Insurers innovate and expand to ride out waves

Across the African continent, South Africa accounts for 80% of all insurance premiums. The market is heavily tilted towards life products, which make up four-fifths of the industry’s premiums, with earnings in the segment 10 times that of non-life in 2013. At the same time, penetration continues to rise: the number of formally insured South Africans grew from 6.2m people in 2012 to 7.8m in 2013. Most of the addition was in life and asset insurance, with 1.4m and 1m new entrants, respectively. While the life insurance segment had a strong performance in 2013, non-life growth was tempered by high claims. As the industry innovates at home and expands across Africa, multiple regulatory changes are diverting attention away from doing business.

Long-Term Success

At the end of 2013 the life insurance segment – or long-term insurance industry – had R2trn ($189.4bn) of assets under management. Long-term insurers did well across the board. Although there are close to 100 life underwriters in South Africa, the industry is dominated by five major players: Discovery Holdings, Liberty Holdings, MMI Holdings, Old Mutual and Sanlam. In 2013 group international financial reporting standards (IFRS) earnings for the big five increased 29% to R24.4bn ($416.7m). The average return on equity (ROE) was 21% (against 17% in 2012 and 20% in 2011), and new business was up 12% by value, while margins on new business fell 3.1%. Sanlam and Old Mutual outperformed their competitors by achieving earning boosts greater than 40%. Long-term interest rates were also up, which resulted in risk discount rates growing by more than 100 basis points. This increase helped the valuation of investment guarantees provided to policyholders, but lowered the embedded value of current and new business for insurers.

Liberty posted the strongest ROE in 2013, followed closely by Sanlam, Old Mutual and Discovery, all falling between 22% and 24%, while MMI had an ROE of 13%. Product innovation was a key growth driver for Liberty, with its new-generation Evolve product garnering R4.5bn ($426.15m) of new business in 2013. Evolve, launched in October 2012, comprises a range of pay-on-delivery investment products. MMI’s Metropolitan Retail – savings products for the low- to middle-income market – only grew business volumes by 2% in 2013, reflecting the tough environment for this earners segment. New wealth management and retirement savings products like Old Mutual Wealth proposition and the XtraMAX helped Old Mutual’s business sales.

Short-Term Woes

Short-term, or non-life, insurers had a tough 2013, largely because weather-related damage saw a high level of claims for the second year running. Similar to the life side, five companies dominate the market. The major short-term insurers are: Absa Insurance, Mutual & Federal, OUT surance Holdings, Santam and Zurich Insurance Company South Africa. In 2013 group IFRS earnings for these major players were down 12% to R2.4bn ($227.3m), but gross written premiums (GWPs) rose by 12%. The claims ratio worsened to 68%, from 66% in 2012 and 62% in 2011. The underwriting margin dropped to 2.7%, ROE was down to 16% and the international solvency margin reduced to 40%.

Along with a low underwriting resulting from a sluggish economy, an increase in natural disasters and crop claims hurt the industry. South Africa has been unlucky in that two major storms occurred within two years, with the Edenvale hailstorms adding R1bn ($94.7m) of claims in 2012 followed by several incidences of severe weather in 2013. Hailstorms in the heavily populated Gauteng province – home to both Johannesburg and Pretoria – in November 2013, resulted in claims in excess of R2bn ($189.4m), according to global insurance analysts PwC. Meanwhile, floods in Limpopo and the Western Cape in January and November 2013, respectively, saw claims of over R400m ($37.9m). Absa was the worst affected by crops claims in 2013 with a claims ratio of 145%, and Santam booked the highest catastrophe claims of more than R500m ($47.35m).

Catastrophe-related claims continued into 2014, with rainstorms causing flood damage in Gauteng early in the year, and in August a 5.3-magnitude earthquake caused damages to buildings in Gauteng, KwaZuluNatal, Free State and Northern Cape Provinces. Strong capitalisation means that these events do not present a systemic risk to the industry, but prices are likely to adjust as insurers reassess their preparedness in dealing with natural disasters.

Auto claims, which are likewise affected by severe weather, are also significant in the segment, as motor insurance constitutes 45% of the short-term market. A falling rand made matters worse: “The depreciation of the rand raises the cost of claims,” Victor Muguto, insurance leader for Southern Africa at PwC, told OBG. According to PwC’s 2014 insurance industry analysis, “Between 65% and 70% of motor repair costs relate to parts, of which a significant component are imported.”

