Japan’s Insurance Industry

During the heydays of the 80s and the first half of 90s, like rest of its economy, Japans insurance industry was growing as a juggernaut. The sheer quantity of premium income and asset formation, sometimes comparable with already the mightiest U.S.A. and the limitation of domestic investment opportunity, led Japanese insurance firms to look outwards for investment. The industrys position as a major international investor beginning in the 1980s brought it under the scanner of analysts around the world.

The global insurance giants tried to set a foothold in the market, eyeing the gargantuan size of the market. But the restrictive character of Japanese insurance laws led to intense, sometimes acrimonious, negotiations between Washington and Tokyo in the mid-1990s. The bilateral and multilateral agreements that resulted coincided with Japans Big Bang financial reforms and deregulation.

Building on the outcome of the 1994 US-Japan insurance talks, a series of liberalization and deregulation measures has since been implemented. But the deregulation course of action was very slow, and more often than not, very selective in protecting the domestic companies interest and market proportion. Although the Japanese economy was comparable with its style in USA in size, the very basis of efficient financial markets – the sound rules and regulations for a competitive economic ecosystem – were conspicuously absent. And its institutional structure was different, too, from the rest of the developed countries.

The kieretsu structure – the corporate group with cross holdings in large number of companies in different industries – was a rare occurrence in Japan. As a consequence, the necessary shareholder activism to force the companies to adopt optimal business strategy for the company was absent. Although initially touted as a form one in the days of Japans wealth, the vulnerability of this system became too apparent when the bubble of the economic expansion went burst in the nineties. Also working against Japan was its inability to keep speed with the software development in other places in the world. Software was the engine of growth in the world economy in the last decade, and countries lagging in this field faced the sagging economies of the nineties.

Japan, the world leader in the brick and mortar industries, surprisingly lagged far behind in the New World economy after the Internet dramatical change. Now Japan is calling the nineties a lost decade for its economy, which lost its sheen following 3 recessions in the last decade. Interest rates nose-dived to historic lows, to thwart the falling economy – in vain. For insurers, whose lifeline is the interest spread in their investment, this wreaked havoc. Quite a few large insurance companies went bankrupt in the confront of negative spread and rising quantity of non-performing assets. While Japanese insurers largely have escaped the scandals afflicting their brethren in the banking and securities industries, they are currently lasting unheard of financial difficulties, including extreme bankruptcies.

Institutional Weaknesses

The Japanese market is a enormous one, however it is comprised of only a few companies. Unlike its USA style, in which around two thousand companies are fiercely competing in the life part, Japans market is comprised of only twenty-nine companies classified as domestic and a handful of foreign entities. The same situation prevailed in 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 is less variety also on the product side. Both the life and non-life insurers in Japan are characterized by plain vanilla offerings. This is more apparent in automobile insurance, where, until recently premiums were not permitted to mirror differential risk, such as, by gender, driving record etc. Drivers were classified in three age groups only for purposes of premium determination, while US rates long have reflected all these factors and others in addition.

The need varies for different types of products, too. Japanese insurance products are more savings-oriented. Similarly, although many Japanese life insurance companies offer a few limited kinds of variable life policies (in which benefits mirror the value of the inner financial assets held by the insurance company, thereby exposing the insured to market risk), there are few takers for such policies. At ¥100=$1.00, Japanese variable life policies in force as of March 31, 1996 had a value of only $7.5 billion, representing a scant 0.08 percent of all life insurance. By contrast, American variable life policies in force as of 1995 were worth $2.7 trillion, approximately 5 percent of the total, with many options, such as variable universal life, obtainable.

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

A without of both price competition and product differentiation implies that an insurance company can grab a firms business and 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 example, ordinarily might shop around for the best deal on the hundreds or thousands of goods and sets it buys. But in the case of non-life insurance, such comparative pricing would be futile, since all companies would offer much the same product at the same price. As a consequence, a Mitsubishi Group company, more often than not, gives business to Tokio Marine & Fire Insurance Co., Ltd., a member of the Mitsubishi keiretsu for decades.

On paper, life insurance premiums have been more flexible. However, the governments role looms large in this part of the industry in addition – and in a way that affects the pricing of insurance products. The nations postal system operates, in addition to its enormous savings system, the postal life insurance system popularly known 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 noticeable, or approximately one per household, and nearly 10 percent of the life insurance market, as measured by policies in force.

