As inflation and its consequences roil global financial markets, preparations for tougher times by Japan's insurers look to have paid off.

The creditworthiness of Japan's insurers will likely remain stable in 2023, in S&P Global Ratings' view. Financial markets will likely continue to fluctuate due to central banks tightening measures globally. However, insurers' accumulated retained earnings and capital bases, enhanced by reduced exposure to market risk, will support their creditworthiness.

For the strongest insurers, however, upside is limited. This is because our sovereign rating on Japan (A+/Stable/A-1) continues to constrain our ratings on insurers.

We expect the moderate rise in domestic interest rates to have a positive impact on life insurers' creditworthiness in Japan. In particular, the rise in the interest rate of super-long-term bonds is likely to improve their economic-value based capital, in our view. This is because it will increase earnings from investments related to yen-denominated bonds, reduce policy reserves burdens, and reduce interest rate risk by insurers extending the maturities of assets.

We anticipate natural catastrophe-related losses will remain the most significant risk factor for domestic non-life insurers. We believe non-life insurers will maintain their capital at a certain level by stabilizing underwriting income and conducting adequate risk management. Still, inflation, stock market volatility, and increased overseas credit risk are on our radar.

Issuance of subordinated bonds by insurers in Japan is likely to slow because of rising funding cost, in our opinion. Needs for issuance have been weakening in the non-life insurance sector for the past few years. This is because non-life insurers have maintained their economic solvency ratios (ESRs) at levels deemed necessary. Meanwhile, life insurers have continued issuing subordinated bonds to enhance their capital bases before the new capital regulations are introduced. Going forward, life insurers will likely issue subordinated bonds to replace existing ones, and new issuance may slow.

Interest rate hikes have reduced unrealized gains from available-for-sale securities. This has pressured shareholders equity under JGAAP. Accordingly, we are watching for rises in financial leverage ratios and falls in solvency margin ratios (SMRs) under the current regulation. SMRs have been plummeting at both life and non-life insurers.

From fiscal 2025, insurers operating in Japan will likely be required to calculate their capital strengths based on new economic-value based solvency regulation. Given that SMR and ESR trend differently, insurers are likely to face difficulty in financial management.

Japan's three non-life insurance groups are Tokio Marine Group, MS&AD Insurance Group, and Sompo Holdings Group. The four major life insurers are: Nippon Life Insurance Co., The Dai-ichi Life Insurance Co. Ltd., Sumitomo Life Insurance Co., and Meiji Yasuda Life Insurance Co.

Macroeconomic Outlook: The Name's Bonds

Japan's real GDP will likely grow 1.2% and its policy rate may turn positive in 2023, in our expectations (see table 1). We believe a rise in domestic interest rates will have a large impact on the insurance sector. In December 2022, the Bank of Japan (BOJ) modified its yield curve control policy. The upper limit it now assigns for 10-year Japanese government bonds (JGBs) is 0.5%, up from 0.25%. As a result, interest rates on the JGBs rose to around 0.5%.

Although the BOJ has maintained very accommodative monetary policy, including keeping policy rates in negative ranges, yields for JGBs have risen to about 1.3% for 20-year bonds and near 1.6% for 30-year bonds, as of Jan. 13, 2023. A rise in domestic interest rates will provide more income from investments in yen-denominated bonds. Accordingly, it will partially mitigate the negative impact of higher hedging costs and fluctuations in stock prices, in our opinion.

Table 1

Life Insurance Sector: Rate Hikes A Plus

Maintaining insurance-related profit and reducing interest rate risk are key.

We expect a moderate increase in domestic interest rates to be a positive factor for Japan's life insurance sector. This is because rates rising would provide life insurers with more income from investments in yen-denominated bonds and reduce policy reserves. Higher interest rates could hurt profits if the yen strengthens as a consequence. However, we believe insurers will manage foreign exchange risk adequately, because they maintain a high proportion of hedged assets. The embedded value (the sum of in-force policies and adjusted net assets) at insurers is likely to improve or remain stable, as the decline in unrealized gains from securities will be offset by an increased value of in-force policies.