Competitive Market

The South African non-life insurance industry remains very competitive, with around 100 companies operating alongside the big five. In contrast to the life segment, where most firms are listed, Santam and Zurich are the only listed short-term insurers. Santam, South Africa’s biggest short-term insurer by GWPs, is majority owned by Sanlam, the second-biggest life insurer. Santam’s earnings were up 120% in the first half of 2014, with significant improvements in underwriting and investment results, crop insurance business picking up and a strong capital markets performance.

Examining the big five’s growth drivers in 2013: Absa reduced its crop insurance appetite; Mutual & Federal’s and Santam’s GWP growth came mainly from inward reinsurance business in corporate and niche lines; OUT-surance was boosted by success in its Australian business Youi and related exchange differences; and Zurich’s growth and retention schemes led its GWP growth.

Distribution Evolves

South Africa’s insurers have evolved from direct-selling models to include innovative distribution channels such as retail and mobile. “In terms of distribution channels, non-compulsory insurance will always be transacted on a direct basis. However, commercial or corporate insurance will remain dominated by the broker market,” Daryl de Vos, CEO of African Re, told OBG, explaining the use of different selling models. “Given that the collection of premiums is the biggest challenge in emerging markets, the bancassurance model would be most appropriate when addressing personal insurance,” he said.

Innovations including loyalty programmes have seen growth as insurers focus on keeping their customer base. In the health insurance sphere, market leader Discovery introduced its Vitality rewards programme in 1997 and has since exported it to Europe and the US, with plans for China. Vitality rewards clients for healthy living through discounted gym membership, cheaper healthy food items and a variety of other discounts.

Moving North

Swiss Re Sigma estimates that insurance penetration in Africa is 1% of GDP, indicating room for growth. Alongside the major potential available domestically, several South African insurers are also looking abroad for opportunities. “Most insurance expansion activity is happening here on the continent, with some firms looking further afield at India and China,” Donald Dinnie, head of insurance at legal practice Norton Rose Fulbright South Africa, told OBG.

Sanlam, for example, has been expanding in 2014. Through its overseas insurance vehicle, Sanlam Emerging Markets, the insurer has raised its shares in NICO Holding’s insurance businesses in Southern and Eastern Africa. According to firm reports, Sanlam now holds 49% in NICO’s general insurance operations in Malawi, 49% in Zambia, 48.4% in Uganda and 32.7% in Tanzania. In 2013 Old Mutual announced it would invest R5bn ($473.5m) in African acquisitions. PwC reports that Old Mutual spent R700m ($66.3m) of this in 2013, through investments in Oceanic’s life and general insurance business in Nigeria, Provident Life Assurance in Ghana and microfinance firm Faulu in Kenya. Also in 2013 MMI acquired a majority stake in Kenyan short-term insurer Cannon Assurance for R300m ($28.4m). Cannon shareholders received a minority stake in Metropolitan Life Kenya in return. PwC reports that MMI aims to spend a further R200m ($18.9m) on African expansion. Liberty has not made significant Africa acquisitions since it purchased CfC Life in Kenya in 2011 but has continued its bancassurance partnerships across the continent. Discovery has a different business model: instead of looking into Africa it is focusing on developed Western markets and has an interest in China.

A challenge for insurers looking to expand into Africa is the dominance of a broker-based distribution model, which limits direct selling, according to Muguto. Regardless, there are some in the industry who believe that South African underwriters will maintain their dominant position in Africa. “While increased competition and tighter margins at home have had insurers looking to expand pan-Africa, South Africa will remain the gateway to the continent’s insurance industry given its superior established hard and soft infrastructure,” Randolph Moses, CEO of Hannover Re, told OBG.

Local Consolidation

In April 2014 Alexander Forbes sold Guardrisk to MMI for R1.6bn ($151.5m) in a bid to reduce debt ahead of a public listing in mid-2014. Guardrisk is a specialist in the cell captive market, enabling retailers and telecommunications providers to insure customers under their own brand without a licence. MMI, operating in 13 African markets, will give Guardrisk a platform to launch across the continent. At MMI’s results announcement in March that year, CEO Nicolaas Kruger said that MMI would benefit from Guardrisk’s specialist insurance skills and experience.

