Plenty of ambition: Opportunities exist to scale up expansion in Africa and scale down policies to attract lower-income clients

As the continent’s most developed insurance sector, South Africa’s insurance market accounts for some 52% of African non-life premiums. It presents fundamentals for significant growth in coming years, with insurance penetration of some 12.9%, according to global accountancy PwC. The domestic life and non-life segments rank 13th and 19th in size globally, with net premiums of R151.67bn ($18.49bn) and R35.58bn ($4.34bn) in the first three quarters of 2012, respectively, according to PwC. Heavily skewed towards long-term (life) products, which account for 79.3% of total premiums, according to insurance credit rating agency AM Best, the non-life (known as “short-term”, in South African parlance) segment is growing steadily following a slump during the global financial crisis.

Reforms

The industry’s regulatory structure is in the process of significant reform that will tighten both prudential and market conduct regulations, presenting new challenges to insurers’ outlook and cost controls. The country’s dominant, larger insurers also view considerable potential farther afield, both in sub-Saharan Africa – with an average penetration rate of only around 0.4% according to PwC – and globally. In the transition to a new regulatory framework by 2016, PwC forecasts growth in the 10-15% range for short-term and 15-20% for long-term segments. Rating agencies like Standard & Poor’s (S&P) are less sanguine in their forecasts for short-term premiums in light of competitive pressures, expecting premium growth at around the same levels as GDP growth, closer to the 3-4% range.

Mature But Growing

Despite contractions during the banking crisis of 2002 and the economic slowdown of 2008-09, the sector rebounded to health in the following two years. A strong recovery in consumption by households, backed by debt and a sustained expansion in the middle class, has underwritten this rise in premiums. Growth in net premiums in the short-term segment reached 8.53% year-on-year (y-o-y) in 2008, spurred by significant investments in preparation for the World Cup, before dropping back to 4.95% and 6.67% in 2009 and 2010, respectively, according to the current regulator, the Financial Services Board (FSB). The following year, 2011 (the latest year for which audited results are available), marked a strong rebound, with net premiums surging 7.59% y-o-y to R45.81bn ($6.34bn) as economic growth regained momentum, although the challenges in 2012 dampened growth in net premiums to 1.87% y-o-y for the first three quarters, with net premiums of R35.58bn ($4.34bn). As the 2009 contraction affected household incomes, new acquisitions slowed while the rate of policy lapses rose as clients cashed in their policies.

Life Performance

The slowdown in long-term premium growth was even sharper during the crisis, dropping from 10% y-o-y in 2008 to negative 3% in 2009, before rebounding to 1% in 2010 and 2% in 2011, reaching R180.56bn ($25.01bn). In contrast to the struggle for margins in the short-term segment, net-recurring life premiums continued to accelerate in the first three-quarters of 2012 with 10.27% y-o-y growth to R84.47bn ($10.3bn), according to unaudited results by the FSB. This performance was driven by growth in living annuities while traditional guaranteed annuities grew at a slower pace, given the low interest rate environment. Meanwhile, net non-recurring (one-off) premiums have contracted from R92.1bn ($13.4bn) in 2007 to R79.54bn ($11.02bn) in 2011.

As in most major developing markets, the short-term segment continues to be dominated by motor and property lines, which accounted for 41% and 34% of the segment’s total gross written premiums (GWP) in 2011, respectively, according to the FSB. Smaller policy lines such as personal accident and health have expanded more rapidly however, with their combined share of net premiums rising from 5.6% in 2009 to 7% in 2011. While the market mandates certain compulsory coverage – for third-party bodily injury under the Road Fund, workers’ compensation and professional indemnity for pension fund trustees – the absence of mandatory car insurance, among other policy lines, as required in other emerging markets has hindered more sustained growth in short-term premiums. The more dynamic long-term segment has benefitted from a structural shift in savings away from banks towards alternative savings products, as well as a strong boost given by widespread purchases of funeral policies.

