Japan s Insurance Market

Japan s Insurance Market The Toa Reinsurance Company, Limited

Japan s Insurance Market 2009 Contents Page To Our Clients Hiroshi Fukushima President and Chief Executive, The Toa Reinsurance Company, Limited 1 1. Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance Group Makoto Hyodo President and Chief Executive Officer, NIPPONKOA Insurance Co., Ltd. 2 2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry Hideya Kubo Professor, Graduate School of Economics, Shiga University 8 3. The Insurance Market in 2009: Changing Channels and Markets Hideki Ishii Insurance Journalist and Editor Inswatch 19 4. A Review of Today s Japanese Non-Life Reinsurance Market Edward Fenton Managing Director, Asia Pacific, Guy Carpenter & Company, LLC 26 5. Trends in Japan s Non-Life Insurance Industry Underwriting & Planning Department The Toa Reinsurance Company, Limited 32 6. Trends in Japan s Life Insurance Industry Life Underwriting & Planning Department The Toa Reinsurance Company, Limited 36 Supplemental Data : Results of Japanese listed non-life insurance companies for fiscal 2008, ended March 31, 2009 (Non-Consolidated Basis) 44 2009 The Toa Reinsurance Company, Limited. All rights reserved. The contents may be reproduced only with the written permission of The Toa Reinsurance Company, Limited.

To Our Clients It gives me great pleasure to have the opportunity to welcome you to our 2009 brochure, Japan s Insurance Market 2009. It is encouraging to know that over the years our brochures have been well received even beyond our own industry s boundaries as a source of useful, up-to-date information about Japan s insurance market, as well as contributing to a wider interest in and understanding of our domestic market. During fiscal 2008, the year ended March 31, 2009, the Japanese economy rapidly deteriorated as the global financial crisis and turmoil in foreign exchange markets infected the real economy, as indicated by sharp declines in exports and production and the adverse impact on corporate earnings and the labor market. In the non-life insurance industry in Japan, sluggish automobile sales and declines in exports and imports reflecting the economic downturn led to lower premium income from motor insurance and marine insurance, resulting in an overall decline in premium income. In the life insurance industry in Japan, both the numbers of new contracts and in-force contracts declined from the previous year, affected by the economic downturn coupled with the aging society and a low birth rate. In the reinsurance market, many reinsurance companies experienced significant deterioration of their business results and financial positions owing to turmoil in financial markets. The operating environment of the Toa Re Group is expected to remain harsh in view of social and economic changes around the world, structural changes in the insurance industry, and the trend of the international regulatory environment for reinsurance. In order to respond to these changes in the business environment in a timely and effective manner, and to achieve sustainable growth of the Toa Re Group, we recognize that the provision of high added value to our customers and the reinforcement of risk management and other internal control systems throughout the Group are important issues. With the aim of promoting the development of the entire Group and enhancing our corporate value, we have formulated a new medium-term management plan, Crescendo 2011, covering the three-year period from fiscal 2009 to 2011 and founded on three core elements, namely Customer/Income, Management and Corporate Social Responsibility (CSR). By endeavoring to act as an exemplary reinsurance company, we are resolved to fulfill our mission: Providing Peace of Mind. In conclusion, I hope that our brochure will provide a greater insight into the Japanese insurance market and I would like to express my gratitude to all who kindly contributed so much time and effort towards its making. Hiroshi Fukushima President and Chief Executive, The Toa Reinsurance Company, Limited 1

Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance Group 1.Makoto Hyodo President and Chief Executive Officer, NIPPONKOA Insurance Co., Ltd. Introduction The past two to three years have been a time of great change for Japanese non-life insurance industry, for several reasons. First, the first revision of the Insurance Law in nearly 100 years was promulgated in 2008. Currently, the non-life insurance industry is conducting various preparations for the enforcement of the law. Second, the economic environment surrounding the non-life insurance industry is changing rapidly. Similar to the global economy, Japanese economy is experiencing the kind of once-in-a century financial crisis. Since autumn 2008, stock prices have remained at low levels, numerous manufacturers have been forced to reduce production, and consumer sentiment for consumption has been poor. Premium income has continued to trend downward at non-life insurance companies, and they have been required to strengthen their financial foundation based on appropriate risk management. Japanese non-life insurance industry experienced several major problems involving the very foundation of the insurance business, including incidental unpaid insurance claims, inappropriate non-payment of third-sector products, and incorrect setting of premiums for fire insurance and other products. Over the past several years, the non-life insurance industry investigated the detailed causes of these problems and then revised business processes from the ground up and formulated countermeasures to make sure that they would not recur. Today, companies are working to raise the quality of their operations by implementing measures to preclude recurrence. I would like to cover trends in Japanese non-life insurance industry as it faces these major changes, and then explain the business strategy of NIPPONKOA Insurance Group. 1. Trends in Japanese Non-Life Insurance Industry (1) Revision of the Insurance Law The first revision of the Insurance Law in nearly 100 years was promulgated in June 2008. The main objectives of the revision are to adapt the rules of insurance contracts to the needs of modern society, and to revise the content of the law from the perspective of protecting policyholders. Currently, non-life insurance companies are executing initiatives such as revising insurance products to conform to the new Insurance Law, restructuring the system in terms of the insurance claims payment, and revising forms for canvassing and claims payment as they prepare for the enforcement of the new law. 2

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 (2) Overview of Results in the Non-Life Insurance Industry The scale of premium income in Japanese non-life insurance market ranks fourth following the United States, Germany and the United Kingdom. However, difficult economic conditions have caused the reduction of premium income for the past two years. According to aggregate performance data for its 26 member companies prepared by The General Insurance Association of Japan (GIAJ), for the nine months ended December 31, 2008, net premium income decreased by 3.5 percent, or 198.6 billion, compared with the same period of a year earlier to 5,435.9 billion due to factors including reduced premium rates for Compulsory Automobile Liability Insurance and lower motor insurance premium income. Moreover, net claims paid increased by 1.1 percent, or 37.0 billion, compared with the same period of a year earlier to 3,258.9 billion due to an increase in claims paid on personal accident insurance and casualty insurance. The situations appear likely to remain difficult. The decrease in motor insurance, a mainstay product, is due to the decline in the number of vehicles sold. Moreover, fire insurance has failed to increase because of the decline in the number of housing starts. As you are aware, the result of non-life insurance industry correlate closely with the real economy. At its meeting in London in April 2009, the Group of 20 (G-20) announced economic stimulus packages totaling $5 trillion by the end of 2010 with the goal of a 4 percent economic growth rate. The Japanese government as well has devised and implemented various measures to counter the economic crisis. These policies are certainly expected to generate growth trajectories for the global economy and the Japanese economy. However, we, the non-life insurance industry, are not just passively looking at economic trends. Non-life insurance is able to deal with a variety of risks. Nonlife insurance companies can provide brand-new products to respond to the new risks that are arising because of various changes in consumer lifestyles and the activities of corporations. Actually, there is an expanding range of products, such as corporate liability insurance. Moreover, the rising age of society is also expected to broaden the scope for insurance products. (3) Initiatives to Enhance the Quality of Operations I became the chairman of GIAJ on June 30, 2008. The occurrence of problems in the non-life insurance industry created opportunities for GIAJ to formulate various measures to enhance the quality of operations. GIAJ is now in the process of promoting efforts to improve their practicality. Moreover, GIAJ is employing a plan-do-check-act cycle centered on the perspective of consumers voices to formulate and enforce the improvements of measures if needed to further improve the quality of operations. An overview of specific initiatives are as follows. 3

1. Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance Group Holding an Advisory Panel to Listen to Consumers Voices The Advisory Panel to Listen to Consumers Voices was established to sincerely listen to consumer opinions so that the industry as a whole can reflect them in operations management. More than half of the panel s members are influential people from outside the industry, and their opinions will lead to measures to improve the quality of operations in various ways. Establishment of Various Guidelines GIAJ has established various guidelines such as canvassing, claims payment, insurance policy provisions and sales literature. Member companies are working to improve the quality of operations based on these guidelines. Enhancing the Quality of Non-Life Insurance Agents and Solicitors Non-life insurance solicitors are the primary point of direct contact with consumers. GIAJ has introduced the qualification renewal system for non-life insurance solicitors and an insurance product learning system in working to enhance the quality of non-life insurance solicitors. Strengthening Consultation and Complaint Resolution Systems GIAJ is strengthening consultation and complaint resolution systems to properly acknowledge the opinions of customers and use them in operational reforms. At present, Japanese financial industry is setting up a new framework for alternative dispute resolution (ADR), and GIAJ is also promoting required standards based on these movements. (4) Trends among Specific Companies in the Non-Life Insurance Industry NIPPONKOA Insurance Co., Ltd. and SOMPO JAPAN INSURANCE INC. have reached an agreement to establish a joint holding company for business integration in April 2010. In addition, the three companies of Mitsui Sumitomo Insurance Co., Ltd., Aioi Insurance Co., Ltd. and Nissay Dowa General Insurance Co., Ltd. have announced an agreement to commence discussions toward a business combination and business alliance under a holding company structure in April 2010. Japanese non-life insurance industry experienced a period of consolidation from 2001 to 2004. These two business integrations are a much more significant development than that. 4

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 2. Business Strategy of NIPPONKOA Insurance Group (1) Results of NIPPONKOA Insurance For the nine months ended December 31, 2008, at NIPPONKOA Insurance net premium income decreased by 4.6 percent, or 24.3 billion, compared with the same period of a year earlier to 506.3 billion, due to factors including reduced premium rates for Compulsory Automobile Liability Insurance. This ranked fifth in Japanese non-life insurance industry. Net claims paid decreased by 3.3 percent, or 10.3 billion, to 303.9 billion. For the nine months ended December 31, 2008, the seven listed companies among GIAJ members recognized revaluation loss on securities totaling approximately 500 billion due to factors including the substantial decrease in the value of their securities portfolios, and net loss for the seven companies totaled 19.5 billion. Among the seven companies, NIPPONKOA Insurance s revaluation loss was relatively low, and we recorded net income of 19.8 billion. (2) Medium-Term Management Plan of NIPPONKOA Insurance Group NIPPONKOA Insurance has formulated a medium-term management plan for fiscal 2009 throughout 2010. NIPPONKOA Insurance Group is acutely aware of the public responsibility of the insurance industry and aims to contribute to society under the premise of substantial management. The medium-term management plan, as explained below, basically entails executing the three main strategies of contributing to society, raising quality and increasing earnings in working to increase corporate value. Contributing to Society We will conduct all of our corporate activities to respond to social issues such as environmental protection. In addition, we will also contribute broadly to society by working to respond to social demands. Our main activities are as follows. Carbon Neutral Declaration We will achieve zero emissions of CO2 by reducing CO2 emissions by 15 percent or more compared to the level of fiscal 2006 by fiscal 2012, and by purchasing carbon credits to offset the portion of emissions that are difficult to reduce. Eco First Commitment NIPPONKOA Insurance is the first company in the insurance industry to be certified as an Eco-First Company under the Eco-First System established by the Ministry of the Environment of Japan. We have made the Eco-First Commitment to the Minister of the Environment to undertake initiatives includ- 5

