The true scale of reinsurance losses following the catastrophe in Japan could belie the horrors depicted in the media

After the initial shock of the 11 March earthquake and resulting tsunami in Japan, a clearer picture has started to emerge about the size of the global (re)insurance industry’s exposure to the event.

On the morning of that day, a magnitude 9.0 earthquake struck off the coast of northern Japan, causing severe shaking across wide swathes of the country. The quake in turn triggered a 3 metre-high wave that slammed into the east coast of Honshu – Japan’s main land mass – swamping Fukushima, Ibaraki, Iwate and Miyagi prefectures in particular.

The event has clearly been devastating from a humanitarian perspective. At the time of going to press, about 5,400 people had been confirmed dead, with a further 9,500 thought to be missing. And judging by initial estimates, which range from $10bn to $35bn, total insured losses will be in line with those from last year’s Chile earthquake at best.

It is also worth noting that some of the numbers released to date, including AIR Worldwide’s $15bn-$35bn insured loss figure, exclude estimates from non-modelled events such as tsunamis and indirect business interruption.

However, international reinsurers’ share of the eventual losses will be limited because the market structure will keep a lot of the risk in the country.

A large proportion of the property losses are thought to be residential rather than commercial. Residential property policies written by traditional non-life insurers are covered by the government-backed earthquake insurance scheme, Jisai.

The scheme provides ¥5.5trillion ($68bn) in cover, which the government assumes, ceding a portion of it to the Japan Earthquake Reinsurance Company (JERC) and private market (see diagram, above). Crucially, Japanese insurers have to retain all the risk they assume from the scheme, so cannot share the burden with reinsurers.

There are exceptions to this – policies written by foreign insurers (which have a small market share) and co-operatives. These firms are not part of the government earthquake scheme and can buy reinsurance in the private market. Some contend there will be an agricultural portion to the losses, which could find their way to the international market.

While there will undoubtedly be commercial losses, a good proportion of which could end up in the international reinsurance market, these might not be as bad as the news images suggest.

One source, for example, mentioned that according to figures from the Japanese tariff association, the combined probable maximum loss for cargo in the ports of the two hardest hit prefectures was ¥6.4bn.

The source also pointed out that fishing vessels are typically covered by a pool arrangement not insured in the private market.

Speaking at the MultaQa Qatar conference on 14 March, outgoing Aon Benfield UK chairman Charlie Cantlay said TV images could lead the industry to believe it faced “an absolute monster of a loss”, but added: “The truth is we simply don’t know at this point.”.

Endurance chief executive David Cash said that while one or two catastrophe firms may find themselves over-exposed to Japan and be forced to rethink their strategy, the effect on the wider global (re)insurance industry would be more subdued.

“I believe this provides some sort of support, for the global reinsurance market: it is not a market-changing experience,” he said. “The fact that this event is plausible and doesn’t cause us to think our models were defective is important. It allows the reinsurance market collectively to be a little more stable than people imagined.”

That is not to say (re)insurers can breathe a sign of relief. Much uncertainty remains. The early loss estimate ranges are wide and some have yet to factor in the implications of the tsunami.

AIR Worldwide said in its loss estimate that the tsunami was the “main event”. It plans to use Japan Meteorological Agency tsunami wave data, and other information as it becomes available, to estimate the tsunami loss. It will then issue a combined loss estimate for the quake, subsequent fires and tsunami.

There are many other sources of potential loss and complication that are still emerging, such as business interruption and the environmental liability impact of the explosions at the Fukushima Daiichi nuclear power station.

There is also the potential for aftershocks. Mitsui Sumitomo at Lloyd’s – a division of Japan’s largest insurer, MS & AD Group – warned on 16 March that the situation in Japan remained volatile and there was a risk of further significant aftershocks.

Understandably, many companies are shying away from putting even a rough number on initial losses. While some tentative initial estimates have been released – ACE has put its losses at between $200m and $250m – most company statements have said that it is too early to say.

Although some are sceptical that the Japan loss alone would be enough to harden the global reinsurance market, others believe the psychological impact of the event – coming as it does after a busy 2010 catastrophe year and a string of losses already in 2011 – will hit harder than the insured losses.

As one source told Global Reinsurance: “I would be surprised if there was no effect from everything that has gone on.” GR