General Insurance in Pakistan-PACRA

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December 2012 The Pakistan Credit Rating Agency Limited SECTOR STUDY GENERAL INSURANCE IN PAKISTAN

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Transcript of General Insurance in Pakistan-PACRA

  • December 2012

    The Pakistan Credit Rating Agency Limited

    SECTOR STUDY

    GENERAL INSURANCE IN PAKISTAN

  • The Pakistan Credit Rating Agency Limited

    BANKING

    December 2012 www.pacra.com

    RATING REPORT CONTENTS PAGE

    Summary Report 1

    Detailed Report:

    1. Insurance Key Concepts 2

    World

    2. Global Snapshot of General Insurance Industry 3

    3. Review of Insurance Performance Globally 6

    Pakistan

    4. Sector Profile 7

    5. Governance 8

    6. Management 10

    7. Systems and Controls 10

    8. Business Risk

    8.1.Sector Structure 11

    8.2.Business Growth and other trends 12

    8.3.Business mix and segments growth 13

    8.4.Profitability 15

    9. Risks summarized 17

    SECTOR STUDY

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    SECTOR STUDY

    PACRA has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but its accuracy or completeness is not guaranteed. PACRA shall owe no

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    PAKISTAN GENERAL INSURANCE

    AN OVERVIEW (DECEMBER 2012)

    HIGHLIGHTS

    2012

    Penetration 0.3%

    Density USD 4

    Gross Premium^ ~PKR 60bln

    Gross Sum Insured^ ~PKR 18 trillion

    Equity base^ ~PKR 80bln

    Loss Ratio* 54%

    Investment income

    as %age of NPR* 25%

    Operating Ratio* 74%

    Penetration: premium as % GDP

    Density: premium per capita

    ^public and private sector, estimated

    *private sector

    KEY DEVELOPMENTS!

    Slow growth in gross premium

    Intensifying competitive landscape

    Diversifying into non-conventional insurance, and product innovation

    evolving Investment strategy, risk averse stance

    Improving Underwriting Risk Management Framework

    Strengthening human resource

    Technology up gradation

    Regulators focus

    ANALYSTS Amara S. Gondal

    [email protected]

    Jhangeer Hanif

    [email protected]

    Abdul Haye

    [email protected]

    Noman Umar

    [email protected]

    +92 42 35869504

    ABOUT INDUSTRY: Pakistans general insurance penetration level (0.3%) is lower than the regional average (1.6%), and in terms of penetration, is ranked at 18

    th

    position in Asia. Low penetration is because of various reasons ranging from cultural to sentimental however, low density beams out growth potential. The sector holds unique strategic significance for the countrys economy as it is predominantly used by the banking sector as a tool to mitigate risks associated with the credit exposures. More than half of gross premium is referred through banks. The General Insurance sector comprises 31 active companies, including one state owned and three takaful companies. A majority of premium (~85%) is written by the private sector, and is highly concentrated in top three players.

    PERFORMANCE: After having witnessing economic boom until CY07,the slowed down in economic growth in the country gave challenge to the industry; real GPW declined between CY08 and CY10.Meanwhile, law and order situation, equity market turbulence, and natural calamities spurred unique challenges to the industrys profitability, year after year. Since CY11 the GPW growth is picking up, yet, at slow pace. The motor segment declined with shrinking leasing portfolio of banks; on the other hand, the fire segment witnessed expansion, and health emerged another area of growth to the portfolio. Moreover, the sector shifted to a more risk adverse investment strategy, post stock market bump, diverting funds into risk free securities. This helped to attain relatively stable investment income to support the bottom line.

    STRENGTHS: The sector not only sustained its equity base from the pressure times but also took corrective measures in bridging the loopholes identified in crisis; though some smaller players had to quit. The sector witnessed shift towards a more diversified business mix with varied growth patterns observed in each segment. After witnessing saturation in conventional insurance, the sector is exploring opportunities in non-conventional insurance and bringing innovation to its product slate. Meanwhile, the sector is eyeing retail clientele. This is expected to tapper down the concentration risk in the medium to long term. Despite underwriting a large size of risk, the sector retains a small proportion of the exposure on its books on the back of strong reinsurance pool; which in itself witnessed expansion in the number of participants due to emerging regional reinsurers entering the Pakistani market. Sophistication in IT infrastructure and MIS, improving risk management framework, and more professional HR, though raised expense level, has improved ability to handle respective growth strategies. This has also helped in achieving efficiency while improving quality of service. Regulators enhanced attention to the sectoral reforms is ensuring better monitoring.

    KEY RISKS: Increasing risk of catastrophic disturbance due to recent geographical changes in Pakistan is critical for the insurance sector. In this regard, reinsurers strong backing and favorable treaty terms with adequate capacity arrangement would remain vital for the sector. Moreover, reasonable premium pricing plays its role, which is on declining trend. The business growth is expected to follow random walk amidst slow demand and high competition, and, hence, the core underwriting profitability remains uncertain. Reconciliation system of inter-company balances have traditionally remained inefficient, resulting in pilling up of old accounts write offs may be inevitable in small companies books. Small companies remain exposed to regulatory non-compliance, unless sponsors support is provided.

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    1. INSURANCE KEY CONCEPTS

    AND HISTORY

    Insurance; Risk sharing and Risk

    transfer

    Insurance dates back as far as

    6000 B.C.

    Marine Insurance was

    the first ever

    form of

    insurance

    Reinsurance; liability is joint

    Co-insurance; liability is

    several, limited

    to each

    participants respective share

    1.1 The concept: Insurance is an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or

    death in return for payment of a specified premium1. While the Insurance Association of

    Pakistan (IAP) defines it as a method of shifting the responsibility for losses to specialists

    (insurance companies) who handle the risk by spreading it over a large number of people or

    firms. It is a system of protection against loss in which a number of individuals agree to pay

    certain sums of money, called premiums, to create a pool of money which will use the

    contribution of these individuals to pay the losses of the few caused by events such as fire,

    accident, illness, or death.2

    1.2 Insurance categories: Insurance today is broadly categorized in two categories 1) Life Insurance and 2) General Insurance or Non-Life Insurance as the terms are used

    interchangeably.

    1.2.1 Life Insurance: Under this policy, the insurance company pays in case of demise of the policy holder or at the time of maturity of the policy. Hence the products available are

    either whole life insurance or term insurance.

    1.2.2 General Insurance (Non-Life): Most commonly it is divided into Fire, Marine, Motor (Auto), Engineering, and Health insurance. However, there are several general,

    specific and sub-classifications available in non-life insurance category having variations

    owing to geographical regions, cultures, customs and economic environment. The

    miscellaneous segment has also received significant growth in recent years with new

    innovative products being added to the category inline with the growing consumer needs.

    1.2.2.1 Reinsurance: In order to reduce risks involved in writing more risky and large policies, insurance companies also transfer portion of their risk to reinsurers. The two basic

    types of reinsurance are treaty reinsurance and facultative reinsurance; (1) Treaty

    reinsurance written to cover a particular class of policies issued by the reinsured automatically passes the risk to the reinsurer for all policies that are covered by the treaty,

    not just one particular policy; (2) Facultative reinsurance is issued on an individual analysis

    of the situation and facts of the underlying policy. It may cover all or part of the underlying

    policy. The reinsurance company after reviewing the associated risk may either accept or

    reject the proposed offer. Treaty policies are more general than facultative policies because

    the reinsurance decision is based on general potential liability rather than on a specific

    enumerated risk. The benefit of Treaty insurance is that it reduces the cost of analyzing

    individual risks for the reinsurance company, due to which it is less costly than Facultative

    arrangements.