Middle Class Market

The growing middle class has driven demand for higher-return savings products: an annual survey of consumer financial services by FinScope in 2012 found that the share of adults with life insurance rose from 11% in 2004 to 13% by 2012, or some 3.9m people, while 10% had medical coverage. Traditional life policies continue to dominate the segment, accounting for 51% of net premium in 2011, followed by long-term fund policies with 40%. The bulk of growth, 81.84%, in net individual premiums in the first half of 2012 was driven by single premiums, where clients make lump-sum payments according to the long-term insurance association, the Association for Savings and Investment South Africa (ASISA).

Long-term insurers have sought to drive premium growth through rider policies, added on to traditional life covers, seeing their medium-term prospects as linked to higher spending on insurance rather than a significant expansion in the number of policyholders. Nonetheless, PwC forecast in 2012 that the number of clients covered by long-term policies, including pensions, would increase from 22.2m to 28.6m between 2012 and 2015, while in the short-term segment, the client base would rise from 9.6m to 12.7m in the same period. While the sector’s prospects remain positive in aggregate, intense competition and pressure on margins in both segments are driving a growing number of South Africa’s leading underwriters to seek growth opportunities in overseas markets.

Commanding Heights

Both segments have a large number of players – 87 registered long-term and 106 short-term underwriters (including reinsurers) in 2012, according to the FSB. Yet, these figures mask a high degree of concentration. While the regulator clearly segregates licences for short- and long-term insurers, a number of (mostly local) groups dominate both segments and hold equity stakes in the larger banks.

A variety of different players compete in the long-term space: 31 general insurers offering all six classes of policies, 10 niche insurers focusing on one policy type, 15 linked insurers offering investment-linked products, seven cell-captive underwriters that extend their licences to third-party businesses, 10 assistance insurers specialising in funeral covers of under R18,000 ($2194) and seven insurers in run-off. The short-term segment is even larger, with 31 typical underwriters, 31 niche players, 10 cell captive and 11 captive insurers, as well as 15 insurers in run-off.

The long-term segment is represented by ASISA, while the short-term players are led by the South African Insurance Association (SAIA), both assuming a key role in ongoing regulatory reforms. While the sector witnessed a spate of mergers in the late 1990s, the number of players has remained relatively stable since then, in contrast to the banking industry. The 10 largest short-term underwriters by premium controlled 81.2% of the market in 2011, although their share continued to be eroded, down from 82.7% of premiums in 2010. Only two of these – Zurich and Chartis (rebranded AIG in 2012), with 5.4% and 3% market shares, respectively, in 2011 – are foreign players. Smaller and mid-sized firms such as Absa, Allianz, Saxum and state-owned Sasria have gained a 1.6% market share in the year to 2012, achieving over 20% annual growth in premiums.

According to a 2012 South African insurance survey conducted by the accountancy group KPMG, the largest players in short-term lines are Santam, part of the Sanlam Group, and Mutual & Federal (M&F), part of the London-listed Old Mutual Group, with operations in 30 countries. With 23.4% and 10.5% market share, respectively, at the start of 2012, they have indeed seen their market share increasingly threatened by the rise of independent direct insurers due to alternative distribution channels (see analysis). KPMG estimated in August 2012 that direct and niche insurers had captured some 10% of the market in the last decade. Underwriters such as OUT surance, Auto & General (both in the top 10) and Dial Direct have been the most successful direct insurers targeting price-conscious, younger clients in the motor and property segments.

Long-term insurance performance, 2007-12 “We do not look at direct insurers as taking market share from existing insurers, but possibly growing the insurance pool as a whole by reaching out to emerging groups of people not previously accessed through traditional channels,” Victor Muguto, insurance leader for Southern Africa at PwC, told OBG. “Insurance has traditionally been sold, rather than bought,” he added.

Acquisitions

Royal Bafokeng Holdings (RBH), which holds a 15% stake in Rand Merchant Bank Holdings (RMBH) and RMI Holdings – backers of OUT surance, health insurance leader Discovery (with a 40% share of the medical segment), MMI Holdings and RMB Structured Finance – has been the driving force in new equity stakes in the market in recent years. RBH also increased its stake in Zurich Insurance from 10% to 25.1% in 2009, while Zurich’s Switzerland holding raised its stake in RBH to 84.05% in May 2012.

