By Gregory DL Morris
In June, Swiss Re hopes to become the latest global reinsurance firm to complete the year-long process of establishing a recognized local operation under the gradual deregulation of a Brazilian market that was once the monopoly of state-owned IRB. At about the same time, reinsurers, underwriters, brokers and insureds hope to get a clearer picture of the latest step in the regulatory evolution.
There have been critics who have said the reform process is either moving too slowly or too quickly. Two things upon which everyone agrees are that the long-term growth prospects for the entire insurance market in Brazil are compelling, but that the current market is soft.
Two years after the Brazilian reinsurance market was liberalized in 2008, a revised code was issued that further loosened restrictions. Now another change is on the horizon, two years from the first update in 2010, and again with the stated intention of further fostering a free market. But this time around there are some concerns that the four-year tinkering is not the clear-cut improvement that the two-year adjustment was.
As that drama begins to play out, it is business as usual for the companies that are active in the market. The 2008 opening created two categories of reinsurers: local firms had right of first refusal, and a mandated 60 percent share of the market; admitted companies were those foreign companies allowed into the reinsurance market, but limited to 60 percent of any coverage. The 2010 revision removed the right of first refusal for local firms, and reduced their mandate to 40 percent.
All along, it was possible for international firms to establish a local operator with full equality to indigenous locals. "We are still in the application process," said Rolf Steiner, regional head for Brazil and the Southern Cone for Swiss Re. "We have received prior approval from the regulators and are now in the final phase of the process.
"We understand those who question the progress," said Steiner, "but governments have the right to protect their industries, and to monitor cash flows and transfers. It is good for the reinsurance business if all transactions are clean and transparent."
Steiner is also confident that the reinsurance market in Brazil will be completely open at some point before too long. That said, he said that his firm could not wait for someday, even if someday were going to be soon. "It is poor speculation to try to guess. We see the next three or four years in Brazil as offering huge opportunities for our industry, especially for infrastructure projects. There is also a growing middle class that needs new coverage and greater capacity."
Brasilia, the capital, is offering advantages to global firms that are willing to bring capital to the market, and even greater advantages for certified local operators. "Near-term, this was the best way for us to proceed," said Steiner.
Hermes Marangos, an international insurance and reinsurance lawyer who heads the Latin American team for DAC Beachcroft, based in London, confirms that the partial liberalization has indeed brought capital into the country, but that the companies attracted by loosening of insurance regulation have found that tax and labor regimes are complex. "But a number of major players went in anyway," he said.
In recent weeks, Marangos reports, a new rule, Provisional Measure No. 564/2012, has been signed to support aviation, surety, construction all-risk and erection all-risk (CAR/EAR), areas that will come into play with Brazil's upcoming marquee events, the 2014 FIFA World Cup soccer and the 2016 Summer Olympics.
An $11 billion fund has materialized in connection with the measure, and some are concerned that this new fund will allow the government to act like an insurance agency, in effect, undercutting reforms.
Provisional measures are the most controversial kind of normative act in Brazilian legislation. They are an instrument with force of law that the president can enact in cases of urgency and necessity and comes into effect immediately, before the National Congress of Brazil votes on it, and remains in force for up to 120 days.
If Congress approves the provisional measure it becomes an actual law including any changes added by the legislative branch. The new measure has been billed as a further reform, a support for segments of the market where there may not be sufficient capital or capacity. But Marangos said that the market is concerned about the true purpose and nature of the new measure and the potential flexibility of its application with the effect that it may compete with the insurance market.
"We are way out front on this," he said. "We are still doing our own research on the true meaning of the law. But there are a lot of questions. The room is full of elephants, and no one is saying anything."
The fear, Marangos explains, is that major organizations, especially those lobbying the government, may be able to get CAR/EAR from the government. "It is not clear where all the payments into the fund originate from but the concern is how it will be used. Will it be a way to compete or in any way pressurize underwriters and reinsurance companies?"
"There is really nothing to stop the government from effectively turning the fund into the genesis of an insurance agency," said Marangos. He reports that the view of some is that the government wants offshore capital and capacity, but wants to minimize the profits that are made, or at least those profits that are repatriated out of Brazil.
"People were waiting for these big infrastructure projects, and now they may not gain very much from them. Even if the fund is never actually used effectively to compete with insurance or reinsurance companies, there may be an intended psychological effect to soften the market anyway."
Other sources did not comment directly on Provisional Measure 564, but one noted that the 2010 revisions were not made in consultation with industry. "We were all very surprised when they were issued," this source said.