Recent merger and acquisition activity has revolved around smaller transactions. The last mega merger in the insurance sector was the joining of Metropolitan and Momentum to form MMI in 2010, becoming the third-largest underwriter. “The last big merger between top life insurance groups happened over three years ago. There has clearly been a huge shift in focus to growth through geographic expansion into Africa and Asia, and we are unlikely to see another big local merger in the next few years,” Muguto said. “While there might be scope for consolidation among smaller insurers, I do not expect to see further consolidation among the large insurers in the near future.”

Pension Reform

One major ongoing development in the sector is pension fund and retirement savings reform. According to a 2014 Sanlam Benchmark Survey, an annual review of South Africa’s retirement industry, only 6% of all South Africans – and 29% of South Africans who are members of retirement funds – are able to maintain their standard of living when they retire. This is due to a number of factors, including retirees simply not having saved enough over the years and their ability to withdraw their savings in one lump sum. An estimated 6m people do not contribute to any retirement fund, either because their companies do not require it, they are self-employed or they do not have enough disposable income. “Changing the savings culture in South Africa is a key priority for the government as it would make the country less dependent on foreign inflows, stabilise the currency, boost certainty and reduce speculative behaviour,” Edward Kieswetter, CEO of Alexander Forbes, a leading independent African retirement fund administrator, told OBG.

Indeed, the government’s aim is to establish a low-cost structure of pensions that can be adopted as a default for all of the country’s pension schemes. Proposed changes would limit people’s ability to withdraw savings from a fund before retirement, require that savings are transferred to a preservation fund when someone changes jobs, and require people to purchase income annuity with provident fund money. Retirement benefits would be defined according to lifetime earnings adjusted for inflation based on an accrual structure. This harmonisation of fund structures would provide for uniform taxation, allow flexibility of contributions for those with uneven incomes and improve preservation of funds by extending incentives. Standardisation is expected to lower costs and create tax incentives for retirement saving. “The National Treasury’s (NT) moves towards mandatory savings, preservation and potential annuitisation are encouraging. It will lead to cost savings with a greater pool of savings and less dependency on the state,” Ralph Mupita, CEO emerging markets of Old Mutual, told OBG.

Regulatory Reforms

An unprecedented number of insurance reforms has hit the insurance industry in recent years under the Financial Services Laws General Amendment (Omnibus) Act, according to Barry Scott, CEO of the South African Insurance Association (SAIA), which represents short-term insurers. SAIA and its members are in favour of the reforms, which aim to bring South Africa in line with G20 standards and the core principles adopted by the International Association of Insurance Supervisors. With the “twin peaks” regulatory structure set to be legislated and operational by early 2015, a series of legislative additions and amendments are also under way. Until 2014, the South African Reserve Bank (SARB) supervised banks while the Financial Services Board (FSB) had regulatory responsibility for other financial service providers. Twin peaks will see both regulators overseeing all financial services providers, with prudential and market conduct responsibilities separated and given to the SARB and the FSB, respectively.

In 2013 the Omnibus Act passed, aligning various financial services laws and extending the powers of the Registrar of Insurance to areas like determining the fit and properness of shareholders. The Insurance Laws Amendment Bill (ILAB) of 2013, which aimed to enhance governance and group supervision, was tabled following elections in early 2014. Instead, sections in the ILAB on the supervision of insurance groups are to be incorporated in the twin peaks legislation expected for public consultation before the end of 2014. A draft Board notice to give effect to the governance, risk management and internal control measures sections was published for public comment in September 2014 with an expected implementation date of April 2015.

The Protection of Personal Information (POPI) Act of 2013 is set to come into force in 2014. Based on similar laws in the UK and EU, POPI creates scope for more products by allowing for class action for data breaches, opening new areas of exposure for insurers.

In June 2013 the FSB released a discussion paper to evaluate prudential and market conduct risks for insurers and policyholders using cell captive arrangements. The paper moots that cell captive business should have its own insurance licence separate from other businesses, and that cell captive insurance arrangements may only be entered into with a binder holder.

Looking ahead, provisions of the Insurance Bill should come into effect at the beginning of 2016. It will introduce a new risk-based solvency regime for short- and long-term insurers called the Solvency Assessment and Management (SAM), which is South Africa’s version of Europe’s Solvency II. SAM – set to test run in 2015 – seeks to improve the financial soundness of insurers. It will align capital requirements of insurers with underlying risks, develop risk-based approaches to supervision, promote better risk monitoring and management tools, and maintain overall financial stability.

