Efforts at better regulatory enforcement in Nigeria's insurance sector

With a growing population of 170m and penetration still low, Nigeria’s insurance sector holds much latent potential in demographics alone. For investors that see an attractive market for insurance in the country, such considerations are enough to outweigh the relatively small size of the sector, as well as the obstacles created by legal and regulatory shortcomings.

At present, a large number of insurers compete for what little business is available, creating a highly fragmented market. Acquisitions are an increasingly common mode of entry for foreign investors – a trend that is likely to continue. In the near term, attempts at better enforcement of laws and regulations are likely, as is the possible scaling-up of microinsurance and the introduction of sharia-compliant products.

A rising middle-class does not, however, guarantee a thriving insurance market in future. Nigerians earning mid-range salaries have far less disposable income than the typical middle-class consumer in much of the rest of the world, and an investment thesis based on Nigeria’s middle class necessarily varies by sector. Consumer-oriented businesses in Nigeria even have different definitions of what constitutes “middle class”, ranging anywhere from 5m to 25m people. Furthermore, as disposable income increases, insurance may not be the top priority for consumers given the country’s historically low penetration rates. As a result, the demographic payoff could come later for the sector.

Market Trends

For now, penetration stands below 1% and has not kept pace with GDP growth. Publicly traded insurance stocks are also falling on the Nigerian Stock Exchange (NSE) – from 3.3% of total market capitalisation at end-2008 to an estimated 0.7% by end-2013, according to the Central Bank of Nigeria (CBN).

Despite what might seem like a long wait for large-scale market expansion, many of the country’s leading insurers have been turning a consistent profit in the interim. Even with relatively high expense ratios, profit margins are favourable – above 10% for many of the industry’s key players, with some insurers reporting net profit margins well beyond that figure in 2012, according to company accounts.

Premiums growth has traditionally been achieved by way of the government making certain categories of insurance compulsory. As of 2014, there were six mandatory covers, though enforcement is lacking and regulations are often ignored. Among the more flouted rules is an element of the 2003 Insurance Law that requires premiums to be paid up-front. Although this stipulation, commonly referred to as the No Premium No Cover (NPNC) policy, has been in effect for over a decade, enforcement only began in earnest in 2013.

New Products

Efforts to ensure greater compliance continue, and a focus on bringing new products to market may also lead to greater uptake. The National Insurance Commission (NAICOM), the sector regulator, introduced guidelines for takaful (Islamic insurance) and microinsurance in late 2013. Financial inclusion has also become a more prominent theme, in line with the CBN’s National Financial Inclusion Strategy (NFIS), launched in 2012. The plan seeks to reduce complete financial exclusion – from all types of financial services – from 46.3% to 20% by 2020. Insurance participation came in at 1% in 2010, according to the NFIS report. Under the federal government’s Financial System Strategy (FSS), the target for insurance penetration was set at 70% by 2020, but the NFIS deemed this too ambitious, lowering it to 40% – more in line with South Africa’s 36% penetration. This will require a compound annual growth rate of 48% in 2011-20. The target for pension plan penetration is also 40% by 2020 – also revised downward from the initial goal of 70%.

In 2011 – the last year for which full-year comprehensive statistics were published by NAICOM – total premiums amounted to N232.7bn ($1.42bn), nearly triple the N79.9bn ($487.4m) recorded in 2005. The overall compound annual growth rate (CAGR) for 2005-11 stood at 19.5%, with CAGRs of 17.4% for non-life insurance and 28.9% for life. At end-2011, non-life insurance premiums accounted for N175.63bn ($1.07bn), or 75.5%, of the total, while life insurance comprised N57.07bn ($348.1m), good for the remaining 24.5%. This compares to a 15.6% share of total premiums in 2005.

Asset growth in the sector followed a similar pattern, with life insurance assets growing at a faster pace, albeit from a smaller base. Non-life assets almost doubled, from N219.09bn ($1.34bn) in 2006 to N417.35bn ($2.55bn) in 2011, for a CAGR of 13.8%, while life assets rose from N88.46bn ($539.6m) to N204.55bn ($1.25bn) over the period, for a CAGR of 18.3%

A Region of Difference

Nigeria’s roughly 1% penetration rate belies a good deal of variation by region. Insurance remains more common in the south-west, which includes Lagos, than in the north, according to a study by Fitch Ratings. In South Africa, a country Nigeria measures itself against, penetration is closer to 40%, according to the NFIS report. Yet South Africa’s insurance market dwarfs that of its neighbours, accounting for more than 75% of Africa’s total premiums in 2013, according to consultancy KPMG. The country also ranks high on a global scale, with PwC reporting that it has the second-highest penetration rate in the world.

