The Impact of the September 11 Terrorist Attack on the Global Insurance Markets: Evidence from the Japanese Property-Casualty Insurance Industry

Transcription

1 The Impact of the September 11 Terrorist Attack on the Global Insurance Markets: Evidence from the Japanese Property-Casualty Insurance Industry Noriyoshi Yanase 1 and Yukihiro Yasuda 2 Abstract: We investigate the significant effects of the September 11 attacks on the Japanese stock market, one of the largest markets in the world. Although several studies have examined the impact of the attacks on the domestic U.S. stock market, few studies have analyzed their impact on the foreign insurance industry through globally well-developed reinsurance transactions. Surprisingly, a mid-sized P/C insurance company, TAISEI Fire and Marine Insurance, went bankrupt on November 22, 2001, two months after the events, due to massive reinsurance claims arising from the terrorist attacks. Using traditional event study methodology for both events, the attacks and the failure, we find that the Japanese stock market reacted to risks of the terrorism event through the global reinsurance market at the time of TAISEI s failure, rather than immediately after the events of September 11. [Key words: Japanese insurance market; reinsurance; terrorist attacks.] T INTRODUCTION he sudden and massive series of terrorist attacks on September 11, 2001 had an enormous impact on the global insurance industry. 3 We investigate the significant effects of the September 11 attacks on the Japanese 1 Associate Professor of Insurance, Faculty of Business Administration, Tokyo Keizai University and Visiting Research Professor, Department of Finance, Moore School of Business, University of South Carolina. yanase@tku.ac.jp 2 Associate Professor of Finance, Faculty of Business Administration, Tokyo Keizai University. 3 In fact, the World Trade Center towers were covered directly by several major insurers and reinsurers around the world. 85 Journal of Insurance Issues, 2010, 33 (1): Copyright 2010 by the Western Risk and Insurance Association. All rights reserved.

2 86 YANASE AND YASUDA stock market, one of the world s largest foreign markets. Although several studies have examined the impact of the attacks on the domestic U.S. stock market (e.g., Cummins and Lewis, 2003; Doherty, Lamm-Tennant, and Starks, 2003; Wang and Corbett, 2008; Chen, Doerpinghaus, Lin, and Yu, 2008), there have been few studies that analyzed the impact on the foreign insurance industry through the globally well-developed system of reinsurance transactions. Surprisingly, a mid-sized property and casualty (P/C) insurance company, TAISEI Fire and Marine Insurance (TAISEI), went bankrupt on November 22, 2001, two months after the events, due to massive reinsurance claims arising from the terrorist attacks. TAISEI s failure provided an opportunity to enhance the regulation of reinsurance in Japan. In fact, the Financial Services Agency of Japan (FSA) decided to amend the guidelines of Insurance Business Law to strengthen the regulations for reinsurance transactions. It is absolutely critical for stockholders, policyholders, regulators, and other stakeholders to know how the disclosure system for reinsurance transactions should be organized. Therefore, the first step toward discussing this issue is to examine how a catastrophic event in one country can affect other nations insurance industries. There are no studies focusing on the effects of the terrorist attacks on stock prices of the foreign insurance companies in Japan, European Union (EU) member nations, and others, even though there are some important previous studies examining the terrorist attacks impact on the U.S. insurance industry. Using the traditional event study methodology for both events the terrorist attacks (September 12, 2001 in Japan time) and TAI- SEI s failure (November 22, 2001 in Japan time) we explore the timing of the Japanese stock market s reaction to the risks of the terrorist event through the global reinsurance market. Our results demonstrate that the Japanese stock market reacted to the risks of the terrorist event through the global reinsurance market when TAISEI s failure occurred, not immediately after the event on September 11. As far as we know, this study is the first that focuses on how the terrorist attacks affected foreign insurance industries. The remainder of the paper is organized as follows: Section 2 provides the background of our study. The literature review is in Section 3, and Section 4 describes the data, methodology, and hypotheses. Section 5 presents the empirical results, and the final section concludes. BACKGROUND According to Swiss Re (2002), the property and business interruption losses arising from the terrorist attacks were estimated at USD $19 billion,