Santam has grown inorganically since the start of the millennium, acquiring Guardian National in 2000 and direct insurer Emerald Risk Transfer in 2010. It also launched its own direct insurance arm, MiWay. Old Mutual has prioritised overseas acquisitions, taking over Australia’s CGU and FGI Namibia in the last decade, although M&F has launched its own direct insurer, iWYZE. Both underwriters hold significant equity stakes in South African banks, with Old Mutual holding 52% of NedBank and Sanlam Group controlling some 40% of its invested assets in a portfolio of minority stakes in the country’s big-four banks.

Takeover Targets

The rapid growth in independent direct underwriters has presented attractive takeover targets for established groups, with Hannover Group buying Motor Underwriting Acceptances in 2009, for instance. “The trend has indicated an increase in direct insurers gaining market share: while they originally focused on personal lines such as motor they are increasingly moving into commercial lines and large underwriters have launched their own direct insurance businesses in recent years,” Suzette Strydom, general manager of technical at SAIA, told OBG.

The third-largest insurer, Hollard, is the largest independent group, with 9% market share in 2011, having acquired FedGen in 2002. Despite significant changes in market structure, S&P expects Santam to cement its industry lead by gaining an additional 1.6% of the market to a total of 25% by the end of 2014. The prospect of consolidation driven by a raft of regulatory reforms could yet benefit established larger insurers able to better cope with the additional costs (see analysis).

Long Term & International

While opinions differ on whether direct long-term insurers will take significant market share from established underwriters, they have faced growing competition for South African savings from the country’s asset management industry. Dominated by four major players with strong international presences and holding over 50% of industry premiums in 2012, according to ratings agency Fitch, the segment’s aggregate assets grew 13% y-o-y in 2011 to reach R1.45trn ($200.83bn) by year-end, according to ASISA. Despite downgrades by all three major rating agencies from October 2012 following sovereign downgrades, long-term insurers hold significant cash resources to fund expansion further afield.

Over 165 years old and listed in South Africa, the UK, Zimbabwe, Malawi and Kenya, Old Mutual competes in over 33 markets. On a global restructuring path for the past three years, the life insurer has sold off non-core assets, recording 51% y-o-y growth in income to R6.7bn ($928m) in 2011 and 22% return-on-equity (ROE). Old Mutual has expanded bancassurance in West Africa and is using Kenya as a base for its East African operations.

South Africa’s second-largest underwriter, Sanlam, bought a 49% stake in Malaysian insurer Pacific & Orient in late 2012, adding to its already wide-ranging geographical operations in 11 African countries, the US, the UK, Australia, Switzerland and India. The long-term insurer has proven more cautious in expanding in Africa than its short-term affiliate (Santam). Yet, in 2012, it raised its stake in Kenyan underwriter Pan Africa Insurance to 60%. Achieving 25% y-o-y growth in GWP and 17% ROE in 2011, to R21.46bn ($2.97bn).

The third-largest underwriter, with over R33bn ($4.02bn) in assets, MMI Holdings (24% held by RMBH), experienced continued difficulty in 2012 with the integration of the two merged insurers – Metropolitan and Momentum – which merged in December 2010. The R500m ($68.2m) target for cost savings as a result of the merger has been slow to materialise and offset by costs of integration. MMI’s aggregate income fell a sharp 25% y-o-y in 2011 to R1.5bn ($207.8m) while its ROE stood at 6%. With operations in 12 markets on the continent, the underwriter is seeking opportunities in Asia, in particular India, although acquisitions will be a less-pressing priority than for other market players pending the full benefits of the merger.

The smallest of the “big four” long-term players, and the only one not active in short-term, with an estimated 18% market share domestically, is Liberty, 53% owned by Standard Bank. Present in 16 countries in Africa and counting 2.2m clients domestically, the underwriter is expanding its successful bancassurance tie-up with its affiliate in East and Southern Africa to the continent’s western region. Faster than its peers at launching a direct insurance arm (Frank.net), Liberty achieved 19% y-o-y growth in income to R2.7bn ($374m) and 22% ROE in 2011. While new players such as BrightRock entered the market in 2012, only Discovery, the dominant health insurer with over 40% share of the medical segment, has challenged the top four’s market share in recent years by focusing on lower-income clients.

