Dusting off the Welcome Mat.

Asia is poised to become a major insurance magnet over the next decade as regulations are relaxed.

With China's imminent entry into the World Trade Organization, the deregulation of the Japanese insurance market and the liberalization of Indian insurance regulations, there is much speculation and anticipation as to how the once-stringently regulated Asian insurance markets will be relaxed to permit the entry of foreign insurers. At stake for nonlife insurers is a potentially immense economic opportunity. For Asian countries, there are potential gains in technology and work-force skills, as well as the stabilization of financial economies. However, few foresee the ongoing process of deregulation and foreign entry as uncomplicated. Many obstacles and possible risks await eager insurers, not only from the Asian governments but also from the ingrained attitudes of the various distinct cultures.

The premium distribution and maturity of Asian insurance markets vary considerably by country. Broadly, Asian insurance markets can be stratified into three levels: fully mature, transitional and incipient. Japan is the only fully mature market, accounting for more than 75% of the insurance premiums in Asia. Transitional markets include South Korea, Taiwan, Singapore and Hong Kong. The two major incipient markets are China and India, which are the world's two most populated countries.

Two indicators help to distinguish the current and potential states of an insurance market: insurance density (premiums per capita) and insurance penetration (percentage of insurance premiums in gross domestic product). Insurance density indicates the current state of the market; it is highest in industrialized nations. For example, the United States and Japan, the world's most industrialized countries, both have the highest premium-density ranking, with more than $800 per capita (see "Insurance Density and Penetration in Asian Markets," page 54.). China and India, in contrast, are represented by single-digit figures. To some extent, this relationship can be explained by the maturity of the tort system and the overall wealth of the countries. The two premises of insurance are protection on properties owned and protection against intangible liability. U.S. citizens possess more assets and are exposed to a greater likelihood of litigation, necessitating higher levels of insurance, both property and liability. T he high insurance density implies that the insurance market is fully actualized and, therefore, has less room to grow.

Insurance penetration, on the other hand, can be used as a rough indicator of growth potential. Consider insurance penetration as follows:

Insurance Penetration =

Insurance Premiums = Insurance Premiums per capita

GDP  GDP per capita

The numerator on the righthand side of the equation, insurance premiums per capita, can be described as the insurance expenditure per household. The denminator of the righthand side of the equation, gross domestic product per capita, can be described as the production per household. When combining the two parts, insurance penetration can be viewed as the relationship between insurance expenditures and economic production per household.

Household wealth increases as the production per household increases, in turn motivating individuals to purchase more insurance. This illustrates a positive relationship between insurance per capita and gross domestic product per capita. But this relationship changes substantially at different levels of GDP per capita. When GDP per capita is low-as is the case currently in China and India-the level of wealth can provide only for basic needs, and the demand for insurance is low. Consequently, insurance demand grows only slightly faster than wealth. Conversely when GDP per capita is high, a point of saturation has been reached; a large portion of the insurable interests already are insured. Here again, demand for insurance grows only marginally faster than wealth.

In contrast to the relatively flat rate of growth exhibited at the low and high ends of the GDP spectrum, the demand for insurance grows significantly faster than wealth in transitional markets--as is the situation currently in South Korea, Taiwan, Singapore and Hong Kong. When income rises above the minimum level, people begin to accumulate personal assets and an awareness of the value of insurance develops. Insurance consumption then rises rapidly to fill gaps of need. Transitional markets thus demonstrate highest growth potential.

Note, for example, the insurance penetration figures for Japan (3.43%) and South Korea (2.23%) as shown in the table on this page. The above-average nonlife insurance penetrations can be partially explained by savings-type policies in nonlife insurance. These policies provide for substantial premium refunds if no claims are made. With the inclusion of savings type policies, the nonlife insurance expenditure may appear to be a larger percentage of GDP in Japan than in the United States, even though Japan has a less litigious environment than the United States does.

Asia's Attraction

The most obvious motivation for foreign insurers' expansion into Asia is the opportunity to access immense, largely untapped markets. Aside from Japan, most Asian countries have extremely underserved insurance markets when compared with highly industrialized nations, such as the United States. In addition to tapping the sizable market potential, expansion into Asia serves several other aims of foreign nonlife insurers, including diversifying risk, servicing existing international clienteles and using capital more efficiently.

* Diversifying risk: Insurance is based on the spread of risk. Therefore, insurers are perennially looking for ways to diversify their risks or to add less correlated risks to their books of business. For many exposures, such as natural catastrophes and weather-related risks, the probability of incurring losses of the same nature simultaneously in the United States and in Asia is less likely than when both risks are in the same market. Foreign insurers can significantly widen their risk base by expanding into disparate markets, such as those in Asia.

