Promoting the Growth and Competitiveness Of the Insurance Sector in the Arab World

Transcription

1 Perspective Peter Vayanos Promoting the Growth and Competitiveness Of the Insurance Sector in the Arab World

2 Contact Information Beirut Peter Vayanos Partner

3 Promoting the Growth and Competitiveness of the Insurance Sector in the Arab World Insurance is one of the cornerstones of the modern-day financial services sector. In addition to its traditional role of managing risk, the insurance sector promotes longterm savings and serves as a conduit to channel funds from policyholders to investment opportunities, including mortgage lending. Accordingly, a thriving insurance sector is not only evidence of an efficient financial services sector, but it is also a key enabler of a healthy economy. Insurance in the Middle East and North Africa (MENA) region has traditionally lagged in growth and development relative to other elements of the region s financial services sector. This is evidenced by the low level of demand as measured by penetration and density levels, undercapitalized supply, and generally underdeveloped legal and regulatory environments. This paper outlines a set of policy recommendations to be adopted to promote the growth and competitiveness of the insurance sector in the MENA region. We begin by reviewing and assessing the existing state of the insurance sector across the region. Thereafter, we examine the key enablers that underpin a successful insurance sector before recommending policy changes for the MENA region. 1

4 Review and Assessment The locally admitted insurance market of the MENA region is small and underdeveloped. According to the Swiss Re Sigma report and other publicly available information, the total gross premium income of the MENA region amounted to around US$9 billion in This compares with US$47 billion for the countries of Middle and Eastern Europe, and US$1,177 billion for the initial 15 countries of the European Union (EU). In terms of share of the world market, the MENA region accounted for roughly 0.26 percent in Exhibit 1 compares the size of the insurance markets of major regions of the world. A measure of the development of an insurance sector is insurance penetration, defined as gross premium income (GPI) as a percentage of gross domestic product (GDP). When comparing the MENA region with other regions of the world, Exhibit 1 Gross Premium Income by Region, 2005 (US$ billion) 1,222 1,241 1, North America Western Europe EU 15 Central and Eastern Europe Middle East and North Africa Source: Swiss Re, 2006b; Bahrain Monetary Agency, 2006j. 2

5 this measure reveals the extent to which the MENA market is underdeveloped. In 2005, the level of insurance penetration in the MENA region was approximately 1 percent, compared with an average of 6 to 9 percent in industrialized countries and 2.5 to 4 percent in emerging markets. Exhibit 2 compares GPI as a percentage of GDP for major regions of the world. To better understand the insurance sector of the MENA region, we assessed the existing state of the market from a demand-and-supply perspective. This assessment revealed a number of findings that are unique to the region. Although there are differences between countries, these findings are present to a greater or lesser degree in each of the countries of the region. The Market Is Growing and Has Significant Potential for Future Growth The markets of the MENA region, albeit small, are undergoing rapid growth. Many countries in the region experienced double-digit growth between 2004 and Furthermore, this growth has not been limited to the most recent years: Between 2000 and 2005, the insurance market in the Exhibit 2 Gross Premium Income as a Percentage of GDP (2005) 8.97% 8.64% 8.44% 2.66% 1.05% North America EU 15 Western Europe Central and Eastern Europe Middle East and North Africa Source: Swiss Re, 2006b; Bahrain Monetary Agency, 2006j. 3

