Adrian Leonard considers the impact of EU enlargement on the reinsurance industry
Europe's great political experiment became a little larger on 1 May, as Poland, Hungary, the Czech and Slovak Republics, the Baltic States and Slovenia joined the European Union. The accession of these eight former communist countries to the EU, along with the island states of Cyprus and Malta, added 75 million people to the EU's single market for insurance, equivalent to the combined population of New York, Texas and California.
With 450 million souls in total, Europe is now the world's largest developed insurance market by far.
For many observers, the expansion of Europe's insurance economy appears to present a mysterious opportunity. The eight former communist countries that are now entrenched as part of what used to be known as 'the West' have adopted insurance laws in line with EU directives, including solvency standards to ensure a measure of security for customers. They have opened their borders to competitors from elsewhere in the EU, allowing them to sell financial services with or without a local presence, and developed relatively sophisticated local supervisory systems. In practice, however, no 'big bang' was heard on 1 May, because the eastward frontier was crossed long ago.
A handful of European companies had entered the insurance markets of central Europe in the early and mid 1990s, and by the time of accession they had established a solid presence in the primary insurance business.
The evolution has been long enough that others - Zurich and Axa, for example - have already been east, tried their luck, and retreated. On the reinsurance side, a small cadre of companies and individuals has been active in central Europe since before the fall of the Berlin Wall, and this group - which includes the world's leading reinsurers - continues to dominate.
Led by Munich Re and the reorganised Swiss Re (which handed responsibility for reinsurance in the region from Zurich to the former Bayerische Ruck in 2001), the main regional reinsurers include ERC Group (through its Frankona Ruck subsidiary, which has a representative office in Warsaw), Partner Re (primarily through the former SAFR, which it acquired in 1997), GeneralCologne Re (although regional pioneer Cologne Re has lately been pulling back), Hannover Re (which has been active since the 1970s and formed a dedicated underwriting unit in 1995), Converium (building on the success of predecessor Agripina Ruck), SCOR (which enlarged its regional business though the 2001 Sorema acquisition, and had a solid renewal in central Europe, where its woes seemed of little concern), Lloyd's (where the former CERES consortium broke down after its sponsoring managing agent failed, but where interest is being revived by agencies such as Chaucer), Everest Re (which underwrites from an office in Brussels dedicated to central and eastern Europe), and, as a catastrophe reinsurer, PXRE (after the Radke family saw the potential in the region early on).
EU entry on its own has not dramatically changed the central European landscape for any of these reinsurers. However, as insurance market development continues in the countries of the former Comecon, both their need for reinsurance and its supply from the international market are changing.
As well as being directly affected by trends in international reinsurance markets such as concentration and limitation of supply, cyclical pricing and a general move towards more technical underwriting, significant local factors in the development of insurance markets are also driving change.
These include consolidation among insurers, foreign ownership, the maturing of compulsory motor insurance markets, market liberalisation and the ongoing but sluggish modernisation of local underwriting techniques.
Poland is by far the largest insurance market in the accession countries and remains crowded, with 37 non-life insurers dividing the 26.1% of total premium that remains after the share of leaders PZU and Warta is deducted.
Poland attracted Euro5,728.1m in total premium income in 2002, but due to exchange rate fluctuations premium income fell to Euro5,225.2m in 2003. In zloty terms, however, gross premium grew 7.4%. The exchange rate will have less of an impact for market leader PZU, which controls 60.5% of non-life premium, since (after much debate) it remains majority state-owned and thus will find zloty income perfectly satisfactory.
Nonetheless, exchange rates will be disappointing for the many foreign investors in the region. The owners of companies such as Warta, Poland's number two non-life insurer with a share of 13.3%, were hard hit. The Belgian bancassurer KBC - an important insurer in the region - owns 75.13% of Warta, and thus is focussed on realising profits in euros, its home currency. It recorded foreign exchanges losses of Euro10.6m from its insurance business in 2003, and blamed a reduced dividend on currency fluctuations.
This is important because most European investors in central Europe will also have felt the effect of falling currency values, since the euro strengthened against currencies in the major markets. KBC's average exchange rates for 2003 were down 13% for the zloty, 3% for the Czech koruna, and 4% for the Hungarian forint. Reinsurers have also felt the cost as a drag on total premium and profit growth figures.
Foreign ownership is high in Poland, at least in terms of the number of companies. Of 38 non-life insurers, 24 have a majority foreign capital.
Among life insurers, foreign ownership is even higher, with 28 of 36 in foreign hands. But in Poland at least, premium figures tell a different story. Domestically controlled companies were responsible for life and non-life premium worth Euro13,934.7m (Euro2,958.1m in 2003, compared to Euro10,821.4m (Euro2,297.2m) for the foreign companies. The dominance of PZU meant the gap was even wider in non-life insurance, where domestic companies controlled 65.6% of premium.
