Kenya’s insurance sector is going through a prolonged period of weakness. The insurance industry tends to grow in step with the broader economy. The recent slowdown in the economy has therefore made growth harder for insurers. Similarly, the problem of fraud still persists and earnings have generally declined across the sector. The Insurance Regulatory Authority (IRA), however, expects that the recent wave of mergers and acquisitions will create stronger, healthier companies.
According to a recent report by the IRA, the industry regulator, insurers made a combined operating profit of Sh17 billion in 2014. This represented a 15 percent slip from Sh20 billion made a year earlier. Interestingly, premiums in 2014 increased by 17 percent to stand at Sh157 billion, up from Sh135 billion a year earlier. The fact that earnings declined against the backdrop of an increase in premiums suggests that insurers are unable to control their costs.
Direct costs in the insurance industry are, however, not rising notably. The only exception to this is management costs, which are on the up because insurance companies are using high pay as a talent retention strategy. Talent is scarce and insurance firms are willing to pay a premium for it. “Companies are offering higher pay as a key talent retention strategy,” said Kuria Muchiru, PwC’s human resource leader for Central and Southern Africa.
Although costs associated with attracting and retaining talent have risen in the insurance sector, the rise is negligible in comparison to the extent to which insurers’ profits have declined. This suggests that there is another cost, probably hidden and indirect, that is undermining the profitability of insurers.
The hidden cost for insurers is the rampant fraud that has, unfortunately, come to characterize the sector. Insurers generally have to factor in the cost of fraudulent claims. However, in an insurance market that is price sensitive and still in its early growth stages, insurers dare not saddle customers with the full cost of fraud. This means that many insurers absorb a considerable portion of the cost of fraud, which is estimated by consultancy KPMG to account for 25 percent of the total cost of insurance premiums in Kenya.
9 percent of all claims made in Kenya are fraudulent, KPMG says. “If this fraud is reduced, then we will start seeing the cost of insurance premiums going down,” remarked James Norway, associate director in charge of risk insurance consulting at KPMG. This means that if the industry regulator is able to clamp down on fraud, costs could decline considerably for insurers, reversing the worrying trend of declining profitability.
The IRA has in recent times taken bold measures to nab fraudsters. As recently as a September, an insurance investigator suspected of fraudulent practices was arrested and persecuted at the Milimani Law Courts following enhanced measures by the IRA.
IRA commissioner Sammy Makove admitted that though fraud was still a problem area for the insurance industry, the issue is not unique to Kenya. It is a problem facing insurers all over the world and insurance companies have been compelled to adapt new technologies to nab offenders. This notwithstanding, the IRA is still strongly committed to ending the vice.
One area where the IRA has focused a lot of its energy is the motor vehicle insurance segment. This is because it is one of the most adversely affected by fraud, as evidenced by figures from the regulator. In 2012/2013, about 29 percent of cases of insurance fraud reported were on motor vehicle insurance. There were 14 fraudulent accident claims, 11 forged insurance certificates and 31 fraudulent theft insurance claims. The trend was replicated in 2014 and 2015 where reported cases of fraud in motor insurance were 27 and 33 percent, respectively.
“It (fraud) is a crime committed with persons who see loopholes in a system,” noted Mr. Makove, adding that motor insurance, especially of PSVs, is one of the ‘biggest soft spots’ for fraudsters. “In those days before the Michuki rules, a 14-seater could crash in a certain area and then more than 40 people could come to claim,” he explained, indicating that, although fraud is still rampant in motor insurance, it has reduced considerably.
The apparent reduction in motor insurance fraud, however, is in vain in consideration of the corresponding increase in medical insurance fraud. Fraud in the medical sector is now becoming increasingly prevalent and pushing many insurers’ medical divisions into losses. In 2014, for instance, CIC Insurance made medical insurance losses of Sh680 million, APA (Sh120 million), Heritage (Sh56 million) and Kenindia (Sh51 million). Overall, Kenya’s insurance industry recorded a medical underwriting loss of Sh437 million last year, down from a profit of Sh282 million in 2013, a report by IRA indicates.
Eleven out of the 20 companies offering medical insurance in Kenya recorded losses last year, IRA further contends. This clearly shows how big a problem medical insurance fraud has become. Medical insurance has also been affected by the fact that a lot of hospitals made upward revisions to their pricing last year, with some of them reviewing prices more than once.
CIC Insurance, which has been adversely affected by medical insurance fraud, has now been compelled to make some new hires. It brought in Elijah Wachira, who previously served as acting CEO of Gateway Insurance, as the new managing director in charge of the general insurance business. His new brief will be to revive the ailing medical insurance arm. CIC will also leverage on new technologies to curb fraud. The Nairobi Securities Exchange (NSE) listed insurer is better off than its smaller peers. This is because it can afford the technology. Other insurers with much leaner finances may not be able to afford new technologies to curb fraud.
It is also becoming increasingly hard for insurers to make meaningful returns from their investments. Insurers usually invest collected premiums in a wide range of investments such as bonds, shares and real estate. The returns made from investment usually act as a great complement to earnings from the core underwriting business.