    1.2.2.2 Coinsurance: Another way of risk mitigation is co-insurance, whereby, risk is spread among the insured (in some jurisdiction), and a panel of insurance companies. In a

    coinsurance arrangement, the insurance company does not write the risk alone, instead it is

    distributed among two or more insurers. In reinsurance arrangement, the insurer transfers the

    risk to reinsurer and liability is joint, whereas, the coinsurance contract results is sharing of

    risk; the liability is several and each participant is not responsible the proportion of other

    participant co-insurer.

    1.3 Evolution of Insurance and development: The concept of insurance goes back in time as far as around 6000 B.C as practiced by Hindus and merchants of Babylon. However,

    most of the development came from Europe, mainly London in the formal developmental

    stages. Its beginning was simple gradual. As the trade and industry developed, the need of

    insurance was also felt and the institution of insurance was invented.

    1.3.1 In the earliest days, contracts known as bottomry were used by money lenders to

    1Oxford Dictionary

    2 Definition from The Insurance Association of Pakistan (IAP)

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    shift the burden of risk from owners of ships or cargoes to themselves. The loan was

    cancelled, if the ship or cargo was lost during a voyage. The charge for the bottomry loan, if

    the voyage was successful, was very high because it included the amount of interest and cost

    of risk. The contract of bottomry loan in fact sowed the seed of the modern insurance idea.

    1.3.2 Marine insurance was the first category of insurance business that was developed. Although marine insurance originated in Italy, its practice gradually spread to other trade

    centers of Europe, including London. Until 1720 A.D., marine insurance was entirely in the

    hands of individual underwriters, whose main business was trade and commerce and

    insurance was a side-business. After the discovery of marine insurance other classes of

    insurance such as fire, life, motor, accident etc. appeared in the market. When the Great Fire

    of London occurred in 1666 A.D., no fire insurance existed. In the same way, life insurance

    made its debut in 1583, when the life of William Gibbons, a sea captain, was insured by

    sixteen individual underwriters in London against a premium amount of GBP 383.

    2. GLOBAL

    SNAPSHOT OF

    GENERAL

    INSURANCE

    INDUSTRY

    Average insurance

    penetration

    2.8%

    USis the largest general

    insurance

    market with best

    practices around

    the globe

    Key products; health &

    accident, motor/

    Auto, fire

    Asia witnessing growth

    Japan, the largest market in

    Asia

    2.1 Globally, life insurance out beats general insurance by

    dominating the 3worlds premium

    of USD 4,597bln with 63% market

    share in 2011. Nevertheless, the

    general insurance business spreads

    its wings all across the world, while

    North America and Western Europe

    being the leaders in general

    insurance contributes 37% and 33%

    to the worlds market, respectively. This makes the global industry

    structure highly concentrated with

    top eight countries occupying

    majority market share (64%); the

    United States (US)topping the list.

    Insurance penetration4 varies

    greatly across different regions of

    the world, reflecting different

    stages of economic development

    and institutional factors, while

    insurance density5 ranges from

    USD 5 (Bangladesh) to USD 4,777

    (Netherland). These measures help gauge the growth and development potential of insurance

    markets. Although average worlds insurance (life and general) penetration is quite decent (6.6%), the general insurance depicts relatively lower penetration at 2.8% of world GDP; the

    general insurance prospects in emerging markets6 though picking up pace rapidly, beams out

    small penetration level (1.3%). However, Netherland recorded highest insurance penetration

    in 2011 at 9.5%, followed by the United States of America and Switzerland; each at 4.5%.

    Key products in majority leading countries fall under accident and health segment, motor

    (including third party liability), and fire & property insurance facing high competition.

    2.2 United States is the worlds largest non-life insurance market. The high level of general insurance penetration in US indicate that the insurance play a central role in risk

    management by households and businesses. The majority of households have one or more

    3Swiss Re Sigma 3/2012; Worlds insurance in 2011

    4Premium as %age of GDP

    5Premium per capita

    6Latin America, Central and Eastern Europe, South and East Asia (Excluding Israel), Central Asia, Turkey, Africa

    World's non-life premium

    2011

    USD 1,969bln

    America43%

    Asia

    18%

    Africa

    1%

    Oceania

    2%

    Europe

    36%

    Distribution of General Insurance Premium among Continents

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    types of insurance and the market is flooded with specialty and general insurance providers,

    which provide the bulk of products. The 7mandatory line insurance workmans

    compensation (accidents at work) and third part liability auto insurance generates majority 8business (~53%), followed by motor (~25%), fire and property damage (~16%), and others

    (~5%).Innovative products, mature distribution and global best practices across the insurance

    value chain are hallmarks of the U.S. non-life insurance industry. In 1999, the Gramm-

    Leach-Bliley Act legislated that banks, brokerages, insurance firms and other types of

    financial institutions can join together to offer their customers a more complete range of

    services. In the insurance business, this has led to a flurry of merger and acquisition activity

    in the past.

    Top countries in term of global premium share 2011

    Rankin

    g Country

    Premium

    (USD mln)

    Share

    of

    world

    market (%)

    Penetration (Premium as

    %age GDP)

    Density (Premium per

    Capita in

    USD)

    1 United States 667,107 33.9 4.5 2,130

    2 Germany 131,292 6.7 3.6 1,578

    3 Japan 130,741 6.6 2.2 1,031

    4 United

    Kingdom 109,486 5.6 3.1 1,188

    5 France 98,359 5 1.9 1,403

    6 China 87,319 4.4 1.2 64

    7 Netherland 79,722 4.1 9.5 4,777

    8 Canada 69,045 3.5 4 2,010

    73 Pakistan 636 0.03 0.3 4

    Top 8 1,373,071 69.8 3.4%

    Rest of the world 595,108 30.2 2.1%

    Worlds Total 1,968,179 100 2.8 283

    Source: Swiss Re Sigma 3/2012; Worlds insurance in 2011

    2.1.1 Germany is the second largest non-life insurance market in the world and the largest in Europe. In Germany,

    9insurance is mandatory for everyone, helping the segment grow

    quickly. Most of the major non-life players are German, though a few pan-European giants

    also have a tangible presence. With more than 200 non-life insurers, the German market is

    highly fragmented. Germanys industry 10generates business mostly from accident and health (~36%), followed by fire and property damage (~25%), and motor insurance (~20%).

