3 November 2016Asia analysis

Japanese captives underutilised: AM Best

Japan’s captive insurance industry remains underutilised, despite having one of the largest commercial insurance markets in the world, according to a new AM Best briefing.

The briefing, titled, “Growing Role of Japanese Captives,” states that the low utilisation in Japan is partly due to historically strong relationships with the major domestic insurance groups, which have been the largest shareholders of the industrial organisations.

However, these relationships have evolved in recent years as evidenced by the continuous reduction in business-related stock holdings by major Japanese insurance groups.

This decline would suggest that there may be additional Japanese captives in the future. This growth would be particularly timely as many companies are investing in or starting new subsidiaries outside of Japan.

The domicile is a key factor for captives’ expansion. Bermuda and Hawaii, which have long histories of captive operations, remain the popular domiciles for Japanese captives.

However, a few domiciles in the Asia-Pacific region, such as the Federated States of Micronesia, have gained traction among the Japanese captives. In addition to geographic proximity, favorable regulations toward Japanese companies have attracted the captives.

The investment portfolios of the captives are yield-challenged just like those of the commercial market carriers. Liquidity is paramount for captives to support prompt claims payment given their role of fronting the parent risks with a number of re/insurers.

Consequently, investment portfolios consisting mainly of highly-liquid assets, such as cash or short-term deposits and investment income, have a limited contribution to overall returns amid the low-rate environment.

On the other hand, a few of the rated captives have managed their capital efficiently in search of yields by offering a loan-back program to the parent through the group’s liquidity management programme.

Rated Japanese captives currently face an increasing challenge due to the weakening credit profiles of the parent companies. Although parent profile is not a sole factor in assessing the creditworthiness of the captive, this factor is increasingly putting downward pressure on the ratings of captives given their main purpose of managing the risks of captive owners.

Another challenge for the Japanese captives has been the inclusion of new lines of business associated with the parent’s business expansion.

For further captive usage to occur, AM Best believes senior management would need to be further educated about the risks and benefits that a captive provides.