6 MENA region grew at a compounded annual growth rate of 12.5 percent. Exhibit 3 illustrates the size of the market by country for 2004 and 2005, and the growth rates between 2000 and Further growth is expected during the foreseeable future, fuelled by a combination of factors, including the following: Macroeconomic growth. Aboveaverage levels of macroeconomic growth will spur the demand for insurance. In particular, many countries in the region, especially the energy-rich countries of the Gulf, are witnessing large investments in infrastructure and growing trade internationally and across the region. Both of these Exhibit 3 Gross Premium Income of MENA Countries (US$ billions) CAGR % 19.6% 18.1% 16.2% KSA UAE Kuwait Qatar* factors will create strong demand for insurance coverage. Emergence of compulsory insurance classes. The recent introduction of compulsory insurance classes, principally automotive and health insurance, in many countries of the region will drive the demand for insurance on the retail side and make these the largest classes of insurance in the marketplace. By way of example, we estimate that in Saudi Arabia, by 2009, the combined health and automotive market could represent up to 75 percent of the total insurance market of around US$4 billion. Privatization and restructuring of government pensions. Government privatization programs will serve as a catalyst for the development of the insurance sector, since entities that were formerly self-insured will now require insurance coverage. In the future, the expected restructuring of state pension funds and the reduced role of the state in providing pensions will also lead to rising demand for life insurance and longterm savings products. Growth of financial services. The growth in asset-based financing, such as housing and auto loans, will lead to an increase in the demand for insurance products to mitigate the risks associated with the underlying assets. From a slightly different perspective, the emergence of the capital markets has provided an alternative source of investments for insurance companies. Although the emergence of the capital markets will not in itself drive demand for insurance, the maturing of these markets will provide opportunities for insurance companies to diversify the sources of their investment income. Demographics of the region. The population of the MENA region is generally very young. As the population matures, the demand for insurance products will increase. 12.4% 12.6% 7.1% 16.0% 5.5% 8.9% 13.1% Oman Bahrain Lebanon Jordan Egypt Morocco Tunisia Despite the recent rapid growth of insurance in the region, the market still has significant potential for future growth. As mentioned above, the level of insurance penetration (GPI/GDP) is very low in the region. Exhibit 4 compares the countries of the MENA region with selected other countries and reveals the sector s future growth potential. 17.0% Algeria Source: Swiss Re, 2006b; analysis. * Qatar CAGR (compound annual growth rate) is for , as 2000 data are not available. Another indicator of the potential for future growth is the level of insurance density, measured in terms of GPI per capita. In 2005, the insurance density in the Middle East ranged from US$10 to 4

7 US$440; this compares with a range of US$40 to US$1,000 in Eastern Europe, US$1,400 to US$5,500 in Western Europe, and US$2,400 to US$2,900 in North America. Exhibit 5 presents a comparison of insurance density for countries in the MENA region against selected other countries. Life Insurance Is Significantly Underdeveloped Life insurance has historically had limited take-up in the region, resulting in an average level of insurance penetration for life insurance in 2005 of around 0.3 percent versus 1.4 percent for general and health insurance. We believe the reasons for this low level of penetration are as follows: Shari a sensitivity. The purchase of life insurance products is strongly influenced by perceptions of whether or not the products are compliant with shari a. Similar to other conventional financial products, life insurance is perceived to have prohibited elements of uncertainty (gharar), gambling (maisier), and interest income (riba). Uncertainty stems from the notion that the outcome of the insurance contract is not known at the time it is created and varies according to the time of death of the insured. Gambling stems from the notion that the insured may gain large amounts (that is, profit) from the insurance coverage if certain events take place. Interest income stems from the notion that the premiums are invested in non-shari a-compliant interest-bearing instruments. Lack of awareness of life insurance products. A limited awareness of life insurance and its benefits among the citizens of selected countries in the region has limited the take-up of such products. This is partly driven by cultural factors, such as the reliance on the extended family network, and partly by structural factors, such as the provision of generous benefits by the state in the event of death or disability. Absence of life insurance in related financial services. Until recently, there were few related financial products (such as mortgage lending) that stipulated the purchase of life insurance to settle outstanding obligations in the event of the death or disability of the borrower. Emergence of Takaful as an Alternative to Conventional Insurance In response to shari a sensitivity, takaful a form of insurance that complies with the principles of shari a emerged as an alternative to conventional insurance. While there is limited information as to the size and penetration of the takaful market, interviews with market participants and the increase in the number of Islamic insurance companies point to rising demand for takaful. Exhibit 4 Insurance Penetration by Country (2005) Exhibit 5 Insurance Density by Country (2005) 15% United Kingdom United Kingdom USA Insurance Penetration (%) 10% 5% 0% Malaysia Lebanon Bahrain Morocco Jordan Oman Qatar Tunisia UAE Kuwait Egypt Algeria Saudi Arabia Small <1 B Medium 1 10 B Premium Value (US$ billions) Germany Spain USA Large 10 1,000 B Insurance Density (US$) 3,000 1,500 Lebanon Malaysia Tunisia Jordan Oman 0 Egypt Algeria Morocco Bahrain Saudi Arabia Spain UAE Kuwait 15,000 30,000 GDP per Capita (US$) Germany Qatar 45,000 Source: Swiss Re, 2006b; analysis. Source: Swiss Re, 2006b; analysis. 5

