Financial crisis highlights need for insurance sector reforms
By JUDITH BALEA, abs-cbnNEWS.com | 11/21/2008 5:03 PM
Printer-friendly version | 
Send to friend | 
Share your views
Given the lessons from the near-collapse of global giant insurer, American International Group (AIG), an inevitable question comes to mind: Will local insurance firms be able to weather a financial shock?
The answer greatly depends on how strong their capitalizations are. Multinational insurance companies like AIG's flagship Philamlife and Sun Life of Canada assert they could survive any unexpected blow because their mammoth capital base could absorb potential heavy losses. But other local firms, especially the small ones, might just not be able to say the same.
We reached this conclusion based on a review of regulatory environment in the Philippines for insurance companies, and various interviews with and reference to the works of industry experts.
If the same question is asked of another financial industry—the more ubiquitous banks—one does not have to blink to respond with a yes.
Philippine banks, like most of their peers in Asia after the 1997-1998 financial crisis, have already beefed up their capital base so that with any “shock”—which may come in the form of heavy withdrawals or plunging values of the assets where they parked their clients’ money—they have enough buffer funds to dip on.
Increasing banks' capital bases was a painful, expensive, but necessary process to nurse them back to stability and financial strength. And this happened on the strong will of the regulator, the Bangko Sentral ng Pilipinas, to impose, and of banks to obey what were then unpopular policies.
Both banks and insurance companies are in the business of using other people’s money. Yet, as far as buffing up the capital base is concerned, the insurance industry tells a different story.
| Capital punishment? To raise or not to raise buffer funds? |
| After being locked in bitter-sweet negotiations for two years, state regulator Insurance Commission and the insurance players have come to terms to tweak an order enforcing capital hikes and fixed net worth requirements on the industry.
Authored by former commissioner Evangeline Escobillo and approved by the Department of Finance two years ago, Department Order 27-2006 mandates all Filipino-owned insurers to upgrade their net worth and paid-up capital to P500 million and P250 million by 2011 from the present P100 million and P50 million, respectively. Net worth, or the difference between a company's assets and liabilities, may include retained earnings and capital that it already received payment for. Big-ticket multinational insurance firms like Philamlife and Sun Life of Canada far exceed the requirements for Filipino insurers, with paid-up capitalizations of P1.65 billion and over P500 million, respectively. Small local players were the ones who objected to the directive because they were unsure they could meet the deadlines. They convinced their regulator, now headed by returning commissioner Eduardo Malinis, to scrap the statutory net worth requirement and extend the target date for full compliance with the directive until 2015. If amendments to the 2006 order get the Finance Department's nod, the much-needed reforms in the insurance industry could drag further. This means the Philippine insurance sector would continue to lag behind its peers in Asia. |
Financial shocks
Insurance is the business of accepting periodic payments from people in exchange for a promise to compensate them for any future damage to life or property. An insurance company then invests these funds in financial or real products that could earn profits over time. Using sophisticated calculation, the insurer bets that the returns from its investments more than make up for the cost of consumers' claims.
Thus, unlike banks, insurance companies do not deal with panicking depositor withdrawals—except for a portion of some players’ business that provide asset management-like products.
To the insurance companies, one of their versions of a man-made financial shock is in the form of severe reductions in their investments’ worth.
Their capital base will be eroded when their investments are worth less—or become worthless.
Poorly capitalized
The capital base of local insurance players is a concern since compared to neighbors, such as Singapore, Malaysia and Thailand, Philippine-based companies are laggards.
According to a 2003 study by Dr. Melanie Milo, who was formerly with the Philippine Institute of Development Studies, the low capital base of local players is especially pronounced in the non-life sector, or that which provides protection against risks associated with an accident, health problem or impairment of property.
While the life insurance industry is deemed strong in terms of capital, "the non-life is characterized by a large number of very small, family-owned firms that are inadequately capitalized and operationally weak," said Milo.
Sadly, this situation has not changed.
