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Fitch: Japanese Earthquake Losses Appear Manageable for Insurers and Reinsurers

Posted on 15 Mar 2011

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Fitch Ratings released an announcement, stating that it believes that while the March 11th earthquake in Japan will be among the largest insured losses in history, such losses can be absorbed by the insurance and reinsurance industries without widespread solvency problems, or undue financial strain.

According to Fitch, due to the scale and complexity of the insured loss, it will take some time for international catastrophe modelling firms and local loss adjusters to accurately estimate insured losses. Initial estimates place the economic loss at approximately USD100bn (EQECAT) and insured property losses in the range of USD15-35bn (JPY1.2-2.8trn) (AIR Worldwide.) These estimates do not specifically include the impact of the ensuing tsunami, demand surge or life insurance.

Many lines of insurance will be impacted including fire, flooding, marine, motor and life insurance. One of the most difficult aspects to assess will be the extent of business interruption losses. Many electronics factories, car manufacturers and oil refineries have ceased production and the ultimate insured loss will be partly predicated on the speed with which businesses can restart. Reports of leaking radiation from some nuclear power plants add to this uncertainty, although Fitch understands that damage to nuclear reactors and nuclear damage for homeowners' policies are typically excluded from coverage.

Fitch emphasises that today's initial assessments are subject to change as new information becomes available.

Fitch believes that the insured loss will be significantly lower than the economic losses due to a number of mitigating factors, including:

- Earthquake damage to residential property is covered under the existing Japanese state-backed Earthquake Insurance System, with the Japanese government assuming up to JPY4.3trn (USD52.6bn) of residential earthquake losses.

- Japanese non-life insurers have accumulated significant residential catastrophe reserves over recent years totalling JPY524bn (USD6.4bn), representing 88.4% of their potential liability under the scheme.

- Earthquake insurance is offered as an optional rider to homeowners' property policies and it is estimated that only 14% to 17% of homes in Japan are covered for earthquake risk.

- The epicentre of the earthquake was located some distance from heavily populated areas such as Tokyo or Osaka. Affected areas have lower insurance penetration than the major cities.

After the Kobe earthquake of 1995 insured losses amounted to USD3.5bn although economic losses were close to USD100bn. The Kobe earthquake increased the demand for earthquake insurance in Japan and therefore the ratio between insured losses and the economic loss is expected to be higher for the 11 March earthquake.

Fitch expects insured losses from the 11 March earthquake will be disproportionately retained by domestic Japanese insurers, due to the Japanese government's active role in providing cover for residential earthquake losses, and as only commercial and industrial risks are directly ceded to the global reinsurance market. This contrasts with the recent earthquakes in Chile and New Zealand, where global reinsurers assumed a majority share of the loss.

Financial Impact on Japanese Primary Insurers

Fitch does not expect major downgrades to arise from this event, though individual insurers could be downgraded one or more notches if loss estimates escalate. Fitch currently maintains Insurer Financial Strength (IFS) ratings on the five largest Japanese non-life insurers, all of which are rated at 'A', or higher, well above non-investment grade. Given the current uncertainty regarding estimated insured losses arising from the earthquake, it is difficult to predict the financial impact that the event will have on primary Japanese insurers. All domestic insurers maintain significant catastrophe reserves that both the Japanese regulator and Fitch include in their capital calculations.

Depending on the ultimate size of insured losses, it is possible that catastrophe reserves will be significantly depleted and consequently capital adequacy reduced. In addition, profitability for financial year 2010/11 will be materially affected. Fitch will continue to analyse loss information received from Japanese primary insurers, and will provide further guidance to the market as company-specific loss estimates are stress tested.
Japanese Earthquake to Add to Global Reinsurers Growing Catastrophe Losses

Fitch expects that the latest earthquake will result in a downward revision of many reinsurers' earnings guidance for 2011 and exposes their balance sheets to further catastrophe losses later in the year. Following the Australian floods in January and the New Zealand earthquake in February, 2011 has already been a very active year in terms of catastrophe losses for the reinsurance sector. The agency notes that prior to the 11 March earthquake, several global reinsurers had indicated that they had already exhausted most, if not all, of their 2011 catastrophe budget.

While the mitigating factors highlighted above for domestic Japanese insurers will partly insulate international reinsurers from loss, the 11 March earthquake is still likely to be one of the most expensive earthquakes in terms of insured losses. Previous earthquakes with large insured losses include Northridge in 1994 (insured losses at current prices of USD20bn), Chile in 2010 (USD8bn) and New Zealand in 2011 (between USD3.5bn and USD8bn).

Will the March 11th Earthquake be a Market Changing Event For Reinsurance Pricing?

Fitch believes that it is unlikely that the 11 March earthquake will be a market changing event by itself, but when combined with other catastrophe losses taken earlier in the year, and with the prospect of further catastrophe losses to come, it could ultimately be a catalyst for a positive change in the pricing cycle.

Based on probable maximum loss (PML) information published by several global reinsurers, a 1-in-250 year Japanese earthquake (approximating to an insured industry loss of USD50bn) would, on average, result in a loss equivalent to less than 10% of shareholders' equity. While some reinsurers are more exposed than others, if the 11 March earthquake proves to be less than a 1-in-250 year event, it would likely be more of an earnings issue than a capital issue for the reinsurance industry.

The March 11th earthquake will have an impact on the reinsurance pricing for Japanese catastrophe risks which are due to be renewed in April 2011. Given the proximity of the recent earthquake to the Japanese reinsurance renewal dates, reinsurers will be able to quickly adjust their pricing to mitigate some of the losses incurred. This could further pressure 2011 earnings of local non-life insurance companies in Japan.

Will the Japanese Earthquake affect Reinsurance Ratings?

Provided the March 11th earthquake proves to be less than a 1-in-250 year event, rating implications are likely to be limited. The reinsurance sector is currently well-capitalised following several profitable years and is capable of absorbing a loss of this magnitude. However, some reinsurers will be more exposed than others. Fitch will closely monitor those companies that have a greater concentration to the loss. As with most earthquakes, the agency expects the estimate of insured losses to increase over time as claims are reported to, and settled by, Japanese primary insurers. An escalation in the loss to a level above a 1-in-250 year event could ultimately result in downgrades for reinsurers that are over-exposed to the loss, and suffer significant capital erosion.

Fitch has attempted to provide as much clarity as possible regarding rating impacts from the recent Japanese earthquake. Without accurate loss estimates it is difficult to be definitive. Fitch does not expect significant negative rating action as a result of the event due to a number of factors.

These include the strong capital position of local Japanese insurers and international reinsurers, specific catastrophe reserves already established by local Japanese insurers, the active role that the Japanese government plays in assuming earthquake risk, the low penetration rates for property insurance, the low take-up of earthquake riders to property policies and prudent setting of Japanese earthquake PMLs by reinsurers. Despite all of these mitigating factors, it is possible that insured losses could be significantly higher than currently estimated by the catastrophe modeling firms which may ultimately result in Fitch taking negative rating actions.

Fitch will comment on the specific ratings of the impacted Japanese non-life insurers, as well as various reinsurance companies around the world, in the coming days and weeks as information is made available on estimated losses.