8 Despite the recent rapid growth of insurance in the region, the market still has significant potential for growth. Lack of qualifications, accreditations, and licensing requirements. The absence of these standards undermines the development of intermediaries because there is no way for customers to independently verify the quality of the agent or broker with whom they are dealing. Fragmented Supply Base with a Large Number of Small Competitors; Limited Presence of Foreign Insurers From a supply perspective, many markets of the MENA region are characterized by a large number of small players when measured by capital employed. Selected countries (including Egypt, Jordan, and Lebanon) have recently introduced legislation to raise the minimum level of capital. However, average levels remain very low when compared with international standards. There is also a limited presence of foreign insurers in the market in terms of market share. Furthermore, many of the international insurers have a narrow focus, particularly on the life side. Intermediary Distribution Channels Remain Informal The role of intermediaries in developing markets is important because they not only increase the distribution of products, but also serve as a means of educating customers about products. Across the region, the level of penetration of brokers and agents varies. In the cases of Lebanon and Saudi Arabia, brokers are very active, especially on the corporate side. In other markets, intermediaries are less active, and the business is driven through sales forces tied to companies. The informal conditions under which brokers and agents operate, however, are common across the region. There are a number of reasons for these conditions, including the following: Absence of regulatory frameworks to govern intermediaries. Until recently most countries in the region did not have a regulatory framework to govern the activities of agents and brokers. This in turn undermines the credibility of companies and individuals acting in this capacity. Bancassurance, or the sale of insurance products through a bank, is a similarly informal channel. Specific challenges facing bancassurance include ensuring adequate training and incentive schemes for bank staff to sell insurance products, implementing systems to facilitate the processing of policies, addressing regulatory issues such as which regulator (banking or insurance) should oversee bancassurance activities, and determining whether conventional banks are able to distribute takaful products. In summary, our assessment has revealed that the market in the MENA region is underdeveloped on both the demand and supply sides. That said, there is significant potential for future growth. Capitalizing on this potential will require regulators and policymakers to address gaps in the underlying enablers of growth. 6

9 Evaluation of the Enablers of Growth The development of an insurance market is a function of the underlying enablers of growth, and the existing state of the market is a reflection of the maturity of these enablers. We believe that there are five types of enablers that shape an insurance market (see Exhibit 6). In order to develop policy recommendations to address the underlying enablers (and consequently promote the growth and development of the market), it is necessary to evaluate the maturity of each of these enablers. Since the state of development of the enablers differs by country, it is necessary to perform this evaluation at the country level. Accordingly, we have reviewed these enablers for nine of the major countries within the MENA region. The results of this evaluation are summarized below. Legal Framework At the legal and regulatory levels, there is wide variability in the maturity of the frameworks that govern regional insurance markets. Until recently, almost all MENA countries had outdated insurance laws and regulations; some countries had no insurance law at all. Over the past few years, many countries have initiated serious efforts to upgrade their regulatory frameworks, as evidenced by the enactment of new laws. They have strengthened the independence and supervisory capabilities of regulatory entities in line with the core principles of the International Association of Insurance Supervisors (IAIS); they have also issued sector guidance notes covering, for example, governance, market conduct, and risk management. That said, there still remains a wide variation in the comprehensiveness and application of legal frameworks across the region. At one end of the spectrum, Bahrain has a well-established and applied legal framework for insurance activities. In April 2005, Bahrain issued the Insurance Rulebook, which sets out Exhibit 6 Insurance Market Enablers ENABLER ROLE SUPPORTING EVIDENCE Legal framework -Protect the rights of policyholders, regulate the activities of market participants, and ensure the financial health of the sector -Existence of an insurance law appropriate to existing market conditions -Existence of insurance regulations/implementing guidelines Regulatory bodies -Oversee and supervise the sector and ensure the enforcement of laws and regulations -Existence of an insurance regulator -Evidence of regulatory processes being applied -Evidence of an insurance judicial authority Nature of competition -Drives innovation, competitive pricing, and the adoption of best practices -Evidence of foreign insurers and the extent to which foreign ownership is allowed -Extent of private-sector involvement market share of private versus public insurers -Extent to which large, well-capitalized insurers exist Skills and training -Assess the risks to be insured -Provide customers with the appropriate products/services -Ensure the availability and development of local skills -Availability of skilled professionals -Availability of training programs, training institutes, and accreditations Market-led initiatives -Drive self-regulation and the development of the industry at the country and regional levels -Existence and application of insurance standards -Availability of insurance statistics and market data -Existence of professional associations -Existence of industry-level programs to create awareness -Existence of regional forums Source: analysis. 7

