With political stability, a growing economy and increasing demand for natural catastrophe capacity, the future of the Mexican insurance industry is looking rosy, discovers Ana Paula Nacif.
The second largest insurance market in Latin America, Mexico boasts 25% of the continent’s market share. And reinsurers are optimistic that changes being implemented by the government, combined with the industry’s efforts to increase insurance penetration in the country, can only generate more growth.
“This is a competitive market in which you will find all major reinsurers and brokers,” says Carlos Boelsterli, country executive at Swiss Re. “One of the main reasons Mexico is an attractive market for reinsurers is the fact that, even though it is not the biggest direct market – the biggest one being Brazil – it is the largest reinsurance market in terms of free cessions, mainly due to its exposure to natural catastrophes.”
The insurance industry in Mexico is mature in terms of products for industrial risks as well as distribution of mass products such as microinsurance (insurance for low-income households and businesses), bancassurance (banking and insurance) and sales via credit cards. Andreas Boex, director general of Munich Re’s representative office in Mexico, adds that the structuring of reinsurance programmes and the purchasing “seem to be rather mature processes due to the strict regulations set by the local supervisory authority”. However he adds: “Where we do see room for improvement is on the claims adjustment side. The profession of the loss adjuster is neither protected, nor does it require specific qualifications, which on occasion leads to a somewhat unprofessional handling of losses.”
The main market driver is the exposure to natural hazards, in particular earthquake and windstorm, and the available capacity for those risks in the world market. “Also the supervisory authority, which applies a rather sophisticated dynamic solvency model, similar to the Canadian market, plays an ever increasing role in the way that insurers and reinsurers are structuring and purchasing coverage,” explains Boex.
The Mexican authorities are currently in the process of developing new rules for the minimum capital required for windstorm. The model is still under review and a new directive is due to be issued in October 2007.
Boex believes that such change should lead to a substantial increase in the demand for nat cat capacity. “In the short term, we expect a surge in demand for nat cat capacity driven by the requirements set by the supervisory authority and the expected increase in frequency and severity of storm events.”
“Reinsurers are optimistic that changes being implemented by the government combined with the industryâ€™s efforts to increase insurance penetration in the country, can only generate more growth
High exposure to natural hazards also means that the amount of reinsurance purchased is considerable in both personal and commercial lines. But in comparison to other markets, this is still a small market for reinsurers as there is a high level of retention within the primary market. According to Benfield’s Mexico review report published in February 2007, the high retention ratio of 84% in the primary market entailed only $2.1bn of ceded income for the reinsurance market in 2005.
Boex adds that in 2006 the total cession to reinsurers in P&C (without motor insurance) amounted to about $1.6bn or 71% of the premium volume. “In life insurance, the cession volume to reinsurers is much smaller with about $210m or 3.3% of the premium volume and has shown a decreasing trend during the last few years,” he explains.
Distribute the wealth
Reinsurers are undoubtedly happy with the Mexican government’s efforts to improve the wealth distribution as well as the initiatives of the AMIS (Mexican Insurers’ Association) to enforce obligatory car insurance and to allow for the deduction of life insurance from income tax which could, if successful, substantially increase the penetration level in the insurance industry.
Although the potential for growth is there, some argue that more needs to be done by both government and the insurance industry to propel the market forward and create new opportunities for insurers and reinsurers in the region.
Swiss Re’s Boelsterli says that when Mexico’s GDP per capita, which is currently around $8,000, reaches $10,000, the insurance industry will reap the benefits. “Studies show that when income reaches $10,000 per capita, the insurance industry experiences significant growth,” he explains. “Insurance penetration in Mexico is just around 1.8% of GDP, which is low in comparison to mature markets which present an average of around eight to 10%.”
“ART is a growing market in Mexico with potential for both central and local governments to access some kind of coverage to help them refinance nat cat losses
One of the main obstacles for stronger growth is the lack of enforcement of compulsory motor insurance (a large number of vehicles in Mexico are allegedly uninsured), missing fiscal incentives for the purchase of insurance and uneven distribution of wealth, which leaves a significant part of the population with insufficient funds or access to bank accounts and insurance products. “Also, we still observe a high degree of legal and judicial uncertainty, which makes the outcome of claims settlements somewhat unpredictable,” says Boex.
