The following is an unofficial translation of the risk factors included in our securities reports for the year ended March 31, 2020 submitted to the Kanto Local Finance Bureau in Japan. The information included in these risk factors, including any forward-looking statements, is as of June 23, 2020, the date of submission of our securities report (available in Japanese only).
The Company identifies "Material Risks" that may have a significant impact on business activities of the Group. Risks are taken into account for business planning and are managed appropriately from the time any evidence is recognized. The "Material Risks" of the Group and the selection process are stated below.
The Company regularly reports the status of these "Material risks" to the Executive Management Board and the Board of Directors and strives to avoid these risks and takes appropriate countermeasures when such risks realize.
Description of "Material risks" and other risks that may have a significant impact on investors' decisions are as follows. Unless otherwise indicated, the matters relating to the future in this section have been determined by the Company and the Group as of the date of submission of the securities report.
In addition, the Group recognizes the risks associated with the COVID-19 pandemic and will continue to closely monitor them.
Risk associated with the COVID-19 pandemic
The Group is exposed to the risk of unpredictable insurance benefit payments in the event of a pandemic (COVID-19, bird flu and influenza) that inflicts a large number of fatalities. The Group maintains and accumulates contingency reserves in accordance with industry practices/accounting standards and regularly assesses risk resistance by means of stress tests, etc. In the event of a situation, which may include a pandemic or financial turmoil, that greatly exceeds the assumptions of a stress scenario, reserves may not be adequate to cover actual insurance payment obligations. This may adversely affect the financial condition and business performance of the Group.
As for pandemic scenario stress tests, the Group considers the situation of COVID-19 in multiple regions. In Japan, our scenario is based on an infection rate of 10% of the total population with a fatality rate (number of fatalities/number of infected people) of 10%. Based on these assumptions, we have confirmed that we are capable of fulfilling insurance payment obligations.
I. Risks Relating to Financial Markets etc.
1. Deterioration in global financial markets and economy
Our results of operations are materially affected by conditions in the economy generally and in global financial markets. In Japan, the future outlook of the Japanese economy includes uncertainty mainly due to a heightening of geographical risk, outcome of trade negotiations with the United States and China. Particular concerns include how financial and monetary policy impacts exchange rates and the economy in developed countries. The uncertainty of global economy may contribute to volatility in financial and capital markets and affect major developed economies.
Although the Group regularly assesses risk tolerance through stress tests, etc., and takes prompt action to reduce risk if there are concerns regarding the financial soundness of the Group, in such cases, economic conditions deteriorate, the demand for our insurance and annuity products could be adversely affected and our surrender and lapse rates for individual insurance products could increase. Low interest yields and any declines in stock prices could also have a negative impact on our net investment income, financial conditions and results of operations.
To secure high financial soundness, the Company set forth an economic solvency ratio (ESR) target range of "170% to 200%" as part of its medium term management plan "CONNECT 2020." We estimate that ESR was within this range during March 2020 in an extremely volatile financial environment. As of March 31, 2020, ESR was 195%(*) securing a level of above 170%.
ESR at this level of soundness not only reflects our efforts to diversify our business by expanding overseas, but also a diversified investment portfolio at The Dai-ichi Life Insurance Company, Limited (Dai-ichi Life) and our capability to manage our assets under market fluctuations with effective risk-hedging operations.
Dai-ichi Life has continued efforts to mitigate market risks that involve interest rates and stock prices. In FY2019, foreseeing that low domestic interest rates will likely persist, we reduced interest rate risk by lengthening duration through purchasing super-long-term bonds and utilizing derivatives. In addition, while we reduced our equity holdings according to our plan, we strategically ceded insurance blocks with high assumed rates to reinsurers. These efforts are aimed at reducing our vulnerability to financial market fluctuations.
It is expected that global financial markets will continue to be unstable. We will take measures to mitigate market risks a further step to stabilize ESR. Specifically, we aim for approximately 20% reduction (compared to the end of FY2019) in economic value based interest rate and equity risks by the end of FY2023 with the intention to reduce group EEV sensitivity to market interest rates and equity value movements by approximately 20%.
Measurement standards updated as from the end of March 2020 (178% based on former standard as of March 2020.)
2. Changes in the value of equity securities
Global financial markets, including Japanese equity markets may be volatile due to the global economic and financial conditions. Any declines in stock prices due to the economic crisis and uncertainty about the prospects for recovery in major economies could have a significant adverse impact on our net investment income, net assets, solvency margin ratio and our financial conditions through losses on valuation of securities, losses on sale of securities and reduced unrealized gains on securities and decrease in gains on sale of securities.
The amount of net unrealized gains on securities available for sale affects our net assets, our total solvency margin and our solvency margin ratio.
In order to prepare for the risk of declines in stock prices caused by volatile market conditions and worsening economic conditions, we continuously pay attention to fluctuations in the market and also use derivative instruments to hedge market risks. If the domestic and international economic environment and stock markets continue to worsen, further losses in the future could have a material adverse impact on our financial condition and results of operations.
3. Changes in interest rates
In an effort to manage our investment assets in a manner appropriate to our liabilities, which arise from the insurance policies we underwrite, we engage in asset liability management, or ALM, which considers the long-term balance between assets and liabilities in an effort to ensure stable returns. Any significant changes in market conditions, such as the increase in volatility of yields, could make our ALM objectives more difficult to achieve and have a material adverse effect on our financial condition and results of operations. In addition, if mid- or long-term interest rates were to fluctuate within a significantly lower range, it would make it difficult for us to maintain the current level of profitability and may require us to suspend the sale of additional savings-type insurance products.
