associated with direct sales). Internal administrative personnel

expense is personnel expense as detailed in the income statement. The analysis covers

direct insurance companies operating in Japan. Reinsurance companies and foreign

non-life insurance companies with branches in Tokyo are excluded. The sources for

the data are Insurance: The Statistics of Japanese Non-Life Insurance Business and the

financial reporting issued by each company.

For fiscal 2007, capital stock accounted for 20.4 percent of total input and per-

sonnel expenses (the total of sales and internal administrative personnel expenses as

per 1) above) accounted for 79.6 percent. In further details, sales personnel expenses

accounted for 48.1 percent, and internal administrative personnel expenses account-

ed for 31.4 percent. With the inclusion in labor input of related business expenses

other than personnel expenses as per 2) above, capital stock accounted for 15.7 per-

cent of total input and labor accounted for 84.3 percent, of which sales personnel

expenses accounted for 37.0 percent. In all cases, sales channel expenses represent 40

to 50 percent of input cost, and the operation of the exclusive agency channel stands

out as a major component of the cost structure.

Moreover, the 48.1 percent share of sales personnel expenses in total input for

fiscal 2007 mentioned above has increased by 10 percentage points from 37.8 per-

cent in 1991, for two reasons. One, assuming commission-based compensation,

commission payments to agencies should decrease if sales decrease, but in reality

commissions are structured so that they do not fall in direct proportion to a decrease

in performance. In fiscal 1991, premium income totaled ¥6.5 per ¥1.0 of sales per-

sonnel expense, but in fiscal 2007 had fallen to ¥5.9. Two, capital has decreased as a


13

result of consolidation. The ratio of capital stock to total input was 32.9 percent in

fiscal 1998 prior to the liberalization of premiums, but had decreased by 12.4 per-

centage points to 20.5 percent in fiscal 2007. This reflected the rapid pace of reduc-

tion in assets such as owned real estate as a result of large-scale consolidation. In

other words, the strategy of non-life insurance companies was to compensate for

reduced labor productivity by increasing capital productivity. Incidentally, capital

accounts for about 40 percent of total input in the life insurance industry, which

would indicate that Japan’s non-life insurance industry is more labor intensive than

the life insurance industry.

Panel data including cross-sections of annual insurance company data bundled

with a time series is used to ensure the stability of the function when using estimates.

The estimate period is the 17 years from fiscal 1991 through fiscal 2007. As a result,

each estimate can be based on up to 458 samples. One sample requires extraction

and synthesis of 55 data points from the financial statements of each company.

Table 1 presents the result of estimates for each production function. The

t-value of the good produced, which is the dependent variable in the estimate equa-

tions, is high (in any case, significant at the 1 percent level). The capital and labor

parameters are also valid numbers.

Note 1: LI = log likelihoodNote 2: *Capital cost (capital replacement cost: depreciation rate + interest rate) may be used in place of

capital stock, and labor input reflects other business expenses.


Direct premium income Ordinary profit Core earnings

Constant

Capital

Labor

δλSample, LI 458, -285.761 345, -469.782 296, -415.221

Parameter

1.67773

0.049508

0.948072

1.42576

2.43729

t-value

8.61257

3.17037

36.4578

60.0708

10.8283

Standarderror

0.1948

0.015616

0.026005

0.023735

0.225085

Parameter

1.07845

0.22987

0.596678

0.726756

1.99969

t-value

3.16649

6.81552

12.6326

20.8775

5.39026

Standarderror

0.340582

0.033727

0.047233

0.034811

0.370982

Parameter

1.6476

0.17028

0.6398

0.67828

2.24504

t-value

5.12467

4.24654

12.4542

20.4606

5.89373

Standarderror

0.321504

0.040099

0.051372

0.033151

0.380921

Goodproduced

Cash flow* Added value

Constant

Capital

Labor

δλSample, LI 317, -407.208 457, -223.875

Parameter

0.705518

0.13705

0.750281

0.714266

3.0099

t-value

1.67966

3.60953

13.24883

22.9593

5.58688

Standarderror

0.420035

0.037969

0.05663

0.03111

0.538745

Parameter

1.36458

0.061163

0.885886

1.81523

1.67761

t-value

10.0196

4.97387

53.6817

36.1526

10.5325

Standarderror

0.136192

0.012297

0.016503

0.05021

0.15928

Goodproduced

Table 1: Parameters for Frontier Production Functions for Japanese Non-Life Insurance Companies, FY1991 to FY2007

14

Let’s consider the impact that deregulation had on the efficiency of the non-life

insurance industry as indicated by the application of this production function.

Graph 2 represents data for which this function is applied to calculate cash flow from

fiscal 1991 to fiscal 2007 (core earnings + depreciation), ordinary profit and direct

premium income to elucidate efficiency for the industry as a whole. Efficiency prior

to liberalization (fiscal 1991-fiscal 1998) is significantly different from efficiency

after liberalization (fiscal 1999-fiscal 2007).

In the economic and financial environment of the 1990s, Japan’s industry was

subject to challenging deflationary pressure due to factors such as the anemic 0.9

percent average annual increase in the corporate price index. Efficiency as measured

by premium income from direct underwriting premium income among non-life

insurance companies (line graph) decreased continuously from 0.63 to 0.615. On

the other hand, two efficiency indicators related to profitability held steady at

approximately 0.7. Corporate initiatives supported this efficiency, and regulated pre-

miums also supported the profitability of each company.

In contrast, however, the soundness of an insurance company is more impor-

tant than for corporations in general, and changed significantly following deregula-

tion in fiscal 1999. Moreover, this period is characterized by the divergence of cash

flow efficiency and ordinary profit efficiency. Ordinary profit stands for the profit

after employing one-time asset sales and other means to compensate for factors such

as large fluctuations in operating income and loss and losses associated with asset

management. As a result, insurance companies with sufficient strength were able to

restrain fluctuations in ordinary profit. For example, actual cash flow and ordinary

profit in fiscal 2004 differed by approximately ¥350 billion, mainly because of com-

pensatory moves using the following two financial resources. The first was reversals


3. Changes in theOperating Efficiencyof the Non-LifeInsurance Industry

15

of the catastrophe loss reserve that had been set aside for major disasters. For fiscal

2004, companies that conducted reversals brought the industry total to approximately

¥154 billion, as estimated from changes in the balance of catastrophe loss reserves.

The second financial resource was sales of investment securities. Compared with fis-

cal 2005, the loss on sales of securities and loss on revaluation of securities for fiscal

2004 was about ¥14 billion greater, but the gain on sales of investment securities was

about ¥120 billion greater. This positive difference of approximately ¥100 billion

was the factor that stabilized ordinary profit.

From fiscal 1999, fluctuations in ordinary income efficiency show that insur-

ance companies were only drawing down reserves created through financial state-

ment manipulation as the revenue environment became increasingly challenging.

The full-scale consolidation that began in fiscal 2001 to respond to these condi-

tions made a substantial contribution to the increase in the efficiency of direct pre-

mium income (line graph). Consequently, evidenced by the black bar graph, cash

flow efficiency recovered even though price competition had caused it to fall. Here,

efforts to reduce costs among companies that had both merged and reduced cost of

capital contributed substantially.

However, the result was that cash flow efficiency peaked in fiscal 2005.

The next topic is the cash flow efficiency of individual companies. Graph 3

shows all individual insurance companies with positive cash flow (317 samples) from

fiscal 1991 to fiscal 2007. Cash flow efficiency is on the vertical axis, and all corre-

sponding log figures are plotted on the horizontal axis using the same scale. In general,

cash flow efficiency increases as the level of cash flow increases. The distribution curve


4. Efficiency ofIndividual InsuranceCompanies and theEffect ofConsolidation

16

(line graph) is expressed as Log (cash flow efficiency) = 0.2592 x Log (same scale) -

1.41. The value of elasticity for the same efficiency on the same scale is 0.2592.

Therefore, the “scaled earnings” for the non-life insurance industry can be observed.

Furthermore, as the dashed lines in the graph show, the scale of the distribution

allows the data to be divided between medium-sized companies (dashed line 1) and

large companies (dashed line 2). The slope of line 1 is steep, and therefore shows that

improvement in earnings efficiency is closely linked to expansion in scale in the

group of medium-sized insurance companies. Thus it shows that consolidation is a

better means of improving earnings efficiency for medium-sized companies than for

large companies.

