The prospect of a deregulated Brazilian market has been offered for some years, but is only just coming into play. Bob Callaghan reports.
Brazil has taken an important step in opening its insurance market with the publication of the regulations which will control the business of reinsurance from the end of April 2000.
The market effectively closed some 60 years ago with the creation of the IRB (Instituto de Resseguro do Brasil) which was granted a monopoly on transacting reinsurance in the country. The motivation at the time was to restrict the outflow of foreign currency to pay for reinsurance obligations and also to foster the domestic insurance market. These objectives have been surprisingly well fulfilled.
The Brazilian insurance market (life and non-life) in 1998 had an income of R$19billion (US$15.5billion before the devaluation of January 1999), a growth of 6% over the previous year. A recession has restricted growth in 1999 but GWP of R$20billion is still expected for the year. However, this only represents an annual insurance spend of around US$65 per capita of the population. The market is by no means saturated.
On the contrary, less than 30% of motorists have insurance (other than the compulsory limited bodily injury cover). Massive amounts of commercial and personal property either have no insurance or very little. The market has been dominated by Brazilian companies, many owned by or linked with banks. Four of the top companies, Bradesco, Sul America, Itaú and Porto Seguro control about 50% of the premium volume. These companies have little business outside Brazil but are big companies by any standards. Bradesco and Sul America each have premium income of around US$2billion.
The state reinsurer, IRB, has controlled the outflow of reinsurance monies well, by ensuring that all external reinsurance is purchased though itself. It is illegal to insure Brazilian assets other than in Brazil. They have also controlled pricing by setting underwriting terms for larger risks on behalf of the market and approving rating plans for companies' own products. The Central Bank has co-operated by not allowing the inward remittance of insurance claim proceeds referring to non-admitted coverages. This acts as a strong fiscal disincentive to non-admitted insurance. The result has been the development of a strong domestic market with excellent cashflow and good profit streams.
The prospect of a deregulated insurance market has been offered for some years. This has encouraged foreign companies to turn their attentions to one of the remaining world markets to offer new development potential, accessibility and a sound basic economy. Aside from that, Brazil's importance in the South American context is unarguable. Foreign companies which have invested heavily in Brazil include AIG, HSBC, Liberty, Aetna, Chubb, AGF, Ace. Of the British companies Royal & SunAlliance, present in Brazil for over 100 years, and the CGU both have modernised and strengthened their local subsidiary companies for the new market.
Despite a land mass similar in size to the US, Brazil offers the attraction to reinsurers that it is remarkably free from exposure to natural disasters. This gives the chance to balance some of the catastrophe hazard which has hit reinsurers hard elsewhere in the world in 1999. Unless someone establishes responsibility for clean-up costs for industrial pollution in Rio de Janeiro's Guanabara bay or the cities of São Paulo or Cubatão the worst claims are likely to arise from some flash flooding or isolated wind-storms.
Legislation published on 25 January 2000 sets the tone for how the reinsurance market will be organised. It answers local concerns that the opening of the market will prejudice local insurers, and aims to create an element of stability to encourage the development of a local reinsurance market.
Three categories of reinsurer are created:
1) Local reinsurer - capitalised in Brazil with a minimum net worth of R$50m.
2) Admitted reinsurer - a foreign company which complies with certain documentary and rating requirements and keeps a deposit fund of US$5m, and a resident representative in Brazil.
3) Non-admitted (eventual) reinsurer - a foreign company not complying with local market requirements and with no deposit fund.
Foreign professional reinsurers have been massing in the country for several years in preparation for the opening. These include General & Cologne Re, Munich Re, Swiss Re, Transatlantic Re, Gerling, Latin American Re, Copenhagen Re, Mapfre Re and Employers Re. A number of these seem likely to opt for local status as being the best way to participate in what is initially estimated as a US$2billion reinsurance market. They will enjoy an enhanced competitive position over companies not wishing to domesticate.
