Growth assured: Increasing awareness and expansion likely to continue

One of the most promising segments in Mongolia’s financial services industry is insurance. It is seen growing rapidly over the next few years as the economy expands, as the market becomes more sophisticated, and as more firms and individuals become familiar with the products and begin buying them. Insurance companies will benefit both from increasing prosperity and increasing awareness of the need for cover. The insurance market is also open – a rarity in Asia. International investors and strategic partners are taking a close look at potential acquisition targets and partners. Should a transaction occur, the market could get a boost in terms of technology, capital and experience.

History

In the 1930s a Soviet entity was established under the Ministry of Finance (MoF) to cover the risks of state and cooperative enterprises as well as those of individuals. It was in many respects an insurance company, with a separate legal personality and its own profit-and-loss statement. The entity eventually evolved into Mongol Daatgal. Meanwhile, life insurance was introduced in 1965. During and after the democratic revolution, a framework was set up to support a free insurance market. A supervisor was established under the MoF in 1990, and in 1995 the MoF started issuing insurance licences. The Law on Insurance was enacted in 1997 and took effect in 1998. In 2004 the law was amended to bring it in line with international standards. Rules were put into place regarding minimum capital – set at MNT500m ($307,000) at the time – and the uses of surpluses. The Law on Insurance Intermediaries was also issued in 2004, and the Financial Regulatory Commission (FRC) was formed in 2006. It supervises the sector, although the MoF is tasked with making policy. The first life insurance company was established in 2008.

Active Regulator

 The FRC has been working to bring the sector ever closer to global best practices. A 2006 regulation requires that each insurer create a reserve fund and outlines how the establishment of that fund should take place. Strict limits are placed on where the reserve fund and paid-up capital can be invested. Up to 25% of paid-up capital should be in separate account as a statutory fund and can be used as policyholder protection fund in case of the insurer’s insolvency, for example, while the remaining 75% can go into bank deposits and buying immovable property. Guidelines on insurance accounting have been issued as have guidelines for auditors of insurers and for actuarial qualifications. Solvency requirements are precisely laid out and parameters for the setting of premiums have been set.

Minimum capital has been an area of particular focus. It was lifted first to MNT1bn ($600,000) and then to MNT2bn ($1.2m), and from there it will be raised in increments of MNT750m ($450,000) until it reaches MNT5bn ($3m) in 2016. Long-term insurance capital will be set at MNT6bn ($3.6m) and reinsurers capital at MNT15bn ($9m). There has also been some significant activity on the legislative side.

In 2011 the Law on Driver’s Insurance was passed, and it took effect on January 1, 2012. The statute requires all vehicle owners in the country to purchase compulsory liability insurance and introduces a fund for paying claims that otherwise would go unpaid: when a driver is uninsured, if the insurer is bankrupt, or if the offending party cannot be identified. The country’s insurance sector is an active one. It comprises a total of 17 companies, according to the FRC. Of those, 16 are non-life insurers and one is a life insurance company, National Life.

Market Players

 The sector is fairly well balanced in terms of market share. Mongol Daatgal remains the top insurer. In the second quarter of 2013, it collected 31% of the premiums paid. The next largest player, Bodi Daatgal, collected 14% of the premiums, while number three, ARD Daatgal, collected 10%. After that, three insurance companies (MIG, Tenger and Soyombo) each took in 7-9% of the premiums. The rest of the sector collected 22% of the total. By June 2013 assets for the sector totalled MNT113bn ($68m), an increase of 16% on the prior year. The vast majority of insurance – an estimated 60% – is property insurance. Liability accounts for around 24% and financial 3%.

Expansion Potential

While the stock market is struggling to regain investor interest after three years of poor performance, and while the banks are working through issues related to slowing GDP growth and aggressive economic stimulus programmes, the insurance companies are free of legacy problems and are set to grow rapidly. Insurance penetration is very low. In first-half 2013, it was just 0.58%. That is up considerably from just a few years ago – 0.32% in 2006 and 0.39% in 2010, according to the Mongolian Insurers Association – but it is still far below world averages.

According to Lloyd’s, insurance penetration in low-income countries is generally slightly below 1%, 1.5% for middle-income countries and above 2.5% for higher-income countries. In the region, most countries have far higher penetration as a percentage of GDP than Mongolia: Indonesia, 1.7%; Malaysia, 5.1%; Vietnam, 1.6%; China, 3.0%; and Korea, 11.6%. “Insurance penetration is low, about 0.5% of GDP,” T. Batzul, the CEO of Mongol Daatgal, told OBG.

