Russia laid bare

Russia has made a buoyant recovery after its financial crisis a decade ago, and could provide a number of opportunities for international insurers. However, this young market, already saturated by domestic companies, requires careful planning to ensure a prudent outcome, writes Alwynne Gwilt

Almost A decade on from the financial crisis that nearly ruined Russia's economy, the country is on a fast-track to becoming one of the strongest emerging markets in the world. With a rising middle class and a reasonable 6% unemployment rate, the country is poised for a massive uptake in insurance products, according to various parties involved in the region. One recent Lloyd's report states the country's insurance market could double to £41bn per annum in just two years.

However, there are some obstacles to foreign entrants as well as currently too many companies for the market to handle, even after massive consolidation. In spite of this an ocean of opportunities remain for those willing to take the plunge.

"Russia has an economy that is growing enormously," says Keith Parker, managing director of Oslo Marine Group, which co-authored the Lloyd's report on Russia. "If you compare 2007 to 2006, the number of cars imported into Russia increased by 70%. When you've got that kind of growth the ramifications for insurance are enormous."

In late 1998 Russia's economy suffered a major downturn that saw its financial markets collapse. As a result of world commodity prices sinking, Russia's slick black oil and gas-driven economy turned into a red sea of disasters - and the insurance market followed suit in a crash of its own. But, slowly, Russia began to rebuild itself. And like any country depending on exports, the win-lose battle suddenly started to improve. With oil prices skyrocketing to a new all-time high of close to $105 (£52.6) per barrel this month, it seems likely the country will stay in the black. "It is impossible to think of any event that might cause a similar fall in country's insurance market," says Nikolay Galushin, deputy chief executive officer for corporate development of Ingosstrakh, one of the country's largest domestic insurance companies.

Through difficulties

But many major foreign insurance companies had caught on long before the market started to become profitable. Those who stuck it out since the 1998 crisis are now well positioned to take advantage of the growing market. "Foreign insurers that decided against entering during the last 10 years are now actively looking for opportunities," says Leonid Zubarev, head of insurance for Central and Eastern Europe at law firm CMS Cameron McKenna, who added it is conceivable that one or two new deals could be announced later this year.

There are 53 insurance companies with foreign capital, he says; those already with a foothold include Zurich, Swiss Re, AIG and Allianz. Royal and Sun Alliance also seems poised to enter, saying only: "We are undertaking a joint venture in Eastern Europe and are planning to start business in Russia, but nothing will happen until later in the year."

But even the companies considered giants on UK soil will have to face stiff competition from the hundreds of domestic Russian insurance companies, although the numbers have decreased in recent years: from more than 2500 a few years ago to less than 1000 today. This is mainly due to the stricter regulations phased in over the past year on minimum capital requirements for companies. But, Mr Galushin says: "the top 100 companies collect 85% of the total premium, while the top 50 companies account for 70%". He continues: "This indicates that there is an excessive number of insurance companies on the market and mergers and acquisitions would only make a difference to the first hundred companies."

So even if a foreign company did decide to throw in its hat, a lot of work would still be needed. Mr Parker comments that AIG may be a major player on the world stage, but it entered Russian market at around number 40; so still has some way to go if it wants to get into the top 10.

As opportunities abound for insurance companies, so are there openings for loss adjusters and law firms that counsel foreign entities on how to enter the market. Walter Bartholomes, regional manager for New Europe at Crawford, says as a loss adjuster the company is putting its efforts behind development. "Crawford has re-named this region the 'New Europe' to reflect its importance because we feel we are entering a new world in Central and Eastern Europe and Russia," he says.

But there is still a long way to go in what is a very immature market, a key starting point for any insurer to understand. "We had a lot of specialists go in before and something I can advise to other market entrants is make sure you have the experts who know the market, do a proper market analysis for the business strategy you want to apply, and plan it very carefully," says Andreas Wania, Ace's country manager for Russia.

Part of understanding the Russian market is acknowledging the lack of public awareness of insurance - for example, it has only been about four years since mandatory motor insurance was brought in. Swiss Re, which has been in the Russian marketplace since 1990 and now works with many of the 25 biggest property and engineering companies, believes there is still room for insurers to grow in Russia because few people use insurance to the extent seen in the UK.

