79233 This volume is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The World Bank does not guarantee the accuracy of the data included in this work. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. The material in this publication is copyrighted. FINANCIAL SECTOR ASSESSMENT PROGRAM PHILIPPINES THE INSURANCE SECTOR: A MARKET & RISK BASED REVIEW TECHNICAL NOTE APRIL 2010 THE WORLD BANK INTERNATIONAL MONETARY FUND FINANCIAL AND PRIVATE SECTOR MONETARY AND CAPITAL MARKETS DEVELOPMENT VICE PRESIDENCY DEPARTMENT EAST ASIA AND PACIFIC REGIONAL VICE PRESIDENCY i CONTENTS I. INTRODUCTION AND SUMMARY ..................................................................................... 1 II. MARKET OVERVIEW .......................................................................................................... 2 A. MARKET SIZE, DEVELOPMENT, COMPOSITION AND DYNAMICS .............................................. 2 a) Life Insurance Market Size and Product Mix ................................................................. 5 b) Non-Life Insurance Market Size and Product Mix ......................................................... 7 c) Insurers, Distribution, Linkages and Competition ....................................................... 10 d) Catastrophic Risks and Reinsurance ............................................................................ 17 B. FINANCIAL PERFORMANCE, ASSETS, LIABILITIES AND SOLVENCY ........................................ 19 e) Profit ............................................................................................................................. 19 f) Assets and Investments .................................................................................................. 22 g) Provisions and Capital ................................................................................................. 23 C. SPECIFIC FOCUS ON ACCESS TO INSURANCE PRODUCTS ........................................................ 28 III. ADDITIONAL COMMENTARY ON REGULATION AND SUPERVISION ............. 32 IV. THE OVERALL AGENDA................................................................................................. 38 Tables TABLE 1: TRENDS IN INSURANCE PENETRATION AND DENSITY ....................................................... 3 TABLE 2: SOME COMPARATIVE STATISTICS (AS AT YEAR END 2008 UNLESS SHOWN)...................... 4 TABLE 3: MOTOR THIRD PARTY MONETARY LIMITS FOR PRIVATE VEHICLES IN ASEAN COUNTRIES .............................................................................................................................. 9 TABLE 4: INSURER TYPES – NUMBERS OF INSURERS ...................................................................... 11 TABLE 5: KEY STATISTICS FOR THE GOVERNMENT SERVICE INSURANCE SYSTEM (PHP BILLIONS) ............................................................................................................................................... 12 TABLE 6: MAJOR INSURANCE COMPANY AND BANK ASSOCIATIONS ............................................. 13 TABLE 7: STATISTICS ON LICENSED INTERMEDIARIES ................................................................... 14 TABLE 8: HERFINDAHL INDEX BY BUSINESS LINE (2002 - 2008) ................................................... 15 TABLE 9: IMPLIED PREMIUM RATES – NON LIFE INSURANCE ........................................................ 16 TABLE 10: CESSION RATES BY NON-LIFE INSURANCE CLASS (2004-2008) ................................... 18 TABLE 11: NET CLAIMS RATIOS BY CLASS OF BUSINESS FOR NON LIFE INSURANCE .................... 20 TABLE 12: CALCULATED COEFFICIENT OF VARIATION - SAMPLE COUNTRIES AND GLOBAL DATA SET ........................................................................................................................................ 20 TABLE 13: EXPENSE RATIOS .......................................................................................................... 21 TABLE 14: EFFECTIVE REPORTED INVESTMENT RETURNS ............................................................. 21 TABLE 15: REPORTED RETURN ON EQUITY .................................................................................... 21 TABLE 16: ASSETS 2004 – 2008 (PHP BILLIONS) .......................................................................... 22 TABLE 17: ASSET MIX OF INSURERS (MATERIAL ITEMS) AS AT 31 DECEMBER 2008 ..................... 22 TABLE 18: ASSET REGULATIONS ................................................................................................... 23 TABLE 19: NON LIFE PROVISIONS TO PREMIUM INCOME ............................................................... 24 TABLE 20: LEVELS OF MINIMUM PAID-UP CAPITAL (TRANSITIONAL ARRANGEMENTS) IN PHP MILLIONS ............................................................................................................................... 25 ii TABLE 22: REGULATORY, SUPERVISORY AND POLICY CONDITIONS FOR ACCESS TO INSURANCE.. 29 TABLE 23: LADDER OF REGULATORY INTERVENTION .................................................................... 36 TABLE 24: NUMBERS OF INSURERS UNDER VARIOUS STATES OF RESOLUTION ............................... 37 Figures FIGURE 1: PRODUCT SHARES BY CLASS OF INSURANCE – LIFE INSURANCE ..................................... 6 FIGURE 2: COMPARISON OF NON LIFE PENETRATION AS AN INDICATION OF THE PRICING CYCLE ... 8 FIGURE 3: PRODUCT SHARES BY CLASS OF INSURANCE – NON LIFE INSURANCE............................. 9 FIGURE 4: CATNET EARTHQUAKE AND WINDSTORM EXPOSURE MAPS ......................................... 17 1 INTRODUCTION AND SUMMARY 1. This note summarizes the conclusions of the review of the insurance sector in the Philippines as part of the Financial Sector Assessment Program (FSAP). The main objectives of the assessment are to review the performance and structure of the insurance sector in the Philippines with respect to:  The potential exposure of the sector to vulnerabilities, either generated from the sector or in response to other circumstances outside the sector that could either be magnified or dampened by the sector;  The potential for the sector to grow and develop, in its own context and also to contribute to the overall long term growth and development of the economy and the well- being of the Philippine people; and  The relationship between the oversight and regulatory arrangements for the sector against international norms and best practices. 2. The note is prepared in varying levels of detail selectively identifying then developing issues. The nature of supervision and regulation is then discussed to the extent that it has not been covered as part of the market analysis. As part of this FSAP, it was agreed that the relative importance of the three objectives was such that the best focus for the analysis, with respect to regulation and supervision, would be to make an assessment against international standards and practices and to reflect that assessment in recommendations but not to produce a detailed report specifically on the observance with the International Association of Insurance Supervisor’s Insurance Core Principles. 3. The final section of the report sets out conclusions and recommendations. In summary, the key conclusions of this analysis are:  The financial performance of the sector has been particularly stable although the outlook is less sanguine. Profitability has been supported by historic investment returns coupled with book value accounting approaches, supportive reinsurance terms, and a market that has avoided risk retention through product optionality. Lower returns on new investments and reducing reinsurance commissions makes the outlook more challenging. In an environment where competition is intense, there are a large number of players and a relatively small market that is not grow in real terms, some consolidation can be expected and the authorities should be vigilant in assessing insurer’s profitability, performance, and stability to ensure that exits are orderly.  Financial vulnerabilities are present but the challenges would appear to be manageable with careful and vigilant oversight and some targeted policy measures. These include addressing: A. addressing excessive competition, and its associated risks and costs; 2 B. further reforming capital rules for the sector and provisioning rules for life insurance; C. close monitoring of profitability particularly with respect to trends in the financial support to the sector provided by international reinsurers, and rates of return from investments; D. ensuring that the GSIS role is complimentary to the private sector; E. revisiting requirements for customer protection with respect to extensions especially those relating to floods and earthquakes.  Opportunities for growth in the sector are wide ranging. Although no single initiative is likely to be sufficient to achieve a more desirable level of sector development, a coordinated suite of initiatives offers promise. These would include the following: A. The high levels of taxation on insurance products may be reviewed as part of a comprehensive set of initiatives to encourage sector growth; B. Advancing microinsurance initiatives would seem to be a significant opportunity. The enhancement of distribution options would be important along with particular consideration given to exempting microinsurance products from premium based taxes. C. Expanding effective distribution is key to growth.  A modernization of the Insurance Code and associated regulations would be of benefit to both the operation of the industry and the more efficient use of scarce supervisory resources. Aside from proposals to codify existing understanding and circulars, it would be useful to further advance a more risk based approach to supervision.  To support reform initiatives, and the move of pre-needs companies under the Insurance Commission’s responsibilities, the Commission should receive additional resources and, to the extent possible, access further external grant and technical assistance support to bring wider experiences and case studies to local considerations. 4. The key policy recommendations that are made in support of this analysis focus on the regulatory and supervisory reform agenda and the useful engagement of the Insurance Commission in the development of Microinsurance products and services and are outlined as they emerge from the analysis. 5. The note has been prepared by Craig Thorburn, Senior Insurance Specialist, of the World Bank. MARKET OVERVIEW Market Size, Development, Composition and Dynamics 6. The insurance market in the Philippines is small relative to the size of the economy and its growth has been stagnant. Insurance penetration (total premium to GDP) stood at 3 1.05 percent in 2008 and insurance density (total premium per capita) was $US18. This places the insurance sector in a nascent stage of development. 7. Growth in nominal terms has been limited and, since 2002 the industry has contracted in real terms. On most measures, the sector is the smallest and most stagnant of private insurance markets in the ASEAN. 1 8. The trend in insurance penetration illustrates that the sector has seen a decline in real terms over the last decade. The most recent year was particularly hard hit by volatility in investment markets causing a sharp decline in life business and may be expected to recover however, the non life performance has been persistently negative in terms of penetration. Table 1 shows the trends in these two indicators. Table 1: Trends in Insurance Penetration and Density Year 1998 2003 2004 2005 2006 2007 2008 Annual Growth (% per annum to 2008) 1 year 5 10 years years Insurance Penetration (Premium as a percentage of GDP) - Life Insurance 0.73 0.95 0.90 0.87 0.92 1.15 0.77 -33.0% -4.1% 0.5% - Non life insurance 0.46 0.35 0.33 0.31 0.30 0.29 0.28 -3.4% -4.4% -4.8% - Total 1.19 1.29 1.23 1.18 1.22 1.44 1.05 -27.1% -4.0% -1.2% Insurance Density (Premium per capita in $US) - Life Insurance 6.8 8.9 9.5 10.4 13.0 20.8 13.2 -36.5% 8.2% 6.9% - Non life insurance 4.3 5.7 3.4 3.8 4.3 5.4 4.9 -9.3% -3.0% 1.3% - Total 11.1 14.6 12.9 14.2 17.2 26.1 18.0 -31.0% 4.3% 5.0% Source: Insurance Commission, Staff Analysis 9. Comparing the market statistics with other countries in the region highlights the extent of the lack of development of the sector (refer Table 2). On every measure, whether it be size, the rate of growth, and whether or not life, non-life insurance or total business is considered, the insurance market in the Philippines is the least developed when compared to ASEAN countries. 10. The comparison has to be interpreted recognizing variations in product mix from country to country including the different roles of the private sector in each case. However, the inevitable conclusion is that the comparative position of the Philippines is weaker. The mix of life and non life business is consistent with other ASEAN countries reflecting the consistent tendency toward a savings culture in the region. 1 For international comparisons, the primary source is figures reported annually by Swiss Re and by AXCO. 4 Table 2: Some Comparative Statistics (as at year end 2008 unless shown) Country Total Insurance Insurance Proportion Rates of change (% per annum) Premium Penetration Density of total Penetration (real) Density Premium (local currency) Premium ($US) Note $US mill % $US % 1 year 5 years 1 year 5 years 1 year 5 years 1 year 5 years Life Insurance Philippines - 1,279 0.76 14.2 65% -33.8% -4.0% -23.9% 9.5% -25.4% 7.2% -22.5% 11.5% Vietnam 2007 587 0.83 6.7 53% -4.8% -0.9% 8.8% 12.5% 11.8% 15.3% 10.3% 14.1% Indonesia 2007 4,981 1.15 22.2 70% 21.3% 12.9% 42.0% 30.6% 43.5% 31.8% 43.8% 32.3% Thailand - 6,664 2.44 98.9 68% 4.5% 2.2% 15.7% 15.3% 12.3% 11.3% 16.4% 16.3% Malaysia - 6,031 2.72 223.3 65% -11.6% -2.9% 3.3% 9.7% 2.0% 8.8% 5.1% 11.7% Singapore - 11,301 6.19 2,446.1 84% -8.4% -0.7% -0.2% 11.6% -3.1% 8.9% 3.8% 13.6% Hong Kong - 21,316 9.89 3,045.1 88% -9.3% 9.6% -2.7% 16.2% -5.7% 16.5% -5.5% 16.5% ASEAN 2007 29,573 2.37 57.6 73% 6.3% 0.4% 24.8% 13.5% 26.4% 15.2% 26.4% 15.2% Non Life Insurance Philippines - 700 0.42 7.7 35% -3.9% -5.7% 10.4% 7.5% 8.4% 5.3% 12.5% 9.5% Vietnam 2007 517 0.73 5.9 47% 12.0% 5.0% 28.0% 19.2% 31.5% 22.2% 29.7% 20.9% Indonesia 2007 2,087 0.48 9.3 30% -6.8% -6.4% 9.1% 8.3% 10.2% 9.3% 10.4% 9.7% Thailand - 3,190 1.17 47.3 32% -1.8% -0.6% 8.7% 12.2% 5.6% 8.3% 9.4% 13.2% Malaysia - 3,262 1.47 120.8 35% -6.0% -5.9% 9.9% 6.3% 8.5% 5.5% 11.7% 8.2% Singapore - 2,101 1.15 454.8 16% 6.7% -5.2% 16.3% 6.6% 13.0% 4.0% 21.0% 8.5% Hong Kong - 2,771 1.29 395.8 12% 8.2% -3.0% 16.0% 2.9% 12.5% 3.1% 12.6% 3.1% ASEAN 2007 10,905 0.87 21.3 27% -4.1% -3.9% 12.6% 8.6% 14.1% 10.2% 14.1% 10.2% Total Philippines 1,979 1.17 21.9 -25.6% -4.6% -14.5% 8.8% -16.1% 6.5% -13.0% 10.8% Vietnam 1,104 1.56 12.6 2.4% 1.6% 17.0% 15.3% 20.3% 18.3% 18.6% 17.0% Indonesia 7,068 1.64 31.5 11.4% 4.7% 30.4% 21.2% 31.7% 22.3% 32.0% 22.7% Thailand 9,854 3.61 146.2 2.4% 1.2% 13.3% 14.2% 10.0% 10.3% 14.0% 15.2% Malaysia 9,293 4.19 344.1 -9.7% -4.0% 5.5% 8.5% 4.2% 7.6% 7.3% 10.4% Singapore 13,402 7.34 2,900.9 -6.3% -1.5% 2.0% 10.7% -0.9% 8.1% 6.2% 12.7% Hong Kong 24,086 11.18 3,440.9 -7.5% 7.6% -0.9% 14.1% -3.9% 14.4% -3.8% 14.4% ASEAN 40,478 3.24 78.9 3.3% -0.9% 21.2% 12.0% 22.8% 13.7% 22.8% 13.7% Source: AXCO, Staff Analysis 5 Life Insurance Market Size and Product Mix 11. The life insurance sector represents around two-thirds of the total premium income. Sector growth had been positive although below the ASEAN average but was significantly impacted by client reaction to volatility in asset markets around the global financial crisis. The relatively high proportion of business that is written as life insurance is consistent with other countries in the region but contrasts with the usual development of insurance markets in other regions where property and motor insurances are more dominant. 