Initial estimates in for Japan’s largest earthquake


Japanese tsunamiFitch Ratings 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.
Due to the scale and complexity of the insured loss, it will take some time for international catastrophe modelling firms and local loss adjusters to accurately estimate insured losses. Initial estimates from AIR Worldwide released on 12 March place the economic loss at approximately US$100 billion and insured property losses in the range of US$15 to 35 billion (JPY1.2 to 2.8 trillion). These estimates do not specifically include the impact of the ensuing tsunami, demand surge or life insurance.
Many lines of insurance will be impacted including fire, flooding, marine, motor and life insurance. 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.
Fitch 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 JPY4.3 trillion ($52.6 billion) of residential earthquake losses.
- Japanese non-life insurers have accumulated significant residential catastrophe reserves over recent years totalling JPY524bn (USD6.4bn), representing 88.4 per cent 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 per cent to 17 per cent of homes in Japan are covered for earthquake risk.
- The epicentre 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.
After the Kobe earthquake of 1995 insured losses amounted to USD3.5bn although economic losses were close to USD100bn. The Kobe earthquake 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 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 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 analyse loss information received from Japanese primary insurers, and will provide further guidance to the market as company-specific loss estimates are stress tested.
Fitch expects that the latest 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 agency notes 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).
Fitch 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.