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Insurance-Linked Securities: First Quarter 2011 Update

The Japan Earthquake and the Asia ILS Market


The Event

On March 11, a mega-earthquake and tsunami struck the northeastern coast of Japan, killing at least 12,300 people, injuring nearly 3,000 more and causing damage to at least 203,000 homes and other structures. The magnitude 9.0 earthquake struck with an epicenter 130 kilometers (80 miles) east of Sendai, Japan and 373 kilometers (231 miles) northeast of Tokyo at a depth of 24 kilometers (15 miles). Ground shaking from the temblor reportedly lasted for two full minutes. Following the main tremor, more than 830 aftershocks rattled the region with at least 57 shocks registering above magnitude 6.0. The Japanese government estimated total economic losses to range between JPY16 to 25 trillion (USD198 to 309 billion); while the World Bank estimated insured losses to fall between JPY1 to 3 trillion (USD14 to 33 billion).

In addition to relief and recovery, additional focus was placed on eorts to cool down fuel rods inside two damaged nuclear reactors at the Fukushima Daiichi plant facility. After the earthquake and subsequent tsunami, the facility lost electricity and back-up generators also failed. This caused the essential cooling systems to shut down, rendering them unable to cool the reactors.

In recent global history, the current earthquake is the fifth strongest since 1900 and one of the strongest tremors ever recorded. The temblor was the largest since a magnitude 9.1 earthquake triggered a tsunami o northern Sumatra, Indonesia in December 2004 that left about 220,000 people dead or missing in 12 countries around the Indian Ocean. The earthquake was even stronger than the February 27, 2010 magnitude 8.8 tremor that struck Chile. The largest recorded earthquake in world history is the magnitude 9.5 earthquake that hit Chile on May 22, 1960.

Insurance Industry Eects

In the wake of the earthquake and tsunami, there are many uncertainties ahead for the Japanese insurance industry. These uncertainties are dominated by the diculty of securing reinsurance capacity, since the catastrophe occurred in the midst of its annual renewal process of treaty covers. It is too early to assess the ultimate outcome of the event, but debates continue over its impact on Japanese insurers, including whether or not the total insured losses (including those from the New Zealand earthquake) are significant enough to reverse the recent trend of falling prices for catastrophe cover.

Following the initial jolt, a tsunami with waves reaching heights in excess of 10 meters (32 feet) swept away thousands of homes, boats, cars and buildings, leaving excessive amounts of debris. The waves rushed several kilometers inland and flattened nearly everything in their path. One of the hardest hit coastal locations was in Sendai, where a nearly 10-meter (32 foot) wave of water submerged a large part of the city. Widespread damage to commercial facilities (including manufacturing sites for companies such as Toyota, Nissan, Honda and Sony) forced a stop in production. The earthquake also triggered multiple fires throughout Honshu. Many sections of the Tohoku Expressway serving northern Japan were severely damaged and all roads out of Tokyo towards quake-damaged areas were closed to all but emergency vehicles. Tokyo’s main Narita International Airport and its secondary Haneda Airport were both closed—leaving a combined 25,000 passengers stranded. Underground subway trains and bullet train service were also halted throughout the country, but have since been restored.

According to the Japan Meteorological Agency (), the earthquake may have ruptured the fault zone from Iwate to Ibaraki with a length of 400 kilometers (250 miles) and a width of 200 kilometers (120 miles). The agency noted that this event may have had the same mechanism as another large tremor that struck in 1869, which also spawned a large tsunami. It should be noted that Japan has a rigorous earthquake building code in direct response to being located on the Pacific Ocean ‘Ring of Fire’—a highly seismic region where earthquakes and volcanoes are regularly recorded. Nearly 90 percent of the world’s earthquakes occur on this arc.

Impact to the Catastrophe Bond Market

At the time of publication, several catastrophe bonds with exposure to Japan earthquake may be impacted by the March 11 earthquake, including Montana Re Ltd.’s Class E and Topiary Capital Ltd.’s Series 2008-1, each of which have been placed on credit watch. Muteki Ltd.’s Series 2008-1 Class A has been downgraded. All these bonds, along with some of the other bonds exposed to Japan earthquake, depend on data from K-Net to determine losses. 693 K-Net stations have become available, and losses on Muteki Series 2008-1 Class A bonds appear to have reached the exhaustion level which will likely put investors at the risk of losing the principal on the bond. Two catastrophe bonds sponsored by Japanese insurers expiring in 2011 were expected to be renewed, but these renewals now remain unclear.

Japanese corporations in various sectors are suering from Business Interruption and Contingent Business Interruption losses due to the continued power shortages resulting from the accident at the damaged nuclear plants. Catastrophe bonds can potentially provide viable options for such companies to mitigate their exposures in future earthquakes. Catastrophe bonds may also become a more realistic and relatively attractive option as an alternative to traditional cover if the capital markets can fully assess and absorb the impact of the March 11 event.


Source: Aon Benfield Impact Forecasting and Aon Benfield Securities

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