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1、This report does not constitute a rating actionJapan Insurance Sector Outlook 2023Outlook Stable;Whats the impact of rising interest rate in Japan?Toshiko Sekine,DirectorEiji Kubo,DirectorFinancial Services RatingsFebruary 22,2023Agenda Global Insurance Sector Japan Insurance Sector Outlook Key Take

2、aways Macroeconomic Outlook Life Insurance Sector Non-Life Insurance Sector The Hazards of Rising Interest Rates The New Economic Solvency Regulation and Views on IFRS 17 Case Study Q&AGlobal Insurance Sector:Insurance Is One Of The Highest Rated Sectors Globally,But Adverse Economic Forces Are At P

3、lay Despite macroeconomic headwinds,insurance ratings remain among the highest globally.However,financial market volatility,economic slowdown,and inflation raise uncertainties.Rise in interest rates is positive for investment income.Covid-19 continued to affect insurance claims in the United States

4、and Asia in 2022,but will it settle down in 2023?The outlook for the global reinsurance sector remains negative from 2020.The outlook for the US non-life insurance sector changed to negative in October 2022.Rising interest rates,inflation and natural disasters are the main drivers.Japan Insurance Se

5、ctor Outlook-Key TakeawaysDespite financial market volatility,Japan-based insurers creditworthiness will likely remain stable in 2023,supported by enhanced capital bases.A moderate increase in domestic interest rates should benefit life insurers.Natural catastrophe-related losses remain non-life ins

6、urers largest risk.Interest rate increases puts downward pressure on the current solvency ratio but has a neutral or positive impact on the economic solvency ratio,complicating the transition to new solvency regulation.Macroeconomic Outlook(1)S&P forecasts GDP growth rate of major countries to decli

7、ne in 2023.Japans real GDP is forecasted to grow 1.2%and the policy rate may turn positive in 2023.A rise in domestic interest rates will provide more income from investments in yen-denominated bonds.It will partially mitigate the negative impact from higher hedging costs and fluctuations in stock p

8、rices.It is a positive factor for economic solvency ratio(ESR)for life insurance sector.Macroeconomic Outlook(2)Source：BloombergJapan interest rate has been rising gradually.Rising FX hedge cost is expected to remain a burden on insurers profitability.0123456US&Japan Government Bond Yield and Hedge

9、CostHedge costUST 10yrUST 20yrUST 30yrJGB 10yrJGB 20yrJGB 30yr%Life Insurance Sector(1)Core profit for the fiscal year 2022(ending March 2023)is expected to decrease due to(1)an increase in FX hedge costs and(2)an increase in COVID-19 related claims.In fiscal 2023(ending March 2024),COVID-19 related

10、 claims are expected to decrease due to changes in the treatment of deemed hospitalization.On the other hand,hedging costs continue to be a downward factor.Life Insurance Sector(2)Annualized premiums for new business has recovered to the level before COVID-19.Sales of foreign currency denominated pr

11、oducts have been a driver for growth in fiscal 2022.In fiscal 2023,savings type products and third sector products(medical insurance,cancer insurance,etc.)are expected to drive the growth.Life Insurance Sector(3)In response to rising hedging costs,life insurers are selling hedged foreign bonds and s

12、hifting to domestic long-term bonds and foreign stocks.Stance on FX risk hedging varies among insurers,but the hedge ratio remains at a relatively high level.Life Insurance Sector(4)Japanese life insurers are working to reduce market risk,especially interest rate risk.A rise in domestic long-term in

13、terest rates is a positive factor.In fiscal 2022,consolidated net income for the three major domestic non-life insurance groups is expected to decline year-on-year.The main factors include natural disasters,an increase COVID-19 related payments,and an increase in the loss ratio for auto insurance.In

14、 fiscal year 2023,the impact of COVID-19 is expected to decrease,and factors to watch are the impact of natural disasters and inflation.Non-Life Insurance Sector(1)Net Combined Ratio and ROEProfitability sensitive to natural disastersNon-Life Insurance Sector(2)Source：S&P Global RatingsNatural disas

