Earthquake in Japan has long been one of the world’s most significant perils. It has been and - continues to be - tightly managed through explicit solvency or risk-based capital regulation, not to mention continually upgraded building construction codes and a disciplined insurance industry that manages earthquake risk in a controlled manner.
Insurance Market Structure in Japan
Property and casualty insurance in Japan falls into two main categories. The first consists of the non-life sector, which includes domestic stock companies and foreign insurers licensed in Japan. These companies are regulated by the Financial Services Authority (FSA). The second is the co-operative, or mutual, sector - otherwise known as “kyosai.” These companies are regulated by their respective ministries. Companies in the first category represent approximately 77 percent of the property and casualty insurance market, with the co-operative sector representing approximately 23 percent.
There are fundamental differences between the two sectors, and they will become salient through a closer look at how they cover earthquake risk.
For dwelling risks, for example, non-life companies provide optional coverage for earthquake by way of endorsement to the standard fire policy. Coverage protects buildings and contents from earthquake shock, fire following earthquake, tsunami and volcanic eruption. Insurance protection is limited to 50 percent of the fire sum insured and subject to maximum monetary caps - currently JPY50 million for buildings and JPY10 million for contents. To put this into some perspective we estimate the average cost of a new home in the affected area to be less than USD200,000, with many of the affected properties with a value considerably less than this.
Earthquake penetration for non-life companies varies by region and on average is roughly 23 percent of all households in Japan and in the three worst affected prefectures around 21 percent.
Dwelling earthquake policies issued by non-life companies are retained entirely within the country by way of a government-supported scheme managed by the Japanese Earthquake Reinsurance Company (JERC). Insurers are not allowed to arrange reinsurance on their retained portion and the JERC does not purchase in the international market.
In addition to the optional earthquake coverage, non-life insurers provide a limited amount of cover for fire following earthquake. This is expense insurance automatically attached to the majority of fire policies. This coverage is known as earthquake fire expense insurance (EFEI). Coverage is limited to 5 percent of the fire sum insured, with a monetary cap of JPY3 million (USD30,000) for dwelling.
EFEI cover can be reinsured to the overseas reinsurance market and is generally included within earthquake catastrophe excess of loss programs, although some coverage is purchased on a standalone basis.
Earthquake dwelling policies issued by co-operatives have a variety of different policy conditions which are subject to the approval or notification of the respective governing ministry. They differ from the cover available in the non-life sector.
The co-operatives are not members of the government earthquake scheme and are free to reinsure their insureds’ earthquake exposures outside Japan in the international reinsurance market. This is generally arranged through catastrophe excess of loss. Consequently, the co-operative sector represents a significant percentage of catastrophe limit purchase in Japan.
In the industrial and commercial segment, earthquake risks are predominantly the domain of the non-life companies rather than the co-operatives. Industrial earthquake insurance has always been a tightly controlled market, and following deregulation in 1996, the variety of policies and coverage sold to corporate customers has increased. Even with this growth, exposures continue to be managed effectively.
Industrial earthquake is an endorsement to the standard fire policy. In addition to shock, fire following earthquake, tsunami and volcanic eruption are also covered. Overall the take-up rate remains relatively modest. Penetration of loss of profits or business and contingent business interruption caused by earthquake is also limited. Guy Carpenter estimates that this represents less than 15 percent of total country-wide earthquake limit.
Non-life insurers cede around 50 percent of their industrial earthquake exposure through proportional treaties. Often these are stand alone earthquake quota shares. The net account is protected by excess of loss which often also includes EFEI.
Other classes covering earthquake include cargo, motor, personal accident and engineering/moveable all risks.
- Cargo: earthquake coverage is given for import and export cargoes but is normally excluded from inland transit and coastal business
- Motor: earthquake coverage for automobiles can be purchased by optional endorsement and the take-up ratio is extremely limited
- Personal accident: earthquake coverage issued under personal accident policies is by way of endorsement and has a broader penetration
- Engineering/moveable all risks: coverage for engineering is provided once again on a restricted basis and reinsured in a variety of different ways
The Earthquake Loss in Japan
It is still too early to give any accurate prediction of the loss amount, but the modeling companies have provided a variety of loss estimates. All Japanese insurers and co-operatives are working tirelessly to adjust and settle claims and it will take some time before an accurate loss figure is known.
At present, Guy Carpenter estimates that between 50 percent and 60 percent of the gross insured loss will be retained in Japan, with around 10 percent ceded proportionally and between 30 percent and 40 percent ceded to catastrophe excess of loss, facultative and other reinsurance classes.
Unlike the recent losses in Chile, New Zealand and Australia, the Japanese market will retain a significant portion of the loss. This is as a result of the dwelling earthquake scheme, which is not ceded to the international market, as well as the high retentions of some of the larger non-life insurers and co-operatives. Further, a number of the earthquake excess of loss programs will not be impacted by loss, generally those in the 2 percent to 3 percent rate on line range. Those likely to be impacted are generally in the higher rate on line range and could be expected to suffer a loss in an event of this magnitude.
Now, let’s take a look at what happened at the most recent renewal.
Despite the earthquake, non-life insurers were able to renew unchanged capacity for earthquake pro rata treaties at the April 1, 2011 reinsurance renewal. In most (but not every) case, commissions were reduced by up to 3 percent. For programs protecting the net account, rates for renewing treaties increased by 15 percent to 50 percent, in some cases, with loss escalators attached. In addition to the renewing treaties, some of the larger non-life and co-operative companies opted to extend their programs for up to three months.
It was a similar story for cargo programs, where we saw prices increase up to 40 percent depending on perceived loss activity. Personal accident saw more modest movement in pricing but again rates increased. For standalone windstorm programs, insurers had been anticipating reductions prior to March 11, 2011. Ultimately this was not possible and the result was that windstorm rates increased by 3 percent to 10 percent. For the non catastrophe classes, fire pro rata and excess of loss treaties that excluded earthquake generally had a smooth renewal. Similarly, general third party liability excess of loss covers and credit and bond treaties enjoyed a stable renewal.
When we look back on the event, it appears that the market structure has performed well, allowing for the sharing of loss amongst a variety of stakeholders with reinsurance programs responding in the manner they were designed. Following the largest earthquake to hit an industrialized country two weeks prior to inception, all treaties were renewed or extended before April 1, 2011, and this is a great testament to the Japanese insurance industry operating under extremely adverse scenarios in the weeks following the loss.
Although it was not always an easy renewal, it is also a credit to the reinsurance community that they have responded by renewing catastrophe lines with similar capacity, adjusting terms and conditions to reflect anticipated experience and, generally speaking, renewing the non-catastrophe treaties in a stable manner.
This week, Guy Carpenter is running a series of articles about the state of the reinsurance market in Japan that can be used to help you manage your capital effectively. To have these articles delivered directly to your inbox every day, click here to register for our GC Capital Ideas alerts.