Asset Intensive Reinsurance in Japan: Current Trends and Future Outlook

By Grace Chang, Takayuki Hanao and David Wang

Reinsurance News, December 2024

Asset-intensive reinsurance, a reinsurance strategy that emphasizes enhancing performance of the underlying assets over mitigating biometric risks, is gaining traction in Japan's life insurance market. Although still in its early stage, several asset-intensive transactions have already been executed between Japanese insurers and offshore reinsurers since 2020, signaling substantial growth potential.

Reinsurance transactions typically fall into one of two main categories: Block reinsurance and flow reinsurance.

Block reinsurance involves the reinsurer assuming a specific portfolio of policies or particular risks, with the reinsurer's liability fixed at the contract's inception. This risk transfer occurs in a one-time transaction, after which the reinsured block enters a runoff phase.

In contrast, flow reinsurance involves the reinsurer assuming new business as it emerges from the insurer. This results in an ongoing liability for the reinsurer as new policies are written and risk is transferred continuously.

The remainder of this article will explore the market dynamics driving asset-intensive reinsurance in Japan, analyze how Japanese insurers are strategically utilizing both block and flow reinsurance to achieve diverse business goals, and discuss key considerations for offshore reinsurers seeking to enter this market.

Market Overview

Japan’s life insurance industry ranked third by premium volume in 2021 and fourth in 2022. Since 2021, a few Japanese insurers, primarily listed or multinational companies, have executed block reinsurance transactions. However, the market remains relatively untapped, with only a fraction of the total in-force reserves being transacted.

Figure 1
Life Premium Volume in U.S. Dollars in 2021 and 2022 (Swiss Re Institute, Table V: Life Premium Volume in USD in 2022, Sigma No. 3/2023)

As of Q3 2024, only three out of the top 10 life insurers have engaged in asset-intensive block reinsurance, with transactions totaling an estimated $20 billion to $30 billion. This figure represents less than 1% of the $3 trillion of in-force reserves in Japan’s life and annuity sector. Yet, there’s growing momentum as more insurers explore reinsurance solutions to manage their liabilities. Up to 30% of the $3 trillion liability pool, or approximately $900 billion, could be opened up for reinsurance solutions. In the near term, 5% to 10%, or $150 billion to $300 billion, could enter the market over the next five years, depending on market conditions and insurers’ capital strategies.[1]

While visible market activity may seem modest, undisclosed flow transactions are also occurring. Meanwhile, the market is evolving, with active discussions between insurers and reinsurers. As Japanese insurers become more familiar and accepting of offshore reinsurance we anticipate continued growth in both block and flow reinsurance transactions. The interest from both insurers and reinsurers remains strong.

Figure 2
In-force Reserves by Listed Insurers with Block Reinsurance Potential (The Life Insurance Association of Japan; In-force Reserve Data for Fiscal Year 2021 Ending March 31, 2022)
All Figures are as of FY2021 and Converted from JPY to USD at FY2021 Spot Exchange Rate of 0.0082.

Key Market Drivers—Insurers’ Perspective

Several key factors are driving the increasing utilization of asset-intensive reinsurance among Japanese insurers:

1. Aging Population and Shrinking Market: Japan's insurance market has matured alongside its economy. However, with an aging population and low economic growth, insurers are shifting focus to back book management, including cost reduction, cash flow matching, and capital efficiency. Reinsurance emerges as a viable option in this context. Additionally, the demand for retirement products is increasing, and reinsurers with strong asset management capabilities can enhance the attractiveness and competitiveness of these products.
2. Interest Rate Environment: Japanese interest rates have been near zero for decades, but the yield on Japanese Government Bonds (JGBs) has recently increased, particularly at the long end. Life insurers, who traditionally purchased long-term JGBs and various derivatives to extend asset duration, have become acutely aware of ALM issues given the specter of rising interest rates and the upcoming Solvency II-type regulations (J-ICS) set to become effective in 2025. Reinsurance can help insurers manage interest rate risk more effectively under the new regulatory framework.
3. Capital Management: Listed companies face significant pressure from capital markets to improve capital management and profitability. Reinsurance offers a solution, especially for companies with low-profit back books. Mutual companies, while not under the same pressure, also need capital flexibility to grow their businesses.
4. New Capital Regime: The introduction of Japan Insurance Capital Standard (J-ICS), an economic-based capital requirement broadly similar to European Solvency II, will require tighter risk and capital management starting in 2025. The new regulation is more punitive to lapse risk, particularly in a higher interest rate environment. Insurers must manage their capital positions and interest rate risks carefully. Some insurers have disclosed that their capital sensitivity to interest rate increases has shown unfavorable results due to large mass surrender risk charges. This situation necessitates exploring alternatives like reinsurance to minimize interest rate risk.
5. High Capital Supply: Due to the influx of offshore reinsurance companies competing in Japan over the past few years, cedents can often receive favorable economic terms, making reinsurance a potentially attractive option.