Petra Fleck, Swiss Re's head of client management in Central and Eastern Europe, for example, believes there are about 80% of properties without insurance. "The issue of liability is not something that everybody understands in Russia. "There are still a lot of people who are driving without motor liability insurance, although this is an obligatory line of business", she says. That, in turn, effects how people deal with liability. "The compensation culture is far behind anywhere in the West," says Andrew Tobin, a senior associate at Clyde and Company law. But that should be expected in a market that is still relatively fresh, adds Mr Parker: "Lloyd's is more than 300 years old. You cannot expect the Russian market to get there in 15."

But with an immature market comes data issues such as limited information, which can make underwriting trickier to negotiate. One new advantage is the implementation of the Federal Supervision for Insurance Services, or FSSN in its Russian abbreviation.

Building the future

"It is now putting in place the building blocks for the insurance market," explains Mr Parker. Part of that is making sure that underwriting regulations become more stringent, since past issues have included poor data collection. The FSSN will now require regular reporting, but if companies are only just starting to keep data, there is no way access historical records. "You can't recreate history, so it will take a few years to build up an accurate database," he adds.

In addition there still needs to be a lot of development in broking, where there are still restrictions placed on foreign brokers wanting to enter the market. Currently, direct business can only be placed by local brokers, if an insurance broker is not domiciled in Russia it can only place reinsurance business with local brokers. Companies have two choices, explains Mr Tobin. Firstly, a company can establish a representative office to act as a shop window for the business it takes on, which can then be written back in Europe. But companies should be aware of the strict compliances: there can be no underwriting at the representative office and no claims can be paid through it.

The second option is to buy into a Russian insurance company. Zurich has done the latter with the acquisition of Nasta in 2007 and rebranded the company to Zurich Retail last December. Its head office in Moscow now employs more than 800 people. "We wanted to have a starting point, a real footprint," explains Lutz Bauer, chief executive officer of Zurich's Central and Eastern Europe business. "A representative office will be always recognisable as a small subsidiary and wouldn't have had the same impact." There is also general agreement that the amount of foreign representation will likely shift the closer that Russia gets to entry in the World Trade Organisation.

Another difficulty lies simply in Russia's workforce: there are not enough people to fuel the growth engine. With such a low unemployment rate "trained and educated people are already becoming a shortage", says Mr Bauer. On the legal side where insurance cases are still quite rare, Mr Tobin says a similar trend is occurring. "There's a skills shortage in the industry because the market has grown so quickly. There's simply no way these people can all be educated," he says. Motor insurance cases, for instance, are not something the courts have had to deal with previously and, as such, "there's a dramatic learning curve". But, he adds, that simply means there is opportunity for growth and education.

The Russian political climate is another area that may impact non-domestic insurers, and some companies could view the recently strained relations between England and Russia as a market turn off; a recent report by Atradius found political influences and corruption was a major concern for 30% of people considering entering the area. Although many experts are hesitant to comment on politics, Mr Parker is more upbeat: "Business is business and politics is politics; insurance is no different."

Next big thing

Although much focus of late has been on penetrating places like India and China, Mr Parker says Russia has more going for it. "If you were looking at China, while it's huge as a country, the actual income per person is tiny - whereas Russia is a multiple of that. So if you were going to sell insurance to people based solely on the gross domestic product per person, you'd go with Russia over China," he says.

Going forward, companies look likely to start focusing on the non-life side - where insurance penetration is still very low - according to Mr Wania. Many personal lines are only just being embraced by the growing middle class who are open to talking about insurance. "That's happened in a dramatic fashion," says Mr Bauer. But, this also stems from systemic changes. In order to get a mortgage today, the process is similar to the UK: people are made to get insurance as a part of the loan approval. This will help increase the public perception of insurance, adds Mr Bauer.

It seems there are few worries about risk in the Russian market. Mr Wania can only think of one area that could cause concern: the under-capitalisation of some Russian companies that may not be conducting proper forecasting, choosing to build up reserves and profitability instead of growing the book. "If some of these companies run into trouble it would have an effect because the insurance industry is dominated by the top 10 companies," he says, but adds even this possibility is low risk.

As the regulations change and laws reshape how the courts deal with the first personal liability cases or directors' and officers' issues, of which there has only been a single civil case to date proving liability, those wanting to get into the market will have to act quickly to maximise the later effects on profitability. "It's still the case that many large risks seem to remain uninsured. But that's all going to change," says Mr Tobin.

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