Ibrahim Muhanna is the chairman of the i.e. Muhanna Group, a leading actuarial firm in the region and publisher of specialized financial strength ratings on Middle Eastern insurance companies. His company also produced the calculations used in devising a program for a Lebanese pension scheme. Executive talked to Muhanna about the situation in the regional insurance market and the evolution of the Lebanese insurance sector.
E What is the importance of financial supervision for insurance companies?
The importance of financial strength for insurance companies is a little bit different than the importance of financial strength for any other industry. If you go to buy a piece of furniture, you certainly want it to last and be of good quality and expect the factory to be of a good standing. But you see what you are buying and your cost is limited to what you pay for that piece of furniture. You bought a chair for a $100, so that’s it and if it does break, the $100 is the end of the story. With insurance, you pay $100 for the policy and the issue is to insure a risk of $10,000 or $100,000 – not the refunding of the $100 when something goes wrong. You cannot take the chance of that company not being in good financial standing.
E Is it easy to discern the credibility of an insurance company?
The man on the street, whether he is a doctor or engineer or lawyer, is not professionally fit to analyze the standing of an insurance company. He mostly has to rely on word of mouth and reputation. This is where a third party, such as a ratings agency, can pass an opinion. A ratings agency can pass a light opinion on an insurance company based upon publicly available information. It can pass a very strong opinion if it is allowed to do a proper due diligence, visit the company, inspect its systems and controls, see all checks and balances, see the structure of the board and so on. Rating is all about that we pass an opinion on the probability of this company defaulting on its obligations. The higher the rating, the lower is the probability of default.
E Do you expect Lebanon’s proposed new insurance law to be adopted, and do you see it as beneficial for improving financial strength and sector transparency?
The law is going to come, although things are sometimes slower than you would expect. The whole world is heading towards proper financial regulation. That is not only because of outside pressures such as those coming from the World Bank, the IMF and the Basel Accord. We also see pressures from inside of Lebanon coming from people who demand proper regulation of the financial sector. The insurance sector needs definitely to be regulated, especially since we need more and more to establish life insurance, which means long-term obligations.
E What makes regulation of the life sector specifically important?
When we are talking about short-term obligations, people are not very concerned. You insure your car and it is no big issue if the insurance company went bankrupt during the year, unless you were so unlucky that it went bankrupt just at the time when you had a claim. But in life insurance, you are accumulating wealth, and there are two points to consider. When this life insurance company is going bankrupt, not only have you lost your savings, sometimes you lose your insurability. If you bought your life insurance when you were young and healthy, sometimes nobody will insure you when you are 45 and have some kind of risk. Long-term security is very important and that is where I see regulations as coming.
E But hasn’t the proposal for the new insurance law met a good bit of resistance from at least part of the industry?
There are always pressures to hold things back. These come from cowboys, people within the industry who are benefiting from not being regulated. However, in financial services there is no longer room for the guys that try to beat around the bush. I do believe if we look at the industry, we must look at regulations not as a deterrent from the activity but really as a proper way of conducting business.
E Is more regulation the way to create a level playing field, or would it give advantages to the more potent companies?
Regulation regulates the process on how much exposure [to risk] you can carry with the capital base that you have. Regulation does not hurt either the big or the small companies; it hurts the people who are not transparent. The best regulation is one that we haven’t seen yet in the Arab world – it is to regulate the structure of the companies’ management, the corporate governance issues. We haven’t seen a regulator come and ask for the general manager of a company to step down, or for the board to be changed. Once we start seeing that, it is really proper regulation.
E Would higher capitalization requirements, as envisioned by the new insurance law, bring greater improvement or could it stifle the growth of insurance companies?
Money is cheap and increasing capital is not a handicap. Sometimes people don’t like to lock in some capital but capital ultimately could be raised. That is why the best regulation really is for companies to be managed prudently, with a properly structured board – where it is not only the brother and the sister and the son holding positions. There is nothing wrong with companies that are family-controlled, but they should be really properly managed.
E Are you averse to family-run and family-owned insurance businesses?
I said family controlled, I didn’t say family owned. That is because even a privately owned insurance company, which is owned by so-and-so, is only owned by so-and-so at the moment of its incorporation. Once it starts conducting business and building up reserves, these reserves belong to the policyholders, not to the shareholders. The original owners of the company own the shareholders’ equity, but they are really entrusted with managing the policyholders’ funds. This applies in particular to life insurance companies where the reserves become huge and by far bigger than shareholders’ equity.
E In this context, do you regard Islamic insurance companies as particularly well suited for operating life insurance lines?