1. Trends in Japanese Non-Life Insurance Industry and Business Strategy of NIPPONKOA Insurance Group ing the reduction of CO2 emissions. NIPPONKOA Insurance is using the character ECORaTTa to represent these environmental activities, and widely publicizes NIPPONKOA s initiatives. Raising Quality As detailed below, we are raising quality throughout our operations, from product development to sales and claims payment, to provide customers with safety and security. ECORaTTa The Highest Quality of Claims Handling We have implemented a system for rapid response to accidents 24 hours a day, 365 days a year. In addition, we aim to provide the highest level of service in ways such as promoting the use of environmentally sound parts when repairing vehicles that have been in an accident. Raising Sales Quality We aim to improve the quality of individual solicitors by conducting efficient and effective education and training. Raising Product and Administrative Quality We are developing simple, easily understood products in ways such as consolidating products or endorsements, and using plain and clear language for policy conditions. Moreover, we are upgrading our information technology base to simplify and standardize the contract procedures and improve administrative quality. Increasing Earnings We will increase corporate value by balancing allocation of Group profit generated through the measures to increase earnings between providing returns to all our stakeholders and investing in growth areas. Main initiatives are as follows. Measures to Strengthen Underwriting and Loss Prevention We are strengthening underwriting and moving to prevent or alleviate losses. Improving the Profitability of Business Units We will work to improve profitability by grouping existing businesses in units defined by products or sales channels and employing unique management indicators to thoroughly analyze, formulate and execute concrete plans for improving profitability. Raising Operating Efficiency We aim to reduce operating risk and achieve low-cost operations by raising operating efficiency. 6

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 (3) Business Integration of NIPPONKOA Insurance and SOMPO JAPAN INSURANCE NIPPONKOA Insurance and SOMPO JAPAN INSURANCE have agreed to establish a joint holding company for business integration in April 2010 for a new solution service group with the aim to provide customers with security and service of the highest quality and contributes to social welfare. The new group aims to make all value judgements from the perspective of customers and aims for enhancement of corporate value and contribution to social welfare, by maximizing synergy effects by way of such measures as standardization and sharing of functions and services. Within the joint holding company, NIPPONKOA Insurance and SOMPO JAPAN INSURANCE will diligently use the strengths of the existing brands and sales channels of each company. At the same time, they will work to achieve economies of scale by sharing IT systems and other resources to reduce the burden of cost centers with the aim of enhancing competitiveness. Conclusion In Japanese non-life insurance industry, deregulation from 1996 liberalized premiums on insurance products in the retail field, which had been uniform throughout the industry up to that time. This engendered competition in the areas of product development and premiums. Moreover, successive business integrations and mergers took place with the primary aim of increasing scale. Subsequently, as discussed earlier some major problems arose, however, over the past two to three years the insurance industry has dealt with them. Moreover, non-life insurance companies have restructured the way they do business from the ground up, from headquarters to front-line sales and claims branches. As a result, our industry has entered a new phase in which companies compete on the basis of the quality of operations. Non-life insurance companies have changed their corporate cultures so that they are better able to listen sincerely to customer opinions than they were in the past. This has created the chance to discuss the risks surrounding customer thoroughly as well as to find links to new business opportunities. In other words, nonlife insurance is fulfilling its responsibility to provide customers with security, which is enabling the industry to develop further. 7

Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry 2.Hideya Kubo Professor, Graduate School of Economics, Shiga University 1. Market Changes Due to Complete Liberalization of Insurance Rates Japan s non-life insurance industry generated stable, consistent growth without price competition under the rating system of Property and Casualty Insurance Rating Organization of Japan, which was established in 1948. Even during the deflation of Japan s bubble economy during the 1990s, in contrast to the negative spread of Japan s life insurance industry, where actual investment returns were below projected investment returns, the non-life insurance industry was only marginally affected by the issues of nonperforming loans, since its products, such as motor, fire and other types of insurance (excluding saving-type insurance), are of shorter duration, and the scale of its assets was only about one-fifth that of the life insurance industry. In addition, major revisions to the Insurance Business Law to 1) ensure the soundness of insurance companies; 2) promote the deregulation of insurance; and 3) ensure fair business operations, took effect in April 1996. Along with the revised Law Concerning Non-Life Insurance Rating Organizations (the Rating Organization Law ), these revisions served to promote deregulation, but the scope of liberalization of insurance rates was small at first. However, conditions dramatically changed as a result of the Japanese version of Big Bang that the cabinet of Prime Minister Ryutaro Hashimoto began promoting in November 1996. The U.S.-Japan Insurance Talks, which had previously made little headway, reached their policy conclusions, and consequently the Rating Organization s compulsory rates based on the Rating Organization Law were abolished. Property and Casualty Insurance Rating Organization of Japan issued regulated rates based on the Law Concerning Non-Life Insurance Rating Organizations of 1948, and it initially provided suggested rates based on its statistical data. However, a 1951 revision to the Rating Organization Law ended suggested rates in favor of compulsory rates, and these regulated rates remained in effect for the next 45 years. As a result of the U.S.-Japan Insurance Agreement in December 1996, the compulsory Rating Organization rates were abolished (Note 1) and regulations were maintained in the third sector. The Financial Reform Law of June 1998 and the revision of the Rating Organization Law of July 1998 also liberalized insurance rates. The liberalization of interest rates, which symbolized financial liberalization in Japan, began in the 1970s. It took approximately 20 years until the 1994 liberalization of interest rates on liquid deposits. In contrast, non-life insurance rates for all main fire, personal accident and motor insurance products were liberalized over a period of three years from 1995, when the revision of the Rating Organization Law rendered the banded rate reporting unnecessary, and advisory rates were introduced for fire insurance for industrial risks. The Rating Organization reportedly set the expected loss ratio (net premium component) lower, and set the additional rate component (premium accretion component) higher. Reductions in this larger accretion rate component have accelerated as a result of liberalization. In general, price liberalization and other aspects of deregulation draw an increased number of new market participants offering new products and services, 8

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 with a concomitant decrease in the market share of companies already in the market. Beginning in 1996, non-life insurance subsidiaries of life insurance companies and companies from other industries successively entered the market, which increased the number of non-life insurance companies doing business in Japan from 23 in 1993 to a peak of 34 in 2000. However, many of the new participants were unable to keep up with the high pace of rate liberalization, and became engulfed in a trend toward consolidation, mainly with existing non-life insurance companies. The non-life insurance market was strongly affected by the liberalization of the price of main products over a short period. Graph 1 shows long-term changes in Japan s non-life insurance market over the past 30 years or so. This time frame is broadly divided into three periods. The first period includes the era of stable growth under regulation and the growth of the bubble in the 1980s. The second period includes the protracted period of low growth in the 1990s as the bubble deflated. The third period includes the period of deregulation beginning in 1999 when premiums were completely liberalized. First, let s consider market change from the perspective of market consolidation as measured by the Herfindahl Index (HI). Here, the HI is calculated using direct premium income, which constitutes revenues for typical companies, and core earnings. Core earnings are calculated by subtracting one-time gains and losses from asset sales; valuation gains and losses; and foreign exchange gains and losses from ordinary income as reported on the income statement, and reflecting provisions to and reversals of the catastrophe loss reserve. In other words, this calculation expresses the primary income for a non-life insurance company. Prior to rate liberalization in fiscal 1998, both versions of the HI are uneventful and show little variation. They clearly show a market structure with little change in share, which is typical of a regulated industry. The HI using direct premium income (the graph with the solid line) stays at about 0.09. At the peak of the bubble, when 9

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry market concentration was generally considered to be low, the HI does not change (direct premium income increased 8 percent annually in 1989 and 1990). Incidentally, with the advent of the second period, the HI using direct premium income does not change, but the HI using core earnings (the graph with the dashed line) gradually rises. The profitability differential between companies widens, and the bar graph shows that among non-life insurance companies core earnings per unit of business expenses including personnel, non-personnel, and operating expenses decreased by half from about 0.2 to nearly 0.1. The non-life insurance industry took no drastic action to address decreasing profitability up to the complete liberalization of rates in 1998. The HI begins to change substantially in the third period. Admittedly, there were numerous extraordinary factors including 1) the occurrence of E. coli O157 food poisoning in 2001 that resulted in provisions to the reserve for outstanding losses (ordinary profit for the industry as a whole decreased 128.9 billion); 2) a 7.0 percent increase in direct premium income (transitional revenue) as a result of the abolishment of government reinsurance of Compulsory Automobile Liability Insurance in fiscal 2002; and 3) the impact of a string of typhoons in fiscal 2004 (claims paid increased 16.1 percent compared with the previous fiscal year because of Typhoons 16 (Chaba), 18 (Songda) and 23 (Tokage)). Nevertheless, their influence on industry concentration could be considered neutral. The HI rose mainly because of the following two points. First, a flight to quality was evident among consumers in their swift reaction to the order to suspend operations given to The Daiichi Mutual Fire and Marine Insurance Company in May 2000 and the petition for corporate rehabilitation filed by The Taisei Fire and Marine Insurance Company, Limited in November 2001. Subsequently, competition intensified as a result of rate liberalization and largescale consolidation took place among existing insurance companies. Features unique to the non-life insurance industry also influenced the progress of large-scale consolidation. In general, deregulation attracts new entrants to a market, and the HI falls. However, the non-life insurance industry requires a large initial investment and the period until new entrants become profitable is long, which serves to limit market entry. Moreover, the non-life insurance industry provides similar products, and so the liberalization of premiums on main products put pressure on companies with weaker sales capabilities to reduce fixed expenses more substantially than the industries in general. Added to the longstanding horizontal structure of the industry, these factors led numerous companies toward consolidation. Domestic non-life insurance companies shortly aggregated into six groups. The HI using premium income from direct underwriting rose to the 0.15 level in fiscal 2004 from the 0.09 level in fiscal 1998. While factors such as the widely varying outcomes of industry consolidation, market concentration as evidenced by revenues accelerated, resulted in pronounced variation along a rising trend line in the HI using core earnings. 10

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 2. Analysis of Efficiency Using Stochastic Frontier Production Functions (1) Frontier Production Functions as an Indicator of Insurance Company Efficiency The large-scale reorganization of Japan s non-life insurance industry has greatly influenced the efficiency of each company in the industry. Careful consideration is required to determine if conventional financial indicators such as the growth rate of ordinary profit and the ratio of operating income to revenue are viable for measuring the efficiency of non-life insurance companies. For example, the disposal of real estate used for operations and the integration of computer systems during an analogous period of large-scale industry reorganization would increase earnings by reducing depreciation expenses but would have little impact on cash flow. In addition, in many cases a corporation that consolidates factories and sells real estate it owns as a result of mergers and acquisitions generally increases return on assets (ROA) and return on equity (ROE; ROA multiplied by leverage). However, a majority of the assets of nonlife insurance companies are managed in underwriting reserves as financial resources for the payment of future claims. The types of insurance products sold determine how a company will fund these reserves, and the level of underwriting risk varies among insurance companies. Consequently, ROA lacks validity as an evaluation tool. Low ROE due to low leverage does not necessarily equate to inefficiency because soundness of an insurance company is more important than for corporations in general. Insurance company efficiency therefore requires a different approach to measurement. In general, corporations are independent economic entities that produce using resources such as capital, technology, human resources and raw materials. Output is determined by the type and volume of inputs and the firm s efficiency. The production function is a simplified relationship between outputs and inputs, and is suitable for measuring the efficiency of non-life insurance companies. The following expresses the production function: Output = f (input a [e.g., capital], input b [e.g., labor], input c [e.g., overhead]... ) However, many of the firms in the current competitive market are inefficient. Therefore, setting the production function of the most efficient firms as F yields the following production function for all other firms: Output = F (input a, input b, input c.) + Inefficiency Moreover, the function should include a margin of error to reflect the use of estimates. Therefore, the function becomes the following: Output = F (input a, input b, input c.) + Inefficiency + Margin of error Various assumptions are available for function F. However, the Cobb-Douglas production function with its highly stable parameters is used here because it is simplest. Moreover, the inefficiency component assumes a half-normal distribution, and the margin of error assumes a normal distribution. The parameters expressing inefficiency are then estimated using the maximum-likelihood method. This methodology for estimating efficiency is known as a stochastic frontier production function (Note 2). The algorithm for this function is detailed in The Restructuring Strategies of Japanese Life and Non-Life Insurance Groups (2008)(Note 3). 11