In part, this is a function of economics. Until recently, Mongolia was relatively poor. With GDP per capita in current dollars still under $1000 in 2005, insurance was neither affordable nor needed. But it is also a function of history. Insurance in Mongolia was dominated by the state until 2003, so the country has very little in the way of a private sector insurance tradition. The product has long been seen as a tax paid by one state company to another state company. Individuals have had very little exposure to insurance and remain largely unaware of what it is and how exactly it works. Much of the population is rural and a good portion of that is nomadic, and their planning tends to be focused on the short term. The average Mongolian sees little reason to pay for something that they may never use, and the health system reinforces this way of thinking. “However, such attitudes towards insurance have been shifting to focus on the responsibility of employers. The majority of our clients have been insured through their employers, and this trend is expected to continue,” the CEO of National Life, G. Mongolkhuu, told OBG.

Transition

 The country is institutionally unsuited for some types of insurance. Life insurance, for example, does not receive favourable tax treatment, and as a result, there is less of an incentive to buy this type of cover. Industry executives also point out that the country is already a low-tax jurisdiction – income tax is a flat 10%. Even if the insurance premiums were tax-deductible or insurance returns tax-free, it would not make a big difference and probably would not drive much money toward the product.

Moreover, owing to the tight regulation of insurance companies, they are unable to invest in much beyond bank deposits, bonds and real estate. For this reason, life insurance is not a very interesting investment, as its returns are not much different from what an individual could easily generate on their own. Local regulations have also limited its potential. “Mongolia is not a country where you can simply copy and paste insurance regulations from other developed countries. This is a particular market, and in some cases, too much regulation can limit the growth of the sector,” Ts. Battulga, the CEO of Soyombo Daatgal, told OBG.

However, the market is changing as economic circumstances improve. The arrival of multinationals has resulted in an increased awareness of insurance. Most of these companies operate to international best practices and are required to insure their workers and their assets, which has influenced local firms.

The larger Mongolian groups are already international in scope. They are often audited by a big four accountancy and raise funds in the global capital markets. In many cases, they are compelled to actively manage risk, and insurance is an essential product for them. Even the most local of firms are starting to see the value of insurance and are beginning to become more active in the market. “In 2011 most of our corporate clients were foreign invested companies, now we are also seeing a lot of local invested companies,” said P. Erdenekhishig, chief risk officer at Tenger Insurance.

Additional Drivers

 Individuals are also starting to get more interested in cover. While many do not necessarily understand how insurance works, enough are now attracted by the potential benefits. In this regard, the poor state of health care has worked over time in favour of the industry. In the past few years, well-off Mongolians have started to see the value of purchasing international-quality policies that allow for treatment in foreign countries – approximately $35m a year is spent by Mongolians seeking medical care overseas, according to the Ministry of Health. At least five companies – National Life, Tenger, Nomin, Monnis and Practical – are offering health policies. The cost for international-style coverage starts at around $1000 per year, but with Mongolians becoming increasingly well off and health-conscious, it is likely that the purchase of health cover will rise. Around 1.2% of total private health spending in the country is from private health insurance, according to the World Health Organisation’s “2013 Mongolia Health System Review”.

The other key drivers of the private insurance market are the rise in home ownership, the revision of the Company Law in 2011 and the introduction of compulsory liability insurance. The government’s 8% mortgage policy has resulted in a rush of home building, and many of the new occupants are taking out policies to cover their properties and the possessions within them. As with all emerging middle classes, the coverage of risk is an important part of the transition.

The new Company Law, meanwhile, significantly increases the risks to corporate officers. While liability in Mongolia was already high, according to law firm Hogan Lovells, the revised Company Law expands the scope of responsible parties and holds them personally liable for disclosure failures. The board, the executive management team, the accountants and anyone holding more than 10% of a firm’s stock are covered under section 84 of the statute. The new law has increased awareness of obligations and has made compliance more onerous, and the result has been a heightened interest in director’s and officer’s insurance. But it was compulsory driver’s liability insurance that did the most to increase uptake. While the programme may not have been a total success, it improved the understanding of insurance in the wider population. “The driver’s liability opened the door for the insurance segment,” said Mongol Daatgal’s Batzul.

Distribution & Foreign Investment

Banks are getting more involved in distribution. This is a key step as these institutions have the best geographical coverage. In August 2013 Khan Bank received a special licence to offer insurance mediation services. It works with Mongol Daatgal, Mandal General Daatgal, ARD Daatgal and Practical Daatgal to provide insurance products at six branches. Mandal is also working with XacBank on distribution, with the bank having agreed to sell insurance products through 12 branches.

The market is especially interesting because of the lack of restrictions on foreign investment. The sector already has significant foreign participation. ARD Daatgal received foreign capital in 1994, while Mongol Daatgal has Russian shareholders. Tenger Financial Group, parent of Tenger Insurance, counts the International Finance Corporation and the European Bank for Reconstruction and Development as owners. Japan’s Orix, a financial firm, also acquired 15% of Tenger Financial in May 2013. Meanwhile, Mandal insurance was until December 2013 majority controlled by Mongolia Growth Group, a Canadian investment company. Following the passage of the new Investment Law in late 2013, insurance has again become a sector where national treatment is generally applied. Under the Strategic Entities Foreign Investment Law, passed in 2012, all financial services would be subject to a schedule of approvals, but now these are only required if the acquirer is state owned.

