Dealing in uncertainty

South Africa is making heavy work of 2016. The economy, already restricted by a number of internal constraints, is being battered by global economic events that are mostly beyond its control. Against the backdrop of stagnant global growth, falling international commodity prices, ratings agency reviews and the unexpected Brexit poll result, there are those who predict Africa’s third largest economy will struggle to post even the dismal 0.6% GDP growth forecast for the year. Britain’s decision to exit the European Union (EU) will have a major impact on the South African economy, though the size and extent of the fallout is difficult to quantify at this early stage. “The first of three impacts will be felt in the financial markets and we have already seen the rand taking a major knock against the international currency crosses, not to mention reactions in the gold and oil prices,” says Dawie Roodt, chief economist at Efficient Group. He adds that the second impact will be felt via the real economy as trade activity between South Africa and Europe inevitably slows – and the third through the realignment of global country-political relations. Most analysts agree that Brexit is the beginning of a more significant reorganisation of country alignments throughout Europe and the world. Scotland and Northern Ireland have made rumblings about leaving the UK to pursue independent strategies on critical economic decisions, while there are concerns that France and Sweden will vote on their continued participation in EU structures.hideMr Roodt believes that Britain’s decision to leave the EU was rooted in significant increases in global sociopolitical unease. Loose monetary policy applied by Western central banks in the years since the 2008 global financial crisis has contributed to massive gains in financial markets, which have added to the wealth of the already wealthy. Meanwhile those participating in the real economies, where global performance has been dire, have found themselves getting consistently poorer in a battle against higher taxes, inflation and unemployment. “The gap between the rich and the poor is getting worse and the poor are directing their anger at the establishment, which includes big business, financial systems and their elected politicians,” he says. Escalating tensions These developments are particularly relevant in a country that has one of the largest gaps between rich and poor anywhere in the world, as measured by the Gini coefficient. And tensions are escalating as South Africa prepares for local municipal elections on 3 August 2016. “We see upheavals around every election but maybe this one is a bit different, in the sense that much of the recent unrest involves factions of the ruling African National Congress (ANC) pitted against one another,” says Johann Els, senior economist at Cape Town-based Old Mutual. Political risk centres on the reaction by the ruling ANC to inroads that might be made by opposition parties later this year. “Does the ANC jump to the left in reaction to losing votes to the Economic Freedom Fighters or does it stick to the path and allow the finance minister to keep the ratings agencies happy?” he asks. It is difficult for the ANC-led government to do the right thing with elections looming, but some tough decisions are needed to improve the country’s lacklustre growth outlook. Mr Roodt singles out the civil service, skills development and labour as three areas for special attention: “The civil service is like a wet blanket that is smothering this economy; the quality of skills development is appalling despite significant financial resource being allocated to it – and labour legislation remains onerous.” Skills are a hot topic in the insurance, insurance broking and risk management environs. “Insurance will always be a necessity – it exists to help individuals and businesses in the event of a loss – but the risks are changing and the shortage in South Africa of actuaries, claims specialists and loss adjusters calls for interventions and planning,” says Edward Gibbens, Santam’s executive head of personal and commercial. Another dimension to the South African skills dilemma is that industry has not paid enough attention to the issue of transformation in the workplace. The Employment Equity Act requires that firms’ workforces reflect the demographics of the country, with slow progress being made on this front since the country’s first democratic election in 1994. Recent changes to South Africa’s Broad-Based Black Economic Empowerment (B-BBEE) legislation – in the form of new financial sector codes and scorecards – mean that insurers, insurance brokers and their clients are under pressure to maintain their BEE ratings. “Clients who do a lot of government business are under particular pressure to procure from firms with high BEE ratings – and insurance broking firms do not escape this scrutiny,” says Neels Kornelius, business development leader at Willis Towers Watson South Africa. Santam, South Africa’s dominant short-term insurer, says that the first six months of the year were characterised by difficult economic conditions: “The overall weakness of the rand, rising interest rates and the recent uncertainties as regards the country’s credit rating have placed added pressure on consumers, given the rise in food, fuel and electricity costs, and hampers growth within the industry as a whole,” says Mr Gibbens. “The pressures being placed on the economy as a whole have brought with them the realisation that short-term insurers will need to think outside the box and break away from ‘business as usual’ if they are to find new opportunities for growth.” Economic instability Large fluctuations in the value of the rand against the dollar, euro, sterling and other major currencies make it difficult to run businesses and also impacts on investors’ decisions to commit foreign direct investment to the southern tip of Africa. But Brexit is not the only shock to have weakened South Africa’s currency. In December 2015, President Jacob Zuma triggered a run on the rand following his irrational sacking of the then finance minister Nhlanhla Nene. The ‘will they or won’t they’ debate around rating agency reviews of the country’s sovereign debt rating have also weighed on the currency. “The media and various economic analysts have perhaps been overly fixated on the risk of a downgrade, but it focused the minds of the politicians and gave pragmatists like the minister of finance the additional impetus to force through some changes that needed to