* Servicing existing international clienteles: The expansion of large North American and European corporations into Asia necessitates appropriate insurance to cover such foreign investments. The coverage required for these firms often exceeds the local insurers' capacities, hence foreign insurers, with their greater resources, are indispensable.

* Using capital more efficiently: Given the current very high level of capitalization and the competitive nature of U.S. markets, little or no profits are left to insurers. Instead of competing for U.S. business that will produce only modest returns, expansion into Asia may provide a higher return over an extended timeline.

The recent regional economic crisis and several major natural catastrophes have induced Asian governments to reassess their insurance structures. The result has been a rise in the level of awareness of the need for protection against various risks. Throughout Asia, liberalization plans have been introduced to allow for greater foreign ownership and increased licensing. Allowing foreign insurers into Asia could result in several benefits, including:

* Financial stability: The regional financial crisis and the subsequent damage to financial infrastructures have made Asian governments much more receptive to foreign partnerships and investments. An influx of foreign capital would help stabilize the local economies.

* Knowledge transfer: Foreign insurers tend to have more sophisticated risk-classification systems, forcing domestic insurers to advance their practices in a competitive market. Local markets and workers benefit greatly from improved technology and other advanced work skills introduced by foreign companies.

* Employment opportunities: New foreign insurance companies will need to hire from local work forces. These companies tend to pay well compared with the existing businesses, and the skills acquired by the local workers add to the overall pool of skilled personnel.

Historically, whenever a corporation has expanded into a foreign market, various difficulties have arisen, ranging from unfamiliar regulatory practices to dissimilar ways of thinking. For example:

* Regulatory environment: In 1998, Japan began relaxing its nonlife insurance market, which previously had been heavily regulated. India chose to privatize its insurance markets at the end of 1999. And China, as a precondition for entry into the World Trade Organization, agreed to relax its stringently regulated insurance market to permit the entry of foreign insurers. Since deregulation in these countries is still in the early stages, their business infrastructures remain relatively undeveloped, and thus they continue to impede the entry of foreign insurers. But some insurers already are in the process of entering Asia, and their early experience shows that much more definition is required before efficient access can take place.

* Sizable investments: Besides the minimum capital required by each country, the cost of establishing an insurance company in Asia can be significant, including the financial requirements to set up branch offices, develop new distribution systems, establish underwriting guidelines and arrange for claims services (see "Capital Requirement By Country," on page 57).

* Localization: This is the adaptation of existing insurance products to a new market. Restated, this is the modification of existing products or services to account for differences in distinct markets. Localization can include language translation, conformation of accounting procedures to local taxation and even tailoring a Web site to achieve a local look and feel.

Risks and Barriers

The adage taught in basic finance--"the greater the expected profit, the greater the risk"--is especially true in the case of Asia's insurance markets. Although there is great potential for financial gain, foreign insurers must be aware of and prepared for a variety of risks that can combine to derail any start-up effort. The following are some of the more significant risks:

* Political and regulatory risks: Many countries in Asia have virtually no nonlife insurance history. To further complicate matters, the few judicial rulings that have been passed on nonlife insurance issues have been erratic. All of this could lead to an extremely unpredictable liability insurance cycle, since pricing, liability estimates and other economic considerations are dependent on a fully developed tort system. Other political risks include the possibility of expropriation of assets, changes in tax policy or other changes in a given country's business climate.

* Exchange-rate risk: The dollar return from foreign investments depends not only on the returns on the foreign currency, but also on the exchange rate between the dollar and that currency. If the local economy collapses, a foreign company's assets could be seriously jeopardized. Currently, foreign currencies are not allowed in China; all business is carried out in the Chinese yuan. The yuan is especially complicated, because it is only partially convertible and is not completely tied to a flexible exchange system.

* Natural catastrophes: The majority of residents in Asia live close to major rivers, including the Yantze and the Huang He in China and the Ganges in India. These rivers historically have been the cause of multiple severe floods that have affected millions of people. In addition, Asia is prone to earthquakes (China, Japan, Taiwan, India), windstorms, hail, typhoons (southeastern coast of China, Japan, Taiwan, Malaysia and the coastal regions of India) and volcanic eruptions (four volcanic fields in western China and six in the eastern portion of China that borders Korea, all of Japan). The region's susceptibility to these natural hazards is illustrated in the map below.

Recently, catastrophe-simulation models have been used to assist in the pricing of catastrophe property insurance. But due to the scarcity and unreliability of historical data for this region, the simulation models may not be dependable. Writing property risks in Asia will thus be a major challenge for foreign insurers.