State of the Law

The main law governing the industry is the Insurance Act of 2003, and NAICOM has been the regulator since its creation in 1997. However, NAICOM has struggled to implement many elements of its agenda, including the NPNC policy and a set of prescriptions known as the Market Development and Restructuring Initiative (MDRI), an overarching strategy for sector growth (see analysis).

One downside to the NPNC rule is that it could shrink headline numbers. However, this will likely better reflect market performance, as unpaid policies will no longer be counted as premium income in official financial statements. Although NPNC was seen as a key reform in the years after its introduction in 2003, it was not until 2013, when NAICOM issued enforcement guidelines, that it gained real momentum. The new rules, released in January, impose a fine of N500,000 ($3050) per policy on any company that offers cover to a policyholder who has not paid the premium in advance.

While this reform is expected to result in a more functional insurance market, implementation means forcing insurers into a reform that may make them look less profitable than previous income statements indicated. However, as Chike Mokwunye, group managing director at Royal Exchange, told OBG, the law could also have some financial upsides for insurers. “We expect the industry to benefit from new initiatives such as the NPNC requirement. The impact in 2014 should be substantial through improved cash flow and margins.”

Nevertheless, NPNC could end up leaving insurers with fewer sales tools and customers. For example, policies are often sold on credit as a way to garner business. Even federal and state government agencies, which are some of the largest customers, are accustomed to buying this way without paying later. Under NPNC, insurers would be forced to abandon this practice. “NPNC is a great idea, but monitoring measures should be put in place to ensure it is fully implemented,” Corneille Karekezi, CEO of Africa Re, said. “External auditors must be asked to verify if the unpaid premiums are taken out of the insurance companies’ books and not merely provisioned. This should be an accounting standard to be enforced by external auditors.’’ Lack of accurate and timely financial data remains an issue in Nigeria. At the end of 2014, eight insurers had yet to submit their 2013 financial statements to NAICOM. One possible explanation for this is NAICOM’s decision to adopt International Financial Reporting Standards (IFRS), starting in 2012. While applying IFRS would be helpful to foreign investors, as is the case with the NPNC reform, the process is unlikely to progress as smoothly or as quickly as the regulator would like. “Due diligence will remain a challenge to the acquisition of existing insurers, despite improvements in corporate governance,’’ Fitch’s report noted.

Uphill Battle

One reason why sector reforms have been difficult may be lack of regulatory independence. NAICOM hopes to achieve financial independence in the future, which would put it more in line with Nigeria’s other financial services regulators, such as the CBN and the Securities & Exchange Commission, which are self-financing. For its part, NAICOM takes a 1% levy on gross premium income, broker commissions and loss adjusters’ fees, alongside other sources of income like fees, penalties and investment income.

There is also a lack of legal clarity regarding enforcement of NAICOM’s guidelines, which, unlike its regulations, are not subject to ministerial approval. This has fostered uncertainty over its ability to enforce them, according to the IMF. It is a particularly high-stakes issue, as this is the form in which NAICOM has issued minimum capital thresholds and investment limits.

Many Options

As of early 2015, there were 30 general insurers, 15 life insurers and 13 composite providers licensed by NAICOM, according to its website. The regulator has also licensed 2453 agents and 588 brokers. However, NAICOM announced a moratorium on new licences in 2013, in part to encourage industry consolidation. The 10 largest insurers by assets accounted for 47.4% of the sector total, according to Fitch Ratings research, making Nigeria a relatively fragmented market. By comparison, the top-10 South African insurers represented 85.8%. Fragmentation is greater for general insurance than for life: the 10 largest general insurers comprise 52% of their segment’s premiums, versus 71% for the top-10 life insurers.

Homegrown

The market has two local reinsurers: Africa Re and Continental Re. Africa Re was formed in 1976 by the Organisation of African Unity – now the African Union – to help retain more risk on the continent. While the company is based in Lagos, it has 41 member states as well as outside investors. In each member state, including Nigeria, Africa Re gets a compulsory 5% of all reinsurance treaty business written.

Their business is further support by a law that requires Nigerian insurers to use domestic reinsurers before seeking treaty or facultative coverage abroad, which needs NAICOM permission. To obtain this, insurers must demonstrate that they have exhausted local capacity. Retention rates among leading insurers vary widely – a Fitch survey of 10 major companies found three at or below 61% in 2012 and four at 82.7% or higher. Leadway Assurance, with 50.3%, spent N12.9bn ($78.7m) on reinsurance according to Fitch, more than double that of any other company reviewed.

Mergers & Acquisitions

Consolidation has been a theme in past decades, as the number of insurers fell from 140 in 1994 to 97 in 2005, hitting a low of 49 in 2007. This trend was reinforced by new minimum capital requirements for insurers, introduced by NAICOM in 2005 with a range of N2bn-10bn ($12.2m-61m) depending on the segment. However, the IMF suggested these levels may be too high, particularly as premium income remains low, instead recommending a $ 4m10m range. “There is a need to study the appropriateness of the capital requirement to balance risk, return and market development,’’ the IMF report noted.