    7World Bank Financial Sector Development Department: The Regulation and Structure of Non-Life Insurance in the United State

    8Organization for Economic cooperation and development (OECD): OECD.Stat Extracts complete database available via OECDs

    Library 9Capegemini: World Insurance Report 2011

    10Organization for Economic cooperation and development (OECD): OECD.Stat Extracts complete database available via OECDs

    Library

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    2.1.2 Insurance in the United Kingdom (UK) is availed by almost every adult and every business, in some way

    11. The insurance industry is also one of this countrys major exporters, with 28% of its net premium income coming from overseas business. Approx. 1,005 general

    insurance companies constitute the UK industry, making the landscape competitive. UKs major product is motor insurance having 24.3mln private and 4.4mln commercial vehicles

    insured. Half of the general insurance premium is sold through brokers, which includes 80%

    of the commercial business, whereas 43% of the private car insurance is sold direct. The

    business from premium written domestically, in 2010, is spread amongst motor (32%),

    accident and health (13%), property (25%), general liability and pecuniary loss (9% each).

    Foreign business is driven by motor (5%) and non-motor (4%).

    2.1.3 The Dutch general insurance12 is fairly fragmented into small sized companies only two insurers holding assets exceeding five percent of the sectors total assets. However, the industry is highly concentrated in accident & health (~73%), followed by motor (8.5%),

    and fire & property insurance (6.9%). The accident and health segment witnessed

    stupendous growth since implementation of health care reforms in 2006, thereby making the

    health insurance mandatory. This is why the sector is prospering in Netherlands despite

    prevailing Euro crisis.

    2.1.4 Japan is the largest insurance market of Asia and third largest in the world. More than half of the

    13Japanese general insurance is driven by automobile insurance, followed by

    fire (17%), personal accidents (14%), and others. Automobile insurance in Japan is operated

    under two different systems and policies compulsory automobile liability insurance (CALI) and voluntary automobile insurance (VAI), each contributing 11% and 43% to the

    industry, respectively. CALI, established under Automobile Liability Security Law

    (promulgated in 1995), only covers bodily injury liability, and the law specifies the limits of

    insurers liability for death, each grade of permanent disability and bodily injury. On the other hand, VAI includes third party liability coverage (bodily injury liability and property

    damage liability), self-incurred personal accident coverage, protection against uninsured

    automobiles coverage, passengers personal accident coverage and coverage for damage to the insureds own vehicle. With respect to liability for bodily injury, voluntary automobile insurance acts as excess cover to CALI. These policies normally have maturities ranging

    from 12months to 60months14

    .

    2.2 Regional Insurance Industry Preview: General insurance in Asia15 represents 18% of the worlds share with premium amounting to USD 356bln in 2011. Within the region, South and East Asia (SEA) is regarded as the emerging market; though average insurance

    penetration of SEA is low (1%), the industrys growth prospects are high. If we further drill down, Pakistans immediate neighboring country, India, posted USD 12bln premium from general insurance business in 2011; ranked

    1619

    thin terms of premium. The insurance

    penetration is very low (0.7%). The 17

    motor insurance constitutes 83% of total general

    insurance business in India, of which, comprehensive insurance is a major contributor

    (41%), while motor Own Damage (OD) and Third party (TP) generates 24% and 17% of the

    industrys premium, respectively. High penetration of motor insurance is because of regulatory requirements for the third party motor insurance. However, privately held insurers

    11

    Association of British Insurers: UK Insurance; Key Facts (Sep 2011) | 300 members account for 90% of UK premium 12

    International Monetary Fund (IMF) Country Report no. 11/205 dated July 2011: Detailed Assessment of Observance on Insurance Core

    Principles 13

    General insurance Association of Japan Statistical data 14

    Non-life insurance rating organization of Japan: a non-profit organization established under law. It advises pure premium rates to

    insurers. 15

    Excluding advanced countries: Hong Kong, Singapore, South Korea and Taiwan 16

    Swiss Re Sigma 3/2012; Worlds insurance in 2011 17

    Insurance Regulatory and Development Authority (IRDA)

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    are increasingly looking to penetrate health insurance. The market has opened up since

    deregulation in 2001, and 22 firms now sell non-life coverage, though the top four are

    public-sector firms. In India, 58% of total premium is generated by public companies. Public

    companies generate 64% of the market share in fire, 70% in marine and 68% in engineering.

    Top countries in term of Asias premium share 2011

    Ranking

    Country

    Premium Share

    of

    world

    market (%)

    Penetration Density

    (Asias Market

    (USD mln) Rank (Premium (Premium

    Share) (Asia) as %age

    GDP)

    per Capita in

    USD)

    1 Japan 130,741 6.6 4 2.2 1,031

    2 China 87,319 4.4 11 1.1 64

    3 South

    Korea

    51,223 2.6 1 4.6 1,045

    4 Taiwan 14,283 0.7 2 3.1 614

    5 India 12,187 0.6 13 0.7 10

    6 Singapore 8,188 0.4 9 1.5 810

    7 Iran 7,555 0.4 8 1.7 101

    20 Pakistan 636 0.03 18 0.3 4

    Top 7 311,496 15.8 1.7

    Rest of the Asia 44,684 2.3 1.1

    Asias Total 356,180 18.1 1.6 85

    b.

    3. REVIEW OF INSURANCE

    PERFORMANCE

    GLOBALLY

    Premium growth slowing down in

    advanced

    markets

    Rising catastrophe

    losses posing

    high risk to the

    industry

    globally

    Robust premium growth in

    Emerging Asia

    while bleak

    3.1 Globally, the general insurance premiums expanded 1.9% in real terms during 2011 on the back of solid economic growth in emerging markets and selective rate increases in

    some advanced markets (Swiss Res sigma 3/12 study reveals). Non-life insurance premium growth remained strong in emerging Asia, with new car owners and an increase in demand

    for health and personal accident insurance being key growth drivers. Product innovation has

    driven fast-paced growth in certain insurance segments, including micro insurance and

    takaful. Nevertheless, the global financial and economic crisis has affected profitability of

    non-life insurance companies around the globe. Claims ratio in many countries has risen as

    the number of premiums written dropped and/or claims themselves increased in frequency

    and size (a trend that tends to worsen during economic downturns). Moreover, around the

    world catastrophe losses18

    played havoc in CY11; (i) the earthquake (Mw9.0) in Mar-11

    triggered tsunami in Japan, which turned out to be the largest insurance loss of the world,

    amounting to USD 35bln, (ii) this was followed by Thailand in Jul-11 where flood caused by

    heavy monsoon rains drained USD 12bln from the industry, (iii) New Zealand was hit by an

    equivalent amount by an earthquake (Mw 6.3) in Feb-11. Put together, all natural catastrophe

    losses caused economic losses of over 370bln which triggered down approximately USD

    116bln losses to the insurers around the globe; second largest on record since 1970. Insured

    losses were highest in Asia, where they were USD 49bln.

    3.2 With the decline in investment income, which once provided a constant profit stream for the non-life industry, insurers have been forced to concentrate on improving the

    operational and acquisition ratios. In many markets, the economics of risk pricing call for an

    18

    Swiss Re Sigma 2/2012: Natural Catastrophe and man-made disasters in 2011

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    underwriting

    profits

    increase in premium rates, but insurers are facing competitive pressure19

    . Nevertheless, the

    premium rates are expected to rise in advanced markets in order to safeguard the

    profitability20

    . Accordingly, the reinsurers are also to come up with improved treaty terms

    benefitting their bottomline.

