Insurance Sector

FIRST has engaged in funding technical assistance (TA) for the insurance sector in developing countries because a strong, growing, well-regulated insurance sector contributes substantially to the growth, size, stability and diversity of the financial sector, and has, in many cases, a positive impact on poverty reduction.

In the past 25 years or so most technical assistance to the financial sector of developing countries has focused, quite rightly, on the banking sector. This tends to account for over 90% of the entire financial sector in early stage development. Especially in Eastern Europe and former Soviet countries, the challenge was to transition from a command driven banking system, where banks were simply a tool of a centrally planned economy, to a risk-driven private sector oriented system. Understandably other potentially important pillars of the financial sector, such as insurance, were given a lower priority.

In the past decade, insurance has risen up the list of priorities. It is, and should be, in most instances the next development leg towards a sophisticated and diversified financial sector. Many financial conglomerates have established insurance subsidiaries alongside their banks. Learn More....

A developed insurance sector contributes in many ways to a well-rounded financial sector and economy:

Risk protection. This can include loss or damage to assets ranging from properties (residential, commercial and industrial) to other assets (e.g. cars, trucks, machinery) and to cover potential liabilities arising from injuries, health, and loss of earnings.
Financial stability. Insured assets add value and protection to, for example, the collateral taken by a bank, assets leased by a leasing company, investments made by a private equity/venture capital firm, investments of shareholders in listed companies. Against this, in financial conglomerates care also needs to be taken to ensure that badly run insurance subsidiaries can not, through contagion, affect the banking part of the group (this was one of the factors behind the Jamaican banking crisis in the 1980s).
Poverty reduction. Better protection against risks to health, small savings and essential assets, may provide a buffer against financial disaster for a poor family. For example, in many parts of the world a serious illness, not covered by basic medical health insurance, can wipe out a life-time saving; climactic disasters can wipe out a herd or a crop with no course to recover. Without deposit insurance, savings in a collapsing bank may be lost.
Growth and diversification of the financial sector. Insurance companies need to invest collected premiums in suitably prudent and relatively liquid securities. This imperative facilitates growth of capital markets. Life insurance companies frequently engage in managing pension fund schemes because they have the infrastructure to collect savings and to manage investment funds – an added impetus towards growth of capital markets, with the extra advantage of providing an alternative vehicle to banking for savings mobilisation.

Insurance companies may engage in a wide-range of insurance products. Those companies that do not offer any life insurance may be described as “general” or simply “non-life” insurers. Sometimes companies only offer life and pension fund management schemes, and they may be described as “life” insurers. Finally, there are companies that offer both “non-life” and “life”, and these are known as “composites”. Among the various classes of insurance that could be on offer by an insurance sector to its clients are:

Property- buildings –commercial and residential (with or without contents cover)
Equipment- machinery
Motor vehicles (often a major proportion of a market’s premium income in developing countries and complicated by other infrastructure needs involving judiciary, police, vehicle registration authorities) - third party liability protection is the usual minimum cover required.
Medical cover
Third party liability other than for motor vehicles
Professional indemnity
Travel
Loss of earnings (usually for business and self-employed individuals)
Deposit insurance (mainly targeting small bank deposits)
Workers accident cover- liability to claims arising from injury or disease arising from the work place

In some countries several of these classes are compulsory under the law i.e. Third-Party Motor Liability (to ensure that those injured in a car accident are compensated); professional indemnity and workers accident. In practice, even if not compulsory by law, a lender against collateral will require insurance on the collateralised asset (e.g. factory, office building, and residence) and a lessor will require insurance against a leased asset (e.g. vehicles, machinery & equipment).

In order to protect consumers, such as the members of pension schemes managed by life insurance companies or consumers relying on the insurer to be able to meet claims for whatever cover they have taken out (be this for assets or protection against other risks such as health, accidents and so on) there is a need for the insurance sector to be well regulated and supervised. Often the regulation and supervision task will be carried out by a specialist, insurance markets regulator, and sometimes by a unified financial sector regulator (as in the UK and some developing countries).

Unlike traditional banking, the insurance sector is collecting premiums up front in return for a promise that it will pay-out for any claims made against it in the future. This business model has often been abused in the past because there is almost a “ponzi” type temptation by the reckless (or even fraudulent) insurer to rack up profits from the up-front income and then avoid settlement (deliberately or not) of claims when they are made. The regulator therefore needs to ensure that the insurance company establishes a suitable reserving policy by setting aside from income and profits sufficient sums to cover likely claims. This process is known as technical reserving and involves analysis of claims history for each type of insurance offered, to assess likely claims in the future. In some cases, such as life insurance and pension schemes managed by life insurers, it is necessary to employ actuarial analysis to establish suitable reserving policies, because claims may be many years into the future and will be (a) definite and (b) variable depending on mortality rates and the pension schemes’ structures. Such actuarial analysis will need to be updated periodically because of various factors, including changes in mortality rates (in some case going down because of improved standards of living and in some cases going up because of epidemics such as HIV) and changes in investment returns. The regulator also needs to ensure that the insurance company pursues prudent investment policies with differing levels of liquidity and may set limits on various asset classes that the Insurer is permitted to invest in.

