Korea is the seventh largest insurance market in the world. Its life market ranks sixth, and its general insurance market ninth. The latter enjoyed 17% growth from 1990 until the crisis of 1997, but as a result of the crisis declined by 19%. However, it has since rebounded, with 7% growth projected through to 2005. Annual GDP growth over the same period was about 8%, which, with inflation averaging 5% or 6%, produced nominal economic growth of 13% to 14% per annum. Thus insurance penetration has been growing, and looks set to continue doing so as Korea matures and develops more sophisticated risk management and financing tools.

Korea is a mature market, as illustrated by its high penetration of 3.55% of GDP, ahead of the UK and even Japan. Yet it has high growth potential, as shown by its low insurance density of $264.6, compared to $744.5 in the UK and $727.7 in Japan. Together these factors suggest that, in the absence of further shocks to the financial system, Korea's insurance growth will outstrip the economy.

The non-life market includes eleven local, three American, and one British insurer (Royal & Sun Alliance), plus approximately 20 representative offices. Local insurers have more than 99% of the market, reflecting the difficulty foreigners have had in gaining a foothold. The five largest players – Samsung, Hyundai, Dongbu, LG, and Oriental – share approximately 80% of the market, and recent consolidation among the majors appears set to continue.

Until 1998 Korean Re (KRIC) enjoyed a statutory monopoly over local proportional treaties. Much of the facultative reinsurance covering larger risks was also heavily influenced by KRIC, a conduit for spreading risks among local and overseas markets. It has also acted as de facto underwriting manager for the direct market, whose focus has been more marketing than technical. As a result, the general level of technical specialisation is relatively low.

For the financial year 1999/2000, local direct insurers' net premium totalled $10.6 billion, comprising personal long term and pension products (51%), motor (37%), and commercial lines (12%). Financial results were uninspiring, with collective net income after tax of just $65 million. The first quarter of 2000 yielded even less, with a reported overall loss of approximately $40 million. Only three insurers were in the black. Long term personal lines classes have made heavy losses due to returns undershooting guaranteed payouts to policyholders. Motor business has been marginal, and the only bright spot is commercial lines. Not surprisingly, the market values of Korean insurers, with one exception, are at a low ebb. The short to medium term outlook offers little encouragement.

Deregulation

The Financial Supervisory Commission (FSC) is a powerful government agency responsible for regulating the financial sector. Its stated aim is to build a more competitive, consumer-responsive, and financially stable market by removing controls on price, product, and distribution, as well as by encouraging weaker insurers to attract new investment to boost their capital positions. The Financial Supervisory Service (FSS), an arm of FSC, regulates the insurance industry day-to-day. The market has been regulated by tariffs that are progressively being disbanded. Some controls remain, but will disappear when a free rating and coverage regime is introduced, probably in 2002.

There are now effectively no limitations on setting up an insurance operation in Korea. Foreign insurers are able to establish 100% subsidiaries, majority- or minority-share joint ventures, and branch offices. Some exchange restrictions remain, but these are set to be relaxed in 2001. Despite the freedom, foreign ownership is uncommon, with only one Korean general insurer, the smallest, having fallen into foreign hands. This is in spite of apparently low market valuations and government encouragement to attract foreign capital. Foreign interest in the life sector has been more active, although a number of proposed deals have foundered because of unrealistic valuations or poor financial disclosure.

Business is handled mainly by agents or marketing teams operating through extensive branch networks. Personal lines are often distributed through armies of housewives selling to friends and relatives. In the past banks have been excluded from insurance, but the government is keen to enhance competition by fostering bancassurance. International brokers have limited involvement in the direct market, although they exert influence and generate substantial earnings from reinsurance activities. They mainly place local insurers' treaties, as well as overseas facultative reinsurance.

Key industry issues

At a time when worldwide reinsurance costs are generally rising, rates are depressed because of the unwinding of the tariff system. Worse, the tariff environment helped breed an obsession with market share at the expense of profit. The challenge is to raise the level of technical skills in underwriting, pricing, and product development before 2002, when the market opens fully.

Another issue is a regulatory shift from the micro to a more consumer-focused framework based on insurer solvency. Raising the extra capital to meet enhanced solvency requirements will be challenging, given current poor profitability. Meanwhile regulators face the issue of foreign insurers using representative offices to prospect for business. Quite rightly, the FSC says that if companies want to prospect they must pay the price of a full licence, rather than hide behind a representative office licence. In response a number of leading international players have moved to apply for operating licences. As these licences start to come on line, the significant amount of reinsurance being bought overseas, currently about $500 million, will decline as locally-available capacity increases.

Distribution is also about to undergo a major overhaul. The frictional cost of doing business in Korea across all segments is among the highest in the world. One of FSC's key objectives in moving toward a more competitive market is to expand distribution into new areas, such as direct marketing, cyber-marketing, bancassurance, and retail broking. This presents a real challenge. Questions that must be addressed include how to deal with the resulting channel conflict with the existing, but inefficient, branch network and agency system; the nature of the migration path towards these more consumer focused channels (that is, the one that leads there without losing the existing business); and how to fund the huge technology cost of building the e-enabled marketplace that Korea is rapidly becoming (with over 60% of share trades transacted over the internet). Only those banks and insurers who invest wisely in technology will survive. The answers to the distribution dilemma are complex, and along with cultural fit present major challenges for those contemplating acquisition.

Finally, on a positive note, economic reform and the unravelling of chaebol webs will deliver transparent, accountable management systems that will allow boards of directors to make investment decisions based on what is good for the business, and unencumbered by links to affiliated companies.

Looking forward

Prospects look bleak in the short to medium term, but the changes occurring have the potential to create one of the world's most dynamic markets. Those changes are:

1) Industry rationalisation. Local companies that survive will be better capitalised and more competitive, being free from chaebol links and government interference. They will also be more international in outlook and increasingly able to engage global markets. Will Korean insurers be able to prosper in their own right in an open, competitive market? What form will engagement take? In some cases mergers with international groups are likely to occur in much the same way as in the economy at large.

2) M&A activity will be limited in the short term, as it is hard to discern value in the insurers currently for sale. There is always the argument about buying a brand, but against that, market research has shown Korean consumers are no longer averse to dealing with foreigners. In the financial services sector foreign companies are increasingly seen as more secure.

3) More foreign insurers and reinsurers will enter the market, intensifying competition but contributing towards building a more professional insurance industry. Market forces will ensure an explosion in products and distribution across all personal and commercial segments and lines of business. Commercial business shows signs that the litigation environment is becoming more aggressive, which will drive demand for casualty and speciality products. As an example, the D&O market is said to have grown to around $80 million from a standing start five years ago, as shareholder groups look set to take action against directors for past indiscretions. Personal lines will be driven by the massive overhaul of distribution towards direct and/or technology-based delivery. The banks, already gearing up to sell insurance products, will encroach aggressively into insurers' traditional personal lines territory.

4) A more competitive environment and a strict governance regime, similar to that in other developed economies, will give birth to a risk management profession. This in turn will drive a more sophisticated and innovative approach to risk financing. It will also open the door for brokers to build meaningful consulting businesses and diversify their earnings.

5) Above all, the consumer will be king!

Reg Bancroft is Chief Executive of Royal& Sun Alliance's Korean operation.