Japan: Powerful, Beleaguered and Consolidating

Until Commodore Peary’s visit in 1848, Japan was one of the world’s most isolated countries, and it still remains rather unique. But something in the Japanese character and society enabled it to turn its back on the past almost instantaneously, and to transform an ancient, tradition-bound, xenophobic and basically, agricultural kingdom into the industrialized giant it is today. No other country has been able to do that.

The Treaty of Kanagawa with the United States in 1854 obliged Japan to open its ports and launched the country on a concerted drive to join the Western, i.e., the dominant world. Barely 50 years later Japan took on the vast Russian Empire in a bloody war in Manchuria that it won decisively, sinking most of the Russian Navy in the process. A combination of social cohesion, dedication, inventiveness and, above all, adaptability, had enabled an island nation, essentially without any major natural resources, to become a great power in the space of 50 years.

The Central Intelligence Agency Factbook notes: “Government-industry cooperation, a strong work ethic, mastery of high technology, and a comparatively small defense allocation (1 percent of GDP) helped Japan advance with extraordinary rapidity to the rank of second most technologically-powerful economy in the world after the United States and third-largest economy after the United States and China.” Japan’s population is a little over 127 million, in an area a bit smaller than California. According to the Factbook, service industries account for 70 percent of its GNP (industry 25 percent and agriculture 5 percent). Japan’s insurance industry—the second largest after the United States—is a sizeable part of those services.

It’s not hard to see why. In addition to financial considerations, which make insurance coverage a necessary component for economic growth, Japan’s vulnerability to natural disasters, and its dependence on trade, made developing an insurance market mandatory. The islands are prone to earthquakes, typhoons and tsunamis; most of its pre-World War II structures were of wood. Fire and catastrophe insurance was vital, as was coverage for the country’s growing merchant marine and fishing fleets.

A singular characteristic of Japan’s modernization was the way in which the government, banks, manufacturers, suppliers, and distributors worked to achieve a single goal. As Japan sought to adopt and to adapt Western ways, it realized that there is power in size. Early in its development, the Japanese economy became dominated by a select number of industrial and financial groups—the zaibatsu.

Michel Fromaget, who spent 22 years in Japan as a top executive with the French bank Société Générale, described them as families. “Essentially they are groups of companies, who work with one another, give business to one another and depend on one another,” he explained. “Zaibatsu refers to the group as a whole, for instance Mitsubishi to which Tokio Fire & Marine belongs. The term keiretsu is limited to companies that are partially, or wholly owned by group members.”

These closely-knit groups continue to exert a great deal of influence on how the Japanese economy operates and how business decisions are made.

A second basic feature of the Japanese economy has been the guarantee of lifetime employment for a substantial portion of the urban labor force. Workers were considered part of the “family” as well. Consider these translated lines from a daily song for the workers at Matsushita Electric:

“For the building of a new Japan. Let’s put our mind and strength together. Doing our best to promote production. Sending our goods to the peoples of the world. Endlessly and continuously. Like water gushing from a fountain. Grow, industry, grow, grow, grow. Harmony and sincerity. Matsushita Electrical.”

Even in his wildest dreams, Jack Welch couldn’t have gotten General Electric’s workers to sing that.

These features have combined both to create Japan’s glory—remember the 1980s and the universal homage to “Japan Inc.” when it looked like the Japanese were taking over the world?—and to cause its economic problems.

“We knew there was trouble ahead as early as 1989, we saw the signs,” Fromaget said. He described a corporate culture based on relationships. Loans were made for costly projects that weren’t economically viable or just didn’t work. The increased use of automation and robotics exacerbated the problem, as redundant workers could not be fired, and were kept on at a high cost.

“Investments in Japanese corporations aren’t made on the same basis as in the West,” Fromaget continued. “Profits and the bottom line are far less important than growth.” Growth, however, is not eternal; it slows down, or even stops. When that happened at the end of the 1980s, the Japanese model proved ineffective in facing the crisis.