10 elaborate licensing and operational regulations for both conventional and takaful insurance. A recent report by the Financial Sector Assessment Program (FSAP), a joint venture between the International Monetary Fund and the World Bank, acknowledged the comprehensiveness of this regulatory framework 1. At the other end of the spectrum are countries such as Kuwait, Qatar, and the United Arab Emirates (UAE), whose regulations are limited. For example, in the United Arab Emirates, regulations do not require companies to adhere to solvency regulations but rather only meet minimum capital requirements. In the case of Qatar, the law lacks adequate legislation that lays out the rights and obligations of parties entering into insurance contracts. The existence of a robust and comprehensive legal framework is one of the core underpinnings of a healthy insurance market. In addition to building the confidence of local market participants, an established legal framework serves to attract international players and, at a regional level, avoid potential regulatory arbitrage. Regulatory Bodies Regulatory bodies operate in tandem with legal frameworks. Not surprisingly, the level of maturity of these bodies is a reflection of the underlying laws and regulations. The effectiveness of a legal and regulatory framework is directly correlated to the existence of regulatory bodies that can enforce the law. All the countries surveyed in this study have an insurance regulator, although the form of the regulator varies. In some countries, the insurance sector is supervised by an existing financial services regulator, such as the central bank or capital markets authority. In other countries, the sector is supervised by a government ministry. Our assessment did reveal the existence of more than one regulator with overlapping responsibilities in selected countries, which leads to inconsistent application of the regulations, potential confusion in the marketplace, and unnecessary bureaucracy for market participants. For example, in Saudi Arabia there is an overlap in the area of health insurance between the Council of Cooperative Health Insurance (CCHI) and the Saudi Arabian Monetary Agency (SAMA). This is in addition to existing overlaps between SAMA, the Capital Markets Authority (CMA), and the Ministry of Commerce. Similarly, in Lebanon, there appears to be duplication between the activities of the Insurance Control Commission and the Directorate of Insurance Affairs of the Ministry of Economy. The comprehensiveness and effectiveness of regulatory processes, especially supervisory processes, varies considerably across the region. As mentioned above, this is a function of the maturity of the underlying legal and regulatory frameworks. Countries such as Bahrain and Jordan, which have well-developed regulatory frameworks, are either applying or developing risk-based supervision processes that comply with the standards of international bodies such as IAIS. Other countries, such as Qatar, Kuwait, and the United Arab Emirates, have less-developed supervisory processes that are more administrative in orientation. The effectiveness of a legal and regulatory framework is directly correlated to the existence of regulatory bodies that can enforce the law. Within the MENA region, there is a need to upgrade the capabilities of selected regulators to ensure comprehensive and consistent enforcement of regulations. The Nature of Competition The insurance markets of the Middle East are generally competitive. This can be measured by the extent to which foreign insurers are present in the market, the level of state involvement through governmentowned firms, and the extent to which the market is fragmented. Over the past few years, countries in the region have lifted restrictions and/or moratoriums on the operations of foreign insurers. As a result, the markets of these countries are now open to foreign insurance companies, which are present to various degrees throughout the region. However, their share of the local market tends to be small; this circumstance can be traced to previous restrictions on market entry, regulations that require insurers to invest a large proportion of premiums in local markets, and the fact that the individual markets of the region may not have been attractive given their small size. With the lifting of restrictions and expected market growth, the level 8

11 of activity of foreign insurers is expected to grow significantly. In addition, foreign insurers in many cases have focused exclusively on the life business. This can be ascribed to the fact that local insurers have been less active in this area due to lessdeveloped capabilities and limited demand from nationals owing to shari a implications. International insurers also benefit from the natural affinity of expatriates, who are more inclined to purchase life insurance. The insurance sector in the Middle East is characterized by a high degree of private-sector involvement. There are notable exceptions, such as Egypt and, until recently, Saudi Arabia. In the case of Egypt, the state-owned insurers command around 75 percent of the non-life insurance market and 60 percent of the life insurance market. However, there are moves afoot to consolidate the activities of the state insurers with a view to ultimately privatizing the resulting entities. Although there is significant involvement of the private sector in the insurance industry, this is offset to some extent by a high degree of market fragmentation. In particular, many markets of the MENA region are characterized by a large number of small players when measured by capital employed. There are a number of ramifications of the current low levels of capitalization. At an overall industry level, this results either in insurance being placed directly outside of the region through international brokers or in the practice of fronting, whereby local insurers retain a small portion of the risk and transfer the remaining risk to their international reinsurance partners. As a consequence of the lack of capacity, risk-management and actuarial capabilities in the region remain underdeveloped, resulting in a disproportionate reliance on international reinsurers to assess the risks and provide appropriate pricing guidelines. At an individual company level, low levels of capitalization limit the resources available to build the required capabilities to serve customers efficiently and effectively. Encouraging the formation of large (but not dominant), well-capitalized insurers is vital to the development of the regional insurance sector, since these companies can invest in the capabilities needed to promote growth. In addition, creating the conditions to attract foreign insurers is important to ensure the transfer of skills and best practices to the region. Skills and Training Across the region, the insurance sector is characterized by a shortage of skills particularly product development, underwriting, and actuarial skills. The absence of skills clearly affects the development of the sector, specifically in the areas of product innovation, risk assessment, and pricing. This situation is exacerbated by nationalization requirements in some countries, which extend the time required to train and equip staff for key positions, and the availability of highly attractive positions in other areas of the financial services sector. The generally limited number of training institutes and the absence of international accreditations hampers the development of skills. Again, there is wide variability across the region in terms of training facilities. Bahrain stands out by virtue of the Bahrain Institute of Banking and Finance (BIBF), which offers 20 insurance programs including courses in underwriting, risk management, and information technology that meet the 9

