Who needs the Russian risks and who will offer reinsurance protection?

15 October 2015 — Olesea ADONEV
Reinsurance represents the continuation of the insurance segment and any negative effects are reflected on the further development of the reinsurance business.

"To implement effective and correct solutions regarding the future development of the reinsurance market, it is necessary to streamline the direct insurance market, and the mathematical formula is very simple, namely, regulatory requirements and core professional practices compel (re)insurance companies to hold assets of sufficient quality and liquidity to match cash outflows generated by the company's liabilities. But at the present most players don't have enough high-quality assets," stated Igor ZHUK, Director of the Department for the insurance market of the Central Bank of the Russian Federation. In this context, the Central Bank continues to "clean up" the domestic insurance market by dealing with the companies whose financial stability raises more questions.

Irina POSTNIKOVA, CEO, TRANSSIB Re, added that "among the insurance companies that left the market there were some really weak in financial professional terms, but at the same time there were those that were highly respected and trusted."

"Some of these companies have violated the law and instructions from the Central Bank of Russia. Many insurance companies were captive within their financial groups and their capital was not paid by real means. As a result, they can't form their own capital.

Deputy CEO
SKALA Reinsurance Brokers
At the same time, we see the process of cutting the number of players on the market in action," commented Svetlana KOMISSAROVA, Deputy CEO, SKALA Reinsurance Brokers.

At the beginning of June, 1st 2015 the Central Bank tightened the control over the insurance companies' assets quality and as a result more than 40 insurance companies have left the market recently.

"The new, rather strict policy of CB, introduced two years ago, is directed towards a completely right way to target market sanitation. The tough control over the financial strength, quality of assets and correct market behavior should clean theinsurance market of weak, non-professional, very small or empty and idle insurance companies to further concentrate services with the large, reliable players," noted Dmitry GARMASH, Head of the Moscow Representative Office, BARENTS Re Panama.

The main claim of the Central Bank to companies is the poor quality of assets in which funds of insurance reserves were placed.

Deputy CEO
At the same time, from the reinsurance point of view, "market shrinkage is no doubt a negative trend because of a narrowed client base and potentially lower written premium but also due to increasing concentration of certain partners within our portfolio. Up to now, being actively engaged with each and every insurance company from Top-50 we did not experience any premium drop getting the same business from larger players; on the other hand we saw a dramatic increase of our main clients share within our portfolio", stated Igor SHEKHOVTSOV, Deputy CEO, UNITY Re.

Key challenges began in 2014 and continued throughout the current year, being reflected in the market results. Dmitry GARMASH explained that "the market figure is a dramatic drop from the growth rates the market experienced in 2010-2014. Unfortunately, it represents the overall Russian economy recession and comprises the more negative inner sectorial insurance dynamics, eg. the number of policies issued across various lines of business decreased from 7% to 30% on average; the volume of corporate property dropped by around 11%; the construction insurance is forecasted to sag by 30% by the end of the year. The macroeconomic environment grounding all these negative changes involves a severe devaluation of the Ruble, a 8-10% inflation and other threats. Insurance is a kind of "downstream", derivative segment to the material sectors of the economy - trade, construction, metallurgy, oil & gaz, etc - so all negative trends finally affect insurance, and consequently reinsurance."

In the first half of 1H2015 the Russian insurance market increased only by 2% and adjusted to the inflation; "growth" can be characterized as a reduction or fall.

Managing Director
Inward Treaty
Reinsurance Division
In the opinion of Igor ALEKSEEV, Managing Director of Inward Treaty Reinsurance Division, INGOSSTRAKH Insurance, "the growth in the Russian insurance market by 2% is insignificant for our emerging market. We should develop by two-digit figures. Of course, the low growth is caused by the overall economic situation, sanctions, as well as the devaluation and reduction of income of the population. During the crisis, insurance is not the first need for people and corporations."

