Foreigners have been buying up troubled Japanese life insurers. This change in strategy takes them into the heart of an unprofitable industry. Is that a good idea?
By Kazuhiko Shimizu
October 2002
Institutional Investor Magazine
Agreeing to snap up a troubled Japanese life insurer seemed like a no-brainer to Timothy Feige. The Prudential International Insurance executive was convinced that a failing local company offered an easy way to gather assets in a country that spends more per capita on insurance than any other on earth. And the transactions carried bargain-basement prices. So when bankrupt Kyoei Life Insurance Co. first came looking for help four years ago, Feige believed he’d found the perfect acquisition candidate. The Japanese unit of Newark, New Jerseybased Prudential Financial already had an informal relationship with Kyoei going back more than 20 years, and the ¥4 trillion ($32.8 billion) insurer operated in several local markets that intrigued Feige. The terms, hammered out over a nearly three-year period, were unbeatable as well. “We did not pay anybody to buy it,” says the congenial, soft-spoken American. “All we did was invest $1.2 billion to recapitalize the company. It was a favorable transaction for us.”
Many foreign firms reached similar conclusions. Kyoei, now renamed Gibraltar Life Insurance Co. and headed by Feige, who became CEO and president on October 1, is just one of ten troubled Japanese insurers resuscitated by foreign giants in the past four years. France’s Artemis bought Nissan Mutual Life Insurance Co. in 1999, and General Electric Capital Corp. acquired bankrupt Toho Mutual Life Insurance Co. in 2000. Last year Manulife Life Insurance Co., the Japanese unit of Canada’s Manulife Financial Corp., picked up Daihyaku Mutual Life Insurance Co., while American International Group took the reins at Chiyoda Mutual Life Insurance Co. These and other foreign-owned companies now generate more than 10 percent of all Japanese insurance premium income, and that share is growing. A burst economic bubble and a spate of deregulation in the late 1990s have opened doors kept shut for decades by stringent rules and informal trade barriers. Finally, foreigners have a shot at the sprawling Japanese market.
Just how alluring is it? Japan is the world’s second-largest insurance market, after the U.S., with $401 billion in premiums, and its citizens have a well-documented obsession with security and health. In all, Japanese life insurers boast ¥180 trillion in assets: That’s less than half the banking industry’s ¥410 trillion but significantly more than the securities industry’s ¥120 trillion.
But Japanese insurance, like banking, is a business beset with big problems. Seven life insurers have gone bankrupt since the late 1990s, and more failures are expected. Negative spreads are costing the industry’s leaders -- household names such as Nippon Mutual Life Insurance Co. -- almost ¥1.2 trillion a year. The sales structures at these tipping giants look to outsiders like rickety antiques from the postwar era. Few Japanese insurers, moreover, show signs of creative thinking. Most consider tying up with a foreigner only as a last resort.
Does this mean that foreign insurers like Prudential are making a mistake? Are their Japanese counterparts worth buying -- at any price? It sure isn’t easy to make headway. Top performers like AIG, Prudential and American Family Life Assurance Co. have battled since the 1970s for a toehold in Japan; yet despite their successes, local behemoth Nippon, with ¥45.2 trillion in assets, remains about 12 times the size of the biggest foreign branch. For now, the foreign leaders have no intention of backing off: “We have done well in Japan and feel comfortable with the market,” insists Feige.
Still, some are beginning to alter their strategies. In the past most overseas insurers gamely followed their own paths. Now they are starting to adopt Japanese practices -- including some notoriously inefficient ones -- to further growth. Aflac, a longtime player in Japan, is a case in point (see box). Its April 2001 alliance with Dai-Ichi Mutual Life Insurance Co., Japan’s second largest, sends a message: Only the Japanese way can lead to long-term success, and the Japanese way, with its massive sales forces and reluctance to change, say critics, has lately been an abject failure.
FOR A LONG TIME THE JAPANESE WAY worked just fine. Indeed, not long ago Japanese insurers wowed the world with record-setting purchases of Western art and real estate, U.S. stocks and Treasuries -- all financed by their success in tapping the stored wealth of risk-averse Japanese consumers. Just 15 years ago Yasuda Fire and Marine Insurance Co. paid a then-record $41.5 million to bring a version of Van Gogh’s Sunflowers to Japan.