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry For productivity derived from the frontier production function, the efficiency of the subject firm is measured by the degree to which it deviates from the line calculated for the most efficient production of goods given capital and labor inputs. Consequently, the higher the number, the higher the productivity. With goods produced as a dependent variable for the production function, the estimates here have five components: 1) direct premium income as a proxy for the total turnover of a typical corporation; 2) ordinary income as reported on the income statement; 3) core earnings that exclude extraordinary gains and losses related to capital from ordinary income and reflect the increase or decrease in the catastrophe loss reserve; 4) core earnings including depreciation (cash flow); and 5) the sum of core earnings and business expenses to represent added value under the concept of gross profit. On the other hand, the independent variable for the production function involves inputs of capital stock and labor, which are defined as follows. Capital stock is net depreciation expense as reported by each company in the statement of depreciation and amortization in its financial statements for the most recently ended fiscal year. For those insurance companies that do not report net depreciation expense in a statement of depreciation and amortization, capital stock is calculated by discounting reported depreciation expense by the average depreciation rate for the industry. Labor inputs consist of 1) total expenses for both sales and internal administrative personnel; and 2) related business expenses other than personnel expenses. Sales personnel expense is the total of agency commissions and brokerage and customer acquisition costs (fees associated with direct sales). Internal administrative personnel expense is personnel expense as detailed in the income statement. The analysis covers direct insurance companies operating in Japan. Reinsurance companies and foreign non-life insurance companies with branches in Tokyo are excluded. The sources for the data are Insurance: The Statistics of Japanese Non-Life Insurance Business and the financial reporting issued by each company. For fiscal 2007, capital stock accounted for 20.4 percent of total input and personnel expenses (the total of sales and internal administrative personnel expenses as per 1) above) accounted for 79.6 percent. In further details, sales personnel expenses accounted for 48.1 percent, and internal administrative personnel expenses accounted for 31.4 percent. With the inclusion in labor input of related business expenses other than personnel expenses as per 2) above, capital stock accounted for 15.7 percent of total input and labor accounted for 84.3 percent, of which sales personnel expenses accounted for 37.0 percent. In all cases, sales channel expenses represent 40 to 50 percent of input cost, and the operation of the exclusive agency channel stands out as a major component of the cost structure. Moreover, the 48.1 percent share of sales personnel expenses in total input for fiscal 2007 mentioned above has increased by 10 percentage points from 37.8 percent in 1991, for two reasons. One, assuming commission-based compensation, commission payments to agencies should decrease if sales decrease, but in reality commissions are structured so that they do not fall in direct proportion to a decrease in performance. In fiscal 1991, premium income totaled 6.5 per 1.0 of sales personnel expense, but in fiscal 2007 had fallen to 5.9. Two, capital has decreased as a 12

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 result of consolidation. The ratio of capital stock to total input was 32.9 percent in fiscal 1998 prior to the liberalization of premiums, but had decreased by 12.4 percentage points to 20.5 percent in fiscal 2007. This reflected the rapid pace of reduction in assets such as owned real estate as a result of large-scale consolidation. In other words, the strategy of non-life insurance companies was to compensate for reduced labor productivity by increasing capital productivity. Incidentally, capital accounts for about 40 percent of total input in the life insurance industry, which would indicate that Japan s non-life insurance industry is more labor intensive than the life insurance industry. Panel data including cross-sections of annual insurance company data bundled with a time series is used to ensure the stability of the function when using estimates. The estimate period is the 17 years from fiscal 1991 through fiscal 2007. As a result, each estimate can be based on up to 458 samples. One sample requires extraction and synthesis of 55 data points from the financial statements of each company. Table 1 presents the result of estimates for each production function. The t-value of the good produced, which is the dependent variable in the estimate equations, is high (in any case, significant at the 1 percent level). The capital and labor parameters are also valid numbers. Table 1: Parameters for Frontier Production Functions for Japanese Non-Life Insurance Companies, FY1991 to FY2007 Good produced Parameter Direct premium income Ordinary profit Core earnings t-value Standard error Parameter t-value Standard error Parameter t-value Standard error Constant Capital Labor Sample, LI 1.67773 0.049508 0.948072 1.42576 2.43729 8.61257 3.17037 36.4578 60.0708 10.8283 458, -285.761 0.1948 0.015616 0.026005 0.023735 0.225085 1.07845 0.22987 0.596678 0.726756 1.99969 3.16649 6.81552 12.6326 20.8775 5.39026 345, -469.782 0.340582 0.033727 0.047233 0.034811 0.370982 1.6476 0.17028 0.6398 0.67828 2.24504 5.12467 4.24654 12.4542 20.4606 5.89373 296, -415.221 0.321504 0.040099 0.051372 0.033151 0.380921 Cash flow* Added value Good produced Standard Standard Parameter t-value error Parameter t-value error Constant Capital Labor Sample, LI 0.705518 0.13705 0.750281 0.714266 3.0099 1.67966 3.60953 13.24883 22.9593 5.58688 317, -407.208 0.420035 0.037969 0.05663 0.03111 0.538745 1.36458 0.061163 0.885886 1.81523 1.67761 10.0196 4.97387 53.6817 36.1526 10.5325 457, -223.875 0.136192 0.012297 0.016503 0.05021 0.15928 Note 1: LI = log likelihood Note 2: *Capital cost (capital replacement cost: depreciation rate + interest rate) may be used in place of capital stock, and labor input reflects other business expenses. 13

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry 3. Changes in the Operating Efficiency of the Non-Life Insurance Industry Let s consider the impact that deregulation had on the efficiency of the non-life insurance industry as indicated by the application of this production function. Graph 2 represents data for which this function is applied to calculate cash flow from fiscal 1991 to fiscal 2007 (core earnings + depreciation), ordinary profit and direct premium income to elucidate efficiency for the industry as a whole. Efficiency prior to liberalization (fiscal 1991-fiscal 1998) is significantly different from efficiency after liberalization (fiscal 1999-fiscal 2007). In the economic and financial environment of the 1990s, Japan s industry was subject to challenging deflationary pressure due to factors such as the anemic 0.9 percent average annual increase in the corporate price index. Efficiency as measured by premium income from direct underwriting premium income among non-life insurance companies (line graph) decreased continuously from 0.63 to 0.615. On the other hand, two efficiency indicators related to profitability held steady at approximately 0.7. Corporate initiatives supported this efficiency, and regulated premiums also supported the profitability of each company. In contrast, however, the soundness of an insurance company is more important than for corporations in general, and changed significantly following deregulation in fiscal 1999. Moreover, this period is characterized by the divergence of cash flow efficiency and ordinary profit efficiency. Ordinary profit stands for the profit after employing one-time asset sales and other means to compensate for factors such as large fluctuations in operating income and loss and losses associated with asset management. As a result, insurance companies with sufficient strength were able to restrain fluctuations in ordinary profit. For example, actual cash flow and ordinary profit in fiscal 2004 differed by approximately 350 billion, mainly because of compensatory moves using the following two financial resources. The first was reversals 14

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 of the catastrophe loss reserve that had been set aside for major disasters. For fiscal 2004, companies that conducted reversals brought the industry total to approximately 154 billion, as estimated from changes in the balance of catastrophe loss reserves. The second financial resource was sales of investment securities. Compared with fiscal 2005, the loss on sales of securities and loss on revaluation of securities for fiscal 2004 was about 14 billion greater, but the gain on sales of investment securities was about 120 billion greater. This positive difference of approximately 100 billion was the factor that stabilized ordinary profit. From fiscal 1999, fluctuations in ordinary income efficiency show that insurance companies were only drawing down reserves created through financial statement manipulation as the revenue environment became increasingly challenging. The full-scale consolidation that began in fiscal 2001 to respond to these conditions made a substantial contribution to the increase in the efficiency of direct premium income (line graph). Consequently, evidenced by the black bar graph, cash flow efficiency recovered even though price competition had caused it to fall. Here, efforts to reduce costs among companies that had both merged and reduced cost of capital contributed substantially. However, the result was that cash flow efficiency peaked in fiscal 2005. 4. Efficiency of Individual Insurance Companies and the Effect of Consolidation The next topic is the cash flow efficiency of individual companies. Graph 3 shows all individual insurance companies with positive cash flow (317 samples) from fiscal 1991 to fiscal 2007. Cash flow efficiency is on the vertical axis, and all corresponding log figures are plotted on the horizontal axis using the same scale. In general, cash flow efficiency increases as the level of cash flow increases. The distribution curve 15

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry (line graph) is expressed as Log (cash flow efficiency) = 0.2592 x Log (same scale) - 1.41. The value of elasticity for the same efficiency on the same scale is 0.2592. Therefore, the scaled earnings for the non-life insurance industry can be observed. Furthermore, as the dashed lines in the graph show, the scale of the distribution allows the data to be divided between medium-sized companies (dashed line 1) and large companies (dashed line 2). The slope of line 1 is steep, and therefore shows that improvement in earnings efficiency is closely linked to expansion in scale in the group of medium-sized insurance companies. Thus it shows that consolidation is a better means of improving earnings efficiency for medium-sized companies than for large companies. The next topic is further detailed measurement of changes in efficiency as a result of this consolidation. The analysis focuses on the six companies that emerged from 15 companies that were involved in large-scale consolidation. Consolidations were conducted by Tokio Marine & Nichido Fire Insurance Co., Ltd. (a merger between Tokio Marine and Nichido) in October 2004; Mitsui Sumitomo Insurance Co., Ltd. (a merger of Mitsui Marine & Fire Insurance Co., Ltd., The Sumitomo Marine & Fire Insurance Co., Ltd. and Mitsui Life Insurance Co., Ltd., with the transfer to the new company of the entire non-life policy portfolio of Mitsui Life in November 2003) in October 2001; Sompo Japan Insurance Inc. (a merger between Yasuda Fire & Marine Insurance Company and Nissan Fire & Marine Insurance, with Taisei Fire and Marine Insurance Co., Ltd. merging with Sompo Japan in December 2002) in July 2002. The analysis also covers the medium-sized non-life insurance company NIPPONKOA Insurance Co., Ltd. (a merger of The Nippon Fire & Marine Insurance Co., Ltd., The Koa Fire & Marine Insurance Co., Ltd. and The Taiyo Fire & Marine Insurance Co., Ltd. with the latter merging with NIPPONKOA in April 2002); Aioi Insurance Co., Ltd. (an April 2001 merger between The Dai-Tokyo Fire & Marine Insurance Co., Ltd. and The Chiyoda Fire & Marine Insurance Co., Ltd.); and Nissay Dowa General Insurance Co., Ltd. (an April 2001 merger between The Dowa Fire and Marine Insurance Co., Ltd., and Nissay General Insurance Co., Ltd.). Table 2 shows cash flow efficiency prior to and following corporate consolidation over the 17 years from fiscal 1991 to fiscal 2007. Estimated data is panel data bundled with a time series including cross-section data by specific company and fiscal year. Consequently, the efficiency shown by the frontier production function incorporates differences in the market environment during each fiscal year. The difference in the market environment must be removed for continuous comparison and observation of the efficiency of companies after consolidation and each company prior to consolidation. Consequently, the companies included in the overall scale of the non-life insurance industry are treated as a single company. The five types of efficiency mentioned earlier are then examined, and averages over the same period of fiscal 1991 to fiscal 2007 are used as the standard deflator. Next, differences in the market environment are removed from the efficiency of each company and fiscal year using the deflator. The method is the way that public 16

