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Thinking the Unthinkable?
In 2011, according to Munich Re, the insurance industry paid over US$ 100 billion in natural catastrophes and extreme events. It was not much earlier (2005) that a similar amount was paid out for similar claims. 2011 topped it, causing the Geneva Association to dub the year, “Annus Horribilis”. Blame it on global warming if you will (but, also, do not under-estimate the human factor as a major cause of loss) the cyclicality of extreme insurance payouts is becoming shorter and the spend progressively higher.
The above is an economic market reality. Faced with this reality it is comforting to note that the insurance industry globally is meeting its financial obligations. However it also poses a few serious questions such as, “is the insurance pot for extreme events being replenished?” or “Are current pricing models adequate to meet both the year-on-year attritional losses and also set aside money for extreme events?”
Certain markets such as the MENA markets, perhaps due to their perpetually emerging nature and the constant interest of new reinsurance entrants, are conducive to retail pricing in constant freefall. One of my perennial arguments is that the primary MENA insurance region is not competitive. It is aggressive; but it is not competitive. Competition follows an economic rationale; price aggression doesn’t.
One suspects that, although pricing in the aggregate seems to be covering attritional claims, in some cases (particularly the Takaful companies in UAE among others) are eating into their capital and more reputable reinsurers are pulling back. The commercial rationale of a larger international reinsurer generally encompasses both long term technical profitability as well as commercial viability (the latter of which is generally although not necessarily dictated by portfolio size). Consequently, by default – all other things being equal – they would set their scope on the larger primary market players. Therefore, when the larger reinsurers start pulling away (and not without reason) from the larger or older primary market players in UAE or within the region, this is a clear indication that something somewhere is amiss. And, as long as the rest of the market continues like a herd to emulate the market leaders by top-line, then it is safe to state that something is wrong with the whole market.
All know that practices such as bouquet reinsurance placements and excessive use of proportional reinsurance are the morphine that continue to fuel the addiction. As long as there are reinsurers willing to supply it there will be primary market insurers willing to buy it and to abuse it. Then when the proverbial hits the fan the larger reinsurers find themselves reeling from anything between two to ten hits from as many treaties; but arising out of one loss which has been insured and reinsured into multiple proportional treaties within the region. The ultimate losers are also the original culprits, that is, the reinsurers supplying morphine to the market. But they are not the only culprits. It is shallow excuse by an insurance company to state that it bought capacity simply because it was available. It is an argument that possibly makes sense in the short-run but does not hold water in the long run.
Some insurance companies consistently paid relatively high double digit dividend over the years (in one case immediately before the crisis one UAE insurance company even paid a 100% dividend!). If we look at one of the top 3 UAE insurance companies any one of them could have paid in excess of AED 0.25 billion in dividends over the last five years or so. That is more than double the capital requirement to establish a general insurance company in UAE. A portion of that can also be the basis of reserve fund on which the primary insurer can start molding a healthy non proportional reinsurance programme on which coded, working and/or aggregate excess of loss programmes can be designed; oil for the lamps in case the unthinkable happens.
Mainly following the crisis insurers, as institutional investors, ceased being investment market makers and became price takers like every other participant in the investment market. This hinders the generation of long term funds or wealth for the industry. This also continues to put more pressure on the ‘here and now’ and casts a doubt on the economical viability of such companies in the region if faced by extreme events. The answer by many to the question of extreme events is that, “the region is not prone to them.”
Oil for the Lamps
Saying that the region is not prone to extreme events is tantamount to an ostrich mentality of burying one’s head in the sand. Hurricane Gonu did happen. Floods in Oman have also become an almost annual occurrence. Riot, civil commotion, sabotage and terrorism in Bahrain, Lebanon, Egypt and other countries in the region are also a reality. Earthquake tremors in Iran suggest that the region is not earthquake-free. Oil exploration and sea transport also suggest that the region is not free from major hull or pollution losses. It might be a only be matter of time before the unthinkable happens. An extreme event in the region is not an “unknown unknown”. It is a known unknown. The rapid development of infrastructure in the form of towers, highways, airports, free zones, metro lines and much more only serves to accentuate the potential magnitude of a possible extreme loss.
The possibility of a significant loss exists. Accumulation also presents us with aggregated severity across lines of business.