The Polish government fought intently to keep PZU Polish under Prime Minster Leszek Miller (a former communist Politburo member), despite an agreement made by a predecessor government with insurer Eureko of the Netherlands to give it control. His ouster by his own party could see a change of direction, but this seems unlikely. Notwithstanding any previous commitments of the Polish government, there is no fundamental reason why Poland (or any accession country) should privatise its state insurers into foreign hands. In the EU eight, only the Czech former monopoly (or Gosstrakh) remains owned by Czechs, while PZU and the former Slovenian monopoly are still in state hands (the former is 20% owned by Eureko, while a local bank partner has another 20%; the latter has been almost 'renationalised' after a bitter battle with its executive). The former Baltic monopolies Eesti Kindlustus, Balta and Lietuvous Draudimas have been sold to Scandinavian insurers Sampo (now If...) and R&SA subsidiary Codan (itself now for sale), and Allianz blazed into the region by buying Hungaria Biztosito in 1989, and, eleven years later, the former Slovak monopoly Slovenska poist'ovna
Many foreign players see that the future lies in life business, which is gaining ground across the region. In 2003, non-life insurance represented more than two-thirds of premium in the EU accession countries, but only 40% in the old EU, according to the Comite Europeen des Assurances (CEA).
Total premium spending per inhabitant was Euro2,168 per year in the EU 15, compared to just Euro196 in the accession countries. But the new members are catching up: in Poland, life business rose to 49.7% of 2003 premium, from 48.3% in 2002. The increase is taking place across the accession countries, as the CEA trumpeted in an April 2004 newsletter: "The dynamism of central and eastern European countries is confirmed," it declared, citing 2003 life insurance premium growth of 50.5% in Lithuania, 29% in Latvia, 15.1% in Czech, 12.7% in Poland and 9.3% in Slovenia.
The Czech Republic is the fastest growing of the major accession country markets, and is expanding from a solid base: insurance penetration is high, and companies are well reinsured. These facts were illustrated starkly by the Czech flood loss of 2002. According to reinsurance broker Benfield, the gross loss was $1,427m - about 130% of the capital of all the Czech insurance companies combined - compared to 2001 householders and industrial commercial property premium of $449.6m. Reinsurers paid 97%, saving the market from bankruptcy. The event also illustrated penetration. "The percentage of economic loss in the Czech Republic was 53% insured, but in Germany it was 15%," said Bruce Selby-Bennett, Head of Central & Eastern Europe for Benfield. "We talk about the sophistication of markets; quite clearly there is a lot more insurance in the Czech Republic than there is in Germany."
Like Poland, the Czech market is still dominated by its former monopoly.
Ceska poist'ovna enjoyed 35.85% market share in 2003, from premium of Euro37,569.6m (Euro1,151.4m). The fall from market domination was hurried by the company's mid-1990s goal of decreasing its size to encourage a healthy market - an outcome aided by the catastrophic floods of 1997, which eliminated weaker players and illustrated clearly the value of reinsurance.
Although the smallest 18 Czech insurers have a market share of less than 1%, several players have a reasonable share, and competition is well-established.
The number two company, Kooperativa, had a 19.1% market share in 2003, including 24.4% of the non-life market. The company is controlled by the Austrian insurer Wiener Stadtische, which is also active in Slovakia (through insurers Kooperativa, Komunalna and Kontinuita), Hungary (Union), Poland (Compensa), and in other central and eastern European markets. Thus Wiener Stadtische has been one of many consolidators in the accession countries.
Generali is another key Czech example of foreign consolidation: it rose to a non-life market rank of fourth in the Czech Republic after acquiring local Zurich Group operations in Czech Republic, Poland, Slovakia and Hungary (unfortunately for Generali, just months after the acquisition the Zurich Czech business delivered a disproportionately large flood loss, due in part to its focus on commercial exposures).
Impact on reinsurance
Consolidation and foreign ownership have created a major brake on the growth of open market reinsurance in central Europe. As an entrepreneurial fervour swept post-Soviet Europe, most countries were quickly overpopulated with small, undercapitalised insurers. As they grew, most relied heavily on foreign reinsurers to supply both the treaty reinsurance necessary to support the risk which they assumed, and for the technical expertise they usually lacked for functions such as product design.
Foreign investment gathered speed in the late 1990s as established insurers rushed to acquire the best local companies. The investments they made immediately reduced demand for open market reinsurance among local companies, although total cessions tended to increase as premiums were retained by parent companies through group internal cession programmes and as outwards reinsurance purchases were centralised (see figure 1). This trend continues, and is exacerbated by ongoing consolidation. "Two insurers in Slovakia were bought by a large Austrian insurer in 2002, which took them out of the market for reinsurance, while the largest insurer in that market was bought by Allianz that year, and is now considering converting its reinsurance to non-proportional," reported Helena Dive, Czech and Slovak underwriter at Converium.
In some cases, reinsurance through the parent has approached 100%, as was the case with the insurers of the Zurich Financial Services Group that operated in the Baltic States until they entered run-off in 2003.
In 1995 Macedonia, with 0% foreign ownership, ceded 10% of its premium, but by 2001, after international insurer QBE had purchased the former local monopoly, cessions increased to 40% but were channelled to the parent.
Such private cessions distort market-wide retention and reinsurance figures, as the reports of regulators and associations tend not to distinguish between open market and internal cessions. In other cases, better-financed insurers have moved towards greater use of excess of loss protections.
For example, Lietuvos Draudimas, the former Lithuanian monopoly, now retains all its motor risk, protecting the book only through excess of loss cover for catastrophe exposures. PZU has done the same.
Over time, rising property values, increased economic development and the inevitable growth in life and health insurance products that accompanies affluence will deliver greater income for insurers and their reinsurers in central and eastern Europe, but it will not happen overnight. EU accession is just another step on the way.
Adrian Leonard is author of Reinsurance Issues in the Baltic Countries, published this year by the OECD.
Adrian Leonard is a freelance insurance journalist and a regular contributor to Global Reinsurance.