The battered economies and insurance markets of Latin America have several challenges ahead of them, but they have the strengths and the resources to pull through, say Salvatore Orlando and Emilio Nualart.
For a large part of the 1990s, Latin America enjoyed economic success. The six largest economies of the region - Argentina, Brazil, Chile, Colombia, Mexico and Venezuela - experienced average gross domestic product (GDP) growth higher than 5% and an average unemployment rate of about 7%. The fiscal deficit, which is currently a threat to economies such as Brazil and Argentina, reached an average of 3% in 1997. Meanwhile, many European corporations, lead by a Spanish contingent, took advantage of attractive investment opportunities by buying recently privatised public companies such as utilities, banks, insurers and reinsurers.
High investment returns meant it was also a successful period for the financial services industry. For example, stock markets grew, on average, 14% in 1996 and 26% in 1997, in the six biggest Latin American economies.
The insurance industry was not outside this trend. Indeed, most insurers took advantage of the economic upswing and the soft reinsurance market. The capacity offered by the reinsurers allowed the cedant companies to face the market in an aggressive way. The commissions paid by the reinsurers, in some cases, did not reflect the real cost of acquisition, so commission leverage helped many insurers to improve their financial statements. Non-life insurance profited from high growth rates in health and personal accident lines between 1996 and 1998. However, during this period non-life insurance premium growth was only able to keep pace with GDP growth.
The real driver of insurance market growth was the life sector. In the last five years, life insurance has grown four times as strongly as the average GDP. This exponential growth was spurred by reforms of the pension insurance systems in many countries of the region. Between 1995 and 2000, Mexico reached a premium growth rate of 10.2 % (19% in life and 7.5% in non-life), the highest rate in Latin America, followed by Chile, with a growth rate of 7.5%.
During this period of economic growth, however, clouds were gathering on the horizon. After several months of uncertainty, Brazil began to feel the effects of the emerging markets crises in Asia, in 1997, and Russia, in 1998. Investors, spooked by the Russian crisis, and by the overvaluation of the real, began to pull their investments out of Brazil. The Brazilian monetary authority reacted by raising interest rates to 34%. The result was a large, and growing, fiscal deficit - the debt to GDP ratio reached 8% - which caused further concern for investors. By January 1999, Brazil had announced that the real would freely float in the market.
Unfortunately, the Brazilian lessons were not taken into consideration by Argentina. During the 1990s, the country preferred to keep the peso pegged to the dollar, despite pleas from the international community to do otherwise. The Argentinian economy was at a cross roads - maintain so-called monetary stability or react by devaluing the currency. The economy would have profited from a weaker peso, which would have improved the competitiveness of exports, but the monetary authorities did not react in time.
After two years of worldwide economic uncertainty, in 1999 and 2000 - mainly due to the ongoing US recession, Japanese deflation and European contraction - Argentina was faced with serious troubles in its own economy. The origin of the so-called Argentina crisis started in April 2001 when the international recession affected the macroeconomic balance of the country. The government found that it did not have enough income to meet its loan payments to the international community. The country's internal troubles, coupled with a slump in tax revenue, increased government expenses and the international crisis made the situation even more serious.
In 2001, the IMF supported new loans of about $26bn to Argentina, tying them to a decrease in the country's fiscal deficit. However, the internal political situation was ill-suited to reduced government spending and a package of austerity measures, and the country was unable to see-off the crisis. Due to a lack of liquidity, Argentina defaulted on its debt at the end of 2001 and was forced to abandon the fixed exchange rate policy that it had followed for ten years.
The international financial markets reacted to this by closing positions in local currencies. Many investors tried to take their money out of Argentina, but the `Corralito', an Argentinian money outflow restriction, stopped this.
Since the Argentinian crisis started in December 2001, Latin America has been experiencing tremendous turmoil. But this is not a recent reaction of the financial markets. Even before Argentina defaulted, Latin America faced a deep crisis as a result of the worldwide economic downswing. As a consequence of the Argentinian crisis, the Brazilian real started to lose its value, and, after several months of uncertainty, the crisis formally spread to other southern corn countries, such as Uruguay and Paraguay - countries that depend heavily on the Argentinian economy.
The upshot of these crises was that investment into Latin America fell sharply from an average of $75bn per year, from 1996 to 1998, to an expected $50bn in 2002. In Argentina, this huge decrease is explained by the private outflow of capital funds and by the reduction of international reserves - one result of attempts to protect the local currency. In Brazil, the local investment rate was affected by investor pessimism and by high interest rates - currently, the so called `tasa basica' interest rate is 18%. Only Costa Rica and Ecuador experienced important increases in foreign direct investment in the first months of 2002.
The decline in capital inflows from international financial markets has been significant, making credit in Brazil, Uruguay and Argentina very expensive, and affecting the solvency of their financial systems. Large foreign banks - American and European - with subsidiaries in Argentina have been hurt by the crisis. Some Brazilian banks also face difficulties, but their volume of activities is small compared to their assets, thus allowing them to absorb their losses and avoid major problems.