In particular, because Dai-ichi Life's liabilities to policyholders generally have a longer duration than our investment assets, it is subject to risks related to changes in interest rates due to duration mismatch between assets and liabilities. During periods of declining interest rates, its average yield on investments declines because maturing investments, as well as bonds and loans that are redeemed or prepaid to take advantage of the lower interest rate environment, are replaced with new investments that provide lower yields. Such lower interest rates reduce yields on its investment portfolio while insurance premiums remain generally unchanged on outstanding policies. As a result, its profitability and long-term ability to meet policy commitments can be materially and adversely affected. In such a case, it could not secure planned profits and the average yield on its investment portfolio could be lower than the assumed rates of return used to set insurance premiums on existing policies, also referred to as "negative spread."
In periods of increasing interest rates, while the increased investment yields should lead to an increase in returns on our investment portfolio, surrenders of policies may possibly increase as policyholders seek investments with higher returns. In addition, a rise in interest rates will have a negative impact on our net assets due to a decrease in the fair value of our fixed income assets. While we accumulate policy-reserve-matching bonds that are valued based on the book value of investment assets in our portfolio subject to certain duration matching strategies as part of our measures to manage the risks related to a rise in interest rates, a significant rise in interest rates over a short period of time could have a material adverse effect on our financial condition and our profitability.
In addition, The Dai-ichi Frontier Life Insurance Co., Ltd. (Dai-ichi Frontier Life) also implements ALM to appropriately manage assets to match liabilities incurred by insurance contract underwriting. Market price adjustments (MVA) are applied to U.S. dollar-denominated and Australian dollar-denominated products, which have been increasing their sales since fiscal year 2018. A sharp and significant fall in U.S. and Australian interest rates could have a material adverse impact on our financial condition and results of operations.
4. Investment portfolio exposes us to a number of other risks
Generating stable investment income is important to our operations and we invest in a variety of asset classes, including Japanese government and corporate bonds, foreign government and corporate bonds, domestic stocks, foreign stocks, loans, real estate and alternative investments. While we strive to minimize risks, our investment portfolio exposes us to a variety of other risks that we may be unable to avoid, as summarized below.
a) Foreign exchange risk
Our investment securities include non-yen-denominated securities. The non-yen-denominated securities consist primarily of foreign bonds (principally foreign government and agency bonds and foreign corporate bonds), foreign stocks and securitized instruments. Changes in market value of these securities, excluding those owned in the separate account or used to hedge foreign exchange risk of foreign-currency-denominated liabilities, would have an effect on our results. While we hedge our foreign currency exposure with respect to a portion of our foreign bond holdings, a significant exchange loss could have a material adverse impact on our financial conditions and profitability.
b) Credit risk
We are subject to the risk that issuers of the debt securities we hold may suffer a decline in credit quality, such as a credit rating downgrade, which would cause a decline of the market value of the debt securities we hold. We are also subject to the risk that issuers of the debt securities we hold may default on principal and interest payments due on their obligations. These risks could lead to losses on valuation of securities, a decrease in gains on sales of securities or a decrease in unrealized gains on securities. We also face counterparty risk with respect to the derivative instruments that we use to hedge market risks, such as interest rate swaps, foreign exchange forward contracts and stock index futures. Any failure by a counterparty to honor the terms of its derivatives contracts with us could lead to losses on valuation of securities and other losses or losses on sales of securities and reduced gains, which would have an adverse effect on our results of operations and financial condition.
In addition, with respect to loans, we are exposed to the risk that the financial position and the credit quality of our borrowers will erode, which could lead to increased credit costs in our loan portfolio. We provide for an allowance for possible loan losses based on evaluations and estimates regarding borrowers. However, actual losses on loans could exceed the amount of the allowance or we could be required to increase allowance amounts in the event of failures or a deterioration of the credit quality of borrowers as a result of adverse conditions in the domestic or global economy, specific industry issues or other causes.
We have significant exposure to major Japanese banking groups, the majority of which is in the form of subordinated debt. Generally, the value of such instruments is more sensitive to changes in the credit profile of the relevant bank issuer than the value of its senior debt instruments. Adverse changes in the creditworthiness and financial performance of Japanese banks could lead to losses on valuation of securities, increases in our allowance, and other losses or reduced gains, which would have an adverse effect on our results of operations and financial condition.
c) Securitized instruments
We hold securitized instruments, including instruments backed by residential mortgages in the U.S. and Japan. In the event that the adverse conditions in credit markets and the lack of market liquidity for such instruments worsen, the value of our securitized instruments and other investments that we hold could decline, and our financial condition and results of operations could be adversely affected as a result.
d) Real estate investment risk
We own domestic real estate for investment and business purposes. In the event an economic downturn resulted in a downward trend in real estate prices, rent and occupancy rates in Japan, our real estate-related income may decrease and our financial condition and results of operations could be adversely affected as a result.
5. Liquidity risk
Many of the products we offer allow policyholders to make policy withdrawals of a portion of the amount of accumulated premiums and to surrender their policies in return for the payment of a predetermined amount.
