[Explanations of Laws and Regulations]

• 1. What Is the Solvency Margin Ratio?

  Insurance companies set aside policy reserves (debts) in anticipation of insurance claims payments related to risks within an ordinarily predictable range, such as a decline in revenue that may be caused by an interest rate drop and a certain increase in payments. Meanwhile, regarding risks beyond an ordinarily predictable range, such as a rapid increase in insurance claims payments due to a large-scale disaster or a deterioration of the investment environment, insurance companies make preparations by building up own capital and contingency reserves. The solvency margin ratio of an insurance company is a yardstick to indicate its soundness in terms of surplus capacity to make payments with own capital and contingency reserves. The solvency margin ratio is also an index used as a reference for the regulatory authorities to encourage insurance companies to improve their management preemptively. If the solvency margin ratio of an insurance company declines below 200%, an early corrective measure will be invoked.

• 2. Processes Leading to the Amendment

  Regarding the processes leading to the amendment, on February 8, 2008, the FSA published the “Outline of Revision of the Solvency Margin Ratio (draft)” (hereinafter referred to as the “Outline (draft),” which included such measures as making risk measurement more rigorous, based on the published a report “Regarding Solvency Margin Ratio Calculation Standards” on April 3, 2007, and solicited public comments. Then, in light of the lessons of the failure of Yamato Life Insurance Co. in October of 2008 and the financial crisis that broke out in the autumn of that year, and in light also of the public comments collected in relation to the Outline (draft), the FSA published the “Revised Outline of Revision of the Solvency Margin Ratio (hereinafter referred to as the “Revised Outline (draft)”) on August 28, 2009 and solicited public comments again.

  In consideration of the public comments collected in relation to the Revised Outline (draft), the FSA published the draft Cabinet Office Ordinance for Partial Amendment of the Order for Enforcement of the Insurance Business Act on December 28, 2009, and solicited public comments. In light of the public comments collected in relation to the draft, the FSA published the results of the public comment process on April 9, 2010, and promulgated this Cabinet Office Ordinance on April 20.

  Solvency margin ratio =	Total margin amount	× 100
  	1/2 × total risk amount

  [Surplus payment capacity] (margin)

  *Own capital, including capital funds

  *Reserves to prepare for such contingencies as a possible increase in insurance claims payments and asset price fluctuations

  [Risks]

  *Risk of an increase in insurance claims payments: Risk of insurance claims payments increasing due to such incidents as large-scale disasters

  *Risk related to asset investment: Risk of assets and revenues declining due to a deterioration of the investment environment

  (Example) Risk of a securities price drop Σ(Outstanding amount of relevant assets × risk co-efficient) − investment diversification effect

  (Risk co-efficient): e.g., 20% for domestic stocks and 2% for yen-denominated bonds

  Investment diversification effect: Calculated based on each company’s portfolio

  Risk of the investment return falling short of the assumed interest rate: Outstanding amount of policy reserves × risk co-efficient for each assumed interest rate

  (Risk co-efficient: In the case of an insurance policy with an assumed interest rate of 5%, life insurance companies shall apply a risk co-efficient of 3.015% and non-life insurance companies shall apply a risk co-efficient of 2.590%)

  *Other risks

• 3. Key Points of the Revision
  The details of the revision are as follows:

  • Adopting a more rigorous approach to the inclusion of some items in the margin, which corresponds to the numerator of the calculation formula of the solvency margin ratio.

    • (1) Introduction of restrictions on the inclusion of the surplus portion of the insurance premium reserves, etc. in the margin.

    • (2) Introduction of restrictions on the inclusion of deferred tax assets related to carried-over deficits in the margin (this does not apply to newly established companies)

  • Making the measurement of risks, which corresponds to the denominator of the calculation formula of the solvency margin ratio, more rigorous and precise

    • (1) Raising the confidence level of the co-efficient of each risk (from 90% to 95%)

    • (2) Renewing statistical data used as the basis of the co-efficient of each risk

    • (3) Calculating the risk of earthquake disaster as the risk equivalent based on VaR 99.5% in each company’s risk model (currently, this risk is calculated as the risk equivalent based on VaR 99.5% in a universal risk model adopted by all insurance companies).

