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GeneralShort-term

The South African short term insurance industry

In the wake of the economic downturn in 2008, the South African economy (and, ultimately, the domestic short-term insurance industry) experienced subdued growth between 2H 2008 and 1H 2009, with little inherent economic impetus provided during this period. In response, the South African government introduced a number of fiscal and monetary initiatives, with the most notable being the lowering of the repo rate, which reflected a cumulative 650 basis points decrease between June 2008 and November 2010. However, given the lagged impact, GDP still contracted by 1,8% in 2009. The resultant pressure on disposal income and business earnings impacted adversely on industry premium levels, with gross premium growth for the industry registering at only 6%, which remained below the 6,3% consumer price inflation (‘CPI’) reported for December 2009. As economic stimulus packages manifested more strongly globally, the domestic economy recovered in 2010, registering GDP growth of 2,8%. This, in turn, underpinned short term insurance premium income, which is estimated to have grown by 9% to R65.4bn in 2010, against CPI of 4% for the year. Together with a relatively favourable claims environment, the industry rebounded strongly, thus continuing the turnaround that began in 2009.

Similarly to prior years, the industry continued to evidence a shift towards the 2nd and 3rd tier of the market, with the collective market share of the four largest insurers (Santam, Mutual & Federal, Zurich and Hollard) reducing to 49% of industry GWP in 2009, down from 51% in 2008. This can largely be ascribed to stronger competition from direct insurers, which, given their business model, were able to better capitalise on the greater price sensitivity associated with the challenging economic environment. However, as economic conditions continue to improve (particularly, in the corporate segment), the top tier players are likely to regain some lost market share, given their entrenched distribution channels and extensive underwriting capacity. Nevertheless, direct insurers are expected to continue to compete aggressively in the personal lines and smaller commercial segment.

From a class perspective, the property and motor classes remained the largest sources of GWP in 2009, accounting for a combined 77% (2008: 76%). In contrast to initial predictions, however, motor business proved to be a key growth driver, evidencing GWP growth of 10% for 2009, driven by a hardening in rates and improved vehicle sales. Property premium growth, on the other hand, remained relatively subdued at 5%, reflective of the depressed housing market and tighter mortgage lending criteria. As the economic recovery remained tentative in 2010, premium growth is assumed to be driven by traditional product offerings (including motor and property), whilst specialist business remained relatively subdued, thus limiting business diversification efforts.

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2010 figures are GCR estimates.

Given the relatively stable market risk profile, net premiums developed in line with overall market growth, increasing by 6% to R45,1bn in 2009 to translate to an unchanged reinsurance premium to GWP ratio for the industry of 25%. As such, industry risk premiums remained dominated by motor and property, accounting for 47% and 31% of NWP in 2009 respectively. As little changes to the business mix are expected to have transpired in 2010, net premium growth for the year is anticipated to largely track the forecast top line growth of 9%, with the reinsurance premium to GWP ratio coming in marginally above 25%. Given the remaining uncertainty surrounding the current economic recovery and the relatively limited volume of new or unexploited risks, it remains unlikely that insurers will significantly adjust their reinsurance approach in the short term. Furthermore, despite the large losses incurred in early 2011, relative reinsurance rate stability is expected in the medium term, as international reinsurers compete for market share in the domestic market and defer rate increases.

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2010 figures are GCR estimates.

Following a continuous deterioration in loss experience over the past three years, the industry earned loss ratio stabilised in 2009, to equate to an unchanged 66%. This was largely attributed to an improved claims experience in motor (traditionally, the single largest contributor in terms of total market claims value), which offset the adverse impact of substantial fire and accident losses in 1H 2009. Given the absence of sizeable property claims during the year, as well as reasonably well contained motor losses, the industry earned loss ratio for 2010 is expected to have registered at a notably improved 62%. A significant driver of the latter was the relative strength of the Rand against other major foreign currencies and the generally low inflationary environment, which helped to alleviate pressure on overall motor claims costs. However, given the prevalence of systemic challenges in motor (including inadequate road infrastructure, poor driving standards and the absence of mandatory third party insurance cover) and the atypically low incidences of fire claims during the year, it remains to be seen if this level can be maintained in the medium term. As such, going forward GCR expects the earned loss ratio to rise, with the extent of the increase dependant on the incidence of weather-related and industrial claims and the industry’s ability to establish effective and sustainable corrective measures pertaining to the motor business.

graph3-10361

2010 figures are GCR estimates.