The implementation of SAM has already been twice delayed due to the magnitude, size and complexity of the project. According to the FSB’s SAM 2014 update, “Enhanced governance and risk management framework requirements will be introduced through a Board Notice, and a formal framework for insurance group supervision will be provided for through the Twin Peaks process.” The first public version of SAM legislation will be available for comment some time after publication of the Financial Sector Regulation Bill.

Treat Customers Fairly

The primary framework that the FSB will use to fulfil its market conduct mandate under twin peaks is the treating customers fairly (TCF) approach. TCF is modelled after the UK, and is an outcomes-based approach dealing with issues of consumer protection, market integrity and consumer education. The issue of subjectivity of whether an insurer is meeting the six outcomes required by TCF is being addressed through consultations and phased testing of the outcomes. The FSB’s baseline study from 2013 confirmed that 65% of short-term insurers were TCF ready. TCF is influenced by the sector’s ongoing retail distribution review (RDR), which aims to ensure that distribution models support fair outcomes for customers. The RDR aims for consumers to know exactly what they are getting for what they are paying. This will be achieved by separating fees and commissions, which have previously been built-in by service providers.

Supporting Change

Suzette Olivier, general manager of the legal department at the SAIA, said that the organisation’s 60 short-term insurer members are largely supportive of the changes. “As a member of the International Association of Insurance Supervisors and G20, South Africa has followed the lead of European regulators and an increase in supervision was expected, with a focus on solvency, governance, consumer protection, risk management and financial inclusion,” Olivier told OBG. The main purpose of increased financial regulation is to mitigate risk, enhance consumer protection and prevent a future financial crisis.

In SAIA’s 2014 annual review, Scott notes that bringing South African regulation up to international standards is important given the country’s clout in Africa. This is illustrated by the country’s membership in groups like G20 and the economic consortium known as BRICS, despite not being among the largest in those blocs.

Consultation Is Key

The FSB conducted regular consultations to obtain industry perspective on regulatory changes. “We have been engaging with industry stakeholders and have been receiving input through interactive mechanisms like surveys as part of our reinsurance review and economic impact studies to assist in the development of the SAM framework,” Ian Marshall, head of the SAM unit at the FSB, told OBG.

The reinsurance review has been concluded and a policy paper is expected to be delivered in 2014 that will influence the reinsurance regulatory framework of SAM. The economic impact study assesses the effects SAM will have on the behaviour of insurers and the potential impact of that behavioural change on regulatory and developmental objectives of the sector as well as the economy at large.

Olivier emphasises the importance of effective and meaningful industry consultation in ensuring that new regulation is appropriate. “The SAIA is engaging with the NT and the FSB as we partner towards effective and appropriate regulation for our sector. Complying with the new rules is a challenge for smaller firms who do not have the requisite capital and operational structure to digest the regulatory reforms,” she said.

Keeping Pace

The rapid pace of regulatory changes and new requirements takes a significant toll on the local insurance sector. “The burden and timing of regulation remains one of the top 10 challenges businesses face,” Olivier told OBG. She adds that insurers are faced with new regulations before they are able to come to terms with previous rounds. “Compliance functions are taking up more and more management time,” she said. SAIA’s 2014 annual review notes that small insurers suffer more, as they now spend more than half their time dealing with compliance. In general, costs have risen by 28% largely due to compliance, putting pressure on underwriting margins. These costs are associated with adapting systems, compliance and understanding new regulations.

PwC reports that acquisition costs and management expenses as a percentage of GWPs remained level at 29.3% in 2013, despite a 12% growth in GWPs. “This indicates the higher costs of doing business, given the many regulatory changes being implemented,” PwC’s insurance industry analysis for 2013 stated.

Olivier does not expect the pace of regulation to abate soon – rather, she expects this trend to continue for the next several years. While the FSB acknowledges that firms will face strain on resources during a consolidation period, Ian Marshall, head of the solvency assessment and management unit in the insurance division of the FSB, told OBG that, “In two to three years the insurance industry will feel more settled.”

Tax Effect

An amendment to the Income Tax Act that will be effective from March 2015 will help standardise tax treatment of insurance policies for death and disability protection. Under the current system, despite tax-free lump sum payments, premiums are not tax deductible. The amendment will make premiums tax-deductible, allowing bigger payouts for claimants, which is expected to encourage more people to take up this kind of insurance. However, the amendment may also motivate people to reduce coverage, as current premiums provide for a pre-tax rather than tax-free income. The Association for Savings and Investment South Africa, which represents long-term insurers, found that South Africans were already underinsured for both death and disability by 62% and 60%, respectively.

