Insured against ranting and rambling

Moneyweb has an article describing the failure of the South African insurance industry to provide insurance to the wider population, including lower income markets such as the banking sector has done.

There are some interesting points to discuss here, and I’m certainly not saying the industry could not do more. However, there are some fairly fundamental social, pyschological and technical reasons that need to be overcome first. I’ve repeated some comments on the article below. I don’t claim this to be an exhaustive list, but I suggest that it lists some more likely suspects for the causes of imperfect penetration of the insurance market.

Sorry Felicity, but this article doesn’t even get into the details and shows a lack of understanding of the drivers of the need for insurance, and the perceived need for insurance.

Life Insurance
Comparing insurance to banking is disingenuous. Transactional banking makes your life easier, now. Basic savings account can work towards short-term goals. Life insurance will always seem less pressing.

1. Savings products will not work for lower income policyholders through an insurance policy because of the assumed average tax rate of 30%. It is a good deal for welathy investors in high marginal tax brackets, but awful for poor people. This is a function of the tax system not the insurers.
2. Life insurance requires payment of a premium now for a possible future benefit to dependents. There is no way this will ever be a priority need. This is human nature. Even if policies are sold, they will be lapsed very quickly and “better” uses are found for the premiums.
3. Lower income market segments typically have greater reliance on extended family for support. Thus, the need is lower for insurance. This is typical of developing countries, and declines as wealth and education increase (along with smaller families, later first children and less support from the extended family).

4. Funeral insurance may be sold through non-traditional outlets, but it is still exactly life insurance. Just that here the need is better appreciated and understood. Therefore it sells. Or do you want insurers to sell products for which there isn’t a need. (hey, easy on the comments that they already do… I don’t think insurers are angels!)
5. Credit life is required to protect the lenders from the death of the borrower. Again, there is a clear need and this form of insurance is quite widespread. Incidentally, funeral insurance and credit life are, unfortunately, typically quite profitable business lines. This might be a better line of attack against the insurance industry.
6. Insurance in South Africa has remarkably high penetration as measured by insurance premiums as a percentage of GDP and compared to other countries. This shows the succes of the industry, and also explains the limited growth prospects. Life insurance is typically less prevalent than short-term insurance in developing economies – if the problem isn’t restricted to South Africa maybe we should look for broader reasons?

7. I know several insurers who are targeting lower income markets with mixed success. The typical complaint against insurers is that they are overly profit-seeking. If (if!) this is true, then one can’t also complain that they aren’t following up on profitable opportunities? Again, maybe the reason is broader than you’ve implied.

Short-term insurance
Several other commentors have already described valid reasons for why short-term insurance take-up is lower than might be hoped. In many countries, third party liability cover is a legal requirement to drive a vehicle, and with good reason. This is the case in Lebanon, another country where I understand a bit about the insurance industry.

Losses on equity portfolios for our short-term insurers don’t really translate to a requirement to provide insurance to new markets. Maybe it suggests a requirement for less reliance on equity bull markets for performance in good years.

Short-term insurance in South Africa would be considered competitive by most standards. If there were large, profitable, untapped markets out there (with sufficient volumes, limited fraud and low enough claims frequencies and severities to make the premiums affordable to the target market) I expect they would be aggressively pursued. The thing about third party liability cover is that it isn’t greatly a function of the value of your vehicle. That makes it relatively expensive compared with the value of a car typical of a lower income target market. Being insured against someone else’s costs, when you would have no way to pay them otherwise and therefore it would be pointless to be sued, doesn’t sound like a very likely expenditure item.

The expenses of adminstering a policy are also not related to the size of policy or the value of insured property. One can argue whether current efficiency levels are right, but that is a separate argument (and one likely to suggest job cuts…).

The propotion of South Africans with short-term insurance should also be compared against those with sufficient assets to make it sensible. Direct comparisons against the populatio as a whole are close to meaninless.

Ok, I think I have done more than enough rambling and ranting. However, let me conclude with one observation on a quote from the article:

“And the plain fact is that local insurers have done way too little to develop products that offer value for the vast majority of South Africans. This is self-evident; precious few South Africans use insurance products.”

Just saying something is a fact doesn’t make it a fact. And please don’t abuse “self-evident”. Just because one item could be a cause of something does not make it the cause, or the only cause, or the primary cause. Especially not when you have just laid out a few of the reasons I also covered as to why insurance is a hard sell.

I wonder whether I should have mentioned the bad debts on house and car loans that are stacking up based (only partially!!) on pressure to lend to households with little wealth for large deposits and strained financials?

Actuarial consulting career part 2 – system development

This is a continuation ofa post considering the relevance of an individual investment product development position to a career in actuarial consulting.

An old contact mailed me a couple of days ago asking my view on two possible actuarial positions. He was interested in whether either would be suitable preparation for a consulting or actuarial consulting role in future. I thought the answer might be of broader interest, so I’m copying it, with a little editing to protect the innocent into a couple of blog posts.