I don’t want to say better or worse. Islamic insurance is very closely comparable to mutual insurance companies, closer than to conventional insurance companies. The big differences between takaful insurance companies and mutual insurance companies are in their investment guidelines and in the structuring of products, but technically speaking the policyholders’ funds are the primary protector in both.
E Regional stock markets fared very well in 2005. Have insurance companies taken advantage of market developments and become institutional investors on a regional scale?
Gulf insurance companies certainly have been riding the wagon of this boom, investing their shareholders’ equity and policyholders’ funds and gaining high returns. This has been reflected very clearly in balance sheets of insurance companies where investment income in certain countries, particularly the GCC but also Jordan, has been tremendous compared to underwriting income. The boom is also reflected in the share price developments of the insurance industry. However, we noticed in a couple of markets that share prices of insurance firms have been manipulated. We sincerely would like to see capital market regulators crack down on these irregularities.
E Manipulated in which way?
E How are Lebanese companies doing in their earnings – are they stronger in investing or in underwriting for their profits?
The Lebanese companies in general are very thin in investments. That is first of all because of the local capitalization, where they don’t really have a big base. We see a lot of their assets in real estate, perhaps because of the very small capital market environment in Lebanon. The Lebanese companies are yet to be a major investor.
E How do the average capitalization ratios of GCC-based insurance companies
compare to those in Lebanon or elsewhere in the region? In the total Arab market, shareholders’ equity is around $8 billion. The GCC alone is $5 billion, so we are talking five mostly small countries having more than two thirds of the capital for insurance companies in the Arab world. Number two, the minimum capital requirements in the Gulf are far higher than the minimum capital requirements in Lebanon. But it is not as important to talk about capital as about the quality of the capital. We really wonder what the fair value of this capital is. The new accounting standards – IFRS 4 – will be touching a lot on the valuation of assets of insurance companies. These are very important and things must be evolving in the next few years. In Lebanon, I envision the market to start consolidation sooner than later.
E It seems that the smaller GCC countries, with the exception of Saudi Arabia, have recently grown more than other countries in the region, especially in terms of per capita expenditure on insurance. Lebanon, on the other hand, seems still to be a leader in insurance penetration as a percentage of GDP. Can you explain this?
It is very important to know how to read these figures. In some GCC countries, expenditure per capita is affected by two factors. First of all, the population is too small compared to the overall premium income and secondly, the premium income is too high directly related to the oil and energy business as well as the construction and engineering business. On the other hand, insurance expenditure in Lebanon appears quite high as a percentage of GDP, but this is not necessarily a true picture because the GDP is too low.
E So what you are saying is that insurance penetration in Lebanon is not where it should be?
It could be higher of course. There is a big role for private sector insurance to play, especially given the lack of proper national social security protection. But unfortunately, there are no government incentives to help the insurance industry in this respect. One typically needed incentive from the government would be tax incentives for pension plans. Until today, insurance companies and employers haven’t been able to structure proper occupation pension schemes with very nice tax incentives or deferred taxes.
E Related to that topic is the project to create a national scheme for continually paid pensions, instead of the NSSF end-of-service payments. Has there been any development on this front?
Transferring the end-of-service indemnity to a pension scheme is on the back burner right now at the parliament and if talked about in 2006, it will probably not be implemented before the end of that year. When the pension scheme was on the table at the end of 2004, it was discussed for implementation in early 2006, allowing for a good year of preparations and implementation. Now we are already at the end of 2005, and nothing has been done, so we are almost a year behind. I envision that if this issue is talked about in 2006, it will be implemented after July 2006 or in early 2007.
E Do you see the chances of this project moving forward in 2006, as strong?
We need a champion. We need someone to push legislation through and say, “this is my mandate to carry through.” People are preoccupied with other issues and keep this on the backburner while in different countries in the region we have seen tremendous pension reforms.
E In the context of Lebanon’s demographics and the situation of the workforce today, how would you assess the impact of a year of delays in implementing pensions? Does it cost a lot to the nation?
Sometimes when you talk about a nation, a year here, or a year there, doesn’t make a big difference. To start with, when you conduct studies on such themes, you make studies that cover 70 or 80 years, or 100 years. So it is a slight issue to push implementation back by a year. It is only a shame that it is not moving forward because this will give the people the impression of a lack of commitment by the government to look at the proper welfare of the citizens. We have seen major reform in Oman, in Sudan, in Jordan, Saudi Arabia, Kuwait; reform is in the process in Bahrain, and we saw a major reform in Palestine. These are ranging from simple reforms to complete parametric reforms. The only two countries that have not touched social insurance properly are Syria and Lebanon, and that is a shame.