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 KAZAKHSTAN International Business Magazine №4, 2009
 Insurance Market: Sight from Outside
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Insurance Market: Sight from Outside

The special report of Standard & Poor’s

After a decade of almost uninterrupted economic growth of about 10% annually, the Republic of Kazakhstan (foreign currency BBB-/Stable/A-3; local currency BBB/Stable/A-3) is today suffering the combined effects of protracted weakness in its banking sector since 2007, and a subsequent fall in world prices for many of its key commodity exports. These exports comprise oil and gas, but also substantial amounts of ferrous and nonferrous metals, chemicals, grain, wool, meat, and coal. Economic growth fell to a little over 3% in 2008, and Standard & Poor's Ratings Services now believes the Kazakh economy is likely to contract by 3% in 2009. The local currency, the Kazakhstani tenge (KZT), was devalued by 30% in February 2009, and we anticipate the current economic contraction to be accompanied by relatively high inflation, now approaching 8.5% for January-June 2009, and growing unemployment, which stood at 6.9% as of end-march 2009.

Kazakh Insurance Sector: Strengths, Weaknesses, Opportunities, And Threats

The local insurance sector has not proven immune to the state of the wider, macroeconomic situation, and, having grown substantially during the "good" years, has contracted by 10% in 2008 in gross premium terms, and has further declined by 30% in the five months to May 31, 2009, relative to the same period last year (see table 2).

Prospectively, we believe economic growth in Kazakhstan will resume as world commodity prices rise. We also think the eventual economic recovery will likely result in increased levels of insurable activity. This will probably create long-term opportunities for the dozen or so insurers with a long-term commitment to the local insurance sector that can be identified among the 45 companies currently established in Kazakhstan.

We expect that possibilities will also reopen for any new entrant to the sector that can bring a combination of expertise, professionalism, and new products, in addition to a reasonable capacity to underwrite risk. Foreign entrants already include Allianz SE (which acquired ATF Insurance in 2007), and an AIG joint venture that is 40% controlled by local Kazakh interests.

Nevertheless, in our opinion, the Kazakh insurance sector is still immature to the extent that probably three-quarters of the country's insurers lack a professional, long-term commitment to the national insurance sector. This is reflected in the significant concentration of total premiums with the country's leading insurers (see table 2).

We also see that many Kazakh insurers are eager to exploit legal or accounting devices to generate short-term gains, even when these are bought at the expense of the sector's long-term credibility and reputation. We observe an increasing tendency for a surprising number of local insurers to resort to the courts before accepting to pay what, from the outside, appear to be large but legitimate claims. Current earnings can also be temporarily bolstered by an unwillingness to recognize the likely full cost of outstanding but as yet unpaid claims, or the true level of incurred but not yet reported liabilities. We therefore consider that many of the country's licensed insurers are looking merely to gain the cash flows inherent in insurance in order to make a profit by investing them, or else they exist for little more than to act as a tax-sheltering mechanism for their corporate owners.

The tax-sheltering role of insurance is significant in Kazakhstan. In effect, we understand that large Kazakh corporations and groups avoid the 20% (30% before Jan. 1, 2009) tax on corporate profits by paying an amount of insurance premium that can often appear disproportionately large to an in-house captive insurer, where the artificially inflated underwriting revenues are then taxed at the special flat rate for insurers of 4% of gross premium income.

The fragile nature of the Kazakh economy in the years immediately following independence in 1991 may have meant that such mutually supportive group structures were a desirable buttress to the development of the country's commercial and financial services sectors. However, what may have been advantageous to the creation of a thriving insurance sector in the country's early years is almost certainly less so today, in our view. The distorting effects of the tax regime are widespread and, we believe, have served to undermine the creation of an open insurance market, particularly in the country's most profitable commercial and industrial line sectors. Irrespective of service quality or technical competency, we see that the desire to minimize taxation has caused the majority of the Kazakh corporate sector's insurance spending to be directed toward related, captive insurers.

While on the one hand creating a barrier to new entrants, this over-reliance on captive business has on the other hand encouraged insurers to become complacent over time, and often slow to adapt to the developing needs of the marketplace, in our opinion. Meanwhile, company staff will often direct their own personal insurance requirements, particularly the compulsory motor liability, to their employer's captive insurer, thereby turning what could have been dynamic retail and corporate insurance marketplaces into a series of blocks of business that are largely dominated by a related insurance company, with very little turnover of clientele between competing insurers from one year to the next. Standard & Poor's therefore considers that the intention of the authorities, stated in the new tax code of December 2008, to do away with the currently distorting fiscal environment for insurers by 2015 is a positive step toward the development of more genuine insurance marketplaces.