Core insurance profit is likely to decrease in fiscal 2022, in our view, due to higher foreign currency hedging costs and a decline in insurance-related profit. The calculation method for core insurance profit changed in fiscal 2022. The new method includes hedging costs for foreign exchange and excludes gains/losses from surrenders of investment trusts and gains/losses relating to reinsurance. Using the new calculation method, we believe aggregate unconsolidated core insurance profit at the four major life insurance companies in fiscal 2021 shrank by about ¥300 billion (see chart 1).

Core insurance profit in the first half (April to September 2022) of fiscal 2022 (full year ending March 31, 2023) decreased ¥174.7 billion from the previous half year result, based on the new calculation method (see chart 1). This is attributable mainly to a ¥357.1 billion, or about 64%, decrease in mortality and mobility margins. Increased payments of insurance claims related to COVID-19, in particular a surge in hospitalization benefits, were behind this. Meanwhile, interest margins increased ¥149.4 billion.

We expect payments related to COVID-19 to decrease in 2023, because of changes in the treatment by insurers of deemed hospitalization (patients who recuperate at home). Since Sept. 26, 2022, insurance claims have been paid only to COVID-19 patients that are at high risk of the disease proving critical.

Meanwhile, we expect hedging costs to push down core insurance profit in 2023. Major insurance groups' profits relating to insurance have been declining in line with decreases in policies in force and increases in information technology costs. Over the next few years, we consider curbing the decrease in insurance-related profits by selling highly profitable protection type products and enhancing cost controls to be major challenges.

Chart 1

We anticipate continued growth of new business. This is for two main reasons. First, we expect sales of saving-type products to increase as interest rates in Japan and abroad rise. Second, we foresee sales of products with survival benefits, mainly in third sector insurance, rising (see chart 2).

Major life insurance groups are likely to continue to pursue multiproduct and multichannel strategies and to expand their overseas businesses. In Japan, the groups have reformed their sales force systems, a focus area, to improve productivity. The groups are also making efforts to combine face-to-face and online sales promotion. In addition, subsidiaries are sharing the supply of products and sales channels. Some subsidiaries are consolidating or establishing agencies that can sell policies from multiple insurers. There are also instances of insurance companies establishing or consolidating subsidiaries that specialize in sales of small-amount and short-term insurance policies. Insurers must win over customers with their products while maintaining profitability, given the severity of competition in the markets for third-sector and savings-type products.

Overseas, the major life insurance groups have been eager to expand business. This is illustrated by the Dai-ichi Life Insurance's acquisition of New Zealand-based Partners Group Holdings Ltd. (Partners Life) in August 2022 and a bolt-on acquisition conducted in October 2022 by StanCorp Financial Group, Meiji Yasuda Life's subsidiary.

Chart 2

With respect to investment performance, we expect major life insurance groups to shift their investment from foreign bonds to super-long-term domestic bonds. In fiscal 2022, the groups are selling hedged foreign bonds because the hedge costs rose as the gap between Japanese and overseas interest rates widened. Some investments shifted toward unhedged open foreign bonds, but the proportion of foreign public and corporate bonds to the entire investment has been decreasing (see chart 3). In addition, about 80% of foreign currency-denominated assets are hedged in aggregate at four companies, even though each group manages foreign currency risk in a different manner. This high proportion of hedged assets suggests companies are cautious toward foreign exchange risk (see chart 4).

The four major life insurance groups are pursuing strategies for reducing interest rate risk. This is in preparation for the introduction of new economic-value based solvency regulation. Accordingly, we expect the groups will continue to shift their assets to domestic super-long-term bonds as interest rates in Japan rise moderately.

