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Russia Non-Life & Life-Market Review

Russia’s Insurance Revolution Begins to Gain Pace

BEST’S SPECIAL REPORTOur Insight, Your Advantage.

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BEST’S SPECIAL REPORTOur Insight, Your Advantage.

Analytical ContactCarlos Wong-Fupuy +44 20 7397 [email protected]

Researcher & WriterYvette Essen +44 20 7397 [email protected]

Editorial ManagementBrendan Noonan

Russian Insurers to Consolidate.

Market ReviewJune 25, 2012

Russia Non-Life & Life

Russia’s Insurance Revolution Begins to Gain Pace

The Russian insurance market is still young, characterised by a competitive and overcrowded market.

Insurance penetration is low, even when including compulsory lines such as medi-cal cover, which has little or no risk-bearing element. The low demand for voluntary insurance in part reflects the public’s suspicion toward the financial sector and their lack of trust in the nearly 600 insurance companies – many of which began 2012 with poor capital levels.

While the insurance sector is fraught with challenges, it is changing radically. There has been a concerted effort to shake off the image that Russia’s insurance market is a cloak for tax-optimisation ruses, with a crackdown on such “grey” schemes in recent years leading to a sharp decline in market participants. The Federal Service for Financial Markets (FSFM), which in 2011 absorbed the Fed-eral Service for Insurance Supervision (FSIS), is overseeing the introduction of increased paid-up capital requirements, which should lead to further, and much needed, market consolidation.

A.M. Best anticipates that although the numbers of insurers will drop significantly, with only the fittest companies surviving, total premiums underwritten will continue to grow. This reflects the introduction of new compulsory lines of business, economic development supporting state spending and, in the long term, increasing awareness of insurance benefits.

Russia’s Insurance Market – An OverviewRussia’s insurance market has undergone significant change since the state’s monop-oly ended in 1988. In 1992, the Law on Insurance was passed, and total insurance premiums have since grown strongly, although the market remains fragmented. According to the FSFM, as of Dec. 31, 2011, there were 579 registered insurance companies. While the number of insurers has contracted sharply over the past two decades from more than 4,000 registered insurers, it is expected to continue shrink-ing in the coming years (see Market Consolidation to Continue as Capital Requirements Increased).

Exhibit 1Russia – Insurance Market Comparison With Selected Countries (2010)

Country

Insurance Market Ranking

2010 Premium Volumes (USD Millions)

No. of Insurance Cos. Insurance Regulator

Gross Domestic Product (USD Billions)

Population (Millions)

China 6 214,626 125China Insurance Regulatory Commission 5,930.4 1,341.4

India 12 74,393 48Insurance Regulatory and Development Authority 1,597.9 1,190.5

Brazil 15 64,264 122 Superintendence of Private Insurance 2,142.9 193.3Russia 19 41,644 579 Federal Service for Financial Markets 1,487.3 142.9Sources: Swiss Re, sigma No 2/2011; International Monetary Fund, World Economic Outlook Database, April 2012; insurance market regulators

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Special Report Russia Non-Life & Life

Based on data received from 527 insurers, the total amount of insurance premiums in 2011 amounted to 1.3 trillion roubles (RUB), equating to USD 39.7 billion, based on exchange rates at Dec. 31, 2011 (USD 1 = RUB 32). The reported regulatory data are for direct insurance only and exclude reinsurance by domestic companies. This repre-sented a 22.1% increase over 2010. Claims totalled RUB 890.4 billion, a 15.8% rise over the previous year.

Despite strong growth in total premiums in 2011, the insurance market as a whole remains relatively small (see Exhibit 1). In 2010, it was ranked 19th in the world – mar-ginally smaller than Ireland’s market (the 18th largest) – with a population of 142.9 million, compared with Ireland’s 4.5 million. Swiss Re’s data are based on average exchange rates for the financial year (USD 1 = RUB 25).

Compared with the other BRIC nations of Brazil, China and India, Russia has by far the smallest insurance market. Russia’s total premium volume was just more than half (56%) of India’s, even though both countries have broadly similar levels of gross domestic product (GDP). Despite the relatively small size of Russia’s insur-ance market, the country easily has the most insurers in the sample of emerging countries.

Russia’s excessively large number of insurers is a result of insurance policies previ-ously being used as tax-optimisation vehicles, which avoided employees’ social insur-ance and income tax. These “grey” financial schemes have reduced following a crack-down in recent years but have not completely vanished. During the global financial crisis they were said to have revived, although this is regarded as a blip during a chal-lenging period.

Previously, some insurers have relied on political contacts or close integration with industrial and financial enterprises for income. Some insurers initially had structures similar to captives, underwriting risks primarily for large companies. For example, close relationships have existed between Sogaz and Gazprom, and Kapital Strahovanie and Lukoil Group. However, in recent years, insurers have expanded their client bases.