Nevertheless, Kazakh insurance, like all markets has its strengths as well as weaknesses, and opportunities as well as threats. A traditional SWOT analysis (Strengths; Weaknesses; Opportunities; Threats) follows.

Strengths:

The principal strength of the Kazakh insurance market is, in our view, the likely burgeoning level of insurable activity once the economy resumes its expansion after the current downturn. Moreover, the premium available to those insurers with a long-term commitment to the sector will prospectively grow even further as currently captive commercial business gradually becomes available to the whole sector as the fiscal incentives for using captive insurers diminish ahead of 2015. This overall expansion in insurable activity appears set to continue into the long term as the country's mineral wealth is better exploited and exported further afield.

A second strength in our opinion is the quality of regulation. Insurance supervision in Kazakhstan is managed in, we consider, an efficient way by the insurance arm of the Agency of the Republic of Kazakhstan on Regulation and Supervision of Financial Markets and Financial Organizations, commonly referred to as the "AFN" from its Russian-language initials. We think the AFN's track record to-date has been strong, having established a relatively clear, predictable, and functioning framework for a domestic insurance sector in a country that is almost as young in administrative terms as the local insurance sector itself.

Moreover, in our observations, the regulators have been reasonably interventionist, and have not hesitated to suspend or withdraw the operating licenses of those insurers, large and small, that have infringed upon regulations or whose capitalization has fallen below prudent levels. They have also been pro-active in introducing compulsory insurance for many aspects of motor and professional liability (see chart 1 below), while simultaneously working to promote a supportive infrastructure for insurance. In 2009, for example, initiatives have included guidelines for co-insurance, for the certification of insurance agents, as well as moves to create a local "Institute of Actuaries," and encouraging more local people to enter the actuarial profession.

Meanwhile, Kazakh insurers have tended not to be directly affected by the problems that have beset the Kazakh banking sector. Insurers are more typically generators rather than users of liquidity. To us, the banks have proven over-reliant on foreign currency funding, on scarce local liquidity, and vulnerable to still-growing levels of bad and doubtful debts. However, many insurers have suffered reduced financial flexibility (the ability to raise additional cash or capital relative to possible needs) to the extent that many, indeed most of them, are part of a larger financial or industrial group that also includes a bank. Furthermore, some groups and their owners have been hit not only by banking losses but also on the commercial side by the downturn in commodity prices and trading volumes. Together, these current problems have sometimes significantly reduced the amount of surplus financial resources available to groups and their owners. This has been detrimental, in our opinion, to the financial strength of those insurers that are controlled by local oligarchs and conglomerates.

Today, at least, it may perhaps appear fortunate that the captive nature of much of the market does act as something of a barrier to entry by larger, more aggressive international and global insurance groups. If the best business in the market is captive to local incumbents – notably the commercial and industrial insurance requirements of the large commodity, aviation, space, and transport groups – then foreign providers cannot realistically hope to win this business during the few remaining years that the current tax regime remains in force, we think. At present, it would seem that most outsiders can only hope to gain access to this business indirectly by providing reinsurance protection.

Weaknesses:

With a surface area of 2.7 million square kilometers and a very thinly spread population of just 15.5 million as of year-end 2008, any insurer attempting to set up a truly nationwide network of branches or agencies will face significant logistical problems, in our opinion. However, the preponderance of captive underwriting has meant that few insurers have principally targeted the retail market, most preferring to specialize in the corporate risks of their immediate parents, while perhaps opportunistically writing some retail business in the main population centers in which they are based. However, we think that because many of the commercial and industrial risks are large and the insurers themselves are relatively small, a disproportionate amount of the actual risk carrying is ceded to foreign reinsurers, as is indicated by the difference between the country's gross and net premiums, notably KZT62 billion relative to KZT35 billion, a retention ratio of 56% for the first five months of 2009 (see table 4).

A further weakness we see is the relatively low GDP per capita at about $8,000 and, consequently, a very low level of expenditure by individuals, with on average only about $60 per person spent on insurance premiums.

Similarly, we consider as an additional weakness of the sector a certain lack of diversification across the sector by line of business. We see reasonable diversity across the retail, commercial, and industrial non-life lines that most local insurers write. However, there is only limited demand for the long-term lines of life protection, life savings, and pensions that constitute much of the premium volume of so many insurance groups elsewhere in the world (see table 5 for a breakdown of premiums by line of business).

