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Opportunities in Latin America

The Latin America insurance outlook for 2015 is generally favorable, with high-single-digit premium growth across the region presenting complex risks and opportunities. Although real economic growth has slowed recently in the largest markets of Brazil and Mexico, stronger economic growth and inflation in some areas continue to drive premiums. Long-term trends (reduced poverty, shrinking unemployment and a population increasing above the pace of most mature markets) are bolstering consumer demand for insurance products.

In general insurance, catastrophic risks from floods, hurricanes and earthquakes are driving premium growth in a number of Latin American countries. Premiums peak following major losses as demand increases and supply becomes more costly. In contrast, the underwriting cycle slowly reduces premium rates after benign catastrophe-loss periods, such as those experienced in the last few years. The development of efficient distribution systems to increase insurance market penetration and encourage product acceptance remains a critical challenge.

As economic, political and regulatory environments evolve inconsistently across the region, inflation risk continues to persist at varying levels. While Chile’s, Peru’s and Colombia’s annual inflation rates averaged 2% to 3% from 2009 through 2013, Argentina’s and Venezuela’s percentages were the highest in the region. Argentina’s battles with its creditors, and its governmental hand in business, have destabilized its currency. In contrast, Mexico’s government remains stable and is progressing with reforms to modernize insurance and other business sectors.

From a tax perspective:

  • Brazil imposes the highest income tax in the region, with insurer profits taxed at 40%. Popular products include health insurance and term life insurance, as well as auto and property covers, which are sold by independent brokers. Tax incentives for retirement accumulation plans are growing in popularity.
  • Mexico’s tax incentives, promoting retirement savings and a reasonable income tax structure, are contributing to growth. In a country where third-party auto liability coverage is mandatory in several cities, auto insurance generates the highest premiums.
  • The scenario is similar in Chile, where auto insurance is also compulsory and characterized by intense price competition. Provisional life and retirement products are part of the national social security system. Approximately half of all insurers are subsidiaries of international firms. Although an open market has led to stability and a competitive balance, insurers continue to adapt in the wake of earthquakes and other natural disasters.
  • In Argentina, independent agents and brokerage firms account for an estimated 75% of total premiums. The nationalization of private pension funds in 2008 changed the insurance industry structure, sharply reducing the size of the life and annuity market and the number of insurers in the country. Argentina imposes a high income tax burden, with profits taxed at 35% and a 10% dividend withholding tax.
  • Colombia, the fifth largest Latin American insurance market,
    is partially focused on investing in infrastructure to encourage demand for guaranty bonds. Automobile insurance, compulsory personal auto accident protection and reinsurance and earthquake insurance are the most important product lines. The industry aims to develop catastrophe insurance markets and enhance risk models, hoping that a stable commercial market will help deter government response to gaps in market coverage.
  • Peru has upgraded its economy in recent years to manage its rapid growth. Significant changes are being made in consumer protection, tax legislation and new regulation. Peru’s growth forecast is 6% this year, compared with predicted growth of 1.5% for Brazil and 1.1% for Mexico. Many foreign companies are considering Peru as a safe and desirable country for investment.

The Latin America insurance environment is becoming more similar to mature markets. Strong economic growth rates and regulatory reforms in the past decade(s) have attracted a number of global insurers, reinsurers and insurance brokers to the region. Mergers and acquisitions continue to help these global players build their positions. And cross-regional expansion efforts by Latin American-based insurers have increased their size and market reach, as well. These deals are enhancing insurers’ capabilities in product development and risk management. The implementation of new Solvency II insurance capital management regulations in 2015 is expected to result in a shift toward greater insurance industry consolidation and increased sophistication in risk management.