Funds invested in Kampo mostly go into a huge fund called the Trust Fund, which, in turn, invests in several government financial institutions in addition as numerous semipublic units that include in a variety of activities associated with government, such as ports and highways. Although the Ministry of Posts and Telecommunications (MPT) has direct responsibility for Kampo, the Ministry of Finance runs the Trust Fund. Hence, theoretically MOF can cause influence over the returns Kampo is able to earn and, by extension, the premiums it is likely to charge.

Kampo has a number of characteristics that influence its interaction with the private sector. As a government-run institution, it inarguably is less efficient, raising its costs, rendering it noncompetitive, and implying a declining market proportion over time. However, since Kampo cannot fail, it has a high risk-tolerance that ultimately could be borne by taxpayers. This implies an expanding market proportion to the extent that this postal life insurance system is able to underprice its products. While the growth scenario presumably is what MPT prefers, MOF seemingly is just as interested in protecting the insurance companies under its wing from excessive competition.

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

Japans life insurance sector also lags behind its American style in formulating inter-company cooperative approaches against the threats of anti-selection and fraudulent activities by individuals. Although the number of companies is far lower in Japan, distrust and disunity among them resulted in secluded approaches in dealing with these threats. In USA, the existence of sector sponsored entities like Medical Information Bureau (MIB) acts as a first line of defense against frauds and in turn saves the industry around $1 Billion a year in terms protective value and sentinel effect. Off late, major Japanese carriers are initiating approaches similar to formation of shared data warehousing and data sharing.

Analysts often complain against insurance companies for their reluctance to to pay attention to prudent international norms regarding disclosure of their financial data to the investment community and their policyholders. This is particularly true because of the mutual characteristic of the companies as compared with their public style in US. For example, Nissan Mutual Life Insurance Co., failed in 1997, generally reported net assets and profits in recent years, already though the companys president conceded after its failure that the firm had been insolvent for years.

Foreign Participation in Life Insurance

Since February 1973, when the American Life Insurance Company (ALICO) first went to Japan to participate in the market, fifteen foreign life insurance companies (with more than 50% foreign capital) are currently in business. However, companies like American Family Life (AFLAC) were initially permitted to function only in the third sector, namely the Medical Supplement Area, like basic illness plans and cancer plans, which were not attractive to Japanese insurance companies. The mainstream life insurance business was kept out of reach of foreign carriers. However, the big turmoil in the industry in the late nineties left many of the domestic companies in thorough financial trouble. In their scurry for protection, Japan allowed foreign companies to acquire the ailing ones and keep them afloat.

Foreign operators continue to go into the Japanese market. As one of the worlds top two life insurance markets, Japan is considered to be as strategically important as North America and the European Union. Consolidation in the Japanese life market, facilitated by the collapse of domestic insurers and by current deregulation, is providing global insurers with chief opportunities to expand their business in Japan. The total market proportion of foreign players is little by little increasing, with global insurers accounting for over 5% in terms of premium incomes at the end of fiscal 1999 and over 6% of individual business in force. These figures are approximately two times higher than those five years earlier.

In 2000, the AXA Group strengthened its base of operations in Japan by the acquisition of Nippon Dantai Life Insurance Co. Ltd, a second-tier domestic insurer with a ineffective financial profile. To this end, AXA formed the first holding company in the Japanese life sector. Aetna Life Insurance Co. followed suit, acquiring Heiwa Life Insurance Co., while Winterthur Group bought Nicos Life Insurance and Prudential UK bought Orico Life Insurance. Also newly active in the Japanese market are Hartford Life Insurance Co., a U.S.-based insurer well known for its variable insurance business, and Frances Cardiff Vie Assurance.

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

The foreign entrants bring with them reputations as part of international insurance groups, supported by popular global track records and strong financial capacity. They are also free of the negative spreads that have plagued Japanese insurers for a decade. Foreign players are better positioned to optimize business opportunities despite turmoil in the market. Although several large Japanese insurers nevertheless rule the market in terms of proportion, 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 the following:

INA Himawari Life
Prudential Life
Manulife Century Life

Skandia Life
GE Edison Life
Aoba Life

Aetna Heiwa Life
Nichidan Life
Zurich Life

ALICO Japan
American Family Life
AXA Nichidan Life

Prudential Life
ING Life
CARDIFF Assurance Vie

NICOS Life

Foreign insurers are expected to be able to prevail over their domestic rivals to some extent in terms of inventive products and dispensing, where they can draw on broader experience in global insurance markets. One immediate challenge for the foreign insurers will be how to establish a large enough franchise in Japan so that they can leverage these competitive advantages.