So these questions remain: Do we continue to bury our heads in the sand? Or do we start building the necessary reserves? Will we redesign our reinsurance treaties to make our companies more resilient and to also add more wealth to the company in the long run rather than pay dividends in the short run? Will we continue to play an “all tactics, no strategy” game or will we stand up and be counted perhaps at an initial (possibly personal) short-run cost?
Reinsurers are not in the business of subsidizing losses in one region by gains from another. Well, not continuously and in the long run at least. To do that would be tantamount to aiding and abetting moral hazard. Of that there is already a lot in the regional market.
The Other End of the Spectrum
A client’s problem is not insurance. A client’s problem is risk. The solution, or the emphasis, therefore should not be on cheaper premiums but on risk mitigation or resilience in the face of risk. Current market behaviour is not conducive to building this culture.
Insurers have a duty towards their client to provide them with long term value and not with a ‘quick fix’. We have an obligation to interact more with the real stakeholders and less with the finance or procurement officers. Although they belong to the same entity, the client, they do not necessarily speak the same language.
To expect a uniform approach by the market, i.e. companies walking away from unsustainable business propositions, is unrealistic. There will always be cowboys in the Wild West. To expect that a regulator micro-manages the technical activity of an insurer is also unrealistic.
But there will be beacon companies in the market that will stand for value and will walk away from prices in freefall even at short term cost. There are insurance clients in the market that have the wisdom and the foresight to choose value over price. This has to be sought out by insurance companies and acknowledged.
What will be happening in the future is that major reinsurers will reward primary market players who walk the talk and who stand for value. Major reinsurers will assist primary market insurers to design sustainable reinsurance programmes which add wealth to the companies and cement relations in the long run. Times are changing.
With the crisis behind us – at least in the Middle East – there is renewed optimism in the region particularly with the expectations of such events as the World Cup (Qatar), the Expo 2020 (Dubai) and the generally constantly buoyant and prudently bullish economy in UAE in general.
Economic activity spurs optimism in the insurance sector.
Insurance Economics Presentation
The attached presentation provides a glimpse of world insurance through the crisis with specific reference to
– emerging markets (of which the UAE is one …. hence the comparison to BRIC)
– Capital adequacy and prudential regulation
– a post 2012 crystal ball glaring (are the predictions coming true)?
This is an essay published in two parts in a regional insurance journal.
Although this is a 2008 Essay the historical analysis of the parallel political and economic development of two distinct markets (EU and MENA) is all very relevant. Furthermore, since 2008 little has changed (Solvency II is still not implemented and little legislative development has occurred in the MENA region since then).
The essay was kindly translated by a friend and ex-colleague, Ms. Ferial Bennai:
Setting the Scene
In July Reuters reported that the UK Financial Ombudsman has started to see a decline in the number of grievances it was receiving in relation to payment protection insurance policies. This does not mean that cases have completely ebbed. It simply means that they had peaked at 3,000 per working day and are now down to around 2,000 per working day.
A stark summary of the PPI situation is quite disconcerting: 15% of the 50 million PPI policies sold in the UK gave rise to claims for compensation. Banks have had to set aside significant reserves to handling mis-selling claims. Lloyds Bank, for example, set aside GBP 6.8 billion and the UK Financial Services Ombudsman was quoted in July stating that Barclays Bank were setting aside an additional GBP 2.6 billion specifically for PPI costs. Other high profile UK banks such as RBS and HSBC also have significant provisioning against PPI mis-selling claims.
These are staggering numbers but what is even more worrying is not so much the quantitative as the qualitative analysis of this debacle. Simple questions would lead to some very obvious answers namely:
1. Were the policies ‘bought’ or ‘sold’? Surveys revealed that several policy holders were unaware that the policy was in place (unconfirmed sources claim as much as 40% of survey respondents indicated that they were not aware that they had such insurance.
2. Were the policies ‘underwritten’ or ‘sold’? In some cases lending institutions seem to have been making more money on the PPI over-riders than from loan interest! Gross margins well in excess of 50% were not unheard of. Had they been charging these margins for lending they would have fallen foul of usury laws! This income was not filtering back to insurance companies as risk premium but constituted loadings of sorts structured into the repayment programme of borrowers.
3. Was there a meeting of minds? If borrowers were unaware of the PPI policy per se they would have been even less educated in the cover it offers them. This begs the question, “Were banks advising their clients or were they just selling this cover?”