Recent consolidation includes Custodian and Allied’s merger with Crusader Insurance in 2013, and Asset & Resource Management’s purchase of a 41% equity stake in Crystalife Insurance, now known as ARM Life. Consolidation has also come in the form of foreign investment, typically from South Africa, such as FBN Insurance buying Oasis Insurance in 2014. Another South African firm, Old Mutual, bought Oceanic Life Insurance in 2013. Other foreign investments include Ivoirian NSIA Participations’ acquisition of ADIC Insurance and AXA’s purchase of Assur Africa and its 77% stake in Mansard Insurance in 2014. Much activity has been driven by a CBN directive requiring banks to divest of insurers or restructure as a holding company by mid-2012, though at least six banks received extensions.

General Lines

Third-party motor liability insurance has been mandatory since the 1945 Motor Vehicle Third-Party Insurance Act. Other mandatory lines include liability coverage for building occupiers and employers, as well as group life insurance, policies for buildings under construction, and health care professional indemnity insurance, though poor or non-existent enforcement continues to limit growth.

Motor policies accounted for 36% of net premiums in 2011, according to NAICOM, or N42.24bn ($257.7m) of the N127.53bn ($777.9m) total. Enforcement means ensuring not only that drivers buy insurance, but that they do not do so willingly or unwittingly from fake insurers offering pretend policies. To this end, regulators have been working with the Nigerian Insurance Association (NIA), the industry lobby that established the Nigerian Insurance Industry Database (NIID) in 2012. The NIID allows buyers to verify the authenticity of their motor insurance policies, and has registered 2.5m automobiles to date, leaving 14m uninsured vehicles in Nigeria, according to the NIA. The NIID is also being extended to marine cover, which accounted for 13% of net premiums in 2011 and is another area where fraudulent policies are common. Nonetheless, some obstacles to the NIID remain, as Tosin Runsewe, chief client officer of Mansard Insurance, told OBG. “There are two major issues: not all insurance companies participate, often due to the cost, and the police do not use it 100% of the time. Resolving these two issues would improve enforcement in Nigeria.”

Distribution Channels

To reach non-government customers, Nigeria’s general insurers have typically relied on their own agents or brokers, who number 2477 by Meristem’s count and drive some 90% of business. Since most demand for insurance comes from companies, not individuals, brokers control much of the market, often remitting premiums late or, in extreme cases, not at all. This was one of the driving factors behind the government’s NPNC policy.

Increasingly, however, new distribution channels are gaining traction, such as bancassurance, microfinance, mobile phones and marketing relationships with retailers. Although the directive requiring banks to divest of insurers will make bancassurance more difficult, by severing some links between the two, in March 2015 the CBN issued bancassurance guidelines allowing insurers to distribute products through banks’ customer bases. This is expected to boost penetration. “Retail insurance follows consumer lending, so as long as bank lending is low, insurance will struggle too,” Wole Oshin, managing director of Custodian and Allied, told OBG. “Insurance companies must therefore find alternative channels in order to drive growth in retail coverage.” Mobile phones, though a relatively new way to reach insurance customers in Africa, are also expanding rapidly. A survey by the Consultative Group to Assist the Poor, a research group under the World Bank, found 84 mobile insurance products worldwide as of early 2014, of which 54% were in sub-Saharan Africa.

Life & Pensions

Although income growth is progressing faster in the life segment than in general insurance, it is starting from a smaller base, with less than half as many premiums. AIICO is the key player in the segment, with a market share of about 20%, according to the IMF.

The pensions sector could also play an important role in development, such as by investing in infrastructure projects, particularly those with long payback periods. The country’s infrastructure deficit includes an electricity sector in need of reform and capital expenditure. The privatisation process under way for most state assets relies on bank loans, and more long-term sources of capital would be welcomed. Authorities are also eager to see more investment from private equity firms and pension funds, though investment in infrastructure bonds and other permissible debt securities is currently capped at 20% of assets for pension funds.

Pension funds are also sought-after investors in the corporate bond market. Federal and state government bonds, which offer high rates of return, comprise almost two-thirds of the $26bn in pension funds, according to the regulator, National Pension Commission. Corporate bonds attract around 2% of pension fund assets, well below the regulatory limit of 35%. However, enlisting insurance assets to serve wider development goals may be a cause for concern among pensioners. Pension funds in Nigeria have been subject to illicit capital flight in the past, although legal reforms have installed processes for combatting this problem.

Outlook

Despite shortcomings in enforcement and financial reporting, the insurance sector continues to post double-digit growth, with a bright future ahead given demographic trends. It is easy to see why foreign insurers are keen to invest, especially if the regulator succeeds with its reform agenda and the middle class acquires the spending power expected in coming years.