Keeping calm and carrying on: Anticipating regulatory changes and looking abroad to expand

With nearly 80% of all direct premiums in Africa, the South African insurance industry is a regional giant. Having weathered the economic slowdown, the sector is facing new challenges, including shifting market dynamics and an evolving regulatory framework that will likely alter the day-to-day operations of licensed insurers.

MARKET STRUCTURE: South Africa’s insurance market is split into two regulated segments with separate legal frameworks and different representative bodies. The Long-term Insurance Act of 1998 addresses life cover, referred to in the domestic market as “long term”. The life sector contains 87 mostly local firms, the largest of which, such as Old Mutual, often form part of larger financial groups with an international presence and foreign stock exchange listings. Industry regulator the Financial Services Board (FSB) divides this group into sub-categories: 30 “typical insurers”, which offer most of the six business classes the act defines; 10 “niche insurers”, which conduct business in a specific target market; 15 “linked insurers”, whose policy values are linked to the assets that are receiving investment; seven “cell captive” insurers, insurers that provide non-insurance entities a share in the business of an insurance firm; nine “assistance insurers”, which offer funeral policies not exceeding R18,000 ($2203); and a further nine insurers which are currently in run-off.

The Association for Savings and Investment South Africa (ASISA), a body formed in 2008 by a merger of two smaller groups, represents the interests of the long-term sector. It plays a major role in ongoing reforms alongside its counterpart on the non-life, or “short-term” side, the South African Insurance Association (SAIA).

The short-term segment operates under its own legislation, the Short-term Insurance Act of 1998. In 2011, it comprised 108 companies, of which 29 were typical, 30 niche, 11 cell captive, 10 captive and 18 in run-off. Rounding out the sector are 10 reinsurers, four of which hold composite licences to engage in long- and short-term business. Despite the numerous insurance firms in each category, both the long- and short-term markets are dominated by a small number of large companies. In 2009, the most recent year for which the registrars of long- and short-term insurance published company-specific data reports, four long-term insurers accounted for 55.67% of total net premiums in the primary market. On the short-term side, the top four companies claimed a market share of 42.7% THE BIG FOUR (LONG TERM):Long-term insurers play a prominent role in the wider economy as a result of the historical directives and restrictive exchange controls that compelled them to direct cash flows towards the Johannesburg Securities Exchange (JSE) and the nation’s publicly listed banks.

By 1992 Old Mutual, the historically dominant insurer, held a controlling stake in 72 JSE-listed companies, including a 55% stake in Nedbank. The company recently broke into international markets, and landed a listing on the London Stock Exchange (LSE). Old Mutual, which now operates in 33 countries, is a particularly strong domestic performer in the group business segments investment and risk (in which it was ranked first by its peers in a 2010 survey by PwC).

Sanlam was established in 1918 and is headquartered in Belville near Cape Town. In 1998 the company demutualised and was subsequently listed on the JSE and the Namibian Stock Exchange. It maintains a presence in foreign markets like the UK and India. Sanlam has expanded from life insurance into personal financial services such as estate planning, stock broking and asset management, and has gained a reputation for investment products and popular group schemes.

MMI Holdings was formed by a merger between two insurance-based financial services firms in South Africa, Momentum and Metropolitan. MMI thus became the third-largest long-term insurer when it listed on the JSE in 2010. Long-term insurance remains the firm’s engine, and it is noted for its life risk lines. MMI has carved out a reputation for providing well-regarded investment products. As of 2011, the company had established operations in 12 countries outside South Africa.

The Liberty Group was established in 1957 as Liberty Life, and the firm was listed on the JSE in 1962. After two decades of domestic expansion, Liberty Group listed on the LSE in 1981, and in 1991 joined the Standard Bank Group, which retains control today. The bulk of insurance activity is carried out by its South Africa retail division, which remains its largest contributor to earnings. The group has also built a strong institutional and corporate base to which it provides pension, provident, investment and risk solutions.

THE BIG FOUR (SHORT TERM): The country’s larger long-term players have traditionally gained presence in the short-term market through buy-in schemes or by establishing separate companies under a shared brand. For example, Santam, the largest short-term player, is 57% owned by Sanlam. With a nearly century-long market presence, it has a domestic customer base of around 650,000, which is largely serviced through its broker network. It has expanded regionally as well, with operations in other African countries such as Zimbabwe, Malawi, Uganda, Tanzania and Zambia. Santam provides a wide array of insurance services, from marine to agriculture, but is particularly known for its motor and property products.

