Greater transparency and proposed regulatory reforms to boost Dubai's long-term insurance prospects

In the UAE, insurance is licensed by the federal regulator for operators in all seven emirates, the Insurance Authority (IA). The sector is highly competitive, with 60 companies angling for business, according to the IA’s 2013 annual report, in a market where insurance has not yet gained popular acceptance as an essential financial service. Owing to a low penetration rate, at about 2%, the long-term prospects for insurers in Dubai and in the country as a whole are positive, with significant growth expected in the years to come. This in part helps to explain the many operators and global players in the national market.

In addition to an opportunity-rich future, another reason for the overcrowded market is the ample supply of liquidity in the region over the past decade. Oil prices rose for most of the last 10 years, and with them the overall wealth of Emiratis and other GCC nationals. As a result, capital has been deployed in new ventures, including insurance companies.

Rich PotentiaI

The market boasts several indicators that bode well for future growth. The low insurance penetration rate, coupled with one of the world’s highest per capita incomes – $43,049 in 2013, according to the World Bank – are major positives in the push to attract greater investment in the sector. However, making the case that insurance is an essential financial service is taking time. For now, the challenge is to stay profitable until the pace of market growth accelerates.

Profit margins on underwriting are often low under current conditions because mandatory lines such as motor and medical are subject to price competition among insurers seeking a larger market share, even if it comes at the cost of profitability. Smaller insurers in particular are still in the process of building capacity and adopting best practices in risk assessment. Instead of generating profits based on underwriting alone, insurers are often heavy users of reinsurance services and achieve their profits through investment accounts. In the years after the 2008-09 financial crisis this became more difficult as a result of declines that affected multiple asset classes, chief among them real estate and equities.

Sector Developments

In 2015 the impact of newly introduced regulations applied in November 2014 is likely to boost transparency and improve operational capacity, in particular for insurance brokers. As of September 2014 the IA was also considering the introduction of a new insurance law that could bring new solvency requirements, boost capitalisation and provide maximum thresholds for specific asset classes in investment accounts. There was no known timeline for introducing the law, but the regulator has issued draft guidelines in the past and industry analysts were expecting these reforms at some point in the near future. In Dubai, 2015 represents a watershed for the insurance sector, with the introduction of compulsory medical insurance, which will provide universal coverage for all residents of the emirate by 2016 (see analysis).

Regional Focus

Growth is also likely in the Dubai International Financial Centre (DIFC), a financial services free zone from which insurers can service the region but not the domestic market. There are already 57 different insurance businesses in the DIFC that are regulated separately according to the zone’s rules and regulations, which include its own courts and laws. The applicable legal framework was designed specifically for the DIFC, but with the assurance that English common law would be followed in the process of dispute resolution. The regulator for the DIFC insurers is the Dubai Financial Services Authority, which also oversees all other financial services offered in the zone.

While the DIFC is open to all, the IA has not issued new licences in the domestic market since 2009, which has increased the value of those already in existence. For licensed foreign investors operating branch offices, the UAE’s insurance market is effectively the most open sector of the economy. While foreign entities cannot own a majority stake in any type of UAE-based company, and ownership in the insurance sector is capped at 25%, the licensed branches of foreign insurers are treated differently. They do not have to share ownership or profits with a local partner, and there are no restrictions on activities within the sector. Branches can even compete with domestic insurers across all lines of business. Until new licences are available, foreign insurers wanting to participate will need to merge with or acquire a local entity. The most recent example is this strategy is France’s AXA, which in 2014 completed an investment in Abu Dhabi-based Green Crescent Insurance (GCI), founded in 2008. AXA partnered with a local conglomerate, Kanoo Group, to invest Dh100m ($27.2m) in GCI through a convertible bond. The respective ownership stakes of AXA and Kanoo were not disclosed, though Hassen Bennour, an AXA executive and the company’s former regional head of strategy and corporate development, will be CEO.

Indeed, this mode of market entry seems likely to continue, if not accelerate. “With more stringent capital requirements being imposed by the regulator on insurance brokers, the inevitable outcome will be a period of mergers as well as full takeovers. After consolidation, the excessive price competition that has beleaguered the industry in recent years should become less of an issue,” Omar Wehbe, managing partner at Wehbe Insurance, told OBG.

Market Structure

According to the IA’s 2013 annual report, there were 34 national insurance companies and 26 foreign branches in operation. A total of 10 are takaful (Islamic insurance) providers, which sell sharia-compliant alternatives to conventional policies. Insurance licences permit a company to offer either conventional insurance or takaful, but not both. Composite insurers account for 13 of the overall number, and 37 sell only general lines. A total of eight of the 10 life insurance specialists are foreign branches, controlling 78.2% of the life segment in terms of gross written premiums (GWPs).

