Julian Taylor and Carlos Andres Rodriguez believe that Colombia holds huge potential for insurance growth

Colombia has long had an image problem for many people in the northern hemisphere. Drug lords and terrorist FARC (Revolutionary Armed Forces of Colombia) rebels have been the prevailing symbols of the country, but the diminishing presence of these negative forces is only a tiny part of the Colombian picture. Important economic opportunities have made the country the second largest recipient of foreign direct investment in South America, and it is a net exporter of oil and coal.

GDP is low but growing, recording a 3.6% increase in 2003. Unemployment is falling. Physically, the country is a gem: as well as bountiful mineral and petroleum resources, its lands host an incredibly diverse natural environment, with six times the world average number of rivers and waterways.

The gateway to South America has much to offer and, for insurers and reinsurers, much potential.

Growing peaceful

Perhaps most important, the negative forces for which Colombia is known around the world are, slowly but steadily, being overpowered by the rule of law. The new administration of President Alvaro Uribe has put security at the top of the national agenda.

President Uribe's democratic security and defence policy has five strategic goals: to regain and consolidate territorial control; to protect the population; to eliminate drug trafficking; to maintain a deterrent capacity; and to ensure accountability, efficiency and transparency in resource administration.

The policy is already paying dividends.

Colombia's standing forces are up 28%, and the number of municipalities without a national police presence has fallen from 168 in 2002 to nil.

Membership of the terrorist groups FARC, ELN (Ejercito de Liberacion Nacional) and AUC (Autodefensas Unidas de Colombia) is slowly falling, while the Ministry of National Defence reports that the number of terrorists captured and killed has risen sharply. Illegal road blocks are down by half, and the number of terrorist events has fallen by a third. Kidnapping is down 45%, illegal coca crops by 50%. A new sense of security is beginning to pervade the Colombian people who, in South America's oldest democratic nation, have finally used their vote to say 'enough is enough'.

Insurance growth

All of this is good news for the insurance market, which has enjoyed recent growth. Overall premium income was up 5.8% during the first six months of 2004 and, although the growth rate has slowed from more than 15%, it remains ahead of more developed markets. According to figures from the Colombian Insurance Association Fasecolda, total premium reached $1.1bn in the first half of the year, comprising roughly 59% property/casualty insurance, 25% life and another 16% pensions-related products, known locally as social security insurance.

Life business is growing at the fastest rate, up 9.1% in the first six months of 2004. Overall claims are also rising, but not as fast as premiums.

The basic claims ratio for all lines of business was 39.2% in the first half of the year, and two thirds of insurers expect claims levels to hold steady.

The growth slow-down reflects the maturation of recent reforms that have shaped the current market. The former monopoly of the state pension system was broken by reform of the pension system, which allowed insurance companies to provide employers with tax-friendly group products, usually through a broker. The government continues to promote the take-up of these products.

About four years ago, new regulations permitted banks to underwrite insurance and distribute products through their branch networks. The ownership of insurance companies by Colombia's main financial entities is driving the growth of bancassurance, and the market is seen as another area of growth in a country where the sale of consumer personal lines insurance covers remains relatively low. The share of total sales through this channel is not yet enormous, but the potential and reach are very high.

Motor developments

The penetration of motor insurance has increased, although this is largely the result of collapsing prices. Rates have fallen significantly from four to five per cent of insured value in 2000 to perhaps less than two per cent today. This step decline has been driven by two fundamental factors: the increased sense of security which has descended upon the nation; and a sharp reduction in car thefts. Both are the result of the rise of law and order.

Reform of liability through a new transit code has also had an impact.

Previously, it was normal for private drivers to have just $10,000 in cover for third party risks. Now, under the new regulations, motorists should be buying $200,000. However, the compulsory component of the limit remains at around $2,000.

Premium for this compulsory cover, called SOAT, is collected by the government to fund a national guarantee of minimum assistance for anyone involved in a car accident (although drivers responsible for their own damages are not eligible for indemnities). SOAT premium collection is linked to the issue of drivers' licences, but cover can be provided by the state or by private insurers. Penetration is high, because police regularly issue fines to uninsured drivers, and government-sponsored minimum terrorism cover for events on the national roads (the only state-backed terrorism facility) does not pay out to uninsured motorists.