Mutual and Federal was established in 1831 as the South African Fire and Life Assurance Company. In 2010 it became a wholly owned subsidiary of Old Mutual Group. It entered the direct insurance market through a partnership with Old Mutual Retail Mass Market by launching iWZE valuables insurance. The company provides short-term insurance to personal, commercial and corporate clients, largely via a broker network, in South Africa, Namibia, Botswana and Zimbabwe.

Hollard describes itself as South Africa’s largest privately owned insurance group. Established in 1980, it operates both a long- and short-term insurance company, but it is in the latter segment where it has achieved most success. The company is known for developing the prepaid concept, a method for selling insurance through retailers in a manner similar to the model used for prepaid mobile phones. The firm has operations and investments in Namibia, Botswana, Australia, India, Pakistan, China and the UK.

Formed in 1965 by the merger of three firms, Zurich South Africa is headquartered in Johannesburg and listed on the JSE. Originally a composite company, it shed its life component in 1972 and now transacts all classes of short-term insurance in the domestic market. It also acts as the local arm of Zurich Financial Services, which retains a 58.5% stake in the company.

PERFORMANCE: The global financial crisis of 2008-09 had a deleterious effect on South African insurers. Both the long- and short-term segments faced internal challenges, such as lower investment yields and higher expenses, and external ones, including an increase in lapsed policies as households struggled with rising food prices and unemployment. Having recorded double-digit growth in 2008, net recurring premiums of long-term typical insurers contracted by 3% in 2009, according to the FSB. On the short-term side, net premium growth, which was 16% in 2006 and 9% in 2008, slowed to 5% in 2009. The resulting pressure on profitability, compounded by the problems facing larger insurers with operations in troubled US and European markets, prompted some to limit dividends to preserve cash.

In 2010 the industry began to recover, assisted by the return of a more normal claims profile, and staged a rise that lasted into 2011. Net premiums of typical short-term insurers rose from $3.78bn for the first nine months of 2010 to $4.27bn for the same period in 2011. Short-term cell captive insurers saw a similar gain, while niche insurers and captives showed minor declines. Net recurring premiums for typical long-term insurers rose from $8.53bn for the first nine months of 2010 to reach $9.28bn for the same period in 2011. Cell captive and assistance long-term insurers had similar gains, while long-term niche insurers showed a higher rate of growth, from $53.2m to $117.9m.

MARKET TRENDS: Against the backdrop of the sector’s recovery, several structures and business model developments are emerging. Although market share remains concentrated with a small number of larger players, smaller insurers have been making inroads in both segments. In the short-term market, smaller players such as OUT surance and Auto & General have gained market share by employing direct writing models. These take the form of inbound (where customers respond to a media campaign), outbound (using databases to contact potential customers) and affinities ( establishing relationships with recognised consumer brands that undertake the selling while the insurer provides the execution ability). A 2011 report by ratings agency Fitch showed OUT surance (which uses the inbound model) had increased its market share to 6%, leaving it just 2% short of the fourth-largest insurer in the short-term market, Zurich South Africa.

Technology is playing a part in this trend. “The emerging middle class is happy to purchase insurance online, making brokers less important,” Darryl De Vos, the managing director of African Reinsurance Corporation (South Africa), told OBG. This preference for direct sales over the tradition of conducting business through intermediaries has been mirrored in the long-term segment. KPMG research has shown large players, such as Old Mutual and Liberty, have been ceding market share to smaller insurers since 2006. Their response has been to step into the direct market. In doing so they learned from the short-term players that responded more rapidly to the emergence of new channels.

REGULATION: As the industry adapts to new business practices and increasingly diverse competition, it must also adapt to a rapidly evolving regulatory environment. As with other financial sectors, the insurance industry is cognisant of the implications of the proposed “Twin Peaks” regulatory framework, wherein the South African Reserve Bank will adopt responsibility for prudential regulation and oversight of financial services while the FSB takes on the roles of market conduct supervision and consumer protection. Following the 2011 publication of “A Safer Financial Sector to Serve South Africa Better”, in which the Twin Peaks model is defined, the FSB published a roadmap for implementing a Treating Customers Fairly (TCF) model, largely based on a similar initiative in the UK. TCF represents a regulatory approach to ensure financial institutions demonstrably achieve specific fairness outcomes for financial services customers. It will require South Africa’s insurers to comply at all stages of their customer relationship, from product design to after-sale processes.