We manage our liabilities and our investment portfolios to provide and maintain sufficient liquidity to meet anticipated withdrawal and surrender demands, payments of policy benefits and requests to pledge collateral in relation to derivative contracts with financial and other institutions and have also entered into overdraft facilities to increase our liquidity. A certain portion of our assets, however, such as real estate, loans and privately placed securities, are generally illiquid. If we are required to pay significant amounts of cash on short notice, for example due to unanticipated withdrawal or surrender activity or a catastrophic event such as a pandemic, we could exhaust our liquid assets and overdraft facilities and be forced to liquidate other assets, possibly on unfavorable terms. In addition, turmoil in financial markets could lead to a liquidity crisis in which we are unable to dispose of our otherwise liquid assets on favorable terms or at all. If we are forced to dispose of assets on unfavorable terms or are unable to dispose of assets, it could have an adverse effect on our financial condition and results of operations.
6. Credit rating downgrades
Developments that reduce our actual or perceived financial strength could have an adverse effect on our business, financial condition and results of operations due to increases in policy surrenders, withdrawals, decreases in new policy sales or increased costs and other difficulties with respect to our investment, funding and capital raising activities. Such effects could be caused by an actual downgrade in our companies' ratings by credit rating agencies or a significant reduction in our solvency margin ratio and other indicators of financial soundness, as well as the potential for ratings downgrades, negative media coverage, negative rumors or negative developments in the Japanese life insurance industry as a whole. Significant declines in our solvency margin ratio, particularly relative to other major life insurance companies in Japan, could adversely affect our business, financial condition and results of operations.
In addition, we may be unable to raise capital on favorable terms, or at all, in the future in the event of a reduction or perceived reduction in our financial strength or due to adverse conditions in debt or equity capital markets or other factors.
II. Risks Relating to Catastrophes
We are exposed to the risk of unpredictable liabilities for insurance claim payments in the event of catastrophic mortality in Japan due to catastrophic events, such as earthquakes, tsunamis, terror attacks, disputes, wars or a pandemic, such as avian or swine flu, and other more localized disasters affecting densely populated areas in Japan. Although we maintain a contingency reserve consistent with industry practice and accounting standards, there can be no assurance that such reserve will be adequate to cover actual claim liabilities. In addition, physical damage and other effects of such catastrophes could result in significant disruptions to our business operations.
As described at the beginning of this section.
III. Risks Relating to the Business Environment etc.
1. Sales are concentrated in individual life insurance policies
A variety of factors affect sales of individual life insurance policies and individual annuity products generally, including:
- Levels of employment and household income in Japan
- Relative attractiveness of alternative savings and investment products
- Public perception of the financial strength, integrity or reputation of insurance companies
- Long-term demographic trends affecting the makeup of Japan's population, such as birthrate trends and the overall aging of Japan's population
- Customer needs related to sales channels and products
Changes in these and other factors could result in a decrease in sales of new individual life insurance products or an increase in policy surrenders and lapses, any of which could have an adverse effect on our results of operations and financial condition.
Our sales of individual life insurance products have relied primarily on the sales representative channel and the bancassurance channel while we strive to diversify our sales channels. In the future, if changes in regulations or business environment result in the emergence of other distribution channels for individual life insurance policies or for individual annuity products, or if the number of our sales representatives decline significantly due to the intensification of recruiting environment, we may face challenges in maintaining our competitive position, profitability and market share, and this could have an adverse effect on our business and results of operations.
2. Sales of annuity products through bank and securities company sales agents
Dai-ichi Frontier Life, our wholly-owned subsidiary that commenced operations in October 2007, is dedicated to the development and sale of new annuity products through these channels. Demand for Dai-ichi Frontier Life's products may decrease due to factors such as poor consumer sentiment in Japan, weak investment performance or increased competition among life financial institutions. In addition, we may have to limit, suspend or cease sales of our variable annuity products through certain of our financial institution sales agents in order to manage our exposure to the risks associated with the guaranteed minimum benefits that some of these products feature.
Although we aim to increase the number of sales agents, the sales of yen-denominated and foreign currency-denominated fixed insurance products and other products as well as to diversify our product lineup, there can be no assurance that we will be able to compete effectively or that we will succeed in increasing our sales or achieving targeted profitability. In addition, competition between our financial institution sales agents, including our bank and securities company sales agents, and our own sales representatives could increase in the future.
3. Unsuccessful initiatives in new markets
As customer needs have diversified recently, sales of both protection and savings-type insurance products through bancassurance channels have expanded, and the number of customers who want to compare and choose insurance products at walk-in insurance shops is increasing. With this type of customer in mind, The Neo First Life Insurance Company, Limited (Neo First Life), our wholly-owned subsidiary, offers a new generation of products and services through agency channels such as retail bank branches and walk-in insurance shops. Neo First Life mainly deals with medical care products that are easy to understand and have simple procedures.
Although we are designing strategies and offering products that match the business environment in which we compete, these competitive strategies may not deliver the expected results and the level of sales anticipated is not achieved due to sales of similar products by competing companies or due to unforeseen circumstances. In addition, sales by independent agents may increase if the commission rates of these independent agent channels remain at a high level, which could result in higher operating expenses than originally anticipated. As a result, it may take longer than expected before our operations in new markets become profitable.
4. Demographic trends in Japan
Since the mid-1970s, Japan's total fertility rate had generally been on a long-term decline. Since 2005, this trend has reversed and marginally decreasing in recent years but the total fertility rate remains to be at a low level.
If the population continues to decline and leads to reduced demand for life insurance products, our life insurance business in Japan may scale down and our financial condition and results of operations may be materially and adversely affected.