Commercial business

Commercial lines are also showing growth, stimulated by increased security and pending free trade agreements. Colombia is negotiating free trade deals with neighbours Ecuador and Peru, and it already has such a deal with Mexico. More importantly, it is pursuing the formation of the wide-reaching Free Trade Area of the Americas with its leading trading partner, the US, and other countries. Potential foreign investors received a further confidence boost this year when the US State Department certified Colombia's compliance with human rights conditions, and officially released $34m in military aid.

Industrial output is concentrated around key cities and dominated by several huge private conglomerates, but thousands of middle-market commercial customers are the bread and butter of the insurance market. The average company purchases a property insurance programme which incorporates business interruption, and terrorism through a buy-back.

Casualty risks are often insured for very low values. Typical Colombian companies buy third party liability cover with limits which are among the lowest in the region, certainly compared to those companies buy in countries such as Mexico or Brazil. However, the advance of free trade will require companies to buy higher. Colombian entrepreneurs, whose largest market is the US, will thus demand greater capacity from insurers and reinsurers, which will help sustain market growth. In addition, companies also purchase directors' and officers' liability coverage, fidelity policies, blanket bond cover, or equivalent products as appropriate.

Companies are obliged to buy insurance from a local carrier. That means fronting is commonplace, although the domestic market - much of which is foreign-owned - has a risk appetite of its own. The US, continental Europe and the UK are all represented among the 29 insurance companies present, and the largest domestic carriers have significant foreign investment.

Terrorism cover

Despite the improving security situation, terrorism insurance is still 'must have' protection for businesses in Colombia. Until about 18 months ago, cover had been prohibitively expensive for most private businesses, so organisations outside the state-owned sector rarely bought it. However, the longstanding efforts of local and international brokers have paid off, and terrorism insurers now segment the risk much more carefully.

That has brought prices down for a great many buyers, and penetration is rising.

The peril does remain an endemic problem, with the general threat felt everywhere around the world exacerbated by local guerrilla groups. However, Colombian terror targets tend to be public organisations and infrastructure such as water utilities, gas and electricity facilities, and other state property. Private sector developments including petrochemical plants, sugar mills, and paper manufacturers have rarely been targeted, yet for years they were quoted the same prices.

Now leading terrorism underwriters in the London market have been convinced, through data, government presentations, and several visits to Colombia, that the high rates typically charged to state facilities for terror cover do not reflect the true risk faced by private sector customers, who are not among the guerrillas' targets. Prices have fallen by 50% to 60% for average private sector risks, and the limits available have soared. In 2000, it would have been very difficult to place a $10m programme; now it is possible to find $50m of cover or even more.

To the credit of the underwriters and brokers involved, the rating process has become far more sophisticated than the traditional approach, which was based far more on statistics than the underwriter's first-hand knowledge.

Today, every risk is rated independently, taking into account basics such as its location, value, and industrial segment, and also factors such as the political inclinations of the people running the company.

Two forms of terrorism cover are available: a basic buy-back which mirrors the standard terrorism exclusion; and more comprehensive additional covers which provide a range of protections. The simplest extension, which covers riots, strikes, civil commotion and malicious damage, can be enhanced to include sabotage, mutiny, insurrection, coup d'etat, and rebellion.

A full political violence policy adds war on land.

With underwriters' new understanding of the risk, brokers have been able to secure creative and cost-effective cover. For example, Marsh built a special programme for industrial risks situated in and around the city of Cartagena. After finding initial reluctance among underwriters even to offer quotes, they were brought to the city to see the risks firsthand, to assess the high level of security the customers had adopted, and to experience the improved Colombian environment. The nation's changing image shone through, and a rating of less than half the previous prices was offered.

Colombia is successfully tackling its negative image, as its new government implements the much-welcomed security and defence policy. Shaking off the country's poor international image may be more difficult, but underwriters are leading the way, and the benefits are already flowing: insurers have a profitable new market, while Colombian businesses finally have essential cover at affordable prices.

- Julian Taylor is Global leader of terrorism insurance at Marsh and Carlos Andres Rodriguez is head of placement at Delima Marsh.