Another key feature of Russia’s insurance market is that the Central Federal District (including Moscow) accounted for 56.1% of non-life premiums in 2011, reflecting the concentration of people and the headquarters of companies in the capital. However, there is not necessarily an aggregation of risk, as this reflects only the region where business is being booked. Risks such as hydrocarbon plants tend to be based outside the district, for example in Siberia.

Lines of Business: Compulsory and VoluntaryThe majority of premiums in Russia’s insurance market are derived from compulsory lines of business, as Exhibit 2 shows. Compulsory premiums – including “osago” or third-party motor liability (TPML) and medical insurance – totaled RUB 716.9 billion, representing 56% of total premiums in 2011.

In 2011, compulsory medical insurance represented almost half (48%) of total premi-ums and experienced steady year-on-year growth. It is debatable whether this segment should be included in insurance statistics, as compulsory medical cover is considered to have a comparatively low risk element, with the insurer effectively administering assets and cash flow on behalf of government agencies.

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Voluntary non-life business has also grown, with a 35% increase in premiums written from 2007 to 2011. However, unlike compulsory insurance, non-life voluntary risks con-tracted during the world financial crisis, with premiums underwritten falling 9.2% from 2008 to 2009, to RUB 404.7 billion. This segment has since recovered to reach RUB 519.2 billion in 2011.

As in many emerging insurance markets, motor insurance is the dominant line of non-life business, accounting for 43% of non-life premium in 2010 (see Exhibit 3). This is followed by property, which repre-sented 28% of the non-life market.

Motor is the biggest driver of growth in non-life insurance, reflecting increased car sales and compulsory third-party liability coverage. The short-tail business benefited from a credit boom in 2006-2008, which resulted in increased customer financing and consumption.

The global financial crisis of 2008 had a negative impact on Russia’s bank-ing sector and subsequently motor financing, and the country’s economic slowdown also caused new car sales to decline. However, in 2011 and 2012, motor sales recovered with a revival of car financing. The Association of European Businesses, based in Moscow, reported that motor sales in April 2012 were 14% higher than in April 2011. Sales of new vehi-cles increased by 18% (or by 135,066 units) in January to April 2012, compared with the same period in 2011.

Currently, low premiums and low liability limits dominate the TPML market. However, the replacement of older vehicles is expected as Russia’s economy grows, with more expensive cars resulting in higher premiums.

Exhibit 2Russia Non-Life & Life – Key Market Statistics (2007-2011) (RUB Billions)Indicator 2007 2008 2009 2010 2011Population (Millions) 142.0 141.9 141.9 142.9 142.4Gross Domestic Product 33,247.5 41,276.8 38,808.7 45,166.0 54,369.1Change in Real GDP (%) 8.5% 5.2% -7.8% 4.3% 4.3%Inflation (%) 11.9% 13.3% 8.8% 8.8% 6.1%Insurance Penetration (Life) % 0.1% 0.0% 0.0% 0.0% 0.1%Insurance Penetration (Non-Life) % 1.2% 1.1% 1.0% 1.0% 1.0%Insurance Penetration (Compulsory) % 0.2% 0.2% 0.2% 0.2% 0.2%Insurance Penetration (Compulsory Medical) % 0.9% 1.0% 1.2% 1.1% 1.1%Insurance Penetration (Total) % 2.3% 2.3% 2.5% 2.3% 2.3%Insurance Premiums Written (Life) 22.7 18.7 15.7 22.5 34.8Insurance Premiums Written (Non-Life) 384.6 445.7 404.7 434.7 519.2Insurance Premiums Written (Compulsory) 78.8 87.5 92.8 98.6 111.0Insurance Premiums Written (Compulsory Medical) 289.9 394.3 464.4 485.3 605.9Insurance Premiums Written (Total) 776.0 946.2 977.5 1,041.1 1,270.9Change in Premium Volume (Total) % 28.9% 21.9% 3.3% 6.5% 22.1%Sources: International Monetary Fund, World Economic Outlook Database, April 2012; Federal Service for Financial Markets, Federal Service for Insurance Supervision

Exhibit 3Russia Non-Life – Premiums Written by Line of Business (2010)

Source: Federal Service for Insurance SupervisionNote: Excludes life and compulsory medical insurance.

Other Compulsory 1%

Motor Third-Party 17%

Liability 5%

Property (Other) 28%

Motor Damage 26%

Personal 23%

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Russia’s Life MarketRussia’s life sector is small, with life premiums totaling just RUB 34.8 billion, equat-ing to just 2.7% of total premiums in 2011. Life insurance premium as a percentage of GDP was a modest 0.1% in 2011.

The low insurance penetration for life risks in part reflects a lack of public trust in the financial system. There has additionally been little incentive to save with life com-panies in the long term, as inflation has been as high as 13.3% in 2008, although it reached historically low levels at 6.1% in 2011.

