Underwriting funds for general insurance companies in Japan includes underwriting reserves, outstanding loss reserves, and price fluctuation reserves. These reserves are set aside subject to the Enforcement Regulation of the Insurance Business Law, the statement showing the basis of working out premiums and underwriting reserves, the Enforcement Regulation of the Law concerning Earthquake Insurance, Notices in the Gazette, the Comprehensive Guidelines for Supervision of Insurance Companies issued by the Financial Services Agency, and the Special Taxation Measures Law.
1. Underwriting Reserves
(1) Ordinary Underwriting Reserves
For all lines of general insurance business except Earthquake Insurance on Dwelling Risks and Compulsory Automobile Liability Insurance (CALI), general insurance companies must set aside an amount of unearned premiums or the "initial year balance", depending on which is greater, as their liability reserves.
As from fiscal 2005, regarding natural catastrophe related risks retained by general insurance companies, they must set aside an amount equivalent to an estimated unearned premiums calculated based on the amount of claims and the probability of such catastrophic event quantified.
The "initial year balance" means premiums received during the fiscal year less claims paid and other expenses incurred under those contracts for which the premiums have been received in the course of the said fiscal year.
In order to ensure proper risk management of insurance companies and to facilitate their accumulation of premium reserves for future claims payment, the FSA has introduced a new rule for the accumulation of reserves for third sector insurance policies effective from May 1, 2006, so that insurance companies take the following measures:
a. Ensure that premium reserves are sufficiently accumulated based on a timely and accurate ex post facto examination
b. Verify whether technical reserves are sufficiently accumulated by applying stress tests
c. Disclose the results of the above tests
(2) Catastrophe Reserves
Catastrophe reserves must be set aside by every class of general insurance, in accordance with the Notice in the Gazette No. 232 issued on June 8, 1998, except Earthquake Insurance on Dwelling Risks and CALI.
As regards natural catastrophe related risks covered by fire insurance policies, from fiscal 2005, general insurance companies must establish a rational catastrophe reserve plan and build up their reserves until the amount reaches the estimated loss caused by a natural disaster which occurs once in 70 years (i.e. typhoon Vera in 1959).
1. Accumulation Rate (A) means the minimum percentage of net premiums stipulated under a statement showing the basis of working out premiums and underwriting reserves.
2. Accumulation Rate (B) means the maximum percentage of net premiums allowed under the Special Taxation Measures Law.
3. Insurers are legally required to accumulate either of the percentages or more, i.e. Accumulation (A) or Accumulation (B) of net premiums as catastrophe reserves, depending on which is greater. They are allowed to accumulate an extra amount subject to notification to the FSA, but if the Ratio of Balance comes under the specified level mentioned in the table, they can accumulate an extra amount without such notification within the limit of 150%.
4. Disposition of Reserves occurs when the loss ratio exceeds the specified level as a Group of Business, and the excess portion of the claims can be withdrawn from the catastrophe reserves.With regard to "Atomic Energy", full amount of net claims paid can be withdrawn.
5. Accumulation Rate (A) of Fire, Marine Cargo, and Inland Transit Group is 3.8% for fire insurance, and 2.0% for marine cargo, inland transit, general liability, contractors' all risks, movables comprehensive, and windstorm & flood.
6. Accumulation Rate (B) of Fire, Marine Cargo, and Inland Transit Group is 5.0% from fiscal 2013 to fiscal 2015 as a transitional measure by the government. In cases where the tax-free balance in the said group is over 30% at the end of each fiscal year, an accumulation rate of 2.0% will be applied.
(3) Reserves for Refunds
As regards policies issued with deposit premiums of a provisional nature subject to adjustment upon expiry of the policy period, and also policies issued for a premium on condition that the whole or part of it be returnable upon expiry without loss, sums required for refunds of such premiums should be reserved at the end of every fiscal year. As regards long-term comprehensive insurance, Family Traffic Personal Accident Insurance with Maturity Refund, and other maturity-refund type (or savings type) insurance policies which are written under an agreement to receive a savings portion of premiums from a policyholder at the outset and to refund it upon maturity at a fixed rate of interest, the sum corresponding to the present value computed at compound interest should also be reserved at the end of every fiscal year.
(4) Reserves for Dividends to Policyholders
For long-term comprehensive insurance, Family Traffic Personal Accident Insurance with Maturity Refund, and other maturity-refund type (or savings type) insurance policies, any balance between the sum of income arising from the investment of the savings portion of premiums combined with investment yield and the amount which has been set aside as "reserves for refunds" as explained in (3). above, should be reserved to provide for future payments of dividends to policyholders.
(5) Reserves for Earthquake Insurance and CALI
As Earthquake Insurance on Dwelling Risks and Compulsory Automobile Liability Insurance (CALI) have their social / public nature, and are operated under a so-called "no-loss, no-profit" principle, any underwriting surplus and investment income obtained from their businesses are set aside and reserved accumulatively.
The reserves for Earthquake Insurance on Dwelling Risks under the Law concerning Earthquake Insurance should be accumulated with the amount equal to net premiums minus net business expenses plus relevant investment income. When claims occur, the amount equal to net claims paid and outstanding loss reserves shall be withdrawn from these reserves.
Reserves for CALI are composed of obligatory reserves, adjustable reserves, reserves for investment income, and reserves for loading costs. Obligatory reserves means pure premiums plus assumed interest income arising from long-term contracts minus claims paid and outstanding loss reserves. Adjustable reserves are accumulated with obligatory reserves which are carried over 5 years.
(6) Underwriting Reserves for Reinsurance Contracts
As regards reinsurance premiums ceded to the following entities, general insurance companies can be exempted from establishing underwriting reserves:
a. licensed domestic insurers in Japan,
b. licensed foreign insurers in Japan,
c. unlicensed foreign insurers which are deemed to pose few risks to the sound management of ceding companies in terms of the condition of business or assets, etc.
2. Outstanding Loss Reserves
(1) Ordinary Reserves for Outstanding Losses
General insurance companies are required to establish, at the time of closing their account, outstanding loss reserves equal to the sum of outstanding claims, premiums returnable, and policyholder's dividends payable for events which have already occurred; and the said reserves should include the sum for any claim of cases still in dispute.
IBNR (Incurred But Not Reported) reserves have formerly been required for automobile insurance, personal accident insurance, general liability insurance, workers' accident compensation insurance, and life reinsurance, based on a Notice in Gazette No. 234, issued on June 8, 1998. The FSA has introduced a statistical evaluation method to estimate IBNR reserves effective from May 1, 2006. Consequently, the lines of insurance products for which general insurance companies are required to accumulate IBNR reserves have been expanded to include all lines of insurance products except for Earthquake Insurance on Dwelling Risks and Compulsory Automobile Liability Insurance. Furthermore, general insurance companies have been required to carry out screening and calculate the IBNR reserves for those long-tail insurance contracts based on a statistical evaluation method, when they are material.
3. Price Fluctuation Reserves
With regard to stocks and other assets designated under the Enforcement Regulation of the Insurance Business Law as those which may bring about losses due to price fluctuations, non-life insurance companies are required to lay aside the amount calculated in accordance with the Enforcement Regulation as price fluctuation reserves so that their claims paying ability can be duly ensured. This does not apply to cases where non-life insurance companies have obtained approval from the Commissioner of Financial Services Agency to be exempted from reserving the total or a part of the amount.
In addition, non-life insurance companies are only allowed to dispose of price fluctuation reserves in order to make up for a deficit when the amount of losses resulting from the trade of stocks and other assets exceeds the amount of profits accruing from such trade.