3 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 87 which was one of the largest man-made insurance losses in world history. 4 Therefore, it has been proposed that the terrorist attacks of September 11 had a major impact on the stock prices of U.S. insurance companies. More importantly, the catastrophic losses of just one country, such as the terrorist attacks in the United States, could suddenly spread throughout the global insurance industry because the global network of reinsurance markets has grown remarkably in recent years. Moreover, the speed of communication through the global reinsurance network, which has also improved with the rapid development of information technologies, 5 might affect the speed of the impact upon other nations insurance industries. Therefore, the damage stemming from the terrorist attacks could spread to many insurance companies around the world. 6 In fact, the stock prices of the insurance companies on the Tokyo Stock Exchange (TSE) and most of the European stock markets plunged immediately after the U.S. terrorism event. For example, shares of all the P/C insurance companies listed on the TSE fell an average of 7.59% in one day. 7 Figure 1 shows the rate of change on closing prices for all the listed P/C insurance companies in Japan at the time of the terrorist attacks. Sometimes it is difficult even for insiders, such as management executives, to understand the details of reinsurance transactions. Clearly, it has also been recognized that reinsurance transactions are too complicated for outsiders, such as shareholders and regulators, to have an accurate understanding of the complete picture. 8 Global reinsurance transactions seem 4 Furthermore, the additional losses related to the attacks were an estimated billion (USD) because the insurance industry had covered not only property but also liability and life insurance. 5 Although the development of the global reinsurance market has a disadvantage that risk exposure because of catastrophic events could spread quickly around the world, it has also given individual insurance companies an advantage in that insurance companies are able to engage effectively in risk management activity. 6 The Wall Street Journal staff reporter Christopher Oster reported, Most of the major reinsurers in the world are going to feel a substantial impact. Reinsurance companies essentially provide insurance to the primary sellers of coverage, sharing risk on policies. Some experts estimated that as many as 100 insurers ultimately will share the cost. (Wall Street Journal, Sep. 12, 2001, p. B.1) 7 The following twelve P/C insurance companies were listed in the TSE on September 11: TAISEI, NISSAN, AIOI, NISSAY-DOWA, NISSHIN, SUMITOMO, TOKYO-MARINE, MITSUI, NICHIDO, YASUDA, NIPPON-KOA, and FUJI. 8 Some comments by stock analysts were reported just after the attacks. One analyst said, The effects of the attacks on the Japanese P/C insurance companies were not serious because the insurers were expected to underwrite the risks arising from the attacks. In fact, many P/C insurance sector analysts were more concerned about serious effects from typhoons at that time (Nikkei Financial Newspaper, Tokyo, Japan, Sep. 14, 2001, p. 20).

4 88 YANASE AND YASUDA Fig. 1. Rate of change on closing prices (All listed P/C insurance companies). like a black box to outsiders. 9 According to Figure 1, although the closing prices of all the P/C insurance companies dropped sharply immediately following the attacks, those prices were trending upward again within a few days after the event. The outsiders, most of the market players on the TSE, seemed to believe that no significant damages would be imposed on Japanese P/C insurance companies as a result of the attacks at that point in time. Even the insiders, the executive managers of the insurance companies, seemed to believe that their companies had not been significantly damaged as a result of the attacks immediately thereafter. 10 For example, although AIOI General Insurance (AIOI) announced that its maximum potential loss 9 The maximum amount of losses caused by the attacks was expected to be only about 10 billion (JPY) industry-wide just after the attacks (Nikkei Financial Newspaper, Tokyo, Japan, Sep. 20, 2001, p. 6). Contrary to the above original forecast, the General Insurance Association of Japan (GIAJ), a trade association representing licensed general insurance companies, announced the actual losses ended up at about billion (JPY) industry-wide at the end of the semiannual financial settlement of fiscal year 2001 just after TAISEI s failure. Further, the eventual losses exceeded the estimation by GIAJ at the end of March 2002 (the end of fiscal year 2001) as we will see later.

5 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 89 was about 800 million JPY on September 17, 2001, AIOI recorded billion JPY as its total related cost of the attacks at the end of March 2002, the end of fiscal year The huge difference between the original expected losses and the final actual losses suggests that even industry insiders like executive managers did not initially understand the potential effects of the attacks on the Japanese P/C insurance companies through reinsurance arrangements. Surprisingly, two months after the attacks, on November 22, a midsized P/C insurance company, TAISEI, became insolvent, with 74.4 billion JPY in reinsurance claims arising from the terrorist attacks in the United States, and filed with the court for protection from creditors under the special rehabilitation law. 12 As noted previously, shortly after the attacks, most Japanese P/C insurance companies had announced that their losses caused by the terrorist attacks were not serious, and they did not seem to have significant exposure in the aftermath of the attacks. It appears that TAISEI s sudden collapse and bankruptcy filing due to reinsurance transactions two months after the event was the first time that Japanese P/C insurance companies recognized that catastrophic losses stemming from the terrorist attacks were in fact affecting their own industry. It should be noted that TAISEI s failure revealed that two Japanese P/ C insurance companies, NISSAN Fire and Marine Insurance (NISSAN) and AIOI, confronted huge exposures in aviation reinsurance through the mediation of Fortress Re, a privately owned reinsurance underwriting manager in the United States. Following TAISEI s failure, NISSAN and AIOI urgently announced that they would have to pay reinsurance claims and would fall deeply into the red for the fiscal year because Fortress Re had pooled the funds of these companies to share the risks of reinsuring aviation portfolios, causing these companies significant aviation reinsurance exposure at that time. 13 Even with those announcements, however, most stakeholders in the Japanese P/C insurance industry failed to fully 10 TOKYO MARINE released their estimate that the maximum amount of losses caused by the attacks was 1 billion JPY on September 12. Moreover, the other major P/C insurance companies, MISTUI, SUMITOMO, YASUDA, NIPPON-KOA, NISSAY-DOWA, and AIOI, announced that their maximum amount of losses were, respectively, 1.5 billion JPY, 500 million JPY, 2 billion JPY, 500 million JPY, and 800 million JPY before September According to the formal announcement by AIOI at the end of fiscal year 2001 (the end of March 2002), the net claim paid was 32.2 billion JPY, and the reserve for outstanding claims was billion JPY. 12 TAISEI s failure was one of only two bankruptcies in the Japanese P/C insurance industry since World War II. Therefore, the bankruptcy had a great impact on the Japanese P/C insurance industry.