Foreign insurers have attempted to establish themselves in the life sector, given Rus-sia’s growing middle class. In 2012, GDP per capita is forecasted to reach USD 14,246, a 9.6% increase from 2011.

However, despite its potential, the life sector is challenging, as evidenced by Munich Re’s recent actions. In 2011, the German reinsurer closed its Moscow life subsidiary, MR Life EECA, having been present in the sector since 2006. Munich Re said this was in part due to “restrained development” and increased capital requirements, which meant “the business therefore cannot operate at a profit in the medium term.”

Life insurance penetration is not antici-pated to rise significantly in the future, in part as the range of life products is lim-ited. For many years, market participants have lobbied for the introduction of new offerings, such as unit-linked life and pension insurance products, arguing that they could assist in improving demand in the long term.

Market Consolidation to Continue as Capital Requirements IncreasedThe number of registered insurers climbed rapidly from 1993, with approximately 4,000 companies at one stage. However, in the past decade, there has been a sharp fall in the number of registered companies; for example, since July 2004, 1,025 licences have been revoked. This contraction has continued steadily in the past five years, with 857 active insurers in 2007, dropping to 579 in 2011 (see Exhibit 4).

The steady reduction in the number of companies reflects the drastic reduction in tax-optimisation schemes, combined with higher capital requirements. These schemes still exist, although to a lesser extent after very active policies from government agencies to reduce tax optimisation. Market participants feel that, considering the size of the insur-ance sector, no more than 100 insurers are warranted.

The pace of consolidation is expected to continue as insurers react to the recent, sig-nificant increase in minimum capital requirements (MCRs). From Jan. 1, 2012, compa-nies underwriting reinsurance risks were required to hold RUB 480 million, compared with RUB 120 million previously. Capital levels for companies providing solely life cover are RUB 240 million, while RUB 120 million is required for non-life companies

Exhibit 4Russia – Number of Insurance Companies (2007-2011)

Num

ber o

f Com

pani

es

Sources: Federal Service for Financial Markets, Federal Service for Insurance Supervision

0

100

200

300

400

500

600

700

800

900

20112010200920082007

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and RUB 60 million for health insurers. In the year to April 27, the FSFM withdrew 40 licences after companies failed to meet the required capital levels.

Small companies exiting the market are expected to have little, if any, negative impact on overall premium growth, as the larger insurers have been increasing their dominance of the market. According to the FSIS, in 2010, the 20 biggest insurers underwrote 71.2% of total non-life premiums, while the 100 largest companies had a 92.3% share. In 2009, the 20 biggest insurers had a 60.6% market share, and the 100 largest companies controlled 89.5% of non-life premiums.

For the bigger insurers, there is little attraction in acquiring smaller companies. In addi-tion to being undercapitalised, the smaller insurers tend to be based in regions, under-writing modest motor and medical portfolios. Large motor fleets are usually insured with the bigger, Moscow-based insurers.

There could be some acquisitions should the bigger insurers want to increase their regional spread. However, some insurers have unrealistic expectations about valuations. Furthermore, many Russian insurers operate old information technology systems, making integration dif-ficult and hampering companies’ ability to introduce new products in a timely fashion.

Insurance Growth DriversThe financial crisis of 2008 resulted in total premiums increasing by a modest 3.3% in 2009, down from a strong 21.9% increase in 2008 (see Exhibit 5). However, strong, double-digit growth returned in 2011, with total premiums climbing by 22.1%.

As noted earlier, the introduction of compulsory lines of business has been the key con-tributor to growth, following the introduction of TPML in 2003. Other compulsory lines are expected to result in increased premium volumes.

From Jan. 1, 2012, compulsory insurance of hazardous industrial facilities came into force under Federal Law 225-FZ. Legislation for the insurance was drafted following the Sayano-Shushenskaya plant disaster in 2009, when 75 people were killed after an engine room at the hydroelectric power station became flooded. The level of coverage

Exhibit 5Russia Non-Life & Life – Voluntary & Compulsory Insurance Premiums (2007-2011)

Sources: The Federal Service for Financial Markets, Federal Service for Insurance SupervisionNote: Percentage figures show growth in total insurance premium.

0

200

400

600

800

1,000

1,200

1,400

Compulsory Insurance Premiums Voluntary Insurance Premiums

20112010200920082007

(RUB

Bill

ions

)

Total Insurance Premiums

21.93%3.31% 6.50%

22.08%

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ranges from RUB 10 million to RUB 6.5 billion, depending on the hazardous facility and the number of people who could be injured.

On May 25, 2012, the State Duma of the Russian Federation approved the law on obligatory liability insurance for carriers for life, health and property of passengers. Impetus for the compulsory insurance has resulted from the passenger cruise accident in the Volga River in July 2011, when a tourist boat sank, killing 128 people in Russia’s worst river accident in three decades. It is planned that the compulsory coverage will take effect July 1, 2013.