Low penetration rates in Latin America are caused by a number of factors and afford significant room for growth if economic expansion continues. Factors include:

  • Wealth disparity
  • Insufficient tax incentives for retirement products
  • Lack of knowledge among the general population about the value of insurance

Also contributing to potential opportunity is the changing perception of insurance as a necessity or investment, rather than a cost. This comes about with a change to the region’s income disparity, which in most countries is shrinking. Brazil is expecting double-digit declines in premiums across many low-hazard markets. In this heightened competitive environment, many insurers believe they can accelerate premium growth by targeting rapidly growing market clusters.

In comparison, Argentina is experiencing high inflation, tight regulation and a fluctuating economic market; nevertheless, insurance is a fast-growing industry that continues to show resilience in premiums and tolerance for expansion in a challenging environment. Argentina and Venezuela also have strict foreign-exchange control regimes. These generally do not allow residents to pay dividends or inter-company services/royalties outside of the country — in some cases, also limiting the deductibility of certain payments.

In general, it is worth discussing the value added tax (VAT) system in these countries,which is a key concern for insurers.TheVATpaid on the local purchase or importation of goods or services constitutes “input VAT” that typically should be credited against the “output VAT” generated on the taxable sale of goods or services. VAT should not be a cost of doing business. However, VAT is often an unexpected cost when entering a market. In the case of Latin American insurers with VAT taxable and non-taxable activities, the VAT calculation methodology is complex and usually generates some level of irrecoverable VAT.

Some products sold by insurance companies are exempt from VAT, meaning that any VAT incurred on the local purchase of goods or services becomes an irrecoverable cost for the insurance company (although deductible for local corporate income tax purposes). For example, the following are exempt:

  • Argentina’s life insurance and workers’ compensation policies
  • Mexico’s life and pension insurance
  • Certain insurance contracts in Chile, including those related to international trade, insurance of assets located outside of Chile and earthquake-related coverage

Brazil deserves a separate analysis because Brazilian insurance companies are subject to Social Integration Program (PIS) and Contribution for the Financing of Social Security (COFINS) taxes on gross revenues, at a combined rate of 4.65%. PIS/COFINS are not a VAT type of tax but, rather, they are paid on a cumulative basis: any PIS/COFINS paid by the local insurance company is not a recoverable cost. Brazil has a state VAT (ICMS) and a federal VAT (IPI), but these taxes do not apply to the sale of insurance products.

Property/casualty, auto insurance, professional liability, environmental and finance solutions are generally subject to VAT in Latin America, so any VAT paid should be fully recoverable for the local insurance company.

In addition to the VAT, some Latin American countries impose additional layers of indirect taxes that should be carefully reviewed by local insurers (e.g., gross revenue taxes, taxes on financial transactions, net worth taxes and stamp taxes, among others).

Insurance Risk in Latin America

Latin America’s compound growth remains attractive and yet, overall, insurance penetration rates still remain low in many countries. Particularly in life insurance, despite continuing economic growth and reduced poverty levels, penetration is low, suggesting there is still significant growth ahead for the insurance sector. We have seen significant reforms across the region from both a fiscal and regulatory standpoint, in everything from capital and exchange controls to consumer protection. We believe a key challenge for insurers over the next decade is navigating this rapid acceleration toward modern regulatory and operational realities.

Around the world, regulators are setting the expectation that insurers will raise their game. The trend is clear, toward better risk management, better governance, more precise measurement of capital in a risk sensitive way and more detailed and transparent reporting to regulators.

We presented our first report for Latin America in 2012, focusing on risk-based capital (RBC) and emerging regulations in four markets: Argentina, Brazil, Chile and Mexico. We have expanded our coverage and also added Colombia, Peru and Uruguay to our new overview.

In the past two years, each Latin American market has faced a different journey to a risk- and economic value-based solvency framework. More open markets in the Pacific Alliance (Chile and Mexico) have enhanced their risk management processes, while Brazil is seeking Solvency II equivalence by 2016. Mexico’s new law, modeled on Solvency II, is likely to be implemented ahead
of the rest of the world. Peru and Uruguay have no immediate plans to pursue a Solvency II approach. Although both countries are attracting foreign investment, the market size and number of players are impeding regulation. With Argentina’s high inflation and economic concerns, adopting an RBC framework in the short term is unlikely.