But, according to Boelsterli, the country is going in the right direction and the future prospects for the insurance industry are promising. “We have a new president [Felipe Calderón] who is tackling several major issues in the right way,” he explains. “The previous president had good intentions but was not able to get urgently-needed reforms approved by the congress. We are seeing a more positive attitude about the country, which will also attract investors and bring more money into the country. This means more development and therefore the need for insurance will also increase. When I talked about the average annual income of $10,000, we are just about there.”
But he is not putting all his hopes on the government to promote internal growth or boost the economy. He believes that, apart from the initiatives promoted by AMIS, there is a lot more the industry can do to close the gap between the economic and insured losses following natural catastrophes. He also argues that insurers and reinsurers have a key role to play by getting attractive and affordable products on the market through adequate distribution channels and efficient operations.
“It is a question for the industry to realise what needs to be done,” Boelsterli says, “not only in terms of reinsurance but also primary insurance. We need to attract all insurable risks, which represents an interesting challenge for our industry.”
But it may be a long time before the gap between economic and insured losses after natural catastrophes can be closed, so both the industry and the government have been working together to find alternative solutions.
“The Mexican government is exposed in many ways to natural catastrophes and might therefore seek to invest in more alternative solutions in the future to prevent large budget fluctuations
Last year, the Mexican government issued a $160m catastrophe bond, which was assigned a “BB+” rating by Standard & Poor’s, to cover the country against losses from a severe earthquake. It was the first time a sovereign country had securitised natural catastrophe risk in this way. The cat bond was structured by Swiss Re and Deutsche Bank, and issued by Cayman Islands registered special purpose vehicle Cat-Mex.
Boelsterli explains that alternative risk transfer (ART) is a viable solution not only in Mexico, but in other countries which also have high exposures to natural catastrophes as well as low insurance penetration. He adds that ART is a growing market in Mexico with potential for both central and local governments to access some kind of coverage to help them refinance nat cat losses, which would otherwise be completely uninsured. “The good thing is that it pays out when an event occurs, even if losses are not incurred,” says Boelsterli. “That means if the event triggers the coverage, the government will get the money within a few days. Other countries and organisations such as the World Bank are looking closely at Mexico to see how they can replicate this model.”
He adds that the way traditional insurance works is through indemnity triggers, which require a lot of information to calculate the exposure and get the pricing right, whereas the ART solution is based on a parametric trigger that focuses on the hazard. “The insurance and reinsurance sectors have a lot of information about natural catastrophes, such as hurricanes and earthquakes, so we can use that to price the coverage without having to assess the vulnerability of assets to those hazards.”
Boex agrees that ART solutions are of particular interest to government insurance buyers. “The Mexican government is exposed in many ways to natural catastrophes and might therefore seek to invest in more alternative solutions in the future to prevent large budget fluctuations.”
The government spent around $50bn in catastrophe-related costs over the past ten years, according to Mexico’s Ministry of Finance. A large part of the spending was cost-related to damaged infrastructure, cleaning efforts and first aid for affected people. Boex says that, for such cost, “reinsurance with a parametric trigger and the payment of a lump sum, if such trigger materialises, would certainly be an interesting solution for budget planners.” He refers to the recently launched Caribbean Catastrophe Risk Insurance Fund as a possible model.
But at the moment, he says, local insurance companies do not use instruments of alternative risk transfer often because such instruments are not fully recognised in the dynamic solvency model of the local supervisory authorities. “Should this model be adapted, the potential for those kinds of products could increase substantially due to the high catastrophe exposure of the portfolios of local insurers.”
Ana Paula Nacif is a freelance journalist.
Mexico - the Mexican market in figures
According to figures from AMIS (Mexican Insurersâ€™ Association), the Mexican market had a total insurance market premium of about $14.4bn in 2006, 43% of which is life, 57% non-life. Of the non-life sector, about 60% of the premium is attributable to motor business, the other heavyweight being fire and allied perils.
In non-life, 40 insurance companies issue around 88% of the premium volume. And the largest five companies together hold a 56% market share. In life, the figures are 95% and 68%, respectively. The total market grew by 13% in 2006, which is mostly attributable to the life sector, which grew by 26%. The non-life sector grew by only 3% year-on-year, mostly driven by the motor market.
Within the last five years the total insurance market grew nominally by 27%. After inflation adjustment, the real growth rate should be minimal. Insurance penetration remains below 2% of the GDP.