MONEY MATTERS: Up next for reform: Insurance

Between 2006 and 2008, the insurance industry embarked on a recapitalisation programme raising about N50 billion of new money.

Like with the banks, the recapitalisation was forced on the industry by regulation. At the end of this exercise, the number of insurance companies in Nigeria reduced from over seventy to about forty five but shareholders' equity increased to about N275 billion. Are we right to ask how much of this capital is bubble capital? Have the insurance companies been buying their own shares?

The additional capital has put a lot of pressure on the industry to make competitive returns for its shareholders. In 2005, the industry made a profit of N5.5 billion on a capital base of N70 billion. This represents a modest return on equity of 8%. With capital of N275 billion and a more competitive return of say 20% per annum, the industry needs to deliver N45 billion of profits to its shareholders annually. Have the players in the industry been taking above normal risks in order to deliver more competitive returns to shareholders?

Insurance companies are traditional investors and they usually take a long-term view about their investments. According to Agusto & Co.'s most current report on the industry, 64% of the assets of these companies are investments and about 30% of these investments are in the equities of companies listed on the Nigerian Stock Exchange (NSE). We all know that, on average, the value of shares listed on the NSE is down by about 60%. Have the insurance companies marked their portfolio of investments to market and reflected the impact of these losses on their shareholders' funds? Or have they ducked, arguing that they are long- term investors, and have either refused to mark to market or have held their losses in suspense hoping that the market will soon rally when the most optimistic ones amongst us will agree that we are in this for the medium to long haul?

Profit pressure also makes some insurance companies play games with the level of "claims outstanding" at year-end. This is similar to the level of provision a bank makes in respect of bad debts. By under-providing you can show higher profits and make shareholders and the tax man happy until the regulator catches up with you or your business collapses. To what extent is the insurance industry under-provided in respect of claims outstanding?

Some of our insurance companies also have legacy problems. Before the advent of the Pension Reform Act 2004, some insurance companies were writing Deposit Administration Schemes. Under these schemes, they took deposits from their clients guaranteeing the safety of their deposits and a fixed rate of interest on these deposits. The prudent thing for such institutions to do would have been to invest these monies safely in fixed income instruments that gave a slightly higher return.

However, some of them invested these monies in equities and equities have lost value. This means that liabilities are far in excess of assets supporting them. How has the insurance industry treated these losses? Have they affected headline profits or are the losses being held in suspense?

Even after consolidation, competition in the insurance industry is still fierce. This has made a number of players abandon the basic principles of risk management that underlie their business. This business is about proper evaluation of risks and setting your premium in line with the quality of the risk. Competition has led to under-pricing therefore when large under priced risks crystallize they threaten to wipe out players who have insured them or the insurers simply look for ways of rejecting the claims.

For example, fire gutted one of the bottling plants of Nigerian Bottling Company recently and that company presented its insurers with a bill of N15 billion! When the re-insurers learnt of the extent of the loss and premium being charged they insisted on a 300% increase! What can we do to encourage players in the industry to price their risks properly?

Fortunately, solving the problems of the insurance industry will be less expensive than the banks. Firstly, the total assets of the industry is roughly the size of a medium sized bank and shareholders' funds are less than that of First Bank of Nigeria, but we better get cracking.