The leaders' opinion on CEE&CIS and the Russian reinsurance business

Despite the close historical and economical relations between Russia and the Independent States (CIS), the situation regarding the CIS partners was complicated.

Chairman of the Board
AZ Re, Azerbaijan
Fuad KULIYEV, Chairman of the Board, AZ Re, Azerbaijan underlined that "it is interesting to note that some large reinsurance companies have recently tended to reconsider their policies towards underwriting risks from CIS&CEE countries. One example is MUNICH Re to close down its Moscow non-life branch and stop writing business in this area. Another example, yet quite opposite, is SWISS Re that demonstrates now clear interest in the reinsurance business from the CIS countries, and from Azerbaijan in particular. So the reinsurance landscape is never still." He added that "reinsurers are currently overseeing the decrease in the motor insurance market and other business lines associated with the banking channel in the region. The devaluation of local CIS currencies also leads to a decrease in volumes of the regional outward reinsurance premiums."

Head of the Moscow
Representative Office
Moreover, according to Dmitry GARMASH the reinsurance operations within the CIS are "rather volatile and vulnerable to the general regional and domestic economies trends. This is what determines the volume of business available both for treaty and facultative reinsurance. From a purely technical point of view, the market is still very soft, very competitive, with quite a low risk representation culture. This is a result of corporate risk management still being quite poor."

The further development of the Russian reinsurance market is directly dependent on the state of the global reinsurance market. The share of the Russian market, including the CIS markets business on the international market is quite small, about 1-2%.

So, it is worth noting that in recent years the main tendency of the international reinsurance market is an overcapitalization of the reinsurance companies or even described as a "soft" market. On average the reinsurer capital grew by 5% year on year. A traditional "soft" market is coming as an alternative capital and puts pricing pressure on the reinsurance market flows to the primary market. Nomura analysts say in their report that one impact of the growing alternative capital presence will be the further price weakening in property/catastrophe reinsurance rates, followed by the weakening across all reinsurance lines before finally affecting the primary commercial rates.

M&A, the main challenges on the global reinsurance market

Overall, the "soft" market is attractive and generates profits for the industry. However, due to an excess in the capital and an intensified competition on the international market, reinsurers have frequently forced the prices decrease in many lines of business in order to maintain their business volume and market share. In this context, further mergers and the consolidation of the reinsurance business is to be expected, not only among strong the re/insurers players, but also among brokers that can also follow this trend.

The massive trend of M&As, started in 2013 and 2014 has been accelerated in the current year (2015). So, Guy HUDSON, Partner, JLT RE, described this trend as "structural, not attritional." Among the indicators supporting a M&A positive trend are the strengthening macroeconomic conditions; the continued growth challenges; the historic levels of over capital; the competitive dynamics driving the consolidation of the reinsurance sub-sector and the increased interest in insurance M&A from strategic, private and foreign buyers, etc.

The opinion of the Russian reinsurers on the "Soft" markets

As for the Russian reinsurers, "the "soft" international market represents an advantage for those insurance companies which place outgoing reinsurance programs. More competition on the market leads to more favorable terms and conditions for passive reinsurers. The same reasons represent disadvantage for active reinsurers accepting incoming reinsurances from local and international clients. It is becoming practically impossible to compete with global players and multinational reinsurance giants," explained Igor ALEKSEEV.

At the same time, Irina POSTNIKOVA sees the "soft" international reinsurance market as an advantage "since we protect our own portfolio and the protection price is one ot the main items in a company's budget. Due to that we could manage to transfer our retrocession programs for the Russian market into RUB."

Also, "from our perspective, except for Kazakhstan, no significant changes took place for the last year and markets remained the same. On the Kazakhstan side we experienced the long awaited decrease of the rating requirements enabling us to write Kazakh business without additional reservation which resulted in a considerable business flow", affirmed Deputy CEO of UNITY Re.