As with so many other Japanese industries, the life insurance business at its heart was structured to provide employment -- initially, in this case, for the tens of thousands of women widowed during World War II. Little has changed. Today most of the major Japanese life insurers still use a system of salaried saleswomen whose skills in persuading customers to buy policies -- often out of obligation or sympathy -- are legendary. These saleswomen, who today number more than 300,000, have carte blanche to prowl the corridors of companies whose shares are held by their employers. These elaborate cross-shareholding arrangements, known as shokuiki eigyo (the closest approximation in English would be “in-company sales”), are similar to the famous keiretsu system. “Saleslady workforces are very unproductive and inefficient,” says Takao Yamaguchi, president of Credit Suisse Life Insurance Co. “The cost of keeping these sales forces has been passed on to customers through high insurance premiums.”
There are other problems. This in-house sales system has locked the insurers into mutual financial relationships that have burdened them with massive portfolios of shares that have been battered in Japan’s ten-year bear market.
To keep this house of cards from collapsing, Japan’s Ministry of Finance decades ago concocted a government-supervised cartel known as the “escorted convoy” system. Everything, including new products, pricing and market shares, was controlled by bureaucrats by way of unofficial but binding consultations with the insurers. In effect, the ministry kept the life insurance companies alive with fixed market shares. They in turn followed market leader Nippon Life’s example in new products, pricing and even fund management. “Everyone did the same things and sold the same products,” says Ichiro Kono, the 61-year-old vice chairman of Prudential Life Insurance Co., the Japanese life unit of the U.S.'s Prudential Financial. Kono ought to know: Before joining Prudential he worked for the country’s third-largest insurer, Meiji Mutual Life Insurance Co., and then for American Life Insurance Co., a unit of AIG.
All this is hardly startling in the Japanese context, and neither is what has happened since the mid-1990s, when the industry began to crumble under the combined forces of U.S. trade pressure and the country’s general economic decline. The first sign of real trouble came in 1997: Nissan Mutual Life Insurance, with ¥2.06 trillion in assets, collapsed after a disastrous bet on foreign bonds and local real estate. To help restore public confidence, the government’s newly created Financial Services Agency the next year began to deregulate the industry to allow foreigners into the game. Today foreigners, some of which retain separate entities for their Japanese acquisitions, own 19 of the country’s 42 life insurers. Of the ten old-line Japanese insurers still in business, more than half are losing money, and two of them are considered to be in serious trouble.
It’s easy to pinpoint the industry’s problems. Ongoing declines in the value of life insurance policies in force and yawning negative spreads -- the difference between guaranteed policy yields and returns on the insurers’ funds in an environment of low interest rates -- are primarily responsible for the seven bankruptcies to date. In the year ended March 31, 2002, the top ten traditional Japanese life insurers reported ¥1.2 trillion in negative spreads. Nippon Life, which still claims 25 percent of the market, has been reporting negative spreads of more than ¥300 billion annually since 1993; it has also reported five straight years of decline in the value of policies in force.
Even so, there doesn’t seem to be much impetus to change. “We can cope with a negative spread for eternity,” says Shoei Ueda, general manager at Nippon Life, “because we have ¥2 trillion in capital to cover it.”
True, but won’t that capital eventually evaporate? Not according to Yuichi Kosaka, who as manager of the corporate planning department for Dai-Ichi Mutual Life handles relations with credit rating agencies. With their huge asset bases and ready access to capital, the largest insurers don’t view their situation as particularly grave. “We can keep on like this for another 100 years,” Kosaka says from his office in Tokyo’s tony Marunouchi district.
An industry this anachronistic and messy would seem ripe for a jolt of amply funded foreign innovation. And the most logical way for an outsider to enter the industry would be to take over one of the faltering giants. “It would take at least ten years to start making profits if you started a life insurance company here from scratch,” says Yamaguchi of Credit Suisse Life, which bought the smallish Nicos Life Insurance Co. for ¥17.4 billion two years ago. Another spur to foreign purchasers: Insurers that bail out bankrupt life insurers are allowed to lower the guaranteed yield on policies in force. Thus, by lowering the yields offered policyholders from, say, 5.5 percent to 1.5 percent, the acquirer can directly tackle the negative spread problem. Solvent insurers don’t have the luxury of adjusting outstanding yields on policies that may have been written a decade or more ago, when rates were much higher.
In the few years since their arrival in Japan, most foreign insurers have made good use of the competitive advantages they enjoy over their stodgy rivals. Generally, they have combined new products with sales and marketing strategies that cut down on the preposterous costs of local companies, while targeting niche markets like industrial organizations, trade groups and high-net-worth individuals.