Key Market Drivers—Offshore Reinsurers’ Perspective

For offshore reinsurers, the motivation for seeking asset intensive reinsurance opportunities is driven by three main factors:

1. Market Size: Japan boasts one of the world's largest insurance markets by premium volume. A large portion of liabilities remain untapped despite recent activities in offshore block reinsurance transactions. Additionally, the steady growth of saving-oriented products is driving demand for flow deals. This makes the market attractive to reinsurers as an opportunity to gain significant growth and scale.
2. Stable and Competitive Environment: Japan's mature life insurance industry provides a solid foundation for reinsurance operations. The well-developed infrastructure and experienced market players create a stable environment for reinsurers to establish their presence. Additionally, the country's established insurance regulatory framework ensures a conducive business climate.
3. Continuous Funding and Growth Potential: Given the substantial success achieved in the U.S. market, private equity and alternative asset management firms are extending their focus to Asia, particularly Japan. These firms possess the expertise to originate higher-risk, higher-return assets, aligning them strategically with the life insurance and annuity industry's needs. By acquiring a life insurance book, these firms gain access to long-term assets, which can be used to fund alternative credit investing. This synergy between permanent capital and credit investing continues to fuel interests from private equity and alternative asset management firms in the asset-intensive reinsurance space.

Challenges and Considerations

Asset intensive reinsurance activities with Japanese life insurers have been going strong over the past year. There seems to be a clear preference for long-duration products, especially for whole life, in block transfers while flow deals tend to focus on annuities. The primary objective of asset-intensive block reinsurance is to enhance capital efficiency and reduce exposure to interest rate risk associated with long-duration, and/or high guarantee products. Conversely, Japanese insurers engage in asset-intensive flow reinsurance primarily to enhance price competitiveness in savings-type products offered through bancassurance channels and to mitigate investment risks.

With the exception of RGA, most of the reinsurers involved in recent transactions are Bermuda-based and backed by private equity or alternative asset management firms. This underscores how asset-intensive reinsurance has become a strategic growth area for private equity and alternative asset management firms.

Figure 3
Publicly Announced Transactions in 2023 and 2024
Transaction Value in JPY was Converted to USD Based on Exchange Rate as of 8/28/2024.

For long-duration product block transfers, asset-liability management (ALM) is key, but finding long-dated assets to back the liability can be challenging. For products with high JPY guarantees, reinsurers may convert JPY assets to USD-denominated credit strategies, necessitating careful liquidity management and FX hedging.

For flow reinsurance, the primary goal for insurers is to create competitive products and increase market shares by leveraging reinsurer’s asset management capability. Unique features like the knockout option, where the denomination of the liability is automatically converted from a foreign currency to JPY at a defined contract value threshold, may create liquidity concerns depending on market conditions.

Cedents evaluate various factors in reinsurance transactions, including pricing, counterparty risk, relationship dynamics, and internal constraints. For counterparty risk, Japanese cedents are shifting from a credit rating-based measurement to a more robust risk assessment, including aspects such as structural protection and liquidity management.

For reinsurers, navigating the Japanese life insurance market comes with its challenges. Areas of consideration include:

1. Understanding Product Features: Understanding product features and the associated risks is crucial for offshore reinsurers. Product features such as tontine uplift for annuities and knockout option for foreign currency-denominated products are common in the Japan life insurance market but are unfamiliar to markets outside of Japan.
2. Market Dynamics and Policyholder Behavior: Understanding the unique interplay of market dynamics, economic trends, and policyholder behavior is essential for pricing and assessing feasibility for Japan transactions. Japanese life insurance product designs are generally easy to understand, but the underlying market dynamics, economic trends, and policyholder behaviors differ significantly from U.S. norms. Predicting the market and policyholder response to economic shifts is challenging, given the limited historical data.
3. FX Hedging Strategies: Implementing effective foreign exchange hedging strategies is a crucial operational aspect for reinsurance transactions involving foreign currencies. A common hedging approach involves a combination of cross-currency swaps and FX forwards. Ensuring regulator and cedent comfort with the hedge program is also important, as regulatory scrutiny on offshore reinsurance is increasing.
4. Competitive Market: Competition is heightening as more offshore reinsurers are exploring opportunities in the market. Reinsurers need to build strong relationships and trust with potential targets and existing cedents through continuous dialogue, education, and support. Strengthen the relationship by helping cedents get comfortable around the asset and hedging strategies, reinsurer’s risk management framework, and the regulatory requirements in the reinsurer’s jurisdiction.
5. Regulatory Compliance: Staying informed about Japan's regulations and industry standards, such as J-ICS and counterparty risk measurement, is crucial. Reinsurers should proactively engage with cedents to address concerns, understand the implications of changing regulations, and ensure compliance.
6. Cultural Differences: Be mindful and respect language and cultural differences in all communication and interactions. For reinsurers, having a Japanese-speaking contact can significantly streamline negotiation during the transaction and correspondence in post-transaction operational processes. Plan well in advance for reporting and rate-setting cycles to minimize operational disruptions due to time zone and holiday variations.

Future Outlook and Conclusion

The Japanese asset-intensive reinsurance market is poised for growth, driven by desire for market competitiveness, regulatory changes, and the need for effective capital management. While challenges remain, the market offers significant opportunities for both cedents and reinsurers. As the market expands, understanding the market, products, and regulatory requirements, as well as fostering strong relationships will be key for offshore reinsurers to navigate this evolving landscape successfully.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or the respective authors’ employers.

---

Grace Chang, FSA, MAAA, is a consulting actuary at Milliman. Grace can be contacted at grace.chang@milliman.com.

Takayuki Hanao is the president and CEO of T&D United Capital North America and a board member of Fortitude Re. Taka can be contacted at takayuki.hanao@tducna.com.

David Wang, FSA, FIA, MAAA, is a principal and consulting actuary at Milliman. David can be contacted at david.wang@milliman.com.

Endnote

[1] Estimated figures based on market research conducted by the authors.