The Value of Curiosity
Liane Hirner, CFRO of VIG, has a strong belief in the merits of listening. It is a trait that has helped her navigate the shifts seen in life insurance in recent years, including macro volatility and the advent of trends
Japan’s financial regulator finalised a highly anticipated overhaul of its asset-intensive reinsurance (AIR) rules this month. While the Financial Services Agency (FSA) has achieved its goal of bringing the rapidly expanding market under closer supervision, it has chosen a surgical approach rather than a sledgehammer.
The changes represent a significant update to the country’s reinsurance supervisory framework. But crucially, they do not seek to stymie what has proven a vital capital-management tool for the country’s life markets.
And participants appear happy with the outcome.
Japan’s life market
The FSA’s move comes at a significant time for Japan’s $3 trillion life insurance sector. The country’s transition to its new J-ICS solvency framework, which was implemented in March this year and requires insurers to assess assets and liabilities at market consistent rates , has led to insurers offloading legacy, high-guarantee and more capital-intensive books of business to third-party reinsurers in a bid to clean up their balance sheets. Already this year has seen deals from insurers including Japan Post, Tokio Marine & Nichido Anshin Life and Daiichi Life to go alongside previous deals from Taiju Life and Sony Life, most of it flowing to Bermuda.
At the same time, momentum for AIR has been driven by new business opportunities. Japan, which currently holds about 5.2% of the global life insurance market by premiums according to figures from the Japanese Life Insurance Association, is facing one of the most rapidly ageing populations in the world, with individuals aged 65 and over constituting 30% of its total population. An increased demand for higher-returning self-funded retirement savings has proved a catalyst for insurers to enter the market with new products.
Given these dynamics, increasing numbers of Japanese insurers have been encouraged to use AIR as a capital management resource. At the same time, though, Japanese regulators may have been noticing the increased attention from supervisors on AIR around the globe. Both the Bermuda Monetary Authority and the US’s National Association of Insurance Commissioners have passed rules tightening up their respective oversight of AIR in the last few years while, in the UK, the Prudential Regulatory Authority took a step further with its imposition of a 10% capital charge on funded reinsurance transactions this year. The Japanese FSA’s move comes as no surprise then.
Assessing the Addressable Market
So how big can this market grow? As of now AIR remains a small part of the overall life business in Japan with about 1% to 2% of in-force life insurance reserves currently being ceded to offshore asset-intensive structures, according to Freshfields. However, some estimates suggest up to 30% of the market is addressable, potentially unleashing between $150 billion and $300 billion in transaction volume over the next five years.
Another indicator of the growth of AIR is offered by AM Best which found the overall cession rate as a percentage of total gross premium written for the segment rose to more than 24% in 2023 and 2024 from just under 10% in 2020. It is the potential future growth of this market that remains a focus for the supervisory authorities.
“In recent years, the use of asset-intensive reinsurance (AIR) has expanded among Japanese life insurance companies,” the Japanese FSA told Life-Re. “Given its scale and risk profile, AIR may give rise to relatively significant impacts on insurers, particularly in the event of recapture or a deterioration in the creditworthiness of reinsurers. Against this backdrop, this amendment seeks to promote more robust risk management practices by insurers.”
The changes
Broadly speaking, the new rules require life insurers to look past formal contract language to the underlying economic realities of their offshore deals, putting a premium on robust stress-testing, collateral protection, and strict limits on counterparty exposure.
One of the major changes relates to reserve credit, or “reserve non-accumulation”: specifically, whether a Japanese cedant can avoid holding significantly large policy reserves for business it has ceded to a reinsurer. The previous standard asked, at a high level, whether the reinsurance contract formally transferred risk and whether the recovery of those funds was highly probable. Under the newly implemented guidelines, the FSA has established strict criteria to evaluate whether a deal structure practically exposes the domestic insurer to sudden losses. In particular, the regulators will look at whether the reinsurer’s discretion can impair the economic value of the ceding company’s assets.
To enhance stress testing, the amendments add a new requirement for insurers engaging in AIR to incorporate scenarios involving simultaneous recaptures and reinsurer failures across multiple counterparties due to changes in economic environment, together with the resulting effects on the insurer’s solvency margin ratio and overall financial conditions, including the impact of asset rebalancing and reestablishing policy.
The guidelines also focus on unilateral recapture rights, preventing reinsurers from arbitrarily terminating agreements and dumping the liabilities back onto the ceding company during a crisis.
Scalpel over sledgehammer
The new guidelines suggest the FSA has been careful to put an emphasis on insurers engaging in AIR to control their own risks, rather than taking the proverbial regulatory sledgehammer to the market via highly prescriptive moves.
For example, the guidelines require companies to establish “an upper limit” on their total reinsurance exposure. They do not, however, issue a specific calculation methodology for this limit.
“Each insurer is expected to establish its own limit based on its risk-taking capacity, taking into account, for example, the potential impact of a recapture event,” said the FSA.
Similarly, for “high-risk” AIR transactions, companies are now required to analyse how changes in the economic environment will affect the soundness of multiple reinsurers. But the rules do not impose a uniform definition of what constitutes high risk transactions. “Rather, the assessment is to be made by each insurer, considering factors such as the size and duration of each AIR transaction,” the FSA said.
The market response
Unlike the UK’s PRA, which clamped down hard on its own funded reinsurance market with the imposition of a 10% capital charge for future transactions, the Japanese FSA’s approach appears more open-minded to the use of the technique, provided risks are controlled.
“Reinsurance, including AIR, is intended to transfer risks borne by insurers to third parties, and its use taking into account impacts on capital and valuation metrics is not, in itself, considered inappropriate,” the FSA said. “However, it is understood that such use should be predicated on sound management judgment and appropriate risk management, commensurate with the characteristics of the transactions.”
Reinsurers have welcomed the clarity offered by the update.
“We welcome the JFSA’s proposals to incorporate AIR-related stress scenarios into stress testing, perform enhanced monitoring of reinsurers and collateral, and strengthen governance,” said Phill Beach, Executive Vice President, Savings & Retirement at Pacific Life Re, which in June announced its third block transaction with Tokio Marine & Nichido Life. “These measures will encourage sound AIR practices across the market.”
Beach contrasted the FSA’s approach with the PRA’s which could have potentially negative consequences for insurance clients.
“We believe that the PRA’s proposals will have the unintended consequence of limiting access for UK pensioners to reinsurers’ capital and diversification, and raising pension provision costs, leading to fewer pensioners protected by a regulated insurance regime,” Beach said, noting that such heavy-handed limits do not apply to the dynamics of the Japanese market.
The Life Insurance Association of Japan (LIAJ) also acknowledged the positive impact the new rules bring to the reinsurance business in Japan.
“The recent revision is intended to improve reinsurance risk management across the industry,” the LIAJ said. “By encouraging appropriate reinsurance arrangements and more sophisticated risk management, the revision aims to set a higher standard.”
Crucially for the industry, the LIAJ emphasized that the FSA’s rules are meant to be applied in a “principle-based and proportionate manner,” acknowledging that the materiality of these transactions varies from giant conglomerates to smaller players. The regulator also confirmed that existing contracts signed before 1 July this year will not be retroactively reassessed.
With the regulatory dust settling, the Japanese reinsurance market is shifting from an era of rapid, unchecked growth to one focused on execution quality. As J-ICS disclosures become public throughout this fiscal year, pressure on capital metrics will only intensify. The appetite for AIR is likely to remain strong. And the FSA’s emphasis on not crushing the business is a move that many will applaud.
