Rites of passage: Australia and New Zealand are often viewed as the gateway to larger markets in Asia, but insurers have to overcome problems in those countries first. (Globalization: Cover Story).

Asia--particularly the Pacific Rim--is considered one of the most promising potential markets for global insurers, particularly those based in the United States and Europe, where market penetration is higher. With its huge population and steadily climbing standards of living, the Pacific Rim beckons the world's leading insurers with the possibility of years' worth of business growth.

From the perspective of many in the business, Australia and New Zealand are the gateway to that Asian market. As outposts of the former British Empire, with stable traditions of contract law and a sense that business is the driver of culture, Australia and New Zealand seem a logical step between the United States, United Kingdom and Europe to Singapore, Malaysia, Hong Kong and China.

"There are a lot of synergies between Australia and Asia," said Selina Man, A.M. Best Co.'s Australia/New Zealand regional manager. "Australia's biggest trade partners are China and Japan. You find a lot of knowledge of Asian markets in Australia and New Zealand."

Man said that, in terms of regulating the financial markets, Australia is much closer to the United States and the United Kingdom in its well-established regulatory institutions with extensive supervisory authority, whereas New Zealand, with a population of one-fifth that of Australia, is the only country not to have a standard insurance regulatory agency. Instead, it has the Ratings and Inspections Act, which requires all non-life insurers to obtain ratings from two officially approved global rating agencies, thereby indirectly implementing global standards of disclosure and accountability.

Australia and New Zealand are both leading members of the International Association of Insurance Supervisors and are strong supporters of transparency and rigorous risk-based capital standards for insurers and banks, Man added.

Hugh Morris, lecturer in insurance and risk management and insurance programs coordinator at the University of Technology in Sydney, said 54 companies, representing 33% of admitted general insurers in Australia who are active in the domestic and corporate markets, are directly foreign owned. "A substantial number of these insurers use Australia-and to a lesser extent New Zealand--as a regional center from which to direct Pacific Rim activities, for market development, underwriting or claims management," he said.

Foreign insurers tend to come and go in Australia, but overall the foreign share of the market Down Under is fairly high, said Darryl Roberts, general manager with the Australian Prudential Regulation Authority; the government's financial-services regulator. "Over the past year, we have seen a foreign withdrawal from long-tail liability lines--including public liability, medical indemnity and professional indemnity-and some foreign entry into personal lines and niche or specialist commercial lines," he said.

Three foreign insurers--Royal & Sun Alliance, GGU and Allianz--are among the six largest insurers in Australia, and are in diversified lines, but new foreign entrants generally have a niche focus, Roberts said. Foreign insurers-particularly those based in the United Kingdom-have a long history of doing business in Australia, and in the past 30 years more insurers from the United States and continental Europe have built up a presence.

Mergers Increase Market Share

"Consolidation in recent years has seen the foreign market share grow to an extent-though it has often been one foreign entity buying another," said Roberts. "We would not be surprised to see some divestments or withdrawals due to capital or funding pressure at the parent company, as well as strategic changes in the year ahead."

There have not been many new foreign entrants in Australia and New Zealand lately, but consolidation within the market in Australia is giving the bigger foreign companies more market share, said Grant Robson, president and chief executive officer of GE ERC Group's Asia-Pacific property/casualty operations. "The Australian marketplace has been seen by many over the past five to 15 years as being overpopulated with insurers," he said. "From five years ago, where there were some 150 or so licensed entities, we are now seeing significant consolidation and rationalization, whereby the top five to 10 insurers control 80% to 90% of the market."

Underwriting agencies are playing a greater role in the Australian market, serving specialty niches with specific facilities--both onshore and offshore--as larger players concentrate more on their core lines of business, added Robson.

Ashraf Kamha, general manager of one specialist underwriting agency, Dexta Corp. Ltd., said he has seen an exodus of foreign insurers from Australia, rather than an entry. Recent departures cited by Kamha include Royal & Sun Alliance, St. Paul Cos. and Aviva plc. "Those foreign insurers that have a representation in Australia--principally Lloyd's--compete with local insurers on their own turf. There are very few, if any, cooperative ventures," he said.

Many foreign companies do not consider Australia and New Zealand viable because the market is not that large, and because of the number of companies already there, said Kamha. "There is a small number of Lloyd's agencies writing specialist classes of risks such as professional indemnity, marine," he said.

While there have been notable withdrawals of foreign insurers from Australia, GE ERG's Robson said that is not an unusual phenomenon in the global market. "Due to the globalization of our industry and the ability to move capital quickly, we will and are seeing a series of withdrawals in certain markets and certain products as the capital moves to secure greater returns," he said. "Shareholders are demanding that their capital be serviced and with adequate returns. This is one of the elements forcing the upward movement of pricing to a level where technical underwriting results return to the industry."

