For the three Baltic states of Lithuania, Latvia and Estonia, accession to the European Union on 1 May this year is expected to reinforce - not threaten - their 'financial tiger' status. Jeremy Golden reports
According to a report by the European Commission, the three Baltic states of Lithuania, Latvia and Estonia have small, open and functioning economies that will be able to cope with the competitive pressures and market forces within the enlarged European Union. Their status as 'financial tigers', with 5.5% to 6.5% growth in real gross domestic product over the past five years, sits well above the Western European average. The report concludes that a free and open trade system has been the key to strong economic performance - with Latvia the most dynamic of the three.
The same confidence is broadly shared by the local non-life-insurance industry. This sector has performed solidly rather than spectacularly for many years. As perceived by other financial services providers, the transition to the EU is regarded as a springboard from which insurers and brokers can raise consumer awareness and appreciation for insurance.
Currently, non-life and life insurance penetration rates remain low, albeit rising rapidly for general policies.
Legislation in line
One important outcome of accession has been to steadily bring insurance legislation in line with other EU countries. This is particularly beneficial to Lithuania - the largest market in the Baltic region based on non-life premiums sold. Asta Liepiene, assurance and advisory services senior manager at Pricewaterhouse Coopers, explains: "It is difficult to state categorically that Lithuanian non-life insurance companies are as financially stable as their Western European counterparts," adding that the vast majority of Lithuanian insurance companies are young businesses that were established only after the restoration of Lithuanian independence in 1990.
"In the early days - for some of the owners of now bankrupt insurance companies - insurance was seen as an easy way to collect cash from people and use it as they wished. This led, of course, to the bankruptcies of several insurance companies and damaged the image of the insurance business in society, but also contributed to the understanding that regulation should be strengthened."
She explains that the majority of insurance companies currently operating in Lithuania are owned by Western European companies. "And this has definitely had a major impact on the implementation of risk management procedures, which contributes to financial stability."
Ms Liepiene says the Insurance Supervisory Commission has tried to follow the Danish model and style of regulation - a consequence of the traditionally close co-operation between the Lithuanian and Danish regulatory authorities.
"The ISC has shown itself to be very eager and strict in solving minor technical issues, but the system is still relatively new and it is not clear how it would act in the event of a major problem. The one area in which insurance buyers would definitely like to see the authorities act more aggressively is in sanctioning companies for ungrounded non-payment of claims," says Ms Liepiene.
In the Lithuanian market, compulsory motor vehicle liability insurance, which only came into force in April 2002, is the largest class, representing around one-third of total premiums in 2003.
Premiums fell steeply by 7% between 2002 and 2003, while claims shot up by more than 70% during the same two years, representing 33.6% of premiums received in 2003. The decline can mainly be attributed to overcapacity in that there are 11 non-life companies that were practising aggressive price cutting in an attempt to boost market share.
However, in the first five months of this year, compared to the same period a year ago, premium sales have increased almost fourfold, according to preliminary data released by the ISC. This can be attributed to the new EU-compliant law that took effect on 1 May, which has substantially increased the amount of compulsory motor insurance cover required and has, in turn, raised premium levels.
The same trend is also apparent in Latvia and Estonia. As Latvian Insurance Association vice-president for non-life insurance Janis Abasins says: "The rapid growth was in anticipation of 1 May. The drivers were buying long-term agreements of third-party liability insurance very actively, which they would not have done in other circumstances".
The amount of cover for personal injury now stands at EUR500,000 (£335 780) per single road accident and EUR100,000 for damage to property per single road accident.
All three Baltic states belong to the Green Card system to facilitate the free movement of vehicles over borders and to protect the interests of the victims of foreign-registered vehicles. The system provides liability insurance whereby the loss caused by the vehicle of the insured is indemnified to the injured person in compliance with the rules of the country in which the accident took place.
The largest Lithuanian non-life insurer, Lietuvos Draudimas, has a 19% share of the market and an estimated 32% of compulsory motor liability premiums.
Lietuvos Draudimas, formerly a state monopoly, sold a 70% holding in the company to strategic investor Codan Insurance Denmark in 1999. Codan belongs to Royal and Sun Alliance and, although RSA recently divested the life and pensions arm of Codan, it has retained Codan's non-life operations and, therefore, ownership of Lietuvos Draudimas.