6 90 YANASE AND YASUDA comprehend the actual amount of risk exposure the entire insurance industry faced through the global reinsurance market. In response to this apparent failure of the reinsurance system, the public s concern over the lack of transparency of reinsurance transactions and the absence of high-quality disclosure has been growing. 14 Insurance regulators also have recognized the necessity for tighter regulation of reinsurance transactions because investors need greater transparency in the reinsurance transactions or high-quality disclosure of the reinsurance risks. As mentioned before, TAISEI s failure provided an opportunity to enhance the regulation of reinsurance. After some discussion, the FSA decided to amend the guidelines of Insurance Business Law to strengthen the regulations for reinsurance transactions. The new guidelines require insurers to disclose the details of reinsurance premiums, policy reserves, reserves for outstanding pending claims, and their risk management policy. Eventually, this new regulation was enforced for all Japanese insurance companies after fiscal year The concern with reinsurance disclosure also has grown worldwide, especially after the catastrophic terrorist event. The International Association of Insurance Supervisors (IAIS), the international organization representing insurance regulators and supervisors around the world, has discussed how regulation for the global reinsurance market should function because the recent reinsurance transactions involve all the global insurance markets. 15 LITERATURE REVIEW Over the past years, a considerable number of studies have been made on the impact of catastrophic events on capital markets. Baginski, Corbett, and Ortega (1991) examine the capital market response to the catastrophic 13 NISSAN announced that the claims paid related to the terrorist attacks were estimated at 74.4 billion JPY just after TAISEI's failure. AIOI also announced that the total related cost of the attacks was expected to be between 80 and 100 billion JPY. As we mentioned before, however, the costs to AIOI eventually reached up to billion JPY at the end of the fiscal year. 14 In September 2003, the GIAJ announced they would strengthen disclosure and accountability of reinsurance transactions as much as possible, although it is quite difficult to obtain a clear picture of reinsurance transactions. 15 The secretary general of IAIS, Dr. Yoshihiro Kawai, referred to the standards and transparency of the global reinsurance market in the Standards Setting Activities in February 2004 as follows: There are two dynamic developments in the area of reinsurance. One is in setting standards and the other is in enhancing disclosure and transparency in the reinsurance sector. Both are regarded as key areas not only by insurance supervisors but also by the international financial community in general.

7 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 91 event of the MGM Grand fire and the announcement of MGM Grand s purchase of $170 million in retroactive liability insurance. They find that news of the fire had an adverse effect on MGM s stock price. Shelor, Anderson, and Cross (1992) examine the market response of propertyliability insurers to the Loma Prieta earthquake, and they find positive abnormal returns for property and liability insurers after the earthquake, indicating that investor expectations of a higher demand for insurance may have more than offset the potential earthquake losses. In fact, their research is based upon two opposing hypotheses regarding such catastrophic losses. One hypothesis is that the rapid depletion of surplus accounts fostered by catastrophic events causes investors to discount insurance firm stock values. The other hypothesis is that insurers benefit from an isolated catastrophic event because of subsequent increased demand. 16 Since Shelor, Anderson, and Cross (1992), several important studies have investigated which hypothesis is empirically supported. Contrary to the findings of the Shelor et al. study, Lamb (1995) finds that Hurricane Andrew produced a significant negative stock price reaction on property-liability insurers with direct premiums written in Florida or Louisiana, indicating that the market efficiently interpreted the information about the effects of the hurricane and discriminated among property-liability insurers on the basis of the existence and magnitude of insurance written. Although several studies have been made on the impact of catastrophic events on the U.S. capital market, little is known about how a catastrophic event might affect foreign capital markets. Yamori and Kobayashi (2002) is the first and only study to test the previously mentioned hypothesis using a case outside the United States. Yamori and Kobayashi investigate how the Japanese stock market reassessed domestic insurance company values after the catastrophic event of the 1995 Hanshin Awaji earthquake, finding negative stock price reactions. In recent years, the impact of man-made catastrophic events on stock markets has been shockingly brought to academic attention by the terrorist attacks of September Cummins and Lewis (2003) examine the impact of several catastrophic events: the terrorist attack, the Northridge earthquake, and Hurricane Andrew. They find not only a strong negative impact on insurer stock prices immediately following these catastrophic events but also different reactions of the financially strong firms from those of the financially weaker firms, indicating the flight to quality phenomenon. 16 According to Chen, Doerpinghaus, Lin, and Yu (2008), the former hypothesis is called the Claim Effect in the short term, and the latter hypothesis is called the Growth Effect in the long term.

8 92 YANASE AND YASUDA Their empirical implication of the flight to quality predictions is that stronger insurers should sustain a smaller negative impact from the terrorist attacks than financially weaker insurers. In other words, although the immediate effect of the attacks was a general decline in insurance stock prices, they find that the stock prices of insurers with strong financial ratings rebounded while those of weaker insurers did not during the period after the first post-event week. Doherty, Lamm-Tennant, and Starks (2003) examine the same issues in terms of capacity constraints and market transparency. Wang and Corbett (2008) examine whether the market reactions are different between two groups, property and liability insurers and life and health insurers, finding that stocks of property and liability insurers do generate much larger abnormal returns than those of life and health insurers. Most recently, Chen, Doerpinghaus, Lin, and Yu (2008) investigate the effect on insurers of both the large unexpected losses experienced in the short term and the long-run potential growth opportunities for insurers due to supply reduction and potential risk updating following the terrorist attacks. Unlike previous studies, they find the respective effects separately for short-term negative and long-term positive impacts on the stock market, using the data of short-term and long-term abnormal forecast revisions. Although several important studies have been conducted on the impact of catastrophic events on the local capital market, little attention has been focused on the impact on foreign capital markets through the global reinsurance networks. Therefore, the global impact of catastrophic events, such as the terrorist attacks of September 11, needs to be examined in detail. To our best knowledge, this is the first study to examine how the catastrophic event (the terrorist attacks) affected a foreign insurance market, the Japanese P/C insurance market in particular. Table 1 summarizes the relationship between our research approach and the previous studies. 17 In the U.S. academic context, the impact of the Terrorism Risk and Insurance Act of 2002 (TRIA) is also an important issue. Because insurance companies began to exclude the terrorism risk from their coverage after the terrorist attacks, several companies were faced with a constraint of their insurance management. In response to this trend, the U.S. government passed TRIA in November 2002, to protect against the impact of terrorist attacks on the businesses. Under the new law, while insurance companies are required to underwrite terrorism coverage, the government provides the insurance industry with some protection through government reinsurance. Marlett, Griffith, Pacini, and Hoyt (2003) find significant stock price changes after the passing of TRIA, showing that stock prices adjusted to perceived effects of the legislative process.