happen,” says Mr Els. Despite the country’s sovereign debt making up only a small portion of government’s total debt, the arguments for a downgrade to junk status remain. “South Africa’s businesses have become accustomed to a situation in which instability is the new normal,” says Mr Kornelius. He singled out the 35% devaluation in the rand against the dollar during 2015 and subsequent currency volatility as a “game changer” for insurers, insurance brokers and corporate risk managers alike. Volatility introduces complexity and additional cost for multinational clients that place corporate premiums in overseas markets in hard currency, for example. It also has obvious consequences for firms that rely heavily on imports for their raw materials inputs and/or their plant and equipment. “A whole range of our customers derive a significant amount of their earnings from offshore sources, so we have had to make large adjustments to the sums insured in that regard, to cater for the currency depreciation,” he says. Insurers are also hard pressed to manage South Africa’s devaluing currency due to the sector’s considerable exposure to the motor sector. “We buy most of our parts from offshore suppliers in hard currencies and have to balance the impact of replacement parts on our claims costs against the fact that premiums are being kept low by the soft insurance market,” says Nash Omar, joint managing director at Hollard Broker Markets. Slow domestic car sales add fuel to the fire as local vehicle manufacturers try to shore up their profits through higher margins on spare parts. Mr Gibbens agrees, saying: “The depreciating rand and the weak economy continue to impact insurers when it comes to the cost of claims – mainly due to the cost of imported motor parts – and thus the challenge for insurers is to contain that cost as far as possible while remaining competitive in a marketplace where consumers continue to buckle under increasing financial pressures.” Insurance brokers are likewise hard pressed to balance tough economic conditions that drive client behaviours but, at the same time, must place business against the backdrop of the softest insurance market in living memory. Soft market A soft market occurs due to there being excess liquidity or an oversupply of risk-seeking capital in the insurance and reinsurance markets, which results in continued downward pressure on insurance rates. This is good for insurance consumers but in the broker world it results in unprecedented levels of competition, as risk managers seek to place their risk programmes with other insurers. To illustrate just how soft the insurance market is, Mr Kornelius refers to the fact that recent claims in the mining sector, while understood to be among the largest ever to be reported into the South African insurance market, were not enough to cause a ripple in the rates in that market. “The tough economic conditions we are currently facing in South Africa are making consumers look at ways of cutting back on spending – as a result, consumers are often underinsured or worse, elect to have no insurance due to affordability issues,” says Jacqui Mayne, financial adviser at PSG Insure. She says that South Africa’s insurance advisers will have to convince clients of the dire consequences of cancelling insurance policies or being underinsured and assist them in structuring appropriate cover within their budgetary constraints. The insurance sector offers plenty of insight into a country economy. “The financial sector makes a significant contribution to the overall economy and with GDP growth forecast at less than 1% for 2016 we are feeling the pressure from both a business and consumer perspective,” says Pierre Geyer, joint managing director at Hollard Broker Markets. Slow growth plus soft insurance markets has forced the insurer to seek other ways to enhance returns from its underwriting activities, including by leveraging its buying power across the supply chain. “We are going to have to learn to do things smarter, make each rand stretch further and still bring value to the broker and the client,” he says. Putting the client first A greater challenge will be to manage consumers’ responses to the bleak economic outlook. According to Willis Towers Watson, the biggest trend at its large clients is the rise of the corporate risk manager, which is to an extent driven by the King III and King IV codes for corporate governance: “This in turn is driving the integration of the insurance-buying function into the overall picture of risk management within the company.” Large firms are buying insurance strategically and selectively to fit in with the risk management programmes that they themselves are internally organising. A warning to short-term insurance brokers is that those simply selling product will struggle to survive. “There is an absolute premium on good advice to assist clients in buying only the cover that truly supports the risk management goal and is truly fit for purpose for that specific customer,” says Mr Kornelius. This could mean that the age of the generic policy is over and that the move to true professional advice is underway. Professionalism and improved outcomes for consumers are products of South Africa’s world-class financial services regulatory environment, the development of which presents certain challenges to the private sector. According to Mr Gibbens, the realisation that the client is – and always has been – at the heart of the insurance transaction constitutes a game changer for large intermediated insurance businesses. “Being client-centric requires different ways of thinking – it is the reason why we’ve invested so heavily in our claims-processing model and why we pay out the most money in claims in South Africa,” he says. Mr Kornelius refers to looming regulatory changes as the third contributor to the perfect storm facing the short-term insurance broking sector. “The retail distribution review (RDR) will have more of an impact on the smaller brokers than on those who focus on the commercial and corporate sphere; but it is nevertheless applicable to everybody,” he says. Many short-term insurance brokers are concerned with the possible impact of the regulation on their earnings through the proposed capping of binder fees. A binder agreement is a contract between an insurer and a broker (called the binder holder), in terms of which the broker performs certain functions on the insurer’s behalf. “Our preference is to operate in a free market environment where binder holders are paid a fee that is commensurate with