Winning entry rose to the occasion to take that title this landmark Multaqa
To celebrate the 10th annual Multaqa Qatar, Global Reinsurance and the Qatar Financial Centre Authority hosted the third annual essay competition. The competition has proven to be a successful platform for industry practitioners to share their knowledge and opinion on the future of the industry in the region.
The competition was open to insurance and reinsurance professionals based in or doing business in the region.
Entrants were told that the essays should not exceed 1,500 words and could be written on one of the following four topics:
- The potential for digital disruption in MENA insurance
- Addressing macro-economic headwinds: Insurance companies’ strategic options for resilience
- Making Takaful a profitable proposition: The way forward
- Evolution or revolution: MENA (re)insurance in 2020
Each entry was then judged by a panel of experts.
After much deliberation by a panel of industry experts, the judges chose Ashley Moheeput, an actuary at RGA Middle East, as the winner for his essay on addressing the macro-economic headwinds: Insurance companies’ strategic options for resilience.
Macro-economic headwinds: Insurance companies’ strategic options for resilience
By Ashley Moheeput
Since the onset of the 2008 credit crunch, the world economic stage has been set for an abnormally long period of protracted sub-par growth. The US bore the full brunt of the Credit Crunch and proceeded with a programme of buying asset securities on a massive scale-known as Quantitative Easing (“QE”)- the effect of which has been to drag rates down to low levels of 0.25% over a long period.
The macroeconomic ramifications of this growth slowdown have been unprecedented:
- Europe and the BRIC countries have followed the US into low economic growth path.
- As the US benefits from cheap money, hopes of Fed rate increase have sent the dollar up relative to other major currencies.
- Poor economic growth coupled with an exogenous increase in oil supply as well as strong dollar pummelled oil prices down to as low as $27 per barrel.
- The combination of the above led to deflationary pressures worldwide.
The consequences on the MENA region have already begun to be felt mainly for the following reasons:
- Oil exports represent a significant share of Government revenues for many countries in the MENA area- especially Saudi Arabia, UAE, Bahrain, Qatar and Kuwait.
- Many GCC countries maintain a dollar peg- which means that their currencies are directly linked to the US greenback. Any US interest rate review is therefore reflected domestically.
- Shortfall of government revenues disrupts the money transmission system by lowering deposits in banks and as a result, increasing the costs of money market rates here.
- Falls in Government revenue would delay many on-going investment projects – leading to unanticipated layoffs.
- Regulators have stepped up with measures to strengthen the insurance framework faced with the difficult times ahead but this proved a challenge to many insurers.
The combined effects have reflected within the first 9 months of 2015 financial reporting performance of listed UAE insurers where 45% of them reported underwriting deficits. The combined ratio of insurers was 103% over the same period and net profits fell by 90% compared to the past period.
Faced with the prospect of a dilution of their economic capital, MENA insurers need to consider their strategic options carefully. The following lines will expand on this aspect.
The most direct impact of the global economic turbulence is felt through the insurer’s profit and loss and balance sheet statements- most notably from changes in underwriting surplus as well as return on investment.
Because of the dollar peg maintained by several GCC countries, low interest rate engineered by the Fed through QE would translate into low domestic interest rates as well. Therefore, short term insurers – mostly health and P&C which invests heavily in short term bonds would have a low return on their surplus assets. Equity volatility would add to this misery further.
Going forward, as the Fed ends the QE programme, domestic rates are expected to increase but this will add to the insurer’s cost of capital.
The most obvious response would be to consider or improve their existing hedging strategy through better use of forwards/futures, swaps and options. For instance, selling a futures stock index will give the insurer the ability to lock in a certain price at the time of selling shares. Likewise, adopting interest rate futures or currency futures may enable them to lock in the cost of future borrowing – therefore, protecting against potential interest rate lift up or exchange rate volatility.
It is also common to expect a higher likelihood of default during difficult economic times. In order to protect against possible loss of default or counterparty risk, an insurer may consider buying Credit Default Swaps product with the aim of protecting against credit risk.
