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Japan's Insurance Industry


During the heydays of the 80's and therefore the half of 90's, like remainder of its economy, Japan's insurance industry was growing as a juggernaut. The sheer volume of premium income and asset formation, sometimes comparable even the mightiest U.S.A. and therefore the limitation of domestic investment opportunity, led Japanese insurance firms to seem outwards for investment. The industry's position as a serious international investor beginning within the 1980's brought it under the scanner of analysts round the world.

The global insurance giants tried to line an edge within the market, eyeing the gargantuan size of the market. But the restrictive nature of Japanese insurance laws led to intense, sometimes acrimonious, negotiations between Washington and Tokyo within the mid-1990s. The bilateral and multilateral agreements that resulted coincided with Japan's explosion financial reforms and deregulation.

Building on the result of the 1994 US-Japan insurance talks, a series of liberalization and deregulation measures has since been implemented. But the deregulation process was very slow, and more often than not, very selective in protecting the domestic companies interest and market share. Although the japanese economy was comparable its counterpart in USA in size, the very basis of efficient financial markets - the sound rules and regulations for a competitive economic environment - were conspicuously absent. And its institutional structure was different, too, from the remainder of the developed countries.

The kieretsu structure - the company group with cross holdings in sizable amount of companies in several industries - was a singular phenomenon in Japan. As a result, the required shareholder activism to force the businesses to adopt optimal business strategy for the corporate was absent. Although initially touted as a model one within the days of Japan's prosperity, the vulnerability of this technique became too evident when the bubble of the economic boom went burst within the nineties. Also working against Japan was its inability to stay pace with the software development elsewhere within the world. Software was the engine of growth within the world economy within the last decade, and countries lagging during this field faced the sagging economies of the nineties.

Japan, the planet leader within the "brick and mortar" industries, surprisingly lagged far behind within the "New World" economy after the web revolution. Now Japan is looking the nineties a "lost decade" for its economy, which lost its sheen following 3 recessions within the last decade. Interest rates nose-dived to historic lows, to thwart the falling economy - vainly . For insurers, whose lifeline is that the interest spread in their investment, this wreaked havoc. quite few large insurance companies went bankrupt within the face of "negative spread" and rising volume of non-performing assets. While Japanese insurers largely have escaped the scandals afflicting their brethren within the banking and securities industries, they're currently enduring unprecedented financial difficulties, including catastrophic bankruptcies.

Institutional Weaknesses

The Japanese market may be a gigantic one, yet it's comprised of only a couple of companies. Unlike its USA counterpart, during which around two thousand companies are fiercely competing within the life segment, Japan's market is comprised of only twenty-nine companies classified as domestic and a couple of foreign entities. an equivalent situation prevailed within the non-life sector with twenty-six domestic companies and thirty-one foreign firms offering their products. So, consumers have far fewer choices than their American counterparts in choosing their carrier. there's less variety also on the merchandise side. Both the life and non-life insurers in Japan are characterized by "plain vanilla" offerings. this is often more apparent in car insurance , where, until recently premiums weren't permitted to reflect differential risk, such as, by gender, driving record etc. Drivers were classified in three age groups just for purposes of premium determination, whereas US rates long have reflected of these factors et al. also .

The demand varies for various sorts of products, too. Japanese insurance products are more savings-oriented. Similarly, although many Japanese life assurance companies offer a couple of limited sorts of variable life policies (in which benefits reflect the worth of the underlying financial assets held by the insurance firm , thereby exposing the insured to plug risk), there are few takers for such policies. At ¥100=$1.00, Japanese variable life policies effective as of March 31, 1996 had a worth of only $7.5 billion, representing a scant 0.08 percent of all life assurance . against this , American variable life policies effective as of 1995 were worth $2.7 trillion, roughly 5 percent of the entire , with many options, like variable universal life, available.

Japanese insurance companies in both parts of the industry have competed but their American counterparts. In an environment where a couple of firms offer a limited number of products to a market during which new entry is closely regulated, implicit price coordination to restrain competition would be expected. However, factors peculiar to Japan further reduce rivalry.

