Fitch Ratings: Japan Quake/Tsunami Losses ‘Appear Manageable’

March 15, 2011

Fitch Ratings has issued a bulletin, indicating that it “believes that while the 11 March earthquake in Japan will be among the largest insured losses in history, such losses can be absorbed by the insurance and reinsurance industries without widespread solvency problems, or undue financial strain.”

The rating agency also expressed its “deep sympathy with the people of Japan whose lives and livelihoods have been affected by the 11 March earthquake.”

Fitch also noted that it will take some time for international catastrophe modeling firms and local loss adjusters to accurately estimate insured losses. At present Fitch referred to the $35 billion insured loss figures, and the $100 billion economic loss figures.

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

Fitch said it believes that the insured loss will be significantly lower than the economic losses due to a number of mitigating factors, including:
– Earthquake damage to residential property is covered under the existing Japanese state-backed Earthquake Insurance System, with the Japanese government assuming up to JPY4.3trillion ($52.6 billion) of residential earthquake losses.
– Japanese non-life insurers have accumulated significant residential catastrophe reserves over recent years totaling JPY524 billion ($6.4 billion), representing 88.4 percent of their potential liability under the scheme.
– Earthquake insurance is offered as an optional rider to homeowners’ property policies and it is estimated that only 14 percent to 17 percent of homes in Japan are covered for earthquake risk.
– The epicenter of the earthquake was located some distance from heavily populated areas such as Tokyo or Osaka. Affected areas have lower insurance penetration than the major cities.

Fitch noted that the 1995 Kobe earthquake generated insured losses of $3.5 billion, while economic losses were close to $100 billion. However, that quake also “increased the demand for earthquake insurance in Japan and therefore the ratio between insured losses and the economic loss is expected to be higher for the 11 March earthquake.”

Fitch said it “expects insured losses from the 11 March earthquake will be disproportionately retained by domestic Japanese insurers, due to the Japanese government’s active role in providing cover for residential earthquake losses, and as only commercial and industrial risks are directly ceded to the global reinsurance market.

“This contrasts with the recent earthquakes in Chile and New Zealand, where global reinsurers assumed a majority share of the loss.”

Fitch’s bulletin added that it “does not expect major downgrades to arise from this event, though individual insurers could be downgraded one or more notches if loss estimates escalate. Fitch currently maintains Insurer Financial Strength (IFS) ratings on the five largest Japanese non-life insurers, all of which are rated at ‘A’, or higher, well above non-investment grade.

“Given the current uncertainty regarding estimated insured losses arising from the earthquake, it is difficult to predict the financial impact that the event will have on primary Japanese insurers. All domestic insurers maintain significant catastrophe reserves that both the Japanese regulator and Fitch include in their capital calculations.

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

However, the rating agency also indicated that the Japanese Earthquake “will result in a downward revision of many reinsurers’ earnings guidance for 2011 and exposes their balance sheets to further catastrophe losses later in the year. Following the Australian floods in January and the New Zealand earthquake in February, 2011 has already been a very active year in terms of catastrophe losses for the reinsurance sector.”

The rating agency also noted that prior to the 11 March earthquake, “several global reinsurers had indicated that they had already exhausted most, if not all, of their 2011 catastrophe budget.

“While the mitigating factors highlighted above for domestic Japanese insurers will partly insulate international reinsurers from loss, the 11 March earthquake is still likely to be one of the most expensive earthquakes in terms of insured losses. Previous earthquakes with large insured losses include Northridge in 1994 (insured losses at current prices of $20 billion), Chile in 2010 ($8 billion) and New Zealand in 2011 (between $3.5 billion and $8 billion).

As to whether or not the Japanese event will have an effect on reinsurance pricing, Fitch said it “believes that it is unlikely that the 11 March earthquake will be a market changing event by itself, but when combined with other catastrophe losses taken earlier in the year, and with the prospect of further catastrophe losses to come, it could ultimately be a catalyst for a positive change in the pricing cycle.”

Fitch explained that: “Based on probable maximum loss (PML) information published by several global reinsurers, a 1-in-250 year Japanese earthquake (approximating to an insured industry loss of $50 billion) would, on average, result in a loss equivalent to less than 10 percent of shareholders’ equity. While some reinsurers are more exposed than others, if the 11 March earthquake proves to be less than a 1-in-250 year event, it would likely be more of an earnings issue than a capital issue for the reinsurance industry.

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

If the above impact assessment proves correct, Fitch said that “rating implications are likely to be limited. The reinsurance sector is currently well-capitalized following several profitable years and is capable of absorbing a loss of this magnitude.

“However, some reinsurers will be more exposed than others.” Fitch added that it would “closely monitor those companies that have a greater concentration to the loss. As with most earthquakes, the agency expects the estimate of insured losses to increase over time as claims are reported to, and settled by, Japanese primary insurers. An escalation in the loss to a level above a 1-in-250 year event could ultimately result in downgrades for reinsurers that are over-exposed to the loss, and suffer significant capital erosion.”

Fitch cautioned that despite its attempt to be as accurate as possible regarding rating impacts, “without accurate loss estimates it is difficult to be definitive.” Fitch stressed, however, that it “does not expect significant negative rating action as a result of the event due to a number of factors.

“These include the strong capital position of local Japanese insurers and international reinsurers, specific catastrophe reserves already established by local Japanese insurers, the active role that the Japanese government plays in assuming earthquake risk, the low penetration rates for property insurance, the low take-up of earthquake riders to property policies and prudent setting of Japanese earthquake PMLs by reinsurers.

“Despite all of these mitigating factors, it is possible that insured losses could be significantly higher than currently estimated by the catastrophe modeling firms which may ultimately result in Fitch taking negative rating actions.”

Source: Fitch Ratings

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