Philippines’ Non-Life Sector: Meeting the Capital Challenge
THE PHILIPPINE NON-LIFE INSURANCE SECTOR IS GOING THROUGH A TRANSITION AS IT SCALES UP TO MEET HIGHER CAPITAL REQUIREMENTS UNDER A NEW REGULATORY CODE. CHALLENGING MARKET CONDITIONS, WITH LITTLE DRIVING MOMENTUM IN THE INDUSTRY, HAS LEFT MANY INSURERS FEE
Agradual increase in capital requirements should help to reduce inefficiencies and enhance profitability, given the existing poor economies of scale and high operating costs. Moreover, A.M. Best expects capital enhancements should strengthen the ability of companies to retain more business and improve profitability. Consequently, this could enhance the industry’s profile, making it more attractive to investment, external capital and new participants. Historically, regulatory change and reform has been slow in the Philippines. The industry has still not seen vibrant merger and acquisition activity. Given current
The recent hike in capital requirements has led to industry consolidation. As a result, the number of non-life insurers is shrinking.
conditions, A.M. Best believes an abrupt change in the insurance landscape is still a way off. The non-life sector has generated stable underwriting results despite the country’s high exposure to natural catastrophes. Low insurance penetration in the Philippines, combined with low risk retention by insurance companies, has contributed to steady business performance for most non-life players. Nevertheless, most companies have low capital bases with less capacity to write substantial business and improve profits. Philippines’ non-life market space is crowded, with a large number of small to medium-sized companies offering similar personal line products. In addition, non-life companies have relatively high expense ratios compared to their peers in the Association of Southeast Asian Nations (ASEAN). Going forward, A.M. Best believes the industry would be better served by moving towards a leaner market with more efficient operation. The non-life sector has posted sluggish growth over the past few years. Despite last November’s devastating damage from Typhoon Haiyan in Philippine’s central provinces, particularly hard-hit Leyte province, low insurance penetration in the region prevented a large impact on the industry’s bottom line. However, the event prompted government and industry action for a national, natural catastrophe insurance scheme. The country’s demographic structure, with a high rural and low income population, highlights the potential for microinsurance, which is ripe for further growth. Among ASEAN countries, the Philippines has taken a lead in developing microinsurance products.
CAPITAL STRESS BUILDS
The insurance industry is confronting regulatory change with the major challenge of stronger capital requirements under the amended Insurance Code, which was passed into law in August 2013. The new capital requirements focus on the level of net worth instead of paid-up capital. The components of net worth are broader, including paid-up capital, retained earnings, unimpaired surplus and revaluation of assets approved by the insurance commissioner.
The requirement for minimum net worth is 250 million Philippine pesos (PHP) (USD 5.5 million) by June 2013; PHP 550 million by 2016; PHP 900 million pesos by 2019, and PHP 1.3 billion by 2022. New entry insurer needs to have PHP 1 billion in paid-up capital. Nineteen out of 80 non-life companies had a net worth lower than PHP 250 million in 2012, according to the Philippines Insurance Commission (IC). In 2011, 35 out of 84 non-life insurers had a net worth lower than PHP 250 million. The recent hike in capital requirements has led to industry consolidation. As a result, the number of non-life insurers is shrinking. For example, three non-life companies, Philippines Phoenix Insurance & Surety Corp., Summit Guaranty Insurance Co. Inc. and CAP Gen Insurance Corp., were not issued licenses for failing to meet capital requirements last year, according to the IC. In addition, two non-life insurers were merged into other companies: Utility Assurance Corp. was absorbed by Stronghold Insurance Co. in September 2012; and Manila Insurance Co. was absorbed by Premier Insurance & Surety Corp. Capitalization has been a major issue for most non-life companies. Small to medium-sized players in the non-life industry, in particular, are finding it difficult to comply with increased capital requirements. Lack of resources, the inability of stockholders to raise funds, and too few investors to inject capital are among the difficulties facing insurance companies, according to the IC. Also, there has not been much interest in buying into insurance business in the Philippines in recent years. For instance, Starr International has been the only company to launch a branch in the country over the past few years. Regulatory changes are aimed at making the insurance sector more competitive for the upcoming free trade agreement in the creation of an ASEAN Economic Community (AEC) in 2015. According to the IC, “the competition to sell insurance products would be greater as an even playing field will be established.” With increasing capital requirements, the regulator believes that mergers and consolidations will result in the pooling of resources, assets, manpower and liabilities. This will improve the market’s structure as smaller companies merge with bigger players to create firms with stronger, more stable financial positions. In other regulatory developments, the Philippines introduced a risk-based capital (RBC) framework in 2006, but it has been implemented as a supplement to the solvency margin requirement. The regulator has stated that the current RBC framework “has to be strengthened before it becomes the sole basis for solvency determination of insurance companies under the new Insurance Code.”