“We’re bringing modern products to Japan,” says Trevor Matthews, the Australian president and CEO of Manulife, which bought the bankrupt Daihyaku Mutual Life last April. Six months later the company launched ManuFlex, a universal life product that allows customers to adjust premiums and coverage to reflect their changing needs and accounts for almost three quarters of Manulife’s ¥105 billion in new contracts.
Foreign firms have acted as pioneers before the recent wave of takeovers. Prudential first ventured into the Japanese market back in 1979 in a partnership with Sony Corp. Utilizing a U.S. concept, the two created an innovative sales position known as a “life planner.” Although the partnership ended in 1987, Prudential still markets its plans through life planners, who are usually male, college-educated agents trained to analyze the specific needs of potential high-net-worth clients and tailor policies for them. They can also offer asset management and tax advice. A typical life planner sells nearly 100 policies per year, more than twice the average production of a traditional saleswoman.
Alico Japan, a Japanese branch of AIG’s American Life Insurance Co., also began with a go-it-alone strategy. Since arriving as the country’s first foreign life insurer in 1973, it has spent billions of dollars on television ads to win over middle-income customers while using “life designers” (its version of a life planner), direct-mail sales and agencies to target wealthy individuals. Alico’s asset base has soared roughly 60-fold to ¥1.59 trillion in the past 20 years.
“There are only two foreign companies that have brand recognition in Japan: Alico and Aflac,” says Mitsumasa Oka-moto, a senior insurance industry analyst at Merrill Lynch Japan Securities Co. Now, however, after building its business from the ground up and creating its own formidable brand name, Alico is starting to adopt some Japanese insurance practices. When it acquired bankrupt Chiyoda Mutual and renamed it AIG Star Life Insurance Co. last year, Alico was seeking to reach further down into the marketplace. “We wanted the saleslady channel to expand our customer base from high-net-worth [clients] to Japanese of all walks of life,” says Hiroo Tanabe, regional vice president of corporate communications for AIG companies in Japan and South Korea. After taking over Chiyoda, AIG kept half of the company’s 7,000 saleswomen and added 1,200 of its life designers.
Similarly, Prudential, through its purchase of Kyoei, wants to extend its reach beyond life planning for wealthy urbanites. Pru found in Kyoei an insurer that specialized in serving teachers’ associations and small-business owners. As Gibraltar, it will target middle-income customers throughout the country. “Kyoei gave us unusual opportunities,” says Feige.
“AIG, Prudential and other foreign insurers are beginning to realize that chasing high-net-worth individuals is not necessarily a winning strategy in Japan,” says David Threadgold, head of research and a senior analyst at ING Baring Securities (Japan). Because wealthier Japanese are so conservative, “it proved very difficult to get access to that market,” he explains. “If you want to do decent business here, you probably have to go to mass-market-oriented business.”
Indeed, the foreigners have made little headway in market share. Although they now own almost half the companies, overseas firms command only 13 percent of a market worth ¥26.19 trillion in total premium income. Cautious Japanese customers remain wary of foreign names, however rocky the state of the old standbys. It took Alico and Aflac almost 30 years to win even a modicum of local trust.
Also, the foreign companies’ recent acquisitions are taxing that trust. Reductions in guaranteed yields that were imposed after the takeovers of failed insurers have prompted massive cancellations by angry policyholders. The postpurchase numbers make that clear: Kyoei lost 20 percent of its policies in the year ended last March, its first year as Gibraltar; AIG Star Life lost 28 percent, and Manulife lost 37 percent.
Still, foreign entrants persist. Hartford Life Insurance, the Japanese unit of U.S.-based Hartford Financial Services Group, sells variable annuities insurance not through saleswomen or life planners but via securities broker Nikko Cordial Securities. And the company had lined up ten banks to start selling the product on October 1, when restrictions on bank sales were scheduled to end.
Foreigners are also targeting other areas such as medical care, nursing, postretirement living and savings to supplement Japan’s feeble social security system. Gary Bennett, president and CEO of PCA Life Insurance Co., a unit of U.K.-based Prudential (unrelated to the U.S.'s Prudential or its affiliates), says he sees great potential in “third sector” insurance products such as cancer, death and disability benefits as well as trust-linked products and variable insurance. The U.K.'s Prudential spent ¥23 billion to take over Orico Life Insurance Co. in February 2001. “Everyone keeps saying the Japanese life insurance market is saturated and saturated by one product. Everyone has three whole-life insurance contracts,” says Bennett. But “it is a growing market on a much broader basis, giving people more innovative solutions as far as their investments, retirement and protection goes.”