Of the 60 companies in the sector, 29 are publicly traded on the Dubai Financial Market – one of the emirate’s two equities exchanges. As many as eight of the listed insurers are takaful companies. The IA has also licensed 18 insurance agents, 168 brokers (seven are foreign companies), 19 insurance consultants, 72 loss adjusters and 36 actuaries. The IA was formed by law in 2007, but most laws governing insurance in the UAE date from 1984.

In the domestic market, GWPs rose 12.2% year-on-year in 2013 to a value of around Dh29.5bn ($8.03bn), according to the IA’s annual report, with general insurers accounting for 76.2% of the total, or Dh22.5bn ($6.12bn). Investment accounts were valued at a combined Dh37.8bn ($10.29bn), of which 30.5% was channelled into equities and 26.8% into bonds. According to credit ratings agency Standard & Poor’s (S&P), UAE insurers invest more than the global average in equities and real estate, which has the potential to make their earnings more volatile than their counterparts in other markets.

Penetration

The national insurance sector is the largest in the region, accounting for 45% of GWPs in 2013, according to credit ratings agency Moody’s. However, as other countries in the GCC share the similar features of a low penetration rate and high per capita income, it suggests that there are opportunities for growth above and beyond the pace of economic expansion across the region.

In contrast to the UAE’s penetration rate of 2%, the five other countries in the GCC only registered figures of around 1%. While the UAE’s insurance sector continues to outpace GDP growth, it does not necessarily need to do so by wide margins in order to be profitable. According to Moody’s, premiums in the region tripled from 2006 to 2013, to $18.4bn, while penetration rates remained comparatively static in most other GCC countries.

The Dubai-based investment bank Alpen Capital predicts compound annual growth on the order of 18.1% from 2012 to 2017 for GCC insurers, which implies a total value of $37.5bn by the end of the period. For its part, S&P expects premium growth of around 6% annually in the region in the coming years, whereas in the UAE specifically, GDP growth is predicted to reach between 4% and 5% per annum.

A recent study by Zurich International Life helped to shed light on where the insurance industry should target its promotional and educational efforts if it is to boost the penetration rate significantly. The study found that almost 80% of residents in the UAE lack disability coverage and 64% do not have a financial safety net should the family’s primary breadwinner unexpectedly perish. Among those who do have life insurance to cover such risks, 66% could use more – under their current policies, the family would only receive two years worth of salary or less.

Challenges

The structural obstacles to growth are particularly notable for life insurance providers, especially for their long-term savings schemes. Emiratis are not offered pension plans, but are instead given a lump-sum payment, called a gratuity, when they either retire or quit a job. While there are some pension programmes available in the private sector, this system makes them a harder sell. The lack of public sector pensions means insurers cannot offer schemes that allow government employees to top up retirement savings with additional contributions.

Another issue is that there is no personal income tax in the UAE, as tax incentives are used to encourage workers to contribute to pension funds in most other countries. Indeed, most insurance companies in the UAE have traditionally focused only on compulsory areas, such as the importation of goods, casualty, and liability insurance for small and medium-sized enterprises – policies that tend to turn around quick profits as opposed to others like life insurance. However, this policy makeup is likely to change as the mandatory medical insurance scheme is phased in (see analysis).

Improving The Figures

That story can also be told in numbers: for example, 37 of the UAE’s 60 insurers write only those general risks that bring in revenue faster. The vast majority of the wider activity comes from accident and liability lines, with 32.8% of premiums in 2013, and from medical insurance, which comprised 44.1%. In these categories insurers tend to retain risk, but for others they are more reliant on reinsurance coverage, with about half of all risks passed on in this way. According to the IA, in 2013 the retention rates for those lines of business were 65.2% for accidents and liability and 63% for medical. The next highest was for land, sea and air transport insurance, at 27.5%.

“The UAE insurance market is a high user of reinsurance protection, particularly for high-value risks such as marine, aviation, and transport or property lines,” a recent S&P sector update said. “Reinsurers are now much more selective on partners and terms and conditions than they were a few years ago.”

DIFC: At the DIFC, which marks its 10th anniversary in 2015, insurance activity is focused on advanced commercial services, including reinsurance, trade credits, regional coverage and boutique coverage for wealthy retail customers in the region. A total of seven of the world’s 10 largest reinsurers are present in the zone, with Dubai seemingly closing the gap on playing the same role for the Gulf that Singapore does for reinsurance in South-east Asia. The expertise within the DIFC lessens the need for travel between Europe and the GCC to negotiate reinsurance treaties, as well as for facultative coverage (reinsurance that falls outside the general terms set out in treaties and must be negotiated individually).