    4. PAKISTAN SECTOR

    PROFILE

    35 active general

    insurance

    companies in

    Pakistan

    Low premium penetration

    Positive correlation

    between

    economic

    expansion and

    premium

    development

    4.1 General Insurance in Pakistan a brief: Pakistans general insurance penetration

    21 level (0.3%) is lower than the regional average (1.6%) due to various reasons

    ranging from cultural to religious. The premium growth in real terms follows the trend in

    GDP growth, reflecting co-relation of the industry with the economic activity in the country.

    The general insurance in Pakistan is majorly used by the banking sector as a tool to mitigate

    risks associated with the credit exposures.

    4.2 Currently, the general insurance sector in Pakistan comprises 3522 active insurance companies, including one state owned insurer and three takaful operators Islamic insurers. The industrys product slate mostly comprises commercial lines of insurance solutions under conventional model; Property insurance (fire and engineering), Marine (Cargo and Hull),

    Motor and Miscellaneous, whereas Health insurance is a separate category commercial and personal line. The health segment has lately attracted industrys great attention. The Miscellaneous Insurance category includes a number of other prospective insurance classes

    such as aviation, cash related insurance, travel insurance, credit, agriculture, bond, etc. EFU

    Allianz is the first specialized insurance company in Pakistan that offers health related

    insurance solution. Over time, the concept of specialization has been picked up; TPL Direct

    Insurance majorly provides personal line motor insurance, though it is gradually entering

    into other personal lines like health and travel. Few of the insurers, though small sized,

    specialize in credit insurance, travel insurance, etc.

    4.3 In Pakistan, fire insurance is mainly required by the construction and industrial sector. Higher the growth in industrial infrastructure, the more is the fire and allied insurance

    business for insurance companies. Similarly, marine insurance is associated with trade of

    goods and services. Marine insurance usually increases with the increase in imports and

    exports of goods. Motor insurance on the other hand has two major sub-components:

    comprehensive motor insurance and third party or liability insurance. This segments growth is normally triggered by the car leasing business of the banks. Health insurance, which

    depends extensively on individuals preferences, has attracted considerable attention in the recent past. Moreover, the recent trend has been in the form of innovative products in the

    miscellaneous segment. In the banking sector, Islamic banking has been taking quiet deep

    roots in Pakistan within a short span. This riba-free banking model has become very popular

    among the people attracting the Pakistan insurance industry towards Islamic insurance i.e.

    Takaful. At present three Takaful Insurers are operating. The first Takaful to function was

    Pak Kuwait Takaful General Ltd. sponsored by Pak Kuwait Investment Co. Ltd in December

    2005. Takaful Pakistan Limited was the second Islamic insurer to arrive on the scene in

    2007. Two more Takaful were established during 2007; Pak Qatar General Takaful Ltd. and

    Pak Qatar Family Takaful Ltd.

    4.4 History & Developments: At the time of partition, in December 1971 when East Pakistan became an independent sovereign state, Bangladesh, there were 77 foreign

    insurance companies dominating Pakistani insurance market. Whereas the strength of local

    insurers was only 523

    . In 1952 Government established Pakistan Insurance Corporation (PIC)

    19

    Capgemini World Insurance Report 2012 20

    Swiss Re 21

    Premium as %age of GDP 22

    SECP has issued orders to cease operations of four insurance companies, which have been challenged in the court of law by the insurers;

    it is pending final decisions. 23

    Financial Sector Assessment 2003; SBP

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    to promote the local insurance industry. Consequently, the number of local insurance

    companies increased to 47 while number of foreign companies reduced to 25 by 1972. In

    1976, National Insurance Corporation (NIC) was formed with the purpose of undertaking

    General Insurance business relating to public property. In 2000, PIC was converted to

    Pakistan Reinsurance Company Limited (PRCL). PRCL has a mandate to provide

    reinsurance support to the local insurance industry in respect of treaty & facultative business

    as well as managing specialized insurance schemes assigned by the Federal Government of

    Pakistan. PRCL enjoys the monopoly in local reinsurance business, being the only company

    providing such services.

    4.4.1 Whereas, in terms of premium, the partition (in 1971) deprived the Non-Life premium of PKR 290mln of that region (now Bangladesh). Out of this total of PKR 290mln,

    the share of foreign insurers was PKR60mln, West Pakistani companies of PKR 180mln and

    East Pakistani companies of PKR 50mln. Later on in 1979, private sector insurers

    experienced imposition of tax on exceptional loss reserves, which used to be tax free.

    Nationalization policy of the seventies of the government further brought difficulties for the

    insurance industry. 31 industries, along with ghee mills, shipping, banks, petroleum

    marketing companies, automobile, etc. were bracketed under the umbrella of public sector

    and which, in turn, gave a loss of PKR 353mln to the private sector insurance industry.

    5. GOVERNANCE

    Regulator Securities and

    Exchange

    Commission of

    Pakistan

    Insurance Association of

    Pakistan (IAP)

    5.1 The governance system prevailing in the industry is important in assessing its feasibility and efficacy towards achieving sustainable development. In Pakistan the

    governance of the insurance sector is entrusted to the Securities and Exchange Commission

    of Pakistan (SECP). SECP has been regulating the Insurance industry, since January 2001

    after it took over from the Controller of Insurance operating under Ministry of Commerce,

    Government of Pakistan. The powers of SECP to regulate and monitor the Insurance Sector

    are vested in the Insurance Ordinance, 2000 and the Companies Ordinance, 1984. SECP is

    an autonomous statutory body established through SECP Act 1997. It also regulates, besides

    insurance, corporate and financial sectors and all corporate entities across Pakistan,

    including the securities market, non-banking finance sector, stock markets, credit rating

    agencies, brokers (including insurance brokers), surveyors (including insurance surveyors)

    and auditors.

    5.2 SECP, being the apex regulator of the insurance industry, has a strategic priority and commitment to strengthen and maintain an effective regulatory environment in which

    insurance and takaful business can flourish and prosper in Pakistan. SECP has established an

    Insurance Division headed by a Commissioner. The current Insurance Commissioner is Mr.

    Mohammed Asif Arif. The Insurance Division is been divided into two main departments; (i)

    Policy, Regulation and Development Department, and (ii) Supervision Department.

    5.2.1 Insurance Ordinance 2001: The insurance ordinance 2001 brought in more comprehensive approach in governing the insurance sector of Pakistan. It clearly set out

    rules and regulations in order to support sector growth while at the same time protecting the

    policyholders. The objective was to strengthen the foundations of the industry. Thereon, the

    insurance rules 2002 further elaborated the scope of the regulations. They also laid ground

    for the Takaful operators for which detailed rules were published in 2005. The insurance

    ordinance 2000 (along with amendments later on) became effective with some of the

    important highlights. SECP, while exhausting its monitoring responsibilities, issued orders to

    many companies prohibiting them to underwrite any insurance business, and has so far

    cancelled licenses of ten insurance companies who failed to comply with various

    requirements contained in the insurance ordinance and allied laws and regulations.