15、ters continue to be the biggest risk factor.In fiscal year 2022,major events included hailstorms,typhoons Nanmadol&Talas in Japan,and Hurricane Ian etc.overseas.Non-Life Insurance Sector(3)Reinsurance premiums continue to rise,and further increase is expected at the next renewal.Non-life insurers ar

16、e trying to balance cost and risk by changing reinsurance schemes and terms.Non-Life Insurance Sector(4)For investments,non-life insurance groups have announced to accelerate the sale of strategically held stocks.Investments in foreign corporate bonds and alternatives are increasing.Increasing credi

17、t risk requires attention.Non-Life Insurance Sector(5)Major non-life insurance groups ESRs are expected to remain within their target range by appropriately controlling natural catastrophe risks and market risks.Pressure for shareholder returns remains strong and dividend increases are likely to con

18、tinue.However,we expect that share buybacks will be conducted in a flexible manner.The Hazards of Interest Rate Hike(1)Subordinated debt issuanceThe trend of subordinated debt issuance for life insurers and non-life insurers is different.Life insurers,whose balances continue to grow,may also see the

19、ir issuance slow as funding costs rise.The Hazards of Interest Rate Hike(2)Leverage ratios may go upA decrease in unrealized gains on securities may reduce net assets and increase the financial leverage ratio.However,we believe it will remain below the 40%threshold to change the Funding Structure as

20、sessment to“moderately negative.The Hazards of Interest Rate Hike(3)Regulatory solvency margin ratios dropThe current regulatory solvency margin ratio(SMR)and the economic value-based solvency ratio scheduled to be introduced in fiscal year 2025 move differently by the rising interest rates.Japanese

21、 insurers place more weight on ESR than SMR.However,there is a need to watch SMRs as they often serve as mandatory interest deferral triggers for subordinated debt.The New Economic Solvency Regulation and Views on IFRS 17(1)In June 2020,an expert panel on economic value-based solvency regulations pu

22、blished a report on new regulations.In June 2022,the Financial Services Agency announced the provisional decision on the basic content of economic value-based solvency regulations.Reconfirmed schedule for finalization of standards around spring 2024 and enforcement from April 2025.According to the l

23、atest FSA FT,if the March 2021 base ESR of all domestic life insurance companies is 212%,the ESR will be decreased by about 19 points assuming the yen interest rate is shifted downward by 50 basis points in parallel(but the ultimate interest rate(UFR)is fixed).If the March 2021 standard ESR for all

24、domestic non-life insurance companies is 193%,the ESR will rise by about 0 points,assuming the yen interest rate is parallel-shifted downward by 50 basis points(but the ultimate interest rate(UFR)is fixed).The New Economic Solvency Regulation and Views on IFRS 17(2)IFRS 17 is effective for annual re

25、porting periods beginning on or after 1 January 2023 with earlier application permitted as long as IFRS 9 is also applied.In March 2004 the International Accounting Standards Board(Board)issued IFRS 4 Insurance Contracts.IFRS 4 was an interim standard which was meant to be in place until the Board c

26、ompleted its project on insurance contracts.IFRS 4 permitted entities to use a wide variety of accounting practices for insurance contracts,reflecting national accounting requirements and variations of those requirements,subject to limited improvements and specified disclosures.In May 2017,the Board

27、 completed its project on insurance contracts with the issuance of IFRS 17 Insurance Contracts.IFRS 17 replaces IFRS 4 and sets out principles for the recognition,measurement,presentation and disclosure of insurance contracts within the scope of IFRS 17.In June 2020,the Board issued Amendments to IF

28、RS 17.The objective of the amendments is to assist entities implementing the Standard,while not unduly disrupting implementation or diminishing the usefulness of the information provided by applying IFRS 17.Other Standards have made minor consequential amendments to IFRS 17,including Amendments to R

29、eferences to the Conceptual Framework in IFRS Standards(issued March 2018)and Definition of Material(Amendments to IAS 1 and IAS 8)(issued October 2018).The New Economic Solvency Regulation and Views on IFRS 17(3)Will S&P take rating action after the introduction of the new economic value-based solv

