Interview: Bruce Hemphill, Nicolaas Kruger, Ralph Mupita, Johan van Zyl
How is the regulatory environment developing and what are the prospects of a twin peaks approach?
BRUCE HEMPHILL: The movement toward a twin peaks regulatory approach, where the Financial Services Board regulates all of the interactions customers have with financial services organisations, while the South African Reserve Bank focuses on the prudential capital side of things, certainly makes a huge amount of sense. Our regulatory environment is solid and our capital markets work efficiently, making South Africa a natural starting point for anyone wanting to do business in southern Africa. However, the regulator has to be careful to not take something that works well in more easily regulated developed markets and apply it to South Africa, which has two distinct markets and a wide gap between the haves and the have-nots.
NICOLAAS KRUGER: Twin peaks will provide the benefits of regulatory focus. New capital requirements for banks and insurers might have caused conflict in oversight if market conduct regulation and prudential regulation continued being regulated by the same institution. The regulatory changes have been well thought out and follow a discussion-based approach that the industry is supportive of, though unintended consequences sometimes arise when a one-size-fits-all approach is used and regulations of a first-world country are applied to a developing nation. Some regulations that make sense for the UK, for example, might prevent access to financial services for those at the lower end. We need regulatory refinements to allow for the fact that a large proportion of our population is developing.
RALPH MUPITA: On the whole, there is a sensible regulatory landscape with a good conversation happening between all the participants. The regulators have applied common sense and a pragmatic approach toward regulation, with principles rather than rules-based regulation taking precedence. There appears to be a push to transition away from solo toward group regulation. Some of the challenges the global financial services industry faced in 2008 were the result of regulators looking at entities on an individual basis, as they did not notice the contagion effects revealed when looking at the group. Related to this comes the issue of twin peaks and a more macro-systemic view toward the separation of prudential regulation and market conduct. This makes sense, as financial institutions, by their nature, often blur into other product regimes, with insurers increasingly doing more of what was traditionally seen as banking business, for example, and vice versa.
JOHAN VAN ZYL: Regulation is fairly intrusive with very detailed and specific legislation around products, profit, commission structures, and how and where money can be invested. For the most part, our regulation is aligned with the old British system and issues that are being reviewed throughout Europe – related to retirement redistribution, commission, capital and solvency – are all on the table here. The trick becomes localising some of these things in a manner that makes sense for our own unique social issues, rather than trying to replicate what other markets have been working on and preparing toward for decades. Too many regulatory changes at once can create uncertainty. When we evaluate proposals about where group capital can be invested for growth and earnings, we do so on a risk-return basis. The vast changes in the South African market have allowed the rest of Africa to become more attractive, based on the expected returns adjusted for risk.
To what extent could Solvency Assessment and Management (SAM) affect consolidation?
KRUGER: Generally speaking, SAM is a positive development from a risk-based and governance perspective, but it may result in consolidation of smaller players that find the compliance burden of SAM more onerous. SAM has become a difficult process to navigate.
The UK keeps postponing Solvency II (which SAM is based on), and we have to keep postponing SAM in turn.
Continually dragging things out creates uncertainty.
VAN ZYL: The larger insurance groups which have more diversification around capital and business units will be able to stomach compliance burdens and capital requirements, while smaller independent players will be squeezed out. The worry is that the compliance burden could become so large for some that it comes at the expense of taking care of clients. Mono-line specialists will find the new regime quite punitive and difficult to survive. They will either have to develop strong partnerships with re-insurers or be taken over.
MUPITA: Overall, what is playing out in the South African market is more sensible than in developed markets where the pendulum has swung too far. Our regulators are more pragmatic about the level of regulation that can be brought on with consideration towards what will and will not work locally. So SAM will not look like Solvency II in all its details. That said, groups like ours can spread the compliance costs across our various businesses because of our size and scale. But it will be a tough operating environment for insurers that lack scale or unique differentiators. Survival for smaller players will depend on innovation in how they distribute and propose their customer offering.
HEMPHILL: More focus on the capital side of the business and moving to a regime where an organisation is better able to properly understand the risks it is taking on enables everyone to compete more effectively. There is a danger that SAM could force consolidation and theoretically decrease competition. However, even smaller organisations, as long as they understand their business and are on top of what they do, should not find SAM unnecessarily burdensome. It requires a change of mindset. If you, as a business, properly understand the risks you are taking on, you should be able to conform to the regulatory framework quite easily.
How can the government support insurers to effectively reach the lower-income segments?