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 economic data are used, and are adjusted to nominal prices to present the data in real terms for comparability. Table 2 shows the result of using nominal prices to present efficiency in real terms. Table 2: Changes in Cash Flow Efficiency Due to Consolidation in the Non-Life Insurance Industry Group 1 2 3 4 5 6 Average Company 1 before Consolidation 0.5733 0.4576 0.4951 0.4835 0.6625 0.4514 Company 2 before Consolidation 0.7034 0.6562 0.4092 0.3841 0.3042 0.0100 0.4184 Company 3 before Consolidation 0.0531 0.3011 0.3304 Companies after Consolidation 0.9277 0.6535 0.5046 0.2690 0.5203 0.2766 0.5253 Note 1: The figures showing efficiency are actual figures with differences in performance in each fiscal year eliminated using the deflator. Note 2: Figures are simple averages of actual numbers for each fiscal year from fiscal 1991 to fiscal 2007. Therefore, the figures do not reflect changes in the scale of companies. Table 2 shows average figures for cash flow efficiency for the companies that make up the groups prior to consolidation from fiscal 1991 to the year prior to consolidation, and the equivalent figures for the year in which consolidation took place up to fiscal 2007. For example, in Group 1 efficiency of 0.5733 and 0.7034 for the two companies prior to consolidation is shown to rise to 0.9277 after consolidation. For Groups 1 through 3, the efficiency of each company after consolidation generally rises compared to efficiency prior to consolidation. In contrast, efficiency after consolidation drops substantially for the companies in Groups 4 through 6. This shows that the progress of consolidation exerted a significant impact on efficiency. In Groups 1 through 3, large companies consolidated. In Groups 4 through 6, medium-sized companies consolidated. Therefore, while consolidation includes numerous elements, scale is clearly the most significant. Each company successively disclosed in fiscal 2008 that they would work to increase scale in their subsequent management plans, and the figures in Table 2 show the rationality of that approach. Conclusion Pricing in Japan s non-life insurance industry was regulated for nearly half a century beginning in 1951. Liberalization took only three years, and completely liberalized insurance rates. The effects of deregulation were substantial, and market concentration changed rapidly. Moreover, large-scale consolidation emerged as a means of enhancing competitiveness, and it effectively increased the efficiency of insurance companies by at least fiscal 2005. However, price competition among main products became more severe than expected and introduced a challenging revenue environment, resulting in significant variation in the effect of consolidation. Substantial differentiation among products 17

2. Analysis of Long-Term Efficiency Gains and Evaluation of Large-Scale Consolidation in Japan s Non-Life Insurance Industry and services is difficult in the non-life insurance industry, which suggests that the future will bring more consolidation with the objective of maximizing scale. Thus stochastic frontier production functions for analyzing efficiency are effective for analyzing long-term changes in the market and studying the relative effectiveness of management strategies. Looking forward, the use of improved production function models will offer worthwhile suggestions for risk management by each company and supervision of soundness by the Financial Services Agency. Notes 1. From July 1, 2002, Property and Casualty Insurance Rating Organization of Japan became the Non- Life Insurance Rating Organization of Japan (NLIRO), and its primary functions became calculating appropriate reference loss cost rates and standard full rates through high-precision analysis of insurance statistics and reporting them to the Minister of the Financial Services Agency. The reference loss cost rate is calculated for fire, personal accident, motor and nursing care expense insurance, and the standard full rate is calculated for Compulsory Automobile Liability Insurance and earthquake insurance. In other words, NLIRO assumed the functions of calculating insurance rates and serving as an industry databank. 2. Analysis using frontier functions primarily entails production functions and cost functions. Estimation methods are classified as data envelopment analysis (DEA) or parametric analysis through the use of linear programming. Moreover, the latter are classified as deterministic functions or stochastic functions. This paper uses parametric stochastic functions, otherwise known as stochastic frontier production functions. 3. Hideya Kubo 2008. The Restructuring Strategies of Japanese Life and Non-Life Insurance Groups. Journal of Insurance Science 601 (June): 129-148. 18

The Insurance Market in 2009: Changing Channels and Markets 3.Hideki Ishii Insurance Journalist and Editor Inswatch 1. Introduction The financial crisis that originated in the United States in September 2008 resulted in issues such as the global decrease in stock prices that have strongly impacted the Japanese insurance industry. In particular, both life and non-life insurers posted very large devaluation losses on investment securities, which caused a number of insurance companies to report net losses for fiscal 2008. In the meantime, our aging society with fewer children has sluggish insurance sales, causing a consistent downward trend at life and non-life insurance companies. In the non-life insurance industry, decreasing vehicle ownership and reduced vehicle production as a result of the financial crisis has led to a drop in new motor insurance policies. Moreover, Japan s falling birthrate and rising age have resulted in a decrease in sales of death benefit coverage in the life insurance industry. These factors have caused sales of the main products that support earnings in both the life and non-life insurance sectors to plateau. Amid these environmental changes, insurance companies have worked to further enhance operating efficiency. They have also shifted to a business model that emphasizes customer needs by moving away from their former mass market product and sales strategy to a focus on product quality and service. A new wave of non-life insurance industry restructuring began at the start of 2009. In the life insurance industry, Yamato Life Insurance Company became insolvent and other companies implemented measures to increase their capital as their operating capabilities weakened. Beset by this challenging environment, Japan s insurance industry is seeking new approaches to management as the financial crisis affects the real economy. Moreover, insurance companies pursuing low-cost operations accelerated the movement to replace the conventional channels such as agencies or salespersons by launching new channels in the direct sales area, which intensified competition for customers. The market will inevitably eliminate simplistic sales methods that cling to the conventional agency model without adapting to change. A discussion of Japan s changing insurance market and channels in 2009 with a focus on non-life insurance follows. 2. The Non-Life Insurance Industry in 2009 The largest change in Japan s insurance industry during 2009 is the trend toward restructuring in the non-life insurance industry. In January 2009, Aioi Insurance Co., Ltd., Nissay Dowa General Insurance Co., Ltd. and Mitsui Sumitomo Insurance Co., Ltd. agreed to integrate their management with the aim of forming a new insurance and financial group. Moreover, in February 2009 Sompo Japan Insurance Inc. and NIPPONKOA Insurance Co., Ltd. reached an agreement to establish a joint holding company for management integration. These were among the industry s moves to reorganize under a new structure. Against the backdrop of the collapse of the bubble economy, the non-life insurance industry conducted mergers and combinations during the 2000s to reorganize into six major domestic companies (Tokio Marine & Nichido Fire Insurance, Mitsui Sumitomo Insurance, Sompo Japan, Aioi Insurance, NIPPONKOA Insurance, and Nissay Dowa). However, the impact of the contraction of the Japanese insurance market and the global financial crisis has put an end to the six-company structure. In 19

3. The Insurance Market in 2009: Changing Channels and Markets April 2010, the Tokio Marine Group and the two recently announced groups will inaugurate a three mega-company structure (Chart 1). The financial crisis that originated in the United States rapidly sapped the operating strength of the non-life insurance industry, which was one factor giving rise to another round of restructuring. For example, the six non-life insurance companies mentioned earlier recognized valuation losses on investment securities in excess of 400 billion in the nine months ended December 31, 2008. Further to that, the insurance market itself continues to contract. The average age in Japan is rising rapidly while the birthrate is falling. Japan s population as of April 2009 was 127.6 million, a decrease of 90,000 from a year earlier. Conversely, the senior demographic of people age 65 and older increased 2.78 percent from a year earlier to 28.289 million, and is projected to increase to 35.7 percent of the total population in 2050. (Source: April 2009 Population Estimates for Monthly Report, Statistics Bureau, Ministry of Internal Affairs and Communications.) This changing environment has especially affected motor insurance, a mainstream product supporting earnings in the non-life insurance industry. The drop in the number of vehicles owned and the September 2008 financial crisis have caused vehicle production and sales to decrease dramatically, and significant growth is not projected for the domestic market. Therefore, non-life insurance companies are concentrating on strengthening their domestic life insurance subsidiaries and raising the efficiency of their non-life insurance operations by reducing operating expenses. This is enhancing their management foundation. At the same time, the industry is executing a concurrent strategy of aggressively investing their management resources in business overseas, particularly by using mergers, acquisitions and other means to expand in Asian markets. 20

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 The aim of creating extremely large non-life insurance companies is to deploy these strategies to expand organizational and business scale while raising efficiency through restructuring. Specific measures for the domestic market include developing efficient sales channels while reducing operating expenses, and responding to markets by raising quality in conventional channels and strengthening customer relationships. Other tasks include the integration of head offices and exclusive channels to enhance capabilities and restructure, as well as the standardization of services and more cross-selling of life and non-life products. 3. New Channels in the Non-Life Insurance Business Two major sales channels have emerged in Japan s insurance industry. One is the bancassurance channel, in which all restrictions on sales were lifted as of December 2007. The other is sales of insurance through Japan Post Bank Co., Ltd., Japan Post Insurance Co., Ltd. and Japan Post Service Co., Ltd. following the October 2007 privatization of the postal system. Bancassurance sales began when the first set of restrictions were lifted in 2001 and progressed over six years until all restrictions were eliminated. Non-life bancassurance products include fire insurance bundled with home mortgage products, but the primary bancassurance product is annuity products offered by life insurance companies. In particular, the balance of variable annuity insurance sold through the bancassurance channel as of September 30, 2008 exceeded 17 trillion. Moreover, the total lifting of restrictions has allowed banks to become a major channel for medical insurance, cancer insurance and other life insurance and third-sector products, while for non-life motor insurance, only 10 banks act as direct sales intermediaries. In addition, the September 2008 financial crisis has had the greatest impact on bancassurance sales of variable annuity insurance, which have been restrained by the deteriorating fund management environment. New contracts of variable annuity policies decreased substantially up to March 31, 2009, which was the end of fiscal 2008. Moreover, variable annuity market share leader The Hartford, along with other companies including ING, Crédit Agricole Life and Allianz Life and domestic firms Mitsui Life and Sumitomo Life, has exited the market or terminated the sales of some variable annuity products because of worsening environment of fund management and funding book reserves for the products including guaranteed minimum for accumulated capital and other uses. Sales are subject to some restrictions. Banks are prohibited from selling insurance to companies to which they extend loans, lending officers and sales officers of insurance must be separate, and misuse of private information (without customer approval) is prohibited. However, bancassurance is regarded as a promising channel for life and non-life insurance companies, which will definitely invest the know-how, personnel and sales support to develop it. A chronology of bancassurance follows. Lifting of Restrictions on Bancassurance The first set of restrictions was lifted in April 2001. Products were insurance 21

