Where the growth is

Emerging markets provide risk and reward for the industry

BRIC picEmerging market growth has been the economic headline of the last decade and particularly apparent as the developed world has wallowed in the recessionary mire of recent years. While China recorded double-digit GDP growth from 2005 to 2010 and near double-digit growth in subsequent years, growth in Europe and the US has been in low single or, at times, negative figures. According to the IMF, developed world growth rates are predicted to pick up in 2014 to 2.2%, compared to 1.3% last year, but they still fall far short of emerging economies, where growth this year is expected to be 6%, and particularly strong in developing Asia (7.1%) and sub-Saharan Africa (5.8%).

While the asset management industry has capitalised on this growth, insurance penetration remains woefully low and this means there is a potentially huge market yet to be tapped. Insurance penetration in emerging markets was 2.7% in 2012, according to Swiss Re, compared to 8.6% in developed markets. In addition, there is no insurance linked securities penetration in emerging markets, with the vast majority - 70% - focused on the US property catastrophe market.

The narrow focus of insurance linked securities is largely driven by its newness and rapid expansion in traditional developed markets, which has meant there has been little need to look elsewhere. But according to a recent report by PricewaterhouseCoopers (PwC) called ‘Reinsurance 2020: Breaking the mould’, this picture must change if the industry is to continue expanding at its present rate over the next five to six years.

According to the report published in September 2013, the focus of reinsurance should shift towards the emerging markets of South America, Asia, Africa and the Middle East. This is where there is huge potential for growth both because these regions are expanding economically and because they are severely underpenetrated by the insurance industry. But there are challenges to doing business in emerging markets, including how to gain access and how to price insurance linked securities given that reliable data is usually lacking.

According to PwC, the first of these issues – access – is becoming easier because, “as the insured values in these markets continue to rise, state-owned reinsurers and the governments that ultimately underwrite the losses may be readier to spread some of the currently locked-in exposures to private reinsurers. So, differentiation becomes a key issue.”

The impact of typhoon Haiyan - which caused between $6.5 billion and $14.5 billion in economic damage to the Philippines, equalling up to 5.5% of the country’s GDP – also affected how emerging economies view insurance and reinsurance. This is according to Aaron Koch, a consulting actuary at Milliman, an international actuarial and financial consulting firm.

Haiyan served as a wake-up call to governments and companies in emerging markets that new strategies are needed to cover major catastrophes, he says. “Thus, while Haiyan was not a major insurance event, its effects should drive continued interest in sovereign catastrophe risk transfer product - increasing the odds that today’s emerging economies will be able to rely on global insurance markets to help fund future Haiyans.”

International development banks have “championed the potential for emerging economies of solutions based on insurance-linked securities”, he adds, and a number of countries, including Taiwan and the Philippines, have expressed interest in sovereign cat bond transactions.

The second issue, that of poor data, was highlighted by the unexpectedly high reinsurance losses from the 2011 floods in Thailand and the Chilean earthquake in 2010. This demonstrated the dangers reinsurers could face in emerging markets if they enter the market with deficient data. The only way to tackle this issue, according to the PwC report, is to “take determined and proactive steps to build up the necessary data and modelling capabilities on the ground.”

If the issues of access and data are tackled then there is a vast potential in emerging markets. But there are risks too, warns the PwC report. Companies in emerging economies could make aggressive moves into developed markets, “either using rates or trading political clout and access to their markets for business from established clients in developed markets,” it says.

The result could be that some of the strongest competitors to established companies may not come from traditional rivals, but rather from new entrants or new ways of doing business that haven’t been accounted for.

Posted: Monday, January 20th, 2014