Japan earthquakes to have ‘moderate’ impact on insurers’ earnings

Non-life insurers will be able to withstand the losses from the recent earthquakes that have hit Japan, with a moderate impact on earnings but little effect on financial strength, said a new report from AM Best.

This month, the Island of Kyushu in Japan has been hit by series of large-scale earthquakes, the largest since the Great East Japan Earthquake in 2011.

The 6.5-magnitude earthquake occurred in Kumamoto Prefecture on April 14. This turned out to be a foreshock to the magnitude 7.3 earthquake in the same area in the early hours on April 15. Since then, aftershocks continue in the Kumamoto, Aso, and Oita areas.

The series of earthquakes are expected to lead to a sizeable loss, which would have a moderate impact on the insurers’ earnings, while the impact could be mostly mitigated by the release of catastrophe reserve.

According to AM Best, insurers have reported robust growth in capital amount over the past five years, largely owing to an increase in unrealised gains under J-GAAP (Japanese Accounting Standards) and the recent improvement in profitability, driven by premium rates hikes in major insurance lines and benign catastrophe loss experiences.

In particular, the earthquake premium rate doubled since 2011, while overall, the companies experienced moderate loss experience during the period. The combined capital amount (including catastrophe reserve and price fluctuation reserve) of the rated non-life insurance companies amounted to JPY 9.3 trillion at the end of December 2015, which far exceeded the capital amount before the large catastrophe losses in 2011.

The combined catastrophe reserve of the rated non-life insurance companies reached JPY 2,323 billion at the end of December 2015 from JPY 2,324 billion at the end of March 2010.

Property exposures are underwritten through separate earthquake risk coverage in Japan.

Currently, earthquake insurance, as a rider, is attached to the main contract of fire insurance for both corporate and household coverages. Commercial earthquake risks are covered by both primary non-life and reinsurers from both the domestic and overseas markets. On the other hand, residential earthquake risks are borne primarily by the government, which reinsures a significant portion of the earthquake insurance liabilities underwritten by the private insurance companies in Japan. This scheme is operated for households based on “no profit, no loss” given the nature of earthquake risk and the potential impact on Japanese citizens.

As sources reported, these quakes have halted operations at a number of companies in the impacted area, including the auto parts and semiconductor industries. It indicates an increasing risk of business interruption in addition to the physical damage loss on properties.

Around a quarter of total insurance loss from the earthquake in 2011 was related to business interruption, with many examples of suspensions of operations for a stretch of six months to one year. However, it is worth noting that the non-life insurance companies tightened terms and conditions of business interruption coverage since 2011, with strict control of the aggregate exposure.

Additionally, corporations have enhanced risk management over time by preparing for the countermeasures to continue the businesses under the stress scenario, said AM Best.