Strong headwinds

Gareth Stokes takes a look at the changing fortunes of South Africa and the impact on business South Africa, once the darling of emerging market Africa, is teetering at the edge of an economic abyss. A poisonous cocktail of cadre deployment, corruption, mediocre policy implementation and state capture has stymied domestic economic growth and fuelled the twin evils of unemployment and inequality. As we pass the midway point of 2017 the country finds itself in a technical recession with increasingly subdued forecasts for GDP growth. Research firm Nomura has pencilled in a paltry 0.2%, 0.7% and 1% for the coming three years. Chris Gilmour, an independent investment analyst, assesses the country’s health on three measures, namely GDP growth, inflation and government debt as a percentage of GDP. “The economy is in technical recession and we are unlikely to return to meaningful growth any time soon; inflation is falling slowly and should remain within the target range of 3% to 6% this year and next; but debt to GDP at around 50% is uncomfortably high,” he says. Overall government debt surges to 65% of GDP when the country’s abysmally performing state-owned enterprises’ (SOE) debt is added to the pile. “A recession means we are growing poorer as individuals while the relatively high capital market interest rates give an indication of the risk associated in investing in SA,” says Dawie Roodt, chief economist at Efficient Group. The measurement of this risk, as reported on by international ratings agencies, has kept local analysts and financial journalists on their toes of late. Both Standard & Poor’s and Fitch have downgraded the country’s foreign debt to ‘junk’ status while Moody’s retains a rating at one notch above junk. Mr Roodt says the recent sovereign ratings downgrades were expected and were largely discounted by the markets; but warns that downgrades to the local debt could have a major detrimental impact on the economy. “In terms of our local debt, which accounts for about 90% of total debt, we are still in investment grade territory, but only just,” says Mr Gilmour. “Any tampering with the central bank – or delay in getting back onto a sustainable growth path – could result in further downgrades and put our local debt into junk status too. This would result in massive flight of foreigners’ bond holdings, a spike in interest rates and a collapsing rand.” A country’s credit rating has a major impact on firms trading in the financial services sector. “Spurred largely by negative growth in the mining and manufacturing industries, our low GDP growth, the ‘junk’ status downgrade and recession have all impacted SA’s investment risk profile. The result is that the cost of living continues to rise for everyday citizens as well as businesses,” says Ms Mercia Wallis, head of retail at Bryte Insurance Company. As a result, consumers face higher unemployment and the rising costs of electronic equipment, imported parts, motor vehicles and repairs to name a few. Businesses meanwhile have to accommodate a growing cost base, due to the rising costs of imported materials, the high cost of borrowing and losses from natural disasters. “The silver lining is that insurance sector growth will come from other lines of business such as corporate (property and liability), accident, health, travel and various forms of liability – insurers will need to review their strategies to ensure cost effective business models, flexibility of their portfolios and innovation in value-add products,” says Mr Juan-Pierre Holmes, national head: specialised property division at Bryte. While insurers have to make the best of the economic situation the political landscape leaves a great deal to be desired. SA is straying back into the realm of race politics with terms such as white monopoly capital and radical economic transformation (RET) being the order of the day. These attempts at deflection are not unexpected given that the sitting President has been subject of no fewer than seven motions of no confidence in recent years. “The end result will hinge on factors such as the leadership struggle in the African National Congress, whether or not the President survives the upcoming (3 August) vote of no confidence and whether or not he has his day in court on a range of criminal charges,” says Mr Roodt. The sitting President is also facing a number of court challenges, including one brought by the Economic Freedom Front for his impeachment, to be heard by the Constitutional Court in September. The private sector has also expressed its concern at the failure, by government, to implement growth policies such as the National Development Plan, as evidenced by a slide in the South African business confidence index to a 15-year low of just 29 points in June 2017. Government’s response is to rush through additional draconian policies that are clearly anti-growth and anti-investment. One such example is the mining charter, launched by the Minister of Mineral Resources late in June 2017. The SA Chamber of Mines, which represents 90% of mining companies in SA, has already indicated it will challenge the charter in court. And criticisms have come ‘thick and fast’ from the private sector. “It is an ominous development; but the mining charter is symptomatic of the bigger picture wherein government recommends something absolutely extreme and absurd and then forces the private sector into a compromised agreement,” says Leon Louw, executive director of the Free Market Foundation. He warns that the charter will prevent investment in the mining industry and inhibit growth, investment and job creation. Mr Roodt adds that it is a horrible development that further undermines trust in the economy. President Zuma, meanwhile, has also done a great job of ‘capturing’ various state institutions to serve his broad interests, not least of which the Public Protector (PP), Advocate Busisiwe Mkhwebane. In a bizarre review of a decades-old state-funded bank bailout, Ms Mkhwebane not only ordered that more than ZAR1.1bn be recovered from Barclays Group Africa trading as Absa Bank; but that Parliament amend the constitution with respect to the SA Reserve Bank’s (SARB) mandate. “The Absa matter should never have gone to the PP,” says Mr Louw. “If Absa has obtained money illegally then the correct avenue for recourse would be through the courts; the PP could investigate the matter and hand it over to the police or prosecuting authorities for further action, provided a law has allegedly been broken.” His view is shared by Mr Gilmour, who observes: “The PP would appear to have been deployed in a misguided attempt to attack the independence of the SARB, but the only way