Chart 3

Chart 4

Gradual increases in credit investment and nonliquid assets require attention, in our opinion. The groups are likely to maintain their balances of domestic stockholdings by shuffling their portfolios to replace laggards with better performing stocks. At the same time, the groups have been increasing investment in foreign corporate bonds and stocks to secure investment income. Low liquidity assets, such as infrastructure investments and alternative assets, have been also increasing. However, the proportion of these holdings to total assets is small. Each group controls risk strictly by setting upper limits for each type of investment asset. Accordingly, risk volume is unlikely to increase to a degree that threatens the creditworthiness of the groups. Still, we are closely watching trends surrounding credit risk overseas.

We expect the major life insurers to maintain their ESRs at about 200% by accumulating retained earnings and reducing market risk (see chart 5). In the first half of fiscal 2022 (through Sept. 30, 2022), we observed improvement in ESRs at some listed insurers that proactively worked on reducing equity risk and interest rate risk. Mutual insurers have also been enhancing capital bases by accumulating retained earnings and issuing subordinated debt. In addition, they have been making clear efforts to reduce interest rate risk. Consequently, we believe their ESRs will be enhanced.

Chart 5

Non-Life Insurance Sector: It's Mainly About Natural Catastrophe Risk

Equity and credit risk management are key; inflation is a factor

We consider the occurrence of natural catastrophes in Japan and consequent payouts to remain the most significant risk factor for Japan's non-life insurance sector. Extreme weather events continue to occur across the globe, and the severity of the resulting natural catastrophes tends to be increasing.

We expect Japan's three major non-life insurance groups' total consolidated net income to decrease year on year in fiscal 2022 (see chart 6). This is mainly attributable to an increase in net incurred losses from natural catastrophes in Japan and abroad, an increase in insurance claim payouts relating to the pandemic, and a rise of loss ratio of automobile insurance. Net incurred losses from catastrophes in Japan is approaching the level of fiscal 2019, due to damage caused by hailstorms and typhoons Nanmadol and Talas (see chart 7). Overseas, the groups estimate the aggregate net incurred losses of the three major groups on a pretax basis for fiscal 2022 at ¥190.8 billion, up by ¥22.8 billion from the previous fiscal year. This is mainly attributable to damages from floods in South Africa and Hurricane Ian in the U.S.

Chart 6

Chart 7

We anticipate reinsurance premiums for hedging natural catastrophe risk will continue to rise. Premiums for Japan's property lines related to typhoon and flood damage have been increasing (see chart 8). They are likely to go up further following renewals expected in April 2023. In these circumstances, non-life insurance groups are looking to better balance cost and risk. They are doing so by reviewing reinsurance schemes and contractual coverage, while maintaining risk volume for natural catastrophes. For instance, they continue to maintain reinsurance cover related to catastrophe layer reinsurance but may change working layer reinsurance, for which ceded reinsurance rate increases are particularly large, and accept profit volatility to a degree.

Chart 8

In the domestic non-life insurance business, the groups have three challenges in common. These are: improving the profitability of fire insurance, maintaining the profitability of automobile insurance, and achieving growth by offering new types of insurance. Given the intensification of natural disasters, the General Insurance Rating Organization of Japan (GIROJ) raised reference rates repeatedly and reduced policy terms for long-term fire insurance to a maximum of five years, down from 10. This has allowed non-life insurers to seek improvement in profit by raising premium rates and tightening underwriting in fire insurance.

Regarding voluntary automobile insurance, GIROJ proposed a 3.9 percentage points decline on reference rates. However, non-life insurers kept premium rates unchanged or lowered them only marginally in January 2023. Loss ratios on such insurance are rising in fiscal 2022, as people who stayed home during the worst of the pandemic get back behind the wheel. Accordingly, insurers may need to adjust their premium rates again, depending on trends for the cost of repairs.

New types of insurance, especially liability insurance, have been growing. We expect them to drive the growth of domestic non-life insurance business.

Meanwhile, inflation may become a moderately negative factor for the domestic non-life insurance sector, in our view. Prices are rising at a slower pace in Japan than elsewhere, and inflation risk for domestic non-life insurance business has not emerged yet. However, we are closely monitoring trends for insurance claims, adjustments of premium rates, and accumulations of reserves.