12. The life insurance product profile implies the sector has to manage with limited financial flexibility. The sector offers a range of products including both savings and risk oriented policies however, traditional savings oriented conventional business still dominates. In the Philippines, most conventional business is written on a non participating basis. The absence of participating contracts in the life insurance market means that financial flexibility for insurers is less than otherwise and implies a more conservative asset mix is required. 13. Investment linked “variable” business has grown in relevance over the last few years increasing product options for clients and financial flexibility for the insurers that write this product line. There has be a reduction in volumes in the most recent year due to market volatility, but it can be expected to bounce back quickly as the demand is significant and the longer term prospects are bright. Recent instability in global asset markets is having a short term impact favoring more “guaranteed” business. The usual form of variable contract is offered with a menu of investment options. In the main, the variable business innovation has come from insurers able to access product management expertise through foreign shareholders although some larger domestic companies have also successfully entered this business line. This means that the constraining influence of non participating traditional business compared to variable business is not uniform from company to company. Only six of 27 domestic life insurers wrote variable life new business in 2008 compared to the largest six of the eight foreign life insurers. 14. Other forms of risk protection include personal accident, disability income, and critical illness riders and stand alone policies are marketed by many of the life insurers demonstrating a broad product development capacity. Some insurers offer products denominated in other than Pesos. Product mix charts for 2004 and 2008 are shown in Figure 3. 6 Figure 1: Product Shares by Class of Insurance – Life Insurance 2004 2008 Variable Group Business Business 7% 1% Variable Business 30% Group Ordinary Ordinary Business Business Business 69% 1% 92% Source: Insurance Commission, Staff Analysis 15. When analyzing the reasons for the level of development and the trends in the life insurance sector, four elements were considered as explanations for the current situation:  In 2008, the volumes of life insurance reduced markedly due to the response of clients and potential clients to asset price volatility as a result of the global financial crisis. This impact can be expected to be of limited impact going forward;  More structurally, low levels of disposable income limits available funds for longer term savings products for many people. It is well recognized that income levels are a key determinant for life insurance sector development2. The Philippines has one of the lower levels of GDP per capita in the region. Most other countries with comparable levels of GDP per capita have lower life insurance penetration than is observed in the Philippines3. As an offsetting element, remittance incomes are a source of income across the country but still have the potential for more effective access by the insurance sector with improved distribution;  premium based taxation on insurance products. For the life sector this is considered especially relevant when compared to other investment products and some insurance is either not purchased, or arranged outside the Philippines, for this reason; 2 Refer Enz, R. (2000) “The S-curve Relationship Between Per-Capita Income and Insurance Penetration ”, Geneva Papers on Risk and Insurance, Vol. 25; pp 396-406. 3 For example, countries with GDP per capita around the level in the Philippines (measured in $US), demonstrate the following life insurance premium density measures. Country GDP per capita Life Insurance Country GDP per capita Life Insurance $US Penetration $US Penetration Indonesia 2247 1.15 Philippines 1877 0.76 Sri Lanka 2142 0.51 Paraguay 1768 0.11 Syria 2123 0.02 Mongolia 1764 0.00 Egypt 2085 0.40 Bolivia 1665 0.29 Honduras 1956 0.51 Kosovo 1644 0.00 7  Most compelling, it is clear that the key to life insurance sector growth, and therefore the key driver of slow progress, is the volume and reach of effective distribution. There are very material aspects of bias for like products to be treated differently depending on providers, however, the consensus of discussions was that none of these issues was sufficiently significant as most providers sought to serve a target client base that was not being competitively serviced from another group of providers. Given that the most material life products sold are not easily able to be subject to price comparison across providers, the sale is secured largely by the first distribution channel and representative who can get to the client and demonstrate the need and relevance of the product. With such a low level of penetration, despite the competitive pressures derived from the numbers of insurers, price and taxation distinctions between mutual insurers, mutual benefit associations, cooperatives, and stock company insurers were not seen as the most critical challenge. Non-Life Insurance Market Size and Product Mix 16. The trend in the non life insurance sector penetration measure shows sector contraction in real terms. The insurance penetration has followed global price trends after a period at the end of the last decade where liberalization of some price controls also had an impact4. Figure 2 shows the trends in the insurance penetration for non life insurance for the Philippines and for OECD, G7 and global totals. In each case, the values are scaled to a common base of 1.0 in 2002. The international pricing cycle is represented by the major groupings, with the residual trend of variation being related to price levels in the case of the more global measures5. In the case of the Philippines, up until 2002, there was a significant fall that was largely attributed to some liberalization in product pricing rules rather than a reduction in the tendency to take out insurance. 4 AXCO figures are used for international comparisons. 5 On the assumption that the tendency to insure can be considered to be effectively constant for these large country grouping aggregates and the amount of insurance is therefore solely a function of the level of economic activity then the trends in insurance penetration will be left as the residual effects of pricing cycles. 8 Figure 2: Comparison of Non Life Penetration as an Indication of the Pricing Cycle 1.60 1.40 1.20 Ratio to standardised year 1.00 0.80 0.60 0.40 Philippines OECD 0.20 G7 World Average - 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Year Source: AXCO and Staff Analysis 17. Since 2002, the steady decline in the non life insurance market reflects significant reductions in prices partly offset by an increase in insurance utilization. From 2004 to 2008, the rates applied in the market have fallen dramatically. When calculating premium divided by sums at risk as a proxy measure, rates have fallen by over 40 percent over the period. This compares with a fall in the insurance penetration measure of 15% over the same period. The implied 25% increase in insurance utilization is a more positive aspect of the development of the non life sector. 18. The non life insurance sector also provides a varied product range but is largely focused on short term property type business lines. As is usual in less developed insurance sectors, motor insurance is predominant in the non life sector along with the “fire” class6. Most insurers have a business mix from direct business that reflects exposure to all product lines although individual insurer product portfolios favor one or other particular class of insurance so have a degree of specialization that goes beyond merely taking a standard market portfolio. In many cases, unusually, companies accept inward reinsurance from other companies at around 20% of their total premium although this does not tend to alter the portfolio mix with respect to their exposures to product classes. Product mix charts for 2004 and 2008 are shown in Figure 3. 6 Fire insurance, globally, can be interpreted as often including more general property damage insurance and a considerable element of householders or homeowner property insurance. 9 Figure 3: Product Shares by Class of Insurance – Non Life Insurance 2004 2008 Surety Life for PR Surety Life for PR 3% 0% 4% 0% Casualty 18% Casualty 20% Fire Fire 35% 33% Motor Motor 30% 32% Marine Marine 14% 11% Source: Insurance Commission, Staff Analysis 19. Third party motor insurance and some other indemnity covers are obligatory. There are some compulsory classes of business in the Philippines. Chapter VI of the Insurance Code deals with third party motor liability insurance. Motor insurance policies are mandatory for each vehicle (rather than driver so reducing the risk of uninsured drivers) and authenticated through a central facility run by the industry association (PIRA) in an effort to limit fraud7. The motor indemnity limit was doubled to PHP 100,000 in 2007 and, although the industry suggested that it continues to be relatively low, is not starkly out of line when considering other ASEAN countries. There are requirements for personal accident coverage on public transport, liability cover for condominiums, and professional indemnity for doctors, engineers, architects and insurance brokers. Workers compensation insurances are obligatory but are managed through the social security system. Table 3: Motor Third Party Monetary Limits for Private Vehicles in ASEAN Countries Country Death Bodily Injury Property Damage Brunei unlimited Cambodia USD 5,000 per person USD 5,000 per person and also subject to limits USD 5,000 for (Note: and also subject to limits for any one accident (USD 25,000 for cars, USD vehicles with less limits are for any one accident 12,500 for vehicles with less than 4 wheels) than four wheels and expressed (USD 25,000 for cars, USD 10,000 for in USD in USD 12,500 for vehicles others for any legislation) with less than 4 wheels) accident Indonesia IDR 10mn (USD 966) (optional covers available above this level) Laos LAK 700,000 (USD 82) LAK 700,000 (USD 82) to LAK 3mn (USD 350) to LAK 3mn (USD 350) for permanent total disablement. LAK 80,000 subject to a maximum (USD 9) to LAK 1.8mn (USD 210) for medical liability per accident of expenses. Partial disablement is compensated as a LAK 10mn (USD 1,170). percentage of the total disablement benefit all subject to a maximum liability per accident of LAK 10mn (USD 1,170). Malaysia unlimited Myanmar MMK 25,000 (USD 24) Permanent crippling disablement MMK 20,000 MMK 10,000 (USD (USD 19) 10) 7 PIRA is the Philippines Insurance and Reinsurance Association. The requirement for authentication was mandated by the Insurance Commission through Circular Letters 12-2007 and 21-2007. 10 Blinding in both eyes, Breaking of spine or hip Serious injury to other parts of body MMK 10,000 (USD 10) Philippines PHP 100,000 (USD 2,072) Singapore unlimited SGD 5mn (USD 3.5mn) Thailand - Basic coverage: THB - Basic coverage: medical expenses THB 15,000 35,000 (USD 989) (USD 424) subject to overall limit of - Addition where fault ordered: bodily injury: THB 50,000 (USD 1,412) THB 35,000 (USD 989), not to exceed THB including medical costs 50,000 (USD 1,412) in total, for defined before death disablement: up to THB 100,000 (USD 2,825) in - Addition where fault total and also subject to limits for any one ordered: THB 100,000 accident THB 5mn (USD 141,243) (USD 2,825) in total and also subject to limits for any one accident THB 5mn (USD 141,243) Vietnam VND 50mn (USD 2,967) per person (motorcycles VND 50mn (USD VND 30mn (USD 1,780) per person) 2,967) per person (motorcycles VND 30mn (USD 1,780) per person) Source: AXCO, Staff Analysis 20. Several insurance covers are provided by state systems rather than the private sector. Workers compensation is operated through the state social security system rather than the private sector. Other state provided insurance type services include an agricultural guarantee and crop insurance program provided by the state owned Philippine Crop Insurance Corporation (PCIC), a mortgage redemption insurance program operated by the state owned Home Guarantee Corporation (HGC), and the state owned Government Service Insurance System (GSIS) (see below) that has a legislated mandate to carry insurance for the government sector 21. Many non-life insurance products are offered with optional extensions that are not taken up by clients. One topical example given the experiences with tropical storms in 2009 has been attention been drawn to the fact that property covers offer, as an option, cover for “acts of God” including storms, floods, and earthquakes. Customers wishing to limit their insurance costs may decline these extensions. Some insurers offer these extensions and require the client to “opt out” whereas others provide a process of “opt in” that is more problematic from a customer protection perspective as it is more open to disputes after the event and consequent erosion of sector reputation. The interaction of this heavy option-based structure with the social security and support mechanisms, and with the level of product based taxes creates an incentive for potential customers to avoid taking insurance, to under-insure, or to seek covers outside the Philippines. Insurers, Distribution, Linkages and Competition 22. Insurance products and services are provided by a range of institutions. Under the current law, the Insurance Code envisages that insurance can be provided by locally incorporated stock companies, mutual insurance companies, cooperatives, and branches of foreign insurers (collectively considered to be “insurance companies”) and mutual benefit associations (MBAs). Aside from operating a branch, foreign ownership of a locally incorporated insurer is also 11 unrestricted. Health insurance products are provided by HMOs are outside the scope of this analysis. Non guaranteed forms of risk pooling are also not considered here. 23. There is a significant insurance-type activity known as “pre-needs” largely offering education funding plans and other endowment type schemes. To date, the pre-needs business has not been defined as being within the scope of the Insurance Code so is not officially counted as insurance in statistics although it is widely seen as such by the general population. Moves to transfer the “pre-needs” companies under the jurisdiction of the Insurance Commission had passed through the congress and was awaiting presidential consent at the time of the mission. 