Reassurance

The market’s reinsurance segment is highly competitive, with three long-term-only reinsurers, three short-term players and four composite licence holders alongside reinsurers providing cover from offshore. “Compared to a number of African countries, South Africa is an attractive market for an international reinsurer to operate, as it does not have a national reinsurer that the state seeks to protect, making the playing field relatively level,” Randolph Moses, managing director of Hannover Reinsurance Africa, told OBG.

That said, the market is concentrated, with the top-five reinsurers holding 97% of reinsured premiums in 2011, led by Munich Reinsurance (with 30% market share) and Hannover Reinsurance (27%). Uniquely, Lloyd’s is allowed under the 1998 Short-Term Insurance Act to write business directly through its correspondents, generating some R2.6bn ($316.9m) in gross premiums for the British market in 2011, or an 11% market share. Reinsured premiums for domestically incorporated reinsurers as a whole has stayed relatively flat, from R2.39bn ($293m) in 2008 to R2.29bn ($317.2m) in 2011 and R1.8bn ($219.4m) for the first three-quarters of 2012 according to unaudited FSB data. Declining claims, from 64% of earned premiums to 61% in the same period, have bolstered the performance of reinsurers however, with underwriting profit rising from R37m ($5.12m) to R87m ($12.05m) in 2011.

New Competition

The award of a composite licence to France’s SCOR in 2009 brought new competition. While still a small player, with a 7% market share, SCOR was the fastest-growing reinsurer in 2011 with 60% yo-y premium growth. Swiss Reinsurance, traditionally the dominant short-term reinsurer in the market, closed its non-life business in 2009 and has focused on long-term since then. Another recent entrant, Flagstone Reinsurance, announced its intention to sell operations in April 2012, following significant losses worldwide in 2011. On the life side, the FSB recorded 28.4% y-o-y net reinsured premium growth for the seven life reinsurers in 2011, while that in the short-term reinsurance space grew a more moderate 6%.

While rates are competitive internationally, the FSB is seeking to prompt local incorporation and registering to level the playing field between locally registered and offshore reinsurers. Underwriters must seek FSB approval and offer the tender locally first before being able to cede risk offshore. With an estimated half of short-term risk ceded offshore, according to the FSB, the aim is to expand domestically incorporated reinsurance capacity and develop South Africa as a reinsurance gateway for the continent, alongside existing offshore centres such as Mauritius and Bermuda.

“We are reviewing rules on reinsurers in line with global practices and are considering whether to continue with the current regulatory requirement that all reinsurers must be incorporated locally,” Jo-Ann Ferreira, a senior manager in the insurance supervision department of the FSB, told OBG. “These new rules will be part of the Solvency and Asset Management (SAM) legislation.” While the scope of reform remained uncertain in early 2013, the move to incorporate locally is likely to face resistance from global reinsurers concerned about excessive regulation in South Africa, particularly at the level of local labour laws.

Pooling Risk

The country is also part of a number of specialised pools. The state-owned South African Special Risks Insurance Association (Sasria), structured similarly to the UK’s Pool Reinsurance and the US’s Terrorism Risk Insurance Act, pools risk in terrorism, riots and other political risks by covering physical damage only (rather than business interruption and other costs).

Rising claims related to strikes and riots since 2006 have grown to account for 70% of the R211.6m ($29.31m) in claims on Sasria in 2011. The market also boasts a South African Pool for the Insurance of Nuclear Risks for cover of its nuclear power plants, administered by SAIA and linked to an international pool. While claims and loss ratios have followed a downward trend since 2010, a series of natural catastrophes in 2012, including fires, hailstorms and floods, is expected to increase reinsurance rates during treaty renewals in 2013.

Costs, Losses & Returns

Underwriters’ profit has generally improved in both segments in recent years on the back of aggressive cost controls and declining loss ratios, although a raft of natural catastrophes in late 2012 is likely to spur rising rates in 2013. The claims ratio in short-term typical insurers have gradually slumped from 66% of earned premium in 2007 to 60% in the first three-quarters of 2012, while those in long-term have dropped from 99% of net premium to 87% in the same period, according to unaudited FSB data. Insurers have focused on improving the sophistication of claims processing in recent years, according to KPMG, settling legitimate claims faster, while cracking down on fraudulent or duplicated claims by centralising data. Underwriting profit in the short-term segment has thus improved from 6% of earned premium in 2007 to 9% by the end of third-quarter 2012.