The arrival of Lloyd’s of London to Dubai in 2014 has been a key sector development. While the UK group has historically attracted GCC business in its home market, it has been seeing less turnover on that basis. Instead, it is now pursuing growth potential in Dubai, according to Roger Bickmore, an insurance executive with Kiln Group, a Lloyd’s of London insurer. “Underwriting capacity and broking expertise, mostly based in Dubai, is rapidly evolving in the key lines of business,” Bickmore said in response to Lloyd’s announcement, which came in January 2014.

Diversifying Its Portfolio

Another example of growth in regional insurance services within the DIFC is the trade credit market, in which importers and exporters protect themselves against non-payment for international trade. In August 2014 specialist insurer Markel International said it had applied for a licence to open a regional office in the DIFC. Markel’s plan may extend into other property and liability lines, including marine, which is often written in London currently, according to market commentary from AM Best, the US-based provider of data, ratings and news on the insurance industry.

Demand from financial services firms for professional indemnity coverage is rising in part because Dubai is becoming an increasingly attractive destination for raising capital through a wide variety of structures, including equities, bonds and bank credit products, but also sharia-compliant alternatives. In the last category, Dubai’s government has announced that Islamic finance is a core element of its plan to become the capital of the global Islamic economy (see Islamic Financial Services chapter).

This is an attempt to organise and standardise several economic activities specific to Muslims and how their religion informs economic needs – for example, sharia mandates interest-free financial services. In addition, the emirate’s government also believes it can foster economic growth by establishing industry- and service-based value chains for the food-processing industry, which must adhere to a set of religious restrictions. The standards for what is classified as halal (allowed) and haram ( forbidden) are currently set within Muslim countries, and Dubai aims to centralise this process and capture economic value as a result.

Regulation

In the domestic market, 2015 may bring major changes. The regulator is now in its seventh year in its role, and has in the past few years signalled its intent to provide more clarity on the rules and enhance standards in several areas of operation.

In 2011 the IA published three separate drafts of new laws to boost minimum capital requirements, to refine how reserves are calculated, and to provide more specific guidelines on how to maintain liquidity and diversity in investment accounts. While the draft laws were not enacted, the IA announced in December 2013 that the concepts would be consolidated into one framework that would, if approved, govern both conventional insurers and takaful providers. As of late 2014, specific details and the timeline for implementation had yet to be shared.

Some expectations are clear, however. To start with, the minimum capital requirement is likely to climb, from a current one-size-fits-all level of Dh100m ($27.2m) to a more flexible regime. According to one report, risk-based solvency measures would be instituted and the minimum capitalisation would be set in alignment with solvency margins calculated according to this new system. Caps on investment accounts are also expected, and would likely result in insurers lowering the overall level of risk in investment portfolios, which would trigger sell-offs of equities. Insurers would also be required to use actuaries in reviewing life operations, though there is no requirement as of now to publish any such actuarial reports. The law may also empower the regulator to levy fines, an ability which it currently lacks.

Strengthening The System

The UAE’s history of regulation in financial services suggests that even if a law is passed, implementation is not guaranteed. There have been several instances in which laws or regulations that were approved have been retracted or not enforced in full.

In the insurance sector, for example, there is a stipulation in the 2007 Insurance Law that calls for the end of the composite insurer business model. Insurance companies were given until 2012 to pick either the general or life category to operate in. However, this did not take place in the allotted time-frame, and the deadline was subsequently pushed back to 2015. It was unclear if the rule would be enforced, and whether it would mean divestiture or a separation of operations under the same corporate umbrella. Composite insurers say the plan would be difficult for them to implement, as if they chose to separate companies under the same umbrella, this would result in higher administrative costs.

Another issue to keep an eye on in 2015 is the new set of regulations for brokers that took effect in November 2014. The market is home to many brokers, and some of the smaller ones have harmed the segment’s reputation and level of professionalism, chiefly by failing to pass along payments from policyholders to insurers. The new requirements are expected to improve standards and benefit the market more broadly, mandating an increase in minimum capital requirements from Dh1m ($272,200) to Dh5m ($1.36m) for local brokers and Dh10m ($2.72m) for international ones.

Outlook

With medical insurance providing a new and competitive line of business in Dubai, and the IA working to update regulations, the sector is likely to benefit from greater clarity and transparency. “The UAE insurance market is poised for growth, with new health regulations affecting most residents, and there is a huge untapped market for personal lines insurance that needs to be developed and promoted – both of which will result in tremendous growth in GWPs and enhance and strengthen the UAE’s position as an industry leader in the MENA region,” Mahmoud Nodjoumi, chairman and founder of Nexus Group, told OBG. While foreign interest remains high, the pace of reform will impact whether insurers will see significant consolidation, and if the promised changes are fully implemented. Nonetheless, the market is expected to continue growing.