The Russian insurance industry has undergone perhaps the greatest overhaul of any market in the last 15 years, but just how far has it come? asks Nigel Allen

Any attempt to gauge just how far the Russian insurance market has come since it was liberalised in 1988 should begin with a detailed analysis of the current size and health of the sector. According to statistics produced by Swiss Re sigma for its "World Insurance in 2004" report, updated in November 2005, total premium volume for the Russian insurance market amounted to $16.4bn in 2004, compared to $14.1bn in 2003, a rise of approximately 16%. Break this down into life and non-life premiums for 2004, and the split is $3.5bn and $12.8bn respectively. Filter these figures through a population of approximately 143 million and it is clear that insurance penetration is limited, with premiums per capita amounting to $114.5 (life: $24.8; non-life $89.7).

It should, however, be noted that while the non-life market experienced growth of almost 18% in 2004, reflective mainly of a sharp rise in compulsory motor third-party liability premiums, (which was introduced in 2003), the overall market growth was achieved despite a massive 38.4% dive in life insurance premiums, attributable to a major slump in short-term policies which are used for their beneficial tax properties.

Tackling taxation

One of the main stumbling blocks in trying to get a handle on the size of the Russian insurance market is the prevalence of financial schemes, which are often used to exploit tax loopholes.

According to a study entitled "Reforming the insurance market in Russia" conducted by the Organisation for Economic Co-operation and Development (OECD) at the end of last year, accurately assessing the size of the insurance market on a premiums basis is hampered by the fact that a large percentage of "premiums" are made up of these non-risk transferring financial schemes.

Fitch Ratings estimates that of the gross written premium figures provided by the Federal Insurance Supervision Agency (FISA) for 2004, on the life side schemes accounted for approximately $3.55bn of the $3.7bn total (this figure is slightly higher than that produced by the sigma study), meaning that actual life savings insurance accounts for only 4% of the total GWP.

Non-life linked schemes accounted for $3bn of the $13.3bn of life premiums.

Furthermore, the OECD study revealed that of the seven largest Russian insurance companies in 2003, four gained over 90% of their premiums from schemes, with only one of the top seven deriving most of its premiums from standard insurance business.

Schemes prove a very effective mechanism for "tax optimisation purposes" as they take advantage of the tax legislation under which insurance premiums are tax deductible. Such schemes can also be used to transfer funds out of the country via reinsurance contracts with reinsurers located outside of Russia, a fact that is of great concern to the Russian authorities.

However, the use of schemes is on the decline, which is clearly reflected in the life figures for 2004 as shown earlier, and the government scrutiny of these entities is increasing, a fact that the OECD claims is highlighted by the recent decision by the insurance supervisor to suspend the licence of Stolichnaya Insurance Company, a company believed to be heavily reliant upon financial schemes. This does pose a very real problem though according to Standard & Poor's in that if the government moves to ban the use of schemes then many Russian-based insurers could lose their licences overnight.

Regulation Russian style

Another key element of the potential of the Russian market is the regulatory base upon which it is founded. A decree in 1988 brought to an end the state monopolisation of the insurance industry through Gosstrakh and saw the rise of the private insurance company. However, the fact that Gosstrakh had operated in a virtual legislation-free zone meant that what the decree left in its wake was a sector almost devoid of any regulatory framework and for the next five years insurers operated with virtually no government oversight. 1993 saw the implementation of the law "On Insurance" later to be renamed "On the organisation of insurance business" which sought to impose some sort of order on the industry. The law was followed in 1995 by the implementation of the Civil Code of the Russian Federation, Chapter 48 of which dealt with insurance and established the basic principle of insurance and defined types of insurance product.

In an effort to limit the ability of foreign companies to exploit this new liberalised environment, a barrier to entry was established. In conjunction with the "On Insurance" legislation, the country imposed a limit on foreign involvement in Russian insurers, restricting foreign ownership of shares to 49%. The restriction, however, did not prove overly effective as foreign companies could bypass it by acquiring shares in a Russian insurer through a Russia-based holding company, and thereby effectively gaining control.

In 1994 the signing of the Partnership and Co-operation Agreement with the EU saw Russia agree to remove the 49% barrier in five years time, and in 1999 an amendment to the insurance legislation permitted foreign control of Russian non-life insurance companies. However, the amendment did impose an alternative means of restricting foreign access to the market, by introducing a 15% cap on foreign capital as a percentage of total charter capital for the industry. This limit was raised to 25% in 2004 for EU-based companies, but effectively means that once this limit is reached no further licences will be granted to foreign-controlled insurers.

The 2004 amendments to the insurance law are extremely far-reaching, amounting to a virtual overhaul of the Russian market. Key elements of the regulatory restructure include requirements for the specialisation of insurance companies, stipulating that those companies established after the implementation of the amendments are allowed to provide only life insurance or carry out activities related to personal and/or property insurance, while those insurers in operation prior to the amendments have until July 2007 to confirm their specialisation. In addition, the revision to the legislation prevents providers of reinsurance from participating in the life sector (see table 1).

A further issue which the authorities have sought to tackle with these amendments is the severe undercapitalisation of the insurance market and the problems of meeting minimum solvency requirements. FISA puts the market's share capital at $5bn as at 1 January 2005. While the body does not produce equity figures for the market, Fitch estimates this to be around $1.5bn (net of capital inflated via promissory notes and other round-trip schemes), which means that under Solvency I insurer requirements only about 40 Russian insurers would currently meet the requirements.

The regulators have set about rectifying this by implementing, under the 2004 amendments, a massive increase in the capital requirements for insurers and reinsurers. The new requirements have raised the minimum charter capital to Rbs30m (approximately $1m). For those insurers providing life insurance the minimum charter capital level rises to Rbs60m ($2m), while for reinsurers the base level is quadrupled to Rbs120m ($4m). Those companies set up prior to the legislation are required to have the required capital in place by July 2007 or risk losing their licences.

The road ahead

When asked in the annual Lloyd's underwriters survey in 2005 which developing country do you expect to be the single most important source of new specialist insurance opportunities over the next five years, 11% of respondents put Russia. While this may not seem like a significant figure it put the Federation second behind China (59%) and ahead of India (8%).

It is clear that the Russian insurance market has come a remarkable distance in the last decade towards achieving a level of sophistication and security equivalent to that of many of its international insurance counterparts.

The regulatory parameters and financial requirements which have been imposed are pushing the market towards ever increasing levels of financial stability, a fact which is being speeded up by the much improved standards of professionalism which have been achieved. But while much work has been done, it is clear that there is still much more to be done.

- Nigel Allen is editor of Global Reinsurance.

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