The next topic is further detailed measurement of changes in efficiency as a

result of this consolidation. The analysis focuses on the six companies that emerged

from 15 companies that were involved in large-scale consolidation. Consolidations

were conducted by Tokio Marine & Nichido Fire Insurance Co., Ltd. (a merger

between Tokio Marine and Nichido) in October 2004; Mitsui Sumitomo Insurance

Co., Ltd. (a merger of Mitsui Marine & Fire Insurance Co., Ltd., The Sumitomo

Marine & Fire Insurance Co., Ltd. and Mitsui Life Insurance Co., Ltd., with the

transfer to the new company of the entire non-life policy portfolio of Mitsui Life in

November 2003) in October 2001; Sompo Japan Insurance Inc. (a merger between

Yasuda Fire & Marine Insurance Company and Nissan Fire & Marine Insurance,

with Taisei Fire and Marine Insurance Co., Ltd. merging with Sompo Japan in

December 2002) in July 2002. The analysis also covers the medium-sized non-life

insurance company NIPPONKOA Insurance Co., Ltd. (a merger of The Nippon

Fire & Marine Insurance Co., Ltd., The Koa Fire & Marine Insurance Co., Ltd. and

The Taiyo Fire & Marine Insurance Co., Ltd. with the latter merging with

NIPPONKOA in April 2002); Aioi Insurance Co., Ltd. (an April 2001 merger

between The Dai-Tokyo Fire & Marine Insurance Co., Ltd. and The Chiyoda Fire

& Marine Insurance Co., Ltd.); and Nissay Dowa General Insurance Co., Ltd. (an

April 2001 merger between The Dowa Fire and Marine Insurance Co., Ltd., and

Nissay General Insurance Co., Ltd.).

Table 2 shows cash flow efficiency prior to and following corporate consolida-

tion over the 17 years from fiscal 1991 to fiscal 2007.

Estimated data is panel data bundled with a time series including cross-section

data by specific company and fiscal year. Consequently, the efficiency shown by the

frontier production function incorporates differences in the market environment

during each fiscal year. The difference in the market environment must be removed

for continuous comparison and observation of the efficiency of companies after con-

solidation and each company prior to consolidation. Consequently, the companies

included in the overall scale of the non-life insurance industry are treated as a single

company. The five types of efficiency mentioned earlier are then examined, and aver-

ages over the same period of fiscal 1991 to fiscal 2007 are used as the standard defla-

tor. Next, differences in the market environment are removed from the efficiency of

each company and fiscal year using the deflator. The method is the way that public


17


Company 1 before Consolidation

Company 2 beforeConsolidation

Company 3 beforeConsolidation

Companies afterConsolidation

1

2

3

4

5

6

Average

0.5733

0.4576

0.4951

0.4835

0.6625

0.4514

0.7034

0.6562

0.4092

0.3841

0.3042

0.0100

0.4184

0.0531

0.3011

0.3304

0.9277

0.6535

0.5046

0.2690

0.5203

0.2766

0.5253

Group

Note 1: The figures showing efficiency are actual figures with differences in performance in each fiscalyear eliminated using the deflator.

Note 2: Figures are simple averages of actual numbers for each fiscal year from fiscal 1991 to fiscal2007. Therefore, the figures do not reflect changes in the scale of companies.

Table 2: Changes in Cash Flow Efficiency Due to Consolidation in the Non-Life Insurance Industry

economic data are used, and are adjusted to nominal prices to present the data in real

terms for comparability. Table 2 shows the result of using nominal prices to present

efficiency in real terms.

Table 2 shows average figures for cash flow efficiency for the companies that

make up the groups prior to consolidation from fiscal 1991 to the year prior to con-

solidation, and the equivalent figures for the year in which consolidation took place

up to fiscal 2007. For example, in Group 1 efficiency of 0.5733 and 0.7034 for the

two companies prior to consolidation is shown to rise to 0.9277 after consolidation.

For Groups 1 through 3, the efficiency of each company after consolidation general-

ly rises compared to efficiency prior to consolidation. In contrast, efficiency after

consolidation drops substantially for the companies in Groups 4 through 6. This

shows that the progress of consolidation exerted a significant impact on efficiency. In

Groups 1 through 3, large companies consolidated. In Groups 4 through 6, medi-

um-sized companies consolidated. Therefore, while consolidation includes numerous

elements, scale is clearly the most significant. Each company successively disclosed in

fiscal 2008 that they would work to increase scale in their subsequent management

plans, and the figures in Table 2 show the rationality of that approach.

Pricing in Japan’s non-life insurance industry was regulated for nearly half a

century beginning in 1951. Liberalization took only three years, and completely lib-

eralized insurance rates. The effects of deregulation were substantial, and market

concentration changed rapidly. Moreover, large-scale consolidation emerged as a

means of enhancing competitiveness, and it effectively increased the efficiency of

insurance companies by at least fiscal 2005.

However, price competition among main products became more severe than

expected and introduced a challenging revenue environment, resulting in significant

variation in the effect of consolidation. Substantial differentiation among products

Conclusion

18


and services is difficult in the non-life insurance industry, which suggests that the

future will bring more consolidation with the objective of maximizing scale.

Thus stochastic frontier production functions for analyzing efficiency are effec-

tive for analyzing long-term changes in the market and studying the relative effec-

tiveness of management strategies. Looking forward, the use of improved production

function models will offer worthwhile suggestions for risk management by each com-

pany and supervision of soundness by the Financial Services Agency.

Notes1. From July 1, 2002, Property and Casualty Insurance Rating Organization of Japan became the Non-

Life Insurance Rating Organization of Japan (NLIRO), and its primary functions became calculatingappropriate reference loss cost rates and standard full rates through high-precision analysis of insur-ance statistics and reporting them to the Minister of the Financial Services Agency. The reference losscost rate is calculated for fire, personal accident, motor and nursing care expense insurance, and thestandard full rate is calculated for Compulsory Automobile Liability Insurance and earthquake insur-ance. In other words, NLIRO assumed the functions of calculating insurance rates and serving as anindustry databank.

2. Analysis using frontier functions primarily entails production functions and cost functions.Estimation methods are classified as data envelopment analysis (DEA) or parametric analysis throughthe use of linear programming. Moreover, the latter are classified as deterministic functions or sto-chastic functions. This paper uses parametric stochastic functions, otherwise known as stochasticfrontier production functions.

3. Hideya Kubo 2008. The Restructuring Strategies of Japanese Life and Non-Life Insurance Groups.Journal of Insurance Science 601 (June): 129-148.

19

3. Hideki Ishii Insurance Journalist and Editor Inswatch

The Insurance Market in 2009: Changing Channels and Markets

The financial crisis that originated in the United States in September 2008

resulted in issues such as the global decrease in stock prices that have strongly

impacted the Japanese insurance industry. In particular, both life and non-life insur-

ers posted very large devaluation losses on investment securities, which caused a

number of insurance companies to report net losses for fiscal 2008. In the meantime,

our aging society with fewer children has sluggish insurance sales, causing a consis-

tent downward trend at life and non-life insurance companies. In the non-life insur-

ance industry, decreasing vehicle ownership and reduced vehicle production as a

result of the financial crisis has led to a drop in new motor insurance policies.

Moreover, Japan’s falling birthrate and rising age have resulted in a decrease in sales

of death benefit coverage in the life insurance industry. These factors have caused

sales of the main products that support earnings in both the life and non-life insur-

ance sectors to plateau.

Amid these environmental changes, insurance companies have worked to fur-

ther enhance operating efficiency. They have also shifted to a business model that

emphasizes customer needs by moving away from their former mass market product

and sales strategy to a focus on product quality and service.

A new wave of non-life insurance industry restructuring began at the start of

2009. In the life insurance industry, Yamato Life Insurance Company became insol-

vent and other companies implemented measures to increase their capital as their

operating capabilities weakened. Beset by this challenging environment, Japan’s

insurance industry is seeking new approaches to management as the financial crisis

affects the real economy. Moreover, insurance companies pursuing low-cost opera-

tions accelerated the movement to replace the conventional channels such as agencies

or salespersons by launching new channels in the direct sales area, which intensified

competition for customers. The market will inevitably eliminate simplistic sales

methods that cling to the conventional agency model without adapting to change.

A discussion of Japan’s changing insurance market and channels in 2009 with a

focus on non-life insurance follows.

The largest change in Japan’s insurance industry during 2009 is the trend

toward restructuring in the non-life insurance industry. In January 2009, Aioi

Insurance Co., Ltd., Nissay Dowa General Insurance Co., Ltd. and Mitsui

Sumitomo Insurance Co., Ltd. agreed to integrate their management with the aim of

forming a new insurance and financial group. Moreover, in February 2009 Sompo

Japan Insurance Inc. and NIPPONKOA Insurance Co., Ltd. reached an agreement

to establish a joint holding company for management integration. These were

among the industry’s moves to reorganize under a new structure.

Against the backdrop of the collapse of the bubble economy, the non-life insur-

ance industry conducted mergers and combinations during the 2000s to reorganize

into six major domestic companies (Tokio Marine & Nichido Fire Insurance, Mitsui

Sumitomo Insurance, Sompo Japan, Aioi Insurance, NIPPONKOA Insurance, and

Nissay Dowa). However, the impact of the contraction of the Japanese insurance

market and the global financial crisis has put an end to the six-company structure. In

1. Introduction

2. The Non-LifeInsurance Industry in2009

20

April 2010, the Tokio Marine Group and the two recently announced groups will

inaugurate a “three mega-company structure” (Chart 1).