The challenge to understanding Latin America remains that most insurers in the region are not well-prepared for the expected changes in governance, risk management, capital requirements and reporting. At EY, we believe that effective risk management and the ability to quantify and price risks accurately are a core competence for a successful insurance company. We also observe globally that the leading insurers will typically look to define their own vision for their capabilities in these key areas, rather than simply following the iteration of each piece of regulation. Leading firms will also typically go on to deploy these capabilities more quickly and effectively across their businesses at the point of decision making, and being ahead of competitors in this way is a source of clear commercial advantage.

Argentina

The Argentine insurance market has made minimal progress in its approach to RBC in recent years. As other Latin American countries take steps toward Solvency II equivalence, Argentina is only superficially addressing this issue. In a country experiencing high inflation, tight regulation and fluctuating economic market concerns, RBC is only one in a long list of initiatives on the regulatory agenda of the Superintendencia de Seguros de la Nación (SSN).

Nevertheless, insurance is a fast-growing industry that continues to show resilience in premiums and tolerance for expansion in a challenging environment. Annual growth percentages are measured in Argentine pesos, so the inflation rate has a significant impact on those figures. As of 30 June 2013 (last fiscal year-end), there were 184 companies (108 in property/casualty) writing insurance in Argentina – with 29 new companies added in the past two years. International players continue to make acquisitions to enhance their positions in the industry. Growth has been most prominent in workers’ compensation and motor insurance, producing increases of 42% and 35%, respectively, from June 2012 to June 2013.

Brazil

The Brazilian insurance market continues to achieve double-digit growth. The industry is witnessing a series of mergers and acquisitions and the arrival of multinational insurance and reinsurance companies, mostly from Europe. In addition, the sector experienced the largest initial public offering in the world last year, when BB Seguridade raised approximately US$5.75 billion in the BOVESPA stock exchange.

Although national bancassurance players dominate the Brazilian insurance market, international insurance companies continue to grow at a higher rate through M&A and strategic alliances.

Given the continuous growth in the market, the Brazilian regulator, Superintendência de Seguros Privados (SUSEP), is working with the European Insurance and Occupational Pensions Authority (EIOPA) to achieve Solvency ll equivalence in Brazil. This will facilitate the investment of European insurance companies in Brazil and Brazilian companies in Europe. SUSEP will sign an agreement that will adopt Solvency ll rules partially or fully by 2016, based on a comparative study that EIOPA will perform to measure Brazilian regulation against the Solvency II regime.

Chile

The insurance market in Chile continues to shift from its present regulatory framework to a more sophisticated RBC approach to solvency assessment that better reflects current industry risks. New methodology proposed by the Superintendencia de Valores y Seguros (SVS) is an important step toward building an integral and holistic RBC model.

The Comframe capital framework implementation requires each risk category to be managed individually, with most supervision on a product-by-product basis. Most insurers will need to improve their risk function or implement a holistic approach to risk management. Also, local skilled resources are scarce for the level of technical knowledge imposed by this regulation. Many will need to develop better data analytics, systems and precise risk measurement if they are to increase capital efficiency and profitability.

Chile is one of the more stable markets in the region, primarily because of tight controls over insurance products and asset portfolios. This stability is essential in a market that offers rich growth potential. While the ease of doing business in the country presents an opportunity, product expansion remains an emerging challenge due to a lack of insurance product awareness and consumer perceived value.

Colombia

Colombia enjoys strong economic growth and enormous potential for financial stability over the next three to five years. GDP growth is about 4% a year, ahead of the average for the region. This is driven by stronger activity from foreign investors, a stable macroeconomic environment and a growing middle class. The free trade agreements that Colombia has engineered with major world markets are one example of the tremendous potential the country offers.