GE ERC, like other global players, views access to Asia-Pacific markets in general as something more than just a capacity game, said Robson. "The foreign insurers and reinsurers who operate in the region have done, in my view, an excellent job of bringing new products and ideas into the Asia-Pacific region," he said. "Working with new or emerging markets and assisting them with new product development is paramount to any foreign player's activities."

Australia and New Zealand offer virtually no barrier to entry, making them attractive for foreign insurers, said David Carter, national marketing manager with broker Willis Australia Ltd. "You can write risks on a nonadmitted or nonauthorized basis. But if you were to establish an insurer in Australia, there are capital requirements to meet," he said. "It's a nice, stable environment from which to do business. The only drawback is the distance from the rest of Asia--seven hours by plane to Singapore or Hong Kong."

Exporting Captives

Those capital requirements are probably the only thing keeping Australia from becoming a major captive domicile in the South Pacific. Captives have to comply with the same capital guidelines as regular insurance companies, said Carter. As a rule, there is a minimum capital requirement of A$5 million (about US$2.8 million) to set up an insurer, but the reality is that it's about A$7 million.

"That's quite a large investment for a captive insurance company, so I think it's going to be a deterrent," Carter said. "If a client wants to go that route, we would tell them to go to Singapore, where there are a number of Australian captives. We have an active captive division in Singapore. Labuan and Malaysia are also options."

Singapore, which also enjoys a stable legal environment and well-developed tax structure, has seen increasing captive insurer development originating in Australia. "There is an increased interest in captives here, for the same reasons as anywhere else--higher premiums, limited coverage," said Carter.

"Will you see more captives formed in Australia? Probably not. But in other regions such as Singapore, absolutely."

APRA's Roberts agreed that Singapore is the domicile of choice for most captives operating in Australia. He added that, while captives generally are subject to the A$5 million capital minimum, "we are prepared to exempt a captive from our supervisory regime, if it offers insurance only in the property classes.

"There are a number of financial centers in the Asia-Pacific area which offer offshore insurance licenses," Roberts added. "Many of these licensed entities are active in the Australian market, particularly in segments where authorized insurers have been reducing capacity. Within Australia, an offshore insurer can write business via authorized agents and brokers, who are subject to licensing by the Australian Securities and Investments Commission."

Corporations in the Asia-Pacific region are becoming more interested in alternative risk transfer methods, as they mirror trends in other parts of the world in seeking new ways to handle higher prices and restricted coverage, said Robson. "We are seeing that trend emerge in the Asia-Pacific region, where conglomerates are looking to at least stabilize their insurance and risk transfer purchasing."

Dealing with Common Troubles

Within Australia and New Zealand, insurance markets have experienced some of the same kinds of turbulence as in Europe or the United States. The Sept. 11 terrorist catastrophe and resulting capacity loss, investment erosion and litigation have all had their impact. "The market here has been a bit chaotic over the past couple of years," Carter said. "World events such as Sept. 11 have had an impact, but particularly the legal environment, which is very litigious--which means that various long-tail riders have been suffering some severe losses."

The litigious nature of Australian society, especially in the state of New South Wales, has prompted efforts to introduce legal reform, said Carter. While the individual states are pushing for some kind of resolution, "we're still far from a national resolution" on reform. "We're really not going to see much in the way of relief anytime soon. So premiums have been going up, coverages have been restricted, and some customers have cut back on their coverage," he said.

General liability and medical malpractice have been particular problems. For property insurance, the capacity is there, but rates and deductibles have been rising substantially, as well as standards to improve risks, Carter said.

The medical-insurance industry has traditionally been dominated by discretionary mutual funds, which are technically not insurers and not regulated as such, said APRA's Roberts. Such mutual aid schemes generally do not have contractual terms and conditions governing payment of claims. Claims are paid solely at the discretion of the fund, and if the funds are available. "In our view, the industry's problems highlight the fundamental weakness that arises in a discretionary fund structure," Roberts said.

Other lines of business that are seeing problems for policyholders caused by reduced availability and rising premiums are public liability--the liability of an insured to bodily injury or property damage to the public as the result of the insured's operation of his or her business-and professional indemnity. "This is forcing some policyholders to consider unregulated insurance-like solutions, or withdrawal from activities where insurance is mandatory," said Roberts.

Big Players Pull Out

Capacity in the general insurance market also took a hit early in 2002, when HIH Insurance Ltd. became insolvent, prompting a Royal Commission inquiry that has brought about some changes to insurance laws. (See "Australia and New Zealand Face Regulatory Challenges," page 20.) "That failure took the market's largest general insurer, which had a presence across all lines of business, out of market," said Carter. "As a result of that, the market was in a bit of disarray. St. Paul Cos. pulled out of the market in late 2001--they had come in and left within two years."

