Rewarding risk: The Russian insurance market in 2013

Rewarding risk: The Russian insurance market in 2013 June 2013 kpmg.ru KPMG in Russia and the CIS

2 Rewarding risk Introduction Adrian Quinton Partner, CIS Head of Insurance and Actuarial Services The continued strong insurance premium growth in Russia appears lucrative compared with the global average. The insurance industry is forecast to grow to RUB930bn (ex OMI) in 2013 which reaffirms Russia s place among the world s leading insurance markets. Ensuing expansion of credit lending, albeit at a reduced pace than in 2012, is cited as the prime growth driver. Despite prevailing growth, pressure on profit margins remains stubbornly intact and companies have confirmed to be diversifying focus away from solely managing premium growth towards improving profitability through mostly monitoring expenses and quantifying risk. Insurers can no longer afford to be spread across the entire market and will increasingly operate in only the segments where they have a marked competitive advantage. Client centricity, service efficiency and continuous streamlining of the cost-base are emerging as the more prominent competitive differentiators in this regard. The Russian insurance market has experienced a number of significant regulatory changes in recent years, such an increase in statutory capital, mandatory transition to IFRS and introduction of new compulsory segments, while the formation of a single financial mega regulator is underway. Despite these developments, a majority of insurance executives highlight that insurance regulation in Russia is still a factor requiring further sustained attention, particularly in the area of supervision of intermediaries and financial reporting. Continued market growth coupled with the recent relaxation in the foreign capital quota presents a window of opportunity for entry of new foreign players. Though market participants believe that M&A activity in the Russian insurance sector will pick up over 2013 2014, against recent periods, the feeling is that transactions will predominantly be among the larger domestic players. We invite you to explore these keynotes in greater detail in our fourth annual survey of the insurance industry in Russia. We also take this opportunity to thank our colleagues who provided input and made this survey possible. Enjoy, Adrian Quinton Partner, CIS Head of Insurance and Actuarial Services

The Russian insurance market in 2013 3 Contents Executive summary 04 Stage of the insurance maturity cycle and key priorities 06 Top line growth 07 Bottom line management 13 Market regulation 17 M&A activity 18

4 Rewarding risk Executive summary KEY DEVELOPMENT PRIORITIES FOR INSURERS The Russian insurance industry remains attractive as the market is likely to remain in the growth and development phase for another 3 5 years. That said, insurers ought to keep a close eye on maintaining distinct competitive advantage through the following key elements becoming evident in our survey: Defining and targeting market segments and associated distribution channels where they have a distinct competitive advantage. Strengthening client centricity alongside improving service efficiency and quality. Optimising the cost base including enhancing risk management to enable a more tangible view on the size and nature of accepted risks. GROWTH PROSPECTS Our respondents predict that the combined insurance market will grow by 10 15% in 2013, propelling it to between RUB890bn RUB930bn, which is just short of the pivotal RUB1trn milestone. Economic growth which was headlined as the main growth factor in last year s survey was not marked as the prominent contributor to growth in 2013, which is perhaps linked to a dampened forecast on GDP growth for Russia. Insurers feel that overall market growth in 2013 will for the most part be supported by the continuing boom in retail credit lending (which is forecast to increase by *) and regulatory factors (such as the recently introduced mandatory insurance of Passenger Carrier s Liability). In 2013, Casco will be the dominant contributor to expansion of the non-life market. As in previous years, growth is primarily supported by the increase in consumer lending. Life insurance is the fastest growing segment today. Gross premiums grew by an impressive CAGR of 63% translating to a RUB23bn to RUB53bn leap in market size from 2010 to 2012, which has led to an improved share of life insurance in the total voluntary insurance market of 8% from 5%. It is expected that the double digit growth of 30- will prevail, fuelled by the increase in the volume of mortgage lending forecasted at 15- for 2013**. Banks continue to be the fastest growing insurance distribution channel in 2013. Market players participating in the Casco, Life and Accident lines will have the opportunity to boost premiums in these segments, albeit at the expense of reduced profit due to upscale commissions demanded by the banking groups. IMPROVING EFFICIENCY Corporate property insurance maintains its status as the industry s profit centre while other mass-market lines such as Casco, Osago and Voluntary Medical Insurance ( VMI ), will generate only marginal profits in view of intense competition in these segments. As in 2012, optimisaton of administration and acquisition expenditure remains an area of key importance for most insurers, though some of the focus has diversified towards reducing claims costs. The preferred methods of keeping the cost of claims under control in 2013 are fostering improved relationships with business partners (car dealerships, health care clinics, etc), enhancement of the process for monitoring and settlement of court-originated claims as well as improving the processing of subrogation claims. * Forecast of the Central Bank of Russia. ** Forecast of the household mortgage agency.