9 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 93 Table 1. Previous Research and Our Research Position The event has an effect on: United States Other countries Baginski, Corbett, and Ortega (1991) Shelor, Anderson, and Cross (1992) Lamb (1995) Cummins and Lewis (2003) Catastrophic loss event from: United States Our research Doherty, Lamm-Tennant, and Starks (2003) Wang and Corbett (2008) Chen, Doerpinghaus, Lin, and Yu (2008) Other countries Yamori and Kobayashi (2002) DATA, METHODOLOGY, AND HYPOTHESES Data and Methodology The book value data used in this study are obtained from the annual special issues of The Statistics of Japanese Non-Life Insurance Business published by the Insurance Research Institute of Japan, and stock data are obtained from The Nikkei Economic Electronic Databank System (NEEDS). We examine three groups of Japanese P/C insurance companies listed on the TSE between the end of fiscal year 2000 and the end of fiscal year The first group consists of AIOI and NISSAN (Re-Ins Gr.). As we mentioned before, AIOI and NISSAN, as well as TAISEI, were closely related through their reinsurance contracts through the mediation of Fortress Re, a U.S. reinsurance underwriting manager. Because Fortress Re had pooled the funds of these companies to share the risks of reinsuring aviation portfolios, AIOI and NISSAN both faced the problem of enormous payments of reinsurance from the attacks. The second group consists of YASUDA Fire and Marine Insurance (YASUDA) and NISSAN, which were supposed to merge with TAISEI into a new insurance company, Sompo Japan Insurance (Sompo Japan). Although these companies YASUDA, NISSAN, and TAI- SEI had already announced, before the terrorist attacks occurred, a schedule to merge by April 2002, TAISEI s failure forced them to rethink their 18 The Japanese business year starts in April and ends in March, meaning the end of fiscal year 2000 (2001) is the end of March 2001 (2002).

10 94 YANASE AND YASUDA schedule for the merger 19. We set up the second group (SJ Gr.) to control for the effect of the merger on the stock price. The third group consists of all of the P/C insurers listed on the TSE, which we use as a benchmark in our study. Note that two of the groups (Re-Ins Gr. and SJ Gr.) contain the same firm (NISSAN); the pure effect of TAISEI s failure on Re-Ins Gr. (or SJ Gr.) is respectively observed in the sample containing just AIOI (or YASUDA), which is a limitation of our analysis resulting from this small sample. Therefore, by investigating the reactions of the stock prices not only of these three groups but also of the two insurers (AIOI and YASUDA), we examine whether the effects of TAISEI s failure are the same for other insurers. We test these impacts by conducting an event study of the stocks and comparing the magnitude of the effect on the groups (e.g., Mackinlay, 1997). The event days are September 12 and November 22. The former day is the immediate aftermath of the terrorist attacks, and the latter day is the public announcement day of TAISEI s failure. The market regression coefficients were estimated using the Tokyo Stock Price Index (TOPIX) returns as a benchmark. 20 R it = β 0 + β 1 R mt + ε it (1) where R it is the return on stock i on day t, R mt is the daily return on the value weighted TOPIX index, and ε it is the residuals. The market model is estimated using an estimation window from April 2 to August 23, 2001 (100 business days). We then calculate the abnormal returns (AR) for each day t in the event window, days 0 through +10, where the parameters β 0 and β 1 are estimated by the market model (1). AR it = R it ( β 0 + β 1 R mt ). (2) The cumulative abnormal returns (CAR) are calculated for the event days t = 0,+1,+2,...,+10. Then, we average CAR it across all stocks to obtain CAR t After that time, it was resolved in October 2002 that the failed insurance company, TAISEI, would be split into the TAISEI Under Rehabilitation Co. and the TAISEI Reinsurance Co. to protect Sompo Japan from reinsurance obligations related to the failed company. Eventually, Sompo Japan and TAISEI merged with the financial support from the P/C Insurance Policyholders Protection Corporation of Japan in December TOPIX is the stock market index for the TSE in Japan, tracking all domestic companies of the exchange s First Section, which is commonly used as a proxy for market index to conduct event studies for Japanese stock data.

