Japan's P&C sector surges with focus on profitability and international expansion

Positive trends drive Japanese insurers towards growth, bolstered by rate revisions and strategic initiatives, a Jefferies report said.

Japan ranks as the world's third-largest life insurance market, trailing only the US and China, and the fourth-largest property and casualty (P&C) market globally, according to a Jefferies report.

Despite its substantial size, Japan's insurance industry has often been overlooked by foreign investors. Structural challenges such as a declining population, stagnant growth, and prolonged low-interest rates have constrained the profitability of Japanese insurers compared to their global counterparts.

However, the sector is undergoing significant changes, attracting attention from investors within and outside Japan. Three key factors are driving this turnaround: inflation, interest rates, and governance.

Rising inflation in Japan is leading to a positive cycle of premium revisions in both P&C, including fire and auto insurance, a trend unseen for many years. Higher inflation may also spur demand for savings and longer-term insurance products amidst sector reforms.

The Bank of Japan (BoJ) may terminate its negative interest rate policy (NIRP) by March or April 2024. This move would have significant implications for insurers, as a prolonged low-rate environment has previously hampered profitability.

Reforms in the Tokyo Stock Exchange (TSE) and antitrust investigations have encouraged Japanese insurers, particularly in the P&C sector, to unwind cross-holdings and improve business performance domestically and internationally.

These changes suggest a clear path for the recovery of Return on Equity (ROE) among Japanese insurers, potentially leading to a revaluation of the sector and reaching new heights. Investor interest is expected to grow, particularly after the upcoming results and guidance refresh in May.

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Japan's P&C market has seen a surge of 25-39% year-to-date, driven by optimism regarding the unwinding of cross-holdings, which could increase ROEs by 4-6 percentage points. 

Compared to global peers, Japanese insurers have a long runway for growth supported by secular and macroeconomic tailwinds.

Regarding specific companies, MS&AD is identified as the top pick, followed by Sompo and Tokio Marine, which represent late-cycle plays and the highest quality, respectively. Daiichi presents a levered rate trade opportunity.

Key areas of improvement within Japan's P&C sector include a favourable Combined Operating Ratio (CoR) cycle, driven by positive rate revisions, digitization efficiency gains, and the phasing out of unprofitable legacy policies. Overseas expansion is also a focus, with Japanese insurers seeking growth in international markets.

Furthermore, Japan's insurers are expected to accelerate the disposal of business-related equities in response to regulatory pressure, potentially boosting ROE by 4-6 percentage points. Rising interest rates and strong capital returns are additional factors contributing to the sector's positive outlook.