3. The Insurance Market in 2009: Changing Channels and Markets linked to home mortgages (fire insurance, loan repayment assistance insurance, group trust life insurance), and overseas travel personal accident insurance. As a result, a group discount system was introduced for fire insurance bundled with home mortgages, which affected conventional channels partially. The second set of restrictions was lifted in October 2002. Products were individual annuity insurance products (fixed and variable), and savings-type personal account annuity. Low interest rates accelerated the flow of funds from savings to investments, and the rising average age of society also heightened annuity needs. Sales of annuity products also matched the desire among banks for commission income, and therefore increased rapidly. The third set of restrictions was lifted in December 2005. Products were life insurance (single payment whole life insurance, single payment endowment insurance), non-life insurance (fire insurance, individual liability insurance, savings-type personal accident insurance). At this time, city banks and certain regional banks began creating systems in preparation for the lifting of all restrictions, such as initiating bancassurance sales and deploying experienced personnel. Variable annuity products that guarantee principal and provide for early receipt of benefits were launched. All restrictions were lifted in December 2007, and sales of life, non-life and third-sector products started. City banks expanded their product lineups and regional banks expanded the variable annuity products they handled and strengthened sales of medical-related products. Credit banks began selling cancer insurance, medical insurance and fixed annuity products. At the end of March 2007, the balance of assets in separate accounts for variable individual annuities exceeded 14 trillion. Sales of nonlife motor insurance began, but are limited to direct sales of motor insurance through bank intermediaries. Privatization of the Postal System and Insurance Sales Another large and new channel emerged for the insurance industry on October 1, 2007 with the privatization of Japan s postal system into four businesses: Japan Post Bank Co., Ltd., Japan Post Insurance Co., Ltd., Japan Post Network Co., Ltd. and Japan Post Service Co., Ltd., under Japan Post Holdings Co., Ltd. as the holding company. Among these four companies, Japan Post Bank, Japan Post Insurance and Japan Post Network began selling Japan Post Insurance products and also began serving as agents for the products of other insurance companies. The Japan Post companies have been involved with initiatives such as construction of and training for compliance systems for sales, and as a result have not initiated full-scale sales yet. However, Japan Post Network operates 24,000 post offices nationwide, and has started full-scale initiatives with the aim of becoming analogous to a convenience 22

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 store for financial products using its status as a kind of government-backed brand and close ties with local communities. Currently, sales of life insurance, including Japan Post Insurance products, have taken precedence. However, they have also been selling the motor insurance products of seven non-life insurance companies since becoming private companies. As of January 2009, 277 post offices nationwide were selling motor insurance, and this number is expected to increase to 2,000 post offices in 2010. The start of full-scale sales in this channel will significantly affect the nonlife conventional channel of exclusive agencies closely linked to local communities. An outline of the current status of insurance sales at the three privatized postal companies follows. Japan Post Bank (11,200 employees) began selling the variable annuity products of seven life insurance companies in May 2008. Japan Post Insurance (5,400 employees, 80 directly managed branches, 21,000 post offices serving as agencies) began selling products for companies offered by eight life insurance companies from June through October 2006. It has formed an alliance with Nippon Life Insurance Company and has also submitted a request to launch sales of cancer insurance and increase death benefit limits during fiscal 2009. Japan Post Network (116,100 employees, 24,000 branches nationwide) has started sales of Japan Post Insurance products as well as the products of other companies (the variable annuity products of four life insurance companies, the cancer and medical insurance products of two life insurance companies, and the motor insurance products of seven non-life insurance companies). 4. Direct Impact and the Emergence of New Insurance Companies Motor insurance is a primary product of non-life insurance companies. In September 1997, restrictions on sales of risk-segmented automobile insurance products were lifted, and direct sales of motor insurance began. Since that time, a succession of direct motor insurance companies have appeared, and now eight companies (American Home Direct Corporation, Zurich Financial Services Ltd., Sony Assurance Inc., AXA Direct, Mitsui Direct General Insurance Co., Ltd., Sonpo 24 Insurance Co., Ltd., SBI Insurance Co., Ltd. and Adlick Insurance Company Limited) sell motor insurance, relying on the Internet as the primary channel. Among them, SBI Insurance and Adlick Insurance are new companies that began operating in January and April 2008, respectively. Net premium income has been increasing each year, and at the end of March 2008 totaled approximately 150.0 billion for six companies. Sony Assurance held more than 1 million policies as of January 2009, and became profitable in fiscal 2008. In addition, AXA Direct held 650,000 policies at the end of March 2009 and was moving into the black for the fiscal year. Mitsui Direct exceeded 700,000 policies and became profitable too. Moreover, Tokio Marine Holdings, Inc. is cooperating with NTT Finance Corporation in direct sales of motor insurance. The two companies jointly established E.design Insurance Co., Ltd. and began direct sales of motor insurance in June 2009, mainly via the Internet and mobile phones. The entry of major domestic nonlife insurance companies into the direct sales market is considered a sign that this 23

3. The Insurance Market in 2009: Changing Channels and Markets new channel is certain to increase its share of the Japanese motor insurance market. On the other hand, companies are also conducting direct sales of non-life insurance products other than motor insurance. These include H.S. Insurance Co., Ltd., which began sales of overseas travel personal accident insurance via the Internet in November 2007. In the life insurance market, SBI Life Insurance initiated sales in April 2008 and Lifenet Insurance Company began sales in May 2007. These companies specialize in selling insurance via the Internet, and are among the life insurance companies being established with a new business model that employs the Internet. In this backdrop insurance product prices have been decreasing and products have become simpler. In addition to the convenience of remote channels that allow purchases anytime and anywhere, the number of Internet users in Japan has increased rapidly. Incidentally, according to the 2008 Survey of Communication Usage Trends issued by the Ministry of Internal Affairs and Communications in April 2009, Japan has 90.91 million Internet users over the age of six, or 75.3 percent of the population. By demographics, more than 90 percent of people age 13 to 40 use the Internet, but Internet usage drops off among people 60 or older. In addition, insurance products themselves are changing due to the increasing popularity of remote channels such as the Internet. Previously, the standard policy of the Japanese insurance companies had numerous riders attached, which served to increase unit premiums per contract. As a result, however, both life and non-life insurance companies frequently overlooked riders when they had to pay claims and benefits, which became a major social problem in 2007 and 2008. Companies reflected on these problems and incorporate customer demands for with clear terms and conditions and explanatory materials. The trend now is toward the development of fewer riders and simple, understandable products. Further to that, remote channels increasingly involve sales of commoditized motor, personal accident, medical, cancer and other insurance products. (Chart 2) 24

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 5. The Present and Future of Conventional Channels Meanwhile, as the insurance market has contracted, the insurance industry has become more competitive and companies are focusing on efficiency. Conventional channels have contracted sharply, with the number of agencies falling by more than 50 percent over the last 10 years. Agencies for Japan s non-life insurance industry include exclusive insurance sales agencies and ancillary agencies such as auto repair shops, dealerships, rental property operators and licensed tax accountant. In addition, large companies, banks and other corporations have institutional agencies with the same functions as exclusive agencies. Overall, agencies accounted for about 93 percent of new contracts written in fiscal 2008. Chart 3 shows changes in the number of non-life insurance agencies. There were 217,864 agencies as of March 31, 2008, of which 164,911 were exclusive agencies of designated insurance companies and 52,953 were agencies that handle the products of multiple companies. The number of conventional insurance agencies increased as Japan s economy grew and the number of motor vehicles increased. However, productivity has decreased with the recent contraction of the market as the number of small-scale and individual contracts has increased, and the high cost structure of agencies made industry rationalization and restructuring inevitable. In particular, rationalization has proceeded since the post-bubble restructuring of insurance companies in 2000 and the liberalization of agency fees in April 2003, with agencies exiting the business, merging or being absorbed, and agencies or shops directly owned, or managed by insurance companies rationalizing small-scale and inefficient agencies. The number of solicitors, however, has increased because of the emergence of large-scale agencies such as banks and postal companies, and the merger or increased size of small agencies. As the movement of operating expenses reduction at insurance companies accelerates further merger and acquisition among agencies, the sales competition among diversified channels will inevitably be intensified. Over the coming two to three years, a considerable number of agencies will therefore exit the market (Chart 3). 25

A Review of Today s Japanese Non-Life Reinsurance Market 4.Edward Fenton Managing Director, Asia Pacific, Guy Carpenter & Company, LLC It is often said that we live in a rapidly changing world. But it is also reasonable to ask the meaning of this statement, which has both general and specific implications. In this paper we attempt to give context to the statement by examining the effect of changes in world conditions on the Japanese non-life reinsurance market. We do this by taking a look firstly at the world market and the Japanese market s position within it and then secondly by reviewing in more detail some of the dynamics of the market at a local level. Finally we end with some simple conclusions and tentatively consider the future. A Changing Risk Landscape in the Global Market That there has been change in the reinsurance market is not in doubt. But the change has not been smooth or continuous. Instead it can be broken into distinct periods of upheaval during which different factors have been the drivers and different responses have been elicited from market participants. Table 1 below gives a simple view of the progress of world markets starting with the liability crises of the mid 1980 s and ending in the present day. Table 1 Period Key Factors Market Responses Capital Market Responses 1985 1992 2001 2005 2007 to date Liability Crises Hurricane Andrew WTC KRW Credit crunch Overhaul of coverage Pricing improvements Emergence of Cat models Improved Data Rating agencies Recognition of Correlation Potential for Casualty Cat Rating agencies models revised Re-assessment of frequency and severity potential Increased focus on capital preservation Creation of dedicated casualty market (c USD 1bn) New capital enters market. Some new companies started (c USD 14bn) New capital enters market. Many new companies started (c USD 15bn) New capital enters market. Many new companies started (c USD 28bn) Initial stages marked by closed debt and equity markets In simple terms each upheaval has been marked by losses to the market. What is also equally clear from the table above is that each upheaval has been followed by a flow of new capital to replace that lost. In fact flows of new capital have grown following each crisis up to the present one, leading many commentators to talk of a growing convergence between the reinsurance and capital markets. The current crisis is different in one sense because it has affected the asset side of (re)insurers balance sheets. But in another sense it underlines the convergence of the reinsurance and capital markets: how easy would it have been for the market to re-load if a large event had occurred over the past year? 26

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 The Japanese Market s Position within the Global Market But what effects do changes in the global risk landscape have on the Japanese market? In order to try to understand this question, it is worth investigating the position of the Japanese market in a worldwide context. Table 2 shows the approximate amount of economic and insured loss in a 1 in 200yr event, according to Swiss Re1. Table 2 Location Peril Economic Loss % of Economic Loss Covered by Insurance Japan* USA USA Japan Europe Earthquake Earthquake Windstorm Typhoon Windstorm USD 500bn USD 300bn USD 300bn USD 50bn USD 50bn 6% 14% 52% 30% 74% *NB Japan EQ excludes JER, which is counted as not insured Clearly Japan has large amounts of exposure to catastrophe losses, with an especially large economic loss potential from the earthquake peril. Even though large amounts of earthquake insurance are purchased, they represent only a small portion of the potential economic loss. Turning to reinsurance, Table 3 (from the same source) takes these insured loss amounts and examines the quantity of reinsurance cession that would be made in the event of loss. Table 3 2 Location Peril Insured Loss % of Insured Loss Ceded to Reinsurers USA USA Europe Japan Japan Turkey Israel Canada Australia Windstorm Earthquake Windstorm Earthquake Windstorm Earthquake Earthquake Earthquake Earthquake USD 140bn USD 41bn USD 37bn USD 30bn USD 15bn USD 13bn USD 13bn USD 12bn USD 12bn 43% 77% 73% 57% 57% 84% 85% 71% 96% Here we see that Japan s insurers retain a sizeable portion of their cat risk within themselves, whilst insurers of US risk, predictably, are the largest potential users of the cat market. Note 1: Source: Swiss Re Sigma No 2 / 2007 Note 2: Source Swiss Re Sigma No 2 / 2007, Guy Carpenter research, Turkey and Canada 1 in 500yr loss, Israel and Australia 1 in 1000yr loss, US wind excludes FHCF, Japan EQ excludes JER When actual loss experience is considered, the picture becomes even more skewed. Analysis of the largest 20 cat losses shows that by dollar amount paid 83% of these have come from the US, 10% from Europe and just 7% from Japan. Of course this is a reflection of the fortunate position that Japan has not had its big one, whereas the USA has suffered a series of very large catastrophes. 27