Ali Celebi, RSA's international relations manager responsible for the Baltic region, expresses his concern that many players in the Lithuanian market are setting premium rates not according to the increased risk levels but rather at an unrealistic level based on what people are willing to pay. He attributes this reckless trait partly to lack of experience - compulsory vehicle insurance is only two years old - and contrasts it to the far longer-established and realistic premium pricing structures in neighbouring Latvia and Estonia.
As the market leader, Mr Celebi says Lietuvos Draudimas is trying to persuade the competition and also the Lithuanian Motor Insurers' Bureau not to allow price dumping, which he believes could have serious long-term repercussions. Should the consequences of non-payment of liability claims by insurers arise, ultimately the obligation to settle claims would fall on the LMIB.
Edvardas Skupas, underwriting director of If Draudimas, Lithuania's fourth-largest non-life insurer, states that the main driver for personal lines is the burgeoning mortgage and leasing markets. "Insurance is still in the 'developmental stage' in Lithuania and most people are not particularly concerned about insuring their assets; however, they have to do this when taking out a mortgage on a house or leasing a car because the lending company insists on it." Mr Skupas' observation is reflected in the sharp rise in premium income growth for property and non-compulsory motor insurance over the past two years.
If Draudimas is owned by the Finnish financial services conglomerate, the Sampo Group, which also controls Estonia's largest non-life insurer, If Eesti Kindlustus. If Draudimas is focusing business development more strongly on commercial lines, and the company is newly established among the leading commercial property insurers in Lithuania, for which the majority of contracts are arranged through brokers.
Lack of common wordings
According to Mr Skupas, most commercial clients expect to get the best insurance deal via a broker, particularly because of the large number of players and the lack of common wordings, products or pricing systems used. These can create confusion in the minds of buyers.
"From the client's perspective, it could be rather difficult to know where to look for the best proposal without professional advice. It could also be difficult to compare and evaluate the quality of proposals from a number of insurers - hence the enduring need for brokers," he says.
Jeffrey Manners, chief executive officer of Marsh Central and Eastern Europe, says that traditionally manufacturers have operated either within local markets or predominantly within central Europe and Commonwealth of Independent States markets. "Western European markets were used but not predominantly, so companies were not keen to explore the risks in trading with these countries," he says. "Now many countries in the region are turning to EU member states with the EU legislation in place, which means that the significance of cross-border trade in terms of managing risks has increased dramatically."
For Lithuania, mainly a low-cost, heavy-industry manufacturing base requiring 'classic' insurance cover, the trading risks are not so apparent. For Estonia and Latvia, however, with lighter, middle-segment industries including food and beverages, textiles, IT and telecoms that are more export-orientated, Mr Manners anticipates a significant growth in demand for many liability classes.
"Manufacturers face four main areas of impact: product liability for obvious reasons; environmental liability because in almost every manufacturing process there is some waste; workplace health and safety because probably the most exposed industry to injuries at work is manufacturing; and directors' and officers', which is a change common to all sectors," says Mr Manners.
"The Baltic states industries, as generally low-cost producers, certainly need to consider new compliance requirements or it will erode their competitive advantage."
Marsh has been active in the region since the early 1990s at a time when its international clients began investing but Mr Manners says his client portfolio is by no means restricted to Western multinationals. Marsh is developing risk consultancy services in collaboration with locally owned manufacturers, especially in Latvia. This process is eased by the trend for companies to employ risk managers, not just insurance managers, to manage risk and make informed decisions.
Prior to the EU accession, Lloyd's business in Central and Eastern Europe was mainly limited to underwriting specialist reinsurance risks for local domestic carriers in the form of bankers blanket bonds; however, the EU accession in May opened up a number of markets in the region, including the three Baltic states, which allows Lloyd's syndicates the freedom to write as direct insurers for the first time.
Beazley has already accumulated significant experience during the past 10 years in underwriting international professional indemnity in central Europe for mainstream professional service providers such as lawyers, accountants and insurance brokers. Demand has been especially concentrated in Slovakia and the Czech Republic.
"EU accession has opened up the possibility of looking at a whole new client base," says Eddie Wattenbach, underwriter, speciality lines at Beazley. He highlights the EU Insurance Mediation Directive to which accession states must comply by 15 January 2005, as providing a very promising long-term growth opportunity to Beazley.
As we know from the UK, according to the Directive, insurance intermediaries must be covered by PI insurance for professional negligence and Mr Wattenbach believes local underwriters are unlikely to be able to satisfy the surge in demand. He reports that Beazley has already seen interest in its PI services from brokers in the region and this seems set to rise sharply as the EU compliance date gets nearer.
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