The insurance industry is optimistic that further obligatory lines of business could be introduced to help increase demand for insurance. Market participants have suggested that compulsory coverage could include fire insurance for private houses, entrepre-neurs’ liability for product and service quality, and organisers’ liability for mass events.

Certain voluntary lines of business are expected to see heightened demand in the coming years. For example, insurers underwriting property risks are expected to benefit from spending on construction and infrastructure initiatives as Russia’s economy expands. A total of 183 infrastructure facilities will be constructed and modernised for the 2014 Sochi Olympic Winter Games. Projects in the Southern Federal District of Russia will include new roads and railways, modernized engi-neering infrastructure and a rejuvenated coastline. The Games will be followed by the FIFA World Cup in 2018.

The Russian government’s privatisation of 5,500 businesses to raise funds after the most recent financial crisis could theoretically benefit insurers. Should these businesses fall into the hands of international buyers, which are more accustomed to purchasing insurance (or have shareholders that expect assets to be protected), this could result in increased demand for insurance.

The fires and drought in 2010 highlighted the potential for other lines of risk, such as business interruption insurance as airlines made claims for smog caused by forest fires. Furthermore, as Russia is a major wheat exporter, there is hope for greater demand for agricultural insurance.

Increased trust in the insurance sector and growing awareness of the benefits of insur-ance are important long-term drivers for improving insurance penetration. Better stan-dards and greater scrutiny of the sector can be achieved in part through the increased MCRs and the introduction of International Financial Reporting Standards (IFRS).

Russia’s accession to the World Trade Organization (WTO) could also help instill greater confidence in the insurance market from both the Russian public and overseas investors. The Russian Federation applied to the WTO in June 1993, and in November 2011 the WTO agreed to the terms for the country’s membership. There are hopes that accession will lead to higher standards and greater transparency, as foreign insurers will be allowed to establish branches in Russia, nine years after the country is granted WTO status.

Main Challenges Facing InsurersAs discussed earlier, the biggest problem facing the majority of insurers is their need to meet increased capital requirements.

Poor demand for insurance products is another key challenge for insurers. Growth driv-ers are diverse, but penetration remains low. Total insurance premium as a percentage of GDP was just 2.3% in 2011, even when taking into account state compulsory medical

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Economic Development Supports Insurance Growth

In 2009, Russia’s GDP declined by nearly 8% as a result of the global financial tur-moil, although a modest recovery has since led to an annual GDP growth of 4.3% in 2010 and 2011. The economy is forecasted to expand by 4% in 2012 and sup-

port further growth in the insurance market.

Several of the world’s largest companies are based in Russia, including energy con-glomerates Gazprom and Lukoil. Russia is the world’s largest exporter of natural gas, with the energy industry accounting for about one quarter of GDP.

A.M. Best places countries into five categories, ranging from “CRT-1” (Country Risk Tier 1) to “CRT-5” (Country Risk Tier 5) for countries considered to face the highest risks. Russia is a CRT-4.

In 2008, high inflation, a slower pace of premium growth, poorer investment income and reduced asset values from a collapsed stock market resulted in insur-ance companies posting losses. Volatile or low investment income places additional pressure on insurers to underwrite profitable risks.

The banking system has continued to be fragile after the recent economic crisis, with tight credit conditions remaining, partially due to limited competition among banks. Furthermore, Russia faces political uncertainty as the support base for recently re-elected president Vladimir Putin dwindles.

In addition to domestic uncertainties, the ongoing challenges in the Eurozone area could lead to subdued growth in Russia. An escalation of the Eurozone crisis could present considerable risks, impacting exports.

insurance. Insurance penetration for voluntary non-life and life premiums was 1.1%. In comparison, India’s total insurance penetration in 2011 was 6%.

Underinsurance in Russia is widespread, with inadequate amounts of cover being pur-chased for risks such as business interruption, which is not tax deductible.

In general, Russians do not regard insurance as essential, with many being “fatalists.” To an extent, there is an expectation that the state will provide support, so insurance is not necessary.

As the liability culture in Russia has not developed to the extent it has in countries such as the United States and the United Kingdom, there is little demand for liability cover-age, with liability risks representing 5% of total non-life premiums in 2010. Insurers complain that unless the Russian courts make larger awards, there is little incentive for companies to purchase liability cover.

The low insurance penetration in Russia is in part a consequence of the lack of pub-lic trust in insurers. Credibility is fundamental in the development of non-compulsory classes of business. However, some insurers that have attempted to increase their top lines rather than focus on profitable underwriting have consequently defaulted. To an extent, the reputations of the more disciplined insurers have been negatively impacted by these poorly managed companies.

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Russia’s insurance market lacks transparency for clients and counterparties. It is a broadly accepted opinion that the numbers reported by the regulator do not provide a clear impression of insurers’ health.