A lack of both price war and merchandise differentiation implies that an insurance firm can grab a firm's business then keep it almost indefinitely. American analysts sometimes have noted that keiretsu (corporate group) ties are just such an excuse. A member of the Mitsubishi Group of companies, for instance , ordinarily might go searching for the simplest deal on the hundreds or thousands of products and services it buys. But within the case of non-life insurance, such comparative pricing would be futile, since all companies would offer much an equivalent product at an equivalent price. As a result, a Mitsubishi Group company, more often than not, gives business to Tokio Marine & insurance Co., Ltd., a member of the Mitsubishi keiretsu for many years .

On paper, life assurance premiums are more flexible. However, the government's role looms large during this a part of the industry also - and during a way that affects the pricing of insurance products. The nation's postal system operates, additionally to its enormous savings system, the postal life assurance system popularly referred to as Kampo. Transactions for Kampo are conducted at the windows of thousands of post offices. As of March 1995, Kampo had 84.1 million policies outstanding, or roughly one per household, and nearly 10 percent of the life assurance market, as measured by policies effective .

Funds invested in Kampo mostly enter an enormous fund called the fund , which, in turn, invests in several government financial institutions also as numerous semipublic units that engage during a sort of activities related to government, like ports and highways. Although the Ministry of Posts and Telecommunications (MPT) has direct responsibility for Kampo, the Ministry of Finance runs the fund . Hence, theoretically MOF can exert influence over the returns Kampo is in a position to earn and, by extension, the premiums it's likely to charge.

Kampo features a number of characteristics that influence its interaction with the private sector. As a government-run institution, it inarguably is a smaller amount efficient, raising its costs, rendering it noncompetitive, and implying a declining market share over time. However, since Kampo cannot fail, it's a high risk-tolerance that ultimately might be borne by taxpayers. this suggests an expanding market share to the extent that this postal life assurance system is in a position to underprice its products. While the expansion scenario presumably is what MPT prefers, MOF seemingly is simply as curious about protecting the insurance companies under its wing from "excessive" competition.

The net effect of those conflicting incentives is that Kampo appears to restrain the premiums charged by insurers. If their prices go up excessively, then Kampo will capture additional share. In response, insurers may roll back premiums. Conversely, if returns on investments or greater efficiency reduce private-sector premiums relative to the underlying insurance, Kampo will lose market share unless it adjusts.

Japan's life assurance sector also lags behind its American counterpart in formulating inter-company cooperative approaches against the threats of anti-selection and fraudulent activities by individuals. Although the amount of companies is way lower in Japan, distrust and disunity among them resulted in isolated approaches in handling these threats. In USA, the existence of sector sponsored entities like Medical Information Bureau (MIB) acts as a primary line of defense against frauds and successively saves the industry around $1 Billion a year in terms protective value and sentinel effect. Off late, major Japanese carriers are initiating approaches almost like formation of common data warehousing and data sharing.

Analysts often complain against insurance companies for his or her reluctance to stick to prudent international norms regarding disclosure of their financial data to the investment community and their policyholders. this is often particularly true due to the mutual characteristic of the businesses as compared with their "public" counterpart in US. for instance , Nissan Mutual life assurance Co., failed in 1997, generally reported net assets and profits in recent years, albeit the company's president conceded after its failure that the firm had been insolvent for years.

Foreign Participation in life assurance 

Since February 1973, when the American life assurance Company (ALICO) first visited Japan to participate within the market, fifteen foreign life assurance companies (with quite 50% foreign capital) are currently in business. However, companies like American Family Life (AFLAC) were initially permitted to work only within the third sector, namely the Medical Supplement Area, like critical illness plans and cancer plans, which weren't attractive to Japanese insurance companies. The mainstream life assurance business was kept out of reach of foreign carriers. However, the large turmoil within the industry within the late nineties left many of the domestic companies in deep financial trouble. In their scurry for cover , Japan allowed foreign companies to accumulate the ailing ones and keep them afloat.

Foreign operators still enter the japanese market. together of the world's top two life assurance markets, Japan is taken into account to be as strategically important as North America and therefore the European Union . Consolidation within the Japanese life market, facilitated by the collapse of domestic insurers and by ongoing deregulation, is providing global insurers with prime opportunities to expand their business in Japan. the entire market share of foreign players is gradually increasing, with global insurers accounting for over 5% in terms of premium incomes at the top of fiscal 1999 and over 6% of individual business effective . These figures are roughly twice above those five years earlier.

