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. Last Updated: 07/27/2016

Huge Growth to Transform Insurance Industry

The insurance industry has been steadily growing, albeit from a low base, over the last few years -- but the pace of growth now looks set to accelerate strongly.

United Financial Group has recently produced a model to predict the size of the market going forward, and the forecast is for massive growth. The model, based on statistical analysis of the experience of 40 countries, predicts that by the year 2016 the Russian insurance industry will write over $70 billion in premiums per year -- slightly over half of which will be in the life insurance segment.

These figures are a far cry from last year's. In 2001, non-life insurance accounted for under $5 billion in premiums written, although the figures vary depending on how the insurance market as such is calculated. Most of this sum was collected by captive companies -- those belonging to financial-industrial groups -- for tax management purposes. Yet some was actually genuine insurance -- especially medical insurance for those companies' employees -- so there is no clear definition of what the market is or could be.

Life insurance sales in Russia at the moment are negligible, but nobody quite knows the size of this market either. The difficulty here is that the official life insurance returns of Russian insurance companies are grossly inflated by so called "short-term" life insurance. These premiums, possibly accounting for 99 percent of the total "life insurance" market in 2001, do not actually represent any insurance at all. Rather, they are a means used by many companies to avoid income taxes. There are several variations on these "gray" schemes, but the thematic idea is that companies take out short-term (typically, one- to five-year) life insurance policies for their employees and then pay out tax-exempt annuities from this policy instead of a salary. For the record, such gray schemes are likely to disappear next year due to changes to the Tax Code.

UFG recently released a detailed study on the insurance market. This report contains the assumption that about 1 percent of the life-insurance market is long-term life insurance -- whereby insured parties pay a certain amount of money per month over their working lives, and if they die before they retire then their loved ones receive a lump sum or annuity, or, if they live until they retire, then they receive a lump sum or an annuity for themselves. In a number of countries -- although not in Russia -- statistics on life insurance also include some types of accident and illness insurance.

This 1 percent figure is backed up by industry managers -- both those practising long-term and short-term life insurance. It has frequently been reported that the figure is between 7 percent and 10 percent, and these reports have tended to cite governmental sources, in particular, the Finance Ministry's Insurance Inspectorate. However, industry managers generally discount such figures; the main reason behind such assertions by the authorities probably lies in the desire to give the impression that they are having at least some success in enticing insurance companies to come out of the shadows, and that there is some substance to this potentially crucial leg of financial intermediation -- the means by which savings are turned into investment via companies providing financial services -- and savings of the population. Note that these governmental sources have not produced any documentary evidence to support their assertions -- and no statistics showing the difference in numbers or value between policies greater than or less than five years are published.

This means that while gray schemes accounted for nearly $5 billion in premiums written last year, the real life insurance market was perhaps $48 million, although some estimates put it at as little as $25 million.

This figure is paltry: Russians will spend about $3 billion on cellular phone calls this year.

So, what drivers will enable the insurance market to grow?

From $5Bln to $70Bln

The single biggest driver behind the life insurance industry's growth in particular will be the increase in incomes that will be accompanied by higher spending on non-essential goods, which together with the population's already high propensity to save will lead to an increasing need for organized savings.

Forecasts of nominal dollar increases in gross domestic product -- this figure should be somewhere in the region of $1.4 trillion in 2016 -- are based on two factors: real GDP growth together with the real appreciation of the ruble.

Russians save a lot of money, but most of it is kept tightly sewn in mattresses -- estimates of this volume are around $40 billion to $50 billion. The reasons for this are a deep mistrust of banks and other financial institutions following the collapse of pyramid schemes and many banks in the second half of the 1990s that wiped out the savings of probably hundreds of thousands (and criminals posing as insurance companies have also been involved); and the fact that a huge proportion of earnings are paid cash-in-hand and not declared to the state as a means of evading income and social taxes. People paid in this way are afraid to bank their earnings lest the tax authorities find out.

