We expect the creditworthiness of the Japanese insurance industry to remain stable in 2025.

There are, however, uncertainties. Significant financial market volatility, driven by factors including unknown geopolitical events, and changes in U.S. policy under the presidency of Donald Trump, could rapidly diminish the stability of credit quality for the industry.

The impact of macroeconomic fundamentals in our forecasts should be somewhat beneficial for creditworthiness in the Japanese insurance industry. We expect Japan's real gross domestic product (GDP) to continue to grow modestly after 2025, and policy interest rates in the yen to rise moderately. At the same time, we see policy interest rates in major economies falling. This will likely support earnings and improve the health of the life insurance sector in particular (see table 1).

Table 1

Governance and risk management for insurance groups will become more important in 2025. Japan is deep into demographic decline. Insurers are therefore likely to keep expanding overseas and into non-insurance businesses. At the same time, various changes of conventional practices of insurance business are underway, as was inevitable.

New solvency regulations will be introduced from March 2026. However, it remains uncertain whether political changes, in Japan and elsewhere, will shift the global economy and trigger financial market volatility.

Under such circumstances, insurers will likely work to rejig relationships with customers. Work to correct distorted industry practices and ensure healthy competition is also likely to establish appropriate insurance rates. If these efforts bear fruit, they should lead to stable profitability, mainly in the non-life insurance sector.

Life Insurance Sector: Core Earnings Capacity To Improve

We expect the underlying profitability of Japan's life insurance sector to improve slightly in 2025. Over the past two to three years, capital levels have stabilized at Japan's major life insurance companies, despite market volatility. Profit contributions from overseas insurance businesses have also been increasing. However, the overall creditworthiness of life insurers will continue to be constrained by our sovereign credit rating on Japan (A+/stable/A-1).

The major life insurers we rate are Nippon Life Insurance Co., Dai-ichi Life Insurance Co. Ltd., Meiji Yasuda Life Insurance Co., and Sumitomo Life Insurance Co.

Our base case is that downside risk factors are unlikely to materialize.   Such risks include deterioration in the performance of the investment portfolio and the failure of major life insurers to integrate acquired businesses. However, geopolitical risks or unexpected government policy changes could hurt the economy or damage financial markets. This could pressure the creditworthiness of individual companies. Growing risk appetites, which we could see through actions such as larger acquisitions than we expect that are beyond accumulated capital, would also pressure their creditworthiness.

Divergent global interest rate movements should help earnings

We believe the conditions of earnings in Japan's life insurance sector will continue to improve. Benefit payments related to COVID-19 were negative for the sector in fiscal 2022 (ended March 31, 2023). However, post-pandemic profit levels have generally improved (see chart 1). This improvement in earnings is likely to continue in 2025. Companies are likely to maintain their earnings bases in the domestic insurance business. In addition, we anticipate improvement in market conditions that benefit investment portfolios and higher contributions to earnings from the overseas operations of major groups.

Chart 1

Rate divergence should contribute to stable sales of insurance products.   Until April-September 2024, sales of lump-sum premium products denominated in foreign currencies remained popular in the domestic life insurance market (see chart 2). The foreign-currency products offer higher yields than yen-denominated ones, but major central banks overseas are now lowering policy rates. Meanwhile, interest rates for yen products are gradually rising, albeit at a low level in terms of absolute yields. This will help the uptick in sales of yen-denominated products. The trend of overall sales is near stable, but with slight decline.

Chart 2

Inflation, rising wages, and investment in systems will continue to drive up business costs.   Life insurers, however, will be able to control these costs at a level commensurate with earnings, in our view. During the five years from fiscal 2019 to fiscal 2023, business expenses in the life insurance sector as a whole increased by an average of 1.6% per year. However, the ratio of business expenses to premiums and other revenues in fiscal 2023 was 11.7%, decreasing by 2.6 percentage points from fiscal 2019 (see Chart 3).

Multiple factors are driving improvements in the operating cost ratio.   Operational efficiency has improved because of digitalization. We also consider the sales growth to have helped improve the ratio over the past five years. During this period, sales volume returned to growth as new contracts of single-premium products increased. This followed a plunge in sales during the pandemic. We anticipate seeing more progress of operational efficiency improvement in 2025 and beyond. Despite many insurers working to recover the number of sales staff, a labor shortage in the market has led to drives to improve sales operations by using technology, including artificial intelligence (AI).