12 Across the region, the insurance sector is characterized by a shortage of skills. requirements of four internationally recognized professional designations. The shortage of skills and limited training facilities are perhaps the greatest impediments to the development of the insurance sector in the region. Market-Led Initiatives Market-led initiatives refer to initiatives at an industry level that seek to develop the sector as a whole. This includes market standards and the availability of statistics to enable insurers to improve product development and pricing, the existence of industry associations to foster cooperation between industry players, and the existence of industry programs to create awareness among the population of the concept and benefits of insurance. Although these initiatives occur at the country level, our assessment also covered efforts to improve coordination among individual regulators and players at the panregional level. Across the region, there is a lack of reliable market data. In the markets that do collect data, the data are neither comprehensive nor sufficiently granular to provide insurers with the necessary insights to improve product development and pricing. Almost all of the region s markets either have an insurance industry association or are in the process of forming such an association. These associations play an important role in promoting the sector by facilitating cooperation between insurance companies and professionals. On the awareness level, there are limited programs in place in the countries of the MENA region. Bahrain and Jordan appear to be the only countries with formal programs in place to promote such awareness. In the case of Bahrain, the Insurance Market Development Committee (IMDC) initiated its first awareness campaign in 2005, which was aimed at increasing insurance penetration using educational messages through a specially created cartoon character, Taamina. In Jordan, the Insurance Commission (IC) has launched an awareness campaign consisting of three phases: introducing the role of the IC, raising awareness of the benefits of insurance, and introducing various insurance products to the public. Similarly, there are limited, if any, programs aimed at raising the profile of the insurance industry and attracting university/college graduates and other professionals to the industry. On a regional level, pan-regional cooperation has manifested itself in numerous forums, associations, and standard-setting organizations. Each of these bodies aims to foster the development of the regional insurance sector and promote regulatory coordination. At the regulatory level, the Arab Insurance Regulatory Commission (AIRC) was established in September 2006 with the participation of 12 countries. AIRC s objectives are to provide a forum for Arab insurance commissioners to share expertise and training programs, develop regulatory and supervisory standards, and coordinate their activities with those of international organizations such as the IAIS. At the sector-development level, the General Arab Insurance Federation (GAIF) plays a regional role, with annual recommendations geared toward the development of the insurance markets through initiatives led by the public and private sectors. Finally, regional insurance forums play a positive role by using panel of experts to address issues and emerging trends facing the markets. Key regional forums include the annual Middle East Insurance Forum and, on a Gulf Cooperation Council (GCC) level, the Gulf Insurance Forum, which is organized by the UAE-based Coordination Commission for Gulf Insurance & Reinsurance Companies. However, while there is no shortage of regional bodies, there is limited evidence of coordination among pan-regional bodies, leading to overlapping efforts and diverging priorities. In summary, our evaluation revealed that there are a number of gaps to be addressed at the enabler level. In particular, there is a need to ensure a consistent level of maturity for legal and regulatory frameworks and the concomitant regulatory bodies, as well as to address the shortage of skills in the marketplace. 10

13 Policy Recommendations to Promote Growth and Competitiveness Policymakers in the MENA region have the opportunity to play a central role in unlocking the growth potential of their respective insurance markets. We have identified a set of recommendations to be adopted by policymakers or regulators that builds on our evaluation of growth enablers and takes into account best practices from other markets. The recommendations will not apply in their entirety to all the countries of the region, given the varied state of development of individual markets. Therefore, we encourage policymakers to select the recommendations that are most applicable to their respective markets. We have grouped our recommendations within the same framework adopted for the evaluation of growth enablers. Legal Framework Enacting a modern legal framework and designating a special judicial authority to handle insurancerelated cases are key requirements to enable market development by protecting the rights of policyholders and regulating the activities of market participants. As noted earlier, there is wide variability in the maturity of legal environments across the region, and a number of countries have underdeveloped legal frameworks. Insurance regulators in such countries should seek to upgrade their legal frameworks and ensure that they reflect international best practices, such as the principles of the IAIS. In addition, policymakers should seek to establish a specialized insurance judicial authority to resolve insurance disputes in countries where such an authority does not exist. A modern legal framework should regulate all insurance market participants, including insurance companies, intermediaries, and professionals. The regulations covering insurance companies should address a number of areas, including, among others, licensing, product approval, financial reporting, investments, reinsurance, and solvency margins. In addition, and in line with IAIS principles, the regulations should stipulate the minimum internal capabilities of market players, such as governance and risk management. The regulations covering intermediaries and insurance professionals should 11

