There is no doubt that the local insurance industry is going to be shaken up over the next ten years and that by 2021, the South African insurance industry will look very different to what it does today. There are currently about 120 short-term insurance licences in South Africa, and more than 80% of the gross written premium can be attributed to the 10 largest insurers. It comes as no surprise then, that, in the very near future, many smaller insurers (depending on who you talk to, this figure ranges between 17% to 25% of the market), will be questioning their viability in an increasingly onerous – both from a compliance and capital point of view – environment.
No doubt the single biggest challenge today to the sustainability of small insurers (that is, those with income of less than R500 million per annum) is sharply rising fixed operating costs. These can be attributed largely to enhanced compliance, governance and enterprise wide risk management (EWRM) requirements emanating from different legislation and regulators. The most commonly debated issue currently is the Financial Services Board’s (FSB) proposed new capital regime, Solvency Asset Management (SAM).
On the one hand, the growth of small insurers will always inherently be limited by their licence restrictions; and, on the other, many will find it difficult, if not impossible to attract new investment, if they unable to generate the required return on capital.
One needs to take stock of the full cost of compliance, including the resources to complete quarterly and annual submissions to the FSB, external auditors, non-executive directors’ remuneration, and audit and risk committees. Small insurers that tally up these costs might find their fixed regulatory cost somewhere between R3 million to R5 million a year. While profit margins obviously differ between classes of business, the industry average short-term insurer profit margin is between 5%-6% of premium. Comparing the fixed regulatory cost with the profit margin should give an indication as to where the ‘breaking point’, that is, the point below which the regulatory cost cannot be sustained by the premium volumes the business is producing.
And it’s not just financial challenges that are impeding the prospects of small players. Competing for skills in a market that’s characterised by a chronic shortage of skills is difficult, even for the bigger players who are often able to offer employees more, either financially or from a career growth point of view. Then there’s the fact that executives, forced to deal with compliance, governance and EWRM issues have less time to focus on the front end of the business, which puts further pressure on the bottom line.
One option for smaller insurers is to increase their reinsurance, but this only addresses the capital requirements side of the equation without lessening the cost of compliance.
Having to absorb the fixed cost of compliance and knowing their margins in pricing, smaller insurers – especially those writing lots of guarantee business and/or engineering business that has a longer tail liability profile – will be asking themselves whether a stand-alone licence is worth their while in the long term.
So, whichever way you look at it, evolution will happen for the South African insurance industry over the next decade. Pricing will become more scientific and it is possible that mergers and acquisitions will be the solution that many smaller players seek to save their businesses. Others may apply to the Financial Services (FSB) for dispensation, but there are significant costs associated with that option too.
The alternative risk transfer market may also provide a solution, allowing smaller insurers to retain their niche profile; effectively comply with arduous governance requirements; operate on a capital requirement reflective of the size of and inherent risk in their business; and serve their customers, which is, after all, the main reason for their business’ existence.