4. A Review of Today s Japanese Non-Life Reinsurance Market Moving to look at the reinsurers share of these large losses, in the US reinsurance recoveries range between 20% and 60% of the insured loss, whereas recoveries in Japan are smaller at 20%-25% for typhoon and just 2% in the Hanshin earthquake of 2005. Comparison of Growth in Purchased Limit: USA vs Japan Clearly there appears to be potential for greater purchase, and utilisation of catastrophe reinsurance in Japan. It is interesting to view the growth of limits in the USA since 1989 and compare growth in the market with that in Japan. Charts 1 and 2 show the development of cat limit in the two markets over the past 20 years. Examination of the two charts shows that there has been considerable growth in both markets over the period. In fact growth in the Japanese market has not been dissimilar to that in the USA. Source: Guy Carpenter Source: Guy Carpenter 28

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 The Changing Risk Landscape in Japan So the Japanese market for catastrophe risk has grown, and some of the factors are shown in the explanatory boxes in Chart 2 above. But there has also been a fundamental shift in the catastrophe risk landscape which has underpinned the increased reinsurance limit purchased. Chart 3 below shows the increased amount of cat risk in the Japanese market, split by peril. Source: Guy Carpenter The reasons for the increase differ by peril. Since the introduction of windstorm perils in 1985 the perception of the risk amount has altered drastically upwards, firstly following typhoon Mireille (1991) and latterly as companies have increasingly employed catastrophe models to assess their risk amount. In the case of earthquake the insurance market has always considered the possibility of a full limits loss. Here the amount of limit put out by insurers and mutual organisations has actually increased. The risk has also become more immediate because the commercial and industrial earthquake exposures taken on by the non-life companies have increasingly become accepted on a first loss basis rather as a replacement of the traditional reduced indemnity product. Rating Levels in the Japanese Reinsurance Market A bellwether for cat pricing sentiment in the Japanese market is the pricing of the windstorm catastrophe ELCs, as seen in Chart 4 below. In the modern era since the end of the long soft market of the 1990 s the Japanese market has moved in line with the international market generally. Local factors have made a contribution of course: hence Japanese cedants suffered increases in cat pricing following the record typhoon season of 2004, where other markets around the world were still enjoying reductions. But generally there is clear correlation between movements in world cat pricing and that in Japan. 29

4. A Review of Today s Japanese Non-Life Reinsurance Market Source: Guy Carpenter Recent Renewal Seasons in Japan Like all markets around the world, Japan has local issues and events that have a localised effect on the renewal of Japanese reinsurances in particular. A recap of the renewal seasons of the past few years gives a flavour of some of these issues. The 2005 Renewal: Abundant capacity appeared to suggest that there would be a softness in the market, but this was conflicted by adverse loss experience. 2004 had been a year of record losses including the largest fire loss ever in Japan and an unprecedented number of land falling typhoons. Fire and windstorm losses and expansion in windstorm capacity purchased gave many reinsurers the excuse to quote high excess of loss prices and talk of significant pro rata improvements. Property Classes were generally more difficult than the previous year, especially fire pro rata. Casualty Classes remained problematic. The 2006 Renewal: A better year for Japanese insurers in their original businesses meant that reinsurer demands for a continuation of the increases in prices seen in 2005 were partially resisted. A stream of adverse Hurricane Katrina and Wilma developments added incentive to the reinsurer community to push prices up. However large amounts of new capital flowed into the world cat market reducing capacity concerns. In the end risk adjusted rates, in classes other than windstorm, were flat to down slightly. All other classes remained stable with the exception of US exposed JIA which experienced a challenging renewal. The 2007 Renewal: A mixed message from the 1st January renewal season left many in the reinsurance market unsure as to the likely direction of the Japanese renewal. It appeared that windstorm ELC pricing was likely to be the critical issue. In the end rates were flat to down in many classes and the market was significantly easier, in terms of both price and capacity availability. Prices were flat or reduced in all classes, but this was an orderly market. There had been some expectation that some of the newer entrants to the market would look to gain market share through aggressive pricing. However, this eventuality did not materialise and there was no rogue quoting reinsurer or group of reinsurers to drive prices down. The 2008 Renewal: The two major issues facing buyers entering the 1st April Japanese renewal were their ability to maintain fire proportional capacity and the level of rate reduction achievable for their catastrophe protections. A series of fire losses experienced by the market led to a challenging renewal for 30

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 many companies of their fire proportional treaties. However once terms and conditions were accepted by major reinsurers there was sufficient capacity for main fire treaties. This capacity came from both existing reinsurers and also newcomers. There was a modest reduction in most lines of catastrophe business. The 2009 Renewal: For this renewal season, buyers faced a reinsurance landscape where the indications were that rate increases were to be expected on catastrophe lines of business. At the same time indicators on per risk property and casualty lines were more unclear. A good year of results for most companies treaties in all lines relieved the pressure on per risk business and assisted in the resistance of reinsurer demands for large increases on catastrophe business. Movements in exchange rates meant that capacity was restricted for some reinsurers in the market. In the end catastrophe lines experienced modest increases. With mostly good results during 2008, the fire market enjoyed an orderly renewal. A read through the simple renewal précis above shows that Japanese renewal seasons are affected by both local and macro factors. Summary The global economic crisis has emerged from problems in the financial sector, and it has ushered in an era of greater uncertainty about financial products, especially in relation to their level of underlying security. Despite headline examples like AIG, XL Capital and Swiss Re, the (re-) insurance industry has shown itself so far to be relatively less exposed to the debilitating balance sheet impairment that has been experienced by others in the financial sector. Even the problems faced by the named companies above arise from their involvement in lines of business outside of their core P&C lines. Nevertheless the industry lost at least USD 150bn of capital during 2008, and has continued to lose capital in 2009. Declines in global stock markets have driven the insurance industry to consider the benefits of consolidation to improve returns. Price to earnings ratios have fallen to a level where mergers and acquisitions look attractive to those with capital to spare. There has been already some activity in this area and there may well be more. Liquidity and capacity following a major catastrophe event are a concern. Despite a mini-bubble in capital raising recently, it still seems unlikely that reinsurers could easily raise significant funds in the way that they did in 2002 and 2005. However, despite the events of 2008, overall capital is now at a level consistent with long term averages. The factors described above highlight the need for cedants globally to seek greater diversification in their reinsurance panels, for reasons of both security and bargaining power. Japan should be no exception to this rule, though the market highly values stability and continuity. It is clear from the studies above that the Japanese market is an important component of the global reinsurance landscape and, potential upcoming mergers notwithstanding, it is likely to continue to grow in importance in the future. Our study of the amount of insured and reinsured risk in Japan as a proportion of economic exposure is perhaps particularly telling and indicates that the reinsurance market has scope to continue to grow in the future. The challenge for Japanese companies, which are currently facing tight margins in an extremely mature domestic market, will be to continue to find innovative ways to finance the risk on their balance sheets in the most cost effective manner. 31

Trends in Japan s Non-Life Insurance Industry 5.Underwriting & Planning Department The Toa Reinsurance Company, Limited 1. Market Trend (1) Domestic Market Net premium income of all 9 major domestic non-life insurance companies decreased in Fiscal 2008. In addition to a reduction in premium rates for Compulsory Automobile Liability Insurance for the first time in 11 years, motor insurance was sluggish due to stagnant automobile sales and a consumer shift to smaller cars. Premium income from marine insurance, which had increased for 7 consecutive years, declined due to a decrease in the volume of distribution caused by the global economic recession. A large loss on revaluation of securities in the wake of the financial crisis led to a fall in ordinary profit (including return on asset investments) for all companies. (2) Industry Reorganization The business integration of Sompo Japan Insurance Inc. and NIPPONKOA Insurance Co., Ltd. was announced after that of Mitsui Sumitomo Insurance Group Holdings, Inc., Aioi Insurance Co., Ltd. and Nissay Dowa General Insurance Co., Ltd. The non-life insurance market will thus be dominated by three major groups including Tokio Marine Holdings. Furthermore it was announced that Sumi-sei General Insurance Co., Ltd., a subsidiary of Sumitomo Life Insurance Company, would exit the market. As a result, the business of Sumi-sei General Insurance will be terminated and its existing policies will be switched to those of Mitsui Sumitomo Insurance Co., Ltd. (3) Business Expansion into Overseas Markets Given that growth in the non-life insurance market has peaked in Japan, nonlife insurance companies have been expanding their overseas businesses. In Fiscal 2008, this included the establishment of local subsidiaries in China. Recent major overseas initiatives are summarized as follows. Date Company Name Recent Overseas Initiatives July 2008 Tokio Marine Holdings, Inc. Acquired Philadelphia Consolidated Holding Corp. August 2008 August 2008 September 2008 October 2008 November 2008 January 2009 March 2009 March 2009 Tokio Marine Holdings, Inc. Mitsui Sumitomo Insurance Co., Ltd. NIPPONKOA Insurance Co., Ltd. Aioi Insurance Co., Ltd. Tokio Marine & Nichido Fire Insurance Co., Ltd. Mitsui Sumitomo Insurance Co., (Europe) Ltd. Aioi Insurance Co., Ltd. NIPPONKOA Insurance Co., Ltd. Established Tokio Marine Underwriting Limited (Provision of capital to Lloyd's syndicates) Obtained approval to establish a local subsidiary in Vietnam Obtained approval to establish a representative office in Moscow Agreed on a strategic business alliance with Lotte Non-Life Insurance Co., Ltd. in Korea Started business operations at a local subsidiary in China Established a branch in Doha, Qatar Started business operations at a local subsidiary in China Announced the acquisition of stock in and a business alliance with Navakij Insurance PCL in Thailand 32

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 (4) Distribution Channels Sompo Japan became the first Japanese non-life insurance company to open company-owned over-the-counter insurance stores. In recent years, there has been increasing demand for such stores from customers, who state that they need professional advice, they want to consult with specialists whenever they please, and they do not welcome customer calls to their home or office. The company plans to use its over-the-counter stores to provide customers with a greater level of convenience, to grasp, verify and accumulate know-how, and to understand customer requirements to support Sompo Japan s agents. Although some insurance agents in the non-life insurance industry have over-the-counter insurance stores, this is the first time a non-life insurance company has opened companyowned over-the-counter insurance stores. Tokio Marine Holdings announced the establishment with NTT Finance Corporation, the financial arm of the NTT Group, of a non-life insurance company dealing in motor insurance products online. The new company will focus on selling motor insurance products for the younger generation mainly through mobile phones. (5) Small Amount and Short Term Insurance Providers and Unregulated Co-operatives In accordance with the enforcement of the revised Insurance Business Law in April 2006, mutual aid associations which had been outside the scope of the relevant laws (in other words, unregulated co-operatives), were brought within the scope of supervision of the authorities as specific insurance businesses. Furthermore, a small amount and short term insurance system was established to allow the underwriting of small amount and short term insurance policies within the scope of certain business scale criteria. By March 2008, specific insurance businesses were required to register as small amount and short term insurance providers. In the wake of this revision, the number of registered small amount and short term insurance providers reached 64 as of March 2009, of which 52 had switched from specific insurance businesses (unregulated co-operatives) and 12 were new entries. The insurance products range over death benefit, medical insurance, household contents insurance and pet insurance. When the Reform of Public Benefit Corporation Law came into force in December 2008, the insurance (co-operative) business operated by public benefit corporations was brought within the ambit of the Insurance Business Law, as such corporations are no longer to be supervised by the current ministry in charge as a result of their conversion into new corporation, regardless of whether they are recognized to represent public interests. Therefore, public benefit corporations that plan to continue operating mutual aid business after the conversion are basically required to obtain an insurance license or register as a small amount and short term insurance provider, otherwise they would need to take measures in accordance with the Insurance Business Law such as a transfer of their cooperative business into other insurance companies and closing their business. 33