24. The number of insurance companies has been progressively reducing whilst the number of MBAs, particularly those oriented to serve lower income markets, has been growing. The sector is currently constituted by some 120 “conventional” companies (including stock companies and foreign branches), 20 MBAs, and two cooperatives licensed to conduct insurance business. Additionally, the domestic reinsurance company, National Reinsurance Corporation (PhilNaRe), was successfully privatized through an IPO in 2006-07 and is licensed under the Insurance Code. None of the non life companies with the exception of PhilNaRe are listed directly although some are members of listed groups. Conventional insurance companies are able to operate with separate legal entities for life and non life business or as composites writing both in the same legal entity although it is currently unlikely that new applicants for composite licenses would be forthcoming. There is no plan to require change to the structure of the three existing composite insurers. MBAs are not permitted to write non life insurance under the current law. The currently licensed cooperative insurance societies do not provide non life insurances although there is an application being reviewed by the Insurance Commission for a non life insurance cooperative at the time of the mission. Table 4: Insurer Types – Numbers of Insurers 2004 2005 2006 2007 2008 Insurance Companies that write life insurance business only 34 33 33 32 32 - locally incorporated & owned (includes one mutual) 24 24 25 23 25 - locally incorporated some or all foreign ownership 9 8 7 8 6 - Branches of foreign insurers 1 1 1 1 1 Cooperatives licensed to carry out insurance business MBAs Pre-needs Companies Insurance Companies that write non-life insurance business only 97 93 93 87 85 - locally incorporated & owned 87 84 83 80 78 - locally incorporated some or all foreign ownership 5 5 5 4 4 - Branches of foreign insurers 5 4 5 3 3 Composite Insurance Companies 4 3 3 3 3 - Locally incorporated and owned 3 2 2 2 2 - Locally incorporated with some or all foreign ownership 1 1 1 1 1 Source: Insurance Commission, AXCO 25. The state operated GSIS is one of the largest and most important institutions not included in statistics of the private insurance sector. Insurance of government property and interests (excluding those related to the armed services) is mandatory and compulsorily insured 12 with the GSIS8. The GSIS was established in 1937 to provide insurances to civil servants and for government risks. “Government risks” is widely defined and includes business of governments at all levels, schools, public health delivery properties, as well as the generally more commercial public corporations such as power corporations, food authorities, and the national oil company. It is obligatory for these entities to take out insurance and to place it with the GSIS. The GSIS also manages the pension risks for government employees and, as a result, is potentially the largest long term institutional investor in the Philippines asset markets although reported figures do not differentiate between pension obligations and other life insurance business. The GSIS reported that efforts by their clients to minimize cost means that they often insure for the current written down value rather than replacement value and, with the effect of the averaging clause, this implies that they have a large portfolio that is not materially exposed to natural catastrophes due to underinsurance. 26. The GSIS also provides an element of insurance directly competing with the private market as government employees are able to take out insurances with GSIS. Around PHP 24 millions of premium was involved in 2008 in this business. Further, a significant amount of life insurance is compulsorily included on the lives of borrowers who are recipients of GSIS loans. 27. A current proposal to nationalize the third party motor insurance portfolio to the GSIS is subject to a court action. This move is controversial and has only limited support from the insurance sector. This is not at all surprising because, if it was to proceed, it would not only lead to a loss of a significant market for the private sector but could be expected to lead to a material prudential risk for insurance policyholders more generally in the near term due to the reduction in market size and increase in expense rates flowing through to risk of profit and capital erosion and even some insolvencies. 28. Statistics on the GSIS are reported in the Insurance Commission’s annual reports including assets, reserves, and surpluses as well as “premium income/earned” as shown in Table 5. Table 5: Key Statistics for the Government Service Insurance System (PHP Billions) 2004 2005 2006 2007 2008 Aggregated assets 313.5 376.2 412.5 438.2 483.8 - Attributed to life business 298.2 358.7 393.9 421.2 466.5 - Attributed to non life business 15.2 17.5 18.7 17.0 17.2 Investments 268.2 287.6 339.0 380.5 342.7 - Attributed to life business 255.7 273.3 324.6 365.2 330.5 - Attributed to non life business 12.5 14.3 14.4 15.3 12.2 Total Reserves for future claims 282.2 328.5 366.9 412.3 446.6 Net worth and unassigned surpluses 20.6 32.6 33.4 14.8 23.9 Premium income (life) and earned (non-life) 46.2 45.0 42.7 44.9 49.1 Total benefit payments disbursed 30.5 31.7 32.2 33.5 36.1 Source: Insurance Commission Annual Reports 29. Linkages between the insurance and banking sector exist and are increasingly important. Several insurers are part of conglomerates that also contain banks, in part as a response to the regulatory requirement for part equity ownership for banks that sell insurance products in branches. 8 Refer Presidential Administrative Order 141 of 1994. 13 30. At the same time, and less concerning in such cases, some bank owned insurers are largely operating to insure business from within the group and, as such, operate as captive insurers by nature where the insurer may be less than commercially capitalized but the wider group is considered to be well capitalized. Table 6: Major Insurance Company and Bank Associations Bank Non Life Life Insurer Insurance Pre needs Other Insurer Broker organization Bank of BPI/MS Ayala Life Ayala Aon Ayala plans Universal Philippine Insurance Assurance Brokers Reinsurance Islands (BPI), Corporation Corporation Far East Bank Metro Bank, Philippines Philippines Asian Bank Charter AXA Life, Pan Insurance Corp Philippines Life Insurance Corp Philam Bank Philippine Philam Philam Plans Inc Philam Care American Life Equitable PCI (health care and General Life, Philippine management), Insurance Co, American Life Philam Asset Philam and General Management Insurance Co Inc Insurance Co (Mutual Funds), Philam properties (property development) Rizal Malayan Great Pacific Pacific Plans Inc Universal Commercial Insurance Co Life, Nippon Malayan Banking Corp. Inc, Malayan Life Philippines Reinsurance Zurich Insurance (JV), Corporation, Co (JV), First House of Nationwide Investments Inc. Assurance Corp 31. Distribution channels are diverse reflecting attempts by insurers to access customers. Insurance is able to be distributed by ordinary agents, general agents, “variable life” agents, and brokers and all are actively pursued. Life insurance is heavily oriented toward the agency system in a similar way to the rest of the region and markets at similar levels of development but, less characteristically, has struck out to distribute through other financial institutions and groups especially those providing banking services. Life insurance agent registration obligations, for those marketing the full range of products, requires separate registration for general and variable life products. 32. Under current arrangements, banks are only able to offer financial products in branches subject both the usual rules regarding product disclosures and a requirement of the banking law that the bank has at least a 5% ownership stake in the insurer. Banks are able to offer insurance and other financial products within branches subject to the usual rules that make it clear that the product is issued by other than the bank and is not guaranteed by the bank itself. However, the requirement that banks can only sell products in this fashion when they have a stake in the insurance provider tends to pull in the opposite direction. In fact, these rules were established at different times and for different policy objectives. As a result, several insurers 14 have been established to reflect such a 5% - 95% holding arrangement. Other savings and loans institutions, rural and cooperative banks, are restricted to distributing insurance products outside the branch premises through identifying one of the agency or broker related forms and informal arrangements between the organization or individual staff within it directly with insurers and doing so outside the bank premises. 33. However, although it has shown positive signs, bancassurance has further to develop. Insurers are making progress but expect much more in future as they continue to progress with the usual issues that arise such as channel conflict, cultural issues for bank staff, overcoming the fear of canibalisation of deposits, and alignment of incentives. Given that the progress is at an early stage, the opportunities for development of this channel are significant for the sector9. 34. Agency productivity is low and turnover of agents also points to a lack of efficiency in distribution. Table 7 suggests low productivity in terms of numbers of policies per agent, even on generous assumptions, is less than one policy per month – a largely part-time agency force. Further, the rate of renewal of agents shows a high wastage rate and a focus on new agent recruiting rather than agency retention. Table 7: Statistics on Licensed Intermediaries 2004 2005 2006 2007 2008 New Ordinary Agents 18,604 18,942 16,865 11,936 17,130 - life 16,053 16,208 13,946 9,992 14,831 - non life 2,551 2,734 2,919 1,944 2,299 Total Ordinary Agents 40,762 41,770 41,065 35,987 40,865 - life 30,852 30,466 30,228 25,430 29,740 - non life 9,910 11,304 10,837 10,557 11,125 General Agents 619 431 342 232 233 - life 51 44 67 35 54 - non life 568 387 275 197 179 Variable Life Agents - new 537 1,766 1,490 3,194 3,148 - total 857 2,623 3,502 4,834 7,863 Brokers 170 119 130 125 113 - Insurance 127 86 100 93 80 - Reinsurance 43 33 30 32 33 Ordinary Agent Renewal Rate - life 46.2% 53.4% 51.1% 58.6% - non life 86.5% 70.0% 79.5% 83.6% Life Agent Productivity Index (see note 1) 10.90 9.74 13.84 12.44 9.06 Source: Insurance Commission, Staff Analysis Note: Ratio calculated based on numbers of new policies divided by numbers of ordinary agents. It is recognized that not all sales of life insurance are made by agents, not all agents are dedicated to life insurance products, and the ratio is intended for illustrative purposes only. 35. Consistent with low herfindahl index measures for the market and its sub-segments, the market is highly competitive in both life and non life business segments. Research suggests that a wholly competitive insurance market tends toward international norms and that, taking into 9 For more discussion on the challenges and opportunities of bancassurance models more generally refer Sigma (2007). 15 account the level of development of the insurance market and the absolute size, a neutral level for the herfindahl index can be estimated to inform the assessment of actual market measures. The argument, supported by cross country observations, is that markets with higher concentration are characterized by limited innovation and the arrival of new participants who take advantage of market niche opportunities gradually chipping away at existing player positions. Of greater prudential concern, unnaturally low levels see low profitability, insurers launching price and agency poaching wars in an effort to grow and achieve economies of scale that can undermine the financial stability of the sector, and eventual merger activity to resolve the lack of economies secured through organic market growth. At more neutral levels, non life insurance markets tend to be more diversified than life markets as the non life sectors in many countries see concerns about aggregations of exposure in property risks work against holding higher market shares and in favor of expansion in alternative markets (Herfindahl indexes tend to be of the order of 1,000 to 1,500). In life insurance, where economies of scale are more readily secured then the index tends to gravitate toward a higher level (index values of the order of 2,500 to 3,000)10. Table 8: Herfindahl Index by Business Line (2002 - 2008) 2002 2003 2004 2005 2006 2007 2008 Life Insurance - Traditional Insurances 917 - Variable Insurance 1,836 Subtotal Life Insurance 1,405 1,379 1,440 1,361 1,343 1,439 1,014 Non Life Insurance - Fire 743 - Marine 756 - Motor 522 - Other 607 Sub-total Non Life 435 403 474 481 524 522 504 Insurance Source: 2008 Insurance Commission, and earlier AXCO, Staff Analysis 36. With respect to the Philippines, the index is well below neutral levels and potentially represents a source of concern from a prudential perspective (refer Table 8). For Life insurance, the specific result in the Philippines can be explained initially by the liberalization of the market that included the arrival of a number of foreign players however, through merger and exit, their departure has not led to a return of the index to more natural levels. For non life insurance, the sector has shown some gradual consolidation but still has a long way to go before competition might be more normal. Material price cutting and low profitability are particularly evident in the non life sector (refer Table 9). These conclusions were validated through interviews with industry participants who noted that the price competition in the non life sector had benefited from a supportive stance in reinsurance terms. Overall market expansion would assist economies of scale and performance but this cannot be expected to occur sufficiently quickly and some rationalization is to be expected. However, this needs to be balanced with the understanding that not all companies operate on a fully commercial motivation as conventional 10 Refer Thorburn (2008) 16 insurers. Increased absolute minimum capital requirements may yet lead to some consolidation but, to date, their effect has been minimal11. Table 9: Implied Premium Rates – Non Life Insurance Category 2004 2005 2006 2007 2008 Change over 2004-2008 direct business 0.199% 0.164% 0.121% 0.143% 0.117% -41.3% direct business ceded 0.192% 0.156% 0.118% 0.147% 0.134% -30.1% net direct risks written 0.208% 0.174% 0.124% 0.140% 0.104% -49.9% assumed risks reported 0.280% 0.190% 0.118% 0.121% 0.099% -64.8% gross risks including reinsurance 0.204% 0.167% 0.125% 0.147% 0.117% -42.6% implied inward reinsurance 0.200% 0.163% 0.126% 0.153% 0.131% -34.3% addition retrocessions 0.271% 0.182% 0.100% 0.105% 0.087% -67.9% net risks 0.227% 0.180% 0.131% 0.143% 0.108% -52.6% 37. The tax regime gives rise to inconsistency across providers within the insurance sector and with other financial services. Depending on the entity that issues the contract and provides the service, there is a difference in the taxation treatment. Premium-based taxes are different between types of provider: mutual insurers, MBAs, and cooperative insurance societies on one hand, where many taxes are not assessed, and conventional insurers on the other.12 More broadly, when comparing life insurance products with other forms of savings vehicles, the taxation is inconsistent as contributions to the savings element are not subject to equivalent tax burdens of, for example, mutual funds and bank deposits contrasted with a life insurance savings product. There are also a range of transaction based investment taxes that are payable by shareholder insurers only. The taxation of insurance products is thus creating incentives to underinsure risks particularly optional coverage extensions, use informal mechanisms, or go outside the local market. 