The Russian insurance market in 2013 5 MARKET REGULATION Senior executives maintain the view that the market is in need of progressive regulatory and legal reform. In their view, the areas that require the most intervention are regulation and supervision of financial reporting and enhanced monitoring of brokers and intermediaries. With reference to the latter, the specific items pointed out in our survey are oversight of commission levels, client-intermediary-provider linkages and broker licensing. In the near future, market participants foresee a decline in profitability of OSAGO due to the anticipated adverse impact of legislative reforms under discussion, such as the extension of the law on consumer protection and the uncertainty around lifting tariffs to compensate for the corresponding expected increase in OSAGO limits. M&A ACTIVITY Market participants believe that the Top 10 segment will improve its market share by more than 2% in 2013. It is expected that the speeding up of consolidation will be supported by a rise in M&A activity among large domestic players. The assessment of premium multiples, expressed as the ratio of the company s price to gross premium, has softened since 2012, which is suggestive of a more cautious outlook on future market growth and the economy in general.

6 Rewarding risk Stage of the insurance maturity cycle and key priorities The insurance sector remains fundamentally attractive in view that the growth and development phase will prevail for at least 3 years. of executives are of the view that the insurance industry as a whole is still in the growth and development phase of the market maturity cycle and that this would last for 3-5 years. Despite the relatively attractive prospects for growth in the medium term, insurers need to identify the segments that offer the greatest potential and focus on only those where the companies have a marked competitive advantage. 1. Position of insurance industry on the maturity cycle 2013 3 5 years INVESTMENT GROWTH MATURITY DECLINE 2. Priority development areas in 2012 2013 2012 2013 72% 72% 44% 44% Premium growth Customer service Improving profitability Lowering acquisition and administration costs Managing profitability Optimising distribution Optimising distribution Development of new products Growing retail lines 33% 33% Risk management* Growing corporate lines 28% M&A Strengthen the brand and reputation *including the actuarial and the underwriting functions Risk management Product innovation and development Premium growth Cost reduction Client retention HIGH PRIORITY MEDIUM PRIORITY LOW PRIORITY In 2013, insurers are diversifying attention away from portfolio growth towards improving profitability through customer service, optimising distribution and strengthening risk management.

The Russian insurance market in 2013 7 558 RUB bl 24% 14% +21% 664 RUB bl 25% 812 RUB bl 24% CAGR +18% +25% Top line 15% growth 13% +21% 3. Gross written premium dynamics per market segment 62% 62% 61% 558 RUB bl 24% 14% +21% 664 RUB bl 25% 13% 812 RUB bl 24% 15% CAGR +18% +25% +21% Contrary to previous expectations of increasing 2010 consolidation 2011 it is evident 2012 that the distribution of market Outside share Top 20 among Top 11 to the Top 20 main segments Top 10 of the industry (Top10, Top11-Top20, and Other) has remained relatively inert over the last three years, suggesting 140 that the positions of players beyond the Top 20 are 120 reasonably secure. 100 1 62% 62% 61% RUB bl 80 60 40 4 5 6 7 20 8 4. Year on year (2012 over 2011) change 9 in 10 gross written 0 premium per market segment Rosgosstrakh SOGAZ 2 Ingosstrakh 3 RESO-Garantia AlfaStrakhovanie VSK Soglasie Allianz VTB Strakhovanie Generali PPF 2010 2011 2012 RUB bl 140 120 100 80 60 40 20 0 Outside Top 20 Top 11 to Top 20 Top 10 Top 10 insurers by gross written premium in 2012 1 2 3 Rosgosstrakh SOGAZ Ingosstrakh RESO-Garantia 4 AlfaStrakhovanie 5 VSK 6 7 8 Soglasie Allianz VTB Strakhovanie Generali PPF 9 10 Players ranked outside the Top 20 Top 11 to Top 20 Top 10 > 15 to 5 to 15% 0 to 5% CAGR +6% +13% +13% Average +12% Source: Federal Service for Financial Markets. Players ranked outside the Top 20 Top 11 to Top 20 Top 10 CAGR +6% +13% +13% > 15 to 5 to 15% 0 to 5% Average +12%