The financial crisis that originated in the United States rapidly sapped the oper-

ating strength of the non-life insurance industry, which was one factor giving rise to

another round of restructuring. For example, the six non-life insurance companies

mentioned earlier recognized valuation losses on investment securities in excess of

¥400 billion in the nine months ended December 31, 2008. Further to that, the

insurance market itself continues to contract. The average age in Japan is rising rap-

idly while the birthrate is falling. Japan’s population as of April 2009 was 127.6 mil-

lion, a decrease of 90,000 from a year earlier. Conversely, the senior demographic of

people age 65 and older increased 2.78 percent from a year earlier to 28.289 million,

and is projected to increase to 35.7 percent of the total population in 2050. (Source:

April 2009 Population Estimates for Monthly Report, Statistics Bureau, Ministry of

Internal Affairs and Communications.)

This changing environment has especially affected motor insurance, a main-

stream product supporting earnings in the non-life insurance industry. The drop in

the number of vehicles owned and the September 2008 financial crisis have caused

vehicle production and sales to decrease dramatically, and significant growth is not

projected for the domestic market. Therefore, non-life insurance companies are con-

centrating on strengthening their domestic life insurance subsidiaries and raising the

efficiency of their non-life insurance operations by reducing operating expenses. This

is enhancing their management foundation. At the same time, the industry is execut-

ing a concurrent strategy of aggressively investing their management resources in

business overseas, particularly by using mergers, acquisitions and other means to

expand in Asian markets.

3. The Insurance Market in 2009: Changing Channels and Markets

21

The aim of creating extremely large non-life insurance companies is to deploy

these strategies to expand organizational and business scale while raising efficiency

through restructuring. Specific measures for the domestic market include developing

efficient sales channels while reducing operating expenses, and responding to mar-

kets by raising quality in conventional channels and strengthening customer relation-

ships. Other tasks include the integration of head offices and exclusive channels to

enhance capabilities and restructure, as well as the standardization of services and

more cross-selling of life and non-life products.

Two major sales channels have emerged in Japan’s insurance industry. One is

the bancassurance channel, in which all restrictions on sales were lifted as of

December 2007. The other is sales of insurance through Japan Post Bank Co., Ltd.,

Japan Post Insurance Co., Ltd. and Japan Post Service Co., Ltd. following the

October 2007 privatization of the postal system. Bancassurance sales began when the

first set of restrictions were lifted in 2001 and progressed over six years until all

restrictions were eliminated. Non-life bancassurance products include fire insurance

bundled with home mortgage products, but the primary bancassurance product is

annuity products offered by life insurance companies. In particular, the balance of

variable annuity insurance sold through the bancassurance channel as of September

30, 2008 exceeded ¥17 trillion. Moreover, the total lifting of restrictions has allowed

banks to become a major channel for medical insurance, cancer insurance and other

life insurance and third-sector products, while for non-life motor insurance, only 10

banks act as direct sales intermediaries.

In addition, the September 2008 financial crisis has had the greatest impact on

bancassurance sales of variable annuity insurance, which have been restrained by the

deteriorating fund management environment. New contracts of variable annuity

policies decreased substantially up to March 31, 2009, which was the end of fiscal

2008. Moreover, variable annuity market share leader The Hartford, along with

other companies including ING, Crédit Agricole Life and Allianz Life and domestic

firms Mitsui Life and Sumitomo Life, has exited the market or terminated the sales

of some variable annuity products because of worsening environment of fund man-

agement and funding book reserves for the products including guaranteed minimum

for accumulated capital and other uses.

Sales are subject to some restrictions. Banks are prohibited from selling insur-

ance to companies to which they extend loans, lending officers and sales officers of

insurance must be separate, and misuse of private information (without customer

approval) is prohibited. However, bancassurance is regarded as a promising channel

for life and non-life insurance companies, which will definitely invest the know-how,

personnel and sales support to develop it.

A chronology of bancassurance follows.

Lifting of Restrictions on Bancassurance

■ The first set of restrictions was lifted in April 2001. Products were insurance

3. New Channels in theNon-Life InsuranceBusiness


22

linked to home mortgages (fire insurance, loan repayment assistance insurance,

group trust life insurance), and overseas travel personal accident insurance.

• As a result, a group discount system was introduced for fire insurance bundled

with home mortgages, which affected conventional channels partially.

■ The second set of restrictions was lifted in October 2002. Products were individ-

ual annuity insurance products (fixed and variable), and savings-type personal

account annuity.

• Low interest rates accelerated the flow of funds from savings to investments, and

the rising average age of society also heightened annuity needs. Sales of annuity

products also matched the desire among banks for commission income, and

therefore increased rapidly.

■ The third set of restrictions was lifted in December 2005. Products were life

insurance (single payment whole life insurance, single payment endowment

insurance), non-life insurance (fire insurance, individual liability insurance, sav-

ings-type personal accident insurance).

• At this time, city banks and certain regional banks began creating systems in

preparation for the lifting of all restrictions, such as initiating bancassurance sales

and deploying experienced personnel. Variable annuity products that guarantee

principal and provide for early receipt of benefits were launched.

■ All restrictions were lifted in December 2007, and sales of life, non-life and

third-sector products started.

• City banks expanded their product lineups and regional banks expanded the vari-

able annuity products they handled and strengthened sales of medical-related

products. Credit banks began selling cancer insurance, medical insurance and

fixed annuity products. At the end of March 2007, the balance of assets in sepa-

rate accounts for variable individual annuities exceeded ¥14 trillion. Sales of non-

life motor insurance began, but are limited to direct sales of motor insurance

through bank intermediaries.

Privatization of the Postal System and Insurance Sales

Another large and new channel emerged for the insurance industry on October

1, 2007 with the privatization of Japan’s postal system into four businesses: Japan

Post Bank Co., Ltd., Japan Post Insurance Co., Ltd., Japan Post Network Co., Ltd.

and Japan Post Service Co., Ltd., under Japan Post Holdings Co., Ltd. as the hold-

ing company. Among these four companies, Japan Post Bank, Japan Post Insurance

and Japan Post Network began selling Japan Post Insurance products and also began

serving as agents for the products of other insurance companies. The Japan Post

companies have been involved with initiatives such as construction of and training

for compliance systems for sales, and as a result have not initiated full-scale sales yet.

However, Japan Post Network operates 24,000 post offices nationwide, and has

started full-scale initiatives with the aim of becoming analogous to a convenience


23


store for financial products using its status as a kind of government-backed brand

and close ties with local communities. Currently, sales of life insurance, including

Japan Post Insurance products, have taken precedence. However, they have also been

selling the motor insurance products of seven non-life insurance companies since

becoming private companies. As of January 2009, 277 post offices nationwide were

selling motor insurance, and this number is expected to increase to 2,000 post offices

in 2010. The start of full-scale sales in this channel will significantly affect the non-

life conventional channel of exclusive agencies closely linked to local communities.

An outline of the current status of insurance sales at the three privatized postal

companies follows.

• Japan Post Bank (11,200 employees) began selling the variable annuity products

of seven life insurance companies in May 2008.

• Japan Post Insurance (5,400 employees, 80 directly managed branches, 21,000

post offices serving as agencies) began selling products for companies offered by

eight life insurance companies from June through October 2006. It has formed an

alliance with Nippon Life Insurance Company and has also submitted a request to

launch sales of cancer insurance and increase death benefit limits during fiscal

2009.

• Japan Post Network (116,100 employees, 24,000 branches nationwide) has start-

ed sales of Japan Post Insurance products as well as the products of other compa-

nies (the variable annuity products of four life insurance companies, the cancer

and medical insurance products of two life insurance companies, and the motor

insurance products of seven non-life insurance companies).

Motor insurance is a primary product of non-life insurance companies. In

September 1997, restrictions on sales of risk-segmented automobile insurance prod-

ucts were lifted, and direct sales of motor insurance began. Since that time, a succes-

sion of direct motor insurance companies have appeared, and now eight companies

(American Home Direct Corporation, Zurich Financial Services Ltd., Sony

Assurance Inc., AXA Direct, Mitsui Direct General Insurance Co., Ltd., Sonpo 24

Insurance Co., Ltd., SBI Insurance Co., Ltd. and Adlick Insurance Company

Limited) sell motor insurance, relying on the Internet as the primary channel.

Among them, SBI Insurance and Adlick Insurance are new companies that began

operating in January and April 2008, respectively.

Net premium income has been increasing each year, and at the end of March

2008 totaled approximately ¥150.0 billion for six companies. Sony Assurance held

more than 1 million policies as of January 2009, and became profitable in fiscal

2008. In addition, AXA Direct held 650,000 policies at the end of March 2009 and

was moving into the black for the fiscal year. Mitsui Direct exceeded 700,000 poli-

cies and became profitable too.