Due to a reduction in broker commission payments (resulting from the increasing prominence of direct insurance transactions and the stronger utilisation of affinity channels), the net commission ratio for the industry decreased to 11,5% in 2009 (2008: 12,3%). Together with the ongoing commitment by most insurers to further reduce operating costs, this saw the industry delivery cost ratio decrease to 28% in 2009, from 29% previously. Whilst it is likely that the abovementioned trend has persisted in 2010 (with the commission ratio decreasing to 11%), operating costs are believed to have risen considerably over the past 12 months, translating into at least a one percentage point increase in the management expense ratio to 18%. This is largely driven by greater discretionary spending in light of the economic recovery (particularly performance related incentives and bonuses), as well as additional costs incurred in relation to the compliance with future regulatory requirements. Overall, the delivery cost ratio is anticipated to have risen to around 30% in 2010, a level which is likely to be maintained in the medium term.

Overall, supported by the containment of delivery costs and a relatively stable claims environment, the industry reported an underwriting profit of R2,9bn in 2009, which translated into an improved underwriting margin of 6,4% (2008: 5,8%). On the back of the favourable loss experience and notwithstanding greater cost pressures, the underwriting margin in 2010 is expected to have strengthened further to 8%, a level last achieved in 2005. Whilst the industry is expected to remain profitable going forward, a slight decline against the 2010 underwriting margin is expected in the medium term.

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2010 figures are GCR estimates.

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2010 figures are GCR estimates.

A key aspect in ensuring the risk appropriate capitalisation of the insurance sector is the proposed introduction of the new capital management model, the Solvency Assessment and Management (‘SAM’) framework, which will replace the current Percentage of NWP statutory solvency regime. An integral part of this framework (which is scheduled to be implemented by 2014) forms the employment of a well-defined risk based capital model, which is to be adopted in standardised form from the FSB, although the option of utilising an internally developed model also exists, provided that the model complies with regulatory requirements. With the inclusion of other guidelines (pertaining amongst others to risk management & governance aspects), the framework is expected to contribute to a sustainable insurance industry that has the ability to withstand an adverse environment, whilst meeting policyholder obligations. However, given the added resources and costs involved in ensuring compliance with SAM, the implementation could result in some consolidation in the industry.

Reflective of the impact of slightly higher retained earnings, the international solvency margin improved marginally to 49% in 2009, whilst the statutory solvency ratio remained unchanged at 38%. The financial base ratio (including technical reserves) also remained flat at 96% in 2009. In 2010, the international and statutory solvency margins are believed to have strengthened further (to 53% and 40% respectively), as insurers bolster capital reserves in preparation of the risk based capital regime. On the back of this, the financial base ratio for 2010 is expected to have increased slightly to 97%.

graph7-10361

2010 figures are GCR estimates.

With the timing of the economic recovery uncertain, traditional business lines will continue to drive industry growth in the short to medium term. This paired with the expected entrance of new, well-capitalised market players is likely to drive competition and place pressure on premium rates. Underwriting pressure will further be compounded by rising operating costs, as well as an expected normalisation in claim patterns, with the atypically low loss experience of 2010 unlikely to be sustained. As such, whilst the industry is likely to remain reasonably profitable in the medium term, the underwriting margin is expected to soften from 2010.

Positively viewed is the proposed introduction of the SAM framework, which is likely to result in more effective risk management processes and an overall greater level of financial stability. In turn, however, this comes at the cost of added capital pressure and capacity constraints, particularly for smaller and less diversified players, and may result in some premium migration to better capitalised insurers.

For further information, please contact the insurance division at GCR on 011 784 1771







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