8 Rewarding risk 5. Premium growth drivers in 2013 Volume of bank lending Regulation and legislation Economic growth Business partners Competition Intermediaries Improvement in the culture and awareness of insurance Compulsory classes of insurance Infrastructure growth and development HIGH PRIORITY MEDIUM PRIORITY LOW PRIORITY The growth of the insurance market will be primarily upheld by an increase in credit lending and legislative reform In 2013, the market expects a slowing in pace of growth of credit finance relative to 2012 figures. For example, the volume of loans to individuals is forecast to increase by * compared with in 2012 while the growth rate in corporate lending is expected to remain at the 2012 level of 15%. The deceleration of the pace of credit lending in the retail sector may slow growth in the auto, life and accident insurance segments. Despite this, credit finance is still marked as the primary growth driver in 2013. The slowdown in the Russian economy in 2013 (GDP is set to reach 2.4%**) has reduced the importance of GDP relative to last year when 78% of managers reported economic growth as the main driver of insurance market growth. * Forecast of the Central Bank of Russia. ** Forecast of the Ministry of Economic Development. Доля основных сегментов добровольного страхования по размеру страховой премии с 2010 по 2012 6. Premium share by key segment in 2010 2012 Life insurance and accident insurance grew remarkably from 2010 to 2012 which caused this segment to significantly increase its share in the voluntary insurance market 5% 6% 8% 6% 5% 5% 8% 9% 12% 19% 18% 17% CAGR +3% 1% +4% 2% Life Liability Accident VMI 31% 31% 28% 3% Property 31% 31% 1% Casco 2010 2011 2012

The Russian insurance market in 2013 9 7. Gross written premium growth dynamics per line +19% +13% RUBbl 196 165 139 180 169 140 +13% 109 86 97 +43% 75 +6% 2010 2011 2012 +63% 37 49 27 28 30 23 35 53 CASCO Property VMI Casualty Liability Life Sources: RBC, Federal Service for Financial Markets, KPMG analysis. 8. Outlook of the pace of growth of non-life insurance in the near-term The dominant segments of non-life insurance will continue to prosper at double digit rates in 2013, though the pace of growth has slowed. As before, Casco and Property insurance will be the largest contributors to growth of the market 33% Growth will be slower than in recent years, but will remain attractive Continue to grow at a relatively high growth rate 67% 9. Expected premium growth in 2013 over 2012 per segment Casco Property VMI Accident Liability 5) Expected premium growth in 2013 over 2012 per segment 80% 90% CAGR 2013 +12% + + +16% +18% CAGR 2010 2012 +19% +13% +13% +43% +6% > 15 to 5 to 15% 0 to 5%

