Radical economic transformation hobbled by intrusive, excessive regulation in insurance industry

By Gerrit Sandrock

It is an entirely predictable response to the intrusive and extensive overreach of muddled Government agencies in their quest for control of the industry. Through its regulatory exuberance, the State has curtailed industry growth, and thus capital and job creation.

The South African insurance industry is an oligopoly. That is, a market structure similar to a monopoly, but in which a small number of companies has the majority of market share. This is not the creation of faceless “white monopoly capital”. It is an entirely predictable response to the intrusive and extensive overreach of muddled Government agencies in their quest for control of the industry. Through its regulatory exuberance, the State has curtailed industry growth, and thus capital and job creation.
If the industry is to grow at all in the future, it needs to welcome and enable new entrants in radically new ways. However, the current path that we are on, especially the impending “Twin Peaks” changes to legislation and the unproven Retail Distribution Review (RDR), will further limit new entrants and make it all but impossible for existing insurers to transform and diversify. Instead, one should expect more consolidation, greater exclusivity, and more oligopoly.

Monolithic mindset of rigid control
Contrary to the popular political view, the apparent lack of industry transformation is therefore not due to intransigence on the part of the owners of existing insurance companies or the lack of entrepreneurial drive from previously disadvantaged persons to set up new insurance enterprises more reflective of our demographics. Instead, the current regulatory and legislative environment (as set out in more recent and pending insurance legislation and the inscrutable Twin Peaks idea) favours large-scale consolidation of existing insurers, making transformation and future inclusive growth highly unlikely. It creates and nurtures a monolithic mindset where everything must be rigidly controlled and where innovation and flexibility is severely subjugated to the power of authoritarian bureaucrats.
With most premiums paid going to no more than four or five dominant insurers, the rest of the insurers active in the market are relegated to a minor league. Skimming through the list of 98 Short-term insurers on the FBS’s website is an interesting exercise. Once you eliminate the insurers owned by other major financial institutions, like the Banks and other Insurers (for instance, Santam owns several smaller licences), the four or five State-owned ones and the ones that are there but not active (First Central, saXum), you are left with a small number of smaller “independent” operators. The position is exacerbated by constant consolidation as smaller underwriters and underwriting agencies are absorbed into existing insurers due to the impenetrability of the ever-increasing and invasive regulations imposed upon them.
A generation ago, several of the bigger insurers in South Africa were created by entrepreneurs, and several came from intermediaries expanding their reach into becoming insurers. Hollard, and Auto and General come to mind. I am willing to bet though, that hardly any such Greenfields operations have been created in the decades since the advent of FAIS, itself one of the most expensive and least successful Acts in our country’s history.
So why is it so difficult to set up an insurance company?
A cursory glance at current and proposed legislation is instructive:Firstly, you need great gobs of capital. Ironically, no capital is in fact necessary to operate an insurer. When expenses, claims, and reinsurance costs are paid from written premiums, no capital is utilised. The capital requirements are there merely to cover the possibility that things go wrong.
The latest iteration of the experimental “Solvency Assessment and Management (“SAM”) regime for insurer capitalisation goes far beyond the simple solvency measures applied with almost 100% global success over the past 100 years. No longer will entrepreneurs need the traditional simple percentage of earned premium as capital, but the Regulator will now impose an additional minimum capital base (money in the bank) of north of many tens of millions of Rand – and that is before the entrepreneur has provided a single cent of insurance cover. He or she will also need additional capital on top of that to cover their expenses as well as the operational risk.
No single entity may own more than 25% of the insurer without the Regulator’s personal consent, and almost certainly not any individual with that level of shareholding. Institutional shareholding is all that seems permissible and funding will likely have to be spread over several of those. That requirement specifically excludes any potential financial industrialists, let alone Black candidates essential to the transformation agenda.

In addition, entrepreneurs have to lodge a five-year detailed business plan for regulatory approval, including operational expenses, underwriting standards, claims policy and reinsurance facilities. They must agree to abide by a plethora of often inexplicable regulation on market conduct and convince the Regulator that they have competent management and staff of “fit and proper” quality (read “educated, long-experienced and skilled”). Again, all of this must be in place before a single policy is issued. Other skills also need to be on tap, such as actuaries and lawyers to monitor compliance with both the law and the ever-changing regulation.
You need deep pockets and strong legal skills to play this game
Insurance intermediaries are likewise subject to regulations that prevent them from easily setting up new businesses. Besides the innumerable laws and regulations that all small and medium businesses are subject to, insurance intermediaries are pressurised by intrusive protocols that determine their income (through commission regulation), their service levels and their market practices. Their employees need to be conversant with the minutiae of the regulations and laws as well as the extent and implication of the policies that they sell. If they do not pass stringent Regulatory examinations on these matters they will lose their jobs.
Economists speak of “Barriers to Entry” when they consider aspects that prevent new entrants into an industry from creating new participants in a market. Whilst not overtly protectionist, regulations frequently shelter current operators from new competitors. In the South African context therefore, it is doubtful whether any real transformation could possibly take place in terms of ownership or entrepreneurship for many decades to come.
Assuming for a moment that the current enthusiasm for “radical transformation” could lead to real change and the inclusive growth that is desired, how would that be achieved? A radical solution in the insurance industry would be for Government to take the following steps inter alia:
– Appreciate firstly that the insurance industry has the potential to enable small businesses and people to prosper by providing security against risk. Not every risk needs a major conglomerate to underwrite it;
– Recognise that the emerging market may need products beyond funeral and micro-insurance, and support in getting insurance concomitant solutions;
– Review the capital requirements for new insurers to a more risk-based approach. This may include setting up a fund for possible failures instead of relying on capricious regulators and defective “Twin Peaks” type regulation in particular;
– Adopt a more benevolent and supportive regulatory approach to small and medium intermediaries. New (Black) entrepreneurs will come from this segment of the market and will employ people in areas that the current big operators cannot service and those jobs are what are sorely needed;

– Admit that the current bureaucratic regulatory environment is not suited to the national need to democratise our economy. We need South African solutions for South African problems, and the global developed economies are not equipped to advise us on how to achieve that;
– Abandon the notion of a state-owned insurer. This will merely reduce the economic space for transformation of the insurance industry into a broad-based supplier of risk management solutions, funded by willing private sector investors.
If this is not done, politicians must come to terms with the fact that the South African insurance industry has been forced by non-economic, bureaucratic and political forces to become an untransformed oligopoly, the result of overreach by dogmatic civil servants intent on achieving hegemony of control over all aspects of our economy. If the industry is to grow and transform at all, new entrants need to be enabled in radically new ways. The path that we have been on since 2002, including RDR and the proposed “Twin Peaks” regulatory architecture, will greatly limit new entrants and make it ever more difficult for existing insurers and intermediaries to diversify. All that may be expected under the current and pending regime is yet more consolidation and exclusivity.