Capital Market Solutions
An alternative risk management strategy would be to securitize a pool of receivables through the creation of a Special Purpose Vehicle (SPV). This provides direct access to capital market and may imply lower cost of capital. Securities would be issued through tranches (the lowest tranche qualify for higher returns but also, face higher risks as opposed to mezzanine and higher tranches) and would be backed by the pool of receivables.
An alternative solution here would be to consider financial reinsurance. This means engaging with a reinsurer who will be providing the capital (or loan) repayable out of any future surplus. This avoids the necessity in some jurisdictions to book a liability.
It has been a common practice in the MENA region for many insurers to consider a Quota share arrangement for their risk transfer. In the face of stiffed competition, many insurers have been relaxing their underwriting standards to gain market share. A quota-share mechanism allows them to offload a significant portion of their risk while earning valuable commission upfront. Also, this practice reduces the capital requirements thanks to the risk transfer.
Insurers should re-consider their business model and try to consolidate their core operations – whilst offloading any unprofitable activities.
Mergers and Divestment
Mergers have been common place in a difficult economic environment as it enables consolidation of their market share, a reduction in unit cost through economies of scale as well as human capital transfer. Along the same line, insurers may consider expanding into activities which may not bear a direct correlation to the anticipated economic travails such as P&C or into different geographical markets such as Africa.
Takaful is also gaining rapid prominence within the MENA region (currently the fastest region in terms of growth) and provides a valuable alternative business model which has been demonstrated to show resilience during testing times. The more common Wakala – Mudarabah model involves a sharing of the risk and surplus between the Takaful operator and the participants in a pre-defined ratio from the investment account and wakala fee payable out of underwriting fund. If there turns out to be a deficit, an interest-free loan is advanced (‘Qard’) by the operator and repayable out of future surpluses of the insurers or pool. This concept of paying the loan when a surplus is generated clearly distinguishes the model from conventional loan and brings stability in the face of economic turmoil. It is therefore not a surprise to see the Takaful concept making such great strides recently and this is expected to continue.
One effective way for resilience has been for insurers to adopt product differentiation in the face of stiff competition coupled with innovative distribution channels including digital support. One example would be health insurers which have been developing low cost product with restricted provider network for those companies unable to afford more comprehensive cover to their staff members. This provides a better cost effective solution to their needs while helping them stay compliant at the same time.
Insurers are also expected to step up efforts to reach a greater mass through smart technology while remaining competitive.
Business process re-engineering
It is important for insurers to consider and test the soundness of their internal business processes and if possible, attempt to reduce the costs of operations with a view of maximizing economic efficiency. For instance, in health, an increasing number of insurers are adopting TPA rather than managing claims in-house. Another strategy for resilience has been to strengthen the underwriting and claims process. This implies the strengthening of their underwriting teams and implementation of strict guidelines as well as rigorous actuarial pricing to ensure sustainability of their underwriting surplus. Insurers are also investing in stricter claims adjudication to control costs. Fraud and abuse require a special attention here as it is estimated that 5% -8% of claims within MENA in health insurance could be due to fraudulent behaviour.
From a performance management view, it has been common practice for insurers to align their internal reward systems for the staff members in line with the performance of the corporates. This alignment of incentives is crucial to bring down cost. Some insurers may adopt options or warrants to compensate the top management. This would align the costs in line with the company’s performance.
Enterprise Risk Management (ERM) framework
A survey by EY showed that 40% of MENA insurers have not adopted ERM practices yet. It may be high time to consider implementing one with a view to manage the risks centrally within a given risk tolerance set by the Board.
MENA insurers need to consider means to remain resilient in the face of testing times. The options range from quick balance sheet dressing- through use of risk management instruments to more elaborative process – namely through business process re-engineering and product re-designing.
Insurers need to bear in mind that these strategic choices have economic costs and may imply sacrificing short term profits for longer term resilience.
It is within this context that regulators of some jurisdictions such as KSA and UAE have been actively stepping up measures aimed at improving the insurance framework. The new regulations comprised the implementation of proper reserving, actuarial led pricing and certifications as well as introduction of better governance and controls and investment related measures.
Hopefully, with regulators aligning with the interests of insurers, we can see positive benefits from those insurers bold enough to adopt the necessary measures in the face of difficult times ahead.
 Standard&Poor Report
 HAAD report
 EY and Munich Re