The non-life sector is shared by a large number of insurers, mostly small to medium-sized domestic players. The top 10 non-life insurance companies generated 62% of total gross premium written (GPW) based on the IC’s 2012 report on 81 insurers. The top five players accounted for 41.2%. Fire and allied perils cover was the major line, accounting for 38% of non-life premiums in 2012, followed by motor at 27%. The Philippines has a small non-life market among ASEAN countries, with a premium size similar to that of Vietnam. The non-life industry posted a 10.9% increase in GPW to PHP 54.6 billion in 2012, according to the IC. The non-life industry has posted an average annual growth rate of about 6.5% over the past decade with a penetration of around 0.5%.
The non-life sector has been
The non-life sector has been challenged by pricing competition, an unfavorable economic structure, high taxes and the threat of natural catastrophes.
challenged by pricing competition, an unfavorable economic structure, high taxes and the threat of natural catastrophes. Pricing competition continues to drive premium rates down in the Philippines. Motor, fire and personal accident products are generally offered by most companies. However, demand has been tepid. Economic prosperity in the Philippines has not risen at the same rate as other ASEAN markets, which have seen the middle class grow significantly and fuel insurance demand. The Philippines has a very young population and a high concentration of wealth among a relatively small part of the population. Many individuals remain financially challenged and unable to afford insurance. Investment activity has also been weak in the Philippines due to underinvestment in the infrastructure, power plants and utilities. The Philippines Insurers & Reinsurers Association (PIRA) has pushed for a lower tax structure to improve non-life penetration. Currently, taxes amount to over 26% of premiums, including a 12% value-added tax, a 12.5% documentary stamp tax, a 2% fire service tax and 0.15%-0.75% in various forms of local government tax. The association has lobbied to reduce these various taxes in order to make non-life products more affordable. The non-life sector reported loss ratios ranging from 42% to 50% during a five-year period that ended in 2012. Insurers have maintained low retention rates, particularly for higher risk business lines such as fire and allied products, with a retention rate at 22.3% in 2012. Total reinsurance premium ceded amounted PHP 32.3 billion, representing 53% of gross premiums in 2012. This high reinsurance utilization has contributed to most non-life insurers’ stable underwriting results despite high natural catastrophes risks. Investment returns have also been a key income source. However, most non-life companies have high operating expenses compared to their counterparts in neighboring countries such as Indonesia and Thailand. As a result, companies need to reduce
costs or increase revenue to cover expenses. In 2012, the industry saw a 16% drop in net income to PHP 2.4 billion, according to the IC.
THREAT OF NATURAL CATASTROPHES
The Philippines are prone to natural catastrophes including earthquakes, typhoons, floods and volcanic eruptions. The country is hit by more than 20 typhoons every year on average. The U.N. has identified the Philippines as the world’s third-most disaster prone country after Vanuatu and the Republic of Palau. In the aftermath of Typhoon Haiyan (known locally as Yolanda), the government revealed plans to set up a mandatory risk insurance pool to help local government units better respond to natural catastrophes. The disaster risk insurance pool is expected to cover local government infrastructures, such as municipal buildings, schools and markets. In addition, the U.N. Office for Disaster Risk Reduction has worked with global insurance entities on a new approach for catastrophe risk financing in the Philippines. The proposed catastrophe scheme, known as the Philippines Risk and Insurance Scheme for Municipalities (PRISM), is being designed as a fasttrack way of providing budgetary support after a major natural disaster. The payment of claims is not based on actual losses, but on a pre-agreed amount when a specific trigger is met. For instance, insurance will be paid out in the event of rainfall exceeding a certain number of inches, or wind speed that exceeds a certain threshold.