    Moreover, the Commission has also addressed various issues through formulating rules and

    regulations pertaining to bancassurance, micro-insurance, takaful, and is also working on

    terrorism pool like concepts. The following are the important areas that SECP has taken a

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    serious note of:

    5.2.2 Minimum Paid-up-Capital Requirements: The insurance ordinance 2000 required stepped increase in the paid-up-capital in life and non-life insurance companies, through a

    circular in 2007 as shown in the following table. While most of the medium to large

    companies did comply with the requirements, by issuing bonus shares (as allowed by huge

    reserves in hand) or fresh cash injection by the sponsors. However, some of the small players

    were forced to take exit due to non-compliance24

    . At end-Dec-11, although most of the

    insurance companies achieved paid-up-capital of PKR 300mln, the equity base of approx.

    five insurance companies were lower than the paid-up-capital due to losses mounting from previous years. However, the regulation was silent in this regard and no action was seen

    from the regulator side.

    5.2.2.1 Going forward, the Commission is considering to take up another round of increase in MCR (expected: PKR 500mln); which would be a challenge for many small companies to

    follow. This may trigger mergers and/or acquisition, if the sponsors of these companies fail

    to inject (/mobilize) fresh capital; equity positions are already weak. Furthermore, if the

    regulator takes up a more prudent stance by requiring the equity (instead of paid-up-capital)

    as the base of compliance, seven insurance companies would fall under the ambit of non-

    compliance.

    5.2.3 Solvency Requirements: The ordinance provided detailed requirements to be met for the purpose of solvency. It laid the admissible assets which can be used for the purpose of

    preparing solvency statements to be submitted to the regulators. As a general rule, the

    admissible assets should be able to meet all the liabilities of the insurer. Although the

    requirements have been revamped, making adjustments according to changing financial and

    economic environment, strict compliance thereof remains to be seen.

    5.2.4 Sound and Prudent Management: While addressing operational issues, the Commission now requires all executives of an insurance company to be more experienced in

    the relevant field, while eradicating conflict of interest. This is the first step that SECP has

    taken in bringing operational excellence in the insurance industry.

    5.2.5 Miscellaneous: The ordinance provides complete framework on all the possible issues the industry may face with amendments being made periodically. This includes

    providing criteria for agents, reinsurers, statuary deposit requirements and offences.

    5.3 Insurance Association of Pakistan (IAP): Before 1947, there were three Insurance Associations in the subcontinent at Calcutta, Bombay and Madras; Bombay Association had

    a branch in Karachi. After the establishment of Pakistan, the Insurance Association of

    Pakistan was formed and inaugurated in 1948.The Insurance Association of Pakistan is a

    forum for the exchange of information, knowledge, experience and statistics among its

    members. IAP provides a professional platform to guide the members in technical matters

    related to industry.

    5.4 The IAP is managed by 6 committees; 2 Executive and 4 Technical. The Executive Committees include one at the national level and one at the regional level. Whereas the

    24

    SECP has issued orders to cease operations of four insurance companies, which have been challenged in the court of law by the insurers;

    it is pending final decisions.

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    technical committees include (i) Accident Committee, (ii) Property Committee, (iii) Marine

    Committee, and (iv) Life Committee. Elections are held yearly to induct members in these

    committees. The committees provide statistics to the members, conduct workshops, and also

    address members in the developmental areas. IAP presented its three year goal and plan in

    2010, which is part of its five year plan being set earlier and presented below.

    Association Functions

    Insurance

    Association

    of Pakistan

    (IAP)

    Five year goal and developmental plan set out by IAP is:

    1. To have in place a practicable and effective Code of Conduct and to evolve a process for its strict adherence/compliance by its Members

    2. To ensure that IAP Members fully understand and adhere to the regulatory requirements, thus managing their business based on

    sound financial footings with a keen emphasis on the best practices

    of corporate governance.

    3. To initiate and develop a comprehensively planned campaign of insurance to create awareness amongst the public to impart its

    advantages focusing on specific products and quality customer

    service.

    4. To ensure that current and future Human Resource needs of the Insurance Industry are adequately met.

    5. To stop the Motor Third Party Insurance extended by fraudulent or unrecognized insurance representatives.

    6. MANAGEMENT

    Experienced Human

    Resource

    Moving towards insurance

    related

    professional

    qualification

    Committee Structure in

    place

    6.1 HR Profile: The industry has been in existence in the region even before the creation of Pakistan. This has provided ample time for the industry participants to mature in

    terms of human resource; however, professional qualification had been a neglected area. The

    trend has been taking a shift. Now, the top reputable insurance firms are hiring qualified

    MBA-IRMs (Insurance and Risk management), ACII (from Chartered Insurance Institute -

    UK), CPAs, FCMAs, MPAs and MCP individuals. Some entities offer sponsored programs

    for its employees to achieve professional diplomas such as insurance diploma from Chartered

    Insurance Institute, London. The growth of health segment has also included doctors in the

    human resource pool having insurance related diplomas. Likewise, life insurance companies

    employ human resource related to actuarial sciences.

    6.2 Management: The general insurance industry model is not a complicated one in Pakistan and most of the business is reliant upon marketing efforts. Karachi being the largest,

    industrial and coastal city captures most of the insurance business in Pakistan. Since the

    industry in early days was dominated by marine business, Karachi remains the hub. Even

    today, most of the companies are located in Karachi with branch operations around the

    country.

    6.3 Management Committees: The sector often manages its operations through committee structures; Underwriting Committee, Claims Committee, and Re-insurance/Co-

    insurance Committee. These committees focus on areas such as underwriting, claims and

    reinsurance. These committees have been mandated in 2001 through the insurance ordinance,

    which has enabled the industry participants evolve strategic solutions to large risks.

    7. SYSTEMS AND CONTROLS

    Increasing trend

    7.1 Traditionally, the insurance industry in Pakistan had a great reliance on physical record system. With the promulgation of insurance ordinance in 2001, the industry was made

    to adopt sophisticated records and registers; premium register, claims registers, etc.

    Gradually, with the passage of time, with increasing competition, it became inevitable for the

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    towards advanced

    IT solution

    Real time and integrated

    insurance system

    Inter-company reconciliations a

    neglected area

    industry players to take proactive approach towards decision making system and achieve a

    competitive advantage. For this the industry had to make use of the standalone computers

    and later on moved to insurance solution on advanced technology.

    7.2 To date, the IT infrastructure has been upgraded with a significant margin. A real time insurance solution has been deployed by most of the players, using client/server

    technology, and capable of running in centralized and distributed environments. The most

    common insurance system being used in the industry is the General Insurance System (GIS),

    developed by Sidat Hyder and Morshed Associates. It has released various versions with

    changes in its modules from time to time. However, some large insurance companies have

    moved to relatively customized and sophisticated systems. The expansion of business

    requires more control and real time processes, which are often beyond the reach of general

    systems. This flexibility also allows implementing hybrid control systems with variation of

    centralization and decentralization mode of mechanism.

    7.3 Although the industry is taking a major shift towards automation of information processing and MIS system, the complete transformation would take time in bringing in the

    advanced level analytical decision making platform. A special attention is required for

    sophisticated MIS related to claims. Furthermore, a large number of to-and-fro transactions25

    are taking place between the insurance companies in the capacity of reinsurer (facultative26

    )

    and co-insurer (own lead/ others lead27

    ). However, the industry is deficient of advanced tools

    and procedures to keep the inter-company balances reconciled; making the balances continue

    to appear in the accounts in disputes. Moreover, claims remain subject to long procedures

    and delays in assessment processes, which most of the times remains uninformed by the lead

    co-insurer to other participant co-insurers.