Insurance regulation is moving toward a more risk- and economic value-based solvency framework, with tightened capital market regulations. As a result, Colombia is ahead of many global rapid growth markets in reforming regulatory processes, protecting investor rights and cross-border trading to increase the ease of doing business for small companies.

Recent rules that allow foreign insurance companies to establish branches and operate as local insurers have changed the complexion of the Colombian market. Global industry players are entering, buying local insurers or considering start-up companies. This should encourage increased capacity, product diversification and greater competition. Colombia’s premium growth was US$8b in 2013, and rate reductions of as much as 10% were expected for property and life/accident insurance in 2014.

Mexico

The Mexican insurance market is the second largest in Latin America. As of December 2013, gross premiums totaled $334.19 billion Mexican pesos or approximately US$25.6 billion, an increase of 11% over the prior year; this increase includes the effect of a large biannual policy of the government. Despite having one of the lowest proportions of insurance penetration in the region (almost 2% of GDP), Mexico continues to grow above the country’s nominal GDP. New insurance laws and Solvency II regulations are leading to market consolidation, as well as growth in specialty and consumer product lines. The high demand for life insurance is reflected in individual life premiums, which rose 23% in 2013, following a 19% increase in 2012, basically for the success of some savings products.

The regulatory framework in Mexico is evolving toward a more sophisticated risk-based capital approach. A proposed Solvency ll – type insurance law has been under review by the Mexican regulator, Comision Nacional de Seguros y Fianzas (CNSF) and the Mexican association of insurance companies, Asociacion Mexicana de Instituciones de Seguros (AMIS) since the second half of 2008.
The Mexican Congress approved the new regulation in April 2013. Quantitative impact studies and qualitative impact studies are moving forward, and new accounting principles are under discussion. Legislation in the country continues to advance and is likely to be implemented ahead of the rest of the region.

Peru

Peru’s steady economic growth and expanding middle class are attracting new business and opening doors for insurance companies. The Peruvian economy is supported by rapid growth in investment, low inflation, strong economic fundamentals and an annual GDP growth rate of nearly 6%. The country has an investment rating in Latin America that is second only to Chile and offers a favorable legal framework for foreign investors. The financial sector, including insurance, is second only to mining (gold, zinc and copper) in direct foreign investment.

In the last decade, insurance industry sales in Peru have grown more than 200%, from PEN2,700 million (approximately US$776 million) to PEN9.069 million (approximately US$3.36 billion) in 2013. As of December 2013, 40% of total net premiums were from general insurance, 14% from accident and health, 21% from life insurance and 25% from the private pension fund system. It is important to note that only approximately 16% of the urban population has private insurance and 18% has health insurance – and this number has stagnated over the past five years.

The insurance market is highly concentrated in Peru, with 2 of the 15 insurance companies accounting for 60% of total gross written premiums. Overall, insurance penetration rates remain low, as they are in many other Latin American countries.

Uruguay 

Uruguay is a small country with stable economic growth, expanding tourism and rising disposable income. It was one of the few countries in Latin America that was able to avoid recession in 2008, and it continues to grow, with an economy based largely on exports of commodities like milk, beef, rice and wool. Some of world’s largest banks and financial institutions maintain branches there, and it was fortunate not to experience the impact of the global financial crisis or ensuing government intervention.

Although the Uruguayan insurance market is highly competitive, it has no more than 15 companies competing for market share. The largest in the country is Banco de Seguros del Estado (BSE), a government-owned insurer with about 65% of the market share as of December 2013.

Gross written premiums for the insurance industry totaled UYU21.6 billion (US$1.1 billion) in 2012, with a CAGR growth rate of almost 19%. Motor insurance and general liability insurance were leaders in the non-life segment. An increase in demand for pension products contributed to the significant growth in the life segment.

For the full report from which this excerpt is taken, click here.