Chart 3

Reviews of sales practices and other measures for customer-focused management will have a limited impact on earnings, in our opinion.   Many companies have suspended sales of so-called targeted insurance. They have done so because of concerns such products are being used in a way that deviates from their intended purpose and could be traded. Life insurers, like non-life insurers, are reviewing their relationships with agents. They are revising sales commissions structure for agents with a large lump-sum paid at the time of policies sold. They are also eliminating provisions of unfair benefits to agents, for example, in the name of advertising expenses. We believe the impact on earnings of these revisions will be small. The products and sales channels that will be affected by these revisions, especially for large life insurers, will only account for a portion of total sales volume.

Groupwide enterprise risk management is a key part of stable overseas profits

Profit contributions of overseas businesses to major life insurance groups will be around 20%-30%, in our view. Major life insurance groups are pursuing strategies to increase overseas business profits. This is particularly the case in the U.S. and Asia, where the growth of insurance business is expected to be higher than in Japan.

In fiscal 2022, groups' underlying profits (or adjusted profits) for domestic operations declined due to COVID-19-related payments, and the contribution of overseas operations increased. Excluding this temporary factor, the three life insurance groups other than Nippon Life Insurance Co. have continued to increase profits from their overseas businesses through the growth of their existing overseas subsidiaries and affiliates, as well as bolt-on acquisitions (see Chart 4).

Chart 4

Nippon Life is now expanding overseas.   It has lagged Japanese peers in heading abroad. However, in 2024 it invested about $3.8 billion in U.S.-based Corebridge Financial Inc. and announced its acquisition of Bermuda-based Resolution Life Group Holdings for about $8.2 billion. As a result, Nippon Life expects overseas contributions to its basic profit to increase from about 4% at present to about 25% by fiscal 2035.

Some major groups are trying to expand beyond the traditional insurance business.   To do so, they are acquiring domestic companies in nursing care and welfare services. However, over the next two to three years, we expect the contribution of non-insurance businesses to profits in each group to be more limited than that of overseas businesses.

Overseas expansions make enterprise risk management even more important for creditworthiness.   Large acquisitions impose financial burdens, such as raising funds and booking goodwill on the balance sheet. These burdens reduce the credit quality of acquirers at the time of the deals. After deals close, acquirers need to handle changes in the business environment and the emergence of business risks that were not anticipated when making the purchase.

Group management and governance structures are key for acquirers.   We typically reflect the record of post-acquisition risk management of the acquirer in our qualitative assessments of business risk profiles. It also affects our financial projections for capital and earnings over a two to three year horizon. In general, the acquirer expects to help mitigate various risks through diversifying business lines and geographies for groups. Business complexity, however, often increases. Therefore, the acquirer likely needs to further enhance group enterprise risk management.

A moderate rise in yen interest rates would be positive

A gradual rise in yen interest rates will have positive effects on life insurers' earnings and risk management, in our view. The average guaranteed yield on liabilities of Japan's major life insurers is likely to continue to decline in 2025, though at a slower pace. The rise in the yen's interest rate will therefore contribute to higher interest and dividend income.

Life insurance companies are gradually raising the guaranteed yields on new yen-denominated contracts.   Guaranteed yields for new contracts are still in the middle of the 1.0% range though, except for those on some educational endowments. This remains lower than the average guaranteed yield for existing contracts (see Chart 5). Furthermore, each company has already reduced the duration gap between yen-denominated assets and liabilities considerably with the rise in yen interest rates.

If Japan's interest rates continue to rise moderately, related risk will either decline further or stay flat.   If the gap between Japanese and overseas interest rates narrows further, foreign exchange hedging costs could be lowered. Although hedging costs have remained high for the past two to three years, it would become easier for insurers to keep hedge positions on foreign-currency-denominated bonds at current levels (see Chart 6).

Chart 5

Chart 6

We expect investments in alternative assets to increase but remain manageable.  To improve investment returns, major life insurance companies are diversifying their investments in high-risk assets such as private debt and overseas infrastructure. We estimate the four major life insurers' exposure to private equity, hedge funds, and bonds with ratings of 'BB' or lower to be small, about 5% of their groupwide investment portfolios (see "Japan Insurers Splash Cash As Performances Improve," published June 28, 2024).

Listed insurers, such as Dai-ichi Life, are working to reduce equity holdings.   The four major life insurers' aggregate holdings of domestic and foreign equity are trending upward both in terms of outstanding balance and proportion (see chart 7), partly due to rising stock prices. However, volatility of major life insurers' economic solvency ratios (ESRs) remains limited. Significant amounts of unrealized gains on these holdings would work as a buffer against market volatility (see "Japanese Insurers Can Handle Tumultuous Markets," Aug. 15, 2024). However, in our credit analysis, it remains important to update their risk appetite and the condition of their portfolios.