5. Competition in the Japanese financial services industry
Our domestic life insurance subsidiaries face intense competition in the Japanese life insurance market from both domestic and foreign-owned life insurance companies and from large domestic financial service providers that either have their own insurance subsidiaries or enter into cooperative arrangements with major insurance companies. Particularly, competition has increased in the Japanese life insurance market due to industry deregulation, an overall decline in demand for insurance products with death benefits and increased competition from foreign insurance companies, among other factors. Some of these competitors may have advantages over us, including greater financial resources and financial strength ratings, greater brand awareness, more extensive marketing and sales networks, more competitive pricing, larger customer bases, higher policyholder dividends and a wider range of products and services. In addition, big data is actively being utilized for product development and services. If we fall behind our competitors in the utilization of information and communication technology, we may not be able to expand our business and secure future profitability.
In addition, Japan Post Insurance enjoys competitive advantages in the Japanese insurance market due to its large existing customer base and nationwide network of post office branches. Japan Post Insurance remains subject to limitations on the type and amount of insurance coverage it may provide. If these limitations are eased or eliminated, upon Japan Post Holdings Co., Ltd. ceasing to hold 50% or more of the voting rights of Japan Post Insurance or otherwise, competition in Japan's life insurance market could further intensify. Under these circumstances, on March 29, 2016, we entered into a basic agreement with Japan Post Insurance to form a business alliance in certain areas with the aim to complement our expertise and further strengthen our business foundation. We also face competition from various cooperative associations such as the Japan Agricultural Cooperatives, the National Federation of Workers and Consumers Insurance Cooperatives and the Japanese Consumers' Co-operative Union, all of which offer competing life insurance products.
Various deregulatory measures have had the effect of increasing competition in the Japanese life insurance industry. For example, a number of deregulatory changes enacted between 1998 and 2007 enabled securities companies and banks, respectively, to engage in sales of an increasing array of insurance and annuity products. Future deregulatory measures that favor large, established financial conglomerates could result in additional consolidation financial services industry in Japan. As the regulatory barriers between different financial services industries in Japan continue to be relaxed, we expect competition within these industries to continue to intensify. In addition, we may face price competition from other Japanese life insurance companies that sell lower-priced insurance products through outlets such as walk-in insurance shops, as well as increasing price competition in the future from new entrants to the Japanese life insurance industry that rely on the internet as their primary sales channel. Japan's financial sector may face consolidation that could affect the competitive environment for the sale and distribution of life insurance products.
In addition, as a result of our acquisition of insurance companies in Vietnam, Australia and the United States, our investments in overseas insurance companies in Indonesia, India and Thailand, and our establishment of an insurance company in Cambodia, we face competition from life insurers already operating in each of these overseas markets. Furthermore, in Myanmar, we are preparing for launching life insurance business operations and we expect to face competition with local insurance companies.
Increased competitive pressures resulting from these and other factors may cause our new policy sales to decline and policy surrenders to increase if we are not successful in maintaining our competitiveness, which could have a material adverse effect on our businesses and our results of operations.
6. Advancement of medical technology
In recent years, R & D is progressing in various fields of medicine and such developments will improve such practices as prediction of disease occurrence, medical diagnosis, preventive treatment and cure. And diseases that were not discovered in the past would be discovered. By being able to grasp the risk of future disease there is a possibility that customers with high risks may proactively join insurance with higher benefit coverage and insurance payments may significantly increase.
On the other hand, competitiveness of current products may deteriorate influenced by:
the intensification of price competition due to further segmentation of risk,
the significant divergence of benefits from soaring medical costs led by expansion of liberalized medical care and variety of medical treatment,
the insurance policy coverage may become obsolete due to discovery of new diseases.
In addition, for customers with lower risk, the need for insurance may decline resulting in the decrease of sales of new contracts and increase in surrender of existing policies. As a result, there is a possibility that the Group's business results may be adversely affected.
7. Climate change
The awareness that environmental concerns, climate change in particular, are issues for the international community as a whole has increased with the Paris Agreement of 2016. The Dai-ichi Life Group, which operates life insurance and asset management businesses globally, also recognizes climate change as an important management issue that could significantly affect the lives and health of its customers, corporate activities, and social sustainability.
Based on such awareness, in addition to strengthening management resilience through an assessment of the risks and opportunities posed by climate change, we announced our endorsement of the Task Force on Climate-related Financial Disclosures (TCFD) Recommendations in September 2018 in order to enhance corporate value through sound dialogue with stakeholders based on such disclosure.
Physical and transition risks of climate change (policy/legislative risk, technological risk, market risk) may adversely affect the performance of the Group. Physical risks are expected to increase due to an increase in heat stroke and infectious diseases due to global warming that could result in an increase in insurance payments and benefits. Likewise, if there is an increase in flood damage due to typhoons. In addition, as for transition risk, the value of investments and loans to companies that are insufficient to respond to environmental changes such as carbon tax introduction, asset damage due to changes in market and social environment, new technology development, response to changes in consumer behavior, etc. are expected to decrease.
IV. Risks relating to Corporate Brands etc.
1. Cyberattacks and system failures
The Group promotes the establishment of a group IT governance system that adopts COBIT5 (*) in order to support its global business and continue to provide value to customers around the world.
In addition, "Group IT Governance Basic Policy" is set forth to share the direction of the IT governance system based on COBIT5 within the group. Based on the promotion of IT governance, we aim to utilize IT to contribute to the global business by creating synergies with domestic and overseas group companies by exchanging opinions and sharing information on various IT initiatives. In addition, once a year, we hold a conference that brings together IT managers of domestic and overseas group life insurance companies to discuss group-wide initiatives considering the business characteristics of each group company.