* Cultural barriers: Many Asian countries highly value relationships, even if certain of these relationships may be viewed by Americans as merely contractual obligations. Because of this respect for relationships, lawsuits are uncommon--business or personal. This behavior impedes the need of liability insurance to have an established, highly developed tort system upon which to rely. It remains to be seen how Asia's gradual relaxation of its economic and social systems will affect the perceptions and behaviors of its citizens.

Another cultural disparity is the inclination of Asians toward saving. This is a long-held ethic in Asia, one that could lead to that public's view of insurance as atrophy. Further, in those Asian countries historically observant of superstitions, purchasing insurance may be considered as cursing oneself and asking for misfortune.

* Distribution systems: Although the demand for insurance may be growing in Asian countries, coverage may not be accessible due to the poor distribution systems in place. For example, in the past, Japanese insurers distributed life insurance policies through "seiho ladies." (Seiho is the Japanese word for life insurers). These representatives, often housewives, sold life policies in the workplace, sometimes pressuring workers to purchase coverage with little or no explanation of the policies.

* Target markets: Insurers often target existing segments of the insurance business, rather than expanding the market. For example, 50% of the current demand for general insurance in India comes from corporations. However, the corporate segment as a whole is not likely to grow rapidly, so when the market expands, the competition for these same corporate risks will drive down potential insurance premiums. Thus, new entrants should both target the existing market and develop specific niches in the currently underserved lines of business.

Asia's nonlife insurance market contains enormous potential profit. Both domestic and foreign insurers stand to reap the expected rewards of insurance deregulation and financial restructuring. Even with these countries' stringent and often ambiguous laws, the general absence of established tort systems and the myriad cultural barriers, foreign companies continue to exhibit a great eagerness to enter these markets. The interested parties have obvious reasons to look ahead, but they should take caution to carefully consider and prepare for the many risks that may be realized.

Julia F. Chu is an associate actuary at Milliman & Robertson in New York.

           Insurance Density and Penetration in Asian Markets
          The emerging Asian markets, such as China and India,
             offer insurers the greatest growth potential.
                                     Insurance
                                      Density:     Gross
                Nonlife               Premiums    Domestic
               Premiums  Population  Per Capita   Products
                (US$M)   (Millions)    (US$M)      (US$M)
United States  $280,000     270.0    $1,037.0    $9,255,000
Japan           101,277     126.0       803.7     2,950,000
South Korea      13,959      47.0       297.0       625,700
Taiwan            4,790      22.0       217.7       357,000
Hong Kong         1,945       6.8       286.0       158,200
Singapore         1,265       3.5       361.4        98,000
China             5,872   1,247.0         4.7     4,800,000
India             2,074   1,001.0         2.2     1,805,000
                Insurance
               Penetration:
                 Nonlife
               Premiums as
                 % of GDP
United States     3.03%
Japan             3.43%
South Korea       2.23%
Taiwan            1.34%
Hong Kong         1.23%
Singapore         1.29%
China             0.12%
India             0.11%
Source: Milliman & Robertson
              Insurance Marketing Models for Asian Markets
            The following models may be appropriate for the
             specific markets targeted and their respective
                    levels of economic development:
Level of
Development   Countries              Type of Insurance
Fully mature  Japan                  Sophisticated liability
                                     insurance for protection of
                                     personal wealth and
                                     advanced risk-management
                                     structure for large
                                     commercial firms.
Transitional  South Korea, Taiwan,   Auto insurance and some
              Hong Kong and          forms of liability insurance.
              Singapore
Incipient     China, India, Vietnam  Property and fire insurance
                                     or some type of savings
                                     policies.
Level of
Development   Motivation
Fully mature  Japan's well-developed
              economy can sustain the
              full range of modern
              insurance products.
Transitional  People in these developing
              economies are becoming
              aware of the importance
              of protecting personal wealth,
              but may not have the full
              appreciation to warrant an
              ultra-sophisticated approach.
Incipient     People in these countries
              are mainly concerned with
              preserving what they have
              acquired through hard work.
              Insurance policies with a
              savings mechanism will
              attract people by offering an
              accumulation of wealth
              rather than an expenditure.
                     Capital Requirement By Country
               Establishing an insurance company in Asia
             requires a significant investment in capital.
                            (US $ millions)
                             Capital
Country                  Requirement
China                         $60.40
Taiwan                         57.30 [1]
South Korea                    18.75
Singapore                      14.53
Japan                           7.69
Hong Kong               1.28 or 2.56 [2]
India        50% of written premiums

(1.)$57.30 million for domestic insurers, including foreign joint ventures.

(2.)$1.28 million for life and nonlife companies. $2.56 million for composite or nonlife companies writing compulsory lines of business.

Source: Milliman & Robertson