We believe that because of the relative lack of diversity in the business available, prudent insurers have had to resort to the substantial use of foreign outward reinsurance to help ensure the stability of their earnings. We regard the dependence on external reinsurance capacity to some extent as a sector weakness, although the inward reinsurance revenues may bring diversification if written professionally.

Aware of these issues, the regulators have recently introduced new legislation whereby the long-term disability benefit that insurers pay in the event of an industrial or motor liability claim must now be paid as an annuity by a life insurance company. As we understand it, this means that the non-life insurer that has provided liability cover must, in effect, pay any successful indemnity claim by means of a lump sum cash payment to a life company, and the life company will then in turn set up and manage the regular annuity payments that have to be paid to the insured. It is possible that these new regulations will act as a stimulus to the development of the life assurance sector over time.

However, we think the final problem still remains – whether for life or non-life companies – of finding suitable investment assets in which to invest cash-flow and the funds covering the technical and shareholders' funds. Many companies opt for local equities, which are few in number and which display highly volatile valuations given the lack of depth in the local equity markets. Alternatively, insurers place their funds with banks, which then brings into play the considerable credit risks associated with some of the banks whose very weakness obliges them to offer the most attractive deposit rates.

Opportunities:

Although Kazakhstan has been severely affected by the recent global economic downturn, its financial center, Almaty (as opposed to the new capital, Astana), remains a clear leader in terms of insurance activity, in our opinion. The gross premiums written split by region demonstrates this gap (see chart 2). In our view, Almaty is in a better position than most regional rivals to become the de facto hub of Central Asian insurance, reinsurance, trade, and finance, as it connects the Russian, Turkic, and, to some extent, the Korean and Chinese-speaking worlds. At the same time, we expect Kazakhstan – and Almaty within it – can contribute the volume of its own large and prospectively dynamic economic activities to give substance and depth to its capital markets.

We consider Almaty-based insurers and reinsurers to be able to create a regional (re)insurance center in Kazakhstan, even if we would consider it unreasonable to expect them to take more than a minority share of the region's overall (re)insurance requirements. In our observations, insurable risks in Kazakhstan, including commodity-based industrial risks, exposure to severe and catastrophic losses through extremes of temperature, or earthquakes are often too large for domestic insurers to take on at this point and risk premiums are often ceded to international reinsurers.

The opportunity is also seen to retain more risk premium within Kazakhstan by having Kazakh insurers set aside their mutual rivalries and distrust and try to develop a more active market for co-insurance. The AFN has this year introduced new regulations to facilitate the development of co-insurance. Additionally, we think the larger, better-managed Kazakh insurers could also develop the capacity to write local inward reinsurance, following the example of the market leader, Eurasia Insurance Co. (BB-/Stable/–; Kazakhstan national scale rating 'kzA-'), which is already extremely active on the local, regional, and Commonwealth of Independent States (CIS) reinsurance scenes.

Finally, insurers generally have the potential to strengthen their balance sheet in order to increase their own capacity for risk retention, enabling them to keep more of the good, profitable business that is available in Kazakhstan (see table 6). We believe that all of these initiatives, whether singly or jointly considered, have the potential to reinforce the long-term development and profitability of the Kazakh insurance sector.

Threats:

One of the most immediate threats for Kazakh insurers, in our view, is the deteriorating financial strength of significant elements of the local banking sector. As Kazakh insurers often invest in the equity of local banks in addition to holding their often sizable cash deposits with them, we see them as particularly exposed to the market and credits risks associated with the banks. This is further exacerbated at those insurers who also invest in the banks' bond issues. Consequently, we expect the insurers' actual level of credit exposure to the banking sector to be almost certainly significantly higher than the 39% shown in chart 3.

In our view, Kazakh banks are continuing to experience high credit and liquidity risks in deteriorating domestic macroeconomic environments, as they endure the impact of the weakening of the international economy, global banking sector stress, and a sharp squeeze on access to external liquidity. Moreover, we see few current indications of banking sector recovery in Kazakhstan and we believe that the resolution of the sectors' problems will be lengthy.

We consider the threats to the Kazakh insurance sector to be similar to those in other developing markets of the world. Following in the footsteps of AIG and Allianz, other major international (re)insurers will likely seek to incorporate locally. Once the tax distortions discussed above have been removed, these big players will probably target the larger, more attractive "big ticket" covers required by the country's energy and minerals sectors. Arguably, however, this "threat" is merely one of a genuine, competitive marketplace being created in Kazakhstan, which should ultimately be to the benefit of both efficient insurers and cost-conscious, risk-aware insureds.