38. In addition, as a consequence of the bias toward MBAs as providers of micro insurance, these products do not currently attract premium-based taxes. Expanding the range of providers and types of benefit requires the product to be treated consistently – by defining the treatment using the definition of micro-insurance products rather than by form of provider. Micro- insurance should continue to be excluded from premium based taxes, but this needs to be defined on the basis of the product, not the provider. 11 See below for more information on the proposed changes. Notably, as the 2007 increase was deferred to 2008 then some market participants may not yet be considering that the future increases will occur with any certainty and, so, the impact of these changes on strategic plans may be awaiting greater confirmation that they will, in fact occur. 12 For life products, conventional insurers would have to charge a premium including taxes around 10 percent higher than mutuals and cooperative insurers to provide the same product and benefits. For non-life products, this tax- induced gap is of the order of 45 percent. The figures for the differential vary slightly depending on the exact terms and covers of the product. 17 Catastrophic Risks and Reinsurance 39. There is a significant exposure to natural catastrophes in the Philippines. Flooding associated with tropical storms and typhoons is a serious concern across the country. The country is in an active seismic zone with the consequent risk of earthquake, tsunami, and volcanic activity being material risks that the insurance sector has to measure and manage (refer Figure 4). 40. Minimum tariff rates for earthquake and flood are set by the Insurance Commission. These rates are not distinguished by zones within the country although companies do have a zone system in place that is used for reinsurance transactions. Figure 4: CatNet Earthquake and Windstorm Exposure Maps Source: AXCO and Swiss Re CatNet ™. 41. Reinsurance retentions and cessions are subject to national restrictions and compulsory reinsurance placement arrangements. As a result of the exposure to natural catastrophes, non life insurers are not permitted to retain more than 20% of their net worth on any one risk13. Section 218 of the Insurance Code requires all non life insurance companies to cede their excess risks to other insurers in the market before resorting to foreign reinsurance placements. Section 219 of the Insurance Code requires that companies ceding facultative reinsurance outside the Philippines must demonstrate to the Commissioner that the local market cannot provide the cover being sought. A mandatory cession to PhilNatRe also applies. As a result, most direct insurers write a volume of inward reinsurance in addition to their direct portfolios. 42. The remittance of reinsurance premiums and the return of claim proceeds has been accessible directly through the banking sector since the BSP Circular 1353 of 1992 removed exchange 13 This rate is high for comparative countries however. In Guatemala, for example, where risks are similar but lower than the Philippines, the required retention is capped at 8% of net worth. 18 controls. Specifically, however, Circular Letter No 14 of 2008 from the Insurance Commissioner requires insurers and brokers to seek prior approval before entering into a treaty or agreement involving remittances of US dollars outside the Philippines. It also imposes approval authority before contracts are entered into for all renewal of reinsurance treaties. 43. The optionality in products to take up “acts of God” coverages reduces insurer exposure to these events and many insurers report that their actual exposure is more limited as a result of this feature of the market product design and sales processes. Insurers report that access to reinsurance is not an issue. 44. Examining cession rates indicates a pattern consistent with the market dominated by small insurers with limited capacity (refer Table 10 for cession rates by class for the sector). As is usual, the motor portfolio is less reinsured than other classes; a feature that may well be an issue as claims from 2009 flooding in Manila have a high motor component when vehicles were submerged. 45. The GSIS, with a large portfolio, can be expected to have a catastrophic exposure that could, as a result of its state ownership, present a fiscal risk. Interviews indicated that the exposure is, however, lower than the balance of the market due to the desire for government clients to reduce their insurance costs so not opting for “Acts of God” coverages to a far greater extent than the broader market and also as a result of the insurance of written down values coupled with the average clause impact. That is, the GSIS reports that many of its clients self insure much of their risk rather than insurer it with the GSIS, deliberately or for other reasons. That said, the management of this risk at the GSIS was less sophisticated than it would be at commercial insurers of such importance and could be subject to review and refinement. Table 10: Cession Rates by Non-Life Insurance Class14 (2004-2008) Class 2004 2005 2006 2007 2008 Fire 64% 62% 62% 58% 59% Marine 58% 62% 49% 46% 42% Motor 8% 8% 0% 0% 1% Casualty 45% 46% 46% 43% 42% Total 40% 41% 36% 32% 33% Source: Insurance Commission, Staff Analysis 46. In summary:  The insurance market in the Philippines is small relative to the size of the economy and its growth has been stagnant. Since 2002, the industry has contracted in real terms. On most measures, the sector is the smallest and most stagnant of private insurance markets in the ASEAN.  The life insurance sector represents around two-thirds of the total premium income. Sector growth had been positive although below the ASEAN average and was significantly impacted by client reaction to volatility in asset markets around the global financial crisis. Investment linked “variable” business has grown in relevance. 14 The Cession Rate is the proportion of premium received that is “ceded” to reinsurers, that is, paid to reinsurance companies for the purchase of reinsurance protection. 19  Non life insurance has contracted more sharply, due to significant falls in premium rates in a particularly highly competitive environment.  The life insurance product profile implies the sector has to manage with limited financial flexibility and implies a more conservative asset mix is required.  When analyzing the reasons for the level of development and the trends in the life insurance sector, income levels and taxation play a role but the most significant explanation lies in the need to find effective and efficient distribution, currently performing inefficiently – something that largely rests with the industry.  In the non life sector, the combined influences of the role of state owned entities, and the combined impacts of taxation with benefits provided as optional extensions, all contribute to incentives to underinsure or utilize less formal mechanisms.  Competition levels are significant in the life sector and particularly strong in non life insurance. Some rationalization has been taking place, albeit slowly, but can be expected to continue. In an environment of high competition, the risk of loss of profitability, irrational price wars, and an inability to achieve economies of scale can all suggest careful monitoring of profitability and solvency.  Important linkages between the insurance and banking sectors are growing.  There is a significant exposure to natural catastrophes. Product optionality and low penetration reduce insurer exposure to these events. Access to reinsurance is not an issue for insurers and cession rates are consistent with the market dominated by small insurers with limited capacity.  A taxation distortion across the diverse range of potential providers creates some inconsistencies and would merit review. Financial Performance, Assets, Liabilities and Solvency Profit 47. Insurance companies show persistent and stable profitability based on the local accounting regime. All assets, except equities and real estate, are recorded using a book value accounting approach. Liabilities use a net premium approach for the substantial conventional life insurance stock. Whilst both of these elements contribute to an accounting stability, the performance in the Philippines has been particularly stable. 48. Non life insurance claims ratios by class of business and after reinsurance indicate that the business is stable and profitable, although this outcome is largely attributable to the support of reinsurers. Claims ratios are remarkably stable and are at low levels. Given that the actual rates charged to policyholders has fallen so dramatically over the period (refer Table 9) then the stability in the claims rates has to be explained through supportive reinsurance terms. This observation holds for all classes except motor where the reinsurance cessions are minimal 20 (refer Table 11). However, despite the issue noted above with respect to product optionality, the impact of the tropical storms and typhoons in 2009 is expected to push non life insurance claims up materially particularly as the season’s storms had a more severe impact than is usual in the more highly insured geographic areas in Manila15. Table 11: Net Claims Ratios by Class of Business for Non Life Insurance 2004 2005 2006 2007 2008 Fire and Allied Perils 41.1% 33.2% 50.9% 40.6% 53.1% Marine 29.5% 43.7% 42.9% 43.9% 54.4% Motor Car 55.9% 51.6% 47.1% 52.7% 50.2% Casualty 42.0% 42.9% 47.1% 40.2% 40.7% Surety 21.1% 15.2% 19.6% 13.3% 6.4% All Non Life Classes 47.1% 44.8% 47.5% 46.1% 48.5% Source: Insurance Commission, Staff Calculations. Note: Claims adjustment expenses are not reflected in the above ratios except for the total class. 49. Claim stability is low particularly considering the small size of the market however, it is greatly assisted by the fact that companies write business across most classes. In fact, for each of the reported comparable classes of business, rates compare favorably with peer countries and the broader global comparisons. (Refer Table 12). Table 12: Calculated Coefficient of Variation - Sample Countries and Global Data Set Philippines Singapore Indonesia Malaysia Thailand Vietnam Global USA Property 31.4 37.3 44.4 37.8 45.8 19.1 23.2 66.5 Construction & Engineering 41.7 46.8 79.1 48.0 26.0 Na 16.8 55.9 Motor 10.9 10.3 13.6 15.9 20.9 12.4 8.3 17.3 Surety, Bonds and Credit 55.1 130.9 654.2 Na Extreme Na 85.2 80.4 Miscellaneous 49.3 68.3 57.0 28.8 26.6 22.2 19.5 56.3 Marine, Aviation and Transit 41.6 60.1 123.6 37.3 27.4 23.9 30.3 44.9 Personal Accident 28.6 9.6 36.3 17.1 8.8 3.9 9.2 27.2 Source: AXCO, Staff Calculations 50. There is evidence that the support of reinsurers has been reducing more recently through reduced expense support. Table 13 shows that non commission expenses have increased compared to total business for non life insurance with the exception of the latest year but that net commissions (after rebates from reinsurers) have also increased compared to retained business consistent with this reducing support. 51. Expense performance shows deteriorating efficiency in the non life sector. The failure to resolve excessive competition has led to a dead weight cost that is contributing to sluggish sector development. Increased expenses through commissions are consistent with competition measures where higher commissions are being paid in an effort to buy business through distribution. Operating expenses have increased consistent with the absence of effective 15 Estimates vary by insurer depending on their exposure but, for some, is reported to represent an additional 15 to 20 percent in claim rates, that is around 10% of premium. 21 progress in consolidation and price reductions that exceed cost justifications. Operating expense measures compared to net earned premium points to a loss of efficiency and value to the Philippines economy of at least 4% of non life premium over the last five years. This dead weight drag on the wider economy is also a brake on insurance affordability that limits growth and the contribution that the sector could be making to the wider economy. 52. The life sector has also shown an inability to secure expense efficiencies until the most recent year when the significant premium fall imposed more focused attention. Table 13: Expense Ratios Ratio 2004 2005 2006 2007 2008 Non Life Expenses Total non commission expenses to gross premium 20.2% 23.5% 25.3% 25.9% 21.8% Net commissions to net written premium 22.7% 21.1% 26.3% 28.4% 27.8% Operating expenses to net earned premium 20.0% 21.1% 23.3% 22.5% 24.3% Life Expenses Total non commission expenses to premium income 24.3% 27.6% 26.3% 30.5% 20.9% Source: Insurance Commission, Staff Analysis. Table 14: Effective Reported Investment Returns16 2004 2005 2006 2007 2008 life insurance - on total assets 8.7% 9.4% 9.2% 7.7% 7.4% - on total investments 10.9% 11.9% 12.0% 10.5% 9.7% non life insurance - on total assets 3.3% 3.6% 3.9% 3.8% 3.3% - on total investments 6.9% 7.5% 8.4% 8.4% 7.0% Source: Insurance Commission, Staff Analysis. 53. The third component contributing to profit performance is the return on investments. Consistent with the asset mix of the companies and the accounting methodology, returns have been positive and satisfactory (refer Table 14). The life insurance sector returns are particularly important given the more guaranteed nature of their investment promises and the rate implied in the establishment of provisions. The outlook for returns is for a continued fall in the book value based figures shown as more historic investments made at higher rates mature and are replaced with new investments at lower current earning rates. As such, it can be expected that this measure will continue to decline placing pressure on reported profitability in the future. Table 15: Reported Return on Equity 2004 2005 2006 2007 2008 life insurance 7.3% 7.0% 7.1% 9.0% 10.0% non life insurance 5.6% 4.7% 3.5% 4.3% 4.9% Source: Insurance Commission, Staff Analysis. Note: Estimate based on after tax net income compared to net worth as defined in Insurance Circulars 54. Overall, the combined results of stable underwriting performance, favorable contributions from reinsurance and satisfactory although falling investment performance 16 This ratio is calculated using the traditional formula [ 2I/(A+B-I) ] and returns to the Insurance Commission. Note that the values for assets represent the reported book values. 