Permissions are still needed. A licence must be obtained from the FRC to carry on insurance business in the country, and a foreign firm wishing to engage in the business in Mongolia as a locally incorporated company or as a branch office must obtain special permission from the FRC. In addition, anyone buying more than 10% of a Mongolian insurer must get the permission of the FRC and the officers of the acquirer must be approved as being fit and proper by the regulator; if the entity sells the 10% or above stake, it must also get permission. Mergers require regulatory approval. Nevertheless, the playing field is now almost perfectly level, and this should make a big difference over the long term.

As the sector grows, foreign strategic partners can play a significant role. A number of local insurers say they are open to selling equity to non-Mongolian entities and they are already receiving enquiries, especially from regional players. Also, investors are intrigued by insurance in Mongolia because it both acts as a proxy for the broader economy and promises growth better than the general trend. The sector will reflect the rising GDP and also the increasing sophistication of insurers and customers, and that could result in returns superior to local and global benchmarks. Insurance may also perform in a weak or down market, as people become more aware of risk and the dangers of not being insured when times are tough.

Missteps

 Even so, challenges remain present. While insurance literacy is increasing, missteps have caused the educational process to stall. The roll-out of the compulsory liability insurance, for example, left many people disillusioned with the product. Payouts have not been as expected, and some consumers are claiming they have been cheated. However, insurers have countered that the payments were probably correct but that many customers failed to read their contracts properly. Nevertheless, the result of the disappointment has been considerable bad press – reinforcing negative opinions on insurance in general– and low sign-up rates in the second year of the programme. But the real problem with the law over the long term, insurers say, is that premiums are built into the actual text of the law, reducing flexibility and the ability to adjust prices. Any changes would require an amendment.

Some insurance firms are especially concerned about the smaller players. They argue that in many cases these companies come in with highly aggressive pricing but try to avoid making payments – they see premiums as income and do all they can not to honour claims. This is putting pressure on the entire sector, has the potential to destabilise pricing, and could lead to insolvencies at the lower end of the market should unexpected and unavoidable claims hit. “The big insurance companies are there to compete the proper way,” said Tenger’s Erdenekhishig. “But the small insurance companies are making the rates too low, making it difficult for the big insurance companies.”

Also, according to B. Batbayar, business development executive at insurer ARD Daatgal, there are non-rated insurance companies operating in Mongolia. “Therefore, bringing in foreign companies to the market would have a positive impact on the sector, as it would force local companies to bring up their operations to international standards,” Batbayar told OBG.

Small Market

 Most of all, the market is small. The entire sector brings in around $50m in premiums a year – National Life is now finally garnering some MNT1bn ($600,000) annually in premiums. It will take years before critical mass is achieved to make the sector self-sustaining and independent. As it stands now, the vast majority of premiums are leaving the country to reinsurers, putting a strain on the currency and on the foreign exchange reserves. Most of the profits go overseas, and the local companies are not able to earn much from actually taking on risk. Insurers say the arrangement is costly for other reasons. Given the size of the market, the reinsurance segment is not particularly active, so the pricing, some contend, is not as competitive as it should be. Considerable leakage occurs, with foreign policies being sold by non-admitted insurers. Companies and individuals simply bypass Mongolian firms and go directly to the overseas markets. The FRC got so worried about foreign insurers operating illegally in the country that it issued a special announcement in June 2013 warning non-Mongolian firms to abide by the terms of the Insurance Law requiring permission to sell insurance domestically.

Finally, investment is a major challenge. The stock market is small and risky, while liquidity is low in the bond market. Real estate has become volatile as a result of the 8% mortgage policy, other subsidy programmes and considerable investment by individuals. Even if a more diverse range of investments were allowed by the regulators, the choices are few until the capital markets become more developed. Some insurers are already facing potential asset-liability mismatches. With international health insurance, some claims need to be paid in foreign currency, but the insurers are prohibited from owning foreign assets. While the intentions of the regulators are good, this can be potentially dangerous if the tugrik falls.

The sector sees a number of solutions on the horizon. Consolidation, for example, is bound to happen as the capital requirements are raised. Rates should become more consistent and risk should become better priced. A national reinsurer has been discussed, to keep more premiums onshore and improve the negotiating position with the international reinsurers for risk placed offshore. Some firms are pushing for regulations to standardise contracts. The hope is that more consistency and transparency could reduce the confusion on the part of the buyers as to what a policy covers and help improve the sector’s reputation.

Outlook

 The prospects for the sector are excellent. If consolidation takes place and if insurance awareness increases as expected, margins will be solid and growth almost certain. The regulatory history – with the possible exception of compulsory liability insurance – has been solid, and a good set of laws and rules have been passed. If the FRC can continue to monitor, supervise and manage the sector effectively, expansion is likely to remain steady going forward.