Reinsurance in Japan: Ensuring continuity in an evolving risk environment

*This article was first published by Hoken Mainichi on 6 July 2024.
*This article is a translation. In case of any confusion or discrepancies, please refer to the original Japanese version for clarification.

We recently interviewed Atsuhiro Dodo, Head of Swiss Re Japan, about the state of Japan's reinsurance market in Japan and the global environment. Dodo explained that the prevalence of large-scale or unexpected disasters around the world, as well as the monetary policy environment, have affected reinsurance dynamics. He noted that though market anxiety has declined, climate change and the threat of cyber-attacks are likely to complicate the risk landscape in future. He also emphasised the need to maintain stable, long-term relationships with primary insurance companies through consistent and open communications.

Although conditions were generally calmer last year, weather disasters such as severe convective storms, floods, wildfires, and more recently hailstorms are occurring with greater frequency around the world each year. The scale of the resulting damage is also increasing. While these events typically result in less catastrophic damage than earthquakes and hurricanes, predicting how and where they will occur poses a challenge to the insurance industry. We will also need to think about how climate change will affect these dynamics in the future.

To add to the complexity, there were questions about how the impact of the COVID-19 pandemic may shake up the non-life insurance industry. Geopolitical risks such as insured losses arising in connection to the Russian invasion of Ukraine would also remain a challenge. In other words, we are seeing a steady stream of health, geopolitical and environmental impacts that forces us to apply a social lens to determine how insurance cover will be applied.

To ensure insurance continuity and discipline, the basic premise must be that insurance payments will be made properly for events specific to the interest of the insurance, and that no payments will be made for events that are not covered in insurance policies. Over the past few years, the re/insurance market has been faced with urgencies to revisit so that the basic principles, coverage and limitations of insurance products are clear, in order for insurance to be continuously and appropriately provided.

Just as economic activity goes through cycles driven by multiple factors, the reinsurance market also consists of cycles of reinsurance capacity. Renewals are particularly affected by the extent to which large-scale or unexpected disasters have occurred around the world, as well as by the global – and especially the US – interest rate environment. Last year, while the reinsurance industry's combined ratio remained still high, the Fed raised interest rates, causing the market to suddenly harden. Market anxieties have eased somewhat this year due to the Fed’s steadier policy, and a lack of significant damages stemming from natural disasters and similar events. The stable renewals earlier in the year of insurance companies based in North America and Europe have also helped provide a sense of relief to Japanese renewals in April.

However, it is not entirely calm. For example, the amount of compensation paid for litigation cases in North America is increasing. As a result, liability insurance programmes that accept contracts from global companies were required stricter underwriting in terms of rates, limits, and conditions. In addition, as loss ratios for fire insurance continue to deteriorate over an extended period, underwriting companies have been asked to further tighten terms and conditions, such as fire rates for large corporate risks.

One we kept in mind is the clarification and discipline around insurance wordings and coverages I have described earlier. We’ve taken actions to ensure our programme is both appropriate and can continuously provide coverages in the future. Another point is the need to utilise underwriting data. Recent developments in technology and data analysis are creating a foundation for more detailed risk assessment at the level of large corporate accounts and the entire portfolios.

To eliminate unexpected claims situations and negative surprises, it is important to use more data to analyse aggregate trends, and project profitability levels, hence increase portfolio transparency. On the other hand, despite quantitative analysis we perform, there remain uncertainties that lie at the foundations of insurance products.

We emphasized maintaining long-term, stable relationships with primary insurance companies since not everything can be attributed to numbers. Establishing dedicated channels of communication can help to strengthen successful collaborations in mitigating risks.

Swiss Re has been underwriting risks in Japan since we signed our first contract with a Japanese insurance company in 1913. This year marks the 20th anniversary of the opening of our Japan branch in 2004. As the risk environment evolves and grows more complex, we are working relentlessly to clarify and revisit our insurance contracts and coverages. In close collaboration with primary insurance companies, we ensure smooth payments when incidents occur to help our societies become more resilient.

