One of the largest potential insurance markets in Europe is only just getting off the ground. James Hydzik discovers that Ukraine is shedding its shady image in an effort to establish a lucrative insurance industry.

Until recently, most of the insurance for Ukraine's financial and industrial groups was provided by captive insurance companies and, with a few notable exceptions, there were no moves to form a classic insurance industry. The overall environment at the time would have rendered this a difficult task. Government legislation, in force since Ukraine gained independence in 1991, favoured the use of insurance companies for tax optimisation strategies and even accounting methods were structured in a manner at odds with international accounting standards. Rampant corruption in the judiciary was seen as another stumbling block in enforcing claims. For these reasons and others the general population tended to view insurance unfavourably.

But things are picking up, and a growth rate of 25-30% in the volume of premiums is attracting major foreign players. Regulations are changing, and even before the 2004 "Orange Revolution" insurers interested in working in a transparent, level marketplace were pushing for reform. Non-life insurance in particular is growing as the formation of a middle class, in metropolitan centres at least, has given a growing proportion of the population the feeling that they can and should insure.

Institutional corruption

Andriy Peretyazhko, president and CEO of PZU Group Ukraine, says that official figures for insurance volumes do not show the true size of the current market. Non-life segments such as reinsurance, corporate property, financial risk and real estate had been used heavily by business groups to funnel money through their organisations. "After independence from the Soviet Union in 1991, many insurance companies were founded to service other companies in a business group. Taxes on gross revenues of 3% were put into place, although the standard corporate income tax is 25%. Sister companies, especially in the financial sector, would pay very high premiums to the insurers, who would then purchase equity or debt in the institution, or send the money out of the country by purchasing reinsurance offshore, often from reinsurers owned, in the end, by the same players."

While insurers wishing to operate in a "classic" regulated market can and do thrive in Ukraine, there is a push from the government to prepare the country for a better-regulated environment. The Financial Supervisory Commission has brought in international experts, including some from the World Bank and European Commission, to give advice on the creation of new laws regarding financial reserves and capital solvency as well as cash flows within the industry.

Some market segments are largely free of institutionalised corruption, and Ukrainian insurers have even shown some ingenuity in creating solutions to problems in a niche. Alexander Viktorov, a sector analyst at the Kyiv (Kiev) financial brokerage Concorde Capital, says that international travel insurance is a small portion of the market but one of the most mature and least corrupt market segments. However, competition has been low because of the requirement to go to outside sources to service the policies.

Universal Investment Group vice president Olexander Pavlenko, who heads the group's insurance holding, says that the company became the leader in the international travel insurance segment by doing its homework: "We were having problems because the companies we were buying coverage from didn't have Ukrainian and Russian speaking staff or doctors on the telephones. We analysed Ukrainian travel patterns and created our own links with the appropriate doctors in Egypt, Turkey and the Gulf States in particular. At this time, most Ukrainians that go abroad head to these destinations, so we were able to concentrate on providing a better service at a lower cost."

Driving competition

Motor insurance is one area where government must step in to do more. Liability damage has been required for a couple of years. Until 2005, though, the traffic police were completely untouched by reform and paying bribes was the norm. Buying one's way out of an uninsured motorist fine finally stopped when the Yushchenko government actually fired the whole traffic police force and later the Minister of the Interior began spot checks in unmarked cars. However, even without the corruption, enforcement is lax as the punishment for being uninsured is low and even then would take some time to be enforced. As a result, only 10% of the driving population has liability insurance.

One factor that has pushed the automobile insurance market forward has been the surge in new car purchasing. Cars bought on credit must be insured, and the insurer is often tied to the source of the financing that is used. But corporations are discovering that retaining their customers is difficult. People who buy their first cars often don't have a clear understanding of what insurance is and how it works and will therefore settle for uncompetitive policies. But there is a significant body of people, who bought cars two to three years ago, and have now paid them off. This group of people have begun to shop around for insurance; especially if they weren't satisfied with the service they had previously. Competition in this market segment is particularly fierce, and even the captive insurers have to charge decent rates, as it is a big factor in the car-buying decision. Currently, new car sales account for roughly half of the auto insurance segment, and of these, roughly half of the policies are taken out through non-competitive means.

The auto insurance industry, if requirements were properly enforced, would generate $600m in new premiums from eight million clients. Andriy Peretyazhko notes that the changes in legislation required to put teeth into the law could come as early as the end of the year. "The Motor Insurance Bureau and Ministry of the Interior are talking, and if the current minister, Lutsenko, keeps his job when the new cabinet is formed, we could see an improvement as early as October."

A new era

The future of the insurance industry in Ukraine looks bright, and any negative aspects must be taken in context. For example, it is likely there will be a reduction in the number of companies operating in the market as a result of the closure of loopholes that currently benefit industrial groups. Out of the 400 market operators doing business at the moment, it is estimated that 80-100 will survive. Only a handful of mergers and acquisitions are expected to occur between domestic entities, as foreign partners are preferred and most Ukrainian firms are too small to make any purchase worthwhile. Universal's Olexander Pavlenko points out that, "There's not much for us to buy within Ukraine if we want to grow significantly. An honest insurer here would have to look at any possible domestic partner very carefully."

