Expanding the base





July 14 - 20, 2003 





The year 2002 was a challenging year for the Pakistani insurance industry in more ways than one. The non-life insurance companies feel that 2003 would be even more challenging year for the industry, both collectively and individually.

The new insurance law promulgated vide an Ordinance three years ago on August 19, 2000 replacing the Insurance Act 1938, and the new accounting guidelines and formats by the Securities and Exchange Commission of Pakistan (SECP) would have an impact on the workings of the general insurance companies.

As is, the phased enhancement of the paid up capital for life insurance companies to Rs 150 million and for general companies to Rs 80 million by December 31, 2004, including to Rs 100 million and for non-life to Rs 50 million respectively by December 31 last year have resulted in closure of a number of mergers, takeovers and closures. The urgency to merge was aimed at fulfilling the new paid up capital requirements end last year. Asia Insurance and Indus International Insurance, with a paid up capital of Rs 25 million each, were merged while Business and Industrial Insurance, with a paid up capital of Rs 41 million, took over Orient Insurance and the paidup capital of the new entity now stands at over Rs 77 million.

However, the most prominent acquisition was the takeover of the general insurance of the Pakistan Branch of Commercial General Union International Insurance of UK by the local New Jubilee Insurance. Effective from January 1 this year, NJI took over the insurance business of the Pakistan Branch of Commercial Union alongwith its assets and liabilities. In a related transaction, NJI together with Aga Khan Fund for Economic Development (AKFED) purchased the shareholding of CGU International UK in Commercial Union Life Assurance (Pakistan) Limited. AKFED has purchased 22.95 million shares of CU Life while NJI has purchased 2.55 million shares thus holding the majority holding of 57.09 per cent and 6.34 per cent respectively.

The number of general insurance companies have been on a continuous decline over the last three years from around 55 to 42 last year and 38 presently, including 34 local and 4 foreign companies. While these 38 companies managed to improve the collective gross premium by almost 15 per cent from around Rs 10.9 billion in 2001 to Rs 12 billion in 2002 the performance masked many inequalities.

For instance, 60 per cent of the total gross premium was claimed by three companies Adamjee, EFU General and New Jubilee while 13 companies shared 27 per cent of the business while the remaining 22 companies shared among themselves the rest of the 6 per cent of the business. The year 2003 would be challenging in many other ways for these companies due to a number of internal as well as external factors: the absence of minimum fixed tariff resulting in rampant undercutting practices to acquire business, the prevalent law and order resulting in snatching and theft of cars pushing the loss ratio beyond economical levels, and the reluctance of the foreign re-insurers to issue terrorism risk cover. The first two have resulted in a market which is driven more by the urgency to get the business at any cost while the third has made many companies to decline to grant terrorism risk coverage due to the non-availability of re-insurance arrangements. It has also made many other companies to issue the terrorism risk coverage on their own, which despite an encouraging idea can result in building substantial pools of reserves over the years, is an extremely risky idea.

The abolishment of fixed minimum tariffs for all classes of business, particularly car, has also resulted in massive and rampant undercutting practices to undermine the quality of protection to the policy buyers. This is evident from the fact that EFU General, the second best ranking company, suffered an underwriting loss of Rs 27.7 million in the motor business making underwriting profits in all other class of businesses namely Fire and Property Damage; Marine, Aviation and Transport; Others and Treaty which helped it make an overall underwriting profit of Rs 44 million last year.

EFU General's Annual Report 2002 said that "the major contribution to rise in premium income for the year 2002 came from increase in rates by reinsurance for coverage of large industrial units in the country. Another factor in the growth of the premium was the increase in motor car insurance business on account of aggressive launching of Car Financing Schemes by banks and leasing companies. However this business portfolio continues to remain unprofitable for the Company due to prevailing law and order situation in the country resulting in snatching and theft of cars."

On the surface the cut throat competition, and the rampant undercutting practices, seem to benefit the insurance buyers. The comprehensive car insurance is available for as low as 2 per cent for corporate clients in a market where the insurers are now free to fix their own tariffs. However, the undercutting seriously undermines the protection to the insurance buyers by pushing loss ratio way beyond economic levels for most of the companies. The undercutting in the Motor segment of the business is all the more harmful as it almost a third of all general insurance business written in the country last year came from this particularly class of the business and plays a vital role to have a direct bearing on the financial performance of an individual company.