The major Japanese players remain enigmatic. Buffered by their huge asset bases, most don’t seem to have awakened to the new realities confronting them. “The industry seems to believe there will be a ‘kamikaze’ or ‘God wind,’” says Yasuo Kofuji, a finance professor at Senshu University in Tokyo and an outspoken specialist on the industry. “They say that if the God wind blows, there will be a quick recovery and we can get rid of the negative spread immediately.”
In the meantime, it’s hard to get a handle on just how bad their problems are. Because only one Japanese life insurer -- Daido Life Insurance Co. -- is publicly listed, information is scarce. “We still don’t know the precise negative spreads of the life insurance companies,” says Kofuji. “There are so many discrepancies between published figures and a total lack of transparency in their financial disclosures.”
To be sure, Japanese insurers aren’t sitting idle. Cost-cutting is in vogue even at Nippon Life and Dai-Ichi, which have reduced their rosters of saleswomen. Asahi Mutual Life Insurance Co. and Mitsui Mutual Life Insurance Co. are in the midst of major restructurings. And in the past two years, a number of Japanese companies have begun to offer variable-rate annuities and universal life products. A few players -- Daido Life among them -- have carved out attractive niches. Daido Life was the first Japanese insurer to introduce asset-liability management, way back in the early 1990s, as the Japanese bubble was bursting. It diversified out of Japanese stocks long before competitors discerned the local market’s grim message.
In fact, there would not be a life insurance crisis in Japan now if companies had begun adopting asset-liability management techniques in 1990, says Kazuki Nakamoto, a certified actuary and financial analyst who is a managing director of Daido. In the early 1990s Nakamoto, who had worked for the firm’s asset management group in London near the height of the Japanese stock market boom, suggested to Daido’s then-president, Shirou Kawahara, that the company start cutting its equity holdings. Over the next ten years, Daido’s local equity exposure dropped from about 20 percent to roughly 5 percent today. Although rivals have cut their holdings, most started much later and still have more than 20 percent of their portfolios in depressed shares. That’s one of the reasons the company’s solvency ratio -- an indicator of financial health -- was the strongest of Japan’s ten traditional insurers when figures were released in June. Even so, Daido’s margin is only about half that of Alico Japan’s.
Most domestic insurers don’t seem much concerned by the foreign incursion on their turf. In part this reflects the strong advantage Japanese companies have long enjoyed over outsiders: Most high-net-worth Japanese are over 60, don’t know much about foreign companies and are conservative investors. These older investors prefer the security of Japanese names and are unlikely to switch to foreign newcomers. Indeed, many industry analysts expect that additional failures among Japanese life insurers will help the big domestic life insurance companies more than foreigners. “The more failures of Japanese life insurance companies, the stronger Nippon Life and Dai-Ichi Life will become,” says researcher Okamoto of Merrill Lynch. “Customers will go to them for the name value and safety. If Nippon Life fails, it means Japan has failed.”
It’s against that stark truth that you hear a lot of talk at the moment about “Merrill Lynch syndrome” -- the idea that foreign insurers will acquire Japanese assets only to fail as Merrill did after buying out 28 branches of failed Yamaichi Securities Co. in the late 1990s. A repeat performance in the insurance business is not impossible. Although no foreign life insurance companies have pulled out of Japan, Allstate Corp., a U.S. property and casualty insurer, closed its Japanese business in January 2000 after an unsuccessful yearlong bid to sell its auto insurance through direct-mail and Internet channels. And last January two more U.S. nonlife insurance companies, Liberty Mutual Insurance Group, which entered the Japanese market in 1996, and Lumbermens Mutual Casualty Co., a unit of Kemper Co. that arrived in 1982, also gave up.
Manulife chief Matthews says he is forever battling rumors that his company will eventually withdraw from Japan. “That’s the disadvantage we have,” Matthews says at his office in the Daihyaku Life Building on the outskirts of Tokyo. “The first question people ask is, ‘Are you really staying?’ It’s a constant issue for us.”
“Yes, we are staying,” Matthews asserts. “I would not have brought my wife and family and two dogs and a cat otherwise. I would not go to that much trouble if we were pulling out in three months’ time.”
How Aflac became Japan’s No. 1 cancer insurer
During a visit to the Osaka Exposition in 1970, John Amos, one of three brothers who founded American Family Life Assurance Co., couldn’t help but notice that many Japanese wore surgical masks -- a habit that persists today among cold and allergy sufferers. Impressed by the locals’ concern for their health, Amos (who died in 1990) spent years lobbying the government for an operating license. After finally winning approval in 1974, Aflac created Japan’s first cancer insurance policy.