5. Trends in Japan s Non-Life Insurance Industry 2. Overview of Results for Fiscal 2008 The 26 companies in the General Insurance Association of Japan (*) suffered from a fall in net premium income in Fiscal 2008. Ordinary profit and net income fell into the red owing to negative returns on asset investments resulting from the financial crisis. Net premium income was 7,161.8 billion yen, down 4.1% on a year-on-year basis. The fall stemmed from cuts in premium rates for Compulsory Automobile Liability Insurance and lower revenue from motor insurance. Net claims paid were 4,399.5 billion yen, up 1.4% on a year-on-year basis, due to increased claims payments for casualty insurance and personal accident insurance. Operating and general administrative expenses related to insurance underwriting were 1,268.5 billion yen, up 3.7% on a year-on-year basis, because of investments to improve systems for business operations. As a result, the net expense ratio increased 1.9% to 35.1%. Net underwriting profit moved into the black (16.2 billion yen) from the deficit of 63.9 billion yen recorded in the previous fiscal year because of a decrease in provision for outstanding losses and a reversal of underwriting reserves, in spite of lower net premium income, higher net claims paid and increased operating and general administrative expenses. Owing to negative returns on asset investments caused by the financial crisis, ordinary and net losses stood at 257.9 billion yen, down 636.3 billion yen on a yearon-year basis, and 81.0 billion yen, down 317.8 billion yen, respectively. * E.design Insurance Co., Ltd. is not included among the 27 members of the General Insurance Association of Japan for Fiscal 2008, because it began operations on June 13, 2009. 3. Regulatory Topics for Fiscal 2008 (1) Completion of the Insurance Law The insurance law was revised for the first time in about 100 years. Every company is currently revising its terms and conditions in response to the revision, which is due to take effect by June 2010. In light of the recent issue of unpaid insurance claims and in an effort to protect policyholders, the revised law will unilaterally enforce a rule invalidating provisions adverse to policyholders, review provisions on the duty of disclosure and establish provisions on the timing of paying claims. (2) Establishment of Financial ADR System In March 2009, the bill to enact financial ADR (alternative dispute resolution) was submitted to the Diet and will be passed. The bill will establish a uniform financial ADR organization across finance related laws such as the Financial Instruments and Exchange Law, the Bank Law, and the Insurance Business Law through their revisions. In the insurance area, an ADR institution is to be designated for each type of business operations including life insurance and non-life insurance. Financial ADR is a dispute resolution method based on securing an agreement among interested parties through mediation, conciliation and arbitration rather than via court action, allowing the parties to settle the dispute promptly and flexibly and reduce costs. 34

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 (3) Lowering Amount of Claims Paid on Policies against Death for Children in Overseas Travel Personal Accident Policies Some members of the Financial System Council (advisory body to the Prime Minister) raised an issue that fraudulent large insurance claims may be triggered under present conditions. In response to this, the non-life insurance industry established a voluntary rule that the amount of claims payable on policies against death for children under 15 be limited to 10 million yen. Every company lowered the coverage amounts on overseas travel personal accident policies sold by way of non-face-to-face methods such as the Internet and automatic vending machines placed at airports. 4. Fiscal 2008 Data on Losses from Major Natural Disasters Losses from major natural disasters during Fiscal 2008 were as follows. (1) Earthquake Name of Loss Date of Loss Claims paid (JPY Million)* Iwate and Miyagi Inland Earthquake in 2008 Earthquake (Origin: Northern Iwate Coastline) June 14, 2008 July 24, 2008 50 29 *Claims paid for earthquake insurance (2) Wind and Flood Damage Name of Loss Date of Loss Claims paid (JPY Million) Heavy Rain in Tokai at the End of August 2008 August 26, 2008 - August 31, 2008 There was no typhoon landfall on Japan for the first time in 8 years (Since 2000). 252 35

Trends in Japan s Life Insurance Industry 6. Life Underwriting & Planning Department The Toa Reinsurance Company, Limited 1. Demographic Change The trend of decreasing child population shows no sign of bottoming out. According to the Ministry of Internal Affairs and Communications, the Japanese child population under 15 as of April 1, 2009 numbered 17.14 million, representing a fall of 0.11 million from last year, meaning that the child population has now been dropping for 28 consecutive years. The child population represents 13.4% of the total population, a figure which has been declining for 35 consecutive years in similar fashion. Children accounted for 35.4% of the total population in 1950, a figure in excess of one third of the total, but this had dropped to 25.6% by 1965, or about one in four. The same statistic was 15.3% in 1997, about one in 6.5, and was about one in 7.5 based on the survey conducted in 2009. If the child population continues to diminish at this speed, it will have a serious impact on the lives of Japanese people, and industries, as well as public pension revenue, domestic demand and so on. In particular, the domestic life insurance companies, which rely heavily on the domestic market, will face the adverse effects of this trend in terms of future business growth, and they need to develop new markets as well as to maintain their existing level of in-force insurance business. 2. Market Reorganizations There were favorable signs in the life insurance industry in the first half of FY 2008. The reverse spread issue, a heavy burden for the industry since the collapse of the bubble economy, was expected to be resolved. Furthermore, the cancellation rate and lapse rate had improved and, in light of predictions of growth in Bancassurance, the prospects for the life insurance industry appeared to be more encouraging than for some years. In the second half, however, owing to the worldwide financial turmoil triggered by the U.S. subprime loan issue, which was said to be the greatest financial turmoil of the century, business conditions became the most severe since the collapse of the bubble economy. Most primary life insurance companies posted a large amount of unrealized capital loss of securities and declared negative balance sheet results at the end of March 31st, 2009. Under such conditions, each company is striving to implement various strategies in order to stabilize its financial situation and strengthen its management infrastructure. The major strategies adopted are as follows: (1) Three Companies in the AIG Group In October 2008, the AIG Group in the U.S. recorded a huge loss and was placed under the control of the U.S. government. As part of the business reorganization plan, it was announced that three AIG Group companies, American Life Insurance Company (ALICO Japan), AIG Star Life Insurance Co., Ltd. and AIG Edison Life Insurance Company, were to be offered for sale. Although several companies were initially expected to make buyout proposals, buyers of the three companies have not been determined yet, while many worldwide financial institutions have 36

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 got injections of public funds in the wake of the worldwide financial turmoil. In March 2009, AIG Star Life Insurance Co., Ltd. and AIG Edison Life Insurance Company increased their capital by 15 billion yen and 22.5 billion yen, respectively, by exchanging subordinated loans for stock. Likewise, ALICO Japan increased its capital by 29.4 billion yen by obtaining additional funding in the form of outside capital. All of these companies have been consolidating their financial position to enhance their own business value. (2) Bankruptcy of Yamato Life Insurance Co. and its Buyout by Prudential Financial Yamato Life Insurance Co., which started its rehabilitation procedure in October 2008, concluded a sponsorship contract with The Gibraltar Life Insurance Co., Ltd. in March 2009 and applied to the Life Insurance Policyholders Protection Corporation of Japan for financial aid. Financial aid was subsequently granted and the company received approval for its rehabilitation plan from the Tokyo District Court. The company then became a member of the Prudential Financial group as a subsidiary of The Gibraltar Life Insurance Co., Ltd. Its company name was changed to The Prudential Financial Japan Life Insurance Co., Ltd. Yamato Life Insurance Co. s excess liabilities amount to about 64.3 billion yen. As part of the rehabilitation plan, The Gibraltar Life Insurance Co., Ltd. plans to record goodwill of 3.2 billion yen and the Life Insurance Policyholders Protection Corporation of Japan will finance about 27.8 billion yen of the company s liabilities. The anticipated interest rate of in-force business will be lowered to 1.0%, to resolve the excess liability issue of the company. The new company commenced operation in June 2009 as an insurance company specializing in agency distribution and Bancassurance, while maintaining the inforce business of the former Yamato Life Insurance Co. (3) Probable Business Merger between Sompo Japan Himawari Life Insurance Co., Ltd. and NIPPONKOA Life Insurance Company, Limited In March 2009, it was announced that two non-life insurance companies, Sompo Japan Insurance Inc. and, NIPPONKOA Insurance Company, Limited would establish a joint holding company through a share transfer and that the parties had concluded a basic agreement for a merger to take place in April 2010. The new group also plans to start discussions concerning the merger and reorganization of other than non-life business with a view to pursuing group synergies. It is probable that Sompo Japan Himawari Life Insurance Co., Ltd. and NIPPONKOA Life Insurance Company, Limited, subsidiaries of the respective non-life companies, will start moving towards a merger in future. 37

6. Trends in Japan s Life Insurance Industry (4) Preliminary Merger Discussions between Mitsui Sumitomo Kirameki Life Insurance Co., Ltd. and Aioi Life Insurance Co., Ltd. In March 2009, three non-life insurance companies, Mitsui Sumitomo Insurance Group Holdings, Inc., Aioi Life Insurance Co., Ltd. and Nissay Dowa General Insurance Co., Ltd., announced that they had started preliminary discussions concerning a merger to take place in April 2010. As a result, Mitsui Sumitomo Kirameki Life Insurance Co., Ltd. and Aioi Life Insurance Co., Ltd., subsidiaries of the respective companies, will enter merger negotiations. Both of these insurance subsidiaries adopt growth strategies involving the cross-selling of life insurance to non-life insurance customers of their parent companies. (5) Merger of AXA Life Insurance Co., Ltd. and AXA Financial Life Insurance Co., Ltd. In April 2009, AXA Life Insurance Co., Ltd. and AXA Financial Life Insurance Co., Ltd. announced that they had decided to merge by the end of 2009 in order to enhance business efficiency and reinforce their capital management structures. AXA Financial Life Insurance Co., Ltd. used to be known as Winterthur Swiss Life Insurance Co., Ltd. before it switched to the current name in January 2008 due to a purchase of Winterthur group by AXA Group. The merging company will be AXA Insurance. (6) Capital Increases In addition to the cases noted above, in FY 2008, many life insurance companies increased their capital to stabilize their financial situation and strengthen their management infrastructure as a result of worldwide financial turmoil: Date Nov. 2008 Life Insurance Co. Amount of capital increase Contributory Means of capital increase ORIX Life Insurance Corporation 10 billion yen ORIX Corporation, its parent company Third party allocation of shares Nov. 2008 The Dai-ichi Frontier Life Insurance Co., Ltd. 60.5 billion yen The Dai-ichi Mutual Life Insurance Co., its parent company Subscription of 100% share Dec. 2008 Asahi Mutual Life Insurance 35.0 billion yen 11 of its closely related financial institutions and business corporations Capital infusion Dec. 2008 T&D Company 40.0 billion yen T&D Holdings, Inc. Capital infusion Dec. 2008 ING Life Insurance Company, Ltd. 15.0 billion yen ING Insurance International Capital infusion 38