A.M. Best notes that uncertainty about the Russian market is caused by factors such as accounting practices that may not reflect the amount of insurance risk a company bears. A large proportion of premium that is officially reported could still be related to tax optimisation rather than risk transfer.

Although the larger insurers are gradually adopting IFRS, implementation remains patchy.

Weak Insurance Infrastructure a ChallengeIn 2012, Russia was ranked 120 (out of 183 economies) in the World Bank and the International Finance Corp.’s survey examining the ease of doing business.

The International Monetary Fund’s (IMF) Financial System Stability Assessment on Rus-sia, published in September 2011, described the country’s supporting infrastructure for the insurance sector as weak. It stated: “The numbers of accountants and auditors that meet minimal professional requirements is small. Qualified lawyers and judges are in short supply. The supply of actuaries remains inadequate.”

The rule of law is a key issue for foreign investors. Questions have been raised about high-level political influence and the impartiality of the courts. It is hoped that the growing number of international professional service companies building a presence in the Russian insurance market – including law firms, accountants and consultants – will help provide greater transparency and security.

Inadequate Pricing and the Claims EnvironmentThe large number of licenced companies has resulted in intense competition. Some insurers are stating that they plan to maintain and develop profitable portfolios, as opposed to attempting to grow market share at any cost. Industry participants claim there has been some improvement or stability of rates, although clear evidence of this trend is lacking.

Exhibit 6Russia Non-Life & Life – Voluntary & Compulsory Claims Paid (2007-2011)As percentages of voluntary and compulsory insurance premiums.

Sources: The Federal Service for Financial Markets, Federal Service for Insurance Supervision

0

10

20

30

40

50

60

70

80

90

100

Total Claims Paid as % of Total PremiumCompulsory Claims Paid as % of Compulsory Premiums

Voluntary Claims Paid as % of Voluntary Premiums

20112010200920082007

%

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Based on data published by the FSIS and the FSFM (see Exhibit 6), compulsory insur-ance is likely to be loss making. This in part reflects the claims culture in Russia, where policyholders attempt to claim for maximum payouts for compulsory insurance.

The exhibit shows that claims paid as a percentage of gross written premiums for compulsory lines have been in the region of 90% over the past few years. This excludes expenses, meaning that combined ratios are likely to exceed 100% for compulsory risks.

High expense ratios continue to be a challenge for insurers, reflecting the size of insur-ers and the lack of economies of scale. Currently, expense ratios appear better than they would under international reporting standards. This in many cases reflects that under national accounting standards, management expenses are not recorded under operating expenses but under “other expenses.”

Furthermore, commissions paid to agents and brokers are not always transparent and can be classified as introductory fees or consulting contracts, and thus are not necessarily recorded as expenses (see High Commissions Feature of Distribu-tion Model).

Regulatory Change WelcomedIn March 2011, the regulation of the insurance market was overhauled as the FSIS became absorbed by the financial market supervisor, the FSFM. The decision to unite the supervision of non-banking financial institutions has generally been regarded as an opportunity for strengthened oversight. Benefits are considered to include a harmon-ised supervisory approach – with centralised licensing and enforcement procedures – and the creation of economies of scale.

A.M. Best notes the insurance industry appears to support the changes, and the new insurance regulatory team is regarded as experienced. Nevertheless, there are risks asso-ciated with a joint finance and insurance regulator. For example, expertise primarily in other non-banking financial institutions could result in the insurance sector not receiv-ing the attention it requires. Furthermore, rules that have been thought out for other non-banking financial institutions could be extended to insurance companies, although they are not necessarily applicable. In addition, while the insurance regulatory team is respected, the new joint regulator needs considerable resources, particularly given the high number of insurers still operating in the market.

While the regulator is focusing on the strength of companies, it faces challenges in enforcing higher MCRs while simultaneously ensuring an orderly exit of insurers. The collapse of insurers, particularly those offering TPML insurance, could further fuel pub-lic scepticism of the sector.

The FSFM will also need to show its authority as the 2015 deadline approaches for the use of IFRS for consolidated financial reports of insurers and participants in financial markets. The larger insurers, particularly those with foreign participation, have begun to use the international standard, but adoption to date has been partial. IFRS is expected to be used widely by insurers, but a delay in the current deadline for implementation would not come as a surprise.

While the new regulator is still to test its powers, there is plenty of scope for further regu-latory development. The IMF, in its country report published in March 2012, suggested

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that all relevant laws and external regulations should be made available on the FSFM’s website – ideally not only in Russian, but also in a language broadly used by its non-domestic market participants. This would “improve the overall transparency and com-prehensibility of the system,” the IMF said.