We rely heavily on information technology systems, including those of third-party service providers, in conducting our business. We rely on these systems to manage customer policies, invest our assets, record and maintain statistics and personal information of our customers and in other areas of our operations. As we expand our operations and product offerings, our information technology systems could potentially require significant additional investments.
Our information technology systems could fail due to various causes, including problems affecting the internet generally or damage to equipment, software or networks as a result of accidents, fires, natural disasters, power loss, high user volume, human errors, sabotage, hacking, employee misconduct, software and hardware defects and malfunctions, viruses or network intrusions. Any such failure could disrupt the services we provide to customers at our branches, our payments and collections, and the investment of our assets, among other things. Such failures could also have other adverse consequences, including reputational damage, customer dissatisfaction or a loss of customer confidence, which could result in increased policy surrenders, a decrease in new policy sales and legal or regulatory sanctions, and this could have an adverse effect on our results of operations.
COBIT5: Framework for measuring the maturity level of IT governance advocated by the Information Systems Audit and Control Association and IT Governance Institute.
2. Misappropriation of information
We make extensive use of online services and centralized data processing, including through the use of third-party service providers, so the secure maintenance and transmission of confidential information is a critical element of our operations. There can be no assurance that customer information has not been and will not be lost or disclosed or taken without consent or that our information technology and other systems, or those of our third-party service providers or strategic business partners, will not be compromised. If we lose, or disclose without consent, customers' personal information or if a third party is able to penetrate our or our business partners' or service providers' network or otherwise misappropriate our customers' personal information, we could be subject to legal claims, and our reputation could be damaged. Any loss, disclosure or misappropriation of customer information or other breach of our security would likely have a serious impact on our reputation and could have a significant adverse effect on our business and results of operations.
3. Misconduct by stakeholders
We are exposed to potential losses resulting from fraud and other misconduct by our stakeholders, including employees, independent sales agents, third-party service providers and customers. Our sales representatives and independent sales agents have direct contact with customers and knowledge of their personal and financial information. In addition, some of our third-party service providers also have knowledge of personal and financial information relating to our customers.
Misconduct can include, among other things, illegal sales practices, fraud, identity theft or other improper use of personal information.
Customers may also engage in fraudulent activities, including fraudulent use of policies or the use of false identities to open policies. Customers who have not revealed that they are members of antisocial groups may also enter into transactions with us. Though we have adopted measures to prevent or detect such fraudulent activities, our efforts may prove ineffective in preventing fraudulent or illegal activity or transactions with anti-social groups. In the event our employees, independent sales agents, third-party service providers or customers engage in any misconduct, our reputation could be seriously damaged and we could become subject to significant legal liabilities and regulatory sanctions.
4. Non-payments and underpayments of claims and benefits
In October 2007, in response to a reporting order from the FSA, we conducted self-assessments of non-payments and underpayments of claims and benefits and omissions to inform policyholders of the claims they may be able to make in cases where payments were warranted during the five-year period beginning April 2001. We reported nearly 70,000 cases, representing an aggregate of ¥18.9 billion in claims and benefits, in each case on a non-consolidated basis, of non-payments and underpayments to our policyholders. A substantial majority of our underpayments related to unclaimed payments for medical riders to life insurance policies, and we believe they occurred due to the lack of comprehensiveness and other deficiencies in our original claims review process.
In July 2008, the FSA issued a business improvement order that required an enhancement of governance and internal audit structures and an implementation and assessment of the effectiveness of remedial measures. In August 2008, we submitted a business improvement plan to the FSA describing the remedial measures we are undertaking to strengthen and improve our governance and internal audit policies and procedures and to prevent non-payments and underpayments in the future.
We have aimed to establish and enhance the effectiveness of improvement measures by sharing the understanding that the value of insurance is to be displayed when the claims and benefits are paid to our policyholders with our employees based on the perspective of our customers. Although the reporting obligation to the FSA was lifted in December 2011, in the event that the FSA deems that the development of our management structure for payments is insufficient for any reason, our reputation could be harmed and our business and results of operations could be adversely affected. We will continue to regularly report the occurrence of non-payments and underpayments of claims and benefits and improve our management structure for payments while monitoring the advancement of medical technology.
5. Reputation Risk
We may incur loss as a result of deterioration of credibility in case the name of the company is reported through media due to an inappropriate event.
The Group strives to prevent realization of reputation risk by maintaining and improving credibility through press releases and timely information disclosure. However, if media reports inaccurate information, insurance policy holders or other related parties may believe in such news that could lower our reputation and could possibly adversely affect our business development or results of operation.
We are involved in litigation relating to our insurance operations on an ongoing basis. While we cannot predict the outcome of any pending or future litigation, we do not believe that any pending legal matter will have a material adverse effect on our business, financial condition or results of operations. However, given the inherent unpredictability of litigation, an adverse outcome in one or more of these matters could have a material adverse effect on our operating results or cash flows.
V. Risks Relating to Regulations etc.
1. Subject to extensive regulation
a) As a Japanese insurance company, we are subject to extensive oversight, including comprehensive regulation by the Financial Services Agency of Japan, or the FSA, under the Insurance Business Act and related regulations. The primary purpose of the Insurance Business Act and its related regulations is to protect policyholders, not debt holders or shareholders. The Insurance Business Act places restrictions on the types of businesses that we may engage in, imposes limits on the types of investments that we may make and requires us to maintain specified reserves and a minimum solvency margin ratio. The Insurance Business Act also gives the FSA broad regulatory powers over our business, including the authority to revoke operating licenses, suspend operations, request information and conduct rigorous on-site inspections of books and records. In addition, we generally must receive prior FSA authorization for the sale of new insurance products and changes in the pricing terms of our products.
b) Currently, we are required to maintain a solvency margin ratio, which is a measure of capital adequacy, of 200% or above, on both a consolidated basis and non-consolidated basis. If we fail to maintain an appropriate solvency margin ratio or other indicators of financial soundness, the FSA could require us to take a variety of corrective actions.