As the sector matures and competition in key segments continues to harden, underwriters have focused on controlling costs more aggressively. Management expenses and commissions for short-term insurers grew from 27% of net premiums in 2007 to 30% in the first nine months of 2012, while long-term insurers’ commissions remained stable at 6% of net premiums; their expenses grew from 11% to 14% in the same span. While the sector continues to face a significant shortage of qualified human resources according to KPMG’s 2012 report on the sector, insurers have sought to expand their use of outsourcing and shared services. Members of a multinational group have integrated certain back-office functions globally, and local insurers are looking at means of collaboration.

Volatile investment yields from 2009 to 2011 and a falling interest rate environment have placed insurers’ investment income at risk. Yet, short-term players’ combined underwriting and investment income grew from 14% of earned premium to 15% between 2007 and third quarter 2012. Meanwhile, long-term insurers benefitted from stronger investment yields in 2012, with yields recovering from single-digit levels recorded from 2008 to 2011 to reach 10% in the first three quarters of 2012. While the implementation of SAM will bring different risk-weights to various asset classes, long-term insurers are likely to remain overweight South African equities while diversifying gradually overseas in both listed and non-listed (private) equity.

Motor Insurance

As in most developing countries, motor insurance accounts for the lion’s share of short-term net premiums – 41% in 2011 (around R25.54bn, $3.54bn). With growing competition between direct insurers and conventional broker, and agent-based underwriters, margins have been squeezed while penetration has remained flat. SAIA estimates that only 35% of cars are insured, creating strong growth potential should compulsory third-party liability (TPL) be imposed in coming years. Although all typical short-term insurers provide motor cover, the market is led by Santam, with over 25% share of the segment, according to PwC, followed by OUT surance, Telesure and Hollard.

The existing compulsory motor scheme is the Road Accident Fund (RAF) established in 1996 and run by the state, funded by a R0.88 ($0.11) levy on fuel. Covering only physical harm to passengers rather than cars themselves, the fund’s coverage was reduced from unlimited cover in 2008, capping claims such as health bills and loss of earnings to an initial R194,000 ($23,784). The RAF is set to be further reformed in 2014 in the context of a wider social security reform effort, turning it into a Road Accident Benefit Fund Scheme, consisting of a no-fault benefit scheme where the insured are compensated by the fund regardless of fault in an accident, thus reducing potential litigation costs.

Call For Compulsion

As competition has driven pressure on margins, underwriters have struggled to contain loss ratios. Insurers have long called for the introduction of compulsory TPL to expand coverage, lower average acquisition costs and pool risks, with expectations that average premium rates would range from R50 ($6.10) to R200 ($24.38) a month. Insurers expect implementation in the coming years, a development that would significantly stimulate the market. Meanwhile, SAIA has focused on containing loss ratios on motor lines – with over R16bn ($1.95bn) in accident repairs covered by short-term underwriters annually – by focusing on the cost of maintenance, parts and curbing crime. Yet repair costs have remained doggedly high, curbing the enthusiasm of short-term insurers for the segment. “The issue of vehicle repair costs has plagued the motor segment in recent years, especially with import tariffs, combined with currency weakness, affecting the cost of many OEM parts imported from abroad,” Leon Vermaak, CEO of Telesure, told OBG.

Going Micro

Central to the aim of promoting financial inclusion has been the scaling of financial products, including insurance, to the needs and budgets of a mass market of lower-income earners. “We are now looking at using other distribution channels such as micro-agents and retailers, since it is likely that brokers would be uninterested in such thin commissions while aggregators will still experience difficulties because of various legislative requirements,” Viviene Pearson, a general manager at SAIA, told OBG. The success of funeral insurance policies has pointed to the potential for market adoption of simple, limited-cover policies. While virtually all funeral costs were covered by informal burial societies at the start of the decade, by 2012 some 7% of South Africans held a funeral policy from an insurer, alongside 8% covered through their bank, 10% through their funeral parlour and 28% from a burial society, according to a 2012 study by FinScope.