11 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 95 Hypotheses 10 CAR it = AR it. (3) t = 0 Table 2 shows the reinsurance received ratio, defined as the ratio of the reinsurance premium received to the premium income at the end of March 2001, the end of fiscal year 2000, in terms of the ranking across all the listed P/C insurance companies at that time. According to Table 2, the industry average of the ratio was 7.13%, and only three companies AIOI, NISSAN, and TAISEI were above the industry average. Interestingly, these companies revealed that they had heavily committed to the aviation reinsurance market through the mediation of Fortress Re several months after TAISEI s surprising failure. In retrospect, the reinsurance ratio may imply an exposure of reinsurance received by each insurer at the time the terrorist attacks occurred. Therefore, if the reinsurance ratio is recognized as the reinsurance received exposure, we can expect that insurers with a higher reinsurance ratio would experience a more negative reaction on their stock price. Hypothesis 1: The Japanese P/C insurers with a higher reinsurance ratio did NOT experience a more negative reaction on their stock price than the other P/C insurers in the immediate aftermath of the terrorist attacks. As we have mentioned, it is too difficult for stockholders to understand the details of reinsurance transactions. Almost all of the stockholders failed to anticipate the attacks real impact on the industry through global reinsurance transactions until the occurrence of a real event, TAISEI s failure. In other words, an essential meaning of the reinsurance ratio could be revealed by TAISEI s failure. Therefore, we also expect that the TAISEI bankruptcy was the first time the stock market recognized the real impact of the terrorist attacks on the P/C insurers with a high reinsurance ratio. Hypothesis 2: The Japanese P/C insurers with a higher reinsurance ratio experienced a more negative reaction on their stock price than the other P/C insurers in the immediate aftermath of TAISEI s failure. 21 We checked whether there were amy important confounding events around our event days (September 12, 2001 and November 22, 2001) on The Statistics of Japanese Non-Life Insurance Business, 2001 (pp ). Most news items related to issues with new products. Therefore, we suppose there were no crucial events to confound our events.

12 96 YANASE AND YASUDA Table 2. Reinsurance Received Ratio at the End of Fiscal Year 2000 a Company name Reinsurance received ratio b Remarks column TAISEI 11.43% Bankruptcy on Nov. 22 CHIYODA (AIOI) 10.29% Fortress Re c NISSAN 9.32% Fortress Re c DAI-TOKYO (AIOI) 7.46% Fortress Re c DOWA 7.01% NISSHIN 6.56% SUMITOMO 6.48% TOKYO MARINE 6.43% MITSUI 6.37% NICHIDO 6.15% YASUDA 6.09% NIHON 5.79% KOA 5.27% FUJI 5.16% Mean 7.13% Standard deviation 1.89% a The Japanese business year starts in April and ends in March, meaning the end of fiscal year 2000 is the end of March b Reinsurance received ratio is defined as the percentages of the reinsurance premium received to the premium income. c These P/C insurers heavily committed to the aviation reinsurance market through the mediation of Fortress Re. Because CHIYODA merged with DAI-TOKYO in April 2001 and the combined company is AIOI, the new company finally announced its reinsurance losses arising from the terrorist attack after the TAISEI's failure. EMPIRICAL RESULTS Abnormal Returns after the Terrorist Attacks on September 11 Table 3 shows results for each of the days between the event day (September 12, 2001, Japan time) and 10 days after (September 27, 2001). Abnormal returns on the event day are significantly negative across all specifications, indicating that the stock prices of Japanese P/C insurers were statistically getting lower than the average of the TSE market. In contrast, note that the impacts are no different between the high-reinsurance-received group (HIGH Gr.) and the all-listed-p/c-insurer group (ALL

13 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 97 Table 3. Abnormal Returns for September 11 Attacks HIGH Gr. a All listed P/C (excluding SUMITOMO) b All listed P/C (including SUMITOMO) c Day d AR(%) t-value CAR(%) t-value AR(%) t-value CAR(%) t-value AR(%) t-value CAR(%) t-value 0 09/12/ ** *** *** *** *** *** +1 09/13/ ** ** ** ** +2 09/14/ * +3 09/17/ ** *** *** +4 09/18/ *** *** *** *** *** +5 09/19/ *** *** *** *** *** *** +6 09/20/ *** *** *** +7 09/21/ *** *** *** *** *** *** +8 09/25/ ** ** *** N/A +9 09/26/ *** ** *** N/A /27/ ** *** ** *** N/A *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. a HIGH Gr. consists of companies whose reinsurance received ratios were higher than the industry average (7.13%; see Table 2) at the end of March Interestingly, these P/C insurers are TAISEI, NISSAN, and AIOI (the combined company of CHIYODA and DAI-TOKYO), corresponding exactly to the P/C insurance group linked to the reinsurance transaction by Fortress Re. b As we mentioned in context, the following 12 P/C insurance companies were listed in TSE around the events of September 11: TAISEI, NISSAN, AIOI, DOWA, NISSHIN, SUMITOMO, TOKYO MARINE, MITSUI, NICHIDO, YASUDA, NIPPONKOA, and FUJI. However, SUMITOMO (the merged company) was delisted on September 25, 2001 because SUMITOMO would merge with MITSUI on October 1, In other words, the stock prices of SUMITOMO have been used since September 21, Hence, SUMITOMO is excluded in this All listed P/C sample. Instead, we identify the stock prices of MITSUI as those of MITSUI- SUMITOMO, the merging company, for estimation of AR after September 25, c Because SUMITOMO is included in this All listed P/C sample, the AR is NOT estimated after September 25, d Markets were closed Monday, September 24, 2001 in observance of the annual September 22/23 national public holiday, Shubun no Hi (autumnal equinox).