to achieve this would be to impeach the governor, a long and laborious task with no guarantee of success. She has greatly exceeded her authority and needs to explain what motivated this outrageous ruling.” The next step, quite common in 21st Century SA, will be for Absa Bank, Parliament and the Reserve Bank to challenge the PP findings in court. Neither businesses nor consumers are safe from the conjoined socio-political and socio-economic maelstroms. “The broker market is a lead indicator of what is happening in the broader economy, particularly when looking at personal insurance and commercial insurance placed by SMEs. Early signs of financial distress include increased debit order returns, a rise in certain types of claims and the ‘downsizing’ of insurance portfolios – on the commercial side one notices a slight rise in the number of small enterprises that simply close down,” says Peter Olyott, CEO of Indwe Risk. A slowing economy means that insurers, insurance brokers and risk managers struggle to grow their businesses organically, often relying on ‘poaching’ customers from one another by offering greatly reduced premiums. Individual insurers or insurance brokers may outperform; but the outlook for the entire sector is rather gloomy. “The outlook is tempered further by political, regulatory and economic uncertainty – it is almost as though no one really wants to move yet because the horizon appears too vague and risky,” he says. It is logical that customers adapt to the prevailing conditions. “The potential risks are that clients reduce their cover, do not adjust the sum insured or do not maintain their infrastructure, which could potentially increase their risk and result in the product provider increasing premiums, requiring additional underwriting criteria to be complied with, or declining to accept the client due to un-insurability of the risk,” says Rikus Visser, CEO of PSG Insure. “That is why it is so critical for clients to use a qualified and experienced insurance broker.” The effects of poor economic performance gradually permeate through every aspect of an insurance business. As an example the value of the rand has declined from around ZAR9.91/$ in 2013 to around ZAR12.80/$ in June 2017. This represents a 23% decline over the past four years, bearing in mind that at certain times the rand has temporarily traded as much as 40% weaker. The combined effect of slow economic growth, currency instability and political uncertainty forces economic activity to a virtual standstill, with obvious ramifications. “Except for a few national brokers, the broking sector remains fragmented and very much regionalised – it also remains highly competitive as everyone is trying to secure a slice of the ‘cake’ that has shrunk due to lack of economic growth,” says Mr Visser. He says that lacklustre economic growth and the increasing regulatory burden will impact on margins and profitability across the sector, creating uncertainty and deterring new entrants to the market. The brokers’ view is shared by insurers. “Property and motor insurance continues to dominate the insurance sector and given the current economic environment (characterised by slow growth and the rising cost of living) consumers will become increasingly price sensitive,” says Ms Wallis. The main challenge in this regard is that customers opt to reduce cover amounts or exclude cover altogether, which could pose a threat in terms of underinsurance or not having any cover. Regulation remains a ‘game changer’ for all stakeholders in the insurance industry, with countless sector-specific regulations in various stages of finalisation. Government is also pushing ahead with a raft of non-insurance regulations that will have major impacts on both business and the consumer. The mining charter (already discussed) and financial sector charter will further entrench race-based legislation in the new SA and make it increasingly difficult for firms in these sectors to grow, while dissuading foreign investment. And well-intended policies such as the Minister of Health’s National Health Insurance are being rushed through despite massive ‘holes’ in the funding and resourcing components of the policy. These interventions are happening alongside SA’s move to a Twin Peaks model of financial sector regulation, which is conservatively estimated at ZAR4bn per annum to operate, plus billions more in compliance and enforcement costs. “Twin Peaks, recently approved by Parliament and now awaiting the President’s signature, will severely restrict new entrants into the financial services sector and shut the door on black economic advancement, not just in the service provider space; but also among consumers of financial products,” says Mr Louw. The cost and unintended consequences of new regulation are just part of the problem because each new law contributes to an environment of regulatory uncertainty. “The fact that it takes longer to finalise the regulations can be seen as a positive as it means more time is spent on obtaining and incorporating input from the market, evaluating the impact of the regulations (both intended and unintended consequences) and affording the market more time to adjust to the proposed changes,” says Mr Visser. “However, until such time as the regulations are finalised and enacted, some form of uncertainty will exist and it will be difficult to formulate and adjust business plans accordingly.” PSG stays abreast of regulatory trends by actively participating in the consultation process with the regulator, providing input on the proposed regulations and being among the early adopters of regulatory changes in the industry. “Every business leader needs to take a view on regulation and position their business accordingly – organisational agility is required not only from a regulatory point of view but also from an economic and technological viewpoint,” says Mr Olyott. “But when we discuss regulation against the backdrop of political and economic uncertainty it becomes clear why many brokers are uneasy – increasing compliance and industry participation costs together with the pressure of declining revenue growth and of course other general business regulations such as POPI [Protection of Personal Information Act] and King IV, among a raft of others, do not help matters.” The current regulation ‘top of mind’ at insurers and insurance brokers alike is the Retail Distribution Review (RDR). “RDR continues to be a key topic of debate within the broader financial services industry and is set to change how businesses in the industry operate,” says Mr Holmes. “The reforms, which are aimed at keeping the consumer ‘front and centre’ are premised on education through