The crisis has left insurance companies playing a `new game' in the Latin American market. They are now under intense pressure to produce more realistic and profitable underwriting results as investment returns disappoint. They have no choice in an environment of low interest rates, suffering stock markets, inflation and a hard reinsurance market.
The region's direct premium volume was $44bn in 2001. Property and casualty (P&C) accounted for 45% of regional direct premium volume, life for 36% and health for 18%. Compared with Spain's direct premium, it is clear that there is potential to grow the life market - it accounted for 55% of Spanish direct premium in 2001, while P&C generated 37%. Indeed, on a worldwide basis Latin America's share of non-life premium was 2.8% in 2000, while its share of life premium was just 0.8%.
Insurance penetration in Latin America is still very low. In recent years, the average premium per capita in the region reached roughly $77. This compared with premium per capita of $3,150 and $900 in the US and Spain, respectively. One reason for this is the low per capita income in Latin America. However, we expect premium per capita to start to return to a growth trend once the region overcomes its current crisis.
With a contribution of roughly $760bn to the regional economy in 2001, Brazil is the largest economy in Latin America and the eighth largest economy in the world. It faces several challenges at the moment, including the Argentina crisis and the political upheaval caused by the recent elections. But the greatest danger is not related to Argentina or to political issues - it is the growing size of the national debt. Public debt has risen inexorably from 49% of GDP in 2000, to 55% of GDP, or $270bn, in March this year, according to the most recent central bank data. Although Argentina defaulted on $151bn in debt in December 2001, its debt-to-GDP ratio is still lower than Brazil's.
However, the advantage that Brazil holds is that its economy is growing. Also, most of its public sector debt is denominated in reals and held by residents. This means Brazilians face the real, and growing, threat of inflation, rather than the risk of imminent default. The outgoing government of president Fernando Henrique Cardoso is making a huge effort to turn in a primary budget surplus, before interest charges, of 3.5% of GDP. But this is not enough to stabilise debt growth.
The Brazilian insurance market grew by 12.5% in the first 5 months of 2002 but the market continues to be highly concentrated, with the five largest insurers accounting for 59% of total premiums. The top ten insurers accounted for 75% of total premiums. Among these were a number of foreign insurers, including AGF (4%), HSBC/CCF (3%), Caixa Seguros (3%), Real (3.1%) and Mapfre (3%). The most concentrated area is health insurance - just two companies, Sul América (43%) and Bradesco (37%), account for some 80% of the market.
Similar to other recently opened insurance markets, there are two trends to observe - the concentration of premium within a small group of big, often bank-related insurers, and the growing participation of companies with foreign capital. Combining all insurance companies with foreign interests (more than 30), they had achieved a market share of 29.5% by the end of 1999. This is a real change in the market structure. In 1996, when the market was opened and allowed foreign ownership, foreign interests at that time controlled only 6.3% of the market.
In Argentina, the economic outlook is not good. Real GDP is expected to fall by between 10% and 15% this year and inflation is expected to surge. The peso has already lost around two thirds of its value since the beginning of January 2002. The situation has grown worse this year because of the problems facing foreign companies operating in Argentina. This has not only discouraged investment in the country, but also in other countries in the region. The investor retreat reflects fears that other countries will begin to deteriorate due to contagion, and the asset losses already experienced.
It is also worth mentioning that the losses experienced by Argentina-based transnational companies could affect foreign direct investment throughout the region. The decline in European company assets was huge, especially in basic services such as the oil industry, manufacturing and finance.
In respect of the insurance industry, Argentina currently has almost 200 companies working in the market. The top ten players account for about 30% of the market, according to ASSAL, and consolidation is expected, in the near future. Once the situation of the INdeR (the former state monopoly reinsurer) is cleared, many of the smaller players could leave the market. As the recent depreciation affected premium volume in US-dollar terms, the 2002 premium could decrease from $6.8bn to a figure below $2bn. Due to the sharp decline in the economic situation this year, few projects will be developed in the country and lines such as engineering and energy will suffer important decreases in premium. Also, the recession itself will have a negative impact on the market because of the substitution of insurance with critical goods, such as food. At the last renewal season, reinsurers reacted to the uncertainty by raising deductibles and constraining capacity in lines such as liability and motor. Moreover, the lack of confidence caused many foreign reinsurers - such as Swiss Re, Employers Re and Gerling Re - to close their branches in Argentina.
Despite its dependence on the US economy, which serves as a shield for emerging market crises, the Mexican peso weakened in the wake of the uncertainty in Brazil, ending a two-year stretch of strength. Nevertheless, a softer peso comes at a welcome time for exporters who stand to benefit from recovering demand for their products, as the global economy rebounds.
Recently released statistics confirmed a 2% decline in GDP in 2002. However, figures for domestic demand were above expectations due to investment and strengthening in the external sector. Also, a 5.8% contraction in exports was better than expected after a double-digit decline recorded in the preceding quarter.