14 98 YANASE AND YASUDA Gr.). HIGH Gr. is composed of companies whose reinsurance received ratios were higher than the industry average (7.13%; see Table 2) at the end of March Interestingly, these P/C insurers are TAISEI, NISSAN, and AIOI (the merged company of CHIYODA and DAI-TOKYO), corresponding exactly to the P/C insurance group linked to the reinsurance transactions of Fortress Re. 22 The AR of the event day of the HIGH Gr. is 4.56%, which is almost the same as the impact of the ALL Gr. ( 4.32 or 4.26%). This result indicates the Japanese stock market did not react differently to the reinsurance transaction effects from the terrorist attacks. Abnormal Returns after TAISEI s Failure As mentioned earlier, a mid-sized P/C insurance company, TAISEI, went bankrupt on November 22, 2001, two months after the event, because of massive reinsurance claims arising from the terrorist attacks. Table 4 shows the results for each of the days between the event day (November 12, 2001) and 10 days after (December 7, 2001). Abnormal returns on the event day are significantly negative across all specifications. However, note that the impacts vary among them. The AR of the event day of the Re-Ins Gr. is 15.65%, an impact larger than that of the SJ Gr. ( 11.83%); these results come from the different reaction of AIOI and YASUDA because NISSAN belongs to both groups. Therefore, we clarify whether or not the AR is still significant after removing NISSAN from those two groups. In fact, the AR of the event day of AIOI is 12.99%, an impact much larger than that of YASUDA ( 5.34%). This result indicates that the Japanese stock market s reaction to the reinsurance transaction effects was greater than its reaction to the merger effects. Figure 2 shows the cumulative average of abnormal returns. It is clear that the negative impacts of the Re-Ins Gr. are much larger than those of the SJ Gr. The CAR of the Re-Ins Gr. continues to decline until seven days after the event day, where the CAR is 72.05%. The CAR then rises slightly and hovers around 60% through the rest of the event window. By contrast, the CAR of the SJ Gr. is around 30%, and the CAR of the All P/C Gr. is between 10% and 15%. These results confirm that the effects of the failure on the reinsurance-related P/C insurers were much larger than those upon the merger-related P/C insurers, indicating partial support of Hypothesis Because CHIYODA merged with DAI-TOKYO in April 2001, the reinsurance received ratio of the combined company (AIOI) is defined as the average of CHIYODA and DAI- TOKYO at the end of March That is, the average ratio is calculated by dividing the total reinsurance premium received by the total premium income at the end of March 2001.

15 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 99 Event window (-10,+10) 10% % -10% -20% -30% -40% -50% -60% -70% -80% Re-Ins Gr. SJ Gr. All Listed P/C Fig. 2. Cumulative abnormal returns (CARs) for TAISEI s failure on Nov. 22, Determinants of the CAR (0, 1) In this subsection, we investigate the relationship between the price changes resulting from the two catastrophic events and the ex ante risk exposure of the reinsurance transactions. As we discussed in our first hypothesis, we expect no relationship between the price changes and the reinsurance exposure before TAISEI failed, because the Japanese stock market seemed to have not recognized the substantial potential risks through the reinsurance transactions at that time. In contrast, our second hypothesis predicts that the differences of the CAR among Japanese P/C insurance companies are explained by those of ex ante risk exposure of the reinsurance transactions among them just after the failure of TAISEI, because the Japanese stock market seemed to have recognized the risks of reinsurance transactions when TAISEI failed. To investigate the plausibility of our hypotheses, the following simple regression model is estimated: CAR i = α i + β i REINS i + ε i. (4) The REINS variable has the same definition as the reinsurance received ratio in Table 2, the ratio of the reinsurance premium received to the

16 100 YANASE AND YASUDA Table 4. Abnormal Returns for Taisei s Failure on November 2001 Re-Ins Gr. (AIOI and NISSAN) SJ Gr. (YASUDA and NISSAN) AIOI Day b AR(%) t value CAR(%) t value AR(%) t value CAR(%) t value AR(%) t value CAR(%) t value 0 11/22/ *** *** *** *** *** *** +1 11/26/ *** *** *** *** *** *** +2 11/27/ *** *** *** *** *** +3 11/28/ *** *** *** *** *** +4 11/29/ *** *** * *** +5 11/30/ *** *** *** *** *** +6 12/3/ *** *** * *** *** *** +7 12/4/ *** *** * *** *** *** +8 12/5/ *** *** *** *** *** *** +9 12/6/ *** *** *** /7/ *** *** ** *** *** *** *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. a Except TAISEI, ten P/C insurance companies were listed in TSE around the event of TAISEI s failure: NISSAN, AIOI, DOWA, NISSHIN, MITSUI-SUMITOMO, NICHIDO, YASUDA, TOKYO MARINE, NIPPONKOA, and FUJI. b Markets were closed November 23 in observance of the annual national public holiday Kinro Kansha no (Labor Thanksgiving Day). Table continues

17 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 101 Table 4. continued YASUDA All listed P/C (a) Day b AR(%) t value CAR(%) t value AR(%) t value CAR(%) t value 0 11/22/ *** *** *** *** +1 11/26/ ** *** *** +2 11/27/ * *** ** *** +3 11/28/ *** * *** +4 11/29/ *** ** *** +5 11/30/ ** *** +6 12/3/ *** *** *** +7 12/4/ *** ** *** +8 12/5/ *** *** +9 12/6/ *** *** /7/ ** *** *** *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. (a) Except TAISEI, ten P/C insurance companies were listed in TSE around the event of TAISEI s failure: NISSAN, AIOI, DOWA, NISSHIN, MITSUI-SUMITOMO, NICHIDO, YASUDA, TOKYO MARINE, NIPPONKOA, and FUJI. (b) Markets were closed November 23 in observance of the annual national public holiday Kinro Kansha no (Labor Thanksgiving Day).