The Factbook notes: “For three decades overall real economic growth had been spectacular: a 10 percent average in the 1960s, a 5 percent average in the 1970s, and a 4 percent average in the 1980s. Growth slowed markedly in the 1990s, averaging just 1.7 percent, largely because of the after effects of over investment during the late 1980s and contractionary domestic policies intended to wring speculative excesses from the stock and real estate markets.” Fromaget observed that once the growth evaporated “the Tokyo stock market [the Nikkei share index], which had been as high as 39,000 Yen [around $4,000 at the time] dropped to around 10,000 Yen [approximately $1,000]—a 75 percent decrease, most of which occurred in the 1990s.”

During this period Japan’s economy not only slowed down, it actually contracted, as deflationary pressures dragged down wages and prices. Exports, although remaining at a comparatively high level, stagnated. The catastrophic fallout hit every financial institution in Japan—securities firms, banks, trading companies and the insurance industry. Although life insurers felt the impact more severely than the property/casualty sector, the government finally decided to overhaul Japan’s outmoded and inefficient regulatory system for both.

The Factbook notes that government efforts to revive economic growth “have met with little success and were further hampered in 2000-2003 by the slowing of the United States, European, and Asian economies.” In addition, Japan’s huge government debt (approaching 150 percent of GDP), and aging of the population are two major long-run problems.

Japan’s insurance industry model, particularly in the life sector, became another problem. A summary of many studies reveals a sclerotic industry, with very little difference in the products offered, virtually no price competition and the hand of the zaibatsu omnipresent in deciding what business went where. Writing in 1998, in a report for the Japan Economic Institute, Douglas Ostrom commented: “In effect, nonlife insurers operated as a cartel, with the Finance Ministry having at least informal powers to enforce price-fixing.”

A sea change occurred in 1996 when the government announced an ambitious plan—subsequently dubbed the “big bang”—designed to “boost efficiency and the international competitiveness of Japanese financial institutions by significantly deregulating the activities of banks, brokers and insurers by the year 2001,” Ostrom wrote. It could not have come too soon. In May 1997, the unthinkable happened when Nissan Mutual Life went bankrupt—a victim of high guaranteed returns on policies that could not be met. In quick succession, five other life insurers and one P/C company (Taisei Fire & Marine) went into receivership.

As a result mergers and consolidations, even some outside the “family,” speeded up under pressure to cut costs, improve loss ratios and eventually make profits. The regulatory changes also opened the door to foreign competition, virtually for the first time. Most of the acquisitions came in the life sector, where the government was only too happy to see companies like AIG, GE, AXA, Manulife and Prudential bring some much needed capital and added security into the market by acquiring distressed life companies. Japan’s P/C insurers took notice as well.

Starting in November 2001 with the announcement that Tokio Fire & Marine, Japan’s largest P/C insurer, would merge with Nichido Fire & Marine, the sixth largest P/C carrier, Japan’s non-life industry has been on a constant consolidation spree. Millea Holdings Inc., the company formed by Tokio and Nichido, began operations in April 2002. The two companies formally merged operations at the end of September.

In June 2002, Yasuda Fire & Marine and Nissan Fire & Marine announced completion of their merger agreement, which had been in the negotiation stage since October 2000. They formed Sompo Japan Insurance Inc., the country’s second largest P/C insurer with around an 18 percent market share, with premium revenues of over one trillion Yen (almost $10 billion).

The third largest insurance group is Mitsui Sumitomo Insurance Co., formed by the merger of Sumitomo Marine and Mitsui Marine. Similar consolidations have produced: the Nippon Koa Group—Nippon Fire and Koa Fire; the Aioi Group—Dai-Tokyo Fire and Chiyoda Fire, and the Nissay Dowa Group—Nissay General and Dowa Fire & Marine. Together they control 85 percent of the Japanese P/C market.

Foreign companies also participated. AIG further strengthened its already leading position in Japan when, in cooperation with Orix Corp., the country’s largest leasing company, it reached an agreement with Fuji Fire & Marine (which has around a 4 percent market share) to provide additional capital of 34.4 billion Yen ($256.3 million). AIG, whose AIU unit already had a stake in Fuji, increased its shareholding to around 22.14 percent.