The Association of European Businesses believes further legislation is required “to correct a number of weaknesses in the current situation,” such as the absence of modern classifications and definitions. In its European Business in Russia: Position Paper (Autumn-Winter 2011/2012), it said a national system of profes-sional qualifications and minimum requirements for insurance agents is lacking. The association suggested: “Registration and minimal qualification requirements should be introduced both for multi-company agents as well as for tied agents.”

In the longer term, the FSFM could move to a more prudential supervision as opposed to a formulistic approach. This would need to be rolled out gradually.

High Commissions Feature of Distribution ModelIn the quest for strong growth, insurers are willing to pay high commissions, as few companies have their own sales networks, and establishing an agency is time-consuming and expensive. Insurance through Internet sales is minimal.

For motor, commission is paid to agents and banks. The car dealership channel is also important, as insurance sold at the showroom is often regarded as an “add-on” product. Car dealers tend to receive the highest amount of commission and can request repair business as part of “reciprocity” agreements.

Commission for compulsory TPML is fixed at a maximum of 10% of premium writ-ten. However, companies are willing to pay 30% to 40% in the form of “consult-ing fees,” or as “information services” for certain segments of the market, such as experienced drivers with certain types of cars in particular regions. Unprofitable lines are considered to include taxis and rental cars.

A.M. Best notes for property and casualty risks, it is common for a company employee to approach an insurer directly. By acting as an “agent,” this employee would usually receive an unofficial introductory payment.

This unofficial direct approach between company and insurer, as well as the historical relations between some industrial groups and insurers, has previously resulted in the use of brokers being low. However, larger companies seeking cover are increasingly using brokers to approach insurers.

Reinsurance TrendsIn 2010, total voluntary and compulsory insurance (excluding mandatory medical insurance) reached RUB 555.8 billion. According to FSIS data, only 15.6% of these risks were ceded to reinsurers (equivalent to RUB 86.7 billion).

Of this figure, RUB 34.7 billion of reinsurance premium was accepted, implying that domestic reinsurers underwrote 40% of reinsurer risks, while international reinsurers wrote the rest.

The main Russian reinsurers, such as Ingosstrakh, are primary writers as well. Companies writing solely reinsurance risks are considered to be “specialist reinsurers”

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and are small by international standards. According to the FSIS, in 2010, there were 23 specialist reinsurers, down from 27 in 2009.

A.M. Best currently rates three of Russia’s specialist reinsurers (see Exhibit 7). These reinsurers retain 64% to 75% of their risks. Russian reinsurers tend to have fairly low retention ratios and rely on foreign reinsurers for retrocession, as they are perceived to have greater expertise. International reinsurers also have larger capacities and meet minimum security ratings.

Overseas reinsurers are attracted to Russia, as the country is not considered to be a major catastrophe zone, unlike nearby Turkey. Perils exist, as demonstrated by the fires and droughts after 2010’s heat wave. However, this event was not thought to represent a systemic change in risk exposures.

Domestic reinsurers anticipate greater demand for reinsurance, reflecting eco-nomic recovery and higher insurance volumes. Like the insurance market, the reinsurance sector is also expected to experience consolidation as companies struggle to meet the new capital requirements.

Demand for reinsurance is not projected to increase significantly as a direct conse-quence of higher MCRs, as the larger insurers that collect the majority of non-life pre-mium already meet the revised capital requirements. However, it is hoped the increased paid-up capital requirements will improve the credibility of the remaining reinsurers, resulting in the most financially stable companies being able to grow their business out-side Russia and in particular, in the Commonwealth of Independent States (CIS).

While Russian reinsurers tend to be focused on the domestic market, some are underwrit-ing regional business in the CIS, particularly in Ukraine and Kazakhstan. However, interna-tional expansion depends in part on regulatory requirements. For example, in Kazakhstan there are additional solvency requirements for reinsurance placed outside the country, depending on the reinsurer’s security rating with a recognised credit rating agency.

Some reinsurers are seeking international expansion to grow their business and diversify risks farther afield than neighbouring countries. Risks are being under-written in the Middle East and North Africa, Southeast Asia and Latin America.

A.M. Best notes there are challenges for Russian reinsurers seeking to underwrite foreign risks. International expansion exposes some companies to significant nat-ural catastrophe events and large risks, which in many cases are difficult to assess given the lack of direct expertise. Furthermore, expenses are likely to increase with expansion into international, brokered business.

Exhibit 7Russia – A.M. Best Rated Reinsurers & Retention Ratios

CompanyFinancial Strength Rating

Issuer Credit Rating

Rating Outlook

Retention Ratio1

OJSC Transsiberian Reinsurance Corp. B bb+ Stable 75%

Russian Reinsurance Co. JSC B+ bbb- Stable 71%

Unity Reinsurance Co., Ltd. B+ bbb- Stable 64%

1. Net premiums written/gross premiums writtenSource: - Statement File Global

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Russia – a Financial Hub?The Russian government would like to reduce the economy’s heavy reliance on the oil and gas sector, and one way to achieve this could be by establishing Moscow as an international financial hub.

