How to tackle capital flight challenge affecting the insurance industry

A CONFERENCE held on February 8 between capital markets and insurance firms was an initiative to tackle the capital challenge that afflicts the insurance industry’s ability to fully take advantage of the local content regulations.

Conventionally, an insurance company depends mostly on premiums paid in by clients and investment income as a cushion to cover any claims arising from the risks underwritten by the insurer.

Furthermore, insurance companies usually re-insure risks with re-insurance companies in order to limit their own exposure in line with capitalisation. The Tanzania Re-Insurance Company (Tan-Re) is the sole local re-insurance company in the country.

The Tanzania insurance sector is still at its infancy with a total asset base of 908.9bn/-. According to the latest industry performance report published by the Tanzania Insurance Regulatory Authority (TIRA) and covering the period ending September 3 0, 2018.

The value of the insurance industry’s total assets is approximately 0.78 per cent of Tanzania’s GDP and only 3 .0 percent of the country’s banking sector’s assets.

Compared to Kenya’s insurance industry assets which are 8.0per cent of Kenya’s GDP and 15per cent of the banking assets.

To put it into perspective, the total insurance sector’s assets are less than CRDB’s assets net of the bank’s loan book and all receivables.

According to TIRA’s annual report for the year 2017, insurance penetration in the economy (premiums as percentage of GDP) was 0.55 per cent.

Extraction activities require large amounts of financing for capital and operational expenditures on very expensive heavy machinery and sophisticated technology.

For instance, the cost of drilling a single gas well to the point of extraction costs roughly between 20million US dollar and 40 million US dollars.

There are known to be about 101 active onshore and offshore oil and gas wells in Tanzania which. By simple arithmetic it means a minimum total insurable interest valued at approximately 4.0 billion US dollars.

If the insurance industry was to fully absorb the risk involved only in drilling of these wells, leave alone extraction of gas, transportation and other operations, that is the magnitude it has to prepare for a worst case scenario.

This is only the case with oil and gas, while extraction involves mining of gold, iron, coal, steel, uranium and gemstones (including tanzanite and diamonds).

The industry has not had a good record of retaining its revenues. Gross premiums received for general insurance for the nine months up to September 2018, according to TIRA’s report for the period, was 449.3bn/- ($ 195.77mln) of which only 3.83 bn/-($ 1.67mln) or 0.85per cent of general insurance gross premiums related to oil & gas and there was no mention of any other extraction activity.

This implies that, other extraction activities, along with the rest of insurable risks in the oil & gas sector, are covered by foreign insurers. TIRA’s 2017 annual report shows that only two local insurers, Alliance and NIC, provide cover for extractive industries, specifically oil and gas.

A simple survey of the companies showed that the biggest challenges faced by insurers in covering extractive companies are inadequate capital and expertise.

To build capacity and create adequate expertise, insurers and stakeholders such as TIRA, Tanzania Insurance Brokers Association (TIBA) and the Association of Tanzania Insurers (ATI) have to come together and share experience and knowledge to capacitate underwriters.

Nigeria, having a similar local content policy, had insurers come together under the governing council of Nigeria Insurers Association and formed the Energy and Allied Risks Insurance Pool of Nigeria (EAIPN), As a body with the main task of creating manpower capacity and acquire technical expertise in the insurance of oil and gas related risks.

Ghana also formed Ghana Oil & Gas Insurance Pool (GOGIP), to deal with similar challenges following a similar local content policy on natural resources.

The capital market on the other hand comes in handy when facing the capital and financing challenges discussed so far. There are numerous ways that insurance firms can raise financing through capital markets.

One common way is by issuing shares to the public through an Initial Public Offering (IPO), or by arranging a private placement to specific selected investors and raise the required funds to reach adequate capitalization level and take in more risk from the extraction sector.

One of the major advantages of public listing of an insurance company is the increase in visibility where retail investors in the company are most likely to insure with the company.

The most convenient way of insurance companies to raise financing in the capital market is through issuance of Insurance Linked Securities (ILS), most notably catastrophe bonds.

A catastrophe bond is a risk linked security which transfers a specific set of risks from the issuer/sponsor of the bond to investors.

The bond is issued by an insurance company just like any conventional corporate bond, usually through a Special Purpose V ehicle (SPV ), formed by the insurance company.

Usually, an insurance company forms an SPV which issues the bond with a lucrative interest rate to cover for the associated risk to the public.

With that buffer, the insurance company covers a higher volume of risk than would otherwise bear. Bond covenants are specific that in case of occurrence of a specified triggering event/catastrophe that affects the insured party, the bond proceeds or capital, will be used to compensate the insured party at a partial or full expense of bondholders depending on the terms of the cover.

The SPV invests both the bond capital and insurance premiums to generate a return enough to honor enhanced interest obligations arising from the bond in case of nonoccurrence of the specified event/catastrophe.

The bond is usually for a medium term, often three to five years. Insurance linked securities are popular in developed markets being issued by large insurers and reinsurers such as Swiss Re, American International Group (AIG), Munich Re, Kilimanjaro Re Ltd and many more. The World Bank (WB), issued its first cat bond back in 2014 to cover natural hazards in sixteen Caribbean countries.

Although more often risks covered include hurricanes, earthquakes, cyclones and tsunamis, bond covenants of each particular bond clearly specifies the nature and magnitude of the trigger events for a particular issue, and these covenants can be adjusted to include risks/events associated with a particular area.

The advantage of structuring corporate finance through capital markets is the markets’ reach out and visibility to a wider network of global institutional investors and fund managers.

Dar es Salaam Stock Exchange (DSE), has recently been approved for full membership of the World Federation of Exchanges (WFE), and also put on a “Watch list” by FTSE Russell, a global indices operator firm based in London, for a possible upgrade to a Frontier Market status by September 2019, from the current Unclassified Market status.

Achievement of these milestones is expected to significantly raise the visibility of Tanzania’s capital market in the global investment arena. For insurance companies to raise capital through the capital market it means having access to global capital through this web of investors worldwide.

This assures transparency, sufficient availability of competitively priced funds as well as lower servicing costs as opposed to bilateral agreements.

Therefore, the capital markets and insurance industries stakeholders’ conference organised by Orbit Securities on the 8th February 2019 was an important and timely milestone for both sectors considering the complementary relationship between these sectors.

As of September 2018, 11 per cent of the insurance companies’ (63 3 .7bn/-) total investment was in equity securities, and, 8.6per cent of government Treasuries were held by insurance companies in the same period.

This shows that, a growing insurance sector means more investable funds into the capital market, and a growing capital market means a wider variety of financial instruments as investment destinations for insurance companies as well as more accessible capital.

V igilance and collaboration are essential from both sectors’ participants as well as regulators such as TIRA, Petroleum Upstream Regulatory Authority (PURA), and Capital Markets and Securities Authority (CMSA), Energy and Water Utilities Regulatory Authority (EWURA), in implementation of the Local Content Regulations and exploiting the potential they unveil to the domestic financial sector.

Since the Regulations cover a myriad of sectors, it is crucial that other initiatives are engaged to drive the banking sector as well as other cited sectors to exploit opportunities provided so as the economy can maximize potential benefits of natural resources lying underneath our feet. 

  • Imani Muhingo is a Market Analyst O rbit Securities Co. L td Mob: + 2 5 5 7 6 3 6 31 9 9 9 , Tel: + 2 5 5 2 2 2 1 1 1 7 5 8 imani@ orbit.co.tz, research@ orbit.co.tz

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