Amos’ instincts were correct. Today one in four Japanese families has an Aflac cancer insurance policy, giving the company an overwhelming 90 percent market share. The com- pany’s Japanese branch has routinely recorded double-digit annual increases in assets since it was founded, and it now has in force over 15 million policies, the second most of any insurer in Japan. “Any group of citizens that’s so conscious of health is a good market to be in,” says Charles Lake, a former official with the U.S. Trade Representative, who runs Aflac Japan.
It’s highly unusual for a foreign company to become the No. 1 player in a Japanese market. Aflac’s success is especially remarkable because the firm has mostly charted its own course. Unlike other foreign insurers (story), Columbus, Georgiabased Aflac hasn’t made any splashy local acquisitions. At the same time, the insurer has avoided the hallmarks of many of its Japanese rivals: It doesn’t employ an army of saleswomen (it sells mostly through agencies) or price its products too aggressively.
Also unusual: Aflac has benefited from government policies. Until 1982, when other foreigners were permitted to compete, the company had an exclusive license to sell cancer insurance. Even big Japanese companies were barred: The “third sector” -- which includes cancer and supplementary medical coverage -- was only opened to all insurers in January 2001. Before that the government allowed only a handful of foreign and small domestic insurers to provide such coverage.
Last year Aflac took its first steps away from its self-sufficient strategy -- but the switch was made with characteristic independence. It formed a marketing alliance with Japan’s No. 2 life insurer, Dai-Ichi Mutual Life Insurance Co., to sell Aflac-branded cancer insurance products. The link gives Aflac access to Dai-Ichi’s 50,000-strong sales force (many of them saleswomen) spread across Japan, thus limiting its marketing costs; for Dai-Ichi the fee-based arrangement generates new revenue and gives the company access to a new product.
“The tie-up with Dai-Ichi has been a great success so far,” says Xu Jian, a public relations section manager at Aflac Japan. “Out of 820,000 new cancer policies we sold in the fiscal year ended March 31, Dai-Ichi sold 320,000 of them.” Oddly for such a partnership, the Japanese company, Dai-Ichi, benefits because Aflac’s brand name is so well known in Japan. “It saves us the big initial cost of underwriting new cancer insurance products and selling our own brand,” says Yuichi Kosaka, manager of the corporate planning department at Dai-Ichi. “Dai-Ichi’s competitive edge is to sell, and it’s easy to sell Aflac’s product in Japan.”
Moreover, in Japan’s insurance market partnering with a foreign firm adds a sheen of financial stability to an alliance: “Look at their TV commercial saying that they have no negative spread. We envy them,” says Kosaka.
Most of Aflac’s focus remains on new products and markets. The firm has recently set its sights on medical care insurance -- an area expected to grow rapidly with the passage in July of a new health-care reform law. As of next April the share of medical costs covered by the government’s health insurance program will drop to 70 percent for each participant from the current 80 percent. Aflac plans to take up as much of the slack as it can.
To reach this market, Aflac has introduced a new policy, Ever, which provides supplementary hospitalization and operation costs and is available to anyone up to age 80. The company sold 180,000 Ever policies between its February launch and June 30, says Lake.
Aflac must continue to pay close attention to its core product -- cancer policies. Because premiums for other types of insurance, like ordinary life products, can run between $200 and $300 a month -- compared with $20 to $30 a month for cancer insurance -- big domestic insurers have generally stayed away. Five years of declines in aggregate life policy values, however, have prompted the behemoths to look enviously at Aflac’s growth rate: Its total assets increased by 17 percent, to ¥3.71 trillion ($30.4 billion), in the year ended March 31.
“It’s impressive,” concedes Shohei Ueda, general manager of ¥45.2 trillion-in-assets Nippon Mutual Life Insurance Co. The foreign company’s 820,000 new cancer policies last year were more than double Nippon Life’s 365,000, according to industry estimates. “I have Aflac cancer insurance because our company was not able to sell it until last year,” Ueda says. But, adds the Nippon executive, his company has been able to beat Aflac on price.
The cancer market is far from saturated, says Hideyasu Ban, an insurance and banking analyst at Morgan Stanley Japan. There are 35 million Japanese in the workforce who still don’t have cancer coverage, according to the researcher, who notes, “Annual sales of new cancer insurance policies are about 1.5 million, so there will be at least 20 more years before the whole working population is covered.”
--K.S.