10 Rewarding risk In the short term, the life market has a good chance to maintain the pace of growth achieved in 2010 2012 (63% CAGR) 10. Outlook of the pace of growth of life insurance in the near-term 11. Life insurance growth drivers in the near term Moderate growth rates Growth will be slower than in recent years, but will remain attractive Continue to grow at a relatively high growth rate The volume of mortgage lending Improved tax benefits Improving opportunities in investment activity The pace of economic growth HIGH PRIORITY MEDIUM PRIORITY Entrance of major banking groups into the insurance sector (eg, Sberbank) Introduction of state guarantees on benefits LOW PRIORITY One half of respondents note that the pace of growth of the life insurance market may be supressed against the impressive growth levels experienced in 2010-2012 but will remain at a generous range of to. The rise in mortgage lending by 15-* in 2013 will be the principal driver of growth in the life insurance market in 2013. As in 2012, the majority of executives () are certain that improvement in the tax regime may significantly expand life insurance particularly in the corporate segment. *Forecast of the household mortgage agency 12. Change in the level of market premium rates in 2013 6) Market premium rates in 2013 relative to 2012 relative to 2012 per segment Casco 12% 44% 12% 33% 12% 33% 56% Property VMI Accident Liability 33% 22% 12% <90% 95% 100% 105% >1 33% 44% 44% 22% 33% CAGR +1% 3% +1% 1% 4% In 2013 the level of market premium rates for the main classes of insurance will not change relative to the previous year The higher losses in Casco and VMI will deter further price dumping on the part of insurers. For this reason, most executives believe that insurance rates will remain either at the level of 2012 or increase only slighty. The comparatively attractive profitability of property insurance will not entice price cuts in 2013. If rates do decrease it would be by not more than 1-3% against the previous year.

The Russian insurance market in 2013 11 The banking channel remains the fastestgrowing insurance sales channel in 2013 13. Year on year change (2013 over 2012) in gross written premium by distribution channel Year on year change (2013 over 2012) in gross written premium by distribution channel Banks Car dealers and other business partners Direct Brokers Own points of sale (offices and branches) Tied agents Independent agents The rising influence of the banking channel will spur increases in commission. The level of commissions will generally remain at last year s level among other key channels 14. Year on year change (2013 over 2012) in commission rates by distribution channels Increase Stay the same Decrease Increase Stay the same Decrease Banks Broker Tied agents Car dealers and other business partners Independent agents 90% 100% 80% *Expert RA The expansion of the banking channel will drive sales of life and accident insurance where the dominant share of premium income in these segments ( *) is collected through banks. The share of motor insurance sales will continue to increase at the already familiar dealership channel while a growing portion of sales is derived via the the online channel, which is still in its early stages of development.

12 Rewarding risk Changes in the relative importance of purchasing criteria differ between the retail and the corporate segment: with reference to the former, price and speed of claims settlement have become more important in 2013 whereas service quality and financial stability are now preferred more in respect of corporate insurance 15. Change in the relative importance of the purchasing criteria in 2013 (from 2012) from the perspective of retail clients mportance of the purchasing criteria in 2013 (from 2012) from the perspective of retail clients Price Financial stability Speed of claims settlement Quality of client service (excluding speed of claims settlement) Brand Positive prior experience with the Company Increase Stay the same Decrease 16. Change in the relative importance of the purchasing criteria in 2013 (from 2012) from the perspective of corporate clients Price Financial stability Speed of claims settlement 80% Quality of client service (excluding speed of claims settlement) Brand Positive prior experience with the Company Increase Stay the same Decrease

The Russian insurance market in 2013 13 Bottom line management Casco, OSAGO and VMI continue to be the least profitable lines 10) Ranges of estimates of the IFRS loss ratio per segment in 2013 17. Ranges of estimates of the IFRS loss ratio per segment in 2012 2013 2012 2013 Casco Property Osago 6% VMI Accident Liability 25% 69% 6% 75% 19% 6% 44% 37% 63% 82% 18% 88% 12% 29% 14% 29% 14% 43% 43% 100% 71% 43% 57% 86% 57% Casco Property Osago VMI 14% Accident Liability >90% [; 90%] [; ] < This year the respondents expectations on the loss ratio for Casco are more concentrated than in 2012 as 100% of participants predict the loss ratio will be in the interval [-90%], whereas in 2012 a quarter of respondents predicted a more favourable range [-]. More than half of executives anticipate that the loss ratio for OSAGO will be above in 2013 though it is difficult to predict the ultimate result with reasonable certainty in view of the ensuing industry debate on lifting of OSAGO limits and tariffs. Based on responses, our colleagues anticipate that the underwriting performance of VMI will improve in 2013 over 2012. Despite this, VMI remains the least profitable segment and almost a third of respondents cite that the loss ratio will be above 90% this year.