Japan’s Financial Services Agency, which took over regulation of the insurance industry from the Ministry of Finance’s Insurance Bureau in 2001, wanted increased competition and more security in the form of fewer, larger and better capitalized companies. They got it. Maybe they now wish they’d gone a bit slower in creating it. While the Japanese economy has shown clear signs of recovery, it’s still a mature market as far as insurers are concerned. There’s little room for growth in the classic coverage areas: personal lines—homeowners and auto—and commercial lines, including marine. In addition, an invigorated foreign presence has increased competition.

Even the biggest carriers face this problem. When Tokio Marine and Nichido completed their merger at the end of September Standard & Poor’s affirmed the new company’s “AA-” financial strength and long-term counterparty rating with a stable outlook. But it also observed: “A high level of growth of their key product, auto insurance, is not expected in the Japanese market. The company also faces challenges in improving operating efficiency by taking advantage of its scale, and in maintaining profitability by prudent underwriting. The key to sustainable growth will be to enhance ‘third-sector’ insurance business, sales of insurance policies at banks’ counters, and overseas businesses, which will supplement the company’s conventional non-life insurance business.”

This has been one of the main consequences of deregulation. P/C companies, having absorbed some life companies, are now seeking to sell their policyholders’ P/C insurance. Japan’s banks have also raised their bancassurance profile and are actively seeking to sell their customers new insurance products. Life insurers are seeking customers in the P/C sector. One of the leaders has been Dai-Ichi Mutual Life, which concluded cross-selling arrangements with both Sompo (Nissan and Yasuda) and AFLAC’s Japanese subsidiary. Meiji Life and Yasuda Mutual Life, who completed a merger agreement earlier this year, have a similar deal in the works with Nippon Koa.

Speaking at the International Insurance Society’s 40th Annual Seminar in London in July, Dai-Ichi’s Chairman Tomijiro Morita detailed the major changes that have taken place in the Japanese life market on the heels of the financial crisis. However, “a reversal began in 2002,” he said, “when it became obvious that the Japanese life industry had to regroup and start forming alliances. Our alliance with Sompo and AFLAC is a cooperative agreement, it means we mutually sell one another’s products.” He added that the combination had produced more self reliance and more “high value and better products,” while increasing customer satisfaction and management efficiency.

Dai-Ichi was also lucky in its choice of partners. AFLAC’s duck quacks very loudly in Japan, where its supplemental health benefit products found the ideal niche market.

Speaking at the I.I.S. Conference, Kriss Cloninger III, AFLAC’s president and CFO, described a business which insures 25 percent of all Japanese households, earning $8.7 billion in premiums (compared to the U.S.’s $3.1 billion). “Our profits in Japan have been $2.3 billion over the last five years,” he said.

Shortly after acquiring more of Fuji Fire, AIG concluded an agreement to acquire both GE Edison Life Insurance Company in Japan and GE’s U.S.-based auto and home insurance business, for between $2.1 and $2.2 billion. Commenting on the deal, AIG Chairman Maurice. R. “Hank” Greenberg, stated: “This transaction represents a significant opportunity to expand AIG’s presence in the Japanese life insurance market, the second largest in the world. GE Edison, AIG Star Life and ALICO Japan would provide AIG with the leading foreign life insurance presence in the marketplace and a strong distribution platform for serving the life, annuity, and accident and health insurance needs of this important market.”

Japan’s P/C market is still in the process of regrouping. It appears to have slowed down momentarily, while all the deals of the last two years are being consolidated. However, more mergers and acquisitions are inevitable, as are high levels of competition and the growth of “third sector” channels like cross-selling and bancassurance.

The financial picture has also improved. In May, S&P revised its outlooks to stable from negative on the financial strength and long-term counterparty credit ratings of seven Japanese insurance companies—primarily the major components of Millea, Sompo and Mitsui Sumitomo, plus two life companies. They’re all currently rated “AA-.”

Asked what he thought the future held for Japan, Fromaget replied, “Oh, I’m not worried. They’ve had problems before and have always come out of it OK. This time they had to overhaul some fundamental business practices, which were impeding growth and causing [economic] stagnation. They’re well on the way to doing that.”