Meanwhile, we expect the existing threat of opaque group accounting to also diminish with the removal of the current tax distortions. The absence of these distortions will likely allow the introduction of more economically based underwriting that will likely help make the published accounts a better guide to the real value-added nature of an insurer's activities. Also, the removal of the fiscal distortions should, we believe, also encourage the large corporate groups to relax their current 100% ownership of their insurance subsidiaries, and to allow a more widely spread shareholder base. Generally, these prospective new shareholders, albeit from the likely position of minority interests, would probably demand greater transparency of the companies in which they have invested.

The Kazakh government itself is not expected to become directly involved in the fortunes of its local insurers, although its agents, the AFN, will likely continue to maintain close supervision both of industry trends and of the individual insurance companies themselves. Indirectly, however, we anticipate the authorities will have a significant influence on the sector, most significantly by the nature and timing of its reforms to the tax regime, but also by the degree of support that it gives to the local economy generally, which will impact insurers through their investment activities. We see that the government's ability to control interest and exchange rates has affected local banks. We consider this intervention to be less of an issue for insurers as they tend not to use debt finance.

Long-term insurance prospects in Kazakhstan remain good, based on positive economic fundamentals

In our view, the Kazakhstan insurance sector in the summer of 2009 remains one of possibilities, but also of some serious current contradictions. We think that strengths such as prospectively growing levels of insurable activity as well as effective regulation are likely to reinforce the position of the insurance sector in the country. However, we also see weaknesses in the form of much of the country's total premiums being, in effect, captive to a number of industrial-banking-insurance conglomerates. This is increasingly hindering the development of a truly open, competitive marketplace, and has led to a lack of maturity in the sector, in our observations. Many smaller providers allow themselves to become reliant on privileged access to shareholder-related business.

Life assurance remains a very small element of total market premiums, taking only 1% of gross premiums written at present. We expect the local population will have to become much more insurance aware, and the state less welfare orientated before retail customers see the need for voluntary life assurance and related protection products, including health covers. However, most banks already require mortgage and other large loans to be covered by a borrower's term life cover, notably a policy that will pay off the loan in the event of the borrower dying before it has been fully repaid. Meanwhile, we think it is too soon to tell whether the recent requirement that long-term liability payments be paid out as an annuity by a life company will be enough in itself to galvanize the fortunes of the life sector. The history of liability cover remains a checkered one in Kazakhstan, with some employers in the past having themselves pocketed the insurance payouts without passing on the benefit to the injured employee. Similarly, we observed that it was a frequent occurrence for no claim to be submitted either by the injured employee or by the employer, as liability cover remains such an alien concept for those who grew up under the old regime. We understand this mentality also applies to health insurance, and many other forms of cover and protection, where insureds simply do not bother to make even legitimate claims.

Nevertheless, in our opinion, driven by powerful and positive long-term macroeconomic factors, the prospects for a vibrant insurance and reinsurance sector in Kazakhstan appear reasonably bright for the best of the country's existing insurers, notably those that have the technical expertise as well as the management capability to keep pace with what promises to be an increasingly competitive, increasingly transparent marketplace. The medium-term prospects for many of the less good, less efficient, and less committed among today's insurance institutions inevitably seem considerably less attractive, and we expect most will likely close to new business over the medium term.

Copyright © 2009, Standard & Poors, a division of The McGraw-Hill Companies, Inc. (S&P).

 


Table of contents
Caspian Gas: One for All?   Sergei Smirnov 
Insurance Market: Sight from Outside  The special report of Standard & Poor’s 
Macroeconomy. September 2009  Sergey Kasyanenko, Edilberto L. Segura 
· 2016 №1  №2  №3  №4  №5
· 2015 №1  №2  №3  №4  №5  №6
· 2014 №1  №2  №3  №4  №5  №6
· 2013 №1  №2  №3  №4  №5  №6
· 2012 №1  №2  №3  №4  №5  №6
· 2011 №1  №2  №3  №4  №5  №6
· 2010 №1  №2  №3  №4  №5/6
· 2009 №1  №2  №3  №4  №5  №6
· 2008 №1  №2  №3  №4  №5/6
· 2007 №1  №2  №3  №4
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· 2005 №1  №2  №3  №4
· 2004 №1  №2  №3  №4
· 2003 №1  №2  №3  №4
· 2002 №1  №2  №3  №4
· 2001 №1/2  №3/4  №5/6
· 2000 №1  №2  №3





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