For other overseas reinsurers, including Lloyd's, the question will be whether the business in Brazil justifies setting up a reserve fund in Brazil. Companies who do so will be able to participate in treaty and facultative reinsurance to a greater extent than non-admitted reinsurers. Cedants will be limited to ceding a maximum of only 10% of their total reinsurance placements to non-admitted. This strongly encourages placement to admitted or local reinsurers. A tax of 4% applies to all cessions of premium to foreign companies, whether admitted or non-admitted. Though initially it appears that this will give local reinsurers an advantage, this is only partly true. Local reinsurers will be subject to the tax when purchasing their own covers and will doubtless pass on this cost. For major exposures much premium will flow outside the country.
One of the key questions in all this is: “What will happen to the IRB?”. The IRB is unusual among state reinsurance corporations in not being bankrupt and has returned respectable profits over the past several years. It has been restructured, to some extent modernised and reduced in size in prospect of being sold, as part of a process of privatisation of state assets and liberalisation of the economy. True, the IRB has some skeletons in the cupboard in terms of a run-off of “London market” business and considerable pension liabilities to current and former employees. It is, however, a saleable entity with appropriate assets. A minimum price has been set for the sale at R$436m for the government's 50% share of IRB. The other 50% is held by all of the insurance companies in the market. It is presumed that the potential purchaser of IRB would need to offer similar terms to the companies to buy out the remaining shares. The sale is expected to take place in June of this year.
To encourage a healthy sale price for IRB the government needed to give some form of guarantee of income. Compulsory cessions to the “ex-IRB”, after the sale, were considered but risked being unconstitutional by creating in effect a privatised monopoly. The provisions published require cedants during a period of two years to offer 60% of all reinsurance cessions to local reinsurers at the same terms as offered by foreign reinsurers. The cessions must be allocated to all the local reinsurers in proportion to their individual net worth. While not directly favouring IRB, the expectation is that IRB should have a high net worth compared to the other local reinsurers which will guarantee a good income stream for the initial period. The purchaser in effect has two years to fully modernise IRB to a position where it can compete on level terms with international reinsurers.
Speculation as to who will buy IRB is pointless. Several international groups remain interested. Suffice to say that the government would like the purchaser to involve one of the main international reinsurers and to involve some local Brazilian interests. Five percent of the shares are being reserved for IRB employees.The consequences of the opening of the market will be most immediately noticed by purchasers of insurance in the large commercial and industrial sectors. These clients feel they have been prejudiced by IRB's reluctance to reduce rates, or increase coverages to the levels that many can achieve on a worldwide basis. The open market will bring choice of reinsurer and reinsurance structure. Companies will be freer to develop products and offer competitive advantage through innovation and customer focus.
These innovations in product and service are likely to filter down to smaller buyers of cover in the commercial area. Even the man in the street will ultimately benefit, perhaps in terms of product development, but certainly in terms of improved customer service which will start to differentiate companies. Compulsory third party motor insurance is likely to create a huge new market competing for the 70% of motorists who currently have no insurance. The proportion of households with no insurance probably is over 80%. The potential of selling insurance through the internet is enormous if you can find the right proposition and solve the fraud problem - currently most companies carry out a physical inspection of vehicles before granting cover.
But many things about insurance will remain uniquely Brazilian. The compulsory involvement of brokers in insurance contracts - fiercely defended by an association representing 60,000 or so insurance brokers. The highly developed banking system allowing clients to pay insurers directly - brokers are not even permitted to collect insurance premiums. Commissions are paid to brokers by the companies as they receive the premium installments. Non-admitted insurance is still illegal. The future may change some of these things.
For years it has been said that Brazil is a “pais do futuro” (land of the future). It has all the resources to become a fantastic world player in so many areas. However the phrase has been used for so long that it has become a bit of a joke since the future never seems to arrive. Now at last, in insurance at least, it's possible to say that the future looks a big step closer.
Bob Callaghan is technical vice president with Royal & SunAlliance Brazil.