In 2000, the AXA Group strengthened its base of operations in Japan through the acquisition of Nippon Dantai life assurance Co. Ltd, a second-tier domestic insurer with a weak financial profile. to the present end, AXA formed the primary company within the Japanese life sector. Aetna life assurance Co. followed suit, acquiring Heiwa life assurance Co., while Winterthur Group bought Nicos life assurance and Prudential UK bought Orico life assurance . Also newly active within the Japanese market are Hartford life assurance Co., a U.S.-based insurer documented for its variable insurance business, and France's Cardiff Vie Assurance.

In addition, Manulife Century, subsidiary of Manufacturers life assurance Company inherited the operations and assets of Daihyaku Mutual life assurance Co., which had failed in May 1999. In April 2001, AIG life assurance Co. assumed the operations of Chiyoda Life, and Prudential life assurance Co. Ltd. took over Kyoei Life. Both the japanese companies filed for court protection last October.

The foreign entrants bring with them reputations as a part of international insurance groups, supported by favorable global track records and powerful financial capacity. they're also freed from the negative spreads that have plagued Japanese insurers for a decade. Foreign players are better positioned to optimize business opportunities despite turmoil within the market. Although several large Japanese insurers still dominate the market in terms of share, the dynamics are changing as existing business blocks shift from the domestic insurers, including failed companies, to the newcomers in line with policyholders' flight to quality. The list of companies, with foreign participation, is that the following:

INA Himawari Life
Prudential Life
Manulife Century Life

Skandia Life
GE Edison Life
Aoba Life

Aetna Heiwa Life
Nichidan Life
Zurich Life

American Family Life
AXA Nichidan Life

Prudential Life
ING Life
CARDIFF Assurance Vie


Foreign insurers are expected to be ready to prevail over their domestic rivals to some extent in terms of innovative products and distribution, where they will draw on broader experience in global insurance markets. One immediate challenge for the foreign insurers are going to be the way to establish an outsized enough franchise in Japan in order that they will leverage these competitive advantages.

What ails the life assurance industry?

Apart from its own operational inefficiency, Japan's life assurance sector is additionally a victim of state policies intended partially to rescue banks from financial distress. By keeping short-term interest rates low, the Bank of Japan encouraged within the mid-1990s a comparatively wide spread between short-term rates and long-term rates. That benefited banks, which tend to pay short-term rates on their deposits and charge long-term rates on their loans.

The same policy, however, was detrimental to life assurance companies. Their customers had locked in relatively high rates on typically long-term investment-type insurance policies. The drop by interest rates generally meant that returns on insurers' assets fell. By late 1997 insurance firm officials were reporting that guaranteed rates of return averaged 4 percent, while returns on a popular asset, long-term Japanese government bonds, hovered below 2 percent.

Insurance companies cannot structure for a negative spread even with increased volume. In FY 1996 they tried to urge out of their dilemma by cutting yields on pension-type investments, only to witness a huge outflow of cash under their management to competitors.

To add insult to injury, life assurance companies are shouldering a part of the value of cleaning up banks' non-performing asset mess. Beginning in 1990, the Finance Ministry permitted the issuance of subordinated debt made to order for banks. they will count any funds raised through such instruments as a part of their capital, thereby making it easier than otherwise to satisfy capital/asset ratio requirements in situ . This treatment arguably is sensible , inasmuch as holders of such debt, like equity holders, stand almost last in line within the event of bankruptcy.

Subordinated debt carries high rates of interest precisely because the danger of default is higher. within the early 1990s insurers, figuring bank defaults were next to impossible and tempted by the high returns available, lent large amounts to banks and other financial institutions on a subordinated basis. Smaller companies, perhaps out of eagerness to catch up with their larger counterparts, were especially big participants. Tokyo Mutual life assurance Co., which ranks 16th in Japan's life assurance industry on the idea of assets, had roughly 8 percent of its assets as subordinated debt as of March 31, 1997, while industry leader Nippon Life had only 3 percent.

