Keith L. Shroyer casts his eye over the market conditions across Latin America.
Across Latin America, the markets are hardening – a trend that was well-established even before the tragic events of 11 September. The root cause pre-11 September was not so much a contraction of capacity, but rather the fact that numerous reinsurers had drawn the line, effectively saying they could no longer afford to continue writing the business at the prices they had been offering. As a result of September's terrorist activity, we are likely to see an even greater impact on capacity and pricing going forward, for three main reasons.
Domino effect defaults
Smaller to medium sized reinsurers may have some significant losses resulting from the World Trade Center tragedy, and their retrocession programs may not provide enough coverage. Moreover, some of their retrocessionaires might default, causing smaller/mid-size reinsurers to cover that shortfall themselves, ultimately leading to their own default. A number of these reinsurers and retrocessionaires are undoubtedly involved in the Latin American market.
Impact of loss recovery
Major reinsurers will pursue an accelerated recovery of their losses from the World Trade Center event, in the shortest timeframe possible. In order to accomplish this, they will undoubtedly raise coverage pricing worldwide, including in Latin America.
Zero cat rate benefit
Remarkably, the Latin American region has not seen any major catastrophic events this year and in general has been relatively quiet (with the exception of an earthquake in southern Peru that caused little insured damage). Normally this would bode well for the region, but pricing now will be driven by what happened at the World Trade Center.
Beyond the impact of the World Trade Center disaster, two key trends with implications for capacity and pricing have become evident during the last couple of years.
In 2001, the region continued to see reinsurers either depart the territory or significantly downsize their operations. We expect to see even more market departures (and therefore further consolidation) in the rest of 2001 and into 2002. The net result is a region in which reinsurance premium volume is increasingly concentrated in fewer and fewer hands.
Multinationals acquire local entities
The other continuing trend is ever-increasing participation by multinational insurers, meaning that each market more and more is comprised of insurers that are affiliates of multinationals. That trend will definitely continue, creating a new scenario on the reinsurance side, as locally capitalised insurers become fewer and fewer.
A quick look at a few of the region's major economies will offer insight into growth prospects for the region as a whole.
The Argentine market tends to be generally underpriced, at least in part, as a result of lack of exposure to catastrophic perils. So the big question remains, “Why are insurance companies losing money?” The reality is that they have been under pressure for the last couple of years or more. Reinsurers, at best, are seeing marginal profits.
The key issues, then, are: when will the Argentine insurers perceive that they can no longer go on losing money and take appropriate action?; and when will reinsurers decide that it's time to improve terms and conditions on the business?
In a sense, some reinsurers have already begun this process by downsizing or departing. Some international reinsurers – those that have not historically been heavily involved in the market – are the key elements preventing a return to adequate pricing, due to the fact that their recent entry into the market means they have not experienced the last few years' poor results, and do not have past losses to recoup. This, combined with their lack of knowledge of the market, explains why they are offering capacity at inadequate prices.
As for the economy in general, no one can predict, but the government has made a commitment to eliminate fiscal deficits in hopes of recovering from a three-year recession. This is an important step that will require serious austerity measures and could cause higher unemployment. Full recovery will depend on how diligently the government adheres to this new fiscal regimen. The events of 11 September will only make those efforts more challenging.
As neighbour and major trading partner to Argentina, Brazil is directly impacted by the economic difficulties next door. The Brazilian economy has been sluggish, and the erosion of their currency against the dollar is a concern. On the business front, the insurance industry has been keenly disappointed over the endless delays in the privatisation of the IRB, the state-controlled reinsurer, and accompanying opening of the reinsurance market to foreign competition.
Some see the government's unwillingness to move forward as unnecessary foot dragging that is costing the market critical credibility in the global insurance arena. Going back two years, one of the key negotiating items with the International Monetary Fund (IMF) regarding debt restructuring and/or additional loans was that the IRB had to be privatised. Now, two years later, the government of Brazil has not made good on its promise to privatise IRB, and every excuse is offered – from Supreme Court action to union activity and so forth. At this point, a meaningful timeline for privatisation/market opening is not even being offered. With presidential elections scheduled for next year, no major policy initiatives are being discussed for fear of bringing added controversy into the election process.