14 Rewarding risk 18. Ranges of estimates of the IFRS combined loss ratio per segment in 2012 2013 2012 2013 Casco Property Osago VMI 6% 12% Accident Liability 19% 100% 56% 82% 100% 38% 25% 44% 18% 43% 29% 57% 14% 43% 100% 57% 29% 100% 86% Casco 14% Property Osago 14% VMI 14% Accident Liability >100% [90%; 100%] < 90% The overall market perception is a trend to declining profitability in Casco with 43% of the respondents expecting a combined ratio of over 100% in 2013. Despite the low profitability, Casco generates cash, facilitates cross-sales and supports the brand which suggests that only a few players would actually withdraw from this line altogether. Property insurance is set to remain the most attractive segment in terms of own profit margin and contribution to overall profit. Developing the asset management function is not a priority for insurers as immediate opportunities for improving investment income are not obvious 19. Companies' views on improvement of the asset management function in the near term (2013 2014) Yes, we see a good opportunity in this No, we do not see the rationale for this Yes, we have plans for this, but the scope for improving investment returns is not clear

The Russian insurance market in 2013 15 10) Ranges of estimates of the IFRS loss ratio per segment in 2013 Optimisation of administration and acquisition expenses will remain a priority for insurance companies in 2013, though the importance of these areas has decreased due to a shift of attention towards reducing claims costs. In particular, insurers are planning to pay increased attention to subrogation and court-originated claims 20. Components of the bottom line to be optimised in 2012 2013 Administration costs Acquisition costs 33% Claims management costs 72% 89% 67% 2012 2013 28% Administration costs Acquisition costs Claims management costs Greater degree Lesser degree Insurance companies intend to limit administration costs through reducing staff costs, improving organisational design and advancing operating models 21. Methods aimed at reducing administration costs (2013 2014) Reduce employee costs without outsourcing Improve organisational design Reduction of rental costs Improve operational models, including IT Implement shared services HIGH PRIORITY Not planning to significantly change the management of the above costs MEDIUM PRIORITY LOW PRIORITY Compared with 2012, the number of companies who do not plan to curtail administrative costs increased from to. This serves to underline that companies intend to diversify focus away from administration expenditure towards monitoring claims costs.

16 Rewarding risk Optimisation of contractual relationships with intermediaries is a lower priority in 2013, though it remains an important avenue for managing acquisition costs 22. Preferred methods of containing acquisition costs in 2013 Improving relationships with business partners (car dealers, clinics, etc) and enhancing the process for settling courtoriginated claims are the preferred methods aimed at reducing the cost of claims in 2013 23. Preferred methods for reduction of claims costs in 2013 Optimisation of contractual relationships with intermediaries and business partners (e.g. banks, car dealers) Development of internet sales Improvement of direct channels Growth of the tied agent network HIGH PRIORITY MEDIUM PRIORITY Improving relationships with business partners Enhancing litigation processes 67% 67% Increasing application of deductibles and co-payments Tougher anti-fraud management 33% 56% Segmentation of pricing using additional risk factors 33% HIGH PRIORITY MEDIUM PRIORITY 15) Preferred methods of containing acquisition costs in 2013 Exchange of claims data with other insurers LOW PRIORITY Continued strengthening of the influence of banks and car dealers* in the market compels insurers to search for alternative methods of containing acquisition costs such as pursuing ways to improve direct distribution. The relative appeal of digitally-supported distribution via internet and telephone among companies has grown: in 2013 of executives replied that they intend to develop digitial sales further compared to only 44% in 2012. 13) Preferred methods for reduction of claims costs in 2013 Insurers intend to increase expenditure on internet marketing in 2013 to accommodate a growing online audience *Expert RA 24. Changes in marketing costs in 2013 relative to 2012 16) Changes in marketing costs in 2013 relative to 2012 Internet Telephone calls 22% Street advertising TV/Radio advertising 78% 78% 89% 78% increase stay the same decrease 22%

