The world's second largest insurance market is still in a state of transition, finds Shirish Nadkarni

In terms of sheer size, the Japanese insurance market comes second only to the US and boasts an annual premium income of $480bn compared to $1,055bn in the US. In comparison, the UK's insurance market generates a mere $255bn.

Swiss Re has determined that the size of the Japanese life insurance segment is $380bn (compared to $485bn in the US), with the vast majority of the Japanese population opting for life insurance cover. The general insurance segment, however, only bills $100bn a year, marginally more than the size of the UK and German non-life segments. Looking at the wider perspective, one could say that the Japanese insurance market is still in a state of transition, compared to similar markets around the world.

A brief history

Among the important dates in the history of Japan's insurance industry is April 1996, when the Insurance Business Law was amended, and mutual entry was allowed in the life insurance sector through subsidiaries. In addition, the brokerage system was introduced. "For half a century, Japanese non-life insurance companies were required by various regulations to maintain similar business models for their operations as well as offering similar products at similar prices and through similar sales distribution channels," recalls Hiroshi Hirano, president and CEO of Sompo Japan Insurance. "All of this changed, however, as a result of the amendment to the Insurance Business Law. The resultant dynamic easing of restrictions led to unprecedented changes in both the marketplace as well as the players themselves."

A clear differentiation emerged in product strategies as well as actual distribution channels. New players such as direct marketing insurers were able to enter the market. More significantly, the new law set the scene for a complete market reorganisation with mass consolidations and business alliances being created. "These changes were also accelerated by the trend in consumers' own needs diversifying as they became more sophisticated in their product selection," says Hirano. "Looking back at the history of this deregulation shows that it developed in two major ways - the liberalisation of products and premium rates, and the liberalisation of business fields."

Another milestone was in 1998, when the obligation to use premium rates calculated by rating organisations was abolished. The exemption granted to insurers from the Anti-trust Law was abolished, and development of innovative products was enhanced. But the most significant date was 2001 when the general agency system that was to become the backbone of the Japanese insurance system was liberalised. Diversification of the level of agency commission was allowed, and banks were allowed to sell insurance, although the initial range of products was limited.

There were also some dramatic upheavals in 2001, led by the collapse of Tokyo Mutual Life, Japan's 16th largest insurer. It was an indication of the crisis gripping the country's banks and financial institutions. The collapse of Tokyo Life and other insurance firms had its roots in the dramatic decline in the stock market and real estate values from the early 1990s when the financial bubble of the late 1980s burst.

Consolidation and growth

After liberalisation in 2001, several major mergers and acquisitions have taken place. In the last five years, foreign entrants have acquired financially troubled Japanese insurers, particularly in the life segment, in the process gaining a 10% market share. In the non-life sphere, there have been several new entrants; and a few organisations have merged in order to achieve greater economies of scale. As for distribution channels, the agent remains the dominant channel, and occupies 71.7% of the market in the life segment and 93% in the non-life arena.

Despite an expanding economy, Japan's non-life insurance industry, which is regulated by the country's Financial Services Authority, faced growth difficulties in 2005-2006 as competition intensified, particularly in motor insurance which accounts for around half of non-life insurers' total revenues. In addition, claims payments for the year were expected to reach very high levels due to the extreme wind and water damage caused by the ten typhoons that struck Japan in 2004.

Under these circumstances, the amount of direct premiums for all classes of insurance written by General Insurance Association of Japan (GIAJ) member companies in the third quarter of 2005 increased slightly, by 0.2% to Y5,719.1bn, excluding the savings portion of maturity-refund-type insurance. Direct premiums for fire, marine and inland transit insurance registered a positive growth on a year-on-year basis thanks to both the increase in new housing and brisk exports. However, when the savings portion of maturity-refund-type insurance is included, the amount of direct premiums for all classes of insurance decreased by 0.9% to Y6,545bn, due to the effects of the decrease in standard premium rates of compulsory motor liability insurance.

Clear differences are apparent today in the corporate strategies of non-life insurers operating in Japan. "Expanding business opportunities have led to the development of aggressive efforts such as non-life insurance companies establishing life-insurance subsidiaries as well as the sale of medical insurance by the parent companies, with each company seeking to turn changes in the operating environment into profit opportunities," explains Hirano.

Another major change that has dictated the manner in which the non-life segment in Japan functions is the country's socio-demographic situation, with its total population growth heading toward an all-time peak in 2006, supported by a decreasing mortality trend. "We have a combination of an aging society and a reduction in market size for products such as auto insurance, which constitutes almost one half of overall insurance premium income, followed by property insurance, which is the next most important product," says Tadashi Kodama, chairman of the GIAJ. "In general, non-life insurance premium revenues correlate highly with nominal GDP, even if the effects are slightly delayed. However, even if total population is in a decreasing trend, an increase in the percentage of female and elderly workers would stave off any immediate decrease in the overall size of the workforce."