It has, however, been understandably hard for insurers to make money this year from investments. The NSE has not performed too well and investment returns have been low. More than 75 percent of listed firms expect lower earnings at the end of 2015. Similarly, most stocks have experienced market corrections after reaching their peaks.
Britam, for instance, saw its net profit in the first half of the year decline by 67 percent to Sh1 billion, a development it attributed to the lower valuation of companies that it had invested in. “The decrease in our profits is as a result of the downturn in the performance of the securities market, which impacted negatively on the fair value gains from the financial assets,” said Benson Wairegi, the Group Managing Director of Britam.
The real estate market, though a favorite for investors, has also considerably slowed down this year. There is very little headroom for rents and land prices to go up, especially in already overvalued areas in Nairobi. This means that insurance companies invested in the sector will expect lower earnings. A new report from the Global Competitive Index further shows that construction activity in the country is down 9.9 percent this year, suggesting that the real estate sector will experience a considerable slowdown. This will inspire a corresponding slowdown in the earnings of insurance companies which have a huge exposure to real estate.
The IRA, however, believes that there is a way out for insurers—mergers and acquisitions. The recent wave of consolidation, which has seen foreign players assemble at the doorstop of would-be local acquisition targets, has been lauded by the IRA. The regulator believes that the continued trend of large companies buying smaller ones will result in stronger and healthier firms. “The acquisitions represent an opportunity for creating synergies and leveraging on innovation all of which — if managed properly — could enhance long-term revenue growth and profitability for the sector,” said the IRA.
There are 49 licensed insurers but Jubilee, Britam, ICEA Lion, CIC and APA, the five largest firms in terms of market share, control 67 percent of the market. This fragmentation of the rest of the market between smaller insurers presents an opportunity for larger, foreign players with huge amounts of capital to buy into the sector. Bigger players will be better equipped to handle some of the challenges in the sector. A large player, for instance, has the scale to charge lower premiums and still improve overall sales on account of volumes. Similarly, large players can afford the kind of technology needed to overcome the persistent problem of fraud afflicting Kenya’s insurance sector.
Ratings agency Fitch Ratings is of the opinion that sustained mergers and acquisitions are beneficial to the industry. Its stance is corroborative to IRA’s outlook, confirming that consolidation is indeed the way forward for Kenya insurers. “Fitch believes the Kenyan insurance market would benefit from further consolidation as insurers seek to improve scale,” the ratings agency said in a report. “Despite a number of foreign companies, particularly from South Africa, entering the market, it still consists of many small insurance companies, making it fragmented and competitive,” it added.
There is still a lot of headroom for growth in Kenya as evidenced by the low insurance penetration, which is simply the level of premiums as a percentage of GDP. Insurance penetration in Kenya is 2.9 percent, data from the IRA shows. The country comes in fifth in Africa in terms of penetration behind Morocco (3.2 percent), Mauritius (6 percent), Namibia (7.2 percent) and South Africa (14 percent).
Another reason why Kenya remains attractive to foreign investors, according to Fitch, is the market sophistication and transparency of financial disclosure in comparison to other Sub-Saharan Africa markets. The ratings agency also believes that the expansionist stance of Kenyan insurers that has seen a number of them embrace cross-border operations is an attractive proposition. Kenyan insurers give foreign investors access to regional markets, Fitch said. “Some insurers such as Britam, UAP and Jubilee have footprints across the greater East African region which enhances their attraction to investors,” the ratings agency observed.
Fitch, however, stressed that most of the forecasted acquisitions will focus on smaller companies as the larger ones are more stable, and consequently, attract higher valuations. Investors are generally more reluctant about buying into a company with a high valuation because of the risk of not being able to recoup their investment.
Meanwhile, the insurance firms that were involved in deals this year and last year are now preparing for the difficult task ahead—taking market share from the established players. First Assurance, however, which was acquired by Barclays Bank is already off to a good start. Due to the capital injection by a reputable player such as Barclays, the overall credit rating of First Assurance has improved. South African Global Credit Rating (GCR) assigned the insurer an A on its claims paying ability, up from A- accorded last year. This comes after Barclays purchased a 63.3 percent stake in First Assurance for Sh2.2 billion accompanied with a capital injection of Sh700 million.
With a better financial rating, First Assurance can now, if the event arises, get credit or equity on much better terms. This means that it can enjoy comparatively lower financial costs than its peers, putting it in a position to grow profits more sustainably in the long-term.
Some other high profile acquisitions in recent history include the buyout of Shield Assurance by Prudential plc of the U.K. Britam, one of the bigwigs in the country, also bought out Real Insurance. Similarly, Metropolitan Group bought out Canon Insurance.
While the momentum of consolidation has seemingly slowed down this year—contrary to expectations at the beginning of the year—industry experts still maintain that more mergers and acquisitions will occur further down the road. As IRA iterated, consolidation will help stabilize the industry and create stronger, healthier companies.