Chart 7

We believe that a rise in Japanese yen interest rates will continue to benefit life insurers' capital on an economic value basis.   Life insurance products include super-long liabilities that are difficult to hedge through bond investments. Therefore, especially when long-term Japanese interest rates rise, a decline in the economic value of insurance liabilities is typically larger than that of assets such as investment securities. This would have a positive impact on life insurers' ESRs. Recently, we saw some cases where increased risk exposure from business expansion and higher stock prices offset this benefit. However, overall, ESRs trended higher through the end of March 2024 (see chart 8).

Mass lapse risk would likely pressure regulatory ESR amid rising interest rates.   A mass lapse scenario is likely to include in the ESR calculations under the new solvency regulation starting at the end of fiscal 2025 (ending March 2026). Many companies have incorporated mass lapse risk in their internal models. Thus, we will keep monitoring the sensitivity of ESRs to a rise in interest rates.

Chart 8

We expect lapse and surrender risk to remain limited.   Lapses and surrenders remain important factors of insurers' credit quality. Surrender-and-lapse ratios trended slightly higher in 2023-2024, but absolute levels remained low (see chart 9). We consider the higher ratios to be mainly attributable to lock-in profits on foreign-currency-denominated single premium products because of the weaker yen.

In addition, we believe that a possible increase in cancellations of corporate life insurances by small and midsize enterprises is another reason for the rise in surrender-and-lapse ratios.

Moreover, in the 2024 edition of a questionnaire survey published every three years by the Life Insurance Association of Japan, more than 30% of respondents, as in the previous survey, chose "switching to another life insurance product" as the main reason for cancellations and lapses. In contrast, less than 1% chose "uncertainty about life insurers' business operations." This does not indicate a change in the industry trend. However, we will watch for any insurers deviating from the trend of the sector.

Chart 9

Listed life insurers will likely continue transferring risk on existing policy blocks to foreign reinsurers.   Japanese life insurance companies, so far, have closed reinsurance transactions with reinsurers rated 'A' or above, or their group companies. Cross-border reinsurance transactions are increasingly under the scrutiny of regulators in various countries.

We believe that the use of reinsurance has a limited impact on the credit quality of Japanese life insurers. This is because the volume of reinsurance transactions is small relative to their size, and their counterpart reinsurers have high credit quality. That said, we will monitor the regulatory developments on cross-border life reinsurance transactions. Also, risk management approaches of each insurer to reinsurance would remain a focus of our credit analysis.

Non-life Insurance Sector: Positive Signs From Underwriting And Equity Sales

Japan's non-life insurance sector will continue to generate strong earnings, in our view. We expect the average combined ratio for the domestic non-life insurance sector to be around 97%-99%, assuming normalized catastrophe losses, for the next two to three years including fiscal 2024. We base this on the following:

• Deterioration in the profitability of insurance underwriting has decelerated; and
• Increased investment gains from sales of strategic equity holdings are likely to boost earnings at major non-life insurers.

Strong overseas insurance business will also likely continue to contribute significantly to both top and bottom lines on a consolidated basis at major non-life insurance groups--Tokio Marine Group, MS&AD Insurance Group, and Sompo Holdings Group.

We expect the combined consolidated net income of the three major non-life insurance groups to remain strong.   Major contributing factors include increases in earnings from overseas insurance business and in investment gains, including realized gains from the sales of strategic equity holdings (see chart 10).

In the overseas insurance business, the three groups' overseas subsidiaries continue to increase premium rates, resulting in higher earnings.

In terms of natural catastrophes, which are a potential drag on operating performance, the three groups' net incurred losses declined year on year in the first half of fiscal 2024 and remained within budget. This is despite damages suffered in the hailstorm in Hyogo prefecture in April and Typhoon No. 10 (Shanshan) in August 2024 (see chart 11).

Chart 10

Chart 11

Improvement of profitability in automobile insurance remains uncertain, in our view.   This is despite non-life insurance companies' continuing efforts to raise premiums and implement measures to prevent car accidents and catastrophes. The greatest challenge for the domestic non-life sector today is improving the auto insurance business. This is because higher accident rates, together with higher unit repair costs due to inflation, worsened auto insurance loss ratios in the past one to two years (see chart 12). In addition, damages from natural catastrophes such as hailstorms also contributed to a decline in the profitability as well.

Many non-life insurers raised premium rates in January 2024 and 2025. Auto insurance policies are usually for one year, and higher rates take effect quickly. Car accident rates appear to have peaked as post-pandemic travel euphoria has tapered off. In contrast, we expect unit repair costs to continue to rise due to more sophisticated vehicle features and inflation. Unit repair costs are likely to trend higher as a factor driving up incurred losses. It is uncertain whether the premium rate increases will keep pace with the increase in incurred losses, in our view.