Please note this shouldn’t be taken as categorical always applicable advice – just some thoughts:

In-depth knowledge of policy systems and admin is a tremendously useful skill-set in its own right. Companies are always struggling with legacy systems, and the speed, efficiency and flexibility of current systems can generate a competitive advantage in getting new products to market, improving customer service and reducing costs. Although this role would introduce depth rather than breadth to your skills and experience, it could potentially be a stepping stone into a solo consulting career focussed on these areas. Alternatively, if you enjoy that sort of work, there is probably a long-term future for you at the potential employer moving up from coding to systems analysis and improvement.

All insurers struggle with these issues, and I can’t see how this will ever change. As insurance takes off in other developing markets (rest of Africa, Middle East and so on) there will be a range of new companies selling new products to new customers with new designs and special features. This role will always be in demand.

Will an individual investment product development role help towards actuarial consulting career?

An old contact mailed me a couple of days ago asking my view on two possible actuarial positions. He was interested in whether either would be suitable preparation for a consulting or actuarial consulting role in future. I thought the answer might be of broader interest, so I’m copying it, with a little editing to protect the innocent into a couple of blog posts.

Please note this shouldn’t be taken as categorical always applicable advice – just some thoughts:

Insurers are facing stiff competition in the investment space, both on the individual and corporate side. Competing against investment banks and asset managers, often on more direct terms than in the past, and with the albatross of poor reputation, sluggish reaction to changing market conditions and often a higher cost base mean that insurers need plenty of help in this area. Depending on the specific role, you can get involved in anything from market research and customer needs analysis, creative product design, model coding, profit testing, distribution analysis, customer segmentation and analytics, financial reporting (IFRS, FSV/PGN104, EV, EEV, MCEV, Solvency II etc.), administration system design and implementation, liaison with distribution force, sales team training, product profitability monitoring, policy documentation wording etc.

There is plenty of scope to gain breadth of knowledge, but it is likely that you won’t be doing all of this. I’d check out what they envisage you actually doing, see what is in your “performance contract” if this exists and see whether it is a narrow or broad role, and whether it can become broader over time.

Aside from its relevance to an actuarial consulting career, this is an interesting space to be involved in at the moment. Around the world, insurers are only touching on possibilities of product design and customer information and analysis. South African insurers are probably a little further behind the curve.

Good luck!

Packing for Prague

Heading off to a Solvency II conference in Prague this evening. QIS 4 is hot news at the moment, and the conference is going to cover many of the details and requirements of the exercise.
Large European multinationals have spent enormous effort on the 4 QIS exercises. The data requirements alone are huge. Somehow CEIOPS has managed to keep the project more or less on track – the same can’t be said for the IFRS4 Phase 2 project. Given the intended consistency between IFRS and Sol2, I wonder whether this means IFRS will by default be more heavily influenced by Sol2 (and the recently published MCEV principles fomr the CFO Forum) than previously thought.
Will have some specifics from the course to blog about over the next week.

Confidence and capital – Nationwide has neither

Nationwide Airlines is on the ground. A series of business and operational problems met the global economy of skyrocketing avgas prices and left them insolvent by R172m (assets of R46m less liabilities of R218m). They’ve also left friends of mine stranded in South Africa after a trip from Ireland for another friend’s wedding (congratulations Kay and Brennan!).

Simplistic overview of causes

  • High fuel costs – avgas has increased significantly recently.  However, this affects all airlines.
  • High fuel costs combined with fuel inefficient planes.  Nationwide’s older aircraft are less fuel efficient. Fuel costs per flight are thus higher than some competitors. An increase in fuel prices hits them harder.
  • Small capital base (now negative), high fixed costs and challenging break-even targets. Nationwide needed 75% capacity on its flights to break even. This reflects the high fixed costs per flight, and high fixed costs overall. A small capital base means that there was limited time to trade through difficult conditions and preserve the franchise / brand value of the operation.
  • Loss of confidence due to safety concerns, regulatory intervention. Since one of Nationwide’s planes “lost and engine” in flight confidence from the flying public has plummeted.  It has since emerged that the engine was in fact designed to free itself from the plane under certain circumstances. Combined with the pilot’s successful landing shows that the outcome was pretty good compared with other possibilities. However, a large portion of the market was not prepared to fly Nationwide anymore. Combined with the chaos preceding and succeding the operational and safety crisis, I stopped flying Nationwide simply because we had concerns about their ability to get us to our destinations on time. This may not have been based on a thorough analysis, but was based on several specific events. I’m sure I wasn’t the only one to reach this conclusion.
  • Price competition – pretty much the only customers prepared to fly Nationwide were those looking for the cheapest flight at any cost (safety, timeliness etc.). Thus, Nationwide’s pricing power diminished to virtually nothing. This exacerbated the need to fill planes to meet fixed costs.