However, most market participants consider it unlikely that Moscow will become an international financial centre in the immediate future, as material improve-ments in legal and accounting standards are first required. Additionally, from an insurance point of view, a better established life and pensions market is key to attracting long-term funding sources. The Russian government could further encourage the development of the pension and insurance industries as important sources for long-term investment.

Nevertheless, there is no question that Moscow could establish itself as a finance centre with a large influence over most former Soviet countries. Some participants see this as a logical development, considering the natural affiliations through language and culture with the CIS.

Foreign ParticipationFederal law No 4015-1 states that not more than 25% of the total capitalisation of the Russian insurance sector can be owned by foreign investors. However, it appears the foreign limit (which is based on 25% of the insurance market’s aggregate capital) will be lifted, in part to enable companies to meet higher MCRs. In April 2012, the govern-ment approved a bill to increase the overall foreign ownership of Russian insurers from 25% to 50%. The draft law now requires approval from the State Duma.

International companies have already established significant investments in the larger insurers. For example, in 2001, Allianz bought a 45% stake in ROSNO, increasing its holding to 100% (minus one share) six years later.

In 2008, foreign investors were keen to enter the market through acquisitions, and in response, some domestic insurers attempted to increase their market shares to achieve higher prices for their companies. This resulted in fast growth for the domestic insur-ers but a surge in unreserved claims in 2009.

More recent foreign participation has included the purchase in March 2012 of KIT Finance Insurance by Liberty Mutual Insurance Group. KIT’s insurance arm, which began operations in 2008, primarily writes motor insurance. Meanwhile, Chaucer Syndicates became the first accredited Lloyd’s coverholder in Russia in May 2011 when the syndicate joined with broker RFIB to create SeaLine, initially focusing on cargo reinsurance within the CIS. SeaLine is a sub-sidiary of Nakhodka Re. Russian insurer TIT Insurance Co. acquired Nakhodka in April 2011.

However, not all planned Russian ventures have moved forward. In November 2010, Lloyd’s announced that it was to open a representative office in Russia, with a dedi-cated country manager to enable the market to better understand and explore opportu-nities in the country. However, this venture has since been put on hold.

Observations have been made that the market is becoming more “Russian” in terms of ownership, and there are increasing doubts about the level of international interest and commitment to the Russian insurance market. In September 2011, RESO-Garantia announced it would take a 25% stake in rival VSK, with funding in part from the Euro-pean Bank for Reconstruction and Development. In March 2012, Italy’s Generali and Czech investment company PPF were reported to be in discussions to sell their 38.5%

13


Russian Insurance Market Rating Considerations

A.M. Best undertakes quantitative and qualitative analysis of a company’s bal-ance sheet strength, operating performance and business profile as part of the ratings process. One of the primary tools used is Best’s Capital Adequacy Ratio

(BCAR), which provides a quantitative measure of the risks inherent in a company’s investment and insurance profile, relative to its total available economic capital.

Analysis of the key rating components can be drawn from A.M. Best’s data. Exhibit 8 is based on annual reports filed by companies, reported under national reporting standards. The insurers included in A.M. Best’s analysis are the 10 largest non-life insur-ers by gross premiums written, with data capturing personal accident and health care but excluding premiums for compulsory health insurance and life insurance. The 10 biggest insurers are Rosgosstrakh, Sogaz, Ingosstrakh, RESO-Garantia, Military (VSK), ROSNO, AlfaStrakhovanie, Soglassye, Kapital and MCK Insurance Group.

Balance Sheet StrengthEvaluation of a company’s balance sheet strength is the most important area when determining a company’s ability to meet its current and ongoing senior obligations.

A.M. Best notes that the Russian insurance market continues to have low capitalisation. Exhibit 8 shows that in 2010, the 10 largest non-life insurers had combined capital and surplus of RUB 100.2 billion, equivalent to 36.7% of net premiums written.

Furthermore, asset and capital bases tend to be small compared with volume of insurance risk. Financial flexibility can be a challenge, given the complex owner-ship structures of Russian insurers and their strong links with industrial and financial groups. A lack of alignment can exist between the insurance company

Exhibit 8 Russia Non-Life – Aggregated Data For 10 Largest Insurers (2008-2010)Ranked by gross premiums written.(RUB Millions)

2008 2009 2010Gross Premiums Written 219,364 264,019 311,156Year-on-year Growth in GPW 23.1% 20.4% 17.9%Net Premiums Written 191,022 230,393 273,351Year-on-year Growth in NPW 22.7% 20.6% 18.6%Net Retention Ratio 87.1% 87.3% 87.9%Capital & Surplus 54,663 80,766 100,213Change in C&S 27.5% 47.8% 24.1%Loss Ratio 62.2% 67.1% 62.1%Operating Expense Ratio 23.1% 24.3% 24.8%Combined Ratio 85.3% 91.4% 86.9%Return on Premiums 3.8% 7.1% 7.1%Return on C&S 8.5% 19.1% 15.4%NPW to Surplus 350.6% 285.7% 272.8%Net Technical Reserves to Surplus 279.0% 246.0% 219.8%GPW to Surplus 401.3% 326.9% 310.5%Source: – Statement File Global

stake in Ingosstrakh to Russian bank VTB. However, Generali has since been cited in the press as wanting to keep its stake in the Russian insurer.