The Russian insurance market in 2013 17 Market regulation 25. Areas of regulation and legislation that require progressive improvement in 2013 2014 Financial reporting Supervision of brokers/intermediaries Capital Adequacy and Risk Based Capital Risk Management and Governance Independent actuarial review Pricing policy Investment policy Tax benefits (centered on Life and VMI) Internet/telephone policy issuance Competitive activity Fraud/Anti-money laundering HIGH PRIORITY MEDIUM PRIORITY Claims reporting/assessment LOW PRIORITY Insurers maintain the view that the majority of areas of insurance regulation and legislation require comprehensive reform At the end of 2012, the activities for the creation of a single financial mega regulator in Russia were set in motion when the government agreed to integrate the Federal Financial Markets Service ( FFMS ) with the Central Bank. It is expected that this measure will help improve transparency and effectivess of regulatory oversight of the entire financial services market, which will have a positive effect on the insurance industry. The majority of surveyed executives () believe that in the first instance the new regulator ought to focus on improving the process for submission and review of financial statements of insurers. Agents and intermediaries remain the lifeblood of insurance distribution in Russia yet regulation and supervision of intermediaries remains relatively low key. Because of this, almost two-thirds of respondents () would like to see improvements in regulation and legislation in this area, and, in particular, in the areas of oversight of commission levels, client-intermediary-insurer linkages and broker licensing. 17) Areas of regulation Source: and KPMG legislation analysis. that require progressive improvement in 2013-2014

18 Rewarding risk M&A activity Executives feel that the market share of the Top 10 segment will increase in 2013 26. Increase in market share of the Top 10 in 2013 Under the assumption that the ongoing consolidation of the market will be primarily driven by M&A in 2013: 80% of executives expect that deals will largely be between leading Russian players >5% 27. Likely M&A activity in 2013 2014 20) M&A activity in 2013-2014 0% to 2% 2% to 5% Mergers and acquisitions among major Russian players 80% Suspension or withdrawal of the insurance license of one or more leading players Sale of one or more leading Russian insurers Expansion of major Russian players in neighbouring markets (eg CIS,CEE,Asia) Exit of foreign players Entry of new foreign players rease in market share of the Top 10 in 2013 The attractiveness of the Russian insurance sector in view of its high growth potential coupled with the recent relaxation of foreign capital quota (from 25% to ) presents a solid ground for the entry of new foreign players. Despite this only of survey respondents feel that new foreign players will enter in 2013 2014, which is partly explained by the fact that many global insurers are still preoccupied with maintaining performance in their core markets.

The Russian insurance market in 2013 19 In 2013, pricing multiples expressed as company market price/gross written premium have declined in comparison with 2012 for all of the leading 30 players 28. Assessment of multiples per market segment in 2012 2013 Top 10 17% 44% 33% Top 11 to Top 30 Top 31 to Top 50 44% 89% 2012 2013 6% 6% 0 1 1 1.5 1.5 2 >2 0 0.75 0.75 1 1 1.5 1.5 2 >2 Top 10 Top 11 to Top 30 Top 31 to Top 50 80% The decline in multiples is the prime reason for the wait-and-see attitude among market players. Sellers are not keen to give up their prize assets at relatively reduced prices and prefer to wait over the period of subdued economic conditions while the buyers are not willing to offer a premium over the local market price and over European multiples and are playing a wait and see game. Ultimately the market offers a golden chalice of sub 100% loss ratios and double digit growth coupled with a favourable economic climate supported by the government which suggests that deals will be done.

Contacts Adrian Quinton Head of Insurance and Actuarial services Partner T: +7 (495) 937 4477 E: aquinton@kpmg.ru Alexey Nazarov Management Consulting Director T: +7 (495) 937 4477 E: anazarov@kpmg.ru Julia Temkina Transactions and Restructuring Director T: +7 (495) 937 4477 E: jtemkina@kpmg.ru Mikhail Klementiev Tax and Legal Partner T: +7 (495) 937 4477 E: mklementiev@kpmg.ru Philip Sementsov Actuarial Services Senior Manager T: +7 (495) 937 4477 E: psementsov@kpmg.ru kpmg.ru The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2013 ZAO KPMG, a company incorporated under the Laws of the Russian Federation, a part of the KPMG Europe LLP group, and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Russia. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. KPMG Thought Leadership app