In April 1999, prompt corrective action, a system under which the Prime Minister may impose administrative dispositions such as the issuance of business improvement orders and business suspension orders, was introduced under the Insurance Business Act with an aim to ensure the soundness and appropriateness of business operation of insurance companies. Specifically, if the solvency margin ratio of a life insurance company falls below 200%, the Prime Minister may order the insurer to take corrective action in order to prompt swift improvement of its management. Details of the action are determined based on the levels of the solvency margin ratio, etc. Moreover, the Prime Minister may order the suspension of business in whole or in part in the event that the adjusted net assets of an insurer are negative or are expected to be negative. Such prompt corrective action may adversely affect our business development or results of operation.
c) International Association of Insurance Supervisors (IAIS) is developing ComFrame (Common Framework for the Supervision of Internationally Active Insurance Groups (IAIG)) and adopted in November 2019. We fulfil the criteria for the quantitative standards of IAIG and we may be certified as IAIG. Especially, Insurance Capital Standard (ICS), which is a new regulation based on economic value as a part of ComFrame, are expected to be significantly different from the current regulations. Additional requirements that may be proposed in the future could result in significant changes to the current solvency margin regulations, and restrictions included in any such new regulations could result in new limitations on our business or investment activities.
In addition, the Financial Stability Board (FSB) annually selects Global Systemically Important Insurers (G-SIIs) and implements various policies which include enhancement of supervision of G-SIIs. If we are selected as G-SIIs, our business development or results of operation may be adversely affected.
This comprehensive framework will focus on action-based approaches that not only capture the risks of individual companies that include G-SIIs selection, but also capture the risks that could occur if multiple insurance companies take similar actions simultaneously, and will include precautionary supervisory policies and supervisory authority. Additional requirements that may be proposed in the future could result in significant changes to the current regulations, and restrictions included in any such new regulations could result in new limitations on our business or investment activities.
2. Future changes in the laws and regulations
Changes in the laws and regulations applicable to us and changes in government policies regarding their enforcement, regulatory actions against our group and other life insurance companies, and the regulatory trend related to the expansion of the product lineup our group offers, could adversely affect our new policy sales, lead to increased compliance risk and increased expenses required to strengthen and improve compliance, increase the level of competition we face or otherwise adversely affect our business. In addition, we have many third-party sales agents as well as our own sales representatives, and there can be no assurance that they will be able to effectively and timely adjust their sales practices to comply with future regulatory changes.
Current income tax laws permit individuals to deduct for income tax purposes all or a portion of the premium payments on almost all of the insurance and annuity products we offer. Similarly, corporate and small business policyholders are permitted to deduct as a business expense, subject to certain conditions, all or a portion of the costs of premiums of certain types of life insurance products, such as term life insurance, and annuity products. Any further changes in Japanese tax laws or regulations that affect the tax treatment of premiums on our insurance and annuity products could adversely affect our number of new policy sales.
VI. Other Risks
1. Differences between future claims and benefits and the actuarial assumptions used in pricing
Our earnings depend significantly upon the extent to which actual claims and benefits experience is consistent with the assumptions used in pricing our products and determining the amount of policy reserves. Assumptions include future mortality rates, investment returns and expenses related to our business. Actual mortality rates that are higher, investment returns that are lower or expenses that exceed those projected could have a material adverse effect on our financial condition and results of operations. Any revisions to the standard mortality table or the standard prospective yield would affect the determination of actuarial assumptions, and as a result, they would also affect our financial condition and results of operations. The assumptions used in pricing products that insure non-traditional risks, including "third sector" insurance products (a term used in Japan to refer to products such as medical insurance, cancer insurance and nursing care insurance products) with respect to which we have increased our sales efforts in recent years, involve an added degree of uncertainty, as they are often based on limited experience when compared to assumptions used for life insurance and annuity products covering traditional risks.
We re-estimate our policy reserves periodically and, as necessary, record changes in our policy reserves as expenses or revenues. To the extent that actual claims results are less favorable than the assumptions originally used, or if changing circumstances require us to modify our underlying assumptions, we could be required to increase our policy reserves. Such an increase, if significant, could have a material adverse effect on our financial condition and results of operations.
Some of our yen-denominated and foreign-currency-denominated fixed products have a Market Value Adjustment (MVA) function: when the interest rates decrease, we are required to make insurance reserves, and in contrast, when the interest rates increase, we reverse such reserves. Therefore, our earnings may fluctuate depending on interest rates movements. In addition, some our variable annuity products feature guaranteed minimum benefits. For guaranteed products, we are required to re-estimate our policy reserves and to make additional provisions for any shortfall that increases our expenses. In the event that we are required to make significant additional provisions, this could have an adverse effect on our financial condition and results of operations. We attempt to hedge our obligations with respect to guaranteed products, including by employing dynamic hedging (which is one of the measures that can be used to hedge the risk of price fluctuations). However, there can be no assurance these hedging efforts will be successful and they could have a material adverse effect on our financial condition and operating results.