Kodama also feels that the second generation baby-boomers who are currently in their 30s are very likely to be a key driver of personal consumption in the future. This may cause nominal GDP to increase slightly in the short term. "With an aging society, it is anticipated that the role of private insurers in supplementing public-sector insurance systems, such as those providing pensions and medical insurance is expected to continue to grow," he says. Consumer awareness of the importance of medical insurance, which is a central component of the third-sector insurance field, is increasing rapidly. This has lead to estimates that the market will expand by a further Y2trn to Y3trn in the foreseeable future.

Non-life insurers are putting their energies into the sale of such third-sector products which is a reflection of the trend for pursuing new business opportunities. "An increasing number of insurers have made concerted efforts to expand into the third-sector area which includes lines such as medical insurance," says Teruhiko Ohtani, president and CEO of Toa Reinsurance Company. "Remarkable growth has also been seen from some insurers expanding into other insurance markets in Asia, an area which itself is experiencing rapid growth in the insurance sector." There is also a move underway for companies to amend their pension schemes from a defined-benefit basis to one of defined contribution in order to better quantify their future obligations. In this way, it is possible that the trend toward an aging society expressed in Japan's economy will not necessarily lead to an immediate decrease in non-life insurance business, but it could lead to the creation of new business opportunities.

Cat prone market

The GIAJ held its second Exploration for Disaster Prevention Forum in January 2006. "Our member companies have taken measures to grant a moratorium on premium payment and policy renewal to policyholders who suffered from large-scale natural disasters," says Kodama. The GIAJ has been requesting the creation of a premium tax deduction system for earthquake insurance on dwelling risks since 1996, as one of its priority requests for tax reform. The creation of such a deduction system is currently being deliberated in the Diet, Japan's Parliament.

Concurrently, the Non-Life Insurance Rating Organisation of Japan announced on 13 March that the number of contracts in-force for the earthquake insurance on dwelling risks increased by 11.1% over the previous year. Individual insurance companies have also made efforts to increase the dissemination of dwelling risks policies by sending postcards to fire insurance policyholders who had not yet taken out an earthquake insurance policy.

On the reinsurance scene, the effects of natural disasters have made 2004 and 2005 extremely tough years for the industry. Although measures such as contingency reserves enabled insurers to maintain bottom-line profitability for the year, their income actually decreased when compared to the previous fiscal year. Howard Cheetham, managing director of Aon Re Japan and Aon Limited, said, "We may all agree that growth is essential over time, but without damage to shareholders' returns. Margins are being squeezed already. Each area of cost must be analysed and understood as being the most efficient. Objective and scientific measurement has become increasingly important." Cheetham claims that the cost of reinsurance is an important factor. Hence, working with clients to evaluate the efficiency of the company's programmes is one of its key roles.

"We anticipate that our clients will expect their broker to develop this analysis in two directions," he says. "Already we have increased the transparency of the model to allow a more rigorous analysis of the catastrophe reinsurance proposition." Cheetham says this methodology has been welcomed by clients in other markets, where companies are developing their own optimum retention strategies. "In most cases these companies are increasing their retention of risk and, therefore, exposing their balance sheet to the higher probability of damage," he adds. "We are all aware that there exists a basis risk between modelled result and actual performance. If this basis risk is now being assumed on the balance sheet it becomes more important to refine the model to minimise such basis risk."

Regulatory challenges

One of the major challenges facing the Japanese non-life market is the globalisation of regulation in terms of both operating procedures and financial regulations. "Japan must now consider the impact of international accounting standards," says Cheetham. "Whilst the utilisation of finite reinsurance has not been prevalent in Japan, recent developments elsewhere will add to the regulatory scrutiny of the present and future arrangements. The ability to build up catastrophe reserves in a tax advantageous environment, the calculation of solvency margins and consolidation of expanding overseas activities are just some of the factors which Japanese insurers are facing up to."

Another important issue facing the Japanese insurance industry falls under the definition known locally as "unregulated" Kyosai - or mutual aid entities. During 2006, these Kyosai will come within the regulatory authority of FSA and, as such, their relative advantage needs to be neutralised under that regime. "This will create opportunities for all who truly understand the dynamics of the business and expectation of the consumers," says Cheetham. "By definition, brokers will be required to advise their Japanese clients on these and many similar issues."

It should also be noted that overall deregulation of the Japanese insurance industry is scheduled to take place in 2007. Difficulties in negotiations with the insurance industry have pushed back the original timing of deregulation from early-2007 to late-2007. But when it eventually takes place, more consolidation and mergers are expected.

- Shirish Nadkarni is a freelance journalist.