1. © 2003, The Tokio Marine Management, Inc. All rights reserved. Government as Reinsurers-of-Last-Resort: The Japanese Experience June 2003 Yuichi Takeda Tokio Marine Management, Inc Prepared for The World Bank Conference “Financing the Risks of Natural Disasters”

2. © 2003, The Tokio Marine Management, Inc. All rights reserved. Japanese awareness of a disaster Source: Library of the Earthquake Research Institute, University of Tokyo

3. © 2003, The Tokio Marine Management, Inc. All rights reserved. Japanese Earthquake Insurance (JEI) Established 1966 For dwelling risk only –Attached with fire policy as a special contract –Covers fire, destruction, burying or washing-away following earthquake, volcanic eruption, or tsunami following the two perils –Commercial EQ risk and Private/Commercial Wind risks are covered by private insurance policy Sponsored by Japanese government and property & casualty insurers PML estimate with a 250-500 return-year loss –Based on scientific studies of 375 historical major earthquakes in the last 500 years. (from late 15 th century to date)

4. © 2003, The Tokio Marine Management, Inc. All rights reserved. JEI - Background A strong political leadership created JEI, triggered by a large earthquake in Niigata-city in 1964. A public-private partnership form was chosen to create JEI, among other plans. Two strategic goals to facilitate… - Affordability of earthquake insurance - Disaster recovery process

5. © 2003, The Tokio Marine Management, Inc. All rights reserved. Japanese Earthquake Insurance (JEI) - at a Glance 2002 Total Per-Event Capacity $37.5bil (Government $31.3bil) (Private $ 6.2bil) Gross Premium $850mil* Total Sum Insured $48bil** Reserve Balance $12.1bil (Government $ 6.6bil) (Private $ 5.5bil) Maximum Payout in history $653mil (Kobe earthquake in 1995) All the numbers converted into US$ by 120\/$ * round numbers ** presenter estimate

6. © 2003, The Tokio Marine Management, Inc. All rights reserved. JEI - Business Development 1995 Kobe Earthquake

7. © 2003, The Tokio Marine Management, Inc. All rights reserved. Total Reinsurance Limit per Event

8. © 2003, The Tokio Marine Management, Inc. All rights reserved. Total Liability Shared between Government and Private Insurers

9. © 2003, The Tokio Marine Management, Inc. All rights reserved. Maximum Coverage Limit per Policy

10. © 2003, The Tokio Marine Management, Inc. All rights reserved. Rating and Reinsurance Non-life Insurance Rating Organization of Japan (NLIRO) performs risk analysis and files rating plans of JEI. Japan EQ Reinsurance Company (JER), established by private insurers, manages the reinsurance process sitting in between Japanese government and private insurers

11. © 2003, The Tokio Marine Management, Inc. All rights reserved. Role of JER Policyholder Primary Insurers JER Reinsurance Contract (B) Japanese Government JEQR Reinsurance Contract (A) Reinsurance Contract (B) Reinsurance Contract (C) Source: Japan Earthquake Reinsurance

12. © 2003, The Tokio Marine Management, Inc. All rights reserved. Current Risk Tower (per Event) Japanese Government Primary Insurers JER $37.5bil $23.2bil $ 9.0bil $ 5.3bil $ 0.6bil 50% 95% Numbers are originally determined in yen, converted by $=\120 for presentation purpose A PML Scenario: A recurrence of Great Kanto EQ (1923) or similar around Tokyo Bay region in a windy winter evening…

13. © 2003, The Tokio Marine Management, Inc. All rights reserved. How much capacity is enough? A quick guessestimate of Japan’s top risk (Tokyo-Chiba-Kanagawa known as Zone #5) –Total regional GPP*: about $1,100bil * GPP: Gross Prefectural Product –Kobe experience: assume a 3% of regional GPP likely to be lost as an EQI claim payment –Claim estimate: $1,100bil x 3% = $33bil < $37.5bil of total JEI per event capacity

14. © 2003, The Tokio Marine Management, Inc. All rights reserved. Does current risk sharing make sense? A quick comparison between JEI’s reserve balance and its per event limit suggests the system still has many years to go… Private insurers have accumulated their reserve much faster preparing for more frequent events, while Japanese government takes more extreme risks… PublicPrivate Per Event Limit$31.3bil$6.2bil Reserve Balance$6.6bil$5.5bil

15. © 2003, The Tokio Marine Management, Inc. All rights reserved. What if “unexpected” happens? EQI law stipulates “Pro rata claim payment reduction” In case of liquidity crunch of the reinsurance system, EQI special accounts law allows contingent financings from –Government’s general accounts –Government borrowing

16. © 2003, The Tokio Marine Management, Inc. All rights reserved. Rating plans – continuous improvement Base Rates (Basis Points) Non-Wooden Houses Wooden Houses Area 15.0 bps12.0 Area 27.016.5 Area 313.523.5 Area 417.535.5 Rating Zones Area 1 Area 2 Area 3 Area 4 Discounts (Choice of A or B) A. Building Year - 10% discount of build on and after 6/1981 B. EQ Resistance Quality Class - 10% to 30% discount for the three classes inspected and certified according to residential building performance evaluation system (effective 2000) Revisions of Building Standard Law (1998) and Introduction of Housing Quality Assurance Law (1999) enabled new rating plan effective 2001.

17. © 2003, The Tokio Marine Management, Inc. All rights reserved. Claim Payment Three levels of claim payments are stipulated… Damage LevelsClaim Payments (% of Insured Amount) Building and/or Contents Total Loss100% Half Loss50% Partial Loss5% Main Building Structure Floor AreaContents Total Loss≥50% of Building MV≥70% of total floor≥80% of Building MV Half Loss≥20% or <50% of Building MV ≥20% or <70% of total floor ≥30% or <80% of contents MV Partial Loss≥3% or <20% of Building MV N.A.≥10% or <30% of contents MV Level of loss is defined as clear as possible…

18. © 2003, The Tokio Marine Management, Inc. All rights reserved. Making the pool working… Observed Relationship between Household Income and EQI Subscription Higher subscription Higher income levels Risk awareness & motivation to subscribe

19. © 2003, The Tokio Marine Management, Inc. All rights reserved. The Japanese Experience What are the key lessons learned? What are the challenges?

20. © 2003, The Tokio Marine Management, Inc. All rights reserved. Start early so that you can prepare Source: Library of the Earthquake Research Institute, University of Tokyo

21. © 2003, The Tokio Marine Management, Inc. All rights reserved. Leadership makes a difference Source: Library of the Earthquake Research Institute, University of Tokyo

22. © 2003, The Tokio Marine Management, Inc. All rights reserved. Public-private partnership Source: Library of the Earthquake Research Institute, University of Tokyo

23. © 2003, The Tokio Marine Management, Inc. All rights reserved. Simple product provides comfort Source: Library of the Earthquake Research Institute, University of Tokyo

24. © 2003, The Tokio Marine Management, Inc. All rights reserved. Reality and management of risk sharing Source: Library of the Earthquake Research Institute, University of Tokyo

25. © 2003, The Tokio Marine Management, Inc. All rights reserved. Continuous improvement required Source: Museum of Institute for Fire Safety and Disaster Preparedness