Proceed With Caution.

After years of declining profits and sales, the Japanese life insurance industry could be turning to reinsurance to restore its glory days. Reinsurers looking to gain a foothold should be patient.

Japan's recent economic troubles are opening up the world's largest life insurance market to reinsurance. Reinsurers are eyeing the Japanese market, because it's virtually untouched. Less than 1% of Japanese life insurance is reinsured, compared with 20% in the United States and 30% in Canada, according to the Reinsurance Group of America Inc., one of the largest life reinsurers. Reinsurers also are enticed by the Japanese market, because the country accounts for 83% of all life insurance premiums in Asia.

Before Japan's financial problems, which began in the early 1990s, Japanese insurance companies considered their capital base large enough to retain all the risk they wrote, said Thomas Conroy, president of ING Re, Asia-Pacific, Latin America and Structured Reinsurance. At the same time that the financial difficulties eroded their capital, Japanese life insurers faced other challenges that led them toward greater use of reinsurance: a more competitive market, the need to create new products and ways of distributing them, and alliances with foreign partners more comfortable with its use.

While the opportunities have attracted the attention of almost every international reinsurer, establishing a successful reinsurance business in Japan won't be easy. "Almost all of the international insurers are interested in the Japanese market. I would say the market is a hot one but it will be a tough one, because while the Japanese are risk averse, they are sophisticated financially, so they are not going to be an easy market to crack. Virtually all of the international insurers are in Japan attempting to enter that market," Conroy said.

Reinsurers continue to establish offices in Japan. ING opened its doors in Tokyo on June 30. Others active in the Japanese reinsurance market include RGA, Swiss Re, Munich Re, Toa Re, Cologne Life Re and Hannover Re. yoei-Lincoln Re was created in a joint venture with yoei Life Insurance Co. in January.

Michael L. Albanese, life/health group vice president of A.M. Best Co., advises reinsurers entering the Japanese market to be patient. "In theory, it sounds like Japan is ready for business, but in reality, the Japanese market evolves very cautiously," he said.

A New Tool

Though reinsurance as a tool for capital and financial management is a fairly new concept within the Japanese life insurance industry, the use of life reinsurance has been growing. In 1998, Japanese life insurance companies paid [yen]180.95 billion (about $1.67 billion) for reinsurance, up from [yen]51.50 billion in 1995, according to Swiss Re. The increase is due to the use of financial reinsurance for acquisitions and to boost solvency margin ratios, said Hitoshi Morita of Swiss Re, Tokyo.

Conditions are ripe for the use of life reinsurance in Japan to grow further.

"Reinsurance is a proven financial tool with application in any market," said Brendan Galligan, senior vice president of RGA's Asian/Pacific division. "The conditions in Japan that precluded broad value from reinsurance in the past are crumbling."

In 1996, deregulation opened up the insurance market and encouraged competition. Deregulation allowed nonlife companies to enter the life business and vice versa. In the past, Japan's Ministry of Finance mandated tariff rates, which eliminated competition on pricing.

The Japanese regulators stifled competition in other ways, limiting financial or capacity incentives for reinsurance.

For example, when a life insurer sought approval of a new product, the regulators--under what was called the "convoy system"--would pass the information to other life insurers to ensure that everyone was offering the same products at the same prices.

With deregulation, life insurance companies set their own rates. The Financial Supervisory Agency, which approves new products in Japan, still takes a cautious view when approving products with new pricing bases, said Mish Nakazono, RGA's regional vice president, Japan and orea.

Further deregulation of prices would increase the need for reinsurance. "With the dismantling of the tariff rate, we see competition in Japan as we see it in the United States and the need for reinsurance," Galligan said.

The government regulations also eliminated the market for high-figure policies, a strong segment in the United States. Generally, the most a company can issue for one insured is $5 million per policy and $7 million in aggregate. "The world's largest life company, Nippon Life, wrote $60 billion of premiums last year," said Morita of Swiss Re. "The largest claim per person they would have to pay is $6 million."

The mutual status of most of Japan's life insurers also was a roadblock to growth of life reinsurance. "There was little incentive to improve the financial ratio," Morita said. But with demutualization on its way in Japan, there will be more of a focus on tax planning and capital and financial management. "Since Japanese companies are just starting to realize the importance of capital and financial management, reinsurance could play a big role in this area," Nakazono said.

Foreign Partners

The Asian economy collapsed about the same time as deregulation occurred. Insurance companies' investments suffered, because the companies had invested in government bonds, domestic securities and corporate loans. Because they were guaranteeing 5.5% annually for some life policies, many insurers became victims of negative spread, when money from investments doesn't meet the level of rates guaranteed to policyholders.

This led to the failure of several life insurance companies in Japan. The first was Nissan Mutual Life in 1997, followed by Toho Mutual Life Insurance Co. in 1998 and Daihyaku Mutual Life Insurance Co. in May.

