The Middle East insurance market is taking off, but do local players have the strength and skills to take advantage? Jonathan Broughton of EMB says many will require a different business model if they are to prosper.
The Middle East region is expanding rapidly and modernising even in these recessionary times, yet there is some way to go before we see in the region the emergence of a truly modern insurance industry.
In the Gulf States the opening years of this decade recorded 10%+ annual growth in the insurance market, according to Booz Allen Hamilton. In one year, 2006, it rose by nearly a quarter to $6.2bn. Factors driving this development include economic development (current infrastructure projects are estimated to be worth at least $1 trillion) and an emerging middle class with an appetite for insurance products. Compulsory insurance is on the increase in several countries
Despite this upward trend, insurance density remains low. It has been estimated that premium income would have to treble to reach the world average. In other words, the Middle East is a market with a huge amount of potential. The question is, can local companies take advantage of the opportunities that this presents? In our view, they need to radically change their approach if they are to do so.
As you might expect, one should be careful not to over-generalise. There are big differences between different countries and individual companies.
Nonetheless, it is fair to say that the whole region is characterised by small insurers that enjoy significant customer loyalty but lack the technical skills to use their capital effectively or develop new products. They rely heavily on reinsurers for expertise and capital. Indeed, such is their dependency that some of these insurance companies are more like broking houses. (It would only be fair to point out that there are notable exceptions to this picture. In particular, we are aware of a number of mid-east reinsurers who have invested heavily and wisely to compete with international players.)
Overseas insurers have greatly increased their presence in the last few years, partly because many of the region’s biggest markets have been liberalised. Although they are restrained by a number of factors, including continuing restrictions on their operations, they are certain to continue expanding in the Middle East. While this is undoubtedly a healthy economic development, it is surely in the interests of Middle East countries to develop their own insurance industries as well rather than being dependent on outsiders. However, unless local insurers move into the 21st century, they will miss the opportunity.
There are many aspects to this question, especially regulation, supervision and the need for Middle East countries to do more to develop their insurance infrastructures and skills. However, this article will concentrate on how Middle East insurers do business and will argue that, as well as attracting and developing people with expertise, many will need to review their entire business models.
The region’s insurers are often described as under-capitalised, but it is not as straightforward as that. Many of them actually have a lot of capital relative to the amount of business they write. The problem is that they do not optimise that capital effectively and will need to modernise if they are to maintain their margins as market conditions inevitably become more testing.
The typical Middle East insurer business model is very simple. Underwriters will pass on the bulk of the risk to their reinsurers whilst retaining a substantial share as their reward for finding the business in the first place. This may seem like a great basis for guaranteed profits, but there is a catch here. The cosy world that makes it all possible will not last for ever.
The ability to trade like this depends on two things: excellent relations with, and knowledge of, customers; and the willingness of reinsurers to support cedants who compete overwhelmingly on price despite deteriorating results and investment conditions. Insurers may be able to retain the first of these two qualities, but the second is another matter. Overseas insurers with their modern methods and ability to generate profits from the liability side of their balance sheets, have the cutting edge. Perversely, as Middle East insurance markets grow, they will tend to suck in competition and make it more difficult for existing players to prosper.
So what is to be done? The Middle East insurers that are successful in the future will be those that control their own destinies rather than fronting for western companies and depending on them for financial and technical support.
They will have the ability to develop their own products fine-tuned to the markets that they are in; they will have a detailed understanding of their exposures; they will reserve accurately; they will have accurate pricing that reflects the risks they are accepting on a granular basis.
Above all, this activity will take place with an Enterprise Risk Management (ERM) to guide their strategy, supported by the use of capital models. In simple terms, ERM enables a (re)insurer to make full use of its capital and so gain competitive advantage.
The practical financial benefits will be familiar to many practitioners: greater ability to underwrite competitively whilst retaining profit margins in a way that is consistent with the company’s risk appetite; more cost-effective reinsurance purchase; a better understanding of how to deploy your capital and ultimately better returns on capital. (See for example the box below, based on the real-life expenditure of one insurance company on reinsurance.)
To achieve this step change will, of course, require insurers to invest in their infrastructure and especially their skills. The industry is desperately short of human capital. If anything, the region has taken a step backwards in this respect. The Middle East used to employ a large number of Indian insurance professionals, who played a valuable role in their firms. Yet many have returned home in recent years.
There is a strong argument for saying that this investment should be driven at a national level. In the meantime, the insurance companies themselves should be planning the way they adapt to the new world so that they may continue to prosper as independent entities. This means asking themselves what sort of companies they wish to become and how. They need to be willing to abandon the focus on short-term profit in favour of building a long-term sustainable business model. Companies that have relied on investment and property gains to generate profit are seeing the downside of their strategy.
The question is, do enough Middle East insurers have the vision and willingness to invest in the changes that will make them successful and sustainable as their markets are opened up to foreign competition? The region needs them to be successful and they enjoy great customer loyalty, but that on its own will not be enough in the next decade.
Jonathan Broughton is a director at EMB, the non-life actuarial and business consultancy. He is an authorised actuary with the Central Bank of Bahrain (CBB) and has spoken at many insurance events in the region.