    8. BUSINESS RISK PAKISTAN

    Top five insurers

    dominating with

    more than 70%

    market share

    Customers having high

    bargaining

    power

    SECP assumes absolute

    authority to

    grant license or

    cancel it, as

    allowed by the

    law

    8.1 SECTORS STRUCTURE: In the past, the industry comprised reputed families generating business mainly through personal contacts while the premium rates were fixed

    (per type of risk) by the Insurance Association of Pakistan (IAP). However, the situation has

    changed entirely, when financial institutions entered the sector. Now, most of the business

    line insurance is referred through the financial institutions; mainly commercial banks.

    Moreover, most of the conglomerates have established their captive insurance companies.

    Besides providing sustainable group premium to these captive insurance companies, the

    inclusion of financial institutions (especially commercial banks) in the group helps providing

    ready platform in referring business to these companies. Although these captive companies business portfolios have grown in recent years to attain the mid size, a majority of private

    sector insurance premium is still generated by top three insurance giants (market share;

    CY11: 65%, CY06: 70%). Whereas, all public sector business is underwritten by one state

    owned insurance company (CY09: PKR 6,034mln28

    ). With the growth of captive companies

    and other emerging players in recent years, the private sector insurance has become highly

    concentrated with top ten insurers29

    occupying more than 80% of the general insurance

    market (CY11).Although insurance penetration is very low in Pakistan, it contributes to the

    economic progress of the country and plays an integral role towards economic, social and

    technological progress. Without insurance cover major industrial, economic and social

    activities could be jeopardized due to high level of risk involved and no fall back avenue.

    8.1.1 Insurance market: The industrys major customers are the commercial banks and other financial institutions, since more than half of the industrys premium is referred through them. At the same time these banks may be placed in the shoes of suppliers. Large

    25

    Premium (receivable/payable),Claims (receivable/payable), Commission (receivable/payable)

    26any insurance company can accept facultative business from other insurance companies in Pakistan, whereas, the treaty arrangement

    can only be executed by Pakistan Reinsurance Company Limited and/or other Reinsurers around the globe

    27A leader in coinsurance arrangement (may/ may not) manage the cash from the client and distribution among other coinsurer, though

    retains liability pertaining to its own share only 28

    Latest available data 29

    Insurance Association of Pakistan registered companies are 29 (total 34 private sector insurers including three takaful operators)

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    Industry Dominated by

    Fire & Motor

    segment

    Profitability rests on

    investment

    income as it

    compensates the

    declining

    underwriting

    revenues

    Investment strategy:

    conservative

    insurance companies, in addition to financial institution business, are directly contacted by

    the large corporate and multinationals within Pakistan. The commercial banks, along with

    using insurance in managing its own operational risk, undertake insurance solutions as a risk

    mitigating tool for the securities underlying their lending portfolio e.g. stocks pledged,

    machinery mortgaged, etc. Although the policyholder would remain the borrower of the

    bank, the need and adequacy of the insurance cover is required by the banks. The

    commercial banks, after having faced heightened losses from non-performing advances and

    financial market turmoil, have moved towards centralization. The advice for grant of

    insurance contract for banks customer, which was previously designated with the banks branch managers, now, mostly resides within the head office risk management department;

    which has formulated more sophisticated criteria while awarding contract of insurance. Most

    of the banks maintain a panel of insurance companies which incorporates maximum limit of

    business for each insurance company; a concept of diversification of risk. Although the

    policyholder has freedom to choose any insurance company with the limits, mostly relies on

    bankers.

    8.1.2 SECP in the shoes of Supplier: Securities and Commission of Pakistan (SECP) may be considered as the key supplier for the industry, through providing license to carry out

    insurance business in the country. SECP monitors these companies for the regulatory

    compliance and has the authority to cease the operations of the company. To date the SECP

    has issued orders to 8 companies prohibiting them to underwrite any insurance business and

    has sanctioned winding up orders to 10 insurance companies. Additionally, it also works for

    establishing a conducive environment for the industry to flourish. It can dictate, being the

    regulator, any condition to be refrained from or to comply with. If SECP cancels the

    insurance business license, no company can carry out this business in Pakistan.

    8.1.3 Demand and Supply Dynamics: Insurance industry in Pakistan has been facing increasing level of competition in recent years. The insurance sector has picked up its

    momentum since 2001, when SECP took charge of the sector. In countries, where insurance

    penetration is high, the regulator plays a critical role in making insurance mandatory for

    some segments. In this front, SECP has been lagging behind. Additionally, the dynamics of

    intrinsic supply are one of the reasons of low penetration in Pakistan; insurance supply is

    limited because of moral hazards.

    8.1.4 Although the industry is dominated by few players, all of them compete with each other. Moreover, the influx of financial institutions led business has improved knowledge

    about products, price and cost. High insurance rates induce policyholders to seek substitutes

    such as loss prevention, business continuity plans, etc. The traditional business line of

    insurance solutions are homogeneous with standard terms of the insurance policies,

    mandated by law, and, hence, can be readily replaced from one insurer to another. The

    situation has further aggravated on the back of slow GDP growth and muted growth in the

    advances portfolio of the financial institutions, and, hence, declining demand of the

    insurance products. Accordingly, the industry, in order to attract its customers, has entered

    into rate cutting war. This is also reflected in low gross premium per Rupee of risk

    underwritten on average for the industry30

    (fire: 0.3%, marine: 0.2%, motor: 5.1%, health:

    5.3%, others: 0.8%), which has declined significantly in recent years.

    8.2 BUSINESS GROWTH AND OTHER TRENDS: The sector witnessed accelerated growth and robust profitability soon after the introduction of insurance ordinance in 2001 as well as

    in unison with benign economic environment. The industrys premium grew inline with GDP growth, reflecting high correlation. By 2004-05, the conducive business and economic

    environment spurred growth in various sectors including real estate, telecommunication,

    automobile, agriculture, and large scale manufacturing. The marine and accident business

    almost doubled in the period. Higher production and demand in automobile industry (local

    30

    Based 65% market shareon premium

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    and imported) lead to robust growth in motor segment. Until 2007, when the GDP growth

    remained above 5% mark, the industry kept on capitalizing the intrinsic strength of the

    industrial and the trade sector. From that time onwards the economic growth started to slow

    down by a significant gap and the inflation rate touched its peak at 20% in 2008. Meanwhile,

    the assassination of former Prime Minister Benazir Bhutto ignited riots in the country (Dec-

    07), causing damage of billions of rupees, forced the insurance industry to rethink and

    reshape its underwriting practices and a focus towards cautious underwriting approach.

    Moving on, the industry suffered natural calamities (floods 2010 & 2011) damaging property

    and lives resulting in losses for the industry and negative real premium growth.

    Nevertheless, the growth trends have shown revival in 2011 with positive growth number

    outpacing real GDP growth. Whereas, the premium correlation with GDP has been thinned

    down (CY04-CY11: 0.05%). This is

    not the case with regional players,

    emerging markets and developed

    economies, where correlation is

    higher than in Pakistan.

