• Speeches and Material

“Implications of the current crisis for insurance regulation”

Keynote speech by Dr. Takafumi Sato
Commissioner, Financial Services Agency (FSA)

36th General Assembly of The Geneva Association
Kyoto, Japan, May 28, 2009


Good afternoon, Ladies and Gentlemen. It is my great pleasure to speak before the world’s insurance leaders here in Kyoto. I am personally delighted that the first annual meeting of the Geneva Association in Asia takes place not in Tokyo but in Kyoto, one of my favorite cities in Japan. I hope, besides the conference or business dialogues, you will have a chance to go out to find a rich cultural heritage which this old capital has cultivated in its long history.

Today, I would like to talk about three issues. The first is the FSA’s view on the current situation of Japan’s financial system, including the insurance sector. The second is our views on financial crisis management and regulatory reform. Finally, I would like to touch upon a few directions of likely changes on insurance regulation in the future

Current situation of Japan’s financial system

Let me first talk about the current situation of Japan’s financial system.

As you all know, the global financial markets are still under the most severe stress in decades. The global financial landscape has clearly changed from a period of ample liquidity and high risk appetite only a few years ago to scarce transactions and de-leveraging. In response, the world’s central banks and financial authorities have taken extraordinary actions on an unprecedented scale, including liquidity support, capital injection with public funds, and credit guarantee.

Needless to say, Japan is not immune from this global market turmoil. The financial system is increasingly affected by the deterioration of the real economy and high volatility of the financial markets. However, one can fairly say that the financial system itself is relatively sound compared with those in the United States and Europe. This stems from the fact that the losses Japan’s financial sector incurred from complex securitized products are relatively small, which are one digit smaller than those of the American and European financial sectors.

Accordingly, the impact of these losses on capital is less severe in this country. The exposure of Japan’s financial sector to opaque, toxic assets is also significantly smaller. This implies that future additional losses from these assets will be limited as well. This is the bright side of the story for Japan.

There may be a few reasons for this relative soundness.

  • Admittedly, it is partly because Japan’s financial firms were not strongly innovation-oriented as some critics pointed out.
  • But it is also because they were giving priorities to improving their financial soundness rather than enhancing their profitability in the last several years. When the so-called “originate-to-distribute” business model became widespread, it happened that Japan’s financial firms were at the final stage of resolving the non-performing loan problems.
  • In addition, it is significant that risk management practices of Japan’s financial firms were improving in the course of the period I just mentioned. Firms became more cautious than before about investing in financial products with uncertainty on their underlying assets or associated risks. Early implementation of the Basel II framework in Japan has also contributed to ensuring these practices.

Let me turn to the dark side of the story. Japan’s financial system does have considerable risks in other areas, and they are materializing. There are two main sources of risk. The first is underperformance of the core business, such as rising credit costs in banking sector and the declining insurance premiums in the insurance sector caused by the weakening real economy. The other is financial and investment losses, such as valuation losses and impairment on securities held by financial institutions. Given these materializing risks, Japan FSA will remain on a heightened state of alert in monitoring developments in Japan’s financial sector.

If I refer to the situation of Japan’s insurance industry specifically, it is largely as sound as the banking sector. Like other financial firms, Japanese insurers have not significantly invested in complex and opaque instruments, such as ABS CDOs and leveraged loans. The share of these instruments in the total assets is less than 2 percent on an aggregate basis. On the liability side, some non-life insurers have entered into re-insurance with U.S. monoline insurers and provided financial guarantees to municipal bonds, but the losses, both realized and unrealized, are within the manageable size due to the well diversified portfolio. An exceptional case, which I had better mention, is that one small life insurer called Yamato Life went bankrupt last October. It should be noted, however, that the company’s business structure and business model were totally different from other Japanese life insurers. Yamato Life had an extremely high cost structure that is more than twice as high as other insurers, and much riskier investment strategy aimed at higher returns than its competitors in the last few years.

Financial crisis management and regulatory reform

Now let me move on to the next subject, our policy challenges in this crisis period. Like our fellow regulators abroad, Japan FSA is working on two categories of policies at the same time. One is short-term crisis management, and the other is medium-term reforms to “re-design” the regulatory framework.