Moreover, Tokio Marine Holdings, Inc. is cooperating with NTT Finance

Corporation in direct sales of motor insurance. The two companies jointly estab-

lished E.design Insurance Co., Ltd. and began direct sales of motor insurance in June

2009, mainly via the Internet and mobile phones. The entry of major domestic non-

life insurance companies into the direct sales market is considered a sign that this

4. Direct Impact andthe Emergence ofNew InsuranceCompanies

24

new channel is certain to increase its share of the Japanese motor insurance market.

On the other hand, companies are also conducting direct sales of non-life insur-

ance products other than motor insurance. These include H.S. Insurance Co., Ltd.,

which began sales of overseas travel personal accident insurance via the Internet in

November 2007. In the life insurance market, SBI Life Insurance initiated sales in

April 2008 and Lifenet Insurance Company began sales in May 2007. These compa-

nies specialize in selling insurance via the Internet, and are among the life insurance

companies being established with a new business model that employs the Internet.

In this backdrop insurance product prices have been decreasing and products have

become simpler. In addition to the convenience of remote channels that allow pur-

chases anytime and anywhere, the number of Internet users in Japan has increased

rapidly.

Incidentally, according to the 2008 Survey of Communication Usage Trends

issued by the Ministry of Internal Affairs and Communications in April 2009, Japan

has 90.91 million Internet users over the age of six, or 75.3 percent of the popula-

tion. By demographics, more than 90 percent of people age 13 to 40 use the

Internet, but Internet usage drops off among people 60 or older.

In addition, insurance products themselves are changing due to the increasing

popularity of remote channels such as the Internet. Previously, the standard policy of

the Japanese insurance companies had numerous riders attached, which served to

increase unit premiums per contract. As a result, however, both life and non-life

insurance companies frequently overlooked riders when they had to pay claims and

benefits, which became a major social problem in 2007 and 2008. Companies

reflected on these problems and incorporate customer demands for with clear terms

and conditions and explanatory materials. The trend now is toward the development

of fewer riders and simple, understandable products. Further to that, remote chan-

nels increasingly involve sales of commoditized motor, personal accident, medical,

cancer and other insurance products. (Chart 2)



Meanwhile, as the insurance market has contracted, the insurance industry has

become more competitive and companies are focusing on efficiency. Conventional

channels have contracted sharply, with the number of agencies falling by more than

50 percent over the last 10 years.

Agencies for Japan’s non-life insurance industry include exclusive insurance

sales agencies and ancillary agencies such as auto repair shops, dealerships, rental

property operators and licensed tax accountant. In addition, large companies, banks

and other corporations have institutional agencies with the same functions as exclu-

sive agencies. Overall, agencies accounted for about 93 percent of new contracts

written in fiscal 2008. Chart 3 shows changes in the number of non-life insurance

agencies. There were 217,864 agencies as of March 31, 2008, of which 164,911 were

exclusive agencies of designated insurance companies and 52,953 were agencies that

handle the products of multiple companies.

The number of conventional insurance agencies increased as Japan’s economy

grew and the number of motor vehicles increased. However, productivity has

decreased with the recent contraction of the market as the number of small-scale and

individual contracts has increased, and the high cost structure of agencies made

industry rationalization and restructuring inevitable. In particular, rationalization has

proceeded since the post-bubble restructuring of insurance companies in 2000 and

the liberalization of agency fees in April 2003, with agencies exiting the business,

merging or being absorbed, and agencies or shops directly owned, or managed by

insurance companies rationalizing small-scale and inefficient agencies. The number

of solicitors, however, has increased because of the emergence of large-scale agencies

such as banks and postal companies, and the merger or increased size of small agen-

cies. As the movement of operating expenses reduction at insurance companies accel-

erates further merger and acquisition among agencies, the sales competition among

diversified channels will inevitably be intensified. Over the coming two to three

years, a considerable number of agencies will therefore exit the market (Chart 3).

5. The Present andFuture ofConventionalChannels

25

26

Period Key Factors Market Responses Capital Market Responses

1985

1992

2001

2005

2007 to date

Table 1

Liability Crises

Hurricane Andrew

WTC

KRW

Credit crunch

Overhaul of coverage

Pricing improvements

Emergence of Cat models

Improved Data

Rating agencies

Recognition of Correlation

Potential for Casualty Cat

Rating agencies’ models revised

Re-assessment of frequency and severity

potential

Increased focus on capital preservation

Creation of dedicated casualty market (c USD 1bn)

New capital enters market. Some new companies

started (c USD 14bn)

New capital enters market. Many new companies


New capital enters market. Many new companies


Initial stages marked by closed debt and equity markets

It is often said that we live in a rapidly changing world. But it is also reason-able to ask the meaning of this statement, which has both general and specificimplications. In this paper we attempt to give context to the statement by exam-ining the effect of changes in world conditions on the Japanese non-life reinsur-ance market. We do this by taking a look firstly at the world market and theJapanese market’s position within it and then secondly by reviewing in moredetail some of the dynamics of the market at a local level. Finally we end withsome simple conclusions and tentatively consider the future.

That there has been change in the reinsurance market is not in doubt. Butthe change has not been smooth or continuous. Instead it can be broken into dis-tinct periods of upheaval during which different factors have been the drivers anddifferent responses have been elicited from market participants. Table 1 belowgives a simple view of the progress of world markets starting with the liabilitycrises of the mid 1980’s and ending in the present day.

In simple terms each upheaval has been marked by losses to the market.What is also equally clear from the table above is that each upheaval has been fol-lowed by a flow of new capital to replace that lost. In fact flows of new capitalhave grown following each crisis up to the present one, leading many commenta-tors to talk of a growing convergence between the reinsurance and capital mar-kets. The current crisis is different in one sense because it has affected the assetside of (re)insurers’ balance sheets. But in another sense it underlines the conver-gence of the reinsurance and capital markets: how easy would it have been for themarket to “re-load” if a large event had occurred over the past year?

4.Edward Fenton Managing Director, Asia Pacific, Guy Carpenter & Company, LLC

A Review of Today’s Japanese Non-LifeReinsurance Market

A Changing RiskLandscape in theGlobal Market

27


But what effects do changes in the global risk landscape have on the Japanesemarket? In order to try to understand this question, it is worth investigating theposition of the Japanese market in a worldwide context. Table 2 shows theapproximate amount of economic and insured loss in a 1 in 200yr event, accord-ing to Swiss Re1.

Clearly Japan has large amounts of exposure to catastrophe losses, with anespecially large economic loss potential from the earthquake peril. Even thoughlarge amounts of earthquake insurance are purchased, they represent only a smallportion of the potential economic loss.

Turning to reinsurance, Table 3 (from the same source) takes these insuredloss amounts and examines the quantity of reinsurance cession that would bemade in the event of loss.

Here we see that Japan’s insurers retain a sizeable portion of their cat riskwithin themselves, whilst insurers of US risk, predictably, are the largest potentialusers of the cat market.

When actual loss experience is considered, the picture becomes even moreskewed. Analysis of the largest 20 cat losses shows that by dollar amount paid83% of these have come from the US, 10% from Europe and just 7% fromJapan. Of course this is a reflection of the fortunate position that Japan has nothad its “big one”, whereas the USA has suffered a series of very large catastrophes.

Note 1: Source: Swiss Re Sigma No 2 / 2007Note 2: Source Swiss Re Sigma No 2 / 2007, Guy Carpenter research, Turkey and Canada 1 in 500yr loss, Israel and

Australia 1 in 1000yr loss, US wind excludes FHCF, Japan EQ excludes JER

Table 2Location Peril Economic Loss % of Economic Loss Covered by Insurance

Japan*

USA

USA

Japan

Europe

Earthquake

Earthquake

Windstorm

Typhoon

Windstorm

USD 500bn

USD 300bn

USD 300bn

USD 50bn

USD 50bn

6%

14%

52%

30%

74%*NB Japan EQ excludes JER, which is counted as not insured

Table 32

Location Peril Insured Loss % of Insured Loss Ceded to Reinsurers

USA

USA

Europe

Japan

Japan

Turkey

Israel

Canada

Australia

Windstorm

Earthquake

Windstorm

Earthquake

Windstorm

Earthquake

Earthquake

Earthquake

Earthquake

USD 140bn

USD 41bn

USD 37bn

USD 30bn

USD 15bn

USD 13bn

USD 13bn

USD 12bn

USD 12bn

43%

77%

73%

57%

57%

84%

85%

71%

96%

The Japanese Market’sPosition within theGlobal Market

28

4. A Review of Today’s Japanese Non-Life Reinsurance Market

Moving to look at the reinsurers’ share of these large losses, in the US reinsurancerecoveries range between 20% and 60% of the insured loss, whereas recoveries inJapan are smaller at 20%-25% for typhoon and just 2% in the Hanshin earth-quake of 2005.