Lessons for other organisations

Decreased capital bases have become a popular path to increased Return on Equity. Now, theory suggests that decreased equity will boost financial leverage if debt is involved (debt here including debt-like obligations such as fixed equipment leases). On a more practical level, decreased capital provides a smaller buffer against adverse trading conditions (default experience for banks, claims experience for general insurers, equity market declines for life insurers, interest rate shocks for most business). Assuming Nationwide had a viable business, a larger capital base would have allowed them to continue trading through the difficult times and emerge at the end of the tunnel a profitable business.

One of the standard counters to this is that if new capital were needed it could be raised from the efficient, deep, liquid, transparent, costless capital markets. Needless to say, those don’t exist. The practicalities of a bail-out package in sufficient time to keep an airline running make it especially challenging. Incidentally, it’s not unlikely that someone will take over Nationwide’s planes and staff – if our market does need those flights and employees that should find a home somewhere. If there was sufficient slack in the market for the other airlines to mop up the increased relative demand, then a company “exiting” the market is exactly what microeconomics would predict. Pity Mango has our tax money to shield them from a similar fate.

Financial services companies would do well not to dismiss Nationwide’s fate as “nothing to do with me”. Northern Rock’s catastrophic loss of confidence might have been a little closer to home, but shares the same message of significant gearing, illiquid assets and a loss of confidence. Capital strength provides more leeway to ride out tough times, but also adds confidence to customers (deposit holders, policyholders) which is most critical in tough times. The costs of financial distress rise as companies’ capital positions worsen. Low probability events can be catastrophic when they hit, and there is plenty of evidence to show how human beings chronically underestimate the probability of low probability events.

Hedging. Again.

Fuel price skyrocketed. Margins destroyed. Airline no longer profitable. Now, if an increase in fuel price really would be that deadly to an organisation, surely hedging of this otherwise uncontrollable risk should have been sensible? As it turned out, Nationwide was partially taking a bet on fuel prices declining or staying constant. Lose the bet lose your business. If they had hedged, even partially, and fuel prices had declined, they would have still been in a sticky mess, but presumably better than they are now. If the competitive position they would have been in with locked-in higher fuel prices would have meant that they would also have gone out of business, then I’m afraid this sounds more like a wild speculative fling than a sustainable business. Rolling dice on that scale doesn’t inspire confidence.

Three conclusions

  1. High gearing and a small capital base has definite costs they aren’t completely factored into a naive RoE analysis.
  2. Customer confidence is critical to a sustainable business and should be nurtured.
  3. Hedging of major, uncontrollable and potentially fatal risks must be included in an organisations risk and strategic management.

1Time down 11.4% today. Comair up nearly 9%.  Market taking bets on which company is better positioned for the new competitive landscape?

US CPAs to start speaking French

Until very recently, multinationals listed in the US but not resident in the US were required to show a reconciliaton of their local GAAP financial statements to the US GAAP equivalent. Many of these large companies (based in Europe and the Far East) incurred high costs in time, energy and hard cash in preparing US GAAP accounts for this purpose only.

As a result, listing on a US exchange started to appear less attractive to these and other new potential listings. The SEC had been mulling over how to deal with this for a while, and fairly suddenly has now announced that these companies do not need to provide the reconciliaton to US GAAP. As a result, many large companies have already opted not to produce the US GAAP figures.

The next major step would be if the SEC decides that US companies who decide to report under IFRS do not need to provide US GAAP figures. As IFRS gains traction around the rest of the world, nobody wants to be left behind as the special case. This is still a way off, and their is also plenty of trouble brewing with IFRS (Phase 2 Insurance Project particularly) but it does look like many US accountants will need to polish their European language skills.

Solvency II makes another milestone – QIS3 out

Apparently the results for QIS3 are now available.  QIS3 (“Quiz 3”) is the third Quantitative Impact Study along the path to rolling out Sovlency II for insurance companies between 2010 and 2012. It provides further light on what capital requirements will actually be when Sovlency II comes into effect.

Perhaps a warning is required for the overally optimistic. Basel II required 5 QISs before maturing to be ready for roll-out. Many acknowledge that Solvency II is more complicated, with a greater number of complex risks to consider so it could arguably take much longer. Also, Basel II had the framework of Basel I to start with, where many European insurers have had very simplistic capital requirements to date. Watch this space!

I’ll provide some more feedback on the actual results of Solvency II when I’ve had a look through the material.

Retirement age inequality

Iafrica has a story about a court battle against different state retirement ages.

Can’t imagine this will go far in the short-term, but might be the beginning of a serious relook at normal retirement age, for men and women, and in in light of trends of extended retirement periods through “mortality improvements”. Mortality improvement is the lowering of mortality over time as a result of several causes, including better medical care, awareness of the dangers of smoking etc.

A two-day hearing of a case brought by a group of men challenging the unequal provision of the state old age pension to men at 65 and to women at 60 will begin on Tuesday.