18 102 YANASE AND YASUDA premium income at the end of fiscal year REINS is our proxy variable for the ex ante risk exposure of reinsurance transactions in the global market. ε i is the residual error. If stock price decreases are caused by the reinsurance transactions, we expect a negative coefficient for REINS. Table 5 shows descriptive statistics of the CAR (0, 1) and REINS. Panel A in Table 5 shows the means of the CAR for the two catastrophic events, which reveal that the CAR of November 22 ( 8.31%) is much lower than that of September 12 (1.83%). This indicates that the stock prices of Japanese P/C insurers fell substantially more when TAISEI went bankrupt than on September 12. Panel B in Table 5 shows the mean of REINS. The average of REINS is 6.7%, and it varies from 5.2% to the maximum of 9.3% across Japanese P/C insurance companies. Table 6 presents the results of the determinants of the CAR across Japanese P/C insurers, based on the pooled full-sample for the two catastrophic events (Columns 1 to 4) and on each event (Columns 5 to 8). 23 Note that we include the event dummy variable (which takes a value of 1 if the event is on September 12) in order to control for the different effects from each event in the pooled estimation. Column 1 shows the estimated effects of reinsurance exposure for the pooled full sample. The CAR falls by a statistically and economically significant amount. 24 This estimate is representative of the several alternative estimated effects that appear in this table. The size of the estimated effect suggests that for each 1% increase of reinsurance risk exposure, the CAR falls by 2.4%. Column 2 shows the regression result of Eq. (4), replacing REINS with the REINS*0912 dummy and the REINS*1122 dummy, where the 0912 dummy (or 1122 dummy) takes the value one if the event is on September 12 (or November 22); otherwise it takes the value of zero. By this separation of the REINS variable, we can identify the reason why the coefficient of REINS in Column 1 is negatively correlated with the CAR. Row 2 shows that the reinsurance risk exposure on September 12 has no significant effects on the CAR. This indicates that the reinsurance risk exposure of each P/C insurance company is not related to the CAR before the failure of TAISEI. In other words, this result implies that the market did not anticipate at that time the catastrophic losses that would be caused by the terrorist attacks on September 12 through the global reinsurance transactions. One possible reason for REINS*0912 being generally insignificant is that the CAR on September 12 has very little volatility, as shown in Panel A of Table 23 We also estimate the cases of AR, CAR (0, 2), which are qualitatively the same results reported below. Thus, we omit them. 24 T-statistics are in parentheses under each coefficient in Table 6.

19 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 103 Panel A: CAR(0,1) Table 5. Descriptive Statistics Sep. 12, 2001 N = 12 Nov. 22, 2001 N = 10 b Test statistics a Pooled N = 22 Mean 1.83% 8.31% (1.656) 4.77% Std. dev 2.16% 12.70% (34.624)*** 9.08% Min. 4.62% 37.43% 37.43% Max. 3.11% 3.54% 3.54% Panel B: Independent variables (c) Mean Std. dev. Min. Max. REINS (pooled) 6.74% 1.26% 5.16% 9.32% Panel C: Correlation coefficients Pooled sample (N = 22) REINS MERGER MERGER*FORTRESS REINS MERGER d MERGER*FORTRESS e ***Significant at the 1% level. **Significant at the 5% level. *Significant at the 10% level. a Test statistics show both results of the T-test for difference of mean (assuming unequal variances) and F-test for difference of variance. b SUMITOMO is excluded in the sample because it was delisted on September 25, c The REINS variable is the same definition as reinsurance received ratio on Table 2, defined as the ratio of the reinsurance premium received to the premium income at the end of fiscal year In addition, we revise the values of REINS for merged companies since some companies merged in April REINS for merged companies in our analysis is defined as follows: total reinsurance premium received to the total premium income at the end of fiscal year d MERGER is a dummy variable that takes a value one if an insurer is a member of SJ Gr., otherwise zero. e MERGER*FORTRESS is a cross-term variable MERGER with FORTRESS, where FORTRESS is a dummy variable if an insurer has contracted reinsurance transactions through Fortress Re at that time. 5. As we discussed in the previous section, it is true that the CAR was statistically lower than the average of the TSE market, but the variations across Japanese P/C insurers were very small. This implies that the market