Major non-life insurance groups will likely continue to diversify their businesses, in our view. They are pursuing growth in overseas markets while expanding domestic life insurance business to mitigate the risks relating to natural disasters in the home market. The groups are working to diversify their business, as evidenced by bolt-on acquisitions at overseas subsidiaries and investments in insurtech companies.

Non-life insurance groups continue to reduce equity risk and interest rate risk. Equity risk, however, still has relatively large impact on their ESRs. Credit risk overseas is another factor that requires extra attention, in our opinion. Major non-life insurance groups have announced plans to accelerate sales of strategic shareholdings to reduce market risk. In addition, the groups are reducing interest rate risk at their life insurance subsidiaries. Accordingly, their ESRs are becoming less sensitive to such risk. The groups' approaches to foreign exchange risk remain divergent. The impact of fluctuation of foreign exchange rate on their ESRs is neutral for the groups that hedge foreign exchange risk on investments.

Meanwhile, we believe credit risk control will become more important for the groups. This is because they have tended to increase holdings of foreign corporate bonds and equities and alternative assets to improve investment profitability. Although the groups are strictly controlling each asset by establishing upper limits, credit risk may increase, depending on the fortunes of the U.S. economy (see chart 9).

Chart 9

We anticipate the major non-life insurance groups' ESRs will remain within their targets. The groups maintain their ESRs at certain levels by reducing market risk while controlling natural catastrophe risk adequately (see chart 10). Given that pressure for shareholder returns remains strong, the groups are likely to continue to increase dividends. However, the groups will likely conduct share buybacks in a flexible manner, considering a certain level of buffer in their capital.

Chart 10

The Hazards Of Rising Interest Rates

Leverage ratios are up; current solvency margin ratios are down

Japanese insurers' need to issue subordinated debt will likely recede, in our opinion. Issuance of subordinated debt by non-life insurers has been slower for the past few years. This is because these insurers have kept their ESRs at certain levels. Life insurers, however, have been issuing more subordinated debt. They have done so to enhance their capital before introduction of new economic value base regulation (see chart 11). However, we see a possible slowdown of new issuance of this debt in the life insurance sector. Issuance amounts were down and refinancings were deferred in some cases in 2022 because of rises in capital costs.

Chart 11

Insurers' financial leverage ratios may increase, as unrealized gains on securities decrease with interest rates rising. We use financial leverage ratios as one indicator when we evaluate insurers' funding structure. The denominator of the leverage ratio is reported equity (we adjust these at Japanese insurers by adding equity-like reserves). In the first half fiscal 2022, reported equity decreased due to a decline in market value of available-for-sale securities following interest rate hikes in the U.S. and Australia. Given the ongoing moderate rise of interest rates in the domestic market, unrealized gains from securities may continue to decrease. The magnitude of the impact here also depends on how insurers classify securities in their accounting, as amortized costs or on a market value basis. The leverage ratios of domestic major life and non-life insurance groups are below 40%, the threshold at which we evaluate funding structure as moderately negative. Although we consider the ratios are unlikely to exceed 40%, we will closely monitor the trend as we expect the ratios to rise (see chart 12).

Chart 12

We also note SMRs are declining because of decreases in unrealized gains caused by interest rate hikes. SMR has been falling sharply at both life and non-life insurers since the quarter ended March 2022 (see chart 13). The decline is attributable to a decrease in unrealized gains from securities due to a rise in overseas interest rates, as well as to an increase in risk in foreign currency-denominated assets because of the weakening of the yen. Interest rate hikes have a neutral or positive impact on ESR, as it affects both assets and liabilities. Japanese insurers place more weight on ESR than SMR, and they have less incentive to implement measures only to maintain SMRs. Still, we believe SMRs are important, because they serve as triggers for suspending interest payments mandatorily in many contracts for subordinated debt issued by domestic insurers.

Chart 13

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• Insurance Industry And Country Risk Assessment: Japan Property/Casualty, Aug. 21, 2022
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