30、ency regulations?We analyze the economics underlying a companys financials and financial activities.Changes in regulations and accounting standards generally do not affect ratings unless they specifically affect the underlying economics.That said,changes in regulation and accounting standards may ha

31、ve secondary effects.Capital and Earnings is rated 8(vulnerable)if S&P determines that the risk of regulatory intervention in an insurer is high.Depending on the design of future solvency regulations,the risk of conflict may increase.The New Economic Solvency Regulation and Views on IFRS 17(4)The ne

32、w regulations will use new indicators.How will S&P treat these new measures in its models and take into account the differences that arise when using different assumptions?Under Japans new economic value-based solvency regulations,the amount equivalent to the value of in-force business will be inclu

33、ded in qualifying capital.IFRS 17 also introduces a new accounting element,the contractual service margin(CSM).Under our criteria,S&P will include up to 50%of VIF(before cost of capital)in total adjusted capital(TAC)in our capital model.Include up to 50%of either the VIF equivalent amount or the CSM

34、 in the TAC,as with VIF treatment,and in the absence of embedded value information.S&P Global Ratings view of the appropriateness of the assumptions used to calculate the VIF equivalent,particularly discount rates such as the ultimate interest rate,liquidity premiums,and credit spreads,may also infl

35、uence S&P Global Ratings treatment.We may adjust an insurers capital and earnings assessment based on our view of the underlying assumptions underlying the CSM and VIF equivalents.We may also consider part of the IFRS 17 risk adjustment(RA)as a component of TAC.It may also take into account to some

36、extent a margin over current estimate(MOCE)equivalent to the cost of capital,similar in concept to RA.The New Economic Solvency Regulation and Views on IFRS 17(5)Any issue happens if we assess competitive position/profitability based on new accounting/solvency rules?An assessment of an insurance com

37、panys profitability is important in assessing its business competitiveness.However,when IFRS 17 is introduced,there will be fundamental differences from current JGAAP.The loss of comparability extends to measures of income,expenses,profits and capital concepts.Reduced comparability of key financial

38、metrics as defined in S&Ps criteria.For life insurers,the problem is even more acute,as life insurance products have longer contract terms than non-life insurance products.If IFRS 17 is voluntarily adopted,CSM and RA can be included in TAC to some extent.If IFRS is not voluntarily adopted,it might b

39、e an idea to use the VIF equivalent amount and changes in MOCE as supplemental information for regulatory economic value-based solvency.Economic ESR B/SEconomic ESR B/SAmortized HTM BondsStandard Policy Reserve ex.Excess over Zillmer MethodStandard Policy Reserve ex.Excess over Zillmer MethodBook Va

40、lue Best Estimate Best Estimate Fair Value FVTPLCurrent EstimateCurrent EstimateFair ValueAmortized Policy Reserve Matching BondsClaim ReserveBook Value(TVOG)Fair Value FVTOCIRisk AdjustmentFair Value AFS SecuritiesExcess over Zillmer MethodMOCEAmortized Amortized CostContractual Service MarginFair

41、Value Trading SecuritiesContingency ReserveReconciliation to Economic Value(Policyholders Liability)Common StockFair Value DerivativePrice Fluctuation ReserveTax Effect ReconciliationCapital SurplusCommon StockCommon StockRetained EarningsCapital SurplusCapital SurplusAOCIRetained EarningsRetained E

42、arningsAOCI for AFS BondsAOCIAOCI for Deferred HedgeReconciliation to Economic Value(Investment Asset)*BuleIncluded in TACJGAAP&Insurance Business Act B/SJGAAP&Insurance Business Act B/SIFRS B/SIFRS B/SThe New Economic Solvency Regulation and Views on IFRS 17(6)Will new regulation affect ratings/equ

43、ity content of hybrid securities?An insurers hybrid securities must meet regulatory qualifying capital requirements to be included in the TAC.We do not believe that the introduction of ICS version 2.0 will make the existing hybrid securities of Japanese insurers no longer eligible for regulatory cap