Some of the reinsurers with local representation, such as Copenhagen Re, closed down in the wake of Sept. 11. Other reinsurers have been passing on their increasing costs.

Following more stringent capital standards applied by regulators, some smaller insurers have "disappeared" into larger companies, or gone into runoff, said Carter. "We've seen some newer entrants into the market. A couple of South African companies have come in, chasing the domestic business, and they've had to meet new capital requirements. It is purely on things like motor vehicle and homeowners--they're not going after commercial liability or property, the bigger end of the market."

New Zealand's relatively small market has kept general insurance pricing inadequate, even as outside pressures such as the scarcity of terrorism-related coverage and higher reinsurance rates mount. "General insurance remains underpriced relative to the benefit afforded and the underlying drivers of our business," said John Balmforth, president of the Insurance Council of New Zealand, in his annual address to members of the trade group.

"The competitive nature and nominal growth of our market continue to influence low yields, with the ongoing pressure on underwriting returns that comes from the increasing costs of claims, and, particularly, reinsurance," said Balmforth. "The New Zealand insurance market is not immune to the hardening of rates occurring in international reinsurance markets, and this will place further pressure on financial outcomes for the 2002-2003 year."

Carter said that the Oct. 12, 2002, bombing of a resort nightclub in Bali that killed more than 200--including 86 Australian tourists-sent a shudder through the insurance markets, but didn't have the same impact that Sept. 11 had in the United States. "Sept. 11 caused insurers to exclude terrorism from coverages, and Australia has, up until Bali, been untouched by terrorism," he said. "But insurers are not so concerned about terrorism in Australia. Bali was a soft target--outside Australia. If you want terrorism coverage, AIG is very active down here, offering limits in the hundreds of millions, as are Lloyd's and the London market, which can offer quotes very quickly."

In most cases, the reason clients are looking for terrorism coverage is that they are pressured by their financiers and major stakeholders, who are saying if it's available, you should really be getting it, said Carter. Insureds involved in importing and utilities, among other commercial enterprises, are particularly interested in getting terrorism coverage, he said.

New Zealand Property/Casualty Business 2000-2001 Results

Net premiums grew, but combined
 ratio is up.

NZ$ Billions

                       2000   2001 *

Net Premiums Written  $1.598  $1.651
Combined Ratio         97.27  98.56

* 12 Months to Sept. 2001

Source: Insurance Council of New Zealand

Australia's Top 20 Private-Sector General Insurers in 2001

Foreign insurers make a showing among the largest insurers Down Under.

(A$ Billions)

                              Gross   Combined
                            Premium  Operating
Company or Group            Revenue    Ratio *

IAG (NRMA)                   $2.913        110
Suncorp/                      1.982        112
GIO                                        120
CGU/VACC                      1.696        103
Royal & Sun Alliance          1.591        101
QBE                           1.311        111
Allianz                       1.275        106
Zurich                          596        110
Lloyd's                         479         --
ING (Mercantile Mutual)         454        105
Lumley                          278         96
American Home (AIG)             277        108
RACQ                            226        103
Gerling                         195         97
ACE                             178        119
Wesfarmers                      172         92
"RAC" (WA)                      163        108
Chubb                           129         94
Westpac                         122         81
Commonwealth                    118         84
Catholic Church Insurances       99         91

* (Net claims expense + underwriting expense + general administrative
expense) / net premium revenue

Source: Australian Prudential Regulation Authority

Australian Life Insurance 2002 First and Second Quarter Premium Revenue

The premiums for the life industry in the second quarter increased 8.4%
from the June 2001 quarter.

(A$ Billions)

Premiums

March      8.740
June *    10.371

* Figures are preliminary only

Source: Australian Prudential Regulation Authority

Australian P/C Private Sector 2002 First and Second Quarter Preimum
Revenue

The net premium revenue, or premium revenue less reinsurance expense,
for the latest available quarter--June 2002--is up 4.7% on the March
2002 quarter.

(A$ Billions)

        Premium  Combined
        Revenue     Ratio **

March    $3.965        95
June *    4.151        93

* June 2002 quarter figures are preliminary

** Sum of the loss ratio and expense ratio

Source: Australian Prudential Regulation Authority

RELATED ARTICLE: Australia and New Zealand Face Regulatory Challenges

Over the past four years, there has been a sense of upheaval in the regulatory aspect of Australia's insurance industry. The country's financial-services regulator--the Australian Prudential Regulation Authority--came into existence in July 1998, with a mandate to assume the responsibilities of a number of niche agencies. APRA is the prudential regulator--ensuring prudent management--of insurers, banks, friendly societies, credit unions, building societies and superannuation funds.

