In emerging insurance markets, bigger is better.
Often insurance markets are characterised and shaped by the strategies of the larger competitors operating in them. The importance of small to medium insurers is either ignored or in some cases considered destructive to the market's underwriting discipline. Until recently there was no detailed analysis on the performance of large, medium and small companies in emerging markets and how they compare with their counterparts in developed markets.
A.M. Best studied more than 1,900 insurers across four geographical groupings, examining six years of results (from 2007 to 2012) to compare the market dynamics, drivers of profitability and balance sheet compositions for companies in each region. The analysis focused on the markets of MENA, BRIC and MINT and compared them with those of Germany, France and the United Kingdom, examining the performance of the top five companies by premiums (large companies) with that of the next 10 (medium-size) and the rest of the market (small companies).
Important differences, some predictable but others surprising, emerge from this analysis that shows several similarities for small, medium and large insurers in emerging and developed markets. The main findings of the analysis are:
Small insurers drive growth: In all markets, the top 15 insurers account for almost 90 per cent of the premiums written. As would be expected, it is the smaller insurers that show faster premium growth, though in many cases gross written premium remains comparatively low. It is noteworthy that while in most markets the smaller insurers' market share is in the single digits, they are responsible for the majority of the growth.
Significant differences in market strategies: While small insurers are responsible for the majority of growth in developed and emerging markets, the way they achieve this varies. Most of the small companies in developed markets tend to focus on specific niches defined either by product or client segments. By comparison, companies in emerging markets, regardless of size, compete in all segments and businesses. This in turn exposes small companies in emerging markets to greater volatility in their results.
Competition feels more intense in emerging markets: there is a much smaller gap in size between larger and smaller companies in emerging markets than in developed ones. As Exhibit 1 shows, the average small company in the emerging markets is five to 20 times smaller than the average of the top five companies in these markets; in the developed markets, this gap tends to be more than twice as wide, with the large insurers being almost 40 times larger than their small competitors. This combined with the adoption of similar market strategies creates an environment in which no company is too small to accept a given risk, at least in the minds of insurance buyers. In terms of absolute size, the large companies in BRIC countries are comparable with medium-size companies in developed markets, whereas the large companies in MINT and MENA are of similar size to the small companies in the developed markets.
Claims ratios differences between mature and emerging markets: In mature markets, generally small companies hold some distinct advantages, perhaps the most important being a relatively narrow focus that fosters specialised expertise. One advantage can be seen in their underwriting performance, which tends to be marked by good claims ratios that, in the period examined, improve with time. These companies often have a lean cost base and use reinsurance more extensively than larger companies, cushioning their results from large losses. Large companies, by comparison, tend to have good claims ratios when there is low frequency of large claims or no catastrophic activity impacting their results (see Exhibit 2).
In emerging markets, the claims ratios tend to be in the same groupings as those observed in the developed markets, thus dispelling the belief that claims ratios in emerging markets tend to be several percentage points better than those in developed markets. Furthermore, the fact that most companies lack specialisation means that no company segment has a consistently lower claims ratio than the others. Competition for market share is significant in these markets; claims ratios ultimately depend heavily on the quality of risks each company attracts (see Exhibit 3).
Reinsurance is critical in emerging markets: reinsurance plays a key role in the profitability of insurers in emerging markets. Small companies in these markets tend to retain the least, which helps to improve their technical profitability, given that they operate at a disadvantage in terms of cost efficiencies. Unlike their counterparts in developed markets, their broader strategic focus results in higher operating expenses, which given similar claims experience can only be offset by significant reinsurance commissions.
Investment strategies diverge between developed and emerging markets: investment yield remains a key source of income in emerging markets, much more than for companies in the developed European markets.
Smaller companies traditionally have been employing more aggressive investment strategies, especially prior to the recent economic crisis. The reaction to this crisis was a drive for significant de-risking of investment portfolios of insurers in the emerging world, especially among smaller competitors. This in turn has resulted in investment yields among all market segments to converge.
Differences in the make-up of balance sheets: balance sheets in emerging markets are characterised by higher proportions of hard capital and lower levels of financial debt, but also higher operating leverage. Total leverage (i.e., financial and operating leverage) is at similar levels in emerging and developed markets. The combination of slow payments and some financial leverage means that balance sheets of larger companies in emerging markets are more leveraged than those of their smaller competitors.
Probably the most significant difference between emerging and developed markets is that of the different market strategies. Smaller companies in emerging markets compete directly with their larger counterparts for all risks rather than focusing on specific segments as their developed markets counterparts. This makes emerging markets feel more congested, and it also means that small companies' results in these markets are characterised by higher claims ratios and lack economies of scale. As a result, smaller insurers in emerging markets strive to improve their financial performance with higher reinsurance dependence and more aggressive investment strategies.
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