Kurt Müller, chief executive officer of Munich Re Brasil, said that the reinsurance market in Brazil is not yet a totally open market. "There is a preference for local companies, and that is what the government wanted when it enacted the law to open the market. The worldwide re market is not entirely happy with that, but we knew from the start going in that would be the case."
Munich Re has completed the application process and is now a local operator. The global firm has had a presence in country for 30 years, and opened a formal representative office in Brazil 15 years ago.
Munich Re's history and position allows Müller to be sanguine. "After 70 years of monopoly, what we have now is a very competitive market. We never expected a smooth transition just one day to the next. The market has to establish itself, and this will continue to happen over the next few years. There have been some changes, some things that are not so nice, but we did not expect overnight success."
As evidence, Müller said that there were six accredited local companies when the first liberalization was enacted in 2008, and now there are twice as many. "Beyond that there are at least one hundred companies that have been registered as admitted to the country. All of the global and regional players are here."
Part of the reason for the grumbling about the pace of reform is that prize is so sweet. "What makes Brazil different is that it is the largest market in Latin America, twice the size of the next nearest market," Müller said. "That is both re and direct. The economy is booming and there are lots of infrastructure projects."
He estimates that the Brazilian reinsurance market is worth 5.6 billion reales ($3 billion), an increase of 55 percent from the 3.6 billion reales in 2008 at the time of first liberalization. Müller said that growth in the direct insurance market is somewhere around 20 percent per year.
That growth is not just due to the 2014 World Cup and the 2016 Olympics, Müller said. The expansion of the Brazilian economy is broad and deep, and goes beyond the megaprojects. There are roads and rail connections, urban renewal, schools and hospitals. Brazil is also blessed with a notable lack of natural catastrophes, Müller said. "They have no earthquakes and no hurricanes," he said.
Other Latin America insurance professionals note a relative lack of political risk as well. One contrasts the successes of oil and gas exploration and production, both for Petrobras and for international players, to the chilling effect that has followed Argentina's recent nationalization of its domestic oil company YPF.
Brazil is a traditional rival of both Argentina and Chile in continental economics. Since the re-emergence of democracy in Chile, that country has shot up the league tables in per capital affluence and built a reputation as a stable, profitable place to do business.
However, Chile has a relatively small population, and modest natural resources. Both Brazil and Argentina are known as rich in natural resources, but politically fraught.
Both were considered to be making progress on that front, with Brazil perhaps reforming more rapidly. With the YPF debacle, however, global capital is once again eschewing Buenos Aires.
Müller reports that Mexico, the second largest Latin American reinsurance market after Brazil, is totally open to international participation and competition, as is the much-smaller Chilean market. The Argentine market by comparison is highly regulated, he said.
Living With Boundaries
Beyond the new competitiveness and new capital that liberalization has brought the Brazilian reinsurance market, Müller said that new services and coverage have been introduced as well. "There are new products, not just new capacity," he said. "There is better service, and prices have been reduced. That soft cycle right now is a negative right now, but it is a cycle."
Müller said that the unhappiness comes from those who had hoped for a completely free and open market, which he does not anticipate happening any time soon. "We started with a reserve of 60 percent for local companies, and that was reduced to 40 percent. No further reductions are expected. Certainly the market will continue in its current form for some time."
He also said that some dissatisfaction comes from the restriction on transferring volume out of the country. "The government does not want capital removed from the country," he said. "They want it kept here. They want the gains to be used locally, for the benefit of Brazilians. So there is no flux capacity outside the country."
Another source of friction may be that the retail insurance market is perceived as more open. "At the end of the day, the retail market has had more competitiveness than the coinsurance side," said Paulo Mantovani, Brazil power and utility practice leader for Marsh Corretagem de Seguros based in Saġ Paulo. "Rates are expensive compared to the U.S. retail market."
On the reinsurance side, Mantovani said that, "the government has established rules on any company working in the country that make it very difficult to obtain large capacity. There are a lot of companies, but the locals must have a lot of money in place. The minimum is $100 million in capital." He does not dispute the utility of those measures because, "this market is new, so the government has put very restrictive laws. New laws may come to open the market a little more."
He said that within three or four more years the market will be considered more mature, but still asserts that the reinsurance business is not as competitive. That is despite the fact that all of the global majors have a presence, he said. "The problem is not them, it is IRB, which is still in the middle."
"We do not yet have what most people want, but I am confident that we will get there eventually."
GREGORY DL MORRIS has covered the financial services industry for more than 20 years. He can be reached at email@example.com.
June 1, 2012
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