S&P Reports First Half Results in Japan’s P/C Sector Show Companies Still Under Pressure

November 30, 2004

Standard & Poor’s Ratings Services has issued a report noting that Japanese non-life insurance companies recently released results of for the first half of fiscal 2004, which indicate that underwriting profitability remains under pressure.

S&P also noted: “While the impact of natural disasters in 2004 both in Japan and overseas was ultimately limited, the industry is significantly exposed to risks from damage caused by typhoons and earthquakes.”

The report found that overall the non-life insurance business has deteriorated “due to a significant increase in insurance claims paid, including reserves for outstanding claims for damages caused by typhoons. In addition to the enormous natural disaster risk that emerged during fiscal 2004 (ending March 31, 2005), stagnant growth in premium income continues to place downward pressure on insurers’ profitability.”

S&P observed, however, that the results for the fiscal 2004 first half indicate that the “non-life insurers should be able to withstand deterioration from weak underwriting performance resulting from the impact of natural disasters, thanks to the companies’ strong balance sheets, and that the outlook on the non-life insurance industry remains stable.”

According to the report “the nine Japanese non-life insurance companies’ total underwriting performance dropped significantly to a loss of ¥119.2 billion [$1.17 billion] from ¥149.5 billion [$1.465 billion] profit in the same period last year, mainly due to additional provisions in reserves for outstanding claims from record typhoon damage.

“Underwriting profits were recorded far below initial projections in the first half of fiscal 2004. While revenue from third sector and new types of insurance policies increased, net premiums from the core automobile insurance business, which accounted for about 50 percent of net premiums written, decreased by 2.0 percent year on year. Total net premiums also declined by 0.2 percent year on year, which continues to place downward pressure on growth in the core insurance business.”

Japan’s P/C insurers and their subsidiaries were to a lesser extent also impacted by natural disasters overseas, such as the hurricanes in Florida, in addition to major domestic disasters, such as the Chuetsu Earthquake in Niigata Prefecture. S&P said that the events were not significant enough to trigger rating changes.

The rating agency also said: “The non-life insurers’ asset investment performance is relatively stable. Japanese non-life insurers have relatively large domestic equity portfolios, and their profitability and capitalization have been affected by fluctuations in stock prices. Due to the relatively stable performance of the stock market at the beginning of fiscal 2004, revaluation losses and losses on sales of domestic stock were limited. Each company is making efforts to reduce its cross-shareholdings to varying degrees. Investments in corporate and public bonds are increasing due to a shift to fixed income assets, from which stable profits are expected. As a result of such efforts, total interest and dividend income for the nine companies, which had been decreasing for the past years, increased by 2.6 percent, while interest rates remain low. In the medium term, the companies will continue to build up stable profitable bases and capitalization that are better insulated from stock price fluctuation.”

S&P did indicate, however that it expects the insurance companies’ capitalization to deteriorate “from the partial withdrawal of catastrophe reserves at the end of fiscal 2004. However, the industry overall had enhanced capitalization from accumulating profits and catastrophe reserves due to fewer natural disasters in previous fiscal years. The General Insurance Association of Japan announced that as of Nov. 17, 2004, total insurance claims paid in fiscal 2004 by the overall non-life insurance industry for damages caused by natural disasters, including Typhoon Tokage on Oct. 19, 2004, are expected to exceed ¥500 billion [$4.9 billion] before the collection of reinsurance.

“However, nine companies have built up more than ¥1.5 trillion [$14.7 billion] for their catastrophe reserves especially for their fire and automobile insurance segments, which is slightly over 3x the estimated total amount for insurance claims paid. Given the insurers’ ample capital bases other than their catastrophe reserves, the insurers are expected to be able to sufficiently cover the insurance claims.”

Those reserves are necessary, as Japan’s exposure to natural disasters – both typhoons and earthquakes – means that its non-life insurance industry “bears enormous risks.” S&P warned that the “insurers’ balance sheets could deteriorate if similar major disasters continue in the next several years.”

The market is also subject to tough competition. In order to insure profits S&P found that “large insurers will face a number of challenges, including:
— Minimizing downward pressure on net premiums written from automobile insurance by reinforcing professional sales agencies, which are the insurance companies’ core channels;
— Reducing operating expenses through further improving efficiency; and
— Enhancing and diversifying profits through injections of resources into growth areas, such as third sector and new types of insurance, reinsurance business, overseas businesses in Asian countries for both Japanese clients and non-Japanese clients overseas.

“Small-to-midsize insurers will face the challenge of securing profits in niche markets by differentiating themselves from larger competitors, and further utilizing business and capital tie-ups. Also, on the balance sheet side, a key challenge for all of the Japanese non-life insurance companies will be to strengthen their financial bases by reducing their cross-held equity holdings and, in conjunction, reduce their sensitivity to stock market fluctuations.”

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