20 104 YANASE AND YASUDA reacted against the Japanese P/C industry as a whole, but it did not consider the relative different risk exposure of the P/C companies from their reinsurance transactions at that time. In contrast, the coefficient of reinsurance exposure on November 22 is a statistically and economically significant amount: The estimated effect suggests that for each 1% increase of reinsurance risk exposure, the CAR falls by 6.9%. This result is consistent with our second hypothesis, indicating that, contrary to the event of September 12, the market recognized the catastrophic losses from the global reinsurance transactions at this later time. In addition, remember again the difference in CARs between the two subsamples from September 12 and November 22 in Table 5, which supports the idea that the Japanese stock market reacted to the risk of terrorism through TAISEI s failure rather than immediately from September 12 itself. 25 Of course, the negative impacts might come from the contagion effects of the failure of TAISEI, especially for the SJ Gr. that was supposed to merge with TAISEI into Sompo Japan. Column 3 added the MERGER variable, which is a dummy variable that takes the value one if an insurer is a member of SJ Gr., otherwise zero. The coefficient of MERGER is negative but not significant, indicating that there were no contagion effects of the TAISEI failure on the SJ Gr. Column 4 added the cross-term variable MERGER with FORTRESS, where FORTRESS is a dummy variable if an insurer had contracted reinsurance transactions through Fortress Re at that time. Although it is actually a dummy variable for NISSAN in our small sample, the coefficient is negative and statistically significant. 26 As seen in Figure 2, there exists a negative impact from the reinsurance exposure, but an economically small impact on the CAR. Note also that REINS*1122 dummy in Column 4 is a little smaller than that in Column 2 or 3, indicating that for each 1% increase of reinsurance exposure, the CAR falls by 5.4%. As a robustness check, Columns 5 to 8 show the results of the subsamples based on each loss event. Row 1 in Column 5 and Column 6 shows the estimated effects of the reinsurance exposure on the CAR. Presumably, the 25 Our referees suggest discussing this point, and we appreciate their comments. 26 As we discussed previously, AIOI and NISSAN as well as TAISEI were closely related through their reinsurance contracts via the mediation of Fortress Re, a U.S. reinsurance underwriting manager. Fortress Re had pooled the funds of these companies to share the risks of reinsuring aviation portfolios, so AIOI and NISSAN both faced the problem of enormous payments of reinsurance from the attacks. In addition, YASUDA, NISSAN, and TAI- SEI had already announced a schedule to merge by April 2002 before the terrorist attacks occurred. Therefore, only NISSAN was faced with loss exposures closely related to both the reinsurance transaction and the merger issue with TAISEI.

21 THE IMPACT OF SEPTEMBER 11 ON GLOBAL INSURANCE MARKETS 105 Table 6. Determinants of Cross-Sectional Difference of CAR (0,1) a Pooled sample Pooled sample Pooled sample Pooled sample Sep. 12, 2001 Nov. 22, 2001 Nov. 22, 2001 Variable (1) (2) (3) (4) (5) (6) (7) (8) Nov. 22, Constant (1.03) (3.52)*** (3.24)*** (2.50)** (0.54) (2.42)** ( 1.28) ( 1.91)* 1 REINS ( 2.21)** ( 1.29) ( 2.99)** 2 REINS*0912dummy ( 0.42) ( 0.30) (0.13) 3 REINS*1122dummy ( 4.35)*** ( 3.92)*** ( 3.10)*** 5 MERGER ( 1.17) ( 1.66) 6 MERGER*FORTRESS ( 1.80)* ( 3.85)*** F-statistic 4.27** 8.24*** 6.65*** 7.76*** ** *** R Adjusted R Observations a Each regression from (1) to (4) includes time dummies for the first event of Sep. 11. F-statistics test the null hypothesis that all coefficients are zero. T-ratios are in parentheses below estimated coefficients. ***Significant at the 1% level. **Significant at the 5% level. *Significant at the 10% level.

22 106 YANASE AND YASUDA results show almost the same effects as the pooled estimation in Column 2. In addition, the results of Column 7 or Column 8 are similar to those in the pooled estimation in Columns 3 or 4. Overall, our estimation results indicate that the Japanese stock market recognized the catastrophic losses from the global reinsurance transactions when TAISEI went bankrupt. SUMMARY AND CONCLUSION This study investigates the reaction of the stock prices of Japanese P/C insurers, one of the largest foreign insurance markets, to the terrorist events of September 11, 2001 at the U.S. World Trade Center. Recently, catastrophic losses occurring in one country have the potential to spread rapidly to the insurance industries in other countries because the global network of reinsurance markets has become extremely well-developed. In fact, the globally well-developed network could serve as a transmission vehicle of risk exposures for the world economy. Surprisingly, there have been few studies examining the impact on the foreign insurance industry, although several studies have examined the impact on the stock prices of the domestic U.S. insurers. This study is the first to focus on how the September 11 terrorist attack, one of the largest man-made catastrophic events, affected the stock prices of foreign insurance companies. Surprisingly, the second event occurred on November 22, 2001, two months after the first event. A mid-sized P/C insurance company, TAISEI, went bankrupt due to massive reinsurance claims arising from the terrorist attacks. Therefore, this study compares both events using the traditional event study methodology to examine when the losses arising from the events spread to the Japanese P/C insurance industry. We then investigate the relationship between the price changes resulting from the two loss events and the ex ante risk exposure of the reinsurance transactions. Overall, our estimation results indicate that the Japanese stock market did not recognize the risk of catastrophic losses through the global reinsurance network until TAISEI went bankrupt. Thus, our results indicate that the disclosure required for reinsurance transactions was quite insufficient immediately after the events of September 11. In recent years, especially after the September 11 events, public concern with regulation and disclosure for global reinsurance transactions has been growing. In fact, the IAIS has also discussed how regulation of the global reinsurance market should function. This study may help not only investors and insurance companies but also regulators to better understand the consequential impact of catastrophic events on foreign insurance industries through global reinsurance transactions. It appears