VAN ZYL: Our regulations were designed for people with comfortable amounts of money, and have inappropriately been stretched down to apply to those with a limited ability to save. Our regulatory system does not allow for many of the new low-cost insurance solutions you see evolving elsewhere, and this in turn prevents lower-income customers from gaining access to low-cost solutions. While lower-income earners might each only offer a small amount towards premiums, the minute you aggregate for volume, you get solid returns. When factoring in the advances of technology and the fact that most people have mobile phones as access points, the opportunity becomes massive. There will always be people, no matter what you do, unable to access the system. And for them, special arrangements through subsidies or state projects are required. But for 90% of the problem of under-penetration, just changing the rules of the game a little to allow for experimentation of new things, can help make big advances.
KRUGER: The traditional approach to penetrating the lower end of the market is to have a comprehensive physical footprint in rural communities through an efficient and large agency force. Strong branding and face-to-face distribution remain important, as people want to speak to somebody they know and trust. In addition, extensive financial education is required, as people often lack trust in financial services organisations. At the lowest end, a partnership with government can be beneficial. Cost structures are increasingly coming under pressure due to the regulatory burden. Government can play an important role to introduce a “lighter” regulatory dispensation for the emerging market.. With very small policies, it is very difficult to provide value for money, unless a very innovative approach is found to exploit new technologies (including mobile phones) to obtain scale benefits and cost-efficiencies.
HEMPHILL: Government should provide an enabling framework to encourage the private sector to go out and serve the lower-income market, and should not involve itself in the business of micro-insurance itself. Regulators have to think differently about the lower end of the market, perhaps through referencing some of the experiences that Indian and Brazilian regulators have had. The irony is that the bottom end of the market actually requires greater protection than the top end and should be regulated far more aggressively.
MUPITA: For the foundation segment, which sits at the bottom end of the market, the economics of the traditional distribution model does not work. We have adopted an affinity-based distribution approach, acquiring advisors from the communities that we serve. For instance, when targeting a school, we will hire a former teacher as a financial advisor for that particular site. Additionally, what will serve as an important channel of getting to customers in the future, is working with retailers. These initiatives are in the exploratory phase.
What are your views on social security reform?
HEMPHILL: The big issue in the social security debate is the scale of the government’s role in something the private sector can execute more efficiently. The government feels that it is not being seen by its constituency to have delivered on social security as the private sector has not delivered what is required. While the private sector, in turn, feels that the enabling framework to deliver what is required is not there. Thus, more dialogue has to take place between government and the private sector. A further danger with implementing government-executed social security is what this does to industry and associated jobs. More jobs could be created in the financial sector if the state took the view that it should be incentivising people to set up distribution businesses to get people to part with their money at the bottom end of the market. At a theoretical level, this could further drive job creation and savings.
KRUGER: It would make sense for National Treasury to implement compulsory preservation, so that people can maintain a minimum standard of living after retirement. However, union pressure makes compulsory preservation difficult to implement. Along with the introduction of National Health Insurance, government's plans to finance social security reform are in the early stages, and we have not yet seen firm details in the state’s budgets. We anticipate social security reforms will be phased in over the long term, rather than all at once. Philosophically, it would be against the collaborative spirit of the National Development Plan if there is not close cooperation between government and industry, and if government does not use industry’s capabilities to achieve social security reforms. We agree and embrace what government wants to achieve, which is expanded employee benefits and healthcare coverage. We will have to deal with continued pressure on our fees and margins to ensure value for money.
MUPITA: Social security reform is a massive undertaking. The government’s initial approach to this is to improve retirement savings and the environment around it to deal with the issues and associated costs of preservation and annuity payments. Where preservation is made compulsory, individuals would be forced to come to you, and your costs of distribution would become lower allowing you in turn to reduce your charges and fees. There are always going to be instances where savers will need early access to retirement funds, resulting in “necessary leaks”. To resolve this, social security arrangements across South Africa also need to be tackled. There are three main drivers contributing to a lack of savings on a national level, including structural unemployment, easy access to debt and a non-savings culture. The latter two factors can be dealt with through more responsible lending and financial education. However, as long as unemployment remains high, there will always be a significant population unable to save.
VAN ZYL: One of the main expenses associated with financial services is distribution. By making social security compulsory, you create a mechanism for aggregation and cost minimisation, as a single employer is able to deduct payments on behalf of hundreds and thousands of employees. The fact that we lack preservation at present nearly triples the costs for individuals with retirement schemes. Whereby, if we could know for certain that the person preserving will not be accessing funds prematurely, we would ultimately be able to charge merely a fraction of the current level of fees.
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