While the big insurance companies can afford to mop up the business much more comfortably than their smaller counterparts, the rising loss ratio amidst thefts and snatchings across the country and the uneconomical tariffs also undermine the Motor business written even by large companies.

One of the most worrisome aspect of the now enfranchised insurance business is that the growing rift between big and small companies to make matters even worse. The absence of congenial and cordial working relationships among the members makes it hard for the industry to discuss, debate and analyse the pertinent issues hindering the growth of the industry by finding appropriate and concerted solutions. This is evident from the letter written this month by the chairman of Insurance Association of Pakistan (IAP), S. Ziauddin Ahmed, to the secretary of the Association to resign from the post. In his letter Mr. S. Ziauddin Ahmed blamed the attitude of the members of the Central Committee, the majority of whom represent small companies for his decision to resign immediately as of the 2nd of this month. "For some years it has been difficult, in fact impossible, for the bigger and better companies to be elected to the Central Committee." Ziauddin who is associated with the largest general insurance company, Adamjee, further said that "Even Adamjee Insurance as the Pakistan's largest and the best company could not be elected... My election to the Central Committee, as I was later told, was a act of grace by the smaller companies and my election as the Chairman too..."



M.I. Ansari, a former chairman of IAP and head of Agro General, expressed concerns that the cut throat competition and low tariffs seriously undermines the insurance business in the country. "Besides undermining the quality of protection it has also resulted in uneven distribution of business. In addition, an overall general lack of professionalism and awareness about the importance of insurance make situation even worse evident from the fact that insurance still much remains an involuntary expense not only by the individuals but also by the corporate sector at large. It is the first expense axed when an individual or a company tries to save money.

"In addition, the post September 11 world has allowed the foreign reinsurers, on whom the local industry depends heavily to pass off the risks, to dictate terms and conditions as well as rates. The rampant undercutting practices to secure business at highly uneconomical tariffs undermines the honouring of claims as quality cannot impossibly be provided at such cut-throat low rates.

"In addition, the practice also a major detriment to develop economies of scale for the betterment of the industry because increased volume means increased premium incomes for all the players and equitable distribution of the business for all the players to let the tariffs fall naturally. However, the uneven distribution of business undermines the basic principle of protection. Today's free-for-all market may help a small number of big insurance companies but it is certainly not good for the industry as a whole.

"Almost half of all general insurance companies operating in the country face severe financial problems today. Around half of the total 38 general insurance companies are not solvent and I feel that there would be unhealthy mergers and acquisitions in the industry by December next year when the companies have to raise their paid up capital to Rs 80 million. There would also be many closures."

The stricter accounting guidelines and formats for the preparation of accounts announced by the Securities and Exchange Commission of Pakistan would also have an impact on the results of the insurance companies. The reasons which already has, and would have an impact of the financial results include changes in method of providing for Un-expired Risks, Provision for Premium Deficiency Reserve, Deferment of Commission Income and outgo based on the concept of earned premium.

According to EFU General, the financial impact of these amendments would have bearing on the results this year and also had a bearing last year. Since SECP announced these requirement in the second week of December last year, relaxation in implementation has been allowed on provision for Un-expired risks and provision for Premium Deficiency Reserve till last month. The SECP has prescribed two sets of basis for providing for Reserve for Un-expired Risks, either on pro-rating basis or one-twenty-fourth method. EFU chose to adopt the one-twenty-fourth formula Reserve for Un-expired Risks which comes close to 50 per cent to avoid what it said the cumbersome calculation based on pro-rate un-expired risk premium on each policy and re-insurance in such a large diversified portfolio.

EFU also said that its result for 2003 would have a major adverse impact on its profitability due to increase in provision for Un-expired Risks and also for additional provision, if required on account of Premium Deficiency Reserve. EFU's reserve for Un-expired risks for the year ended December 31, 2002 rose by Rs 107 million to Rs 667 million compared to Rs 560 million during the previous year.

The introduction of new Insurance Law three years ago was aimed at briging discipline in the insurance agency to better protect the interests of the policy holders by making companies to enhance their paid-up capital in tune with the economic realities of today. It also aimed to address the rising complaints related to payment of claims and to overall improve the financial conditions of the players. However, it has also resulted in many closures as well as mergers and acquisitions whereby around half of the existing companies reel from inherent financial weaknesses to the point of being unsolvent. It has also resulted in massive undercutting practises to undermine the protection to the policy holders.