In a sense, Australia's regulatory environment is running parallel to that of the United Kingdom's. In both countries, financial services have fairly recently come under the jurisdiction of a single agency that has had to inherit the legacies of a variety of obsolete government offices. The United Kingdom's Financial Services Authority took on its role as regulator of financial services in December 2001, under the U.K.'s Financial Services and Markets Act of 2000.

The FSA assumed regulatory power from a number of niche agencies just as the hardening insurance market and weak equity markets conspired to create a host of problems that hit U.K. insurers' finances. Those industry problems forced the FSA to scramble to update and consolidate financial guidelines and rules in an effort to strike a balance between ensuring the financial health of insurers and safeguarding consumers.

Much like its counterpart in the United Kingdom, APRA has debuted with a trial by fire--in the form of the collapse of Australia's largest general insurer--HIH Insurance Ltd. HIH's financial position began to fracture in early 2000, as APRA was still finding its legs as a comprehensive regulator. As HIH slowly slid into insolvency over the next two years, APRA struggled to identify the source of the company's problems, even as the agency worked on its own reform project for general insurance industry regulation.

In hindsight, APRA officials say the agency could have bandied the HIH situation better--if it had had time to complete its own restructuring. In a recent speech, APRA Chairman Jeffrey Carmichael defended the agency against criticism that it stumbled badly in handling H[H and other corporate failures. "We have had a rocky four years," Carmichael said.

He argued that APRA's role as a prudential regulator is not as clear-cut as Australia's financial enforcement agency, the Australian Securities and Investments Commission, which is similar to the Securities and Exchange Commission in the United States. "The difficulty for a prudential regulator is that it is much easier for the community to identify when you are doing a poor job than it is for them to identify when you are doing a good job," he said. "Unlike a conduct regulator, who can at least count heads on pikes, there is no ready metric for APRA's performance."

APRA's role in the demise of the HIH is currently under review by a special Royal Commission of the Australian government. A recent government-sponsored inquiry, known as the Palmer Report, was released in November 2002, detailing APRA's strengths and weaknesses, and offering suggestions for improvement.

Stronger Guidelines

But given APRA's rocky start, industry insiders say the agency has made a positive impact in tightening insurance regulatory standards. "APRA has toughened the environment considerably in terms of capital constraints on insurers," said David Carter, national marketing manager with Willis Australia Ltd. "Insurers have to look closely at their allocation of capital and reinsurance structures under APRA's new guidelines. Insurers doing things like aggressively buying facultative reinsurance have had to pull back."

"Following the collapse of HIH, regulations have changed quite dramatically, and we have seen a strengthening of the guidelines--which have been designed to bring to the table much greater transparency in insurers' activities and financial well-being," said Grant Robson, president and chief executive officer of GE ERC Group's Asia-Pacific property/casualty operations. "New entrants must comply with strengthened guidelines, not the least of which are new, or strengthened, capital adequacy standards."

APRA General Manager Darryl Roberts said the agency is also focusing on niche markets and financial strategies that may stretch the definitions of some products and services. The agency is concerned with a rising number of offshore insurers who do business in Australia through authorized agents and brokers. "We are concerned with the financial standing of many of these insurers and have adopted an increasingly aggressive profile to warn the public of the potential risks of dealing with them," he said.

"Similarly, we have seen an upsurge in the use of discretionary funds which offer insurance-like products," Roberts added. "Technically, they are not insurance, as there is a discretion held--whether or not to pay a valid claim. These funds are similar to captives, except that they hold no captive reserves."

In regulatory matters, New Zealand is a lot more open than Australia in some ways. "They don't have a regulator," said Carter. "The government more or less looks to the rating agencies to regulate the market. To establish an insurance company there is a lot easier."

Having said that, Carter cautioned that New Zealand's markets have been coming under the same kinds of pressure as Australia's, in so far as rising premiums and tighter capacity are making it difficult to obtain coverage in some lines. "As a result, the two markets have been moving closer together," he said. "New Zealand clients have been coming to Australia to gain access in markets that are not well-represented there. We have a more active reinsurance market in Australia, for example."

In New Zealand, insurers adhere to a "Fair Insurance Code" developed by the Insurance Council of New Zealand Inc., the country's main insurance trade group. The code outlines the responsibilities of insurers doing business in New Zealand, and offers a dispute resolution mechanism through the Insurance and Savings Ombudsman's Office, an independent dispute resolution body. Insurers are required to comply with ISO rulings, but insureds are given another option, should an ISO decision fail to satisfy them. Insureds can pursue complaints through another dispute resolution body--the Disputes Tribunal.

In addition to the Fair Insurance Code and the ISO, the third leg of the council's "self-regulatory framework" is a solvency test, designed to monitor the financial soundness of insurers in New Zealand.