It's a tough environment in Latin America but there are opportunities for re/insurers, if they can control costs, improve their distribution network and attract capital, says Aidan Pope.
Despite a number of recent acquisitions, consolidation is the description that best suits the on-going strategy for international insurers in Latin America. Internal pressures, like local competition and burdensome expense ratios, have combined with external factors, such as the general economic malaise and these insurers' own diminishing returns, to ensure a refocusing of attention on specific products and underwriting profits, rather than market share. Ultimately, this will lead to a more disciplined and mature international presence in Latin America.
The crisis in Argentina was the most newsworthy event of the year and, although its impact on the region has to date been contained, it helped to crystallise a number of already apparent trends. According to JP Morgan, the projected Argentine gross domestic product (GDP) for 2002 is $97.5bn (1998: $288.2bn), while the projected GDP for Brazil in 2002 is $445bn (1998: $776.6bn). In fact, the GDP for the Mercosur countries has nearly halved in the last five years. For international insurers, which trade in hard currency, the impact of such contraction is significant. Their assets (and liabilities, in the case of Argentina) and revenues, in euros or dollars, have taken a severe knock. Furthermore, non-life insurance growth is aligned to infrastructure projects - often financed by foreign investment - as well as industrial production, all of which have reduced or slowed down in recent years. It is not surprising therefore that growth in this sector failed to exceed 5% in the period between 1995 and 2000 (Swiss Re; sigma, 2/2002).
Clearly, 2002 has dented the expectations of some global insurers in Latin America: AGF/Allianz recently announced that their South American revenue was down by a third at 30 September 2002. Yet, despite the despondency, opportunities do exist, particularly in the six countries - Mexico, Colombia, Chile, Brazil, Argentina and Venezuela - that provide over 90% of the region's premium income, which was $39bn in 2000 (see Figure 1). Life insurance here is still in its early stages, so while life premiums exceed non-life in Mexico and Chile, in Brazil they represent only 20% of the total premium pool.
Aside from the economic factors, what internal obstacles are challenging the managements of the multinational insurers? On the technical side, the two most immediate needs are to control expenses (acquisition/administration) and to re-underwrite entire portfolios. The traditional intermediary network is still firmly rooted in Latin American insurance culture, and, while multinationals must learn to confront and/or adapt to this fact, it undoubtedly leads to inefficiencies and high costs. The average commission for motor business in Brazil is 20%, an increase from last year. Similarly, administration expenses there are at 23%, up from 19.4%. For many other Latin American countries, including Chile and Mexico, the trend is downwards, but expense ratios still remain high by international standards. As regards underwriting, international insurers are re-diverting resources towards a thorough understanding and appraisal of the business risks - a sharp contrast from the past pursuit of premium growth, buoyed by attractive investment returns. This phenomenon has caused such companies to reappraise the profile of their managers - they are now intentionally recruiting locals with hands-on underwriting experience.
What can the companies do to succeed in this environment? They must be innovative and buy in to distribution channels, whether traditional or non-traditional. The search for gold (if it ever existed in the minds of the international insurers) has now been substituted by the rather more mundane and laborious pursuit of corporate partnerships and cross-selling opportunities. What was the lesson learnt by the six new international insurers, when the Mexican insurance market deregulated in 1993, allowing majority foreign ownership for the first time? Either go big or develop new corporate partnerships. Ten years on, and one or two exceptions aside, the rest certainly did not realise the aspirations of their North American Free Trade Agreement (NAFTA) inspired shareholders. Why not? The financial crisis of December 1994 did not help, but the fact was that none of these companies quite realised how difficult it would be to generate business from the entrenched local production network. Immediate access to the elusive distribution channels is the key to success in Mexico and other Latin American countries. A combination of innovation and technology is the key to obtaining access to Latin America's new insurance customers - a recipe that has been put to good effect by Aegon/Banamex in Mexico, AIG/Unibanco in Brazil and R&SA in Argentina. But these alliances can prove expensive. Local partners, aware that they have the upper hand, can charge a high price for access and demand real value-added from the internationals.
Another important internal factor for the multinationals is that the domestic insurers have become more competitive. In fact, if we analyse the top eight insurers in the region, we see that the majority are still owned or part-owned by strong local financial groups who have become battle-hardened and wily from the onslaught of foreign competition (see figure 2).
Aside from ING (Comercial America plus 49% of Sul America) and MetLife (Hidalgo), most international insurers command a regional premium income of $700m or less, which has them some way short of their local competitors in the big-ticket markets of Mexico and Brazil. In Chile, on the other hand, the multinationals dominate, with 67% of the non-life sector and over 70% of the life sector in foreign hands, according to Swiss Re. Interestingly, even here, local groups are staging a resurgence: they already own the largest non-life company (Cruz del Sur) and the largest life company (Consorcio Nacional), and Chilean investors recently bought back three companies from their foreign owners: AXA, Mutuelles du Mans and CNA. Chile, as perhaps the most evolved insurance market in the region, may herald the beginning of this new period of consolidation in Latin America.
If local competition and high costs were not enough, the multinationals are also feeling the squeeze from reinsurers and market analysts. Reinsurance conditions have become more onerous on the cedants, and in Chile, for example, the relative cost of catastrophe protection has increased threefold since 1999 (see figure 3).
Underwriting for profit
Meanwhile, the stock prices of the major European insurers in particular have taken a beating back home, while their own assets have been depleted significantly through reduced investment gains and the need to bolster asbestosis and environmental (A&E) reserves. The knock-on effect of these woes may in fact be good news for the key players in the Latin American scene - underwriting for profit will be the aim in this era of risk based capital. This is particularly so for Latin America because it is a volatile area, not just economically but also because of the heightened exposure to catastrophe perils in many countries - hurricanes Isidore and Kenna recently caused significant losses for Mexican insurers. So, investors are likely to require higher profit margins in exchange for the regional risk. The return on equity for Chilean non-life insurance was 0.3% in 2001, and in Mexico the industry registered an overall loss for the year 2000.
Another factor that may become relevant is international competition for insurance capital. Growth rates are exceeding 4% in many Asian countries, and insurance prospects in China and India are looking attractive to many multinationals. Managers of companies in Latin America will have to demonstrate to their investors that exciting opportunities await them. Certainly, future insurance growth (especially life insurance) is expected to outstrip GDP growth in the region, and companies like ING and MetLife have recently made important investments in Mexico and Brazil to back up this expectation.
The key to success will be the development of straightforward and efficient products that can satisfy the needs of the new customers among Latin America's population of 464 million people. Mapfre, an innovative Spanish insurer already well established in the region, recently reported third quarter results where their 11 Latin American subsidiaries contributed over 30% to the company's gross profit of $161.4m. So, opportunities clearly do exist for companies that can manage effectively their underwriting and expenses, whilst seeking to break the mould of Latin America's intractable distribution networks.