14 entail, at a minimum, qualifications criteria, licensing requirements, and a code of conduct. In countries where there is a rapidly growing demand for takaful insurance, the legal framework should also promulgate adequate legislation to address this form of insurance. There are three main challenges in takaful regulation: capital requirements, corporate governance, and consumer protection from misinterpretation. Although the underlying risk is the same, the risk profiles of conventional and takaful insurers are different because the latter has higher operational risk. It is uncertain whether this leads to increased capital requirements for takaful insurance, especially in the Al-Wakalah structure that is predominant in the Middle East. A sound governance system, including risk management and internal control processes, is crucial for meeting these capital requirements. Furthermore, the regulation has to ensure that the shari a compliance claim of a takaful insurer is valid. To do so, the operations of the shari a board have to be scrutinized by the regulator. There are two different approaches for the regulation of takaful insurance. While some countries have established a special takaful law, others have modified their existing regulatory frameworks and adjusted them to the specific needs of Islamic insurance. Whether or not there needs to be a separate takaful regulation should depend on the definition of the term insurance in the conventional regulation. Separate takaful-specific regulation is not required where takaful can be interpreted as a subset of conventional insurance. In implementing a legal framework, countries in the region should start from a compliance-based legal framework that involves setting prescriptive rules and guidelines to be complied with by the market. This is a model that is commonly adopted by newly regulated and underdeveloped markets. In such a model, for example, insurance products are subject to form and rate approval by the regulator prior to being sold in the marketplace. In time, and as the market matures, the regulatory framework can move toward a principle-based model that allows regulated entities more flexibility in meeting regulatory requirements. In contrast to the example above, this model would allow insurance products to be sold in the marketplace immediately after the regulatory filing has been completed. Regulators then would have the authority to intervene at their discretion. A critical component of the legal framework is the establishment of minimum capital requirements to give reasonable assurance that policyholders interests will be protected, and capital adequacy requirements (a solvency margin), to ensure that insurers are able to absorb significant unforeseen losses 2. In setting minimum capital requirements, regulators should consider an appropriate amount based on the characteristics of their markets and the insurance classes being regulated. In the case of solvency margins, regulators are encouraged to adopt risk-sensitive approaches. At present, there are two regimes that govern solvency requirements: Solvency I and Solvency II. Countries in the region can pursue a two-stage plan to adopt risk-sensitive solvency margin requirements. Initially, regulators should adopt 12

15 Although the insurance markets in the region are generally competitive, regulators should seek to further raise the competitive bar. an easy-to-apply solvency model (for example, Solvency I) and use collected market data to fine-tune the risk factors applied to premiums or claims by insurance class. Over time, regulators can apply more risk-sensitive formulas (for example, risk-based capital) after developing the requisite internal capabilities (in terms of data availability, advanced staff skills in risk assessment, and understanding of key risks in the marketplace) and after fostering the development of insurers capabilities (especially in terms of risk measurement). In addition to the above, MENA countries that have not established a dedicated insurance judicial authority should do so. This would require a competent judicial authority staffed with experienced insurance staff and legal professionals who have proficient knowledge and expertise in the field of insurance legislation. The chosen judicial authority can be in the form of a special court or committee that deals with insurance disputes and litigations. Such a court should be independent from the regulatory body. The court should aim to build public confidence through efficiency in handling cases, consistency in interpreting the legislation, independence, and fairness. Regulatory Bodies An empowered insurance regulator with well-developed capabilities enables market development by ensuring appropriate market oversight and enforcement of enacted laws and regulations. In parallel with upgrading legal frameworks, policymakers in the region should seek to empower their insurance regulatory bodies. The empowerment of the regulatory body should be constituted in the legal framework, which should address the body s legal form, ensure its independence, vest appropriate authorities, and clarify any overlapping responsibilities with other governmental entities. In addition, regulators should seek to enhance their capabilities, especially in the area of supervision (including staff and IT). In upgrading supervisory capabilities, regulators should take into account the guidelines set out as part of the IAIS core principles. In general, there are two approaches for supervision: an audit-based (or data-focused) model, under which the regulator focuses on data collection and ensuring compliance with the rules and requirements; and a risk-based model, under which the regulator focuses on early identification of 13