the work that they do for the insurer – the risk in capping the fee is that everyone adopts it as a ‘minimum’ with a severe drop-off in service levels,” says Mr Geyer. There is a major risk in regulating the fee for a complex business relationship. A broker that undertakes to provide an insurer with a set of services must be in a position to have the right people, the right skills and the right systems in place to deliver that service. “If you cap the fee, the binder holder may simply be unable to perform at the expected level,” Mr Geyer adds. Hollard remains committed to the intermediated distribution methodology and believes there will always be a place for genuine binder arrangements. Regulatory interventions Industry stakeholders have for the most part welcomed the transparent process with which the regulator is implementing RDR, but they are concerned about both the extent and duration of the uncertainty that the unfinished regulatory intervention creates. “RDR comes with uncertainty as to how it will be rolled out and leaves questions such as how a reasonable fee will be determined and how will fees be collected unanswered,” says PSG’s Ms Mayne. She adds that the regulation will have a major impact on the relationship between advisers and their clients, as well as between advisers and insurers. The Solvency Assessment and Management (SAM) programme is another regulatory process with a long history. SAM, which is South Africa’s answer to the Solvency II regime in Europe, will be implemented from January 2017 after many years in planning stages. It will have a major impact on both the capital requirements and return expectations of insurers. “In an environment characterised by uncertainty, SAM is an absolute necessity for our industry – it forces us to have a clearer understanding of the risks we face to ensure that we hold the appropriate levels of capital in order to survive disastrous events,” says Mr Gibbens. “We believe SAM is changing the conversation and that the key drivers for strategic change will be the integration of enterprise risk management (ERM) in decision-making.” Hollard’s ERM team agrees that SAM will improve the alignment of risk and capital, as well as improve the governance and reporting standards at insurers. “The new solvency regime will be a benefit to the industry as it provides greater visibility of risks in that it requires insurers to reflect on the type, concentration and quality of risk being taken onto their balance sheet,” says Mr Omar. He adds that insurers will require more and more complete data to fulfil their SAM obligations; but at this early stage in the process it is difficult to speculate on the longer-term impact of the solvency regulations. It is however possible that the new capital requirements will result in insurers declining certain categories of risk or making significant changes to prevailing rates, both of which will impact on brokers and corporate risk managers. “The practical implication of SAM on risk managers and brokers is likely to be overshadowed by the regulatory changes in RDR,” concludes Mr Omar. Regulation is forcing business to review their practices and realign these where necessary, but not without incurring additional costs. “As a traditional intermediated business, RDR presented Santam with an interesting challenge in so far as how we could help our intermediaries to ensure their sustainability while remaining relevant to consumers across personal, commercial and specialist markets, both locally and into Africa and other emerging territories,” says Mr Gibbens. The solution was to evolve its distribution capability to a sophisticated multi-channel model that is mutually inclusive – allowing for competitive positioning to write both commodities risk such as personal lines and small commercial business, or complex risks such as larger commercial and specialist risks, where there is a real need for expert advice from an intermediary. That said, brokers that play in the corporate market are impacted by solvency issues, with a close eye being kept on South Africa’s sovereign credit rating. “Our international parent has a market security committee that monitors both the solvency and claims-paying ability of our carriers on a continuous basis and we are seeing a lot of our South African market suffer downgrades in conjunction with changes to the South Africa sovereign rating,” says Mr Kornelius. Clients with multinational risk exposures often require that their cover be placed at insurance firms with A-rated paper or better, which becomes difficult when the country is rated BBB-. South Africa is fortunate in this regard because the insurance regulation is not as onerous as in some other African dispensations. The Short Term Insurance Act stipulates that if insurance capacity for a specific risk is available in South Africa then that should be given first priority, but brokers and insurers can apply to the South Africa Reserve Bank for exemption to that rule and take the premium offshore. What does the future hold? “Premium growth will remain a challenge within the continued low economic growth environment – that is why we believe insurers must diversify their offering and their distribution channels, in order to offer consumers what they want, how they want it,” says Mr Gibbens. He suggests that a major disruptor lies in wait in the form of InsureTech, which he describes as an insurance entity that uses technology to either compete or provide value-added benefits to the insurance industry. Insurers will have to assess how their current competencies match against the capabilities needed to develop a digitally inclusive and data-driven business model. Santam also forecasts greater segmentation in the domestic risk market. The insurer observes that there is a large and uninsured base of customers in South Africa and that many insurers will be looking at ways in which to capture possible premium growth within this uninsured market. This in turn will impact on the type of products being offered as providers compete to offer more cost-effective insurance solutions. “There is no such thing as business as usual if you want the business to keep growing,” says Mr Gibbens. “The market is competitive, the economy is tough and stringent regulations are at play – and this means that insurers need to find new ways to grow their businesses. But that does not necessarily mean scrapping old models – it’s more a case of adapting with the times,” he concludes.

Dealing in uncertainty

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