Credit Insurance

The FSB together with the NT and the National Credit Regulator are looking to regulate credit insurance because of concerns that customers – especially low-income earners – are being treated unfairly. Credit insurance is mandatory and until now pricing has suffered from inadequate transparency as consumers are tied to the financial services provider offering the credit, which decides which insurer covers the loan. This has led to abnormally high insurance premiums, especially in the unsecured market. The “Technical Report on the Consumer Credit Insurance Market in South Africa”, published by the NT in mid-2014, highlights these abuses. The report recommends that the FSB protect borrowers through better credit insurance regulation. Regulatory proposals may include capping cost of credit and harmonising premiums.

Medical Check-Up

National Health Insurance (NHI) was introduced in 2012 to provide universal health care access, as there has long been a disparity between public and private health care expenditure and quality of service. The scheme is to be phased-in over a period of 14 years and will entail major changes in service delivery structures, and administrative and management systems. In the meantime, private health care costs are rising disproportionally to the cost of living, with customers paying up to 14% of salaries on private medical care plans. The first five years of the NHI roll out will focus on upgrading the public health sector. People in formal employment contribute to NHI, and health care professionals join voluntarily.

Demarcation Concerns

Demarcation regulation was proposed two years ago to specify separate functions of medical aid schemes and health insurance products. The purpose of demarcation is to protect the commercial viability of medical schemes, which by providing more comprehensive coverage tend to attract higher price tags and higher-risk customers. The concern is that certain health insurance products in the long- and short-term segments could entice younger and generally healthier people away from medical schemes, leaving them exposed to higher costs of remaining clients without the premiums base to cover these expenses, thus undermining social solidarity.

In 2012 the first draft of demarcation rules controversially set product restrictions on hospital cash plan insurance policies. The second draft was published in April 2014 and is open for public comment until the end of the year. While this draft acknowledges that health insurance products have a role in the market place, it places limitations on certain products that overlap with medical schemes and fail to support their social solidarity principle. Stricter regulation on health insurance firms in the current iteration of demarcation proposals means certain functions will be prohibited in order to prevent overlap with medical schemes. However, these proposals would also mean that most South Africans would be priced out of medical schemes and would revert to state health care, adding more challenges to an already overburdened system. The final decision on demarcation is expected in November 2014.

Motor Matters

Innovative moves to increase road safety are expected to have a positive impact on motor lines, with a range of technological devices and applications being developed to assess driving standards, such as whether a driver is speeding, braking sharply or making erratic manoeuvres. Mobile phone apps also pick up whether people are talking or texting while driving. The idea is that monitoring motorists will reduce accidents and mortality rates, thereby lowering insurance costs and premiums. Currently, 80% of all motor claims are accident-related. “Use of technology in the sector is growing, with innovations in areas like predictive early warning and communication technologies for hailstorms and floods,” Muguto told OBG. “Embedded devices in cars to monitor driver behaviour are already in use to price coverage appropriately.”

Furthermore, SAIA has been pushing for compulsory third-party motor property insurance for several years. Of the 10m vehicles in South Africa, only 35% are insured, according to the SAIA’s 2014 annual review.

Outlook

Strong investment market performance in the last two years has boosted insurers, but a stalling economy presents challenges in the near term. South Africa only just avoided a recession in 2014 as marginal second-quarter growth of 0.6% offset the equal economic decline in the first quarter. High unemployment at 25.5%, an inflation rate at above 6%, higher interest rates, prolonged industrial action and the burden of regulatory changes are all factors that may subdue insurance sector growth in the coming year. But the sector should still have room to grow. “The slowdown in economic growth has impacted the insurance industry but the high-end retail segment has been resilient,” Thabo Dloti, CEO of Liberty Group, told OBG. And with twin peaks and SAM coming into effect, insurance business management will continue to devote time and resources towards understanding regulation and its compliance.

Deeper cross-border cooperation is expected to continue moving forward. During the July 2014 BRICS summit in Brazil, the five member countries alluded to the potential for their insurance and reinsurance markets to pool their capacities. At the same time, the market is expected to continue consolidating as new approaches to business develop and come on-line. The reputation of the insurance industry on the whole will remain a critical success factor as well for South Africa, especially in terms of expanding across the continent.

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The Report: South Africa 2014

Insurance chapter from The Report: South Africa 2014

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