16 risk, systematic prioritization of risk to allocate supervisory resources to the highest areas of risk, and timely and proportional intervention to help reduce insolvencies. In practice, most international regulatory regimes fall within these two approaches, with developed markets gravitating toward the risk-based model. The choice of the appropriate supervisory approach should be aligned with the development stage of the regulatory body and the legal framework, insurers risk-management capabilities, the qualifications of insurance professionals, and the stage of development of the overall financial market. From an implementation perspective, MENA countries should devise and pursue a medium-term plan to apply a risk-based supervision approach. The adoption of such an approach consists of building advanced competencies in five integrated areas, which collectively provide the regulator with a risk-based view of the highest-risk insurers and the areas of greatest concern within such insurers. These areas include financial reporting, solvency monitoring, financial analysis, onsite inspection, and market analysis. In addition to the above capabilities, supervisors should design an intervention framework with clear stages that link the legal framework, supervisory approach, supervisory conclusions, enforcement powers, and actions of the regulator under various market events. The stages of intervention serve as a primary tool to ensure the consistency of supervisory actions and, when they are communicated to the market, they set market expectations in terms of supervisory responses under certain conditions. The Nature of Competition Fostering a competitive environment drives innovation, competitive pricing, and the adoption of best practices and is a key enabler for the development and growth of insurance markets in the MENA region. The ultimate objective from the standpoint of market growth should be to have a profitable sector adequately serving market demand, with local insurers equipped to withstand the competitive pressures of increasingly liberalized markets. Although the insurance markets in the region are generally competitive, regulators should seek to further raise the competitive bar through higher capital requirements and the introduction of governance and risk-management requirements. In highly fragmented markets, regulators should investigate the option of increasing capital requirements to stimulate market consolidation and increase the level of risk-retention capacity. This in turn would result in larger local companies with the resources to invest in capabilities, and would also reduce the level of fronting. On the governance side, regulators should introduce minimum governance requirements such as the establishment of internal functions (for example, an internal audit), the definition of fit and proper criteria for board members and senior management, the development of policies and procedures manuals, and the formation of an investment policy subject to review and approval by the board. In countries where there is a rapidly growing demand for takaful insurance, regulators should identify, develop, and disseminate risk-management best practices that take into account the contractual relationships of Islamic insurance products. 14

17 Skills and Training Cultivating the growth of a pool of skilled local insurance professionals is paramount to the development of the insurance sector, given the existing acute shortage of skills. Policymakers and regulators should act as catalysts in the development of professional knowledge in three ways: Setting qualification and accreditation requirements for the insurance profession. In general, it is customary to set minimum requirements for insurance professionals that go beyond general educational attainment and include specialized insurance qualifications. Regulators can influence the market in raising the standards of training programs by adopting internationally accredited programs and selectively approving local programs that meet minimum criteria. Organizing specialized training programs. Training programs can be organized by the regulator, the industry itself (such as associations of insurance companies and the companies themselves), and by the private sector as the demand for such training increases. In the absence of market-led training programs, regulators should bridge this gap by organizing accredited training programs through affiliations with specialized training institutions (for example, institutes of banking), general academic institutions (such as universities), or leading training institutions in more developed markets. In countries where the demand for takaful products is growing rapidly, regulators need to ensure the availability of training programs to educate the market on these relatively new products. Encouraging companies to build up the knowledge of their staff. Regulators can require companies to take a more active role in developing the expertise of their employees by mandating training budgets and staff training programs. These programs would be subject to audits by the regulator to ensure companies compliance. As an incentive, regulators can consider subsidizing part of the training budget through a reduction of annual regulatory fees. Market-Led Initiatives Promoting the involvement of industrywide bodies, whether at a local or regional level, is a valuable enabler for the development of the market by providing forums for the harmonization of standards and activities, and for the sharing of best practices. By definition, market-led initiatives lie outside the boundaries of regulators direct control. Nevertheless, insurance regulators can play a key role in bridging market gaps while stimulating the emergence of more-effective industry-led market development initiatives. In particular, policymakers and regulators can play a valuable role in promoting more active involvement from industry associations, encouraging the adoption of market standards, fostering the availability of granular market statistics, generating consumer awareness of insurance, and raising the profile of the industry to attract new talent. Policymakers and regulators should encourage the formation of industrywide associations as a way to harmonize the representation of 15