The rest, of course, is history. Banks and securities companies, to which insurers also had lent, began to fail within the mid-1990s. The collapse of Sanyo Securities Co., Ltd. last fall was precipitated partially by the refusal of life assurance companies to roll over the brokerage firm's subordinated loans. Life insurers complained that they often weren't paid off even when the conditions of a failure implied that they ought to are . for instance , Meiji life assurance Co. reportedly had ¥35 billion ($291.7 million) outstanding in subordinated debt to Hokkaido Takushoku Bank, Ltd. when the bank collapsed in November. albeit the Hokkaido bank did have some good loans that were transferred to North Pacific Bank, Ltd., Meiji Life wasn't compensated from these assets. It apparently will need to write off the whole loan balance.

Subordinated debt is merely a part of the bad-debt story. Insurance companies had a task in nearly every large-scale, half-baked lending scheme that collapsed along side the bubble economy within the early 1990s. for instance , they were lenders to jusen (housing finance companies) and had to share within the costly cleanup of that mess. Moreover, like banks, insurers counted on unrealized profits from their equity holdings to bail them out if they got into trouble. Smaller insurers of the bubble period bought such stock at relatively high prices, with the result that, at 1997's year-end depressed stock prices, about two middle-tier (size rank 9 to 16) life assurance companies had unrealized net losses.

What Lies Ahead

Analysts have identified the subsequent short-term challenges to the sector:

New market entrants;
Pressure on earnings;
Poor asset quality; and,

The recent high-profile failures of several life assurance companies have turned up the pressure on life companies to deal with these challenges urgently and in recognizable ways.

The investment market has been even worse than expected. Interest rates haven't risen from historically low levels. The Nikkei index has sagged since January 2001, and plummeted to 9 year low following recent surprise attack on American soil. Unrealized gains wont to provide some cushion for many insurers, but, counting on the insurers' reliance on unrealized gains, the volatility of retained earnings is now affecting capitalization levels and thus financial flexibility.

Table 1
Major Risks Facing Japanese life assurance Companies

Business risks
Financial risks

Weak Japanese economy
Strong earnings pressures

Lack of policyholder confidence, flight to quality
Low interest rates, exposure to domestic, overseas investment market fluctuations

Deregulation, mounting competition
Poor asset quality

Inadequate policyholders' safety net
Weakened capitalization

Accelerating consolidation within life sector, with other financial sectors
Limited financial flexibility

Most analysts probably would agree that Japan's life insurers face problems of both solvency and liquidity. Heavy contractual obligations to policyholders, shrinking returns on assets, and tiny or no cushion from unrealized gains on stock portfolios combine to form the continued viability of some companies faraway from certain. Many others, while obviously solvent, face the danger that they're going to need to pay off uneasy policyholders before that they had planned. Either solvency or liquidity concerns raise the question on how insurers will manage their assets. Another factor that has got to be considered is Japan's aging population. As Mr. Yasuo Satoh, Program Manager of insurance industry, finance sector, IBM Japan, points out, "The industry must change the business model. they need to consider life benefits instead of death benefits and that they need to emphasize on Medical Supplement and future care sectors because the overall population is aging."

Japanese life insurers are actively pursuing greater segmentation, while seeking to determine unique strategies both in traditional life and non-life businesses. In late 2000, the world witnessed the emergence of several business partnerships and cross-border alliances involving large domestic life insurers. Anticipating increased market consolidation, heated competition, and full liberalization of third-sector businesses, the businesses are reviewing their involvement through subsidiaries within the non-life side of the business, which was first allowed in 1996.

Over the future , Japanese insurers are likely to forge business alliances supported demutualization. Widespread consolidation in Japan's financial markets over the near term will cause an overhaul of the life assurance sector also . Although domestic life insurers announced various business strategies within the latter half 2000 to reply to the present transformation , the particular advantage of various planned alliances for every insurer remains uncertain. Further market consolidation should add value for policyholders, at least, making available a wider range of products and services. To succeed, life insurers will need to be more sensitive to diverse customers needs, while at an equivalent time establishing new business models to secure their earning base. future prospects seem to be good considering the high saving rate of Japanese population. But within the short term, Japan is poised to ascertain a couple of more insurers succumb before the world tightens its bottom line with sweeping reforms and prudent investment and disclosure norms.

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