Chart 12

We expect non-life insurance companies to continue to work to further increase profit from fire insurance business.   In fire insurance, premium rate hikes over the past 10 years are taking effect. A series of rate increases, policy term revisions and limited natural catastrophe losses are contributing to improving the profitability of fire insurance.

At Tokio Marine Group and Sompo Holdings Group, fire insurance business has turned to be profitable. MS&AD Insurance Group expects to report net profit in the business in fiscal 2025 (see chart 13). However, we believe that they have not earned adequate returns for their risk taking. Profitability is still low and the potential risk of natural disasters remains high. We believe the groups will continue to seek higher profitability.

Chart 13

Growth in reinsurance costs is moderating.   We see this as a positive, particularly in terms of improving the profitability of fire insurance. Reinsurance premiums in Japan, which had been on an upward trend, were largely unchanged at the April 2024 renewals (see chart 14).

We attribute this to fewer occurrences of major natural catastrophes in Japan and milder reinsurance market conditions in recent years. We expect a broadly similar trend for April 2025 renewals.

Non-life insurance groups have responded to difficult market conditions by reviewing reinsurance schemes and contractual coverage. They scaled back the working-layer reinsurance cover and increased risk retention. However, with reinsurance rates stabilizing, we expect no further large-scale risk retention.

Chart 14

The restructuring of non-life insurance operations continues

Efforts to reform insurance underwriting structure will likely continue in Japan's non-life insurance sector.   The Financial Services Agency of Japan (FSA) has issued business improvement orders to four major non-life insurance companies for their cartel behavior related to co-insurance policies and fraudulent auto insurance claims.

We consider the following to be underlying structural issues:

• Excessive pursuit of top-line revenue and market share;
• A lack of customer-focused sales structure; and
• Business practices where non-life insurers provide non-insurance value to agents.

Specifically, the allocation of underwriting shares in proportion to insurers' strategic shareholdings and willingness of insurance agents to promote insurance products based on support from non-life insurers for their core business, in our view, have undermined the competitive environment.

The FSA is in discussions to strengthen its supervision of non-life insurance agents. For example, it is considering amending the Insurance Business Act to make insurance sales more customer-focused. A ban on the dominant promotion of insurance products by agents could lead to the end of the so-called territory system. The FSA is also considering introducing a measure to encourage new entrants, including small and midsize non-life insurers and insurance brokers.

We believe key factors will continue to underpin the strong position of major non-life insurance companies.   These are: long-term trusted relationships with corporate customers and insurance agents, reputation and brand, and expertise and capacity, particularly in corporate insurance.

Facing a series of problems, the major non-life insurers are reviewing their internal systems. In relation to co-insurance, they are establishing an underwriting system that considers their own risk-return profiles without sharing information on pricing with others.

The insurers are also expediting the sale of strategic equity holdings to terminate client relationships based on such shareholdings.

In addition, they have started to develop a system designed to prevent excessive secondments of employees to insurance agents and to stop providing support to insurance agents for their core businesses.

In the medium term, unwinding close ties with insurers may give insurance agents more freedom. However, we believe that the oligopolistic market environment for the four major non-life insurance companies is unlikely to change significantly. This is due to their established market advantage.

Penalties imposed by the Japan Fair Trade Commission are likely to have a limited impact on major non-life insurers.   In October 2024, the commission issued cease and desist orders together with penalty payment orders to the four major non-life insurers in connection with issues related to their corporate co-insurance business. The penalties totaled ¥2.07 billion, a level that is well within their earnings capacity, in our opinion.

ESRs remain solid, amid sales of strategic equity holdings

The risk profiles of major non-life insurance companies will likely change significantly as sales of their strategic equity holdings accelerate.   They are making progress ahead of schedule in their goal to reduce the exposure to zero by 2030. In the first half of fiscal 2024, the four major non-life insurance companies sold their positions totaling about ¥1.2 trillion. This added ¥950 billion to their aggregate pre-tax income.

The outstanding balance of strategic equity holdings is likely to drop to about ¥6 trillion at the end of fiscal 2024 from about ¥9 trillion a year earlier (see chart 15). However, we need to keep in mind market value volatility. Sales of strategic equity holdings should significantly reduce equity risk exposure for the non-life insurance groups.