Japanese insurers started turning to foreign companies to bolster their sagging businesses. In 1999, Manulife Financial Corp. of Canada launched a joint venture with Daihyaku called Manulife Century Life Insurance Co. In 1998, GE Capital Services formed a joint venture called GE Edison Life Insurance Co. Ltd. with Toho Mutual Life Insurance Co. Prudential Insurance Company of America plans to invest [yen]20 billion this year to help rescue troubled Japanese insurer yoei Life Insurance Co. Under terms of the agreement, Prudential would be able to reinsure new policies written by yoei. Foreign entrants into the Japanese market also will boost the market for reinsurance, because they are "no strangers to its use," Galligan said.

New Products

Changing sales methods and new products are increasing competition in the Japanese life insurance industry and influencing the increased use of reinsurance.

In the past, Japan's insurers relied heavily on armies of "seiho ladies." Seiho is the Japanese word for life insurers. These representatives sold life policies in the workplace, sometimes pressuring workers to purchase coverage with little or no explanation of the policy "The distribution system in the past was based on no needs-based selling, only obligation buying," Galligan said. Now, new entrants are training sales forces on selling and introducing new products, he said.

"With the elimination of the convoy system, insurers can finally get innovative and get in front of the pack with new product designs," Conroy said. Established products in the United States, like smoker-distinct policies and preferred underwriting categories, are new products in Japan. "Reinsurers can act as a consultant to a Japanese company and bring their knowledge base to them. And since the Japanese companies are not as restricted as they were, the need for that type of consulting is there," Conroy said.

As financial-services giant Citi-group expands in the Asian market, insurers should be ready for sparks to fly with new ideas and products, Galligan of RGA said.

Primerica Life Insurance Co., a Citigroup subsidiary, is laying the groundwork for its entrance into the Japanese market, said John A. Addison Jr., co-chief executive officer. While Japan's life insurance industry is dominated by whole life and endowment contracts, Primerica, with its army of part-time agents, focuses on selling term life insurance and mutual funds to middle-income people.

Serving an Aging Population

The demographic changes in Japan are similar to what's going on in the United States. 12 Japan is ahead of the United States by five to 10 years with respect to its aging population, Albanese said. This change brings great opportunities for insurers to sell retirement and long-term-care products. "However, long-term care requires a special set of underwriting skills, which does not yet exist in Japan. Moreover, product pricing will be a major challenge, since there is no credible industrywide data. This could be a large opportunity for reinsurers to step in and provide product development and risk mitigation," Albanese said.

Japanese insurers tend to be more averse to risk than their counterparts in other parts of the world. So as a more competitive marketplace and the development of new products increases their risks, there's a greater focus on risk management. "The Japanese companies are interested in laying off risks that are bread and butter for reinsurers, like substandard mortality risk," ING's Conroy said.

To succeed in the new environment, Japanese life insurers have their work cut out for them. Life insurers are experiencing declining sales because of the recent life insurance company insolvencies and the continuing effect of negative spread. In 1999 and the early part of 2000, Japan's seven largest insurers reported the value of individual insurance policies outstanding at [yen]1 ,078.49 trillion, a decline of [yen]38.95 trillion. Yasuda Mutual Life said it had a 9.7% cancellation rate in individual insurance and pension policies for the same time period.

What Can Reinsurance Do?

In order for Japanese life insurers to sell more products and expand their markets, they will have to consider turning to reinsurance. "Although the market is mature and has been flat, Japan is still the largest insurance market in the world. The Japanese, on a per-person basis, still buy about twice as much life insurance as Americans," Conroy said. Reinsurance will relieve insurers of having to post their own capital for the risk.

Reinsurance also can unlock some of the capital that's locked up in policies and won't be realized for a long time because of the long Japanese life expectancy. The World Health Organization recently reported that Japan's life expectancy of 74.5 years is the longest among 191 countries.

Business written 10 to 15 years ago had a less optimistic mortality assumption than business written today. "Those gains won't come in until future years. If the life insurers reinsure that business, they can recognize the present value of those gains and help their reserves and capital position, too," Conroy said.

Reinsurance also can be used as a potential capital-management tool as companies convert from a mutual structure to public ownership, Albanese said.

Differentiation Is ey

As foreign reinsurers enter the Japanese business market, they must be aware of the difference in culture. "It's difficult to establish a business abroad," Galligan said. "Companies tend to use their proven track record for success to be a hallmark when they enter a foreign country to do business. You have to realize it's very different doing business in Japan."

The Japanese tend to take a long-term view, so relationships become critical, Nakazono said. He said reinsurers contemplating entering the Japanese market should remember: They have one chance, so they must differentiate themselves, and it will take longer to become established in Japan than in other countries.

Conroy also advises reinsurers to differentiate themselves when they enter the Japanese market. "If all you bring is a me-too product and approach, you will just be another one who came to pay a visit," he said. "Reinsurers have to bring significant value to a Japanese insurance company, and it is twofold: capital management and product innovation."