In addition, PIRA, the IC and the Asian Development Bank have planned for a natural catastrophe pool to cover earthquake risks for households and small and medium-sized enterprises. An earthquake insurance company funded by both the private sector and the government has been suggested to cover the risk. The establishment of Earthquake Protection Insurance Corp. aims to develop the structure for implementing mandatory earthquake insurance coverage with domestic non-life insurers and reinsurers. Currently, only 12% of the country’s buildings are estimated to have a fire insurance policy. A number of insurance companies offer earthquake insurance but the high cost is unaffordable for most people. Typhoon Haiyan, which hit the central provinces in November 2013, was recorded as the most powerful landfall tropical cyclone to affect the Philippines. Extreme winds and storm surges brought severe destruction with estimated economic loss of about USD 10 billion, according to figures from Aon Benfield. Insured losses are projected at USD 1.5 billion, representing just a small portion of economic loss due to low insurance penetration in the typhoonhit area. The material impact of non-life insured losses is expected to drag into the first and second quarters of 2014 as a majority of the claims have not been settled. Natural catastrophes such as windstorms, earthquakes or other allied risks are covered either by extensions to fire insurance policies or under separate policies. Non-life companies offer catastrophe covers backed by reinsurance. Insurers writing fire and allied perils coverage have to secure 5% of their catastrophe risks with reinsurance. National Reinsurance Corp.
The U.N. has identified the Philippines as the world’s thirdmost disaster prone country after Vanuatu and the Republic of Palau.
of the Philippines (PhilNaRe), the country’s sole reinsurer, enjoys a compulsory cession from non-life insurers, which are required to cede 10% of their foreign outward reinsurance to PhilNaRe. Reinsurance ceded amounted PHP 32.3 billion, representing 53% of total GPW in 2012, according to PIRA. Fire and allied perils business had 77.6% of GPW ceded to reinsurance. For the January 2014 renewal, there was an overall 20% increase in reinsurance rates for catastrophe loss hit property programs due to the impact of Typhoon Haiyan.
THE ATTRACTION OF MICROINSURANCE
The Philippines has the highest microinsurance coverage ratio in Asia at 21.3%, compared with 14% in second placed Thailand and 9.2% in India in third, according to a briefing note published by the Munich Re Foundation titled The Landscape of Microinsurance in Asia and Oceania 2013. There were 19.9 million Filipinos covered by microinsurance in 2013, up from 3.1 million in 2008. This favorable trend is a bright spot in the Philippines insurance landscape and stands out among emerging Asian markets attempting to capture this untapped market. The country’s vast low-income population have unmet protection against natural catastrophe, agriculture, medical and life risk. In Asia, the Philippines has played a leading role in developing microinsurance, supported by the government along with international aid. The Department of Finance launched the National Strategy and Regulatory Framework for Microinsurance in 2010, outlining government policy and performance standards for this segment. The key strategies are to promote the participation of private sector in the
delivery of microinsurance products and services, and to enhance insurance accessibility to low income groups. Microinsurance is a key priority of the IC, which targets 27 million low income Filipinos for insurance coverage by 2016. The country’s amended Insurance Code includes a chapter on microinsurance as a financial product and service to meet the poor’s risk protection needs. The regulation outlines microinsurance provisions as well as concessions. Microinsurance products are defined as those policies with premiums not exceeding 5% of the current daily minimum wage rate of nonagricultural workers in metro Manila. Prior to 2010, only mutual benefit associations sold low-cost informal insurance products. Various government programs and reforms have fueled microinsurance development. For insurance, Munich Re rolled out its first microinsurance product in the Philippines to provide protection for the lending capacity of cooperatives to low-income groups against extreme weather events in 2010. About 19 insurance companies and 17 mutual benefit associations now offer microinsurance. The IC approved 80 microinsurance products in 2012, including 54 life and 26 non-life products. Microinsurance has substantial potential in Philippines’ current market structure. About 26.5% of the population lives below the poverty line while 51% of the population lives in rural areas. Extending protection to the majority of the population has not just been on the industry’s agenda in the Philippines, but also in many emerging markets. However, private insurers are generally reluctant to write microinsurance due to financial considerations. Active participation of private insurers, reinsurers, non-government organizations and government is critical to create a sustainable private-public partnership. In Asia, the Philippines is taking the lead in building the structure to facilitate microinsurance development with regulatory framework in microfinance, more active private participation, and through nongovernment organizations such as the Asian Development Bank. Going forward, microinsurance offers a potential market for the Philippines to demonstrate its strength in the ASEAN region. Microinsurance must be commercially viable in order to flourish. Government support as well as international aid are key drivers, but this may ultimately raise concerns over financial pressure on the country’s fiscal budget. Therefore, long-term development requires the participation of private players to help drive the viability of microinsurance products. Building a cost-effective business model for distribution, operation and administration is a key task for microinsurance providers. Raising awareness on risks and protection needs among the low income segment is essential to create an insurance-buying culture. The realization of microinsurance potential depends on the success on pushing forward these driving factors. Overall, the Philippines has proven to offer a good environment to nourish such development.
Microinsurance must be commercially viable in order to flourish. Government support as well as international aid are key drivers, but this may ultimately raise concerns over financial pressure on the country’s fiscal budget.