Moreover, from the Russian broker's point of view, Svetlana KOMISSAROVA stated that "Placing risks on the local Russian market brings us less problems. International markets become more careful in their underwriting of our risks. Some of our clients are still afraid to place their risks in Europe, because the process of claim settlement can be too long and painful. However, some of the biggest European Reinsurers can still give us better rates and conditions than Russian Reinsurers."

Who remains on the playground under sanctions conditions

In July 2014 the United States, the European Union and Canada also imposed sanctions against several Russian state-owned banks and the Russian energy and defense sectors and some of the Russian re/insurance companies. Moreover, economic sanctions against Russia were extended until the beginning of next year. This happened especially for transferring to reinsurers the property or Cargo risks belonging to companies whose owners are already on the "black list".

The main capacity of the world's reinsurance market is concentrated in the USA, UK and Germany. The portfolio of risks ceded abroad consists mainly of risks related to the space industry, construction, power generation, up-and down-stream energy, metallurgy, and large-scale property projects, etc. It is a particularly difficult situation with the reinsurance of the Russian state and the companies in the military industry that were introduced on the sanction lists. As a result, the reinsurance companies operating on the Western and North American markets on such projects do not take over reinsurance.

According to Irina POSTNIKOVA, "the capacity of the Russian reinsurance market overall is formed for "sanction" risks, which include Property, CAR, Freight transportation and Aviation risks. In my opinion, if the currency rate remains the same, the capacity of the Russian market will amount to USD 40 million."

At the same time, "gross capacity is enormous. It has always been sufficient to cover 99% of the risks while net capacity is of great concern, especially now with the sanctions in place. I believe that more or less realistic figures were announced after an informal research was done half a year ago stating that Russian market net retention lacks the following capacities: USD 200 million in respect of Cargo, Aviation - USD 75 million, Marine/Shipbuilding - up to USD 1 billion. Property segment feels better than other making overall net capacity up to USD 100 million still being not enough to speak about no dependency on western capacities", stated Igor SHEKOVTSOV.

During the all-sanction period, Russian companies that have enough capital flow have created reinsurance capacity for some of the sanctions risks. However, there are other more expensive lines of business, for example the insurance of construction risks, where the amount of re/insurance may reach billions of dollars. For these projects it is difficult to find reinsurance coverage on the domestic market.

It is important to mention that the reinsurance business is a highly capital-intensive industry and most of the Russian insurance risks are reinsured abroad - mainly on the European insurance market. Particularly, in the first half of 2015 the total premiums ceded for reinsurance (domestically and abroad) by the local companies totaled RUB 61 billion, down by 10% compared with 1H2014, and about 70-72% of the accumulated risks were placed abroad to foreign reinsurance.

At the moment, it is rather difficult to evaluate the sanctions risks, but it is certain that one that these risks can reach billions of dollars. Thus, sanctions risks can be described as profitable business, which has been lost by foreign reinsurers "temporarily". At the same time, the existing Russian reinsurance capacity cannot completely offer protection for sanctions risks.

Based on personal experience, Igor ALEKSEEV confirmed that the Russian insurance companies have problems placing the sanctioned risks on the European and London markets: "How are we deciding it? First of all we are using a capacity of the local market. Then, we attract reinsurers from Asia and the Middle East, Latin America. At the same time we have to mention that the capacity of alternative markets is not reliable enough. For some big projects in many classes of the business (property, engineering, marine hull and P&I risks, aviation) we need much more reinsurance support. We hope the National State Reinsurance Company which is being set up in Russia now will help us to solve the main part of the problem."

The search for "alternative" markets has not led to success because all the countries (including Asia region) are closely related to the European and London markets, which are in fact dominant. Moreover, Russian official delegates appealed to reinsurance coverage to China (note: the Chinese market is huge and further it is estimated that about 20-25% of the worldwide insurance business will come from China) but without much success.