The groups are likely to use funds from sales of shareholdings to strengthen investments for growth and shareholder returns. Despite uncertainty about the viability of expensive major investment deals, we believe there is a growing incentive for business investment, including bolt-on acquisitions through overseas subsidiaries. While the major non-life insurance companies have indicated their continued appetite to invest in overseas insurance businesses, they are also investing in non-insurance businesses in Japan.

Chart 15

Credit risk will rise while equity risk exposure decreases, in our view.   With dividends from strategic equity holdings declining, we expect major non-life insurance companies to look to increasing investments in foreign corporate bonds and alternative investment assets. Particularly, foreign credit investments are increasingly managed by their overseas subsidiaries or entrusted to funds.

They are also working to diversify alternative investments, investing not only in private equity and hedge funds, but also in real estate, infrastructure, collateralized loan obligations (CLOs), and private debt. Some companies have topped up allowances for credit loss on overseas commercial real estate (CRE) loans. While this requires caution, we do not expect this to be a factor that will affect our ratings.

We believe exposure to private debt will remain limited for now. This is because the major non-life insurance companies are cautious on such investments. Risk management has become increasingly important for the insurers, given that they frequently use outside investment managers in areas where they lack expertise and that they are face diverse risks. We are closely monitoring the pace of increase in credit risk, while recognizing that the insurers are managing their investments in a disciplined manner consistent with their risk appetites.

We expect ESRs at major non-life insurance groups to remain near the higher end of their target ranges in 2025.   It is difficult to make a direct comparison because they use different measurement approaches with different confidence levels. However, overall, their ESRs have been relatively stable (see chart 16). Reduction in equity risk through sales of strategic equity holdings has resulted in higher ESRs.

Shareholder returns are trending higher. Major non-life insurance companies have increased dividends and conducted share buybacks due to earnings growth. Higher ESR levels also put them under pressure not only to provide shareholder returns in the traditional sense, but also to make additional returns to adjust capital levels. We are closely monitoring the trend in shareholder returns, as a substantial increase would lead to a reduction in capital.

Chart 16

Hybrid Capital And New Solvency Regulations: Stability And Progress

For life insurance companies, outstanding balance of hybrid capital may remain unchanged or increase slightly. On the other hand, we believe the need for non-life insurers to issue new capital is decreasing due to their enhanced capital through sales of strategic shareholdings. However, some non-life insurers may consider issuing hybrid capital to maintain access to the market.

Life insurers also have less incentive to raise new capital for the upcoming implementation of new solvency regulations because they have progressed reducing their interest rate risk exposure.

The total outstanding balance of subordinated bonds and loans of major life insurance groups at the end of September 2024 is higher than at the end of March 2024 (see chart 17). We considered this was partly due to major life insurance companies issuing hybrid capital in advance to refinance the existing hybrids. Foreign exchange movements also contributed to the increase. Amid business expansion, we think the outstanding balance may continue to increase, depending on market conditions.

Chart 17

We do not anticipate any major changes in hybrid capital funding with an introduction of new solvency regulations at the end of March 2026.   The insurance companies in Japan have conducted a series of field tests on an economic-value based solvency over a long period. We do not expect any surprises in terms of regulatory ESR levels at life and non-life insurance companies. In addition, the FSA does not plan to introduce any transitional arrangements (grandfathering) for inclusion of regulatory capital. This leads us to believe a very limited number of hybrids currently eligible for regulatory capital under the existing regime will be disqualified under the new regime.

However, we should closely monitor the regulatory ESRs at the time the new regulation is implemented, and the likely direction of future ESRs. Hybrid securities issued by domestic insurance companies typically have a mandatory interest payment deferral trigger linked to the issuer's regulatory solvency ratio. The FSA intends to take an early corrective action on insurers with regulatory ESRs below 100% under the new regime. If so, mandatory interest deferrals of hybrids will occur at this point. Therefore, if the issuer's ESR is getting close to 100% (for example, 165% in Europe), we will consider applying additional notching (a wider gap from the issuer rating) to the hybrid securities we rate. If the hybrid issuer's ESR is below 165%, for example, we would also likely take account of the issuer's willingness and capacity to improve its regulatory ESR and the likelihood of it receiving group support.

Related Research

• Global Credit Outlook 2025: Promise And Peril, Dec. 4, 2024
• Global Reinsurers Must Maintain Discipline To Cement Strong Performance Amid Casualty Risks, Sept. 3, 2024
• Japanese Insurers Can Handle Tumultuous Markets, Aug. 15, 2024
• Insurance Industry And Country Risk Assessment: Japan Property/Casualty, Aug. 21, 2024
• Insurance Industry And Country Risk Assessment: Japan Life, Aug. 21, 2024
• Japan Insurers Splash Cash As Performances Improve, June 28, 2024