22 have contributed to continuing steady profitability (refer Table 15). Overall rates of profitability are lower in non life consistent with the competitive landscape and the risk that reinsurance support will further reduce is a concern. However, challenges in finding expense efficiencies and the less positive outlook for investment related contributions to profit suggest a cautionary element in the profit outlook. Assets and Investments 55. Total assets in the insurance sector have grown from PHP 306 billion in 2004 to PHP 462 billion in 2008 or just 6.2% of GDP. The level of this figure, despite the relatively high orientation toward the more savings oriented life insurance business, reflects the level of development of the sector. Life insurance assets represent the majority at 81% of assets and 85% of investments for the sector. (refer Table 16) Table 16: Assets 2004 – 2008 (PHP Billions) 2004 2005 2006 2007 2008 Total Assets Life Insurance 240.04 273.57 324.74 366.88 372.83 Non Life Insurance 66.25 69.94 79.94 77.84 88.68 Total 306.29 343.51 404.68 444.72 461.51 Invested Assets Life Insurance 229.52 261.84 305.00 305.92 314.13 Non Life Insurance 43.17 47.04 50.13 56.24 57.46 Total 272.69 308.88 355.13 362.16 371.59 Source: Insurance Commission 56. Asset mixes reflect a conservative approach to liquidity generally, a tendency to favor more secure assets, and the nature of liabilities as well as the overall regulatory restrictions. Table 17 shows the heavy weight of life insurers toward bonds and the similar weighting of non life insurers toward cash and similar instruments. Actual investment profiles are conservative reflecting both the impact of the rules and the supply of investable assets. Table 17: Asset Mix of Insurers (Material Items) as at 31 December 2008 Category Life Insurance Non Life Insurance PHP Billions % of total PHP Billions % of total assets assets Bonds 178.4 47.8 14.8 19.2 Stocks 33.1 8.9 11.5 14.9 Real Estate 17.5 4.7 4.7 6.1 Mortgages and Guaranteed Loans 30.1 8.1 0.4 0.5 Policy Loans 27.8 7.5 Cash 24.9 6.7 12.2 15.8 Premiums receivable 2.2 0.6 8.9 11.5 Assets backing Variable Insurances 44.8 12.0 Reinsurance recoverables 0.3 0.1 15.7 20.3 Other 13.4 3.6 9.0 11.7 Source: Insurance Commission 23 57. Insurance company investments are subject to a rule based regulatory system and supervisory oversight. The requirements include a set of assets that are inadmissible. The balance of the assets (admitted) is subject to various maximum exposures (refer 58. Table 18). There is a limited obligation and wider encouragement to invest in Philippines and other government related fixed interest. Additionally, assets that do not have a track record of paying income for three years are not admissible effectively precluding investment in initial offerings. Assets are valued at book value for fixed interest securities and, for market securities, at market value. Many investments can only be made after a case by case approval by the Insurance Commission. As a result, real time opportunities can be missed and considerable resources are applied in the commission to this approval process; something that might be usefully revisited as part of the review of Risk Based Capital rules to bring the two regulatory arrangements closer together and reduce the overall burden on both insurers and the supervisory staff. Table 18: Asset Regulations Type of Investment Restriction (% of admitted assets unless stated) Philippines Government Securities (that must be held Minimum 25% of minimum paid up capital (or minimum free of encumbrance and deposited with the local assets for branches) plus the full amount of any Insurance Commission) legal reserve required for reinsurance ceded to an unauthorized foreign insurer. Real Estate Maximum of 25% Fixed interest, bonds and debentures issued by Maximum of 25% in any one institution solvent entities Preferred stock Maximum 10% in any one institution Common Stocks Maximum 10% in any one institution Certificates, notes, or other obligations issued by No limit trustees or receivers, and equipment trust obligations, provided that they are adequately secured Any obligation of any corporation which is No limit adequately secured and has qualities and characteristics where a speculative element is not predominant Other securities approved by the Insurance No limit Commissioner Provisions and Capital 59. Non life insurers have to hold unearned premium provisions subject to regulated minima and claims provisions that include allowance for both reported and unreported claims. A required minimum of 40% of written premium applies although insurers can hold higher amounts should they feel it is justified17. Provision for claims that are incurred but not reported are largely able to be determined at reporting dates as, due to the strong orientation to property risks, most claims are reported by the date of finalization of accounts even if they were not reported at the balance date. These provisions are subject to supervisory review as part of the on-site inspection process as well as external audit assessment. Table 19 shows that provisions 17 Refer Insurance Code sections 210 to 214. 24 have been strengthened over time and that insurers with a foreign link tend to have higher provisioning levels than domestic insurers. Table 19: Non Life Provisions to Premium Income 2004 2005 2006 2007 2008 - Domestic 2.66 2.81 2.86 2.45 3.92 - Foreign Domestically Incorporated 3.50 3.89 3.96 3.29 4.52 60. Life insurance provisions are subject to actuarial determination and a regulatory minimum using net premium methods and a maximum discount rate of six percent. This rate would appear to be high for new business given current investment rates available in the market but needs to be assessed against the in force stock of both assets and liabilities and considering the nature of the valuation of assets. Table 14 sets out the running yield trend and it is notable that the rate for life insurers remains above this level. That said, as new investment rates tend to be lower, the rate would be inappropriate for new insurers in the current environment. For existing insurers, the rate would be more appropriate provided that the margin between market and book values is adequate as a result of the increase in fixed interest valuation from reduced interest rates since purchase. 61. A new insurance sector minimum capital rule using a risk based approach has been introduced and is being progressively phased in. The law and regulations provide for various controls on provisioning and capital. These rules were substantially reformed with the issue of Department Order No 27 of 2006 that increases the absolute minimum capital requirements and operates to elaborate the requirements of Section 194 of the Insurance Code. Insurance Memorandum Circulars Numbers 6 and 7-2006 that set out the calculation of risk based capital for the life and non life insurance businesses respectively. The transitional arrangements are set out in Table 20 and, in all cases, the insurer or reinsurer must have at least twice the minimum paid up capital as a minimum statutory “net worth” defined to include paid up capital, capital in excess of the par value, contingency surpluses, retained earnings, and revaluation increments (retained earnings and revaluation increments have to be approved by the Insurance Commissioner). 62. The Risk Based Capital approach is largely modeled on the North American systems. Insurance Memorandum Circulars Numbers 6 and 7-2006 set out the calculation of risk based capital for the Philippines Life and Non life insurance businesses respectively. These Circulars were issued under the general powers of Section 414 of the Insurance Code. The obligation of the “RBC Requirement” relates to the statutory net worth. The “RBC Requirement” is expressed in terms of the combination of risk factors with the North American approach of combining risks for diversification through the “square root” type formula. Circular Letter No 22-2007 defines admitted receivables for solvency purposes for non life companies. 63. Requirements for the absolute minimum nominal obligation on insurance companies differentiate between new and existing insurers and provide an incentive for existing local insurers with limited foreign ownership to avoid both accessing increased foreign participation or falling into custodianship. Department Order No 19-06 sets out the requirements for new companies or those seeking to reenter the market through rehabilitation 25 must have paid up capital of at least PHP 500 million for direct companies and PHP 1 billion for reinsurers with twice these amounts in net worth. This implies that only companies licensed prior to 2006 and continuing with less than 60% foreign equity will be able to hold lower levels of minimum capital. Companies that have these concessional levels loose this status if they are taken into custodianship and later rehabilitated. Implementation of the increase shown in Table 20 was deferred however through Circulars of the Insurance Commission. Circular 26-2008 reinforced that the increase due for 31 December 2007 would be required to be met for the December 2008 reporting. 64. Although at the time the reforms were introduced, preexisting levels of absolute minimum capital were low by international standards, when fully implemented, the absolute minimum requirements for conventional insurers will be relatively high. Table 20: Levels of Minimum Paid-up Capital (Transitional Arrangements) in PHP Millions Compliance Direct Life and Non Life Insurers Reinsurers Date Filipino 40% or less More than At least 60% December owned of foreign 40% but less foreign equity 31 of equity than 60% foreign equity 2006 50 100 150 250 375 2007 75 150 200 300 500 2008 100 200 250 350 625 2009 125 250 300 425 750 2010 175 300 350 500 1,000 2011 250 65. The RBC system also has a series of regulatory intervention levels as part of the circulars that involve progressively increased intervention starting from a 125% coverage ratio and increasing in severity until ultimate sanctions at a 35% coverage ratio (this is discussed further below and set out at Table 22). 66. In addition to the RBC obligation and the absolute minimum capital levels, a solvency margin regime is also applied based on the legislative requirements. As a result, all three measures are intended to monitor solvency and place prudent obligations on insurers. 67. Actual observance of the RBC and other solvency rules has been uneven and the implementation of the increases in Table 20 was delayed one year. 68. When considering the approach taken to MBAs, the system for absolute minimum capital creates a multi level set reflecting the complexity of market participants. For MBAs, there is a lower capital requirement set at PHP 12.5 million in 2006 and, for any subsequent new or rehabiliting institutions, at 25% of the level for new insurance companies. 69. Regulatory arrangements offered by the RBC regime are due for review, and the opportunity exists to harmonize and simplify the rule whilst reinforcing a transition to a more risk based supervisory approach. Both life and non life RBC circulars are subject to review after a three year period, coincident with the timing of the FSAP update missions. The review offers significant opportunities to improve and better harmonize the regulatory 26 arrangements. In particular, and to better move the system to meet the overall objectives of supervision as well as toward international standards, a package of proposals should be taken together. These proposals would enhance the credibility of the regime whilst reinforcing the value of a risk based rather than compliance orientation for both regulation and supervision. To illustrate the approach recommended, such a package of elements would have similar scope to the following and could involve:  To ensure that a relevant number of insurers were on the risk based rule rather than the absolute minimum, to keep the absolute minimum closer to international standards, to eliminate some disincentives that work against prudential objectives, and to simplify the system, the absolute minimum could be phased in according to the current proposals but that, in all cases, a maximum step up at the 250 PHP millions level for direct insurers and at 500 PHP millions for any and all insurers that wish to write inward reinsurance. This would imply that t;  Consistent with the approach taken for MBAs, a carve out minimum should be established for more restricted insurance licenses to reflect the existence of the smaller limited activity insurers and to ensure the smooth implementation of the increases in the minima for “full service” insurers. In particular, the carve out should be accompanied by license scope restrictions and other customized and proportionate regulatory requirements such as limitations on asset, reinsurance, and business mix and growth obligations. Full service licences could be subject to more risk based approaches and, therefore, less detailed but more sophisticated approaches to such issues.  The RBC parameters could be revisited against the actual volatility of experience in the Philippines market whilst, at the same time, bringing the intervention levels into line with the rule more closely – that is, to increase the intervention levels closer to 100% than 50% and to reduce the factors.  The solvency margin obligation could be harmonized with the RBC system so that one system applies; and  Most asset rules could be folded into the RBC regime with associated deletion of the admitted asset and investment portfolio rules although this could also require some changes to the Insurance Code18. 70. Such a comprehensive review would greatly improve the supervisory regime, regulatory arrangements, and also set the industry on a direction of sound development. 71. In summary, 18 In many RBC regimes, the admitted asset rules and other investment rules are solely resident in the RBC requirements. That is, the system requires capital to be allocated based on a risk charge up to the threshold but that any asset holding over the admissible level is required to be fully capitalized (backed by capital rather than policy holder liabilities) through a 100% charge. In this fashion, companies do not need to observe separate asset rules and can invest in inadmissible assets should they wish to do so with full capitalization. In the case of the Philippines, this would also facilitate a reduction in procedures and resources dedicated to investment approvals. 27  Profitability in the insurance sector has been low but remarkably stable; the outlook, however, is negative, potentially raising concerns about the soundness of the sector going forward. A. In the non life sector, the immediate impact of the season’s tropical storms in 2009 on insurers is expected to be heavier despite product optionality, and for some insurers, the performance of reinsurance will be important in maintaining profitability. B. In the non life sector, given the intense price competition and observed reductions in non-life insurance rates, profits have historically been maintained by supportive reinsurance terms, but the most recent year’s data shows this support winding back. C. In the life sector, profits have been maintained by investments made some years ago at higher yields. Current yields for new investments are below the rate factored into product prices and the regulated liability valuation requirements for conventional insurance, and are therefore not adequate to sustain profitability of new business or fully observe IAIS principles for liability valuation.  Unless supportive reinsurance terms are restored, something that should not be prudently relied upon to occur, then profitability in the non life sector will be squeezed.  Insurance sector assets are invested consistent with the liability profile under a rule based system. It would be useful to move to a more risk based approach but only in a manner that is coordinated with revision to capital requirements so that the risk based capital can deliver the prudential controls currently provided through the rule based approach. The rule based system ensures a conservative asset profile but limits several investment opportunities and places a heavy compliance burden on insurers and the supervisory resources. As a result, the review of the risk based capital regime could include a harmonization with investment rules that could reduce the reliance on compliance oriented investment processes over time.  Reduced investment rates for new cash flows also suggest that there is a need to review and update the minimum valuation standards for life insurance liabilities19.  A coordinated suite of reforms to the capital and solvency regime would be sensible in line with the planned review of the system. 