Building Blocks.

Special Report: An improving economy and government liberalization is making it easier for insurers to do business in Egypt. But attitudes about insurance must change for the industry to take off.

The worst appears to be over for the Egyptian economy. After two difficult years that have tested the government's progress in achieving economic stability, A.M. Best Co. expects to see positive developments that should benefit the gradually liberalizing insurance industry.

The Egyptian government experienced considerable success in stabilizing the country's economy during the 1990s, with the help of the International Monetary Fund and the World Bank. Egypt's achievements have been reflected in its strong growth in fixed investment, domestic consumption, business spending and exports, and lower inflation and interest rates.

In the politically difficult processes of privatization and restructuring, however, Egypt's progress has been slower than the international business community might prefer. Given the social and political disruptions that could result from excessively rapid reform, A.M. Best believes the government is taking a prudent course in implementing gradual liberalization.

Slow Progress

Progress was hindered in 1998, when Egypt's key sources of foreign exchange suffered external shocks. Violence in 1997 decreased tourism revenues; the Asian financial crisis induced some financial instability, and low global energy prices crippled the petroleum industry Moreover, slower growth in Europe due to international financial disruptions, plus an appreciated real exchange rate, led to a weakened trade position. Under the weight of these pressures, weaknesses in the reform program and in the Egyptian economic structure became more evident.

Today, however, the external shocks of 1998 and 1999 have subsided. Petroleum prices, tourism revenues and global growth are increasing in 2000, and, consequently the reform program appears to be back on course. Since elections will take place in November 2000, the government may be cautious in introducing economic reforms that could rein in government spending or increase the unemployment rate, which already is in excess of 11%, according to The Economist Intelligence Unit. Because of the potential social impact of reforms, some domestic factions are likely to be critical of government efforts at reform. Therefore, maintaining the careful balance between domestic social issues and the internationally accepted economic reform is critical.

The government has facilitated this balance effectively by shoring up its commitments in October 1999, when the Ministry of Economy was merged with foreign trade under Youssef Boutros Ghali and the previous head of the privatization program, Atef Ebeid, became prime minister.

Room to Grow

The insurance market is highly underdeveloped in Egypt and has room for significant growth. In recent years, Egypt has reported annual premium growth averaging 10%, compared with average global growth of about 2%. In addition, total premiums in Egypt have generally represented less than 1% of gross domestic product (regional average 5%, global average 7.5%), and the per-capita spending on insurance historically has been one of the lowest in the world. In Egypt, the most recent data show that the average per-capita expenditure on insurance products was less than $9. This can be contrasted with averages of $271 globally, and in emerging markets. The country with the highest insurance spending is Switzerland, where individuals spend an average of $4,650 on insurance each year.

Egypt's insurance market historically has been affected by a lack of countrywide education as to the importance of insurance. In addition protection has not been available for a wide range of perils, and products have generally been unsophisticated when compared with those in developed markets. Fortunately, however, the landscape is changing. Companies are making use of advertising to attract different parts of society; awareness of the potential in untapped markets such as personal lines, accident and health, and the retirement sector has increased; and products are becoming more sophisticated. In the immediate future the country appears to be on the right track to take advantage of the burgeoning middle class and the huge potential that the market has to offer. Existing companies also undoubtedly will benefit from the presence of foreign players in the market.

Membership in the World Trade Organization has forced Egypt to complete the liberalization of its insurance market by 2003. Four public-sector insurance companies dominate the market, accounting for almost 80% of total premiums. The liberalization of the state-controlled insurance industry began in 1998 and has moved forward in the year.

Fleming CIIC and Merrill Lynch are evaluating the state-owned companies in preparation for privatization. Bacon & Woodrow are performing actuarial valuations of the companies' technical reserves. Simultaneously, the government is performing real-estate valuations. All of these reports are scheduled for submission to the Ministry of Finance by the end of 2000.

New Players

In advance of the privatizarion, the regulatory authorities have been changing the landscape of the market through the approval of new licenses and shareholders. Commercial International Life Insurance Co. was awarded an operating license in December 1999. The company is owned by Legal & General (United Kingdom) and Commercial International Bank (Egypt) and is offering new products to the market and utilizing bancassurance as a means of generating business. Through this method--which is underutilized by the Egyptian insurance industry--Commercial International Life appears to be creating new business in Egypt, rather than capturing market share from the public-sector companies.