Clearly there appears to be potential for greater purchase, and utilisation ofcatastrophe reinsurance in Japan. It is interesting to view the growth of limits inthe USA since 1989 and compare growth in the market with that in Japan.Charts 1 and 2 show the development of cat limit in the two markets over thepast 20 years. Examination of the two charts shows that there has been consider-able growth in both markets over the period. In fact growth in the Japanese mar-ket has not been dissimilar to that in the USA.

Comparison of Growthin Purchased Limit:USA vs Japan

Source: Guy Carpenter


29


So the Japanese market for catastrophe risk has grown, and some of the fac-tors are shown in the explanatory boxes in Chart 2 above. But there has also beena fundamental shift in the catastrophe risk landscape which has underpinned theincreased reinsurance limit purchased. Chart 3 below shows the increased amountof cat risk in the Japanese market, split by peril.

The reasons for the increase differ by peril. Since the introduction of wind-storm perils in 1985 the perception of the risk amount has altered drasticallyupwards, firstly following typhoon Mireille (1991) and latterly as companies haveincreasingly employed catastrophe models to assess their risk amount. In the caseof earthquake the insurance market has always considered the possibility of a fulllimits loss. Here the amount of limit put out by insurers and mutual organisa-tions has actually increased. The risk has also become more immediate becausethe commercial and industrial earthquake exposures taken on by the non-lifecompanies have increasingly become accepted on a first loss basis rather as areplacement of the traditional reduced indemnity product.

A bellwether for cat pricing sentiment in the Japanese market is the pricingof the windstorm catastrophe ELCs, as seen in Chart 4 below. In the modern erasince the end of the long soft market of the 1990’s the Japanese market hasmoved in line with the international market generally. Local factors have made acontribution of course: hence Japanese cedants suffered increases in cat pricingfollowing the record typhoon season of 2004, where other markets around theworld were still enjoying reductions. But generally there is clear correlationbetween movements in world cat pricing and that in Japan.

The Changing RiskLandscape in Japan

Rating Levels in theJapanese ReinsuranceMarket


30

4. A Review of Today’s Japanese Non-Life Reinsurance Market

Like all markets around the world, Japan has local issues and events that havea localised effect on the renewal of Japanese reinsurances in particular. A recap ofthe renewal seasons of the past few years gives a flavour of some of these issues.

The 2005 Renewal: Abundant capacity appeared to suggest that there wouldbe a softness in the market, but this was conflicted by adverse loss experience.2004 had been a year of record losses including the largest fire loss ever in Japanand an unprecedented number of land falling typhoons. Fire and windstorm loss-es and expansion in windstorm capacity purchased gave many reinsurers theexcuse to quote high excess of loss prices and talk of significant pro rata improve-ments. Property Classes were generally more difficult than the previous year,especially fire pro rata. Casualty Classes remained problematic.

The 2006 Renewal: A better year for Japanese insurers in their original busi-nesses meant that reinsurer demands for a continuation of the increases in pricesseen in 2005 were partially resisted. A stream of adverse Hurricane Katrina andWilma developments added incentive to the reinsurer community to push pricesup. However large amounts of new capital flowed into the world cat marketreducing capacity concerns. In the end risk adjusted rates, in classes other thanwindstorm, were flat to down slightly. All other classes remained stable with theexception of US exposed JIA which experienced a challenging renewal.

The 2007 Renewal: A mixed message from the 1st January renewal season leftmany in the reinsurance market unsure as to the likely direction of the Japaneserenewal. It appeared that windstorm ELC pricing was likely to be the critical issue.In the end rates were flat to down in many classes and the market was significantlyeasier, in terms of both price and capacity availability. Prices were flat or reduced inall classes, but this was an orderly market. There had been some expectation thatsome of the newer entrants to the market would look to gain market share throughaggressive pricing. However, this eventuality did not materialise and there was no“rogue” quoting reinsurer or group of reinsurers to drive prices down.

The 2008 Renewal: The two major issues facing buyers entering the 1stApril Japanese renewal were their ability to maintain fire proportional capacityand the level of rate reduction achievable for their catastrophe protections. Aseries of fire losses experienced by the market led to a challenging renewal for

Recent Renewal Seasonsin Japan


31


many companies of their fire proportional treaties. However once terms and con-ditions were accepted by major reinsurers there was sufficient capacity for mainfire treaties. This capacity came from both existing reinsurers and also newcom-ers. There was a modest reduction in most lines of catastrophe business.

The 2009 Renewal: For this renewal season, buyers faced a reinsurance land-scape where the indications were that rate increases were to be expected on catas-trophe lines of business. At the same time indicators on per risk property andcasualty lines were more unclear. A good year of results for most companies’treaties in all lines relieved the pressure on per risk business and assisted in theresistance of reinsurer demands for large increases on catastrophe business.Movements in exchange rates meant that capacity was restricted for some reinsur-ers in the market. In the end catastrophe lines experienced modest increases. Withmostly good results during 2008, the fire market enjoyed an orderly renewal.

A read through the simple renewal précis above shows that Japanese renewalseasons are affected by both local and macro factors.

The global economic crisis has emerged from problems in the financial sec-tor, and it has ushered in an era of greater uncertainty about financial products,especially in relation to their level of underlying security.

Despite headline examples like AIG, XL Capital and Swiss Re, the (re-)insurance industry has shown itself so far to be relatively less exposed to the debil-itating balance sheet impairment that has been experienced by others in the finan-cial sector. Even the problems faced by the named companies above arise fromtheir involvement in lines of business outside of their core P&C lines.Nevertheless the industry lost at least USD 150bn of capital during 2008, and hascontinued to lose capital in 2009.

Declines in global stock markets have driven the insurance industry to considerthe benefits of consolidation to improve returns. Price to earnings ratios have fallento a level where mergers and acquisitions look attractive to those with capital tospare. There has been already some activity in this area and there may well be more.

Liquidity and capacity following a major catastrophe event are a concern.Despite a mini-bubble in capital raising recently, it still seems unlikely that rein-surers could easily raise significant funds in the way that they did in 2002 and2005. However, despite the events of 2008, overall capital is now at a level consis-tent with long term averages.

The factors described above highlight the need for cedants globally to seekgreater diversification in their reinsurance panels, for reasons of both security andbargaining power. Japan should be no exception to this rule, though the markethighly values stability and continuity.

It is clear from the studies above that the Japanese market is an importantcomponent of the global reinsurance landscape and, potential upcoming mergersnotwithstanding, it is likely to continue to grow in importance in the future. Ourstudy of the amount of insured and reinsured risk in Japan as a proportion of eco-nomic exposure is perhaps particularly telling and indicates that the reinsurancemarket has scope to continue to grow in the future. The challenge for Japanesecompanies, which are currently facing tight margins in an extremely maturedomestic market, will be to continue to find innovative ways to finance the riskon their balance sheets in the most cost effective manner.

Summary

32

(1) Domestic Market

Net premium income of all 9 major domestic non-life insurance companiesdecreased in Fiscal 2008. In addition to a reduction in premium rates forCompulsory Automobile Liability Insurance for the first time in 11 years, motorinsurance was sluggish due to stagnant automobile sales and a consumer shift tosmaller cars. Premium income from marine insurance, which had increased for 7consecutive years, declined due to a decrease in the volume of distributioncaused by the global economic recession.

A large loss on revaluation of securities in the wake of the financial crisis led toa fall in ordinary profit (including return on asset investments) for all companies.

(2) Industry Reorganization

The business integration of Sompo Japan Insurance Inc. and NIPPONKOAInsurance Co., Ltd. was announced after that of Mitsui Sumitomo InsuranceGroup Holdings, Inc., Aioi Insurance Co., Ltd. and Nissay Dowa GeneralInsurance Co., Ltd. The non-life insurance market will thus be dominated bythree major groups including Tokio Marine Holdings.

Furthermore it was announced that Sumi-sei General Insurance Co., Ltd., asubsidiary of Sumitomo Life Insurance Company, would exit the market. As aresult, the business of Sumi-sei General Insurance will be terminated and its exist-ing policies will be switched to those of Mitsui Sumitomo Insurance Co., Ltd.

(3) Business Expansion into Overseas Markets

Given that growth in the non-life insurance market has peaked in Japan, non-life insurance companies have been expanding their overseas businesses. In Fiscal2008, this included the establishment of local subsidiaries in China. Recentmajor overseas initiatives are summarized as follows.

1. Market Trend

5.Underwriting & Planning Department The Toa Reinsurance Company, Limited

Trends in Japan’s Non-Life Insurance Industry

Date Company Name Recent Overseas Initiatives

July 2008

August 2008

August 2008

September 2008

October 2008

November 2008

January 2009

March 2009

March 2009

Tokio Marine Holdings, Inc.

Tokio Marine Holdings, Inc.