19 At the same time, the valuation approach should be harmonized with International Accounting Standards. 28 Specific Focus on Access to Insurance Products 72. With a high proportion of the population living in relative poverty20, issues of access to financial services including insurance have been high on the agenda for policymakers . Microinsurance has been growing particularly following the introduction of a National Microfinance Strategy in 1997. In that period, the number of clients of Micro Finance Institutions (MFIs) has grown from less than 500,000 to more than 3.6 million21. 73. MFI growth has been a key driver in the growth of MicroInsurance. MFI growth has increased the awareness and delivery of services particularly through the provision of life insurance protection against lending activities. Increasingly, products and services have expanded to provide coverage on the lives of other family members of the borrower, and some micropensions. 74. Many of the conditions for the success of microinsurance exist in the Philippines. The synthesis of good practice guidelines published under the auspices of the Microinsurance Network and the IAIS suggested a range of important conditions for the development of access to insuance services for the poor. In the case of the Philippines, many of these conditions are present and are the subject of developments. The existence of a national awareness of access concerns and official initiatives to advance the issue is a positive element as is the existence of an active MFI sector. The Insurance Commission’s special Micro insurance circular and distinct regulatory concessions with respect to capital are also recognizable elements. There is a developed payment system based on cell phone use. At the same time, high minimum premium levels for conventional life insurance at around 16 to 20 percent of average incomes excludes many customers from such products. (Table 20 sets out a summary showing how many of the guidelines are represented positively already in the Philippines). 75. The Insurance Commission issued a microinsurance oriented Circular 9 – 2006 that, among other things, :  Defines microinsurance products including premium and sum insured levels that are tied to the daily minimum wage rate for non-agricultural workers in Manila;  Provides for “microinsurance MBAs” with a more limited set of obligations provided that they have at least 3000 (originally 5000 members) and only provide MicroInsurance products.  Sets the guarantee fund obligation, equivalent to absolute minimum capital requirements in nature, at PHP 5 millions and obliges a transition to grow this fund by 5% of gross premium collections each year until they reach the level of 12.5% of that applying to commercial insurance companies being normal full service MBA levels. 76. Microinsurance is provided both through formal and informal service delivery. Formal insurers registered under the Insurance Code can issue microinsurance products. These licensed insurers can be stock companies, cooperatives, mutual insurance companies, and Mutual Benefit Associations (MBAs). Including MBAs that exclusively issue microinsurance products. Informal services (not licensed to issue insurance products under the Insurance Code) are being provided 20 Around 44% of the population are estimated to live under $US2 per day and 14% below $US1 per day. 21 Source: Llanto, Geron and Almario (2008) 29 by other organizations including some schemes where they contend that they are not required to be licensed, their product falls outside the ambit of the Insurance Code, or operate despite the legal requirements at least for now22. 77. However, there are some elements of a completely inclusive system that appear to be absent or provide opportunities for the next steps. These elements include a limited facilitation for a range of providers to be engaged in the initiative to meet the needs of low income clients, the limitation of microinsurance oriented providers from bringing non life insurance products to the market, restrictions on bundling, and an absence of facilitation for a broad range of channels and providers – focusing instead in an MBA orientation for the carve out class. Table 21: Regulatory, Supervisory and Policy Conditions for Access to Insurance Guideline Philippines – Positive Evidence Philippines – Most Significant Opportunities 1: Take active steps to Specific leadership in the regulatory and Current project will advance. develop a supervisory areas are evidenced by microinsurance market. circulars, policy statements and initiatives 2: Adopt a policy on Existing policy evidenced in circulars Current project will advance. microinsurance as part addresses immediate issues that arose of the broader goal of when developed financial inclusion. 3: Define a Existing circulars have a clear definition. Some refinements to the definition are microinsurance product proposed under current project. category. 4: Tailor regulation to MBAs and Microinsurance MBAs have Further specific regulations could be the risk character of the differentiated minimum capital introduced for various aspects of microinsurance product requirements operations over time. category. 5: Allow Although permitted, the current regulation Current project will advance. microinsurance focuses on MBAs. A number of initiatives underwriting by are being pursued by insurers across the multiple entities. full range of institutional forms. 6: Provide a path for Graduated formalization approach is set More structured and active program could formalisation. out in circulars for microinsurance MBAs be developed, with corresponding to achieve “full MBA” status. timelines and pathway, for formalization Cooperatives also able to formalise to of small and informal providers. insurance cooperative status 7: Create a flexible Distribution through a range of innovative Opportunities to revisit bancassurance and regime for the channels is being advanced under other credit providers as channels. distribution of microinsurance programs including Possible functionally defined microinsurance. through relationships with other financial microinsurance distributor may also and non financial institutions. improve access. Available technology platforms such as cell based payment systems or remittances are significant but not utilized, accessible or well understood by insurers. 8: Facilitate the active Many initiatives are underway Coordinating and capturing the potential 22 Examples include damayan funds that provide an element of pooling and risk sharing for participants although their activities fall outside the definition of insurance, some organisations provide insurance type covers but call the charges something other than premiums, and the cooperatives that are licensed insurers previously provided the benefits counter to the insurance law and it is believed that there are still some cooperatives that continue in this way. There are also cases where insurance like benefits are provided and self insured by the providers. 30 selling of for cross fertilization. Functionally specific microinsurance. distribution regulations may assist. 9: Monitor market Insurance Commission takes a responsive Current activity is in line with developments and approach to Microinsurance as it does for recommendations and guidelines respond with all regulations. Insurance Commission has appropriate regulatory taken active role to advance current review adjustments. projects. 10: Use market capacity Limited structures currently available. Opportunity to review over time. to support supervision in low-risk areas. Source: Guidelines taken from Making insurance markets work for the poor: microinsurance policy, regulation and supervision. Commentary on the Philippines case has been developed as part of this review. 78. Crop and other agricultural risks are rarely insured. The government operated Philippine Crop Insurance Corporation (PCIC) has not been able to provide coverage to the majority of the potential market. Although the insurance products offered by the PCIC are subsidized, and the PCIC does not secure premium income sufficient to cover operating costs so is unprofitable, the uptake of the product is low. 79. Currently, MBAs and Microinsuance MBAs can only provide life insurance. This restriction is a result of the Insurance Code as noted in paragraph 22. In part, because the microinsurance oriented circular was designed to facilitate MBA participation in the market, it is focused on life insurance products and MBA related provision of these products and is not, as a result, as comprehensive with respect to other providers or other product types. 80. MBAs have been working more closely with MicroFinance Institutions leading to an orientation toward microcredit packaged products. Under the current settings, MBAs are naturally favored as producers of micro-insurance as their mutuality is consistent with that of most MFIs. Banks and rural banks in particular, could participate more fully as a potential additional reach to clients but this would require a revisiting of the bank distribution rules. 81. Although conventional insurers have released some microinsurance products and are utilizing MFI and other distribution channels to direct them to markets, MBAs have a taxation based advantage in the production and distribution of Micro insurance. Both the premium based taxes and the company profit taxes are waived for MBAs as they are for other mutual institutions. 82. The emphasis on MBAs in the market has been led by CARD MBA and RIMANSI who were instrumental in developing the current market in these areas. The Insurance Commission has supported the market trends without, at the same time, ruling out other options. This said, the restriction on non life products and services through MBAs imposes a constraint in the development of this model. RIMANSI was established in March 2005 and is strongly oriented toward supporting the development of the MBA approach with the objective of providing both affordable as well as comprehensive and quality products managed effectively. The MBA approach has been further popularized by the Center for Agriculture and Rural Development Mutual Benefit Association (CARD MBA). CARD MBA acts as a incubator for groups that do not have the size and resources to establish their own microinsurance MBA until they can build the operation. RIMANSI delivers services to MFIs and other interested organizations through two basic service packages in the Philippines and elsewhere. 31 83. Several donor funded initiatives are being progressed to further advance the prospects for Microinsurance. A draft regulatory framework is currently subject to consultation that includes strategies to increase participation of the private sector in the provision of microinsurance, establishing an “appropriate policy and regulatory environment”, formalizing existing informal insurance and insurance-like schemes, and promotion of financial literacy. 84. The draft framework:  widens the definition of microinsurance. It includes protection products that provide “relief against distress, misfortune and other contingent events” and “all forms of insurance, insurance-like and other similar activities”. The proposed definition incorporates products and services that collect payments in advance of the occurrence of contingent events, and provide guaranteed benefits. To be included as a microinsurance product premiums and benefits are limited based on the current daily minimum wage for non-agricultural workers in Metro Manila with premiums capped at five percent and benefits at 500 times the minimum wage. The premium related requirement is proposed to be after premium related taxes.  Stresses that premium collection should not be onerous for customers. In particular, the manner and frequency of collections implied in microinsurance contracts needs to coincide with the cash flows of clients.  Includes consumer protection and market conduct obligations. To ensure that clients understand their product, easily understood product provisions should be printed in English and/or Pilipino so as to ensure that a proper record exists. Life microinsurance products will have a 45 day grace period in the event of premium default and a restriction on a suicide limitation at return of premiums to one year from commencement or voluntary reinstatement. Non-life microinsurance products are proposed to require a minimum 45 day notice prior to expiry of the contract. Minimum standards for payment and settlement of claims are proposed at 10 working days from receipt of complete documents. Documentary requirements will be subject to regulation through circulars. Regulators will provide complaint handling.  Emphasizes simple requirements for all documentation. “Know your customer” rules and other identification documentation are to be simplified and clarified in regulatory circulars.  Seeks to include a broad range of entities as providers whilst ensuring that they are registered and licensed. The framework proposes including commercial life and non-life insurers, MBAs, Cooperative Insurance Societies, pre-need companies, and Health Maintenance Organizations. MBAs can only provide coverage to their members and their immediate family, and Cooperative Insurance Societies can only cover their cooperative member-owners, their members and their immediate family. Commercial insurers, pre-need companies, and HMOs can transact with the general public. Unlicensed providers are expected to formalize within a year through the formal market or, if they wish to secure a license in their own name, within two years of issuance of circulars envisaged under the draft strategy. It is intended that the circulars would be issued coincident with the final strategy. Microinsurance distribution will also be 32 restricted to licensed distributors although a special class of “microinsurance agent” will be introduced with less onerous ongoing examination requirements and restricted to representing one provider only. Microinsurance agents will not be able to be utilized by commercial insurers, pre-needs companies, or HMOs.  Envisages bundling of products. It is proposed that any of life, non-life, health and pre-needs benefits may be bundled provided that the relevant components are all microinsurance products as defined and that the “lead microinsurer” takes responsibilit y for the product and services.  Outlines expected regulatory requirements. The relevant regulatory authority is expected to issue prudential requirements including product approval, solvency and capital, investments and provisioning. A special regulatory “space” is anticipated including lower guarantee fund requirements for MBAs dedicated to microinsurance and all cooperative insurance societies23, expanded admitted assets for microinsurers when complying with solvency obligations, and an appropriate risk based capital. Existing governance obligations are expected to cover all microinsurance providers subject to appropriate design and proportionality considerations. The Insurance Commission can be expected to be the relevant authority for all providers except HMOs. 85. Additionally, the GTZ supported project is also addressing product development issues and will be providing needed support as a public good. Microinsure are doing work on an index based weather protection product to be sold through MFIs. 86. In summary,  The conditions for and activity in the Philippines with respect to improving access to insurance products is a positive and welcome development with most of the necessary conditions for success;  However, many of these initiatives are developed within defined and limited scope. As a result, the opportunity for improvement largely rests in a more broad scope approach to improve coordination and capture synergies and economies of scale in development.  