A first effort to standardise micro-policies emerged in 2007, when life insurers launched a collective brand of policies called Zimele (“standing on your two feet” in Zulu) – approved by the Treasury. Aimed at low-income earners Zimele is a standardised product defined by its simplicity, affordability and limited cover. A funeral policy capped at R5000 ($708) costs as little as R45 ($6.37) a month, for instance. The initiative has been particularly successful in funeral, life, credit life and disability lines, with over 5m policies sold by 2012. Other forms of assistance insurance have also emerged. Santam has piloted a student insurance policy (“4sho”) since 2012, covering mobile phone and laptop losses, and expects to sell 200,000 policies in 2013.

Yet, by the start of 2013, just 20% of low-income earners held any form of insurance. “By and large, South African insurance firms have failed to adapt and package products that address the needs of low-income social groups that are interested in basic coverage, and struggle to understand complex policies,” Daryl De Vos, managing director at Africa Reinsurance, told OBG.

Insurers have been evaluating the types of products most suited to scaling down. The Treasury circulated a policy document on micro-insurance in July 2011 and has worked with the FSB to draft new legislation due to be passed in 2013. The intention is to aid the segment’s development by granting specific micro-insurance licences to separate subsidiaries with capital requirements as little as R3m ($365,700). In early 2013 the FSB was also reviewing whether rules for market conduct are too stringent for micro-insurers. “We want to adopt a more supportive attitude towards micro-insurance, exempting micro-insurers from SAM legislation while enforcing strict standards for products and perhaps allowing for composite micro-licences,” Ferreira told OBG. “We expect micro-insurance products GWPs by class of business, 2011 to attract most interest from life insurers, although the segment will be open to non-life coverage too.”

Crop Cover

In a country predisposed to a range of natural risks and a large commercial agricultural sector, insurance plays a critical role in the government’s efforts to hedge risks. However, despite more than two decades of coverage, crop insurance has reached only 33% penetration, ahead of India’s 20% and Brazil’s 10%, yet below Australia’s 80%, Turkey’s 46% or Argentina’s 45%, according to SAIA. While South Africa was one of the first economies to establish a crop insurance scheme that was subsidised by the government in 1979, the scheme is now entirely backed by private insurers.

The roughly R1bn ($121.9m) in total annual agricultural insurance premiums is entirely covered by private insurers, led by Santam, M&F, Absa Insurance and Agricola, with Hannover Reinsurance, Munich Reinsurance and Swiss Reinsurance the largest reinsurers covering agricultural risk in South Africa. Larger commercial farms seek cover directly, but as access to crop insurance is typically onerous for smallholders individually, smaller farmers typically form a cooperative that is then insured. As the number of insurers providing multi-peril crop insurance for larger farms has multiplied since the start of last decade, competition has driven premiums lower with a resultant rise in loss ratios to above 100% in years of particularly harsh weather.

Following losses in 2012 reinsurers and underwriters have argued that the current insurance system is inadequate for coverage over the long term. “The present model of crop insurance is not sustainable, particularly given government encouragement to cover small farmers, in the absence of state support through a public-private partnership (PPP), either by backstopping excess-of-losses, supporting a crop insurance pool or another structure,” Debbie Donaldson, general manager for strategy and planning at SAIA, told OBG. While the African Union is backing the creation of an insurance pool for coverage of droughts on the continent, SAIA and the Treasury are studying different possibilities for establishing either an agricultural insurance pool with excess-of-loss covered by the government, or other types of PPP arrangements.

Outlook

While regulatory changes present the single greatest challenge for both short- and long-term underwriters in South Africa, the continent’s most developed insurance industry has significant opportunities to expand across Africa and other emerging markets, as well as at home with micro-insurance. The scope for mergers and acquisitions may draw new players into the competitive market, while renewed pressure on reinsurers to incorporate locally is also likely to draw investment. As South Africa’s largest financial groups seek to leverage connections between banks, insurers, the asset management industry and new partners like retailers, policyholders will likely find a growing array of products and distribution channels on the market. Meanwhile, the potential introduction of new compulsory insurance lines and reform of the social security system could also yield new impetus for growth in South Africa’s insurance market in the medium term.

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The Report: South Africa 2013

Insurance chapter from The Report: South Africa 2013

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