Mitsui Sumitomo Insurance Co., Ltd.

NIPPONKOA Insurance Co., Ltd.

Aioi Insurance Co., Ltd.

Tokio Marine & Nichido FireInsurance Co., Ltd.

Mitsui Sumitomo Insurance Co.,(Europe) Ltd.

Aioi Insurance Co., Ltd.

NIPPONKOA Insurance Co., Ltd.

Acquired Philadelphia Consolidated Holding Corp.

Established Tokio Marine Underwriting Limited (Provision of capital toLloyd's syndicates)

Obtained approval to establish a local subsidiary in Vietnam

Obtained approval to establish a representative office in Moscow

Agreed on a strategic business alliance with Lotte Non-Life Insurance Co.,Ltd. in Korea

Started business operations at a local subsidiary in China

Established a branch in Doha, Qatar

Started business operations at a local subsidiary in China

Announced the acquisition of stock in and a business alliance withNavakij Insurance PCL in Thailand

33


(4) Distribution Channels

Sompo Japan became the first Japanese non-life insurance company to opencompany-owned over-the-counter insurance stores. In recent years, there hasbeen increasing demand for such stores from customers, who state that they needprofessional advice, they want to consult with specialists whenever they please,and they do not welcome customer calls to their home or office. The companyplans to use its over-the-counter stores to provide customers with a greater levelof convenience, to grasp, verify and accumulate know-how, and to understandcustomer requirements to support Sompo Japan’s agents. Although some insur-ance agents in the non-life insurance industry have over-the-counter insurancestores, this is the first time a non-life insurance company has opened company-owned over-the-counter insurance stores.

Tokio Marine Holdings announced the establishment with NTT FinanceCorporation, the financial arm of the NTT Group, of a non-life insurance com-pany dealing in motor insurance products online. The new company will focuson selling motor insurance products for the younger generation mainly throughmobile phones.

(5) Small Amount and Short Term Insurance Providers and Unregulated Co-operatives

In accordance with the enforcement of the revised Insurance Business Law inApril 2006, mutual aid associations which had been outside the scope of the rele-vant laws (in other words, unregulated co-operatives), were brought within thescope of supervision of the authorities as specific insurance businesses.Furthermore, a small amount and short term insurance system was established toallow the underwriting of small amount and short term insurance policies withinthe scope of certain business scale criteria. By March 2008, specific insurancebusinesses were required to register as small amount and short term insuranceproviders.

In the wake of this revision, the number of registered small amount and shortterm insurance providers reached 64 as of March 2009, of which 52 hadswitched from specific insurance businesses (unregulated co-operatives) and 12were new entries. The insurance products range over death benefit, medicalinsurance, household contents insurance and pet insurance.

When the Reform of Public Benefit Corporation Law came into force inDecember 2008, the insurance (co-operative) business operated by public benefitcorporations was brought within the ambit of the Insurance Business Law, assuch corporations are no longer to be supervised by the current ministry incharge as a result of their conversion into new corporation, regardless of whetherthey are recognized to represent public interests. Therefore, public benefit corpo-rations that plan to continue operating mutual aid business after the conversionare basically required to obtain an insurance license or register as a small amountand short term insurance provider, otherwise they would need to take measuresin accordance with the Insurance Business Law such as a transfer of their co-operative business into other insurance companies and closing their business.

34

The 26 companies in the General Insurance Association of Japan (*) suffered froma fall in net premium income in Fiscal 2008. Ordinary profit and net income fell intothe red owing to negative returns on asset investments resulting from the financial crisis.

Net premium income was 7,161.8 billion yen, down 4.1% on a year-on-yearbasis. The fall stemmed from cuts in premium rates for Compulsory AutomobileLiability Insurance and lower revenue from motor insurance.

Net claims paid were 4,399.5 billion yen, up 1.4% on a year-on-year basis, dueto increased claims payments for casualty insurance and personal accident insurance.

Operating and general administrative expenses related to insurance underwritingwere 1,268.5 billion yen, up 3.7% on a year-on-year basis, because of investments toimprove systems for business operations. As a result, the net expense ratio increased1.9% to 35.1%.

Net underwriting profit moved into the black (16.2 billion yen) from the deficitof 63.9 billion yen recorded in the previous fiscal year because of a decrease in provi-sion for outstanding losses and a reversal of underwriting reserves, in spite of lowernet premium income, higher net claims paid and increased operating and generaladministrative expenses.

Owing to negative returns on asset investments caused by the financial crisis,ordinary and net losses stood at 257.9 billion yen, down 636.3 billion yen on a year-on-year basis, and 81.0 billion yen, down 317.8 billion yen, respectively.

* E.design Insurance Co., Ltd. is not included among the 27 members of the General InsuranceAssociation of Japan for Fiscal 2008, because it began operations on June 13, 2009.

(1) Completion of the Insurance Law

The insurance law was revised for the first time in about 100 years. Everycompany is currently revising its terms and conditions in response to the revi-sion, which is due to take effect by June 2010. In light of the recent issue ofunpaid insurance claims and in an effort to protect policyholders, the revised lawwill unilaterally enforce a rule invalidating provisions adverse to policyholders,review provisions on the duty of disclosure and establish provisions on the tim-ing of paying claims.

(2) Establishment of Financial ADR System

In March 2009, the bill to enact financial ADR (alternative dispute resolu-tion) was submitted to the Diet and will be passed. The bill will establish a uni-form financial ADR organization across finance related laws such as theFinancial Instruments and Exchange Law, the Bank Law, and the InsuranceBusiness Law through their revisions. In the insurance area, an ADR institutionis to be designated for each type of business operations including life insuranceand non-life insurance. Financial ADR is a dispute resolution method based onsecuring an agreement among interested parties through mediation, conciliationand arbitration rather than via court action, allowing the parties to settle the dis-pute promptly and flexibly and reduce costs.

3. Regulatory Topics forFiscal 2008

5. Trends in Japan’s Non-Life Insurance Industry

2. Overview of Resultsfor Fiscal 2008

35


(3) Lowering Amount of Claims Paid on Policies against Deathfor Children in Overseas Travel Personal Accident Policies

Some members of the Financial System Council (advisory body to the PrimeMinister) raised an issue that fraudulent large insurance claims may be triggeredunder present conditions. In response to this, the non-life insurance industryestablished a voluntary rule that the amount of claims payable on policies againstdeath for children under 15 be limited to 10 million yen. Every company low-ered the coverage amounts on overseas travel personal accident policies sold byway of non-face-to-face methods such as the Internet and automatic vendingmachines placed at airports.

Losses from major natural disasters during Fiscal 2008 were as follows.

(1) Earthquake

Name of Loss Date of Loss Claims paid (JPY Million)*

Iwate and Miyagi Inland Earthquake in 2008

Earthquake (Origin: Northern Iwate Coastline)

June 14, 2008

July 24, 2008

50

29

(2) Wind and Flood DamageName of Loss Date of Loss Claims paid (JPY Million)

Heavy Rain in Tokai at the End of August 2008

August 26, 2008 -August 31, 2008

252

*Claims paid for earthquake insurance

There was no typhoon landfall on Japan for the first time in 8 years (Since 2000).

4. Fiscal 2008 Data onLosses from MajorNatural Disasters

36

Life Underwriting & Planning Department The Toa Reinsurance Company, Limited

Trends in Japan’s Life Insurance Industry

6.The trend of decreasing child population shows no sign of bottoming out.

According to the Ministry of Internal Affairs and Communications, the Japanese

child population under 15 as of April 1, 2009 numbered 17.14 million, representing

a fall of 0.11 million from last year, meaning that the child population has now been

dropping for 28 consecutive years. The child population represents 13.4% of the

total population, a figure which has been declining for 35 consecutive years in simi-

lar fashion. Children accounted for 35.4% of the total population in 1950, a figure

in excess of one third of the total, but this had dropped to 25.6% by 1965, or about

one in four. The same statistic was 15.3% in 1997, about one in 6.5, and was about

one in 7.5 based on the survey conducted in 2009.

If the child population continues to diminish at this speed, it will have a serious

impact on the lives of Japanese people, and industries, as well as public pension rev-

enue, domestic demand and so on. In particular, the domestic life insurance compa-

nies, which rely heavily on the domestic market, will face the adverse effects of this

trend in terms of future business growth, and they need to develop new markets as

well as to maintain their existing level of in-force insurance business.

There were favorable signs in the life insurance industry in the first half of FY

2008. The reverse spread issue, a heavy burden for the industry since the collapse of

the bubble economy, was expected to be resolved. “Furthermore, the cancellation

rate and lapse rate had improved and, in light of predictions of growth in

Bancassurance, the prospects for the life insurance industry appeared to be more

encouraging than for some years”.