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 Dec. 2008 MassMutual Life Insurance Company 13.0 billion yen MassMutual Financial Group Capital infusion Dec. 2008 Mitsui Life Insurance Company Limited 60.0 billion yen 6 companies in Mitsui group and Sumitomo group, including Sumitomo Life Third party allocation of shares Dec. 2008 Mitsui Sumitomo MetLife Insurance Co., Ltd. 20.4 billion yen Mitsui Sumitomo Insurance Group Holdings, Inc. and Worldwide Holdings, Inc. Capital infusion Jan. 2009 Sumitomo Life Insurance Co. 100.0 billion yen Major domestic financial institutions Perpetual subordinated loan Mar. 2009 The Dai-ichi Mutual Life Insurance Co. 183.0 billion yen 22 domestic financial institutions Syndicated subordinated loan Mar. 2009 Daido Life Insurance Co. 70.0 billion yen T&D Holdings, Inc. Capital infusion Mar. 2009 Taiyo Life Insurance Company 50.0 billion yen T&D Holdings, Inc. Capital infusion Mar. 2009 ORIX Life Insurance Corporation 15.0 billion yen ORIX Corporation, its parent company Third party allocation of shares Mar. 2009 Fukokushinrai Life Insurance Company, Limited 10.0 billion yen Fukoku Mutual Life Insurance Co. Capital infusion 3. Trends in Business Performance The fiscal Year 2008 results for 44 life insurance companies in Japan were as follows: Total Amount of New Contracts During fiscal year 2008, the total insured amount of new individual insurance contracts for all 44 companies decreased 7.8% from the previous fiscal year to JPY54 trillion, due to continued sluggish sales of death benefit products. Regarding individual annuities, life insurance companies selling fixed annuity products recorded a steady growth in sales. Meanwhile, the global financial turmoil since last September substantially reduced sales of life insurance companies, which have mainly offered variable annuity products, in particular through the Bancassurance channel. As a result of stagnant sales of variable annuities, the total sales of new individual annuities were JPY7.2 trillion, down 9.4% on a year-on-year basis, declining for the second consecutive year. Total Amount of In-force Contracts As of the end of fiscal year 2008, the total insured amount of in-force individual insurance contracts decreased 4.7% from the previous fiscal year to JPY 932.9 39

6. Trends in Japan s Life Insurance Industry trillion, due to the sluggish performance of large companies, against solid results at foreign-affiliated companies and subsidiaries of non-life insurance companies. On the other hand, sales of individual annuities were JPY88.4 trillion, up 0.6% from the previous fiscal year, representing the sixth consecutive annual increase. While the global financial turmoil led to a decline in sales for life insurance companies relying on a Bancassurance channel for variable annuities, life insurance companies selling fixed annuity products steadily improved their performance. Group insurance contracts in force increased 0.3% from the previous fiscal year to JPY375.1 trillion, the second consecutive annual increase, though group annuities in force decreased 3.5% from the previous fiscal year to JPY31.1 trillion. Annualized Premiums The total of annualized premiums from new contracts declined 7.6% from the previous year to JPY2.2 trillion owing to a drop in individual insurance despite an increase in individual annuities. In-force business produced a steady result in annualized premiums, rising 0.1% from the previous fiscal year to JPY 19.6 trillion, due to an increase in individual annuity despite a drop in death benefit products. Premiums Revenues / Total Assets Total premium revenues decreased 2.2% to JPY27.3 trillion for all 44 life insurance companies, the third consecutive annual decline. Due to the deterioration in the investment environment, total assets for 21 companies, including 9 major companies, out of 39 companies, were below that of the previous fiscal year. For 5 companies, the figures for total assets can not be compared to those of the previous year since these companies were newly established in Fiscal Year 2008. Overall, total assets declined 4.1% from the previous year to JPY205.1 trillion, the second consecutive annual decline. 4. Market Trends In recent years, life insurance companies in the Japanese market have striven to develop and market new products as new sources of profit, as sales of death benefit products have deteriorated in spite of the longstanding flagship status of such products. Although sales of medical insurance and variable annuity insurance have been favorable for several years, there was a big change in FY 2008. The variable annuity insurance market remained unfavorable due to the serious impact of the reduced market value of assets in the wake of the worldwide financial turmoil. Companies that had started to sell variable annuity insurance at an early stage suffered from the burdens of inflated cost of minimum guarantees for death benefit and accumulated capital of annuity. Some of these companies stopped selling such products because of the pressure of such burdens put on management. The environment surrounding such products changed dramatically in this way. In the meantime, it is no exaggeration to say that medical insurance currently occupies the central position among personal insurance products. The life insurance industry of FY 2008 featured differentiated new products and revised existing prod- 40

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 ucts. Some companies improved sales performance that exceeded the targets set in their respective initial plans as a result of marketing based on such product developments. The main trend occurring in the medical insurance and variable annuity insurance fields in FY 2008 were as follows: (1) Mitsui Life Insurance Company Limited Ceases its Variable Annuity Insurance Sales and Sumitomo Life Insurance Co. Partly Suspends Sales of Variable Annuity Insurance In February 2009, Mitsui Life Insurance Company Limited announced that it would cease its sales of variable annuity insurance products for indefinite period, because the standard valuation reserve for variable annuity insurance increased to 43.0 billion yen triggered by a decline in the market value of assets in the wake of the financial crisis. This burden of the increased cost on the minimum guarantee as a result of a decline in the market value of assets since worldwide financial turmoil had been a common issue for most companies dealing with variable annuity insurance. However, Mitsui Life Insurance Company Limited was virtually the first company to cease its sales of products in this area following the financial turmoil. Subsequently, in May 2009, Sumitomo Life Insurance Co. also announced that the standard valuation reserve on the cost of the minimum guarantee for variable annuity insurance was forecasted to increase to 163.8 billion yen as of the end of 2008, which was 240% of the amount as of the end of FY 2007. The company also announced that it would suspend sales of variable annuity insurance products with accumulated capital of annuity to maintain appropriate risk controls. (2) Suspension of Sales of Variable Annuity Products by Hartford Life Insurance K.K. In May 2009, Hartford Life Insurance K.K. announced its suspension of sales of all insurance products of the company from June 2009. The company dealt in variable annuity, variable whole life insurance and fixed annuity for individual. The company started to sell variable annuity products in 2000 and achieved top-ranking, satisfactory results in the market as a company specializing in Bancassurance sales. However, under circumstances in which sales performance had started to decline in FY 2006 due to severe market competition for variable annuity. Furthermore, amid the worldwide financial turmoil that has occurred in the last year, the market value of the company s assets dropped sharply, putting pressure on management because of the cost burden of minimum guarantee for death benefit and accumulated capital of annuity. Consequently, the company decided to suspend sales of all insurance products. The company provides services in exactly the same way as before and has maintained its existing policies. The company also announced that it will reconsider the suspension of sales in the light of market conditions, but at this moment the length of suspension is indefinite. 41

6. Trends in Japan s Life Insurance Industry (3) Marketing Trends in Medical Insurance Given the rapid progress seen in medical insurance products, each company provides differentiated products that appeal to customers on the basis of simplicity, low premiums and tailored solutions. Mirai Support, which means Future Support in Japanese, which was launched by Nippon Life Insurance Co. in October 2008, is characterized by a simple benefit scheme that unifies traditional medical riders. The new rider allows for changes from existing medical riders without any examination or duty of declaration. Sales of this rider have been expanding steadily. Nyu-in Tokuyaku Sono-Hi kara, which means Hospital Stay Benefit from that day in Japanese, was launched by Japan Post Insurance in July 2008 as its first product since the postal service privatization. The rider guarantees a hospital stay from the first day as its name suggests. This rider is attached to about 90% of the company s new policies and is well-supported by policyholders. Kenko no Omamori, which means Amulet of Good Health in Japanese, was launched by Sompo Japan Himawari Life Insurance Co., Ltd., a subsidiary of the non-life insurance company, in August 2007. This product is characterized by simplicity, low premiums and options that satisfy contemporary needs of policyholders. When annual sales of a medical insurance policy reach 100,000, it is regarded as a blockbuster success in Japan. However, this product successfully achieved annual sales of 200,000 policies. In May 2008, Cure Lady was added to the Cure product lineup launched by ORIX Life Insurance Corporation. Cure has been a big hit and has become a pioneer of low-premium products in Japan. Cure Lady is whole life medical insurance for women and is in great demand. 5. Distribution Channels In recent distribution channel trends, there were two features in FY2008; the number of sales representatives, which had decreased rapidly in previous years in spite of their long history as a main channel of selling life insurance in Japan, has turned upward, and banks have been steadily developing their sales structures as a new insurance distribution channel. The total number of sales representatives in the 9 major companies was 206,786 as of the end of the first half of FY 2008, an increase of 258 compared to the number at the end of FY2007. Although this is a change of no more than +0.1%, the increase recorded is a sign of bottoming out in the trend of reduction in the sales representative population. Major traditional domestic companies have clarified their strategies that sales representatives will continue to act as a key part of their sales forces and that their sales systems only focusing on the acquisition of new policy are to be shifted to a sales structure that also values sales representatives in maintaining in-force policies not to be lapsed and the role of developing successors. In the meantime, banks have come under the spotlight as a new distribution 42

The Toa Reinsurance Company, Limited Japan s Insurance Market 2009 channel for variable annuity insurance since 2002. They have been expected to deal with various products since December 2007, when all restrictions on Bancassurance in Japan were lifted. Major domestic banks have steadily maintained their Bancassurance sales efforts by recruiting and developing employees with professional skills as sales staff of life insurance. They have been particularly aggressive in increasing their efforts to develop sales of insurance products other than variable annuity insurance, especially medical insurance products. 6. Insurance Regulations In June 2008, the Insurance Law was officially enacted in order to regulate the relationships between insurance companies and policyholders. While operations of insurance companies have been governed by the Insurance Business Act, the rules between insurance companies and policyholders were only regulated by a part of the Commercial Law. However, the so-called non-payment of claims issue arose in the industry two years ago, mainly due to inadequate claim payment processes. It became a great social issue and had a significant impact on the life insurance industry. As a result, there was a broad requirement for a new statutory regulation to be developed in a manner consistent with current insurance product features and based on the peculiarities of insurance policies compared to other general contracts. The statutory regulation is an independent law and represents the first significant revision of insurance law in this area for about 100 years. The regulation was developed from the perspective of protecting policyholders in addition to translation into modern Japanese. New regulation sets new or modifies existing duties relating to many items and conditions, such as disclosure, due date for claim payment, and policy cancellation for material misrepresentation. All of the life insurance companies have to change their insurance conditions to comply with the law by its enforcement, scheduled for April 1st, 2010. To be ready in time for the effective date, each company is now preparing its policy terms and conditions based on the new regulation. Changes to terms and conditions are subject to the approval of the Financial Services Agency. In February 2008, the Financial Services Agency clarified certain aspects of the draft revision to Guideline for Insurance Companies Supervision and Guideline for Small-Amount Short-Term Insurance Provider Supervision in response to the promulgation of the new regulation, to clarify some important notes for all insurers to keep in mind in preparing their terms and conditions. 43

44 Supplemental Data: Results of Japanese listed non-life insurance companies for fiscal 2008, ended March 31, 2009 (Non-Consolidated Basis) (Unit: Millions of Yen, %)

The Toa Reinsurance Company, Limited 6, Kanda-Surugadai 3-chome, Chiyoda-ku, Tokyo 101-8703, Japan http://www.toare.co.jp Printed in Japan on recycled paper with soy ink.