What ails the life insurance industry?

except its own operational inefficiency, Japans life insurance sector is also a victim of government policies intended in part to rescue edges from financial distress. By keeping short-term interest rates low, the Bank of Japan promoted in the mid-1990s a comparatively wide spread between short-term rates and long-term rates. That benefited edges, 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 insurance companies. Their customers had locked in comparatively high rates on typically long-term investment-kind insurance policies. The drop in interest rates generally meant that returns on insurers assets fell. By late 1997 insurance company officials were reporting that guaranteed rates of return averaged 4 percent, while returns on a favored asset, long-term Japanese government bonds, hovered below 2 percent.

Insurance companies cannot make up for a negative spread already with increased quantity. In FY 1996 they tried to get out of their dilemma by cutting yields on pension-kind investments, only to observe a enormous outflow of money under their management to competitors.

To add insult to injury, life insurance companies are shouldering part of the cost of cleaning up edges non-performing asset mess. Beginning in 1990, the Finance Ministry permitted the issuance of subordinated debt made to order for edges. They can count any funds raised by such instruments as part of their capital, thereby making it easier than otherwise to meet capital/asset ratio requirements in place. This treatment arguably makes sense, inasmuch as holders of such debt, like equity holders, stand almost last in line in the event of bankruptcy.

Subordinated debt carries high rates of interest precisely because the risk of default is higher. In the early 1990s insurers, figuring bank defaults were next to impossible and tempted by the high returns obtainable, lent large amounts to edges 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 Insurance Co., which ranks 16th in Japans life insurance industry on the basis of assets, had approximately 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. edges and securities companies, to which insurers also had lent, began to fail in the mid-1990s. The collapse of Sanyo Securities Co., Ltd. last fall was precipitated in part by the refusal of life insurance companies to roll over the brokerage firms subordinated loans. Life insurers complained that they sometimes were not paid off already when the conditions of a bank failure implied that they should have been. For example, Meiji Life Insurance Co. reportedly had ¥35 billion ($291.7 million) noticeable in subordinated debt to Hokkaido Takushoku Bank, Ltd. when the bank collapsed in November. already though the Hokkaido bank did have some good loans that were transferred to North Pacific Bank, Ltd., Meiji Life was not compensated from these assets. It seemingly will have to write off the complete loan balance.

Subordinated debt is only part of the bad-debt story. Insurance companies had a role in nearly every large-extent, half-baked lending scheme that collapsed along with the bubble economy in the early 1990s. For example, they were lenders to jusen (housing finance companies) and had to proportion in the costly cleanup of that mess. additionally, like edges, 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 comparatively high prices, with the consequence that, at 1997s year-end depressed stock prices, all but two middle-tier (size rank 9 to 16) life insurance companies had unrealized net losses.

What Lies Ahead

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

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

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

The investment market has been already worse than expected. Interest rates have not risen from historically low levels. The Nikkei index has sagged since January 2001, and plummeted to 9 year low following recent terrorist attack on American soil. Unrealized gains used to provide some cushion for most insurers, but, depending on the insurers reliance on unrealized gains, the volatility of retained earnings is now affecting capitalization levels and consequently financial flexibility.

Table 1
Major Risks Facing Japanese Life Insurance Companies

Business risks
Financial risks

ineffective Japanese economy
Strong earnings pressures

without 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 Japans life insurers confront problems of both solvency and liquidity. Heavy contractual obligations to policyholders, shrinking returns on assets, and little or no cushion from unrealized gains on stock portfolios combine to make the continued viability of some companies far from certain. Many others, while clearly solvent, confront the risk that they will have to pay off uneasy policyholders earlier than they had planned. Either solvency or liquidity concerns raise the question as to how insurers will manage their assets. Another factor that has to be considered is Japans aging population. As Mr. Yasuo Satoh, Program Manager of insurance industry, finance sector, IBM Japan, points out, The industry needs to change the business form. They have to concentrate on life benefits instead of death benefits and they have to press on Medical Supplement and long term care sectors as the overall population is aging.

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

Over the long term, Japanese insurers are likely to forge business alliances based on demutualization. extensive consolidation in Japans financial markets over the near term will bring about an overhaul of the life insurance sector in addition. Although domestic life insurers announced various business strategies in the latter half of 2000 to respond to this sea change, the actual assistance of various planned alliances for each insurer remains uncertain. Further market consolidation should add value for policyholders, at the minimum, making obtainable a wider range of products and sets. To succeed, life insurers will have to be more sensitive to different customers needs, while at the same time establishing new business models to obtain their earning base. Long term prospects seem to be good considering the high saving rate of Japanese population. But in the short term, Japan is poised to see a few more insurers succumb before the sector tightens its bottom line with sweeping reforms and prudent investment and disclosure norms.