In the second half, however, owing to the worldwide financial turmoil triggered

by the U.S. subprime loan issue, which was said to be the greatest financial turmoil

of the century, business conditions became the most severe since the collapse of the

bubble economy. Most primary life insurance companies posted a large amount of

unrealized capital loss of securities and declared negative balance sheet results at the

end of March 31st, 2009.

Under such conditions, each company is striving to implement various strate-

gies in order to stabilize its financial situation and strengthen its management infra-

structure. The major strategies adopted are as follows:

(1) Three Companies in the AIG Group

In October 2008, the AIG Group in the U.S. recorded a huge loss and was

placed under the control of the U.S. government. As part of the business reorganiza-

tion plan, it was announced that three AIG Group companies, American Life

Insurance Company (ALICO Japan), AIG Star Life Insurance Co., Ltd. and AIG

Edison Life Insurance Company, were to be offered for sale. Although several com-

panies were initially expected to make buyout proposals, buyers of the three compa-

nies have not been determined yet, while many worldwide financial institutions have

1. DemographicChange

2. MarketReorganizations

37


got injections of public funds in the wake of the worldwide financial turmoil.

In March 2009, AIG Star Life Insurance Co., Ltd. and AIG Edison Life

Insurance Company increased their capital by 15 billion yen and 22.5 billion yen,

respectively, by exchanging subordinated loans for stock. Likewise, ALICO Japan

increased its capital by 29.4 billion yen by obtaining additional funding in the form

of outside capital. All of these companies have been consolidating their financial

position to enhance their own business value.

(2) Bankruptcy of Yamato Life Insurance Co. and its Buyout byPrudential Financial

Yamato Life Insurance Co., which started its rehabilitation procedure in

October 2008, concluded a sponsorship contract with The Gibraltar Life Insurance

Co., Ltd. in March 2009 and applied to the Life Insurance Policyholders Protection

Corporation of Japan for financial aid. Financial aid was subsequently granted and

the company received approval for its rehabilitation plan from the Tokyo District

Court. The company then became a member of the Prudential Financial group as a

subsidiary of The Gibraltar Life Insurance Co., Ltd. Its company name was changed

to The Prudential Financial Japan Life Insurance Co., Ltd.

Yamato Life Insurance Co.’s excess liabilities amount to about 64.3 billion yen.

As part of the rehabilitation plan, The Gibraltar Life Insurance Co., Ltd. plans to

record goodwill of 3.2 billion yen and the Life Insurance Policyholders Protection

Corporation of Japan will finance about 27.8 billion yen of the company’s liabilities.

The anticipated interest rate of in-force business will be lowered to 1.0%, to resolve

the excess liability issue of the company.

The new company commenced operation in June 2009 as an insurance compa-

ny specializing in agency distribution and Bancassurance, while maintaining the in-

force business of the former Yamato Life Insurance Co.

(3) Probable Business Merger between Sompo Japan HimawariLife Insurance Co., Ltd. and NIPPONKOA Life InsuranceCompany, Limited

In March 2009, it was announced that two non-life insurance companies,

Sompo Japan Insurance Inc. and, NIPPONKOA Insurance Company, Limited

would establish a joint holding company through a share transfer and that the parties

had concluded a basic agreement for a merger to take place in April 2010.

The new group also plans to start discussions concerning the merger and

reorganization of other than non-life business with a view to pursuing group synergies.

It is probable that Sompo Japan Himawari Life Insurance Co., Ltd. and

NIPPONKOA Life Insurance Company, Limited, subsidiaries of the respective

non-life companies, will start moving towards a merger in future.

38

6. Trends in Japan’s Life Insurance Industry

(4) Preliminary Merger Discussions between Mitsui SumitomoKirameki Life Insurance Co., Ltd. and Aioi Life InsuranceCo., Ltd.

In March 2009, three non-life insurance companies, Mitsui Sumitomo

Insurance Group Holdings, Inc., Aioi Life Insurance Co., Ltd. and Nissay Dowa

General Insurance Co., Ltd., announced that they had started preliminary discus-

sions concerning a merger to take place in April 2010. As a result, Mitsui Sumitomo

Kirameki Life Insurance Co., Ltd. and Aioi Life Insurance Co., Ltd., subsidiaries of

the respective companies, will enter merger negotiations. Both of these insurance

subsidiaries adopt growth strategies involving the cross-selling of life insurance to

non-life insurance customers of their parent companies.

(5) Merger of AXA Life Insurance Co., Ltd. and AXA FinancialLife Insurance Co., Ltd.

In April 2009, AXA Life Insurance Co., Ltd. and AXA Financial Life Insurance

Co., Ltd. announced that they had decided to merge by the end of 2009 in order to

enhance business efficiency and reinforce their capital management structures. AXA

Financial Life Insurance Co., Ltd. used to be known as Winterthur Swiss Life

Insurance Co., Ltd. before it switched to the current name in January 2008 due to a

purchase of Winterthur group by AXA Group. The merging company will be AXA

Insurance.

(6) Capital Increases

In addition to the cases noted above, in FY 2008, many life insurance compa-

nies increased their capital to stabilize their financial situation and strengthen their

management infrastructure as a result of worldwide financial turmoil:

Life Insurance Co. Amount of capital increase Contributory Means of capital increase

Nov. 2008

Nov. 2008

Dec. 2008

Dec. 2008

Dec. 2008

ORIX Life Insurance Corporation

The Dai-ichi Frontier Life Insurance Co., Ltd.

Asahi Mutual Life Insurance

T&D Company

ING Life Insurance Company, Ltd.

ORIX Corporation, its parent company

The Dai-ichiMutual Life Insurance Co., its parent company

11 of its closely related financial institutions and business corporations

T&D Holdings, Inc.

ING Insurance International

Third party allocation of shares

Subscription of 100% share

Capital infusion

Capital infusion

Capital infusion

Date

10 billion yen

60.5 billion yen

35.0 billion yen

40.0 billion yen

15.0 billion yen

39

3. Trends in BusinessPerformance


Dec. 2008

Dec. 2008

Dec. 2008

Jan. 2009

Mar. 2009

Mar. 2009

Mar. 2009

Mar. 2009

Mar. 2009

MassMutual Life Insurance Company

Mitsui Life Insurance Company Limited

Mitsui Sumitomo MetLife Insurance Co., Ltd.

Sumitomo Life Insurance Co.

The Dai-ichi Mutual Life Insurance Co.

Daido Life Insurance Co.

Taiyo Life Insurance Company

ORIX Life Insurance Corporation

Fukokushinrai Life Insurance Company, Limited

MassMutual Financial Group

6 companies in Mitsui group and Sumitomo group, including SumitomoLife

Mitsui Sumitomo Insurance Group Holdings, Inc. and Worldwide Holdings, Inc.

Major domestic financial institutions

22 domestic financial institutions

T&D Holdings, Inc.

T&D Holdings, Inc.

ORIX Corporation,its parent company

Fukoku Mutual Life Insurance Co.

Capital infusion


Capital infusion

Perpetual subordinated loan

Syndicated subordinated loan

Capital infusion

Capital infusion


Capital infusion

13.0 billion yen

60.0 billion yen

20.4 billion yen

100.0 billion yen

183.0 billion yen

70.0 billion yen

50.0 billion yen

15.0 billion yen

10.0 billion yen

The fiscal Year 2008 results for 44 life insurance companies in Japan were as

follows:

• Total Amount of New Contracts

During fiscal year 2008, the total insured amount of new individual insurance

contracts for all 44 companies decreased 7.8% from the previous fiscal year to JPY54

trillion, due to continued sluggish sales of death benefit products. Regarding individ-

ual annuities, life insurance companies selling fixed annuity products recorded a

steady growth in sales. Meanwhile, the global financial turmoil since last September

substantially reduced sales of life insurance companies, which have mainly offered

variable annuity products, in particular through the Bancassurance channel. As a

result of stagnant sales of variable annuities, the total sales of new individual annu-

ities were JPY7.2 trillion, down 9.4% on a year-on-year basis, declining for the sec-

ond consecutive year.

• Total Amount of In-force Contracts

As of the end of fiscal year 2008, the total insured amount of in-force individ-

ual insurance contracts decreased 4.7% from the previous fiscal year to JPY 932.9

40


trillion, due to the sluggish performance of large companies, against solid results at

foreign-affiliated companies and subsidiaries of non-life insurance companies. On

the other hand, sales of individual annuities were JPY88.4 trillion, up 0.6% from the

previous fiscal year, representing the sixth consecutive annual increase. While the

global financial turmoil led to a decline in sales for life insurance companies relying

on a Bancassurance channel for variable annuities, life insurance companies selling

fixed annuity products steadily improved their performance. Group insurance con-

tracts in force increased 0.3% from the previous fiscal year to JPY375.1 trillion, the

second consecutive annual increase, though group annuities in force decreased 3.5%

from the previous fiscal year to JPY31.1 trillion.