The existing project being advanced by the Insurance Commission is an excellent step in this direction and the recommendations that are emerging have been reviewed and are supported by this analysis. ADDITIONAL COMMENTARY ON REGULATION AND SUPERVISION 87. The regulation of the insurance sector is established under several laws, the principal laws and regulations being: 23 The draft specifies that the figure for Cooperative Insurance Societies would be half that applying to domestic life insurance companies whereas it does not specify a quantity for other entities. 33  The Republic Act No 275 of 1949 that created the Insurance Commission as an office within the Ministry of Finance;  The Insurance Code 1974 created through Presidential Decree 612; and  Various Department Orders issued by the Department of Finance and Circulars and Letters issued by the Insurance Commission from time to time on specific issues. 88. The Insurance Code and its related regulatory instruments have been discussed above when considering specific aspects of the analysis. The Insurance Code also defines insurance activity, identifies the form of entities that can be authorized, and insurance contractual matters. Obligations to license insurers and the prohibition on carrying out insurance activities without a license are in line with international norms. 89. The detail of the licensing process and the annual renewal of licenses reflect the age of the regulatory arrangements and are consistent with minimum standards of international regulation but would benefit from updating as part of broader reviews. 90. Key reporting requirements centre around annual returns that must be submitted within four months of the end of the calendar year. Commercial insurers, through mutual agreement, exchange information so that each has access to market wide data with respect to that part of the sector however, there is no other public reporting of company by company data in a fashion that covers the whole market. 91. Overall, the Insurance Code and the Regulations and Circulars remain functional but are well out of date compared to what would be expected in a more contemporary insurance law. Particularly with respect to being able to deal with more severe financial stresses, it has material shortcomings. The Code has been used effectively as a policy instrument and continues to provide options but, increasingly, creative drafting is required or simply cannot be accommodated in full. The PIRA and the PLIA have been progressing a project to amend the insurance code so as to incorporate the many amendments from departmental orders and circular letters although this project does not materially introduce new elements. At the time of the mission, the matter was before the House of Representatives and had not been considered by the Senate. 92. The Insurance Commission has, as it’s stated mission, “to protect the interest and welfare of the insuring public and to develop and strengthen the insurance industry”. It’s vision is to “provide the opportunity for every Filipino to secure insurance protection and to observe practices at par with regional and global standards” by 2020. It conducts its supervision through processes of licensing, renewal of licenses, off site analysis and on site inspections, and the use of subsidiary regulatory powers through the development and issue of circulars. 93. The Insurance Commission has a respected record of developing regulatory requirements through circulars on a consultative basis with the industry. 94. The Insurance Commission has considerable autonomy in practice but lacks the independence and standing anticipated by the International Association of Insurance Supervisors (IAIS) Insurance Core Principles (ICPs). The Insurance Commissioner and 34 Deputy Insurance Commissioner are appointed by the President and serve at the pleasure of the President. The Insurance Commission is a government agency under the Department of Finance and is funded by annual budget allocations. Staff are employed under the same rules as other public servants and at rates of remuneration well below industry counterparts. Applying more general public service rules has limited the recruitment of staff and reduced numbers significantly. The hire of consultants in emergency situations is expected to be subject to rules that would delay effective deployment. Staff are not provided with legal protections anticipated under ICPs although the practice is that, if staff find themselves in receipt of an action against them relating to their duties then they are represented by the government solicitors. The effect of staffing limitations has been that the commission is staffed with a small cadre of committed employees who see their career connected with prudential supervision of the sector rather than a wider public service career orientation. Overarching government regulations impose strict time limits on decision making including a requirement to make decisions on “complex decisions” within 10 days. 95. The main supervisory approach is compliance oriented although the regulatory settings are increasingly risk based and have important elements of proportionality. Insurance regulation has become increasingly risk based particularly following the development of RBC. In addition, variable and proportionate regulations for MBAs, particularly microinsurance MBAs, compared to full service insurers, is an example of a proportionate and risk based approach. At the same time, supervision remains largely compliance oriented with the main focus of financial surveillance oriented to the compliance with the RBC rules for capital and net worth, and the more recent addition of governance obligations. 96. On site inspections are conducted rigorously and consistent with a compliance oriented approach. Limitations of resources mean that the Insurance Commission achieves a two year cycle for most commercial insurers (less frequently for the GSIS), and the usual period of examination is of the order of 20 days for a smaller insurer and 30 or more days for a larger insurer. Inspection work does not rely on the work of external audits and, instead, is replicative of it in part. 97. External auditors are approved as fit and proper more generally rather than on a company by company basis. As a result, it is possible that the approval would not address the issue where an approved auditor could be subject to the limitations of too great a burden in terms of the number of entities that they are expected to cover. 98. The Insurance Commission also carries forward its responsibilities under public assistance and claims adjudication regimes. Rules and procedures for this function were issued through Circular No 2-1991 which includes a jurisdictional limit for claim adjudication of PHP 100,000; a figure that has not been amended since, a schedule of application fees, and other procedural matters of what is an enforceable quasi-judicial process. In 2008, the commission received 921 claims, complaints or queries to the public assistance and information division, over half of which related to non life insurance lines. Additionally, close to 20% of the matters dealt with related to institutions where the Commission does not have oversight. 99. Staffing within the Insurance Commission has fallen significantly and is now at minimal levels to support current processes. Being subject to public service terms and conditions, salaries are constrained and access to additional resources has been limited. With the allocation of the 35 pre-needs oversight to the commission, it presents an opportunity to address and revisit staffing levels, capacities and the allocation of resources to various key functions. 100. Corporate governance in the insurance sector has been reinforced after recently implemented reforms. The Insurance Commission introduced a new set of obligations in the Circular Letter 21-2009 including a “scorecard” reporting regime that is then subject to review through the usual on and off site inspection processes24. The MTPDP 2004-10 of the Government and the CAS recognize that “weak governance has long been recognized as a key constraint to sustained growth and poverty reduction in the Philippines”25. Pre-needs supervision 101. Prior to the previous FSAP, some pre-needs organizations had failed to deliver on promises. In particular, where education funding plans were offered, reforms in the education sector led to an increase in the cost of tuition. At the same time, product pricing was based on actuarial cost estimates that included high discount rates or did not have actuarial control. Despite not being regulated under the insurance code, the experience has caused some credibility for the insurance sector in the minds of consumers and, still, there are some potential consumers who consider the failure of these insurance like promises to imply that insurance products more generally might be of uncertain quality26. 102. The regulatory arrangement for the pre-needs companies has been subject to review and change. The previous FSAP recommended that these organizations be brought under the authority of the Insurance Commission. This process has proceeded and, at the time of the mission, was close to completion. The framework for resolution of problem insurers 103. Intervention powers focus on a ladder of intervention and the powers to take custody of insurers under the Insurance Code. Under the Insurance Code, the Commissioner can place insurers under custodianship, and from there receivership and liquidation may follow or the insurer may be rehabilitated27. The statutory trigger for custody and receivership is expressed as “upon examination or other evidence, … the condition of any insurance company doing business in the Philippines is one of insolvency, or that its continuance in business would be hazardous to its policyholders and creditors,” and “"Insolvency" shall mean the inability of an insurance company to pay its lawful obligations as they fall due in the usual and ordinary course of business as may be shown by its failure to maintain the margin of solvency required”. These conditions are, as is the case in most jurisdictions, potentially open to disputes and be subject to action against the decisions of the Commissioner through injunction or restraint although, to date, the experience is that courts are strongly oriented to and guided by the view of the commissioner. The mission is advised that it is not possible for a licensed insurer to be placed into liquidation or wound up except by the commissioner so insurers seeking this course for more commercial reasons have to do so with the commissioner’s agreement. 24 The first scorecards were required to be submitted in August 2009 covering the 2008 year of operations. 25 CAS para 8 page 2. 26 Interviews during the mission confirmed this concern as did focus group interviews during the development of the microinsurance case study (Llanto, G., Geron, P., and Almario, J., (2008)) 27 Refer Sections 249 to 251 of the Insurance Code 36 104. Supervisory intervention based on the level of the RBC ratio in both life and non life cases is identical and is progressive as set out in Table 22. Aside from maintaining an RBC Ratio of at least 100%, non life insurers are also required to pass a “trend test” (refer II.A.2 of the Insurance Memorandum Circular Numbers 6 and 7-2006). Noting that RBC is a different calculation to the “margin of solvency” then it is instructive to note that the initial levels appear to be enforced under more general rule making powers. Table 22: Ladder of Regulatory Intervention RBC ratio less than Less than 125% but Trend test level where, if the linear extrapolation of the RBC Ratio ahead one year greater than or equal shows a ratio less than 100% then also a company action level response. to 100% Less than 100% but Company Action level where company submits an RBC Plan within 45 days and is greater than or equal responsible for implementing the plan to 75% Less than 75% but Regulatory Action level where Insurance Commission has authority to examine the greater than or equal company and issue “Corrective Orders”. Note that Regulatory Action also occurs if to 50% RBC Plans are rejected by the Insurance Commission, or the company advises the Commission that it has failed to adhere to the Plan. Less than 50% but Authorized Control level where Insurance Commission can, if it determines that it is greater than or equal appropriate, take control of the insurer under section 247 of the Insurance Code 28. to 35% Less than 35% Mandatory control of the insurer taken by the Insurance Commission under section 247 of the Insurance Code, the RBC Ratio being a sufficient event for action under section 247 of itself. 105. There is a security fund under the Insurance Code that operates as a policyholder protection scheme. These funds are wholly available support the claims under insurance contracts and are fungible across companies subject to the limitation that separate accounts are maintained for life and non life insurance. The respective share of each insurer in the security fund remains an asset of the insurer and investment earnings on the fund are provided to the insurer. The manner that these funds would be used, especially how they may be allocated between competing claims from various insured parties in a situation where the amount is insufficient to ensure all claims would be paid in full, is not specified in the Insurance Code29. 106. Insurers are required to place 25 percent of the minimum paid up capital invested in government securities and on deposit with the Insurance Commission. This fund can be 28 Section. 247: “If the Commissioner is of the opinion upon examination of other evidence that any domestic or foreign insurance company is in an unsound condition, or that it has failed to comply with the provisions of law or regulations obligatory upon it, or that its condition or method of business is such as to render its proceedings hazardous to the public or to its policyholders, or that its paid-up capital stock, in the case of a domestic stock company, or its available cash assets, in the case of a domestic mutual company, or its security deposits, in the case of a foreign company, is impaired or deficient, or that the margin of solvency required of such company is deficient, the Commissioner is authorized to suspend or revoke all certificates of authority granted to such insurance company, its officers and agents, and no new business shall thereafter be done by such company or for such company by its agent in the Philippines while such suspension, revocation or disability continues or until its authority to do business is restored by the Commissioner. Before restoring such authority, the Commissioner shall require the company concerned to submit to him a business plan showing the company's estimated receipts and disbursements, as well as the basis therefore, for the next succeeding three years. (As amended by Presidential Decree No. 1455).” 29 Refer Insurance Code Chapter V (sections 365 to 372). As at December 37 applied to meet shortfalls in claim obligations with respect to each particular insurer and is not fungible across the industry30. 