2. Re-insurance contracts
We utilize re-insurance contracts to reduce risks related to insurance reserves, etc. However, there can be no assurance we will be able to obtain such re-insurance transactions on favorable terms, or at all, in the future. In addition, we face counterparty risk with respect to our re-insurance contracts. These factors could have an adverse effect on our financial condition and operating results.
3. Acquisitions may not produce the intended benefits
Since our reorganization from a mutual life insurance company to a joint stock corporation, we have engaged in acquisitions as part of our business strategy, and we intend to continue to seek opportunities for further acquisitions in the future. However, we may be unable to engage in future acquisitions due to our inability to identify appropriate acquisition targets, negotiate and agree on acceptable terms of the transaction, obtain adequate financing, obtain required consents, clearances or approvals, address other legal or regulatory issues or for any other reasons. In addition, we may incur impairment loss if the value of the acquired company declines. While we have gained some experience in recent years in identifying attractive acquisition targets, executing mergers and acquisitions and integrating acquired businesses, the success of any future mergers and acquisitions we undertake will depend on factors such as:
our ability to integrate the acquired business operations, products, services and personnel with our existing business operations and culture;
our ability to extend our risk management, internal controls and reporting systems and procedures to acquired companies and businesses;
the degree to which the products and services of acquired businesses complement our existing business lines;
continued demand for the acquired products and services; and
our ability to realize any targeted cost efficiencies.
In addition, Protective Life Corporation may not be able to convert and service policies from other insurance companies, profitability may not be secured from its Acquisitions segment.
If acquisitions do not produce the intended benefits, it could potentially have an adverse effect on our financial condition and operating results.
4. International operations and continuing overseas expansion
In recent years we have been developing our overseas insurance and asset management operations in an effort to secure revenue sources outside of the Japanese market.
Specifically, in the overseas life insurance business, we acquired insurance companies in Vietnam, Australia and the United States, invested in overseas insurance companies in India, Thailand and Indonesia, and our establishment of an insurance company in Cambodia. Furthermore, in Myanmar, we are preparing for launching life insurance business operations. As our operations are expanding overseas, we have enhanced our management and business support structures by establishing regional headquarters in the North America region and the Asia Pacific region. While we believe these markets have growth potential, there can be no assurance that penetration rates for life insurance products will increase to the extent we expect or to the levels seen in more mature markets.
Our international operations and continuing overseas expansion expose us to a number of risks, including:
fluctuations in foreign currency exchange rates;
unfavorable tax regulations in the future;
unexpected legal or regulatory changes;
limited understanding of customer needs, market conditions and local regulations;
difficulties in recruiting and retaining personnel and managing international operations; and
competition with additional multinational firms.
Although we intend to continue to expand our international operations, because of the risks associated with such expansion, including the risks described above, there is no assurance that our overseas expansion will be successful. We may suffer impairment losses on our investments in overseas companies and could withdraw from markets where we do not achieve our intended goals.
VII. Risks other than "Material risks"
1. Changes in relationships with or performance of our strategic partners could harm our business.
We have entered into a number of business alliances with companies inside and outside of the life insurance industry to expand our distribution channels and product offerings, including important alliances with Sompo Japan Insurance Inc., American Family Life Assurance Company of Columbus (AFLAC), Mizuho Financial Group, Inc., Resona Holdings, Inc. and Japan Post Insurance Co., Ltd. These relationships are integral to our business strategy of growing our sales of third sector products and annuity products and enhancing our business bases. In addition, Asset Management One Co., Ltd., is one of largest pension asset managers in Japan, and our joint venture with Mizuho Financial Group. The Company has 49% shareholder voting rights and 30% economic ownership in Asset Management One Co., Ltd. If our strategic partners encounter financial or other business difficulties, if their strategic objectives change (due to industry consolidation or otherwise), or if they come to believe we are no longer an attractive alliance partner, they may no longer desire or be able to participate in our alliances. Our business and results of operations could be harmed if we become unable to continue our alliances.
2. We may not be able to hire, train and retain a sufficient number of qualified sales representatives and other employees.
Dai-ichi Life's business depends to a significant extent on our ability to hire, train and retain qualified sales representatives. Sales generated by sales representatives account for most of its premium income, and sales by its more productive sales representatives account for a disproportionately high percentage of its sales of individual insurance and annuity products. Average turnover of its sales representatives is significantly higher than its other employees, and its efforts to retain or replace productive sales representatives may not be successful. Other group employees, including investment and actuarial personnel, also require a high level of expertise, and special efforts are required to attract, train and retain qualified personnel. If we are unable to attract, train and retain qualified sales representatives, and other personnel, or if, as a result of these reasons, our sales fall significantly below our estimates, our business and results of operations could be materially and adversely affected.
3. Our risk management policies and procedures may not be effective.
Our risk management policies and procedures are meant to address a range of risks, encompassing insurance underwriting risk, investment risk, liquidity risk, operational risk and system risk. Many of our methods of managing risks and exposures are based on our use of observed historical market behavior or statistics based on historical data. These methods may not predict future losses, which could be significantly greater than indicated by the relevant historical data. Other risk management methods depend in part on our evaluation of publicly available information regarding markets, customers or other matters, and such information may not always be accurate, complete, up-to-date or properly evaluated. In addition, our risk management procedures depend in part on the consolidation of information gathered from many group companies and other sources, and errors may be introduced during the process of gathering and compiling such information. Generally, any failure or ineffectiveness of our risk management policies or procedures could materially and adversely affect our business, financial condition and results of operations. In particular, management of operational risk requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and our policies and procedures may not be entirely effective. Operational errors by our employees, strategic partners or outside service providers could result in reputational or financial harm to us and in regulatory sanctions.