44、ital.Existing hybrid securities issued by rated Japanese insurers are typically rated two notches below their long-term issuer ratings.The difference reflects the securitys subordination to senior debt and coupon nonpayment risk arising from optional deferral provisions.Most hybrid security contract

45、s also include mandatory interest deferral clauses.The usual trigger for the mandatory deferral of interest payments is the failure to meet the minimum regulatory solvency margin ratio requirement in Japan,which is currently 200%.Additional clauses may also be included in hybrid securities contracts

46、 which stipulate that the current minimum solvency margin ratio requirement in the mandatory deferral of coupon clauses will be replaced by the new economic capital adequacy ratio(ESR)requirement after the introduction of the new solvency regulations,The New Economic Solvency Regulation and Views on

47、 IFRS 17(7)Will new regulation affect ratings/equity content of hybrid securities?Equity ContentThe New Economic Solvency Regulation and Views on IFRS 17(8)Will new regulation affect ratings/equity content of hybrid securities?(Continued)How close to the trigger level,sensitivity,and other factors c

48、an increase the likelihood of breaching minimum regulatory requirements.We may consider additional notching down to reflect the risk of mandatory deferral of interest payments in the rating.According to a series of field tests conducted by the Financial Services Agency,the ESR of all domestic life a

49、nd non-life insurance companies is 212%and 193%,respectively,as of the end of March 2021.Furthermore,ESR of life insurers is highly sensitive to fluctuations in yen interest rates.Increased risk of not meeting regulatory minimum capital requirements in the future.0%50%100%150%200%250%Dai-ichi GroupM

50、eiji Yasuda GroupSumitomo Life GroupJapan Post LifeT&D GroupFukoku LifeFSA FT(Life)Tokio Marine Group(Before revision)Tokio Marine Group(After revision)MS&AD GroupSOMPO GroupFSA FT(Non-Life)2018/32019/32020/32021/32022/32022/9The New Economic Solvency Regulation and Views on IFRS 17(9)Will new regul

51、ation affect ratings/equity content of hybrid securities?(Continued)In some cases,there is a provision that the trigger will change to the changed regulatory minimum capital requirement,when solvency regulations change.New economic value-based capital regulations may be introduced from FY2025 at the

52、 earliest.If the trigger for mandatory coupon deferral is changed to the minimum requirements of economic value-based new capital regulations,the possibility of trigger conflict will increase significantly depending on the content of the new regulations andthe issuers capital level and market sensit

53、ivity.If S&P judges that the probability of hitting the trigger has increased,the risk of downgrading the subordinated bonds will increase.0102030405060708090100ICRHybridAAABBBBBBCCCCCCDCase Study：The Society of Lloyds Subordinated Debt Issue(1)July 2019：Downgraded to BBB+from A-,reflecting the incr

54、easing mandatory deferral risk January 2023：Upgraded to A-against the backdrop of the improvement of SCR level/Stability and strong track record of ability to raise capital146%144%144%148%156%147%177%179%100%110%120%130%140%150%160%170%180%190%200%Dec-15Dec-16Dec-17Dec-18Dec-19Dec-20Dec-21Jun-22Down

55、gradeUpgradeCase Study：The Society of Lloyds Subordinated Debt Issue(2)January 2017：Assigned A-issue rating toSubordinated bonds（30NC10,fixed-to-floating rate）ICR（The Society of Lloyds）：ASubordination（1）,Optional/Mandatory deferral（1）July 2019：Downgraded to BBB+ICR（The Society of Lloyds）：ASubordinat

56、ion（1）,Optional/Mandatory deferral（2）We previously only applied one notch to reflect payment risk due to coupon cancellation.We now believe that the payment risk on these notes is greater than for other similar hybrids,rated in the A range.While Lloyds cover of its regulatory capital requirement(The

57、 Solvency Capital Requirement or SCR)has improved in recent years(149%at year-end 2018 for its Market Wide SCR),it is materially closer to the point of mandatory deferral(below 100%SCR)than closely rated peers.We also note that Lloyds significant exposure to natural catastrophe risk provides the pot