    8.3 BUSINESS MIX AND SEGMENTS GROWTH:

    8.3.1 Fire: Until CY08, the industrys premium was earned from fire and the motor segment alike

    (31% and 32%, respectively). Even

    in economic conditions as

    challenging as these, however, the

    industry didnt wait for the rising tide to lift all boats to bolster their

    topline. Over the years segmental

    31%

    34% 37% 42%

    32% 28% 26%24%

    23% 26% 24% 23%

    14% 12% 13% 16%

    0%

    10%

    20%

    30%

    40%

    50%

    60%

    70%

    80%

    90%

    100%

    2008 2009 2010 2011

    Industry's segments and composition

    Marine

    Misc.

    Motor

    Fire

    (30)

    (20)

    (10)

    -

    10

    20

    30

    40

    50

    60

    70

    -15%

    -10%

    -5%

    0%

    5%

    10%

    15%

    20%

    25%

    30%

    35%

    2004 2005 2006 2007 2008 2009 2010 2011 2012E

    GP

    W P

    KR

    bln

    Gross Premium Growth and relationship with Economy

    GPW (R.H.S) Nominal GPW Growth Real GPW Growth Real GDP growth (%)

    correlation cofficient (7yrs): 0.04%Source: Swiss Re Sigma 3/2012 and SBP (2012E PCRA Team's own estimate )

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    mix has tilted more towards the fire segment (CY11; fire: 42% and motor: 24%). Although

    the average premium rate31

    is low in the fire segment (CY11 industrys average: 0.3%), the business from the construction sector picked up momentum (FY11: 6%

    32) due to

    rehabilitation of the flood affected areas, increased investment in small scale construction;

    generating business avenues for the fire segment. Moreover, accelerated investment in the

    power sector (CY09 to CY11: USD 2.8bln33

    ) spurred insurance premium in the segment.

    The motor insurance is the second largest segment of the insurance industry, whose

    contribution has declined over the years.

    8.3.2 Motor: The motor insurance segment is facing stagnation on the back of decline in consumer financing (auto loan/ auto leasing). The Motor insurance, in Pakistan has

    traditionally been dependent on the financial institutions auto leasing, which kept its growth in check. Keeping note of the fact, the large industry players have initiated concerted efforts

    to tap the huge potential inherent in personal line insurance. In the last four years, auto loans

    has declined by 21% (CAGR) which directly impacted the insurance business prospects in

    the segment, whereas, the vehicles offtake has been on the rising side; offering huge

    untapped potential for the industry players. This is why the average premium rate in the

    segment has been adjusted downwards to 4.9% in CY11 from 6.7% last year.

    8.3.3 Miscellaneous and Marine: Amidst various challenges for the

    insurance growth, the industry

    continued to explore new avenues

    and develop specialty products to

    generate additional sales. In this

    regard, the miscellaneous segment

    has received due attention of the

    industry players, bringing innovation

    to their product lines especially in the health segment achieving appreciable response from the

    market. A major proportion of the

    health business comprises health

    coverage for corporate customers, on

    the personal lines side; new products

    31

    Gross premium as %age of sum insured based on PACRAs universe constituting more than 60% of market share in terms of premium 32

    Economic Survey of Pakistan 33

    NEPRA State of industry report 2011

    -

    2,000

    4,000

    6,000

    8,000

    10,000

    12,000

    14,000

    0

    25,000

    50,000

    75,000

    100,000

    125,000

    150,000

    175,000

    CY08 CY09 CY10 CY11

    PK

    R m

    ln

    Nu

    mb

    er

    of V

    eh

    icle

    s

    Motor Insurance Growth | Vehicles offtake

    Vehicles Offtake Motor Insurance (R.H.S)

    Linear (Vehicles Offtake ) Source: Pakistan Automotive Manufacturers Association (PAMA)

    -

    2

    4

    6

    8

    10

    12

    -

    10

    20

    30

    40

    50

    60

    70

    80

    90

    100

    CY08 CY09 CY10 CY11

    PK

    R b

    ln

    PK

    R b

    ln

    Motor Insurance Growth | Auto Loan

    Auto Loans by Banks/Fis (outstanding at year end)

    Motor Insurance (R.H.S)

    Linear (Auto Loans by Banks/Fis (outstanding at year end))

    Source: State Bank of Pakistan (SBP)

    -

    1,500

    3,000

    4,500

    6,000

    7,500

    9,000

    10,500

    -

    10,000

    20,000

    30,000

    40,000

    50,000

    60,000

    70,000

    CY08 CY09 CY10 CY11

    PK

    R m

    ln

    US

    $ m

    ln

    Marine Insurance | Pakistan's Trade

    Pakistan's Exports Pakistan's Imports

    Marine Insurance Source: State Bank of Pakistan

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    are being launched to offer individuals various health insurance solutions. Now, many of the

    players health portfolios occupy more ten percent share of the respective business book. The premium quotes are better than any other single large segment in Pakistan provides high cashflows to the insurer, though loss ratio is higher. On the other side, the business from

    marine insurance though experienced volumetric growth, the rates squeezed down, touching

    as low as 0.1% on average. Whereas during CY09, the ship breaking business was increased

    (not reflected in the graph above), which made the marine insurance business grow despite

    decline in overall trade business in the country.

    8.4 PROFITABILITY OF THE SECTOR IN PAKISTAN: The size of topline is very important in deriving profitability in any

    business. However, this

    phenomenon becomes more

    critical when it comes to the

    insurance sector. Moreover,

    higher the premium rate so will

    be the underwriting profits;

    adequately pricing risk

    underlying the insurance policy

    as well as covering the

    acquisition costs and expenses

    would generate profits.

    However, the Pakistans industry premium rates have been

    declining year on year basis, as

    depicted by adjacent graph.

    Accordingly, the loss ratio has

    been following

    an increasing

    trend. Until

    2006, the

    industry

    continued to

    generate

    positive

    underwriting

    results

    (combined ratio:

    97%34

    ), which

    was topped up

    with robust

    investment

    income (74% of

    NPR) making

    the operating

    ratio to stand at

    23%. However,

    the situation has

    turned worse

    and worse year

    by year since

    34

    Combined ratio above 100% means underwriting is in losses. Combined Ratio is calculated as all expenses (claims, commission,

    management and admin expenses as %age of premium)

    0.0%

    0.1%

    0.2%

    0.3%

    0.4%

    0.5%

    0.6%

    0.7%

    0.8%

    2008 2009 2010 2011

    Sector's Average Premium Rate

    Average Premium rate*

    *GPW as %age of Gross Sum Insured (PACRA's universe )

    -24,000

    -16,000

    -8,000

    0

    8,000

    16,000

    24,000

    32,000

    40,000

    48,000

    -75%

    -50%

    -25%

    0%

    25%

    50%

    75%

    100%

    125%

    150%

    CY06 CY07 CY08 CY09 CY10 CY11 CY12*

    PK

    R m

    ln

    Performance - Private Sector

    GPW (R.H.S) Pre-Tax profits (R.H.S) Loss Ratio Combined Ratio Operating Ratio

    Stock Market Crash

    Stock Market Boom

    Political leader assasination led riots

    Floods

    *annualized 9M12

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    then.