107. The numbers of insurers involved in custodianship and rehabilitation and their names are reported in the annual report of the Insurance Commission advancing both the credibility and transparency of the situation of insurers under the various categories. Table 23: Numbers of Insurers under various states of Resolution 2004 2005 2006 2007 2008 Under Liquidation 3 4 12 18 18 Under Conservatorship 5 10 7 2 2 Under Receivership 1 3 2 2 2 108. Domestic insurers have an additional incentive to avoid conservatorship as they would give up their concessional capital obligations if they were to go into such a state and have to be restored, no matter how briefly they were in such a state. 109. In summary:  The Insurance Code is reasonably comprehensive when considering the period when it was first written but is now outdated and in need of reform. In part, the reforms are required to facilitate a more risk based approach to regulation and supervision and, in part, the reforms should take the opportunity to facilitate emerging changes in market structure and overall development.  Regulatory reforms are required to achieve the objective of international good practices. Strengthening insurance supervision toward international best practices and IAIS Standards and Codes requires a number of amendments to the Insurance Code. Licensing requirements could also be updated to new IAIS standards, financial reporting should be revisited particularly in concert with reforms to the liability and capital regimes, and the approach to utilizing audit and actuarial expertise can be revisited with a view to improving supervisory effectiveness and using scarce resources.  Reforms should also take the opportunity to ensure that a fuller clarity is brought to the regime for dealing with weak insurers, especially with respect to insolvency and windup. Such a reform should include consideration of the scope of coverage to all types of insurer and to whether or not an arrangement for some policyholder protection scheme should be considered. Additionally, the less clear aspects of the current arrangements might be clarified. A fire drill may be appropriate as a tool to examine the processes.  Regulatory reforms should also include provisions to provide the Commission with a broader set of discretionary intervention tools so as to facilitate a move to a more risk oriented supervisory system. The current proposals will only go some way in this direction. 30 Refer Insurance Code Section 203 38  There are opportunities to advance a more robust and risk based supervisory approach, to improve consistency between various providers, and to facilitate the more reasonable treatment of small family based insurance companies. A more risk based supervisory approach can also include developing and implementing internal risk assessment processes, internal ratings, risk-focused interventions and targeted inspections within the Insurance Commission. Sector development can be expected from such an initiative delivered collaboratively with all providers. Currently, firms are more oriented to managing against the rules than against the risk.  The move of the pre-needs entities under the supervision of the Insurance Commission is a welcome development. As recommended in the previous FSAP, the move should enhance the supervision of this part of the insurance sector. Any transition requirements to bring the quality of operations into line will need to be short and the management of this process will have to be a near term priority for the Insurance Commission.  It would be useful, preferably with external assistance, for the Insurance Commission to conduct a detailed review of the wind-up and insolvency arrangements through such exercises as a “fire drill”. Such exercises will provide key insights into the functioning of the legal and operational processes and highlight areas where greater clarity is required, as well as providing a basis for input to the legislative reform agenda in this key area. Existing shortcomings include the lack of clarity in use of reserve funds.  As part of the review of RBC and related regulations, the intervention triggers should be revisited. THE OVERALL AGENDA 110. On this analysis, the insurance sector in the Philippines is small and the growth has been disappointing regardless of the interpretation of market statistics. 111. Opportunities for growth in the sector would appear to be wide ranging. Comparative size measures suggest that the sector should be aiming to double in size to be more consistent with comparator countries. This would enable it to better contribute to the wider financial sector, ensure appropriate risk management services to the community and real economy, and act as an effective institutional investor base should this be considered desirable by the government. 112. It is the conclusion of this review that the development of the sector is a significant challenge but not one that is going to be resolved by actions of a policy or regulatory nature alone. 113. Although no single initiative is likely to be sufficient to achieve a more desirable level of sector development, a coordinated suite of initiatives offers promise. These would include the following: 39  The high levels of taxation on insurance products may be reviewed as part of a comprehensive set of initiatives to encourage sector growth.  Advancing microinsurance initiatives would seem to be a significant opportunity. As noted below, the enhancement of distribution options would be important. In addition, particular consideration should be given to exempting microinsurance products from premium based taxes. Many of the target clients for microinsurance could be part of the informal sector and, as such, the purchase of a microinsurance product may well be the first and only time that they incur taxes. Given the levels of the premium based taxes, this could be a significant disincentive and lead to these clients opting to rely on government assistance rather than self provision.  Distribution expansion and improvement is key to growth. Currently, taxation arrangements provide a clear advantage to mutual and cooperative providers however, the existence of this advantage in the case of the large mutual insurer was not perceived or even a matter of great awareness to many market participants. This suggests that competition in the life sector is defined by target markets being distinct in the case of MBAs and driven by a conventional “prospecting” model for more conventional products. As a result, it is clear that competition in the life sector is driven by the ability to reach unserved clients rather than product or price competition at the point of sale. The conclusion is that development depends on developing effective ways to reach customers in the life sector. This includes a formalization of arrangements for non commercial banks to extend a bancassurance model, extensions of access through microinsurance initiatives, and improved access to remittance driven business opportunities. For non life business, price comparisons are more readily made and this means that severe price discounting strategies have been pursued.  The sale of insurance services to workers abroad might be an additional opportunity. The Philippines has been greatly advantaged from the remittance of funds from overseas workers. Facilitating direct payment of premiums through migrant support groups rather than through individual remittances to families and then redirected to insurers would be more effective however, this is undermined by requirements to have policies issued on signed applications in the Philippines. 114. The sector has five principle sources of vulnerability identified through this analysis:  The failure of the conventional insurance sector to resolve excessive competition, particularly in the non life sector, represents a prudential risk and results in a dead weight cost to the wider economy. Resolution of the issue would appear to require appropriate regulatory intervention31. Currently, the increase in the nominal minimum capital requirements is the key policy setting however, this may not yet have the impact that is intended because of an expectation from some market players that it remains open to negotiation in terms of implementation. 31 The potential actions that would be considered could include facilitating smaller insurers through regulations that reflect their activity and are proportionate along similar lines to the carve out that already exists for microinsurance. 40  Life insurance valuation standards will need to be revisited. There are several reasons why this would need to take place anyway including emerging international accounting standards that are moving to a more market based and economic valuation basis for both assets and liabilities. However the existing reserving approach is not in line with international standards and, particularly, the IAIS ICP expectation that liabilities can be considered “adequate” particularly for life insurers with significant non participating conventional business in force.  The financial support to the sector provided by international reinsurers should prudently be expected to reduce over time.  Lower investment returns reported against book values can be expected as historic investments mature, which will further pressure reported profitability in the sector.  Separately from the other policy objectives of the proposal, the transfer of the motor third party business to the GSIS would have serious financial consequences to the non-life industry and potentially undermine the viability of some players. 115. Some reform of the eventual proposed absolute minimum capital requirements could enhance sector development and reduce vulnerability. When fully implemented, the proposed requirements will be among the highest in the world. They also will maintain a disincentive for insurers to seek additional capital from international insurers – representing a prudential risk under the current system. An additional consequence of the current disincentive is to preclude local insurers from accessing available opportunities to enhance capacity in risk management and governance32. It would be useful to revisit to remove the distinction in favor of local ownership33. There may be scope to develop a carve out similar to that of microinsurance for some smaller insurers. Changes would also place more insurers on the risk based capital rule to the benefit that they would be more incentivized to manage to risk rather than rules. The RBC parameters could also be revisited as part of the current review to reduce the parameters and, at the same time, increase the thresholds for serious regulatory intervention from the current 50% and 35% levels. 116. It would be useful to revisit requirements for customer protection with respect to extensions especially those relating to floods and earthquakes. One option would be to ensure that such covers were provided as standard in all “comprehensive” property protection products. Another option would be to mandate the “opt out” approach in the interests of consumer protection. 117. The Insurance Code should be reformed. Efforts to finalize a revised insurance code should take the opportunity for modernization consistent with international trends. Many other procedural changes could be introduced to enhance efficiency. 32 The IAIS survey on corporate governance found that international firms have a positive influence on both the entities that they invest in and through their demonstration effect to the wider market on improved governance. 33 Purely as an illustration of what is proposed, a revised absolute capital requirement may be set at PHP 300 million for direct insurers and PHP 600 for the reinsurer uniformly. With the recommendation that some carve out be applied with a potential lower requirement (PHP 200 or less) then this would force more insurers onto the RBC formula reinforcing the relevance of managing to risk rather than rules. It would also be politically more feasible than the current scale thus reinforcing the ability to implement it in a timely manner. 41 118. To support reform initiatives, the Insurance Commission should receive additional resources and, to the extent possible, access further external grant support. Existing support from external sources has been accessed through the GTZ and ADB projects regarding microinsuance but the opportunity exists to take this model to other areas of interest. Existing resources at the Insurance Commission are able, intellectually, to advance initiatives but would benefit from external assistance so that they can be better leveraged and also to bring wider experiences and case studies to local considerations. 119. The move of pre-needs companies under the Insurance Commission should include supplementary resourcing. The deployment of these resources throughout the commission presents an opportunity to realign staffing. 120. Any financial issues that remain in the pre-needs sector are resolved in a manner that minimizes the potential reputational impact on the wider insurance sector. The pre-needs companies need to be subject to financial standards equivalent to those of the conventional insurance sector. If this causes any financial distress then it should be addressed soon after the insurance commission takes responsibility to avoid as much damage to the confidence in the wider insurance sector that the general public will have as possible. 121. More specifically, the heavy option-based structure in non life property might be revisited with a view to making some of the covers more specifically included rather than excluded. 122. The GSIS role and mandate has to be carefully considered particularly with respect to points where it competes with the private sector, where its monopolies are proposed to be expanded and also where they are currently maintained. The transparency of the organization needs to be considerably expanded in terms of public information that is at least if not ahead of and setting an example for the wider sector to develop. 42 References: Key Legislation and Regulatory Documents: The Insurance Code, Presidential Decree No 612 of 1974 Other: Beck, T. and I. Webb (2003) “Economic, Demographic, and Institutional Determinants of Life Insurance Consumption Across Countries”, World Bank Economic Review, Vol. 17; pp 51-88. Bester, H., Chamberlain, D., and Hougaard, L., (2008) “Making Insurance Markets Work for the Poor: Microinsurance Policy Regulation and Supervision – Evidence from Five Country Case Studies”, Finmark Trust available at http://www.finmark.org.za/ Enz, R. (2000) “The S-curve Relationship Between Per-Capita Income and Insurance Penetration”, Geneva Papers on Risk and Insurance, Vol. 25; pp 396-406. IAIS (2003), Insurance Core Principles and Methodology, available at the IAIS web site www.iaisweb.org IAIS (2009), Survey report of corporate governance, available at the IAIS web site www.iaisweb.org Llanto, G., Geron, P., and Almario, J., (2008) “Making Insurance Markets Work for the Poor: Microinsurance Policy Regulation and Supervision – Philippines Case Study”, Finmark Trust available at http://www.finmark.org.za/documents/MIMW4P_Philippines.pdf Sigma (2007) “Bancassurance: emerging trends, opportunities and challenges”, Swiss Re Sigma Number 5/2007, available at http://www.swissre.com/resources/124cd1804734b45b91c5f900983c6f71- sigma_5_2007_e.pdf Thorburn, C., (2008) “Insurers: Too Many, Too Few, or “Just Right”? Initial Observations on a Cross-Country Dataset of Concentration and Competition Measures”, World Bank Policy Research Working Paper 4578. Churchill, C., editor (2006) Protecting the poor: A microinsurance compendium, ILO 43 d:\fsap\2009 philippines\insurance technical note\insurance tn v1.3 2009 11 06.docx