Meanwhile, other major insurers are seeking to participate or are enhancing their participation in Egypt's market. Both AIG (United States) and Allianz (Germany) have applied for general insurance licenses. In the interim, Allianz has increased its stake in Arab International Insurance Co. to a majority holding of 80%.

Another recent development concerns ARIG (Bahrain), which like Allianz has formed a majority stake (54%) in Allied Investors Insurance Co.--which recently changed its name to Arab Misr Insurance Group. For the time being, the Egyptian government is likely to encourage international investment in privatized companies while facilitating the establishment of foreign-owned subsidiaries.

According to Egyptian government officials, privatization of the insurance industry should be politically easier than the privatization of some other state-owned industries, such as banking. Therefore, the insurance privatization process, despite being affected by logistical difficulties due to a range of internal and external factors, is proceeding in a timely fashion. As Egypt's economy continues to grow in a more favorable global environment, the Egyptian government is making solid progress in 2000 on privatizing the long-awaited strategic sectors of insurance, banking and telecommunications, which will renew foreign financial interest in the country. There is currently great potential for those who want to invest in Egypt, particularly in the insurance industry.

This report was prepared by Andrea Keenan, financial analyst-country risk, international division of A.M. Best.

Signs of Progress Emerge Amid Criticism

Egypt's restructuring program has been widely criticized. Since its implementation, the government's budget deficit has swelled and its debt situation has deteriorated. Financial analysts also have questioned the government's unofficial peg of its currency value to the U.S. dollar.

Nevertheless, there are signs of progress.

Budget issues

The government budget deficit for 1998-99 was [pound]E12.7 billion or 4 2% of gross domestic product--350% above the 1997-98 level and more than three times higher than the previously announced figure.

"The government is reluctant to take on more debt and has pledged to reverse spending patterns, so, the debt service ratio should decline below 7% of GDP in future years compared with 12.7% 2.7% in 1995. The improving economy will induce higher tax receipts and will be an important catalyst in improving the government accounts.

Monetary Policy.

The Egyptian government unofficially pegs its currency to the U.S. dollar at a rate of about [pound]E3.40 to $1. The absence of an official monetary policy has led to complaints regarding lack of transparency, and the peg itself has resulted in overvaluation of the Egyptian pound, larger trade deficits and a shortage of hard currency All of these factors contributed to slower GDP growth. Overnight lending rates fluctuated between 17% and 10% in 1999 and 2000 before settling at about 11%. This made it difficult for banks to expand their credit facilities, adding to the credit crunch in the market.

Credit remains tight but should ease as the government repayment plans, a devalued currency and favorable developments in the stock market materialize. In addition, the central bank appears to be easing its rigid exchange rate stance, as the Egyptian pound has slightly declined against the dollar to about [pound]E3.53. The bank may decide to follow a managed float system but will work to prevent a dramatic devaluation.

Bankruptcy Trends

Liquidity has been tight in Egypt, and the situation has taken its toll on, local businesses According to the Middle East Capital Group, the number of small to midsize firms that went bankrupt increased 54% between July 1999 and January 2000. This was due in part to inadequate access to credit and intensified concerns that the leading state commercial banks have accumulated sizable bad loans But since then bankruptcies in the private sector have decreased.

Other Bright-Spots

Additional favorable developments have occurred this year. For example, foreign reserve figures showed their slowest monthly decline in six months, and balance of payments figures have improved with exports. Also, the stock market has promising prospects. Several prominent companies have released disappointing first-quarter results. That, along with uncertainty regarding economic policies, led the local stock market index to end the first half of 2000 down about 25%. Progress with privatization and the expected initial public offering of a major Egyptian telecommunications company are likely to reverse this.

A.M. Best Ratings in Egypt

A.M. Best Co. began rating Egyptian insurance companies in May 1999. The ratings are based on analysis of the company's market profile, financial performance and financial strength in the Egyptian insurance industry.

The following companies currently are rated:

* Al Chark Insurance Co A-

* Al Mohandes Insurance Co. B++

* Egyptian Reinsurance Co. B++

* MISR Insurance Co A

* National Insurance Company of Egypt A-