Despite the risks, (re)insurers would be foolish not to embrace Latin America, reports Gary C. Petrosino.

Despite the risks, (re)insurers would be foolish not to embrace Latin America, reports Gary C. Petrosino.

As the Asian financial crisis lingers, investors and strategic business planners are redeploying capital and human resources to other corners of the world. It looks like Latin America, which has made tremendous strides in liberalising trade, privatising industry, slowing inflation and encouraging democracy, may pay big dividends to those insurers and reinsurers who have made their own long-term commitments to the region and know how to avoid the pitfalls there.

Although it currently represents about 2% of the world's total insurance premium, the Latin American insurance market is growing rapidly. By 1996, the market's premium volume had reached $31.4 billion, almost a two-fold increase from $18.5 billion in 1992, according to the latest figures available from FIDES.

Premium volume should continue to grow as most countries in the region pursue economic policies that will provide for solid economic growth, controlled inflation and monetary stability. In 1997 Latin American economies registered their best performance in a quarter of a century, despite the instability of international financial markets, according to the Institute of International Finance (IIF). Latin America experienced an overall economic growth rate of 5.2%, close to two percentage points higher than the average rate during the 1990s. Meanwhile, inflation declined to 11%, its lowest level in five decades and a far cry from 888% recorded in 1993 and 335% in 1994. In fact, several countries in the region now have some of the lowest inflation rates in the world.

Growth in Latin America is projected to slow in 1998 to about 3.3%, predicts the IIF, in part due to policy measures designed to respond to the Asian crisis and counter exchange rate pressures. Lower commodity prices, including oil, which is particularly important for some Latin American economies, also are contributing to the slowdown. However, the 3.3% figure is still a full point ahead of the average increase in gross domestic product for emerging market economies throughout the world. And some Latin American countries, such as Argentina, Mexico and Peru, are expected to record growth rates of about 5%.

Democracy is helping to support healthy economic growth. In some cases, Latin American countries are now being led by the third generation of democratically elected government officials. In Argentina and Mexico, pluralism is beginning to replace longtime one-party rule after the Federalistas and PRI, respectively, lost control of their countries' legislative bodies. Colombia elected a new president in a run-off race in late June after both the Liberal and Conservative party candidates each received 34% of the vote and the Independent candidate trailed with 27% in an earlier race.

Government officials are developing the expertise to respond to world events that can trigger or escalate a crisis. Mexico restructured its economy after the peso crisis of 1994 and opened its banking sector to competition. Corporations have been forced to clean up their balance sheets and focus on becoming more competitive. When the price of oil fell sharply early this year, the Mexican government responded by implementing significant spending cuts. Last year, in the midst of a financial crisis, the Brazilian government raised interest rates sharply to protect the national currency and announced a spending cut equivalent to 2% of the nation's gross domestic product. Meanwhile, the government has begun privatising formerly state-run industries as part of its economic reform plan.

Such privatisation efforts throughout the region, combined with lower trade barriers created by such agreements as Mercosur, deregulation of markets and the need for new technology, are fuelling demand for foreign investment. The flow of foreign capital into the region reached an unprecedented high of $73 billion in 1997, according to the IIF. Approximately two-thirds of that total, or $50 billion, came in the form of foreign direct investment.

Wave of insurance liberalisation

As industry is privatised, expanded and modernised throughout the region, the insurance market has seen growth. Although insurance regulation continues to vary from country to country, the insurance industry's continued growth is being supported by what can be considered a general wave of insurance market liberalisation.

Chile took the lead in deregulating its market during the early 1980s, with Argentina, Bolivia, Colombia, Mexico, Panama, Peru, Uruguay and Venezuela following suit over the past decade. Today, foreign ownership of insurance companies is permitted in virtually all countries in the region. Regulators are in the process of eliminating other market obstacles such as filing approval requests for insurance policies and rates. In some cases, it is now only necessary to register policy forms and rates with regulatory bodies. Regulators also are providing companies with greater latitude regarding the investment of reserves and other funds, as they focus more on strengthening solvency margins and increasing minimum capital requirements.