The advantages of life insurance as an alternative form of saving are that, first, Russians can entrust their savings to institutions that are far less likely to collapse than local banks, given that two of the largest insurers in the world already offer this service (American International Group and Allianz) and, secondly, the tax authorities currently show no interest in those people purchasing life insurance.

As for spending on non-life insurance, it is common sense -- and backed up by the country statistics we have examined -- that spending on this increases as a proportion of income as incomes rise.

A third major economic driver is the expected expansion in Russia's currently very depressed mortgages market. The current mortgage market is negligible. Once it takes off it will see an expansion in life and buildings insurance as required by lenders -- and efforts to develop this market are underway with the government intending to see a market for mortgage-backed securities emerge over the next few years.

Meanwhile, on the legislative front, pension reform, which is turning Russians into savers whether they like it or not, will in time whet their appetite for organized forms of savings.

This year has seen the introduction of a major leg in pension reform -- the funded (or "top-up") part of the state pension. Prior to this, the state pension was paid out of taxes, with no individually assigned and accrued contributions.

Now, all Russians whose salaries are paid legally pay 2 percent to 4 percent of their declared gross salary in top-up pension contributions labeled as their own. These funds are currently managed by the State Pension Fund, but people will have an option of moving them into private management from 2004 and they will be able to track the progress of these real savings.

The total value of this fund could be around $30 billion to $35 billion by 2012, when the first pension payments are made from them.

It is this factor that has persuaded UFG to pinpoint 2013 as the year when the life insurance catch-up effect can be expected to complete its course. The year 2013 will be the first occasion that the population will see savings actually working on a large scale and the fact that working citizens will see the payments sitting in the bank accounts of their pensioner parents and grandparents will provide a welcome boost to the industry toward the middle of the next decade.

A second important legislative driver will be the introduction of compulsory auto third-party liability insurance in July 2003. This will introduce most Russians to genuine insurance for the first time in their life and will provide insurance companies with client lists and other valuable marketing data.

The size of the auto TPL market will be a factor of the number of cars in circulation and the policy tariffs set by the State Duma. Premium payments in this market will be at least $600 million in 2003 and will then increase in proportion to the number of cars in circulation in Russia. However, the effect of the appearance of this market may well be far greater than its size.

First, most Russians simply do not know what insurance products are at present and what they are for. Hence, this market will help to introduce them to the concept of insurance products.

Secondly, it is often suggested that automotive insurance is not a profitable activity in the West -- and if the tariffs are so low that the Russian market is worth just $600 million in 2003 then the insurance companies are only expected to break even on this form of insurance anyway -- and that the real advantage to insurers of selling automotive insurance is that it provides them with client lists and cross-selling opportunities. Some insurers believe this too and consider the introduction of compulsory auto TPL to be the leading driver behind the expected growth in the market for both non-life and life products. However, views on this are mixed, given that there is little proven correlation in the West between short-term auto sales and long-term life.

Thirdly, the effect of the introduction of auto TPL will be the creation of networks, as it is a requirement under the new law that all companies offering auto TPL must offer it throughout the country via local outlets, and companies are thus forming national alliances in order to meet this requirement as only very few of them have presence in all localities.

These networks, together with the prospect of fairly large amounts of cash coming in, are likely to make insurance companies more attractive propositions for Western investors who are able to bring their own insurance expertise in order to better explain to the population what insurance is for and why they should buy it.

Finally, the steadily increasing bank deposit to GDP ratio represents Russians' rising confidence in their financial institutions. Russia's deposits to GDP ratio, a measure of financial literacy, has increased from 8.8 percent at the end of 1999 to 11.6 percent as at the end of July 2002 -- and this indicator is estimated to reach 19.4 percent in 2006. This indicates the increasing confidence of Russians in their financial institutions.

Of course, in the long run, bank deposit and life insurance volumes move from being positively correlated to acting as substitute goods -- as competing forms of savings -- but Russia is far from this stage at present.

Ilan Rubin is an insurance sector analyst with United Financial Group, Moscow.