In an interview with abs-cbnNEWS.com, Deputy Insurance Commissioner Vida Chiong said that because the country's insurance sector has "one of the lowest capitalizations in the region," its competitiveness has been hampered.
Chicken and egg
Poor capitalization has been a deterrent in the expansion of the industry's market penetration since each player's capital should more than double the amount of risks it takes in.
Government data showed that the insurance penetration in the country was at 1.16 percent of gross domestic product in 2003, and this grew to only 1.20 percent as of 2006.
Although insurance firms here are unlikely to suffer the fate of their ailing counterparts in the US, Chiong stressed, improving their capitalization is the best way to restore the confidence of consumers, who have been reluctant to purchase insurance policies on fears they could have problems with prospective claims.
In this light, the Insurance Commission, in 2006, ordered Filipino-owned insurance firms to upgrade their net worth and paid-up capital to P500 million and P250 million by 2011 from the present P100 million and P50 million, respectively.
However, because the order was met with objections from some companies, the regulator agreed to defer the increase by four more years and scrap the net worth requirement on the industry.
If improving the insurers' capital resources is too crucial, why did the Insurance Commission agree to relax the order?
The regulator was apparently caught between a rock and a hard place. Chiong explained the order would guarantee the safety of investments of consumers, but was too ambitious for small players whose sales and returns are not really that high. She said they had to compromise.
"We see the justification for the amendments in the capitalization order. If you don't give insurance firms a little leeway, what would happen to their business?"
Add funds or cease operations
The amendments to the capitalization order have yet to be approved by the Finance Department, which oversees the Insurance Commission.
By end 2008, for as long as the current order is not supplanted, Chiong said insurance firms will have to comply with the minimum paid-up capital of P75 million and net worth of P150 million.
Life insurers are amenable to the P75 million requirement, with the amount to be gradually increased by P25 million yearly until it reaches P250 million by 2015.
Non-life insurance firms, on the other hand, also agree to the P75 million but request for an extension in the period of full compliance to the maximum cap until 2025.
As of yet, there are 35 small firms that need to comply with the minimum paid-up capital requirement for 2008. If by yearend they still couldn't come up with the amount, a cease and desist order will be issued against them.
Eagle eyes
Apart from low returns, insurers have another major justification for their weak sense of urgency in raising capital. They claim that their investments are low risk and highly regulated.
“Our investments are well monitored. The regulator is very strict when it comes to investments,” said Sun Life of Canada president Henry Herrera in a press briefing before.
Chiong confirmed that, indeed, they are doing their fiduciary duty by regulating the insurance firms’ investments with eagle eyes.
Unlike their counterparts overseas, local insurance firms are not allowed to put their money in complex financial instruments. The deputy commissioner told abs-cbnNEWS.com that most of the industry's investments are actually in government-guaranteed bonds.
When investing in equities, meanwhile, insurance companies are only allowed to use 10 percent of their total "admitted" assets, and they have to secure the approval of the regulator first.
"Not all of a company's properties are considered. We admit only those assets that can be readily converted into cash and can be used to pay policyholders' claims. We have guidelines that factor in an asset's depreciation value or wear-and-tear quality.”
Does it mean that because local insurance firms' investments are low risk, they are out of the woods?
While their investments remain relatively safe, these are still dependent on market activity, which tends to be really volatile, as the case since the beginning of the year. It is only prudent to take extra precaution by building up one's capital base.
Long overdue
Despite having less risky investments and low proceeds and any other reason cited by insurance companies, the increase in their capitalization will push through, said Chiong.
The only question is when.
The Finance Department has not approved the amended order nor has it hinted that it would.
In a letter to the Insurance Commission, Finance Secretary Margarito Teves specifically instructed the state regulator to strictly impose the mandated capitalization increases approved in 2006. This as Teves said in earlier interviews that small insurance firms may be vulnerable to the financial turmoil.
To an extent, it might be better if the Finance Department doesn't change its mind since the plan to beef up the capitalization of insurance firms is long overdue.
After all, the stringent rules on capitalization are being set in place to develop the financial strength of local insurance firms so they can sustain liquidity in the event of external shocks.