In addition, the foreign re-insurance companies are reluctant to provide terrorism risk cover to the local companies putting them at grave risk to provide the cover themselves. The foreign re-insurers have become much more choosy to accept or turn down business at their own conditions and in the process has find it fit to offer lower commissions to the financial discomfort of local companies.



Meanwhile, the Pakistani insurance industry keeps on reeling from inherent weaknesses in a society which treats insurance as an obligatory expense good only when necessitated by the law. The most glaring example of this is the Third Party motor insurance which offers no protection to anyone. Despite being better regulated, the industry shows few signs of development on sound footing.

The insurance industry as a whole feels that the year 2003 would be another challenging year due mainly to harsh conditions and dominating posture of the re-insurers in the international markets and fierce undercutting in all classes of business, particularly motor which despite snatchings and thefts still make top portfolio for the majority of the companies.

The strict regulation of the insurance industry by the SECP has done much good to make the companies to bring a semblance of professional financial attitude. However, the new law has failed to address many core issues, the top being rampant undercutting undermining the protection to policy holders and induction of professionalism in the industry. Observers don't question the SECP's vision but many of them are critical of the harsh implementation of the regulations, like the issuance of notices to a number of companies for their failure to arrange re-insurance only from "A" rated companies last, because insurance industry like the rest of the sectors of the economy has been operating more or less without documentation for the last 56 years.

The new law has abolished minimum fixed tariff for various classes of the business and though the measure was meant to eradicate the rampant unethical under-cutting it only seems to have resulted in a cut-throat competition undermining the quality of protection and honouring of claims.

The enhancing of the paid up capital to Rs 50 million during the first phase by December 31 last year resulted in many closures, mergers and acquisitions. The enhancing of the minimum paid up capital to Rs 80 million for general insurance companies, and Rs 150 million by life companies, by December 31, 2004 poses challenge to many small companies which managed to fulfil the requirement last year. The fierce competition in the internal market, the reduction in commission paid by foreign re-insurers and the new accounting guidelines and formats for preparation of accounts makes many small companies highly vulnerable in the near future. Right that many of these companies would be able to enhance the paid up capital limit to the required level of Rs 80 million 17 months from now but many fear that it would come in the form of more mergers and acquisitions which would weak to undermine the overall health of the industry. Mergers driven by necessity can hardly be expected to be natural and strong and weak and un-natural mergers would result in creation of financial unsound companies thus negating one of the most important objective of the new law the development of the strong insurance industry and individual companies.

However, the strict regulations have made insurance companies more accountable. For instance, it has made the companies to make parts of their accounts public to better understand the financial health. For instance, gone are the days when many companies big, medium and small found it convenient to post profits despite churning out underwriting loss.

This happened because unlike many other businesses it is much more easier to flaunt a profit despite suffering underwriting loss, the barometer of the professional performance of an individual company. While underwriting profit, and for that matter loss, is the real barometer of the financial health of an insurance company be it profitability, retention, protection to share-holders previously the industry as a whole had no qualms to show a profit despite suffering underwriting loss to mask an otherwise bad financial portfolio. In short, it was easy for an insurance company to show a profit despite incurring underwriting loss to represent a false picture. Many companies posting profit in reality were in bad to undermine the interests of unwary policyholders.



In country where 15 of the total 38 general insurance companies enjoy 94 per cent share of the business and where the overall growth, and profitability, is led by Motor class of the business, which explains the fierce competition despite high loss ration, the need to protect the interests of the policy holders can hardly be over-emphasised. The free-for-all market and the ensuing competition at uneconomical rates undermines the very concept of protection inherently associated with the insurance business.

Much has been done to regulate the financials of the companies while much remains to be done to devise rules, regulations and measures to address the ground realities to better protect the interests of the policy holders on the one hand and the sound development and growth of the industry on the other.

Measures should also be taken to lessen the heavy dependence on foreign re-insurers which has find it appropriate to dictate their terms and conditions to increase the rates, tighten the capacities, reducing the covers and slashing the rates of commission paid to the local companies.