    • (4) Calculating the investment diversification effect related to price change risk based on each company’s portfolio (currently, the ratios of 30% and 20% are applied universally in the case of life insurance companies and non-life insurance companies, respectively)

    • (5) Including the risk reduction effect of hedging transactions only when the hedging is actually effective

    • (6) Adopting a more rigorous risk co-efficient related to securitized products and re-securitized products, creating credit spread risk related to CDS (credit default swap) transactions, and adopting a more rigorous risk co-efficient related to financial guarantee insurance

    Other points of revision include the addition of an appropriate calculation of the solvency margin ratio as a check item for actuaries.

• 4. Date of Effectuation

  The solvency margin ratios of insurance companies are expected to decline as a result of the revision. However, this will not mean a deterioration of their financial conditions but reflects changes in the standard for the calculation of the ratios. As it is necessary to ensure awareness about this among all insurance policyholders and market players, the solvency margin ratio calculated under the revised standard is scheduled to be applied as a benchmark for the invocation of an early corrective measure starting at the end of March 2012. The supplementary provision of the amended Order for Enforcement of the Insurance Business Act stipulates that the solvency margin ratio calculated under the revised standard may be disclosed starting at the end of March 2011, and the Comprehensive Guidelines for Supervision of Insurance Companies states that it is desirable to make such disclosure.

• 5. Major Public Comments

  Among the above points of revision, the introduction of measures to make risk measurement more rigorous drew the largest number of public comments (41). There were two public comments calling for efforts to ensure awareness about the contents of the revision among all insurance policyholders so as to avoid misunderstanding on their part.

* For further details, please refer to “Results, etc. of the Public Comment Process related to the Cabinet Office Ordinance for Partial Amendment of the Order for Enforcement of the Insurance Business Act” (April 9, 2010), in the Press Releases section of the FSA website. (In Japanese only)

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The FSA solicited public comments on the draft partial amendments of the “Comprehensive Guidelines for Supervision of Major Banks, etc.,” the “Comprehensive Guidelines for Supervision of Small- and Medium-Sized Enterprises and Regional Financial Institutions” and the “Comprehensive Guidelines for Supervision of Financial Instruments Business operators, etc.” from January 20, 2010, to February 22, 2010. On April 16, 2010, the FSA published the results of the public comment process and implemented the partial amendments of those guidelines for supervision. The amended guidelines took effect on April 16, 2010.

The key points of the amendments are as explained below:

• 1.“Comprehensive Guidelines for Supervision of Major Banks, etc.” and “Comprehensive Guidelines for Supervision of Small- and Medium-Sized Enterprises and Regional Financial Institutions”

  The following amendments were made in relation to a system for explaining derivatives transactions to customers and a system for processing requests for consultation and complaints so as to enhance the protection of users:

• (1) Explanations made at the time of the conclusion of a contract

  • Losses estimated on the assumption of the worst-case scenario and the cancellation fee must be explained.

  • Explanations based on definitive judgment must not be made in relation to matters involving uncertain elements, such as exchange rates and interest rates.

• (2) Explanations made to people who are de facto business managers

  • In the case of a contract that may have a significant impact on future management, the presence or absence of a decision made at a meeting of the board of directors must be confirmed.

• (3) Confirmation of customers’ needs for hedging and explanations of the effectiveness of hedging

  • The effectiveness of derivative transactions in light of the customers’ needs must be confirmed and the customers’ understanding on how the transactions will affect their future business operations must be obtained.

• (4) Follow-up after the conclusion of a contract

  • After the conclusion of a contract, an appropriate follow-up, including the confirmation of the effectiveness of the hedging in light of the customers’ needs following changes in their business conditions, must be made.

• (5) Others

  • It must be considered whether or not to continue selling products and handling transactions concerning which there are many complaints.

• 2.“Comprehensive Guidelines for Supervision of Financial Instruments Business operators, etc.”

  Amendments similar to those described in 1. above were made in relation to derivatives transactions such as currency option and interest rate swap transactions as well as structured bonds with similar risk characteristics.

* For further details, please refer to “Results of the Public Comment Process related to the Draft Partial Amendments of ‘Comprehensive Guidelines for Supervision of Major Banks, etc.,’ the ‘Comprehensive Guidelines for Supervision of Small- and Medium-Sized Enterprises and Regional Financial Institutions,’ and the ‘Comprehensive Guidelines for Supervision of Financial Instruments Business operators, etc.’” (April 16, 2010), in the Press Releases section of the FSA website. (In Japanese only)

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