Selling or Advising
This last question is a very pertinent one if we are drawing a parallel to bancassurance (or the marketing of insurance products by banks) in the United Arab Emirates.
‘Mis-selling’ implies that policies were sold to customers who:
1. Did not know what they are buying. This goes against the very foundation of insurance because insurance is governed by utmost good faith and not by caveat emptor;
2. In many instances were led to believe that this was an integral part of the loan structure and important for a speedy approval of the loan process. Therefore, insurance was diluted to a complement to another product (i.e. the loan);
3. Were ignorant regarding cost components in their repayment schedules and it is implied that banks preyed on innocent borrowers through the obscure concepts of ‘bundled pricing’ or ‘insurance wrappers’ or the infamous ‘negative option’.
An unalienable, absolute rule on any product (and this specifically applies to all financial services including all insurance products) governed by the principle of Utmost Good Faith is that Financial Services products are not ‘sold’. Rather clients are ‘advised to buy them.’
Disclaimers hidden somewhere in small print in the overall stationery of paperwork that a client is made to sign (or lengthy online conditions on which clients are expected to click ‘accept’) may not necessarily prove to be a formidable line of defense as the fall-out from the PPI debacle is amply illustrating. And so should it be. If the banks have misled clients and/or wrongly sold products then they should be held accountable.
The UAE Saga
This brings me to the situation (or ongoing saga) in the UAE where bancassurance or marketing of insurance products by banks of which credit life insurance, credit protection, loan repayment insurance etc. (i.e PPI under different guises) forms a large part.
The banking and insurance regulators remain indolent as to who should be regulating the insurance activity of banks in the UAE. Under this apparent inertia banks continue to grow their insurance sales.
The situation may be summarized into the following:
1. The UAE insurance law is very clear about all persons selling / providing insurance requiring to be licensed by the UAE Insurance Authority;
2. A few years ago a directive was issued by the Insurance Authority relating to ‘Marketing of Insurance Products by Banks’. Though a diluted form of subsidiary legislation it could have provided a start for bancassurance to be regulated. Whether or not this regulation was activated by the Insurance Authority is not known. What is certain is that none of the banks (and there are several of them) selling insurance have directly registered themselves or the insurance products they are selling with the insurance authority.
3. The Central Bank, as the banking regulator, on the other hand is the authority that regulates banks in their activities. The internal practice is that, while a Central Bank can mandate whether banks stick to their core banking activity or whether they are allowed to diversify into other areas (such as bancassurance), the Central Bank would not regulate insurance activity of banks if banks decide to sell insurance. This would still fall within the realm of the Insurance Authority.
4. In summary the international practice is such that banks who obtain approval from the Central Bank to diversify into insurance who then also seek authorization (and fall under the regulation) of the Insurance Authority in respect of their insurance activity.
The sad reality is that the compliance function of many UAE banks would tell you that they are regulated by the Central Bank and that (even vis-à-vis their insurance activity) they are not regulated by the Insurance Authority. This is further attested by the Insurance Authority who are blissfully aware of banks selling insurance and do not attempt to regulate, license and/or supervise their activity.
By default this translates into an accident waiting to happen.
Conclusion: Once the horses have bolted?
A reality that is integral to the life of an expatriate community is the transiency of the whole experience.
Sadly, to some extent, this brings with it an element of “let tomorrow worry for itself,” or “make hay while the sun shines … we may not be here when the proverbial hits the fan!”
UAE in particular, is such a melting pot of so many nationalities and cultures that in addition to the above we are also presented with dilemmas arising from the different perceptions of what constitutes accepted practice, quality or value. As a result we unfortunately have to learn these lessons in hindsight and one then tries to lock the stable doors once the horses have bolted.
Examples of this include:
1. The losses being incurred in multi-storey buildings exposing certain design, material or procedural inefficiencies (JTL Tamweel, the Oasis fire claim and others come to mind); or
2. The accumulation exposure of certain industrial areas that remain very bad risks as far as insurers are concerned (The Al Quoz Industrial Area fire loss illustrates this);
3. Closer to home, the default of two significant insurance brokers in the region adversely affecting a number of insurers with whom they dealt.
The emerging market nature of the region necessarily implies that some of the above may be inevitable. Or are they? Cannot lessons be learnt in hindsight from other jurisdictions and the principles translated into local practice?
