Interfund's Omar Shafi looks at prospects in Brazil's life insurance sector in the light of the recent devaluation of the Real.
A roller-coaster ride focuses the mind nicely, as North America and European insurers discovered over the first few weeks of January, when the Brazilian currency devalued by 50% against the US dollar. In recent years, more than 20 foreign insurers have entered the Brazilian insurance sector, including powerhouses such as Prudential, Liberty, Cigna, AIG, Aetna and Generali, as well as a number of smaller firms. The main focus has been the life and health sector. The next few months will tell which firms lose their appetite for thrills, and which ones raise their game.
Insurers will be watching three areas especially carefully - the currency, the prospect of inflation and the growth of the economy.
The devaluation of the Real had been foretold almost since its inception in mid-1994. As one executive put it “suddenly, in 1994 (with the creation of the new currency) the cost of a taxi from the airport went up from $20 to $70. Everyone knew that the Real was overvalued. The question was - when would a correction take place? A big correction did eventually take place this January. That same taxi ride now costs $20 again.”
The economy is likely to shrink in real terms by about 5% in 1999. Per se, this is not too worrisome for most insurers. The insurance penetration rate is still fairly low - premiums represent just 2.5% of GDP (well below levels of 8% in the US and Europe). There is considerable scope for growth even if the economy does not grow for a while.
What is critical for insurers is price stability. Everyone remembers the years of hyperinflation prior to 1994, when money was only worth something in the short term, and the promise of fixed amounts receivable in the future was almost meaningless. The growth in the insurance sector has been largely due to four years of very low inflation, coupled with improved marketing by the industry. Inflation could rear its ugly head again, fuelled by the increased cost of imports, but the shrinking economy may just absorb this. The initial signs are encouraging - inflation was still running at only 8% by the end of January.
Life insurance is the biggest magnet for insurers. Premiums rose from 12% ($1.5 billion) of total premiums in 1994 to 18% ($3 billion) in 1998. This compares with a level of 50% of total premiums in the US and 70% in Japan.
“When foreign life insurers began exploring the life insurance market in Brazil, they smelt blood,” according to Oswaldo Cochrane, a veteran life insurance consultant and broker in Rio. “Low inflation suddenly made products viable and very attractive. Foreigners need to introduce new products here, like variable annuities - there is very little competition.”
According to Prudencio Vieira, the American who runs Prudential's Brazilian insurance joint venture, “the life insurance business has been excellent for us since we started in 1997. If inflation continues at the current level (8%) we will see continued growth. At 30% things would still be OK. At 100% inflation, though, contracts just wouldn't look attractive.”
So what is the underlying problem? Brazilians are by nature very enterprising, self-reliant, and receptive to new products. The problems lie within the public sector. The history of profligate borrowing and spending by states has left its mark, with a huge public debt and high interest rates. The haemorrhage of money is hard to stem, since this relies on passing laws such as pension fund reform, not an easy task in a country where the political system effectively gives the power of veto to almost everybody. However, the current troubles may have something good behind them. The first stage of pension reform was hurriedly passed in January, just a week after the sharp devaluation in the Real.
What is the outlook? We feel that inflation is the key to the short-term future of the life insurance sector in Brazil. Insurers need to survive through the short-term to reap the benefits when the economy begins to recover in two years, as we think it will. Insurers can improve the odds of survival by understanding the environment, learning, training their staff, developing good products, and targeting the right customer bases through the right distribution methods.
Omar Shafi is a senior manager with Interfund Research, an international consultancy that helps foreign insurers and reinsurers to evaluate the Brazilian market. +44 (0) 171 794 7541.