Best Comments on Rating Impact of Japanese Earthquake/Tsunami

March 16, 2011

A.M. Best Co. has issued a bulletin indicating that it does not “expect an immediate rating impact on Japanese non-life insurers and reinsurers due to the March 11, 2011 earthquake in Japan. However, the capitalization level will decrease by a fair amount.”

Best has also prepared a briefing paper “addressing the impact of Japan’s earthquake and tsunami on the insurance and reinsurance industry.” A copy of the briefing is available at no charge.

Best noted that while economic losses are expected to be in hundreds of billions of U.S. dollars, and insured losses in tens of billions of U.S. dollars, it is of the opinion that the “non-life insurance companies in Japan are able to absorb the net losses without a negative impact on their current ratings.”

Best explained that as the earthquake occurred outside the “Kanto area (Tokyo and the surrounding prefectures), the gross loss will not exceed the reinsurance protection limit of each company, and the net loss will not exceed the large disaster risk (LDR) amount used in Japanese solvency calculation. Best added that the total LDR amount of the companies that it rates is “JPY 1.173 trillion [$14.4 billion] as of fiscal year 2009.” The total solvency capital of the companies rated “recorded JPY 10.340 trillion ($126.9 billion) as of fiscal year 2009.

“As for the dwelling earthquake risk, the non-life insurance and reinsurance companies will assume a maximum loss of JPY 590 billion ($7.2 billion) from Japan Earthquake Reinsurance (JER). As the industry has set aside more than 90 percent of the exposure as earthquake risk reserve (ERR), which was not accounted for as capital in the balance sheet (it is included in solvency capital), companies will draw down from this reserve to cover the residential claims reducing the impact on the income statement for fiscal year 2010.

“Much of the commercial losses exceeding the net retention amount of the Japanese non-life insurers and reinsurers will be absorbed by the international reinsurers.” What that amount will be cannot as yet be calculated. Best cited the figures released by AIR Worldwide, which put insurance losses in a range between $14.5 billion and $34.6 billion.

“If the final loss amount is closer to the lower band, the losses to the international reinsurance market may not be significant, whereas if the final loss amount lands closer to the upper band, the losses to the international reinsurers could reach up to $ 20 billion,” Best indicated.

In terms of capitalization of the companies, Best said it believes that the “deterioration stemming from reduction of unrealized capital gains due to stock market decline will be more severe rather than deterioration stemming from the earthquake loss, as much of the insurance loss will be absorbed by ERR and catastrophe reserves. Risk-adjusted capitalization may drop further if the companies increase their risk retention due to the higher costs of catastrophe protection going forward.

“As Japanese non-life companies and reinsurers are well capitalized to absorb some volatility,” Best said it “does not expect any rating changes to company ratings due to the current earthquake event but remains cautious that further deterioration in capitalization or a major slowdown in economic activity may pose further pressure on the current ratings. The local solvency ratio of the companies is expected to drop to the fiscal year 2008 level, and further risk retention could result in a lower solvency level.

“The non-life companies in Japan rated by A.M. Best are Tokio Marine & Nichido Fire Insurance Co., Ltd., Sompo Japan Insurance Inc., Mitsui Sumitomo Insurance Company, Ltd., Aioi Nissay Dowa Insurance Company, Ltd., NIPPONKOA Insurance Company, Ltd., The Fuji Fire & Marine Insurance Company, Ltd., and The Toa Reinsurance Company, Ltd. The six non-life primary companies represent 91 percent of net premium written in the Japan non-life market as of fiscal year 2009.”

Best also listed the ratings it has issued on the following catastrophe bonds exposed to Japan earthquakes:
Topiary Capital Limited—”bb+” on $200 million Series 2008-1 Class A Principal-at-Risk Variable Rate Notes due August 5, 2011 sponsored by Platinum Underwriters Bermuda Ltd.; and Valais Re Ltd. —”bb” on $64 million and “b” on $40 million Series 2008-1 Class A and Class C Principal-at-Risk Variable Rate Notes both due June 6,
2011 sponsored by Flagstone Reinsurance Holdings Limited.

“Topiary Capital Limited is a non-indemnity second-event catastrophe bond,” Best explained. It has not yet been subject to an event notice; therefore, the Japan earthquake event will not cause note holders to lose any principal. The Valais Re Ltd. catastrophe bonds are indemnity-based, and the Japan earthquake peril cover includes fire following, tsunamis and other causes of loss.”

Best added that it is monitoring the potential for losses to note holders, but that the ratings on the catastrophe bonds will remain unchanged, unless Best “receives updates from the calculation agent or the ceding reinsurer for each catastrophe bond indicating that the Japan earthquake is a triggering event.”

Source: A.M. Best

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