22-D-0414
July 20, 2022

Impact of Introduction of Economic Value-Based Solvency
Regulation on Insurance Companies
The following is Japan Credit Rating Agency, Ltd. (JCR)'s opinion on the "Tentative Decision of BasicContent Regarding Economic Value-Based Solvency Regulation, etc." released by the Financial Services
Agency (FSA).
(1) On June 30, the FSA released "Tentative Decision of Basic Content Regarding Economic ValueBased Solvency Regulation, etc." The economic value-based solvency regulation (the newregulation) is a regulatory change with a large impact for the life insurance industry, which has a longterm balance sheet, because it requires the mark-to-market valuation of insurance liabilities. While
JCR has been taking into account the adequacy of capital on an economic value basis based on thecharacteristics of insurance liabilities in assessing the capital adequacy of life insurers, life insurers
have steadily reduced the total amount of interest rate risk by lengthening asset durations andreviewing their liability structures. As JCR has been reflecting these factors in its review of life insurers'ratings over the past year, JCR does not believe that the introduction of the new regulation alone will
have any impact on the creditworthiness of life insurers.
(2) The introduction of the new regulation is a major event that has been discussed for many years,
dating back to 2007 when the advisory council indicated that "the future ideal solvency regulation
should aim at a method to evaluate the solvency of insurance companies based on economic value."
The FSA has been indicating in its financial administration policy that it would hold extensivediscussions with relevant parties with a view to introducing solvency regulations at a timing that does
not lag behind the Insurance Capital Standard (ICS). In June 2020, the council recommended in the"Final Report of the Advisory Council on the Economic Value-based Solvency Framework" that asteady study of a more holistic prudential policy that goes beyond solvency regulation of insurancecompanies and takes into account the internal management of insurers should be conducted, with atarget introduction date of 2025, in order to develop a regulatory and competitive environmentappropriate to changes in the environment and risks surrounding insurance companies. The
fundamental elements of the new framework are scheduled to be tentatively determined by 2022,
based on analysis through field tests and dialogue with related parties, and the announcement thistime is positioned as being in line with this schedule.
(3) The new regulation is expected to be finalized around the spring of 2024 and to be implemented in2025, and calculations based on the new standards are expected to start at the end of March 2026.
Similar to the Basel regulations for banks, it consists of Pillar 1 (solvency regulation), Pillar 2 (riskmanagement and supervisory review), and Pillar 3 (disclosure). The tentative decision this time
centers on the "standard model" and the "validation framework for ESR" under Pillar 1, while only themain issues and directions for consideration were presented for the supervisory intervention basedon ESR and Pillars 2 and 3.
(4) In rating insurance companies, JCR focuses on business base, financial base, and risk management
system based on the characteristics of their business, but on the quantitative side, JCR placesemphasis on the assessment of capital adequacy. In assessing capital adequacy, JCR takes into
account not only adequacy of regulatory capital, but also economic value-based adequacy of capital
based on the characteristics of insurance liabilities, and the higher the rating range, the more JCR
increases the importance of the assessment. In general, since life insurers have a certain amount ofvery long-term insurance liabilities due to the nature of their business and duration of their liabilities(insurance policies) is long, a gap with their assets is inevitable, making their ESR structuresusceptible to interest rate fluctuations. Therefore, not only the level of ESR but also the control of its
sensitivity through reduction of interest rate risk and other measures is important.
(5) JCR has long been incorporating interest rate risk arising from the duration gap between assets andliabilities held by life insurers as a relatively large constraining factor in its ratings. With the impending
introduction of the new regulation, the companies have clearly indicated in their medium-term
management plans and asset management policies the direction of measures such as lengthening
asset durations and reviewing liability structures, with the aim of reducing asset management risk
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and reducing/controlling interest rate risk. Although JCR has been thinking that it would take aconsiderable amount of time to reduce interest rate risk, considering balance between securingaccounting-based profits and reducing economic value-based interest rate risk, momentum toward
reducing interest rate risk is growing, and JCR believes that this trend will continue over a medium tolong term. JCR believes that the reduction of sensitivity on economic value-based indicators throughrisk reduction will positively affect the creditworthiness of each company, as already indicated in thepress release "JCR's Rating Review of Major Life Insurers" (21-D-1150) dated January 21, 2022.
(6) In order to enhance corporate value amidst a drastically changing business environment, it isimportant to manage an appropriate risk-return balance based on an economic value-based approach.
Each company has built an integrated management system for earnings and capital based on risk
management through the development of ERM. Although there are some differences among thecompanies, they are working to closely link ERM and management by incorporating economic valuebased approach into their business plans, with risk appetite as the starting point, product strategies,
asset management strategies, and capital policies.
(7) The directions of the new regulation and economic value-based risk management, which isimplemented by each company as internal management under ERM, appear to be consistent.
Nevertheless, with regard to the setting of assumptions that form the basis of calculations, internalmanagement appears to be able to capture the risk characteristics of each company in a more
realistic manner, while the assumptions for the new regulation are expected to be set in a mannerthat is common to all companies. JCR therefore believes that the impact on the management
decisions of each company may differ to some extent between internal management and regulatorycompliance. In addition, as the new regulation is more complex and requires heavier administrative
work than the current regulations, it will be necessary to improve the expertise and understanding of
human resources and take measures for systems. Securing resources related to these matters will
become issues for each company.
(8) With the introduction of the new regulation, the system of eligible capital will be restructured. This will
mean that the current somewhat divergent evaluations of regulatory capital and capital in terms ofrating will converge under an economic value-based approach. It is expected that products forfinancing with equity nature that meets the requirements for eligible capital will be considered in thefuture. JCR will consider its methods for rating of such financing products with equity nature andevaluation of equity content of those products in preparation for the finalization of the regulation.
Kiichi Sugiura, Tomohiro Miyao, Seito Achiha, and Kota Matsuzawa
Japan Credit Rating Agency, Ltd.
Jiji Press Building, 5-15-8 Ginza, Chuo-ku, Tokyo 104-0061, Japan
Tel. +81 3 3544 7013, Fax. +81 3 3544 7026
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