The main explanation of the lack of success is that large Chinese companies have USA and European investors in their capital; they are actively involved in the European reinsurance business. An example in this regard is the opening of Lloyd's China Branch in order to become the top provider of non-life reinsurance business inside China and international reinsurance. Lloyd's China obtained the CIRC's approval to increase capital, so they are now in the position to lead on treaties.

Also, Asia, the Middle East and Latin America cannot ignore completely the sanctions imposed by the countries in the business they are actively involved in.

Moreover, the "potential" market for reinsurance of the Russian risks is made up by those companies/markets that are not absolutely exposed to the sanctions regime of the USA, the UK and EU, namely those foreign reinsurance companies which are not managed by citizens of these countries or gain capital from there.

"Considering the Russian insurance community didn't succeed in finding proper, sufficient support from the so called alternative markets, the ground for creating a state-owned reinsurer looks reasonable to guarantee the high-valued state interests domestically and overseas with a stake on large-scale projects (property, construction and cargo for international trade). The final outcome and market results would highly depend on the deployed conception and model of such a state reinsurer: whether it will work with only sanctioned and, say, CAT-exposed risks, or it will go on the open market where the obligatory cessions could easily ruin the economic mechanisms in the market," stated Dmitry GARMASH.

Keeping risks in the country

In the context of an unclear situation, which is spread out over the international market, since June 2014 some of the Russian officials have started talking about the creation of a National State Reinsurance Company. Primarily the activity of the national reinsurer will be focused on handling sanctioned and military risks, as well as objectives placed in the Crimea and Sevastopol, but also on increasing the reinsurance market's stability in case of further economic isolation.

According to Igor SHEKHOVTSOV, "we see little possibility for such a huge issue to be managed quickly. Latest news for the national reinsurance company project was simply distressing. Central Bank of Russia intends to put a mandatory requirement for 10% obligatory cessions to "NRC" which makes at least RUB 15 billion of annual premium in absolute terms. If the project will commence as proposed by the Central Bank, it will be a huge step back for the whole industry, losing the core market principle - competitiveness. Ministry of Finance totally disagreed with "mandatory cessions" approach suggested by Central Bank and I hope that it is an early point to start panicking because too many legislative changes are still to be introduced and enforced in order to allow such mechanism to work".

"The decision of opening the national reinsurance company is already made. Now they are preparing the mechanism and process of its work. The main purpose of the national reinsurance company is to cover all the sanction risks in Russia. Local companies will probably be forced to place a small percent of their risks in that company. However, the biggest part of our market's players is against mandatory cession," Svetlana KOMISSAROVA explained.

It is expected that the state reinsurance company's share capital will amount to RUB 71 billion, gathered on the Central Bank's expense.

Russian insurers were reserved when talking about the new project because a state reinsurer, named BELARUS Re, was established in Belarus. BELARUS Re is the first and only specialized reinsurance Company in the Republic of Belarus and, in accordance with the domestic legislation, is the only company ceding risks insured on the territory of the Republic of Belarus to foreign insurance and reinsurance companies or brokers. Speaking about the creation of a national reinsurance company and the main principles of its functioning, Igor ALEKSEEV said that this is a complicated issue: "On the market nobody knows now the principles on which the National Reinsurer will operate. It is left to believe that the new creation will not destroy the current reinsurance system."

According to Igor YURGENS, President, All-Russian Insurance Association (ARIA) and President Russian Association of Motor Insurers (RAMI), "there is a list of risks that needed financial guarantees, which are impossible to reinsure on the international markets. In this regard the insurance community position will depend mainly on the kind of business model that will be adopted by the Central Bank. What is clear and important though is that the state reinsurer is not destroying the free market. If the state reinsurer is created to provide reinsurance coverage for sanctions risks, the insurance community will fully support this model. However, we are definitely against the creation of such a player that will take our part of business, and in this case such a reinsurer will not receive support from the markets players."

Lastly, regardless of the decisions of the Central Bank, the capacity of the new state reinsurance company must be huge, comparable with that of the Western and Asian players, reaching billions of dollars.

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