18 In countries where the demand for takaful products is growing rapidly, regulators need to ensure the availability of training programs to educate the market on these relatively new products. market participants. In countries where associations exist, regulators should emphasize the role of the association by channeling regulatory consultation efforts through these bodies or adopting industry standards endorsed by associations. Regulators can also mandate the adoption of internationally accepted accounting standards such as IFRS 4 issued by the International Accounting Standards Board in 2004 to ensure consistent treatment of insurance contracts and appropriate disclosure. Fostering the availability of insurance market data is a requirement for promoting better understanding of the market and supporting informed decision making. By virtue of their access to market data, regulators should support the publication of accurate, consistent, and up-todate information on the market. Some countries in the region have made significant improvements in this regard; however, the lack of good market data remains a visible weakness in many MENA markets. In addition to sector-level data, granular statistics (for example, pricing, claims, and loss statistics) are required to support product development and pricing. The private sector can fill this gap by collecting and providing such statistics. For example, a private company in the United States the Insurance Service Office (ISO) provides statistical, actuarial, and claims data. The ISO gathers information from insurance companies on hundreds of millions of policies, including the premiums companies collect and the losses they pay. In the MENA region, regulators should encourage the establishment of such specialized data services organizations and mandate that product pricing decisions be based on relevant market data and statistics. Creating consumer awareness of the advantages of risk coverage provided by insurance products and services is a key enabler to stimulate the demand side. Promoting awareness among retail consumers is particularly important in the GCC countries, where awareness of the benefits of insurance is considered low. Insurance regulators can increase awareness by launching public communication initiatives, publishing educational material, setting up a function to handle inquiries (whether telephone- or Webbased), and encouraging insurance companies to launch informative promotional programs geared at raising consumer knowledge. The programs to raise the level of awareness of life insurance in Malaysia are a good case in point. In 2003 a joint initiative, InsuranceInfo, was launched by Bank Negara (the Central Bank and 16

19 insurance regulator of Malaysia) and other industry players. InsuranceInfo covers topics such as standard life insurance, annuities, investmentlinked insurance plans, and child education plans. InsuranceInfo disseminates this information primarily through its website, as well as through booklets made available in branches of selected insurance companies and articles published in major newspapers. This program has contributed to the development of the life insurance market, which generated premiums of US$4.8 billion in 2005 more than three times those in the entire MENA region. Furthermore, policymakers should seek to promote the industry as a whole to attract talent. This can best be achieved by industry associations targeting university and college graduates through career days, internships in insurance companies, and similar initiatives. At a regional level, it is important that a standardized regulatory and compliance framework exists across the region before attempts are made to create a regional market. As such, policymakers should seek to harmonize the efforts of the many pan-regional bodies to ensure consistent attention on the key issues. Specifically, regional cooperation should focus on promoting financial stability, participating in the global trend toward cooperation and harmonization (for example, Solvency II), improving risk management and corporate governance practices, protecting the integrity of the financial systems from illegal activities, and preventing regulatory arbitrage (that is, offshore entities that seek out the least restrictive regulatory environment from which to operate locally and cross-border). Cooperation among regional insurance regulators would create significant economic advantages for their respective insurance markets. Primarily, active coordination would accelerate the development of a standardized regulatory framework and harmonize the regulatory compliance requirements, which in turn would enhance the attractiveness of the regional insurance market to international insurance groups and facilitate the formation of regional insurers. In addition, active cooperation among insurance regulators would facilitate the transfer of acquired supervisory knowledge and expertise, and improve the efficiency of supervisory activities by avoiding duplication of supervisory efforts across the region. 17

20 Conclusion The insurance markets of the MENA region show significant potential for future growth. Realizing this growth, however, will require policymakers and regulators to address the existing gaps in the underlying enablers of growth. Specifically, selected countries in the region need to upgrade their existing legal and regulatory frameworks and improve the capabilities of regulators. Similarly, there are opportunities to improve the competitive landscape and thereby drive innovation, competitive pricing, and the adoption of best practices by mandating higher capital levels and introducing governance and risk-management requirements. Across the region there is a need to address the skills shortage by introducing minimum qualification levels and fostering internationally accredited training programs. And finally, at a market level, the use of industry associations, improvements in market data, and the introduction of consumer awareness programs will go a long way toward the overall development of the sector. In the end, each country will need to chart its own course and take into account local circumstances. The speed of development of individual insurance markets will be a function of how rapidly policymakers and regulators are able to address the individual enablers of growth. 18

21 Endnotes 1 see IMF, IAIS core principal number 23. About the Authors Peter Vayanos is a partner with based in Beirut. He specializes in the development and implementation of transformation strategies for retail banks, private banks, and insurance companies and works with leading financial institutions in Europe and the Middle East. 19

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