advice as well as the suitability, affordability and fairness of the eventual insurance solution.” While regulatory change is important, businesses in the sector are cautioned not to lose sight of other (perhaps less obvious) dangers that lie ahead. There is real risk in achieving regulatory compliance only to find an ‘old’ business model has been made redundant by a new entrant with new technology and a better understanding of the consumer. “Changing consumer needs is a reality that every industry needs to address and embrace and particularly, within the insurance industry, discerning customers and decreasing affordability must be given due attention,” says Ms Wallis. The modern consumer is leading a drive to self-directed services. “Convenience is driving consumer choice and it is therefore important to provide options such as self-service apps to enable them to submit claims (and even engage insurers) seamlessly, at a time and place that suits their lifestyle,” she says. The responsible use of data by businesses and data integrity will become an even bigger compliance requirement going forward. “Opportunities will arise for those who embrace change in regulations, embrace and invest in new technology, and scale their business to enable them to manage cost effectively,” says Mr Visser. It would seem that most industry analysts are in agreement that the consumer, regulation and technology ‘trifecta’ will be the main influencer of business models in both the insurance and insurance broking space. Mr Olyott says that insurance brokers must implement the right business model to be able to significantly differentiate their business offering to targeted markets. As part of this solution firms will have to find, hire and retain the ‘right’ people with the necessary skills. “As the economic environment and customer needs change, so too should the value offering of insurance businesses,” says Ms Wallis. “Adopting new models to better identify exposure and niche covers are good growth opportunities – further advantage will come from having a holistic understanding of the global and local trends and best practices, aligned to the insurance industry and the industries in which customers operate.” In this regard Bryte is moving from probabilistic analysis (which relies on what is likely to occur to determine premiums) to a deterministic analysis model (which examines claims from past incidents to determine the same). This change requires proactive management of customers’ risk from the very beginning. Consumers are likely to be at the heart of any resurgence in the insurance sector, so it is important to focus their attention on the value of insurance and good risk advice. “Brokers play an important role in ensuring that consumers are correctly insured for the various perils at the correct value,” says Mr Visser. “In addition, the broker must see to it that the product that is offered and ultimately bought by the client is suitable based on the needs and unique features required by the client.” In complex situations this may require solutions from multiple insurers or product suppliers. “Insurance is a trust purchase and the insured will never know how good the advice or the product is until it is too late,” says Mr Olyott. “In the case of the Knysna fires, the original advice on many of those properties may have been rendered decades ago – so it would be extremely difficult to gauge the value of the advice one received initially and then subsequently.” A runaway fire in the Eden district municipality claimed seven lives and razed more than 600 structures in Knysna early in June 2017. This disaster, combined with a severe storm in Cape Town that hit on 7 June, resulted in an estimated insured risk of ZAR4bn to South African insurers and their reinsurance partners. “With insurers covering a sizeable percentage of the residents affected by the abovementioned events, the large losses have placed significant financial pressure on industry players,” says Ms Wallis. “The SA insurance industry is resilient and to ensure profitable underwriting, insurers with a proactive approach to risk management, comprehensive business strategies and a defined focus on diversification through digitalisation, will maintain the sustainability of not just their business, but also that of their customers.” As painful as they are, fire and weather catastrophes demonstrate the role of the insurance industry as an economic safety net. The industry is established on the basis of strong relationships and the promise of financial support when it is really needed. Insurance affords customers the opportunity to re-establish their standard of living following a defined event and gives businesses the opportunity to return to operations, preventing further financial and job losses. What does the future hold? “As a general market observation we like to think of adversity as the driver of innovation,” says Mr Olyott. “The current and near future positions provide an ideal opportunity to rethink your business offering, including certain insurance products that should have been redesigned ten or more years ago.” He suggests an ongoing interrogation, including questions like: What should I be doing, for whom and where? And how will I be different? At the same time insurers, insurance brokers and risk managers should avoid becoming trapped in the price game, where premium is the only differentiator. The insurance industry has its work cut out given the difficult economic landscape. “The next few years will be extremely tough for SA, even if the Zuma / Gupta Kleptocracy is eradicated – whoever governs will have an incredibly difficult task restoring confidence in the economy,” concludes Mr Gilmour. “Government policy or the lack thereof remains one of our biggest stumbling blocks alongside the state’s refusal to privatise SOEs, and inflexible labour practices – we need profound structural reform of the economy, by which I do not mean the rubbish being bandied about under the RET heading.” The Free Market Foundation lists three factors that it believes will reverse the current economic malaise. “The first is to improve our performance on various global economic freedom indices, something we can achieve by immediately reducing the size of our government,” concludes Mr Louw. “Second, we must strive to end racism and resume our journey to the ideal of a truly non-sexist, non-racial SA – and third, we must, through education, ensure that all stakeholders have a better understanding on how markets function, the function of prices in the market and the function and nature of competition.”

Strong headwinds

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