With PPI, because claims, grievances or complaints can only be large in the aggregate (i.e. requiring class suits which are uncommon in the region) it is unlikely malpractice would surface. But it does not mean that it is not there. It does not mean that this policies are not being mis-sold and/or that borrowers are not being made to pay a high premium for cover they are purchasing which they do not fully understand and may not necessarily be capable of claiming for in the event of a claim (because of the selling function of the banks and servicing / policy management function of insurance companies operating at arms’ length).
It is the right of consumers, i.e. borrowers, to be protected and the duty of authorities (the Central Bank and the Insurance Authority in UAE in this case) to protect them. Consumer protection breeds confidence and confidence breeds long term, sustainable development.
This begs the question, “When will the two regulators jointly and succinctly address the matter?”
The answer to this is not rocket science. Even if, as a start, current legislation is effectively applied, we would be more than half way there.
Insurance Insight’s news-piece dated May 8th entitled, “UAE Insurance Sector Expected to Grow in 2013” proved interesting to read for a number of reasons.
Firstly, as an insurance practitioner active in the region since the 1990s and having experienced the cyclical peaks and troughs emanating from September 11th, petro-dollar activities and the financial crisis, it is heartening to note that the industry is again showing signs of, albeit cautious, optimism.
Secondly, the much needed changes at UAE regulatory level seem to finally be taking place. Some more new faces (and brains) may also be required but the appointment of the current Director General is certainly a step in the right direction. He comes with significant ESCA experience that can and should translate into positive momentum. The market consensus on this is a very positive one.
Thirdly, the financial crisis helped expose the importance of technical competence and heads are still rolling at senior executive level in some insurance companies. Consolidation may not be happening (and won’t, save for one or two exceptions) but changes at top level will continue take place as crisis-savvy Boards demand more technical accountability from their management.
There are some worrying factors from the upturn in outlook and performance in the region. For example, some of the major reinsurers who plundered the heavily proportional markets in all but motor insurance for many years (and contributed to an almost burnt-out market) started pulling out post-crisis on the pretext that rates on line did not justify the financial return on the capacity they provided. This may be true. But it is equally true that consumers – cedants in this case – are programmed to consume more as prices decrease (all other things being equal). Therefore, the blame of readily available reinsurance capital at ridiculous prices has to be shouldered by the reinsurers (and the reinsurers alone). What is worrying is that some of larger reinsurers may already be on scouting reccies to either plunder the only remaining market they haven’t ravished (i.e. offering proportional treaties in motor) and/or in anticipation of the compulsory health insurance legislation in UAE.
At a time when the primary market should be looking at greater market discipline, reinsurers should be at the forefront in providing the UAE market with expertise and capacity that sees primary market companies assuming greater responsibility. Quota Share treaties across all motor and/or medical lines of business is certainly a step (or two) in the opposite direction.
Another concern is that with a positive investment outlook, reliance on the equity and investment markets is again growing. This, in itself is not bad. Insurers are, after all, institutional investors. But one needs to be constantly reminded that we are, first and foremost, insurers and not investors. End of year 2012 and Q1-2013 results of two of the largest companies in the market (i.e. Oman Insurance Company and Abu Dhabi National Insurance Company) are not very encouraging from a technical profitability perspective. Many of the smaller companies also share the same predicament.
2013 Market Outlook
Insurance in UAE is reactive to the economy and therefore any predictions on premium growth would generally reflect the pace of growth of GDP (with some sectors of the economy contributing more to premium growth than others). However, since compulsion is one of the main drivers of insurance demand throughout the region, there is a significant variable that will affect growth in 2013 and 2014. If health insurance in Dubai and the Northern Emirates becomes compulsory then we are looking at a growth rate that would be much higher than the indicated 10%. There are over 1 million lives that still need to be insured and this is not accounting for the influx of expatriates that is again taking place. This alone would generate around AED 1 billion in premium (or 5% of current total UAE insurance premium).
Why 5%? Doesn’t the above mentioned article (quoting the Insurance Authority) mention AED 25.5 billion as the current UAE market size? Yes it does; but this is not quite correct. The figure does not account for the internal spiral generated by local, reciprocal reinsurance. This is again on the increase in the market particularly because of the incestuous relationship of some conventional and Takaful companies in the UAE. One hopes that the spiral is a controlled one and that a catastrophic loss does not expose weaknesses similar to the early 1990s in the London LMX market. There are no readily available statistics for this, but if one had to deduct the impact of local reciprocal reinsurance in UAE, the overall premium spend would probably be more in the region of AED 20 billion.