The reference rates for homeowner insurance set by the General Insurance Rating Organisation of Japan have been raised five times since 2014. As natural disasters occur more frequently over the past decade, we have seen fire insurance constantly produces a deficit. Adjusted for inflation, losses caused by natural disasters have increased tenfold globally in the 50 years since 1970. 

This is partially a result of economic development and urbanisation, where we see a larger concentration of assets in areas that are susceptible to natural disasters. Projections and modelling based on the latest scientific knowledge are being conducted to assess the future impact of climate change. Based on the presumption that global average temperatures will rise 1.5°C by 2040 compared to pre-industrial levels, insurance losses in developed countries related to severe weather events such as typhoons, winter storms, floods, and bush fires will increase 30%-63% by 2040. In Japan, estimates indicate that losses caused by flooding will rise 64% over the same period. 

As the frequency and severity of unexpected weather events increase, insurance premiums will need to rise in response. Climate change can affect the continued availability of insurance, especially if significant increases are required and risk mitigation measures are inadequate, which may make it less economically feasible for property owners to purchase insurance. This may become a social issue that needs to be addressed in the future. If this happens, action by the insurance industry alone will not be sufficient; public-private partnerships between industry sectors, local and national governments that make policy decisions will also be required. The protection gap – the extent of economic losses not covered by insurance - has already become a pressing problem. Strong demand for reinsurance is expected to continue. The industry must communicate the need for collective efforts and action to both transfer and mitigate risks based on risk insights we have been gaining. 

The COVID-19 pandemic has introduced the digital shift, which made a major change to society. Cyber-attacks have also gained more prominence and attention due to the geopolitical tensions following the Russian invasion of Ukraine. 

Cybersecurity company McAfee has estimated cyber-attacks cause US$945 billion in economic damage annually, primarily due to infringement of intellectual property and financial crime. According to Swiss Re Institute, damage to the global economy caused by natural disasters peaked in 2011 at approximately US$500 billion, due to extreme events such as the earthquake in New Zealand, the Great East Japan Earthquake, and flooding in Thailand. In other words, substantive damage from cyber-attacks has nearly doubled the levels of those inflicted by natural disasters in the worst year on record. Ransomware, a form of attack that uses technology to extort money from others, is particularly destructive. The global cyber insurance market is expected to reach US$13 billion in 2022, a 30% increase from 2021, and premiums are expected to increase to US$15.6 billion in 2023. 

The Japanese market for cyber insurance is also growing rapidly at an annual rate of 20%, and recent research predicts that cyber insurance and reinsurance premiums will overtake those of natural disaster insurance by 2040. While the Japanese cyber insurance market has demonstrated robust growth since its inception in 2015, penetration rate in Japan remains low, at 8% in 2020, according to the General Insurance Association of Japan. The notable difference between Japan and the rest of the world in terms of cyber insurance is that payments in response to ransomware are not covered, and compensation for business interruptions is limited. Cyber-attacks sit at the boundary of risks that can be underwritten. The reason for this is that cyber insurance is difficult to diversify, and the arbitrary nature of human beings may also function as a risk. For example, terrorist organisations and hackers may attempt to disrupt social systems in systemic and devastating ways. When such large-scale cyber-attacks occur, countermeasures would be taken based on experience, so the targets for the next incident would be different, making it difficult to digitise and quantify. At the same time, due to the continuous evolution of technology, it is also difficult to develop models for, or even agree upon, new risk environments. 

To reduce the uncertainties, we face in terms of cyber risk, we first need to standardise data and improve our modelling capabilities. This will allow us to calculate degrees of risk and reach agreements on how risks should be priced. Secondly, it is important that the industry is partnering with cyber security companies. Such partnerships will enable us to visualise and mitigate risks by providing minimum levels of prevention, defence, and backup measures - such as risk identification, and business continuity and recovery plans – setting the minimum conditions for providing insurance.