Another significant tranche of regulatory reform comes in the form of the new FSB Solvency Assessment and Management (SAM) regime, similar in design to Europe’s Solvency II Directive. SAM will replace the current volume-based and interim simplistic risk-based approach, and is based on three pillars. Under Pillar I insurers and reinsurers will apply their own or an FSB-supplied internal capital model designed to introduce a risk-based philosophy where a more formulaic approach has hitherto prevailed; Pillar II establishes a new risk management and governance regime; and Pillar III sets out reporting and disclosure requirements. The Twin Peaks model, TCF and SAM all have a final implementation date of 2015. Meeting their requirements, particularly SAM’s capital and risk demands, represents a significant industry challenge (see analysis).

FUTURE GROWTH: At 15.3% South Africa has one of the highest insurance penetration levels in the world, according to PwC. The absence of a significant national social security system has underpinned the long-term segment’s fortunes, with individual pension plans and group schemes forming one of the world’s 15 largest retirement fund industries. With the industry efficiently penetrated in the Living Standard Measure (LSM) 10, the country’s most affluent population segment, tapping into the less affluent segment has become an objective. “LSM 7 and below is where it’s at – people who aren’t presently saving and have low incomes.” Rudolf F Schmidt, the group CEO of Assupol told OBG. “We have a model that serves them. Everyone is trying to get into this segment, and there is a huge opportunity.” A microinsurance policy document released in 2011 and the prospect of a dedicated licence with less onerous regulatory requirements have both increased the level of interest in lower LSM bands.

EXPANSION: Insurers are also looking north for growth opportunities. Expanding sub-Saharan economies have already attracted domestic insurers, with MMI Holdings maintaining the largest regional operation.

Partnering with local banks offers a straightforward route into other African and foreign markets. To this end MMI has joined forces with the UBA Group, Nigeria’s third-largest bank. Similarly, Liberty Life is using its parent, Standard Bank, which is present in 17 African countries, as means to expand its footprint on the continent. Sanlam, already active in six African markets, formed a new life insurance company in Nigeria in partnership with First Bank, the country’s largest lender. As with the domestic market, microinsurance in the sub-Saharan region has significant potential and has been exploited with some success by Germany’s Allianz.

OUTLOOK: In the short term, South African insurers face the challenge of achieving top-line growth in a tumultuous economic environment while adjusting their business strategies to a host of regulatory changes. These new measures, due for implementation in 2015, bring an added level of urgency to effectively adapt to the new regulatory conditions.

Competition for new business is expected to grow in both the short and medium terms. Although global insurers responding to a PwC industry survey identified large domestic players as their most significant competition, the challenging conditions European insurers, such as Lloyds, Zurich and Allianz, are facing in their home markets could lead them to concentrate more resources on frontier and developing markets in Africa. The recent creation of a strategic risk forum by SAIA has brought into focus the long-term, systemic risks the industry faces. The forum discusses a range of concerns that fall into three broad categories: governance issues, particularly institutional capacity for implementing new legislation; environmental concerns, such as a deteriorating infrastructure, a changing ecosystem and inadequate urban planning; and social/political issues, which refer in part to the nation’s transformational agenda by which it seeks to address apartheid’s legacy.

Also in the long term is the development of a South African microinsurance industry. This segment will draw the formalised sector into the territory of traditional burial schemes and stokvels (savings clubs) that make up a considerable informal sector. The possibility of introducing insurance products into this segment, along with the extent to which the government will bring it within the regulatory sphere, will be a major industry theme going forward. Whether through the extension of microinsurance or by other means (such as a proposal suggesting that communities create an insurance pool for which domestic insurers could then effectively act as reinsurers) is not yet clear. Finally, the proposed introduction of a comprehensive social security system, which will exact compulsory contributions from all South African wage earners for the purpose of establishing a state-managed death, disability and retirement benefits, has the potential to radically transform the present insurance landscape (see analysis).