Another important variable is the rate of economic reconstruction and development taking place in Dubai. This seems to be picking up pace again and, with greater optimism, since the Emirate honoured its 2012 debt repayment obligations. The 2020 Expo expectations will also pay a role.
The combined effect of compulsory medical insurance, growth in expatriate work-force and rate of economic growth across all Emirates in the UAE will make it difficult to predict the rate of insurance growth. Per capita and as a percentage of GDP insurance spending will certainly rise as and when medical insurance becomes compulsory. But, netting the impact of this, proportionate insurance spending is otherwise unlikely to change significantly as a percentage of GDP.
What is perhaps predictable is that the combined impact of these economic factors will result in double digit growth, in the higher percentage teens, in insurance within the short to medium term i.e. by, say, 2015.
Barely three months into my new job, I totally immersed myself in the challenges that it has to offer and I am enjoying every step of the journey with the customary “bring it on” attitude to life.
One of the rewarding aspects of being in the underwriting seat is the propensity to think outside the box and offer solutions to problems instead of products off a shelf. From motor or personal accident policies that do not quite fit the cast to the more complicated industrial property or engineering risks, I endorse the, “Why not?” philosophy; emulating Edward Cuthbert Heath the grandfather of underwriting innovation.
One of the main inhibitors of this otherwise utopian underwriting world is the cadre of gate-keepers taking insurance purchasing decisions in commerce and industry within the region. Thankfully, the larger corporations are witnessing an increase in qualified risk and insurance managers or directors within their ranks. However, insurance purchasing within the Middle East still remains largely under the domain of scrooge incarnate, i.e. the top dog in finance (whatever the designation) who understands all there is to know about price but who very often has no clue to what constitute value in insurance. Among them, the good are few and far between and the bad and the ugly (ranging from the blissfully ignorant to the corrupt seeking to line their pockets) generally abound.
Price vs. Value
Although I am strong advocate of competition, the basic premise of competition is the homogenous nature of the products on offer. How does one measure the value of one insurance policy against another? Although what we sell is intangible, some factors come to mind, such as the reinsurance capacity behind a primary insurer, the claims paying ability and, more importantly, the claims paying behaviour of an insurer. In tandem with all of these, one also needs to select an insurer that is able to give sound advice preferably before a loss happens and not while turning down a claim after calamity strikes.
Several incorrect practices continue driven either by price considerations, or by ignorance or by a combination of both. The following are a few examples:
Firstly, although it happened quite a few years ago the conflagration of Oasis Shopping Centre is still fresh in the mind of many in UAE as is the destruction of over 100 warehouses in Al Quoz Area. These and other similar significant losses each took anything between three to five years to rebuild. So why, with such vivid examples, do most chief finance officers still insist on a maximum business interruption indemnity period of 12 months. And, when as a broker or insurer, we cave in to this, who are we kidding?
One of the older but smaller insurers in UAE decided to become significantly aggressive in 2011 and 2012 in a bid to rapidly grow market share. Prima facie some insurers could not understand where this company was pulling its rates out from. A closer examination soon revealed that it was ultimately short-changing clients. A typical example is the capping of third party property damage cover on motor fleets to AED 250,000 (approximately Euros 50,000). In simple terms, one accident with a high value vehicle and the insured is constrained to dig into his pocket. But does it have to take a claim for a chief finance officer or chief accountant, who is otherwise very conversant with numbers, to grasp this very simple fact? Or is it a case of ignorance is bliss until misfortune strikes?
A final example that perhaps takes the cake is a primary insurer granting of unlimited liability in the aggregate when his reinsurer would have capped it at, say, twice the limit any one occurrence.
The primary insurer’s secret? “Cancel the cover if there is a claim.
And if there isn’t? “Oh well no one would have been any wiser?”
Does Professionalism Pay?
These and many others are real life examples from the market where intellect, governance, discipline and professionalism often serve as a disadvantage in the short run.
But in the long run? The story is different. Companies that offer value over price tend to be rewarded not by rapid top-line growth (sadly that would continue to elude such companies) but by strong client loyalty and retention.
The client, broker and insurer interaction is very often a worthwhile process of education. Costly? Not really, when compared to ignorance.