The Brazilian market has been relying on investment income to maintain profitability, but insurance penetration is low. Gordon Feller looks at the potential of the country's insurance business.

Falling interest rates are a challenge to Brazil's buoyant insurance industry, whose profitability derives mainly from the high returns achievable in the country's overheated financial sector.

Insurance policies generate annual revenues of about $10bn, around 3.3% of GDP. The sector is comprised of some 120 insurance companies and another 50 firms offering associated services. The insurance companies have approximately 45,000 direct employees, but the sector is estimated to employ a total of some 200,000 people, including agents.

The reinsurance company IRB Brasil-Re remains state-owned, despite privatisation attempts in the mid-1990s. Although the private insurance companies among them hold 50% of IRB Brasil-Re's capital, these shares are non-voting.

Several international reinsurance companies also have offices in Brazil, some in the hope that IRB Brasil-Re will eventually be privatised, although that seems unlikely to be a priority of the current administration.

Despite significant deregulation in the early 1990s, the largest ten companies still account for about 70% of total premiums. Concentration fell briefly in the mid-1990s, when several international companies entered the market, and 20 of the country's 30 largest insurance companies now have some foreign capital. However, many new players have subsequently merged with existing firms, mainly in an attempt to reduce administrative costs which are still well above the international average.

Banks dominate the sector, and two, Bradesco and Itau, are responsible for about 40% of all insurance sold. The exception is the vehicle segment, whose share of total premiums has been falling steadily in recent years and currently accounts for around 26%. Many of the world's largest insurance companies are also now present in Brazil, where despite a 100% rise in insurance sales in the past decade, the scope for further growth is considered enormous. Some optimistic analysts suggest there is scope for the value of policies sold to double again within four or five years, depending on the country's economic performance.

Although a small number of companies are profitable, for the majority - including some of the largest - the amount paid out in claims (plus operational expenses averaging about 12% of policies), exceeds premium income. The average profitability of between 10-12% is almost entirely explained by revenues from investments in financial services, more than 90% of which are in fixed rate assets. Had it not been for high real interest rates of between 15-20% in recent years, few if any companies would have been profitable.

Revenues from investments have enabled policies to be sold more cheaply than might otherwise have been possible. However, with real interest rates now falling, the industry is facing a major challenge. Despite the concentration in the industry, which is intensifying as some large players move out of low-yield sectors such as motor, life and pensions, rates are extremely competitive. Competition leaves little scope for raising rates in many segments, as this would result in a fall in sales.

Boom in life

The fastest growing sector of recent times has been life and pensions, with the steepest growth of all relating to new products combining the two, which have been launched in the past two years. Margins in this sector are very small, as new business is costly to attract. Life policies now form about 28% of total premiums. The largest companies account for 70% of all life policies, led by banks; the majority of policies are sold through bank branches. Linked life and pension products have been given a boost by the reduction in the ceiling for state sector pensions, encouraging many in the public sector in particular to seek to top up their savings.

The likelihood of further cuts being made to state pensions is expected to lead to steady growth in the private life-pensions sector.

With the rate of inflation far below the average of a decade ago, and the economy much more stable, personal savings are on the increase, including among younger people. Brazil's largest insurance company, Bradesco, is associated with the bank of the same name, which has almost 3,000 branches nationwide as well as 2,000 other outlets. Bradesco sold 8 million policies last year, virtually a quarter of the total business. The strength of Bradesco - followed closely by Itau, which has a 15% share of the insurance business - illustrates the difficulties for companies which cannot reach a far reaching universe of potential customers as easily and cheaply as those with a large network of branches. Bradesco's growth prospects, by contrast, remain considerable: almost half of its customers still have no cover of any kind.

The share of motor insurance has been falling steadily in recent times, as other segments have grown more rapidly. However, companies in the auto insurance segment are hoping for an upturn next year. New car sales are expected to rise to some 1.8million in 2004, up from 1.3million in 2003, one of the smallest numbers in recent years. The extra sales expected are explained both by falling interest rates and by tax cuts on small vehicles, introduced by the government in an effort to boost sales. An overwhelming proportion of motor insurance involves new vehicles; only a quarter of car owners in Brazil have any insurance apart from the compulsory statutory minimum coverage, which involves about 5% of all premiums.

At present, the 40million or so Brazilians who receive the monthly minimum wage of slightly less than $100 are virtually excluded from buying insurance.

Should the economy report sustained growth over the next few years, however, a new universe of consumers could be expected to open up. Even so, the insurance industry admits that it currently benefits from some of the consequences of high unemployment and low wages. These are believed to contribute to high crime rates, including extremely high rates of theft of vehicles and cargoes; firearms killings and kidnappings are also common.

The climate of insecurity encourages consumers to take out life insurance and to cover themselves against theft of property of all types.

Potential growth areas

Agricultural insurance is a segment seen as having great potential. Only a tiny proportion of farmers now have any cover against losses caused by adverse weather. Because of the increasing importance to the Brazilian economy of agriculture, in particular commodities and foods exports, the government is anxious to encourage farmers to increase insurance cover.

It is believed that lower levels of risk would encourage farmers to invest more, increasing productivity and overall yields. However, margins for agriculture-related business tend to be small because, as when claims occur, the levels of loss can be substantial. The government and the industry are seeking a formula which will facilitate more insurance for this important sector.

Another area with major growth potential is that of workplace cover, particularly in the construction industry. As is the case with road accidents - of which some 400,000 occur each year, 10% involving fatalities - Brazil has one of the world's highest incidences of workplace accidents. If cover were to be expanded, insurance companies would demand the adoption of much higher safety standards, thus potentially reducing the number of accidents.

Insurance premiums as a percentage of GDP are less than a third of the proportion in developed countries, which illustrates the sector's potential.

For this to be realised, however, steady economic growth will be needed, while insurance companies will have to reduce their dependence on investments as their prime source of profits.

- Gordon Feller is an independent researcher and journalist, who has also acted as advisor to multinational corporations such as Chevron, Bechtel and IBM, and worked with non-profit think tanks such as the World Policy Institute.