Japan insurers’ global expansion justified by operating results: AM Best

The decision by Japan’s leading non-life insurers to significantly expand their international operations through high profile acquisitions in the past couple of years, has helped them to offset higher levels of financial leverage and manage their interest rate exposures. The deals were not cheap but made economic sense, according to AM Best. The expansion of the Japanese insurers in recent times has been quite dramatic. In 2015 alone, Japanese insurers had spent a huge $22bn by October on overseas acquisition. This compared with $6bn in 2014 and was more than three times as much as any year since 2000. In the non-life sector, the biggest deal was Tokio Marine’s acquisition of US-based HCC Insurance Holdings in 2015 for $7.5bn. Added to Tokio Marine’s 2007 acquisition of Lloyd’s agency Kiln for £442m, this gives the insurer a truly global footprint the specialty market. Tokio Marine paid a premium to share price of 35.8%. Also that year, Mitsui Sumitomo (MS&AD) acquired London-based Amlin for £3.5bn, thus gaining important access to the London, Bermuda, European and Miami markets. Mitsui paid a premium to share price of 36% to gain this footprint. And in late January of this year, shareholders of Endurance Specialty – the Bermuda-based international insurer – voted in favour of its acquisition by Sompo Holdings for $6.3bn, a premium to share price of 40%. The Japanese insurers have been prepared to pay such a premium for these deals because growth in their core domestic market is limited, interest rates remain very low in Japan and the Bank of Japan’s monetary stimulus strategy means that money is very cheap. The big Japanese insurers recently posted their third-quarter results. AM Best notes that the Japanese non-life insurance groups have reported moderate increases in their financial leverage but adds that interest rate coverage remains stable because of improvements in their operating results, partly driven by the recent international acquisitions. The credit rating agency says the profitability of the three major non-life insurance groups improved during the nine months ending December 2016, mainly because of the absence of large-scale catastrophe losses in the domestic market. “Improved underwriting results of the domestic non-life insurance market and growing contributions from overseas insurance businesses fully offset the decrease in interest and dividend income,” states the agency. “The major non-life insurance groups have reported positive growth in terms of premium income and earnings from their overseas businesses, from organic growth as well as the consolidation of recently acquired operations, particularly at Tokio Marine Holdings,” notes AM Best. “In recent years, the non-life insurance groups have made large-scale acquisitions in overseas markets, which boosted their earnings. Although the risk-adjusted capitalisation has been negatively affected by the large amount of goodwill from these acquisitions, the non-life insurance groups still maintained strong levels of risk-adjusted capitalisation due to their efforts to reduce investment risk and the issuance of subordinated debt,” continues the credit rating agency. “In particular, the groups have effectively taken advantage of the low interest rate environment during the period by reducing funding costs in debt issuances,” adds AM Best. According to the agency’s analysis, the financial leverage of the combined non-life insurance groups increased from 4.5% in March 2016 to 6.1% at the end of December. The level of leverage varied across groups during this time. It points out that debt issuances during the past nine months were intended to fund overseas acquisitions and support the capital position of the group companies, in particular life insurers, against potential risks such as a sudden rise in interest rates. Sompo, for example, issued hybrid bonds in the domestic market in July 2016 to prepare for a potential acquisition. In October, the group announced it would acquire Endurance and this would be partly paid for by the hybrid bonds. More recently, both Tokio Marine and MS&AD issued subordinated bonds at the operating level and holding level, respectively. “The proceeds are meant to enhance the capital position of each company’s domestic life insurance operations. Despite the relatively small contributions to the groups’ earnings and capital, the life insurance operations make up most of the groups’ interest rate risk,” states AM Best. “Although these life insurers have relatively well managed asset/liability matching compared to the traditional life insurers in Japan, a sudden rise in interest rates would significantly reduce their regulatory capital position, given their high exposure to long-duration bonds in their investment portfolios,” it adds. The rating agency points out that the Japanese non-life insurance groups have been more active debt issuers in recent years. Following the big catastrophe losses in 2011, a number of companies swiftly issued hybrid bonds to shore up their capital positions. But the hybrid bond issuances during the past year have been employed ahead of large acquisitions or to take advantage of the low interest rate environment prior to a potential increase in rates, comments AM Best. “The Japanese non-life insurance groups are expected to remain active in the debt market to support the growth and manage risks of the group companies. Their diversified businesses should provide stable operating results, which will support sufficient interest coverage,” states AM Best. “Group-based capital management is becoming more important in managing specific risks that each operating company faces. These groups intend to maintain sufficient capitalisation at their operating subsidiary levels while keeping limited available capital at the ultimate holding company. In this respect, the diverse capital needs that have emerged at the operating company level require a more active role at the ultimate parent company in raising capital and allocating it appropriately,” concludes AM Best.

Japan insurers’ global expansion justified by operating results: AM Best

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