Finally, the abolishment of state reinsurance monopolies is providing insurers with greater flexibility and choices in terms of purchasing reinsurance. Technically, even longtime holdout Brazil ended the monopoly status of its state-run reinsurance company, IRB. But despite this move in 1996, the reinsurance market in Brazil remains closed to competition as regulators develop the prerequisite reinsurance regulations. The enactment of regulation is expected in the near future.

In the meantime, several members of the international insurance community prepare to tap Latin America's largest insurance market, with more than $16 billion in annual premium, by setting up offices in Brazil. Companies such as Chubb, which has been licensed in the country since 1973, continue to patiently await the day that they will be able to provide the products, services and global reinsurance programmes their customers require in Brazil.

Weathering the storms

As Chubb has shown in Latin America, where it first entered Colombia in 1958 after opening operations in Puerto Rico in 1922, patience is a virtue in building a business in any emerging marketplace. Insurers and reinsurers who enter these markets must be prepared to weather the storms that go hand in hand with economic development.

Throughout Latin America, once inefficient operations in the public and private sectors are in the throes of downsizing, refocusing and modernising. As economies open up to international competition, there have been wholesale bankruptcies, and unemployment is running rampant. According to the Inter-American Development Bank, unemployment topped 8% in 1997. Meanwhile, certain privatisation efforts have been shelved. For example, in Colombia, a strike by telecom workers at least temporarily derailed privatisation efforts. Widespread opposition in both Ecuador and Bolivia forced the governments to change their pro-privatisation stances.

While insurance markets appear to be inviting, they are highly competitive, especially in Chile and Mexico. Too many insurers and reinsurers have jumped in some countries, creating a glut of capacity, extremely inadequate rates and far too generous policy terms. Consequently, few companies are earning an underwriting profit - if any profit. And in some countries, most notably Argentina, many thinly capitalised insurers are found to be insolvent; however, regulators expect to the bring the problem under control by increasing minimum capital requirements.

One area in which overcapacity is causing irrational underwriting behaviour is inland transit coverage. While cargo theft remains a serious issue, particularly in Mexico, Colombia and Argentina, underwriters are assuming inland transit risks at artificially low prices. Furthermore, underwriters are not making any concerted efforts to stem the theft of such products as high-tech components, as some have done in the United States.

Underwriters also are ignoring other facts of life in Latin America. Despite a recent lack of natural catastrophes, underwriters appear to have forgotten that practically the entire region, with the notable exceptions of Brazil and the business centres of Argentina, are prone to earthquakes. Likewise, fire is a considerable exposure since Latin American countries have few sprinklered facilities, and public protection and water supplies vary considerably from city to city.

Frequently, underwriters fail to fully take into account earthquake and fire exposures in assessing risks and determining appropriate pricing levels in Latin America. Nor do they employ effective catastrophe management tools, such as global positioning systems, which can pinpoint the locations of insureds' facilities to help determine probable maximum loss in the event of an earthquake. Likewise, they tend not to employ engineers who can evaluate construction quality or encourage insureds to employ private protection systems such as fire bridges and to have access to a private water supply.

Finally, as in any type of expansion situation, sometimes underwriters forget what distinguishes them from the competition. As in other markets, successful underwriters should focus on what they do best.

Bright future

Despite the risks of the marketplace and their own ambitions, insurers and reinsurers would be foolish not to embrace Latin America. During each of the next 10 years, it is estimated that Latin America will need as much as $50 billion in investment capital to modernise and expand its infrastructure, including telecommunication, power, highway, rail, port and water treatment facilities. Furthermore, Latin American countries are expected to further exploit their vast natural resources, including petroleum, copper, gold, silver and timber. As more infrastructure projects get under way and investment in mining and other industries grow, so will the demand for insurance and risk management services. In many cases, these investments and projects will not only involve indigenous firms but also insurers' existing customers from the United States, Canada, Europe and Asia who are operating in Latin America.

As Latin America's economies grow, businesses in the region will look toward insurers to provide them with quality underwriting, loss control and claim handling on a local basis. Increasingly, financially strong multinational insurers and reinsurers will be called upon to provide not only capacity but also the products, services and technological expertise they have successfully developed and tested in other corners of the globe.

Gary C. Petrosino is a managing director of Chubb & Son. Based in Miami, he oversees Chubb's Latin American operations, which maintains branch offices in Argentina, Brazil, Chile, Colombia, Mexico, Venezuela as well as Puerto Rico.