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Japanese insurers

Non-life insurers may be more vulnerable than they look

Dateline: TOKYO

THREE big earthquakes, one measuring around 6.2 on the Richter scale, struck north-eastern Japan on July 26th. More than 600 people were injured and more than 5,800 buildings damaged. A week earlier, torrential rain and mudslides killed 22 people, washing away houses and cars in rural areas of Kyushu, in the south of Japan. In Fukuoka, Kyushu's biggest city, the downpour flooded the main railway station and deluged hundreds of businesses for the second time in four years.

The bill for much of this will be picked up by Japan's insurers. Despite the rising cost of such events, however, the country's non-life insurers do not seem to be setting aside enough reserves to cover future disasters. Should a couple of huge catastrophes occur within several years of each other, there are concerns that some might have to dip into, and perhaps exhaust, their capital to cover the shortfall. The Financial Services Agency (FSA), the insurers' regulator, is worried. It wants to tighten rules on how to set aside reserves for natural disasters by April 2004, and is currently studying a report by an industry committee on what to do.

Japan's non-life insurance industry, which has assets of ¥33 trillion ($270 billion), is smaller, but healthier, than the country's deeply troubled life insurers. Like life firms, non-life insurers have suffered as stockmarkets have fallen and dented their share portfolios; but strict regulations have prevented them from making the poor credit decisions that have left life insurers and banks with enormous bad debts. Whereas life insurers were locked into long-term contracts with high pay-outs even though investment returns were plummeting, the non-life trade has been steadier. About half the industry's premiums come from car insurance, for which policies are renewed annually.

Yet in the past year or so, non-life insurers have been selling a growing number of long-term fire-insurance policies (which in Japan cover more general damage to property) that may commit them to huge pay-outs for natural disasters. Since deregulation in 1998, they have faced intense competition from foreign entrants. The car-insurance market is saturated. Meanwhile, the risk of fire damage has fallen because building materials have become more fire-resistant.

Rather than cut fire-insurance premiums, insurers have thrown in extra natural-disaster cover for the same price. Since restrictions were lifted in October 2001, insurers have been selling more fire cover through banks, offering 20- or 30-year policies to customers taking out mortgages. Because these policies are not rewritten annually, companies cannot bump up premiums every year.

However, insurers' reserves are linked to premium income, which has been falling, not to the risks covered, which are increasing. The non-life industry has around ¥800 billion of reserves for fire and natural-disaster insurance. Its biggest natural-disaster pay-out so far, after a typhoon in 1991, is ¥568 billion. Insurers think a similar typhoon now would cost ¥700 billion. A serious flood of the Tone river, just north of Tokyo and Japan's second-longest, would cost a lot more. Admittedly, reinsurers would pay something. But insurers have found reinsurance dearer and harder to get in the past couple of years.

So far the industry is not resisting the FSA's plans, though that might change if new rules requiring extra provisions pushed some firms into the red. In any event, the FSA has learnt from mistakes made in the 1980s by its predecessor, which ignored problems in the banking and life-insurance industries until it was too late. This time, the regulator seems determined to force non-life insurers to fix the problem while they still can.

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