Western companies are said to be conducting due diligence but walking away after closer examination of businesses, as companies lack transparency. Questions also remain regarding Russia’s legal system and the protection offered to foreign investors.

Russia’s insurance market can benefit from foreign companies through capital injec-tions, technical expertise and encouragement to improve standards. However, some domestic companies believe there is little benefit from the presence of foreign compa-nies in an already crowded Russian market.

14


and the management team responsible for its investment portfolio. There have been several instances in which an insurer is owned by a larger conglomerate, which manages the investment portfolio independently and with minimal involvement from the insurance company.

The increased minimum capital requirements (MCRs) are likely to lead to signifi-cant capital injections for some companies. A.M. Best expects half of all insurers will need to increase their capital bases, and rated companies will benefit from the declining number of competitors.

Operating PerformanceWhen evaluating operating performance, A.M. Best’s analysis centres on the stability and sustainability of the insurer’s sources of earnings, relative to its retained liabilities.

Exhibit 8 shows the 10 largest non-life Russian insurers posted double-digit growth in GPW from 2008 to 2010. However, while growth is rapid, it can be volatile and influenced by a major contract win – or loss – as well as compulsory risks intro-duced by changes in regulation.

This unpredictability of business stream and mix has a significant impact on the fluctuations of a company’s results, particularly for smaller insurers. Asset growth is not necessarily in line with increases in insurance risk. In 2010, total investments for the 10 largest non-life insurers increased 3.5% to RUB 263.7 billion (see Exhibit 9), while GPW increased by 17.9%.

Volatile investments are another chal-lenge facing Russian insurers. In 2007, net investment returns were 4.5% for the sample of insurers. However, in 2008 this fell to 2.6% as investment yields were impacted by the low interest rate environment, the declining state of the property market and foreign exchange losses. Significant distortions were cre-ated by the volatility of the rouble, with some insurers holding U.S. dollar and Euro investments, while liabilities were largely for domestic risks.

Return on capital improved in 2009 and 2010. Some insurers have reallocated assets from shares into fixed-income investments in recent years. A.M. Best believes that to expand their balance sheets, insurers have engaged in relatively risky investments, including “repo” transactions. Under the short-term credit facil-ity, a loan is secured by the insurer providing assets as collateral. The insurer pur-chases bonds in pursuit of higher yields, although investments can be made in bonds of variable credit quality.

Exhibit 9Russia Non-Life – Net Investment Return & Total Investments, 10 Largest Insurers (2007-2010)Ranked by gross premiums written.

%

Source: – Statement File Global

0

50

100

150

200

250

300Total Investments

20102009200820070

2

4

6

8Net Investment Return

2010200920082007

(RUB Billions)

15


Separately, A.M. Best expects some insurers to hold onto assets in the immediate future by maintaining conservative dividend policies.

Other Rating ConsiderationsBusiness profile factors drive an insurer’s current and future operating performance and can impact long-term financial strength and the company’s ability to meet obli-gations to policyholders. A number of these factors have already been highlighted in this report, notably in the section providing an overview of Russia’s insurance market, which examined the size of the market; number of companies; and their share of premiums, growth rates and insurance penetration. The market positioning of insurers is further discussed in the section on reinsurance.

An insurance company’s financial strength is also determined by its enterprise risk management (ERM) capability. Risk management should be embedded throughout the organisation, and the development of Russia’s regulatory system is likely to aid a greater awareness of ERM.

In Russia, ERM is at a very early stage, with some insurers taking on large insurance exposures compared with their capital bases. Some insurers' interest in attracting foreign investors seems to drive their rapid top-line growth, while others are seek-ing foreign risks to diversify their risk exposure. They are subsequently relying heav-ily on reinsurance programmes for large risks, particularly in the industrial sector.

A.M. Best believes increased scrutiny by independent parties will assist with the devel-opment of ERM in the Russian insurance market. The use of IFRS, actuarial reviews and rating reviews will assist with identifying the need for better risk management.

Additional Contributor Eva Dvorakova, London

16


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ExECUTIVE VICE PRESIDENT Larry G. Mayewski

ExECUTIVE VICE PRESIDENT Paul C. Tinnirello

SENIOR VICE PRESIDENTS Manfred Nowacki, Matthew Mosher, Rita L. Tedesco, Karen B. Heine

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