With the sale of the IRB apparently nowhere on the horizon, market rumblings are centred on removing the connection of the sale of IRB and the opening of the market, thus allowing foreign reinsurers free access to the Brazilian reinsurance market, regardless of whether IRB is privatised. Uncertainty is the only thing we can be certain of for now.
In 2001, Colombia has experienced a degree of economic recovery compared with the last couple of years. The insurance market itself is still sorting things out. A heightened awareness for increased rates exists, particularly on property business where insurers' profit margins are, at best, very thin. In many cases, companies have faced operational losses. In general, the Colombian market is more and more in tune with the global markets and has begun to raise pricing as insurers are faced with the increasing costs of catastrophe protections.
Life-related lines, including workers compensation, offer the most promise. While many reinsurers are not licensed to work in life business, for those that are, the need is to have the resources in place not just to underwrite the business, but also to provide know-how.
This includes sophisticated mass marketing of life insurance products through bank distribution systems, the same way as in more developed markets. We are actually busy now with programs in place to install and implement these types of sophisticated marketing initiatives for insurance companies in the region.
More than any other Latin American country, Mexico will feel the direct effects of the US economic situation. Even before the tragedy of 11 September, Mexico was burdened with a currency overvalued by a factor of 10-12% if not more. Historically, when the currency has been held at an overvalued level for any length of time, conditions either bend or break. In Mexico's past, they have tended to result in devaluation.
While this is definitely a concern for the re/insurance industry, and obviously for overseas investors, the good news is that Mexico has never before been in a better position to withstand and recover from a temporary fiscal downturn. President Vicente Fox brings to office more advanced political tools, better international relations and more sound economic policies to guide the country through this period. On the industry front in Mexico, price increases are likely for insurance, and therefore reinsurance, products. This ultimately will lead to more stable market conditions across the board.
Much like Colombia, the Peruvian market is seeing property rates on the rise. Reinsurers obviously view this very favourably, since rates had fallen in previous years to inadequate levels. The market also is beginning to develop some interesting opportunities in life insurance-related areas. At XL Re Latin America, we are very much looking forward to participating due to our significant client base in Peru.
Looking ahead, we see a few key areas that offer greater economic stability to the region as a whole.
Life and life-related product growth
Further development of life and life-related insurance products will undoubtedly continue throughout Latin America. From an economic viewpoint, some countries will grow at a faster pace than others, making life products more easily affordable. Both the insurance and the investment sectors will collectively benefit as consumers move toward more enhanced coverages that improve the region's quality of life as a whole.
Obligatory automobile coverage
Today, few countries in Latin America have obligatory automobile coverage requirements as extensive as in the US and Europe. During the next five to ten years, this type of obligatory coverage is expected to greatly expand, and with it the insurance premiums in the region. In Latin America, there is still a delicate balance between the value these coverages offer and the cost incurred to acquire them, because a much larger percentage of the population is living on the poverty line. As fundamental economic conditions improve over time, obligatory automobile insurance will likely become a more significant product offering going forward.
As individual countries assess their situations, it would not be surprising over the next couple of years to see more adopt dollarisation, as El Salvador and Ecuador have done. For example, Argentina, whose currency has been pegged to the dollar for a number of years, could make the conversion quite easily. The obvious advantage for foreign investors, as well as international reinsurers, is the removal of one of the great uncertainties, devaluation. This logically benefits the local country as well, as foreign investors are logically more comfortable in an environment in which their potential loss due to devaluation is either mitigated or entirely eliminated.
If anything, the events of 11 September underscore just how interconnected world economies have become. As for the Latin American insurance industry, it has been through these kinds of cycles before and will experience them again. It is the well-capitalised companies that will be best positioned to navigate through this global economic downturn.
The key thing to remember is that insurance, and therefore reinsurance, is essential to the progress of any country, whether developed or developing, enabling people to protect their personal net worth. Of course, we may not see as much insurance premium growth in Latin America as was previously projected, but the positive benefit that any country derives from insurance will still be significant.
The most important factor is that, regardless of whether one is a local consumer buying a policy from an insurance company or an insurance company buying reinsurance from reinsurers, it is critical to ensure that the provider is a very, very solid company – with people who will be there not just tomorrow but two years from now, five years from now, and beyond.