The introduction of the legislation that will bring Ukraine's insurance market in line with European practice is seen as inevitable, although the timing is currently unclear. A fight between the largest firms, which want a classic market, and those engaged primarily in "grey schemes" (non-market, often legal mechanisms that allow for money laundering and generally run afoul of international accounting standards) is expected as well. Yulia Timoshenko's return to the prime minister's position bodes well for the insurance industry in particular, and may well be an influential factor in pushing through reform sooner rather than later. The heads of the conglomerates which own insurance companies in order to take advantage of grey schemes do not control politicians in Ukraine - they are politicians themselves, as the upside of being an MP is immunity from prosecution. Thus there are powerful groups directly involved on both sides of the upcoming fight, and it will take Timoshenko, as an insider who knows the mechanisms well, to push through the changes. "We can expect some improvement in the law at some point between six months and two years," says Peretyazhko. "Although those who benefit from the current system will try to hold out for as long as possible and bargain for the best terms that they can."

A company looking at coming into the Ukrainian market should do well, in time, although there is some hard work to be done. Growth of about 25% can be expected, but even this comes at the expense of creating an industry from the ground up. Human resource investment will be relatively high, the level of professionalism among workers in the industry is very low and training will be a must. Additionally, all but the largest insurers have poor IT infrastructure.

A large public relations campaign would also be beneficial in educating the public on the benefits of insurance, especially life. Ukraine's retail banking sector began to pick up three years ago, and consumers are becoming savvier regarding financial instruments. Bridging the knowledge gap will be easier for insurers, but the work still needs to be done. Likewise, developing a network of offices will take time, and only the largest market players have a substantial presence outside of the largest cities. Currently, a focus on major cities such as Kyiv, Kharkiv, Donetsk and L'viv will bring the fastest results. Given the effort required to put the appropriate infrastructure and education in place, Andriy Peretyazhko suggests that planning at least two years in advance is advisable.

Trying to come to grips with the lack of indepth and accurate statistics is a problem that used to be rampant across all business sectors in Ukraine. While some industries, such as banking, have become largely transparent, the insurance industry is only now beginning to see this sort of change. Changes in legislation do affect companies tied to financial-industrial groups specifically, and a positive segment dynamic might also show severe drops in reported volumes by a few insurers. "It's an affect of the insurer coming clean," Peretyazhko remarks.

A common error made by firms entering Eastern European countries is that they assume that all markets in the region are the same. "Expats often don't see the market for what it is and tend to make mistakes. There is a tendency to think that what worked in Prague ten years ago will work well in Kyiv now. Russians make the same mistake when coming into Ukraine, and think that Kyiv and Moscow are the same. Both groups forget that differences in mentality, especially between eastern and western Ukraine, require different strategies. The country itself is something between the Polish and Russian insurance markets in outlook, but it's not homogeneous," Peretyazhko maintains. Still, companies that make the effort are practically guaranteed a substantial return.

- James Hydzik is a freelance journalist.

UKRAINE HOW BIG IS THE MARKET?

A lack of accurate information is a normal characteristic for any sector of an emerging market. The insurance industry in Ukraine has suffered from several factors, including a cultural tradition of hiding information and wealth from authorities, the introduction of laws in 2002 that turned insurance companies into vehicles for tax optimisation and money laundering schemes, and until recently the use of a hostile tax collection authority as a tool for political and business-hindrance purposes. All of these factors are changing for the better, and analysts in Ukraine have become more adept at examining businesses and sectors and watching for clues as to the actual size of a company or market.

The official size of the total insurance market in Ukraine is listed at $2,570.7m. Of this amount, however, only about one third is considered to reflect a "classic" regulated market. The rest, approximately $1,700m, is believed to be primarily the result of tax optimisation activity.

Sometimes official figures can be used. Life insurance, for instance, is sold by only 50 of the almost 400 insurers in the country, and according to Concorde Capital's report, the whole segment produced $64.25m in premiums, or 2.5% of the total official reported premiums for 2005. Premiums grew by 171%, while claims dropped to 82% of the 2004 figure, or $1.96m.

However, insurance penetration as a percentage of GDP reveals something unusual. Information from Concorde Capital shows that life insurance premiums were less than 0.0001% of GDP, although that is four times higher than the penetration in neighouring Kazakhstan. Non-life penetration, however, was at 4.4% of GDP, which is higher than Japan and over twice the figure for Poland. Financial risk and property insurance played a large role in the total numbers, with 81% of the whole insurance market premiums being paid under those categories.

Given a population of almost 48 million people, only 10% automobile liability insurance penetration and a modernisation of the health insurance sector long overdue, the untapped potential for the classic Ukrainian insurance market is ripe for exploration.

Source: Author's own.