• Annualized Premiums

The total of annualized premiums from new contracts declined 7.6% from the

previous year to JPY2.2 trillion owing to a drop in individual insurance despite an

increase in individual annuities. In-force business produced a steady result in annual-

ized premiums, rising 0.1% from the previous fiscal year to JPY 19.6 trillion, due to

an increase in individual annuity despite a drop in death benefit products.

• Premiums Revenues / Total Assets

Total premium revenues decreased 2.2% to JPY27.3 trillion for all 44 life

insurance companies, the third consecutive annual decline. Due to the deterioration

in the investment environment, total assets for 21 companies, including 9 major

companies, out of 39 companies, were below that of the previous fiscal year. For 5

companies, the figures for total assets can not be compared to those of the previous

year since these companies were newly established in Fiscal Year 2008. Overall, total

assets declined 4.1% from the previous year to JPY205.1 trillion, the second consec-

utive annual decline.

In recent years, life insurance companies in the Japanese market have striven to

develop and market new products as new sources of profit, as sales of death benefit

products have deteriorated in spite of the longstanding flagship status of such prod-

ucts. Although sales of medical insurance and variable annuity insurance have been

favorable for several years, there was a big change in FY 2008.

The variable annuity insurance market remained unfavorable due to the serious

impact of the reduced market value of assets in the wake of the worldwide financial

turmoil. Companies that had started to sell variable annuity insurance at an early

stage suffered from the burdens of inflated cost of minimum guarantees for death

benefit and accumulated capital of annuity. Some of these companies stopped selling

such products because of the pressure of such burdens put on management. The

environment surrounding such products changed dramatically in this way.

In the meantime, it is no exaggeration to say that medical insurance currently

occupies the central position among personal insurance products. The life insurance

industry of FY 2008 featured differentiated new products and revised existing prod-

4. Market Trends

41


ucts. Some companies improved sales performance that exceeded the targets set in their

respective initial plans as a result of marketing based on such product developments.

The main trend occurring in the medical insurance and variable annuity insur-

ance fields in FY 2008 were as follows:

(1) Mitsui Life Insurance Company Limited Ceases its VariableAnnuity Insurance Sales and Sumitomo Life Insurance Co.Partly Suspends Sales of Variable Annuity Insurance

In February 2009, Mitsui Life Insurance Company Limited announced that it

would cease its sales of variable annuity insurance products for indefinite period,

because the standard valuation reserve for variable annuity insurance increased to

43.0 billion yen triggered by a decline in the market value of assets in the wake of the

financial crisis. This burden of the increased cost on the minimum guarantee as a

result of a decline in the market value of assets since worldwide financial turmoil had

been a common issue for most companies dealing with variable annuity insurance.

However, Mitsui Life Insurance Company Limited was virtually the first company

to cease its sales of products in this area following the financial turmoil.

Subsequently, in May 2009, Sumitomo Life Insurance Co. also announced that

the standard valuation reserve on the cost of the minimum guarantee for variable

annuity insurance was forecasted to increase to 163.8 billion yen as of the end of

2008, which was 240% of the amount as of the end of FY 2007. The company also

announced that it would suspend sales of variable annuity insurance products with

accumulated capital of annuity to maintain appropriate risk controls.

(2) Suspension of Sales of Variable Annuity Products byHartford Life Insurance K.K.

In May 2009, Hartford Life Insurance K.K. announced its suspension of sales

of all insurance products of the company from June 2009. The company dealt in

variable annuity, variable whole life insurance and fixed annuity for individual.

The company started to sell variable annuity products in 2000 and achieved

top-ranking, satisfactory results in the market as a company specializing in

Bancassurance sales. However, under circumstances in which sales performance had

started to decline in FY 2006 due to severe market competition for variable annuity.

Furthermore, amid the worldwide financial turmoil that has occurred in the last

year, the market value of the company’s assets dropped sharply, putting pressure on

management because of the cost burden of minimum guarantee for death benefit

and accumulated capital of annuity. Consequently, the company decided to suspend

sales of all insurance products.

The company provides services in exactly the same way as before and has main-

tained its existing policies. The company also announced that it will reconsider the

suspension of sales in the light of market conditions, but at this moment the length

of suspension is indefinite.

42


(3) Marketing Trends in Medical Insurance

Given the rapid progress seen in medical insurance products, each company

provides differentiated products that appeal to customers on the basis of “simplicity”,

“low premiums” and “tailored solutions”.

“Mirai Support”, which means “Future Support” in Japanese, which was

launched by Nippon Life Insurance Co. in October 2008, is characterized by a sim-

ple benefit scheme that unifies traditional medical riders. The new rider allows for

changes from existing medical riders without any examination or duty of declaration.

Sales of this rider have been expanding steadily.

“Nyu-in Tokuyaku Sono-Hi kara”, which means “Hospital Stay Benefit from that

day” in Japanese, was launched by Japan Post Insurance in July 2008 as its first prod-

uct since the postal service privatization. The rider guarantees a hospital stay from

the first day as its name suggests. This rider is attached to about 90% of the compa-

ny’s new policies and is well-supported by policyholders.

“Kenko no Omamori”, which means “Amulet of Good Health” in Japanese, was

launched by Sompo Japan Himawari Life Insurance Co., Ltd., a subsidiary of the

non-life insurance company, in August 2007. This product is characterized by sim-

plicity, low premiums and options that satisfy contemporary needs of policyholders.

When annual sales of a medical insurance policy reach 100,000, it is regarded as a

blockbuster success in Japan. However, this product successfully achieved annual

sales of 200,000 policies.

In May 2008, “Cure Lady” was added to the “Cure” product lineup launched

by ORIX Life Insurance Corporation. “Cure” has been a big hit and has become a

pioneer of low-premium products in Japan. “Cure Lady” is whole life medical insur-

ance for women and is in great demand.

In recent distribution channel trends, there were two features in FY2008; the

number of sales representatives, which had decreased rapidly in previous years in

spite of their long history as a main channel of selling life insurance in Japan, has

turned upward, and banks have been steadily developing their sales structures as a

new insurance distribution channel.

The total number of sales representatives in the 9 major companies was

206,786 as of the end of the first half of FY 2008, an increase of 258 compared to

the number at the end of FY2007. Although this is a change of no more than

+0.1%, the increase recorded is a sign of bottoming out in the trend of reduction in

the sales representative population.

Major traditional domestic companies have clarified their strategies that sales

representatives will continue to act as a key part of their sales forces and that their

sales systems only focusing on the acquisition of new policy are to be shifted to a

sales structure that also values sales representatives in maintaining in-force policies

not to be lapsed and the role of developing successors.

In the meantime, banks have come under the spotlight as a new distribution

5. DistributionChannels

43

6. InsuranceRegulations

channel for variable annuity insurance since 2002. They have been expected to deal

with various products since December 2007, when all restrictions on Bancassurance

in Japan were lifted. Major domestic banks have steadily maintained their

Bancassurance sales efforts by recruiting and developing employees with professional

skills as sales staff of life insurance. They have been particularly aggressive in increas-

ing their efforts to develop sales of insurance products other than variable annuity

insurance, especially medical insurance products.

In June 2008, the Insurance Law was officially enacted in order to regulate the

relationships between insurance companies and policyholders.

While operations of insurance companies have been governed by the Insurance

Business Act, the rules between insurance companies and policyholders were only reg-

ulated by a part of the Commercial Law. However, the so-called “non-payment of

claims” issue arose in the industry two years ago, mainly due to inadequate claim pay-

ment processes. It became a great social issue and had a significant impact on the life

insurance industry. As a result, there was a broad requirement for a new statutory reg-

ulation to be developed in a manner consistent with current insurance product fea-

tures and based on the peculiarities of insurance policies compared to other general

contracts. The statutory regulation is an independent law and represents the first sig-

nificant revision of insurance law in this area for about 100 years.

The regulation was developed from the perspective of protecting policyholders

in addition to translation into modern Japanese. New regulation sets new or modi-

fies existing duties relating to many items and conditions, such as disclosure, due

date for claim payment, and policy cancellation for material misrepresentation.

All of the life insurance companies have to change their insurance conditions to

comply with the law by its enforcement, scheduled for April 1st, 2010. To be ready

in time for the effective date, each company is now preparing its policy terms and

conditions based on the new regulation.

Changes to terms and conditions are subject to the approval of the Financial

Services Agency. In February 2008, the Financial Services Agency clarified certain

aspects of the draft revision to “Guideline for Insurance Companies Supervision” and

“Guideline for Small-Amount Short-Term Insurance Provider Supervision” in response

to the promulgation of the new regulation, to clarify some important notes for all

insurers to keep in mind in preparing their terms and conditions.


44

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The Toa Reinsurance Company, Limited

h t t p : / / w w w . t o a r e . c o . j p

6, Kanda-Surugadai 3-chome, Chiyoda-ku, Tokyo 101-8703, Japan

Printed in Japan on recycled paper with soy ink.

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