A large insurance company with a wide product range may be a more complex enterprise to regulate and supervise than a bank. It needs to establish claims reserves against a wide range of products where the claims history and risks may be very different. Some of these risks- especially in asset insurance- may be relatively “short tail” in their nature e.g. if a factory is burned down it may be possible (assuming a genuine accident) to assess the loss quite quickly and settle within a year of the claiming event. On the other hand, some risks such as industrial accidents may be “long tail” and take many years or even decades to quantify and settle; for example, the asbestosis claims in the USA were a contributing factor to the collapse and subsequent restructuring of the UK Loyds insurance market. The accounting issues in these circumstances tend to be more complex than in most developing country banks (most of these banks avoided heavy exposure to derivatives with its associated accounting complexities) and the analysis tasks for both the regulator and the insurance sector tend to be more complex.

As with banking, the range of activities of insurance companies tends to evolve over time. In early stage insurance sectors, it is common for the insurance companies to focus on a few relatively simple classes of insurance such as property and motor cars and have only a very limited involvement in liability insurance and life insurance. These early stage companies tend to lack historic data as a sound basis for establishing claims reserves but are fairly simple to regulate and supervise. Therefore, risk management regulation may focus at a basic level with simple, if somewhat arbitrary rules, such as minimum capital, easily calculated solvency margins and reserves set at a percentage of premium income (e.g. 95%). As the sector evolves – develops a claims history and reliable claims data, widens its product range, even starts in areas such as life insurance – then the regulations will also evolve. At some point as the sector moves towards a more mature state, risk-based insurance and related supervision will also evolve. Technical assistance to the sector therefore needs to be sensitive to the stage of development and the capacity of insurance company management and the regulator to respond to demands made upon them. Technical assistance needs to be tailored to the varying stages of development in the insurance sector of developing countries. Hide...

Summary of Lessons Learned

As of June 30, 2008 FIRST had provided funding for technical assistance on 29 completed projects in the insurance sector: 21 of these ($2,926,820) were in support of the legal and regulatory framework and strengthening of supervision and eight ($2,402,595) were involved with product innovation or strategy for the sector. Product innovation projects have cost on average more than double regulation and supervision projects. Learn More...

Lessons Learned:

Working with regulators to strengthen their regulatory and supervisory capacity, including assistance with improving regulations and amending the legal and regulatory framework, was productive in almost all of the projects where this was the focus of the technical assistance.

Identifying potential roll-out of follow-up technical assistance in certain regions can and should be built on. For example, the shared basic principles of legal and regulatory frameworks and insurance regulation and supervision can be spread throughout the South Asia region (through AITRI), and throughout Southern Africa through CISNA.
Cross-border co-operation between insurance supervisors is important in those areas of the world where insurance companies are also cross-border operatives. For example, in Southern Africa many insurance companies are subsidiaries of South African companies, so the regulator in, for instance, Zambia needs to consult with the FSB in South Africa with respect to those parent insurance companies with subsidiaries operating in Zambia. Many countries have subsidiaries of large US or European insurers operating in their countries. Indeed, the Armenian Central Bank is keen to attract a major “western” insurer to the market as a model for higher standards of governance and practice.
There can be cases where an insurance company is involved in pensions schemes management (which in turn involves managing investment funds) and, is even a part of a banking group. In these cases regulation may be split between an insurance regulator, a capital markets regulator (for investment funds managed) and even a banking regulator. There is a risk that compliance failures in one area have consequences for other areas of the company’s or group’s prudent operations, but communications between regulators is inadequate to cross-relate risks arising. FIRST needs to be careful in providing TA support in such a situation to be sure that there is systematic coordination between relevant regulators.
FIRST has learned that it is not suited for providing the longer term TA required for helping develop certain areas of insurance activity such as medical insurance for the poor. This is an important area for poverty alleviation but is also complex because it needs to involve coordination with medical authorities, hospitals and other players in order to be effective. Similarly, the implementation of effective motor third party liability is complex because it involves enforcement regimes that need to tie in with the police, the motor registration and licensing bodies, the judiciary and establishment of claims tariffs. Even the establishment of claims tariffs can have political consequences. For these reasons, FIRST has a developed policy for its support of development of the insurance sector that narrows its focus and fits with FIRST’s Charter mandate. Strengthening regulation and supervision of the sector remains the core of FIRST’s focus in the insurance sector.

FIRST continues to be ready to support the strengthening of regulation and supervisory capacity for private pension schemes managed by life insurance companies. This area may offer retirement savings products for small savers and contributes to development of the financial sector: widening the product base for insurance companies and potentially bringing investment demand and greater liquidity to local capital markets. Hide...

Selected Project Profiles and Reports

FIRST disseminates project outputs that are potentially of value to other countries that are undertaking reforms in the insurance sector. FIRST does not consider that all of the material developed in insurance projects is appropriate for dissemination, because in many cases it is too specific to the particular case. The project examples and outputs shared in this section are chosen because they may apply to other countries' development context.