58、ential for volatility in the level of its solvency cover,although this is partially offset by the ability of the market to request that its members recapitalize following significant losses.Widening the notching between the ICR on Lloyds and the rating on Lloyds hybrid also allows for a smoother tra

59、nsitioning of the rating on the instrument if the markets solvency cover were to near mandatory deferral.We will continue to monitor Lloyds SCR coverage and capital plans to assess whether the subordinated debt ratings adequately incorporate the payment risk associated with Lloyds hybrid instruments

60、.An unexpected deterioration or strengthening in the groups regulatory solvency position not accompanied by a change in ICR could lead us to raise or lower the rating on the notes by widening or narrowing the notching between them and the ICR.Case Study：The Society of Lloyds Subordinated Debt Issue(

61、3)January 2023：Upgraded to A-ICR（The Society of Lloyds）：ASubordination（1）,Optional/Mandatory deferral（1）S&P Global Ratings today raised its issue-level rating on the Society of Lloyds(Lloyds)subordinated Tier 2 notes to A-from BBB+.Lloyds(A+/Stable)market-wide regulatory solvency ratio and central s

62、olvency ratio remained stable over 2022,despite significant reserving for the Russia-Ukraine conflict and Hurricane Ian,rising interest rates,and investments in private assets through its newly launched investment platform.Lloyds holds comfortable capital surpluses in both its half-year 2022 market-

63、wide regulatory solvency ratio of 179%(year-end 2021 177%)and central solvency ratio of 395%(year-end 2021 388%).We expect both market-wide and central solvency ratios to remain robust even in extreme stress scenarios,such as catastrophic events,or if the current inflationary environment continues i

64、n 2023 and 2024.Hence,our rating on Lloyds Tier 2 subordinated notes is now two notches below the long-term issuer credit rating on Lloyds:-One notch to reflect the notes subordination to the companys senior obligations;and-One notch(previously two notches)to reflect the payment risk created by the

65、mandatory and optional coupon deferral features.We previously applied two notches to reflect the higher payment risk due to coupon deferral compared with similar hybrids rated in the A category.This is because we considered Lloyds solvency level in the past to be materially closer to the point of ma

66、ndatory deferral(below 100%solvency capital requirement)when considering its sensitivity to severe events.We note that Lloyds significant exposure to natural catastrophe risk,the challenging macroeconomic environment due to rising inflation,and uncertainty around the Russia Ukraine conflict provide

67、the potential for volatility in the level of its solvency cover.However,this is offset by the stability in the solvency ratio maintained in 2022,better operating performance expectations,and ability to recapitalize when needed.The latter was demonstrated in 2017 when the market injected 3 billion fo

68、llowing Hurricanes Harvey,Irma,and Maria;and in 2020,when it injected a further 3.5 billion following COVID-19-related losses.We expect Lloyds to report a combined ratio of about 95%at year-end 2022.This takes into account its combined ratio of 91.4%at half-year 2022,and reserving 1.1 billion for th

69、e Russia-Ukraine conflict and 2.2 billion for Hurricane Ian.For 2023,we forecast a combined ratio of close to 95%.Related ResearchGlobal Credit Outlook 2023:No Easy Way Out,Dec.1,2022Global Insurance Markets:Inflation Bites,Nov.30,2022EMEA Insurance Outlook 2023:In The Midst Of The Perfect Storm,Nov

70、.15,2022U.S.Property/Casualty Insurance Sector View Dims On Weakening Capitalization,Oct.26,2022Credit FAQ:Japans New Solvency Rules For Insurers,Sept.14,2022Is The Global Reinsurance Sector About To Turn A Corner?Sept.6,2022How Will The Move To IFRS 17 Affect S&P Global Ratings Analysis Of Insurers

71、 And Reinsurers?,Aug.24,2022Insurance Industry And Country Risk Assessment:Japan Property/Casualty,Aug.22,2022Insurance Industry And Country Risk Assessment:Japan Life,Aug.22,2022S&P Global Ratings Latest Research&Insightshttps:/ ContactsFinancial Services RatingsToshiko SekineDirectorS&P Global Rat

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