In addition, as the domestic and overseas life insurance markets continue to evolve and develop in the future, we intend to broaden and diversify the range of products and services that we offer while also expanding our customer base. As we expand our product and service offerings and increase the scale of our business, we may have difficulty achieving the risk management improvements necessary to manage the risks associated with new business activities and increased scale. If we fail to adapt our risk management policies and procedures to changes in our business and in the business environment in which we operate, our results of operations and financial condition could be materially and adversely affected.
4. Declines in our pension assets or revisions in actuarial assumptions could increase our pension costs.
We may face additional costs relating to our employees' retirement benefit plans from changes in the market value of pension assets, a decline in returns on our pension assets or changes in the assumptions and investment returns on which the calculation of projected benefit obligations is based. We may also experience unrecognized losses on plan amendments in the future resulting from amendments to our employees' retirement benefit plans, which could potentially have an adverse effect on our financial condition and operating results.
5. Provisions for reserve for policyholder dividends could reduce return on equity.
Provisions for reserve for policyholder dividends in our consolidated statement of earnings are treated as expenses and decreases net income. Dai-ichi Life has the discretion to determine the provision for reserve for policyholder dividends. It considers many factors, including the competitiveness of our products, its results of operations and its solvency margin ratio, in determining the level of provisions for reserve for policyholder dividends, and it exercises discretion in order to provide an amount. As a result, there is no assurance that we may not make provisions in excess of the current reserve level in the future, which could potentially have an adverse effect on our operating results.
6. Risks Related to impairment of goodwill.
When the Group acquires another company or business, if the expense required for the acquisition (acquisition cost) exceeds the net amount allocated to the assets received and the liabilities assumed, the excess amount shall be accounted for as goodwill. It is recognized and recorded as goodwill or securities on the consolidated balance sheet.
The Group conducts goodwill impairment testing every accounting period. If cash flow obtained from the asset group including goodwill continues to be negative, or if the recoverable amount of the asset group including goodwill declines significantly, or if the business environment of the asset group, including goodwill, deteriorates significantly, there is a possibility that amortization of goodwill will be recognized.
7. Changes to accounting standards relating to the calculation of policy reserves could have a material adverse effect on our reported financial condition and results of operations.
The Insurance Business Act and related regulations and guidelines set forth the standards under which policy reserves are calculated. Changes to such standards that would require us to increase our policy reserves could have a material adverse effect on our reported financial condition and results of operations. For example, the International Accounting Standards Board, or the IASB, which develops International Financial Reporting Standards (IFRS), is currently considering new accounting standards for insurance contracts, including current value accounting for liabilities. Current value accounting for liabilities would require us to calculate policy reserves based on the current fair value of policy obligations taking into account factors such as current interest rate levels. In anticipation of the application of current value accounting for liabilities, we make provisions for policy reserves in excess of the amount currently required under applicable standards. If higher provisions for policy reserves than those that we have made are required, this could have an adverse effect on our financial condition and results of operations.
8. Our financial condition and results of operations will be negatively affected if we are required to reduce our deferred tax assets.
Pursuant to Japanese GAAP, we establish, with respect to each consolidated entity, deferred tax assets for tax benefits expected to be realized during a period that is reasonably foreseeable, net of deferred tax liabilities. The calculation of deferred tax assets is based on various assumptions, including assumptions with respect to future taxable income. Adverse changes in economic conditions or other factors could lead us to decrease our estimated future taxable income which would require us to increase the valuation allowance for our deferred tax assets. As a result, we would recognize additional income tax expense and our results of operations could be materially adversely affected. In addition, changes in Japanese tax policies could result in the reduction of our deferred tax assets.
In the event the corporate income tax rate is changed following tax reforms and our effective statutory tax rate decreases in the future, our performance and embedded value would likely improve in the medium- to long-term. On the other hand, a decrease in effective statutory tax rate may require us to reverse our deferred tax assets estimated based on the corporate income tax rates in effect prior to the reform, and this could have an adverse effect on our results of operations.
9. Risks Related to a Holding Company Structure.
The Company is a holding company and dividends paid to us from our subsidiaries are our main source of revenue. Under certain circumstances, these dividends are restricted by laws and regulations of Japanese and overseas governments and regulators. In addition, if our subsidiaries and affiliates are not profitable, they will not be able to pay dividends to the holding company, which could prevent dividend payout.
10. The failure of other Japanese life insurance companies could require us to increase our contributions to industry-wide policyholder protection funds and could undermine consumer confidence.
Our group domestic insurance companies, along with other life insurers in Japan, are required to support policyholders of failed life insurance companies through payments to the Life Insurance Policyholders Protection Corporation of Japan (LIPPC). The LIPPC provides funds upon acceptance and assumption by a successor life insurance company of the insurance policies of a failed life insurance company and also performs certain other specified functions. The proportion of required contributions allocated to them could increase if their income from insurance premiums and policy reserves increase relative to other life insurance companies in Japan. In the event of future failures of Japanese life insurance companies or if the legal requirements for contributing to the LIPPC change, they may be required to make additional contributions to the LIPPC and our financial condition and results of operations could be adversely affected.
The failure of other Japanese life insurance companies could also damage the reputation of the Japanese life insurance industry and undermine consumer confidence in Japanese life insurers in general, which could lead to a decrease in our sales of new policies or an increase in lapses or surrenders of existing policies.