The first category of policies is short-term crisis management to cope with the ongoing financial turmoil and economic difficulties. Unlike in the U.S. and Europe where the authorities have taken a number of extraordinary actions to stabilize the financial sectors, the policies in Japan are more focused on maintaining the function of financial intermediation in order to support economic activities. They include:

  • Providing the capital injection scheme, which can be used by banks that wish to maintain a sufficient capital base in order to sustain their lending; and
  • Intensive supervisory review of banks’ lending practices to ensure that their financial intermediary functions work properly.

Given its relative soundness, Japan’s financial sector is increasingly relied upon in preventing further deterioration of the real economy.

The second category consists of medium-term reforms to “re-design” the regulatory framework in order to prevent the recurrence of a similar kind of crises in the future. Discussions are underway globally regarding capital adequacy, procyclicality in the financial system, market integrity and transparency, and international cooperation among regulators. They are in line with the recommendations put forth by the Financial Stability Forum (FSF) in April 2008, which were endorsed at the subsequent meetings of the G7 and the G20 leaders.

Recent developments in Japan include the following:

  • First, Japan FSA has strengthened the disclosure requirements for financial firms, including insurers, with respect to their exposure to the securitization market. It has also made sure that the underlying assets of securitized products were traceable along the chains of origination and distribution. Thus we are encouraging firms to examine the contents of underlying assets and to strengthen their risk management;
  • Second, a bill has been submitted to the current session of the Diet to introduce a legal framework for regulating credit rating agencies, which is consistent with developments in the United States and Europe; and
  • Third, given the need to supervise systemically important financial firms on a global basis, supervisory colleges have been established for each of these firms. Japan FSA has established the international supervisory colleges for Japan’s three megabanks and Nomura. Japan is also a member of the supervisory colleges of several foreign firms, including insurers, with significant influence in Japan’s financial markets.

These two categories of policies are common to the financial regulators in major countries, and all of us are facing the challenge of pursuing two possibly conflicting objectives at the same time. In other words, if the policies lean too much toward crisis management, it could cause moral hazard in the marketplace or distort the system in the longer run. On the other hand, too hasty implementation of medium-term measures could rather exacerbate the current situation and make crisis management even more difficult. Japan’s experience in the 1990s suggests that it is important to strike the right balance between the two categories of policies.

Implication for insurance regulation in the future

Finally, I would like to touch upon my views on implications of the current crisis for insurance regulation in the future. The serious problem with a global insurance group has demonstrated that coordination among supervisors both on a cross-border and cross-sector basis is essential to prevent such an event.

To best contain the crisis in the insurance sector, it is important for insurance supervisors to have a robust legal framework for group supervision on a cross-border and cross-sector basis. With such a framework, the authorities can supervise complex insurance groups in an effective manner by capturing all the risks arising from currently unregulated entities, such as non-operating holding companies or subsidiaries engaged in the trading of financial products. At the same time, those risks should be covered with a sufficient level of capital.

In this context, I strongly support the project which the IAIS (International Association of Insurance Supervisors) is now undertaking with an ultimate goal of establishing common solvency standards applicable to internationally active insurance groups. I hope that the IAIS will be able to come up with solutions for group supervision of the insurance business and effectively fill the existing regulatory gap in the near future.

In Japan, the FSA has proposed, at this juncture, a new supervisory guidance to improve risk management of insurers on a group basis. The proposal includes enhancement of risk management practices on non-traditional insurance activities, such as CDS underwriting and financial guarantees. Enhanced risk management will also apply to investment activities on securitized products. The proposed guidance is broadly in line with FSF recommendations I mentioned earlier.


While I have highlighted the regulatory side in this speech, I believe the well- managed business practices by leading insurers is also indispensable for the sound insurance market where policyholders’ interests are protected and their needs satisfied. If insurance regulation is well established in line with the best practice of the insurers and can encourage the continual improvement of their business practices, such desirable combination can generate a synergy effect for the soundness and vigor of the insurance market. To ensure this positive synergy, it is important for both the regulators and the regulated firms to share common values and guiding principles, especially in this crisis period. To conclude my speech, I hope this memorable meeting will be able to provide a valuable opportunity on which all participants can share the common goal of a sound and prosperous insurance market and common understanding about the necessary actions.

Thank you.

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