    8.4.1 In 2007, the assassination of a political leader, Ms. Benazir Bhutto, led tremendous riots, causing the loss ratio to jump over 70%; a significant drag on the underwriting

    profitability (combined ratio: 106%). However, the stock market remained at boom

    throughout the year until the assassination incidence at end-Dec07, resulting into huge

    investment income for the industry (1.7times of Net Premium). The entire investment

    income comfortably absorbed the net burden on Pakistans industry players, though adequate reinsurance treaties in place at that time were the major stabilizer to the bottomline.

    8.4.2 The suffering of the industry didnt stop there, and in 2008, the country was hit by a paramount crash in the stock market in Aug-08 which inflicted nearly 50% loss of the

    investment book. The large players had more than 75% of the book invested in equity

    market, and the investment loss wiped away 20% of the net premium (NPR); the industry

    experienced worst loss in the bottomline in the last two decades, though the intrusion of

    SECP saved the industry by relaxing the requirement to fully record the impairment on

    equity investments. SECP allowed to defer some portion of the total charge till one year, to

    be recorded on quarterly basis after adjusting any reversal in the stock market.

    8.4.3 Although in 2009, the country remained insulated from any major incident, the low premium rates and negative growth in real GPW resulted in underwriting losses for the

    industry. Then, the industry was working to rationalize the investment book by investing in

    risk free Govt securities and mutual funds. Though underwriting remained in losses, the

    bottomline posted positive results on the back of revival in the stock market.

    8.4.4 The industry had not even took a complete sigh of relief when the industry got another shock from huge devastation caused by floods in 2HCY10. The premium rates had dropped

    further down amidst rising competition, which further made the situation poor. Although the

    loss ratio was lower at 63% than previous high in 2007 (71%), the combined ratio crossed

    the previous highest (CY10: 108%, CY07: 106%). Nevertheless, the rationalized low risk

    investment portfolio generated investment income at 20% of NPR, bringing the bottomline

    in positive territory.

    8.4.5 During 2011, the industry has resumed its position by depicting a positive growth in real GPW (2.9%). Moving on in 2012, the sector is expected to sustain the growth trend

    (2012E: 10%, 2011: 11%) and the private sector is projected to report a GPW close to PKR

    47bln. The combined ratio is still sticking above 100% although loss ratio has further

    improved. However, with reference to investment income, the resilience in the Pakistan

    stock exchanges has supported the insurance sector to take an opportunistic move and gain

    out of cautious trading activity. Moreover, stable stream of income from money market

    mutual funds and government securities is providing persistence to the bottomline.

    Resultantly, the operating ratio of the sector significantly improved to 77% (2011: 85%,

    2010: 87%). Nevertheless, the insurers had a stark reminder that they cannot rely on

    investment income alone to deliver results; they must refocus on the core drivers of

    operational excellence, especially the factors that drive underwriting ratios, to achieve

    sustained growth. Many of top players are working on solid ground in improving

    professional excellence and revamping operational efficiencies, revisiting risk management

    practices.

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    9. RISKS

    Declining premium rates

    Catastrophe risk

    Reinsurers statistics reflects

    potential change

    in treaty

    arrangements

    and/or other

    conditions

    Intercoperate debt

    reconciliation

    system

    inefficient

    Regulatory Risk

    9.1 From the above discussion we can clearly establish that the business avenues have been opening up in the fire, marine and the miscellaneous segments, though motor have

    declined. Despite this the real GPW has showed very slow growth, attributable to inadequate

    premium pricing owing to heightened competition amongst large (dominating) industry

    players. These results into high expense ratio and, hence, negative underwriting profitability.

    If the trend continues for long the sector may face sustained trend of loss in the combined

    ratio.

    9.2 Pakistans insurance industry

    depends heavily on

    reinsurers muscles.

    Treaty arrangements

    with reinsurers of

    international repute and

    sound financial strength

    have stabilized heavy

    losses in the past. The

    declining trend of

    commission income is

    reflecting that reinsurers

    have taken a

    conservative view on

    Pakistans market. Since CY11, the reinsurers loss ratio has been

    sustained at ~60%;

    which is high keeping

    the history in view. If

    the industry continues to transfer heavy losses to reinsurers, caused by squeezing premium

    rates and/or rising catastrophe risk, it is likely to put further pressure on treaty terms. The

    situation at Pakistan becomes more relevant for the reinsurers as they are already faced huge

    losses from catastrophic blows in many of the countries all across the world. There must be

    pressure on these reinsurers to review their risk management practices and policies and adjust

    their pricing strategies in order to remain profitable.

    9.3 According to experts, Pakistan is exposed to catastrophe risk; earthquake, floods, and wind storms. The major risk emanates from floods which have been hitting the industry from

    the last three years consecutively, followed by monsoon rains each time. Although, the key

    players are taking pre-emptive measures to obtain reinsurers cover (Nat Cat, etc), absence of

    sophisticated tools within the industry for identifying the area of risk, estimating the

    maximum probable loss (MPL) keeps the arrangement relatively less effective. This leaves

    the industry facing risk to catastrophe damages.

    9.4 The industry has been witnessing surge in inter-company debt balances since CY07 and reached a record level in CY10 an event of historical loss year for the industry. Keeping in view the circular nature of the debt, major portion going bad would impact the

    small industry players.

    65%

    59%

    54%

    79%

    52%

    61%63%

    46%

    36%

    96%

    38%

    59%

    24%

    17%13% 13% 14% 14%

    0%

    10%

    20%

    30%

    40%

    50%

    60%

    70%

    80%

    90%

    100%

    2007 2008 2009 2010 2011 1H12

    Analysis of impact on Reinsurers of rising losses in Pakistan

    Gross Loss Ratio Reinsurers' loss ratio Commission income from Reinsurers

    A sample of large insurance companies (80% market share) likely to influence large reinsurers'

  • The Pakistan Credit Rating Agency Limited

    GENERAL INSURANCE

    GENERAL INSURANCE Page 18 of 18

    December 2012 www.pacra.com

    9.5 Some of the small industry players are already

    going through financial distress

    in the wake of tightening in the

    pricing strategy, squeezing the

    fiscal space, and, hence,

    declining equity due to losses.

    The business profile of these

    companies leaves a nominal

    room to increase the paid-up-

    capital, if the SECP further

    increases the minimum capital

    requirements (MCR), the

    sponsors support (fresh equity) would be inevitable in order to

    avert regulatory no-compliance.

    Furthermore, if the regulator

    comes up with a stricter stance,

    requiring equity (instead of

    paid-up-capital) to be

    maintained above a threshold,

    the risk would penetrate to a

    greater number of insurers.

    (1,000)

    -

    1,000

    2,000

    3,000

    4,000

    5,000

    CY08 CY09 CY10 CY11 1H12

    Inter-Company Debt

    Amounts Due to other Insurers/Reinsurers Amounts Due from Other Insurers/Reinsurers

    Net payable/ (receiveable)

    Insurance SS-Cover Page.pdfInsurance sector-Table of Contents.pdfG.Insurance_Summary Page_Oct12_6Feb13.pdfG.Insurance_sector study_Oct12_6Feb13.pdf