In respect of the insurance market, Mexico is the largest open reinsurance market in Latin America. In 2001, the direct premium reached $11.5bn. Again, the market is highly concentrated in a few companies - the first seven players have almost 50% of the market. Comercial America, the largest company has almost 20% of the market, GNP has 16%, Inbursa has 9% and Genesis has 3.6%.
In Mexico, the main line of business is catastrophe, which has exposures to earthquake, volcano, hurricane and flood. Motor is also very important but high rates of theft mean results from this line have not been good in the past. In respect of life business, an important boost is expected in the future because the authorities are making several reforms to the current pension system.
Independent Álvaro Uribe Vélez was elected president on 26 May in the first round. Uribe comes with an ambitious agenda that seeks to step-up military spending to fight guerrillas. This is likely to mean reduced social spending, if the new administration is to meet IMF fiscal targets amid the current subdued economic climate.
The president's agenda also includes projects for structural reform of the constitution, the economy and the tax system, changes to the pension system and the social security law, as well as a reorganisation of the government.
As in other Latin American countries, the insurance market is highly competitive and highly concentrated among a few players - the six largest companies control more than 50% of the market, with Colseguros, the largest insurer, having 15% share.
Surmaerica, the second largest player, holds an 11.2% share of the market, followed by Previsora with 10.8%. The traditional distribution mechanism is through brokers, not only for direct business but also for reinsurance.
Colombia is the market most affected by terrorism risks. Consequently, it has developed coverages, on a proportional or excess of loss basis, with extra premium, event limits and annual aggregates.
The future of the insurance business will depend on the political success of Álvaro Uribe in the battle against the guerrillas. If the government can control the terrorism threat, the country will be able to return to growth and investors will return to the country.
Chile's broader economy has been deeply affected by the Argentina crisis. Trade, tourism, foreign investment and exports - especially to Argentina - have all suffered. Chile is expected to grow at a rate of 2.5% in 2002 and 4.3% in 2003. Although these figures are well below the growth rates achieved during the 1990s, the country still keeps a strong macroeconomic and fiscal balance, and is probably the Latin American country that is best-positioned for the future.
However, Chile's insurance market has suffered - and is expected to contract further - as consumers, concerned about the effects of the various crises on their country, have restricted their spending on insurance.
The P&C business is dominated by Cruz del Sur, a local company with 15% of the market. This is followed by Chilena Consolidada, part of the Zurich group, with 10.1% and R&SA, with 9.2%. Since 2000, rates in most lines of business have risen sharply - particularly in catastrophe lines - but the main sector of the market, motor, has performed poorly because of the devaluation of the currency.
With consumption dropping significantly, as a result of the continued weakening of the currency, the Venezuelan economy is showing signs of entering a recession. A 4.2% contraction in economic activity in the first quarter has prompted the government to revise growth forecasts downward for the remainder of the year. Officials expect the downturn to have accelerated in the second quarter of the year, with the economy contracting between 4% and 5.8%. Depending on the scale of the second quarter decline, government calculations show that economic growth for the year could drop to between 2.6% and 3.1%. In respect of the oil industry, even though prices in the first six months have grown, lower production levels have undercut the sector's performance.
The insurance market is showing signs of consolidation. Earlier this year, the market leader, Seguros Liberty, which controls roughly 14.5% of the local market, was formed out of a merger between Seguros Caracas and Pan American. In another merger, two medium sized companies, Seguros Orinoco and Mercantil, formed an insurer with a 10% market share. Multinacional, which embraces Interbank and Guayana, has just over 11% of the market and Seguridad has 9.3%. The future of the Venezuelan insurance market will depend on the political stability of the country but many insurers are optimistic that the country can leave the political turmoil behind.
The future of Latin America depends heavily on a recovery for the global economy - particularly in the US and the EU. The newly elected government in Brazil will play a major role in restoring confidence not only in that country but in the region as a whole. This will ease tensions with the international banking system and encourage the inflow of new capital.
The regional insurance industry will have to cope with the pressure of poor returns on investments and negative underwriting results. However, we expect to see changes to the legal frameworks of several countries that will increase the transparency of the insurance sector and guarantee the adequacy of solvency margins and reserves. Yet, the scarce availability of terrorism cover will create an additional pressure on the development of economies such as Colombia.
The insurance sector in the region will not be immune to world events such as high profile corporate collapses, terrorism and the troubles of the world equity and financial markets.
Considering the above, Latin America faces a challenging environment but we are convinced that it has the strengths and the resources to pull through. PartnerRe remains committed to the region and believes that its member countries will not only survive the current challenges but emerge stronger for them.
By Salvatore Orlando and Emilio Nualart
Salvatore Orlando is a member of senior management and an executive client partner for Latin America at PartnerRe.
He is based in Zurich.
Emilio Nualart, who contributed to this article, is based in Chile and is a client partner for Latin America at PartnerRe.