Growing importance of sustainable cat capacity for Japanese typhoon risks

Perils’ Darryl Pidcock discusses the importance of sustainable cat capacity for the Japanese insurance market.

Global cat markets have faced substantial tightening of reinsurance terms in the last 12 months. Japan did not escape this tightening at the 1 April renewals, with risk-adjusted reinsurance rates and retention levels increasing, especially for typhoon risks.

Japan remains one of the major global cat reinsurance markets, and the availability of sustainable capacity is increasingly important as exposures grow. At the same time, the Japanese non-life market continues to offer diversification benefits to the reinsurance and retrocession markets. With hard market conditions, the availability of alternative capital using industry loss warranties and insurance-linked securities (ILS) is also an important alternative source of cat capacity.

The international ILS market has experienced a record year with over $11bn in new transactions and nearly $42bn in risk limits outstanding, driven largely by US cat issuances. In terms of Japanese typhoon risk, there has been a history of primary insurers in the country accessing ILS markets using indemnity-based triggers.

For retrocession buyers such as reinsurers or ILS funds, we observe increasing interest in buying protection for risks outside the US, including European windstorm and Japanese typhoon. Whilst the Japanese primary market has to date relied upon indemnity loss triggers given the basis risk considerations, for reinsurers the use of industry loss triggers is playing an increasingly important role in international retrocession markets as protection buyers become more versatile in hedging cat risk.

For retrocession buyers, the need to disclose proprietary portfolio information, which is often highly complex and constantly moving, can present challenges and risks. Moreover, analysis of such complex portfolio data presents significant uncertainties in terms of risk assessment and determining expected loss costs.

Industry loss triggers, including structured industry loss triggers, require much less disclosure for the protection buyer while the risk assessment is more straightforward and transparent. This is also dependent upon accurate and timely industry exposure and loss information being made available. Protection buyers for Japanese typhoon risk can structure the industry loss trigger with different weights per prefecture resolution or line of business (e.g. personal lines, commercial lines), reducing the basis risk through better alignment with the buyer’s underlying portfolio. This can be attractive to both sellers and buyers as the risk assessment is well understood, disclosure requirements are manageable, and basis risk is acceptable.

Perils’ analysis of major typhoon losses since 2015 shows the Japanese general insurance market on average contributes about 80 percent of the total industry loss over the considered period. Moreover, typhoon losses from the Kyosai market were largely retained and not ceded to the global reinsurance markets. Given this, Japanese general insurance industry losses (i.e. excluding losses from the Kyosai market) are very well suited for retrocession. In addition, prefecture-weighted industry losses with reduced basis risk represent a potentially attractive alternative for Japanese primary companies to buy reinsurance.

The limited and selective deployment of cat capacity will likely continue in the reinsurance and retrocession markets in the foreseeable future. The use of alternative capital to support the sustainability of the Japan cat insurance markets is therefore of growing importance. We believe industry loss triggered protections can benefit protection buyers and sellers alike, and ultimately contribute to the resilience of the Japan cat insurance market.

Darryl Pidcock is head of Perils Asia-Pacific