Catastrophe Lessons From Japan and New Zealand

The Asian insurance industry can use risk-based solvency and the increased use of actuaries to tackle risk-management challenges, according to Moungmo Lee, general manager of analytics at A.M. Best Asia-Pacific Ltd. The devastating earthquakes that occurred in New Zealand and Japan in the first quarter of 2011 have uncovered loopholes in existing catastrophe-related enterprise risk management among insurers.

The outlooks of several insurers have been downgraded by A.M. Best Co. from stable to negative due to capitalization and risk management problems related to aggregate catastrophe exposures.

The earthquakes have damaged the financial stability of insurers in New Zealand, and one of them even sought fiscal support. Lee noted this is "not a liquidity problem, but a capital problem" for the insurers.

"I'd say that the earthquakes occurred in unknown faults and therefore any losses in these regions estimated by catastrophe models would probably have been understated," said Lee. "There could be other unknown faults in New Zealand that may impact insurers in the future."

Christchurch-based AMI Insurance, a mutual insurer and the second-largest residential insurer in New Zealand, received a back-up financial package of up to NZ$500 million (US$394 million) from the government in April to secure sufficient capital to pay out insured claims related to the two earthquakes in Christchurch in February and last September. It has 485,000 policyholders and 1.2 million policies across the country (BestWire, April 7, 2011).

In late April another New Zealand-based insurer, Western Pacific Insurance Ltd., cancelled its all insurance policies as its liquidators were unable to sell, transfer or assign the business (BestWire, April 27, 2011).

On March 23, A.M. Best downgraded the financial strength rating to A- (Excellent) from A+ (Superior) and issuer credit rating to a- from aa- of AMI Insurance Ltd. (New Zealand). Both ratings have been placed under review with negative implications, said A.M. Best.

Key Concerns

Risk management is one of the significant challenges to insurers in Asia after the global financial crisis in 2008, and the recent earthquakes in New Zealand and Japan could provide additional insights to the capital strength of regional market players.

"New Zealand has been ramping up its insurance regulations for the past few years and the earthquake has strengthened the regulators' mandate. Nonetheless, the involvement of more third parties like accountants, actuaries and risk modelers into a process that is also scrutinized and questioned by the regulator does improve risk management," said Lee.

"The inclusion of risk-based solvency and the increased involvement of actuaries increases structure in the process, which can be beneficial to the industry," added the Hong Kong-based analyst.

In Japan, which was stricken by the March 11 magnitude 9 earthquake and tsunami, A.M. Best maintained its stable outlook on six Japanese nonlife insurers' current ratings, according to Lee.

Compared with New Zealand, the Japanese private nonlife insurance sector seems to have sufficient capital adequacy, as no Japanese insurer has sought a government bailout or bankruptcy so far.

However, Lee said it is hard to tell if the insurance market in Japan is generally healthier than that in New Zealand. "There are many angles to this. One is that the earthquake in New Zealand hit the second-largest city whereas in Japan it was not that concentrated," he said.

Government Policies

Both New Zealand and Japan have a public reinsurance pool to cover catastrophes, but individual private insurers generally don't have a sizable amount of capital to cover those risks. A.M. Best noted that solutions for insurer hedging risks would include the review of reinsurance coverage and the establishment of a risk management pool.

"The government scheme is not because of deficient capital by the private sector; it's a social safety net," said Lee.

The Japanese Earthquake Reinsurance Co., according to Lee, was actually established by private insurers and is a scheme backed up by the government to transfer catastrophe risks from the private sector to the reinsurer. "This time, after the earthquake on March 11, government decided to extend their liability until the reserves are restored," he said.

In New Zealand, the Earthquake Commission, a government agency that covers the first NZ$100,000 of building loss and NZ$20,000 for contents loss for personal lines. Private insurers cover losses in excess of the EQC amounts, as well as losses not covered by the EQC, such as fences, driveways, and other items, as well as commercial risks.

Reducing risk associated with property not covered by the EQC can be achieved by the "usual insurance methods," which Lee said include buying insurance from the private sector.

Lee will discuss further the catastrophe impact on insurance risk and capital at the 5th Asian CFO Insurance Summit in Hong Kong on May 24-26. The summit will include industry leaders, consultants and other experts as speakers, covering topics ranging from the strategic opportunities and challenges of entering or expanding in Asia/Pacific markets to how to leverage Solvency II into a competitive advantage.

Listen to an interview with Lee at http://www.ambest.com/media/media.asp?RC=187000

(By Rebecca Ng, Hong Kong news editor: [email protected])