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Friday, January 30, 2009

Insurance Industries Of Bangladesh

Insurance industry in Bangladesh passed through a century long history of evolution, yet
struggling to achieve its mature stage. After liberation, as part of the nationalization process, the industry was nationalized vide Presidential Order. Subsequently, in the process of denationalization, private sector companies were allowed to operate in the industry side by side with two state-owned corporations. Consequent to that, a good number of insurance companies emerged in a small economy thus resulted in tough and unhealthy competition. Underhand transaction on commission appeared as “open secret” in general insurance business. The Controller of Insurance, even being the regulatory authority, failed to unveil sophisticated control mechanism to bring the industry into a good shape. At certain stage, the agency commission system was abolished to stop underhand dealing between the agent and the policy buyer. The move was, however, failed to eradicate the unethical practices and thus resulted to the reintroduction of commission system in the sector. The life insurance companies also follow aggressive marketing strategy for business procurement, many of which are ended with high policy lapse. It is the general belief of common people that insurance companies are not sincere in making payment and resorts many whimsical reasons for declining claims which are not taken care of while opening policy. Due to the negative attitude, the penetration rate in the industry is still very low (only 0.62% of GDP) even having immense prospects. In order to make the sector vibrant and operationally sound, the Government has taken a number of steps and some are in process with the main objective of taming this wild horse. This article is being written to assess the impact of one of the steps taken by the
Government towards this direction.

Credit Rating of Insurance: What does it mean?
Credit rating of insurance is forming an opinion through the assessment of an insurance
company’s capability to meet its contractual obligations to policyholders and other creditors in timely manner after thorough evaluation of its strengths and weaknesses. The basic philosophy behind credit rating of insurance arises from the fact that the insurance companies are undertaking huge risk against small amount of premium. The risks are so enormous that the entire resources of the company may not be sufficient to handle a single claim in case of general insurance. In view of above, the clients looking for insurance protection should ideally look for insurance claim paying ability of the insurance companies while taking insurance policies. Rating is basically an independent, impartial, professional and best judged opinion regarding the ability and willingness of the insurer to make the policyholders and outsiders obligation when due.

Mandatory Credit Rating of Insurance:
A Breakthrough in the Industry The Department of Insurance made several attempts, as part of the control mechanism, to bring the business environment in the industry, yet few endeavors yielded with fruitful results. However, the circular (No: 21/21/98-376 dated March 12, 2007) of the Chief Controller of Insurance regarding mandatory credit rating for the insurance companies is considered to be the most effective breakthrough in the sector. Under the above directive, all general insurance
companies were instructed to get credit rating with effect from 2007 with mandatory
surveillance at the end of each year. The life insurance companies were directed to have the surveillance rating biannually. However, the two state-owned corporations are still out of the rating net. Shadharan Bima Corporation (SBC), the solitary re-insurer in Bangladesh, is to accept at least 50% of the re-insurable amount of policies of all the general insurance companies by virtue of existing Insurance Act. Thus, the claim paying ability of SBC is very important for all the general insurance companies. On the other hand, Jiban Bima Corporation (JBC) directly participates in policy selling side by side with its reinsurance operation. Considering their immense role and responsibilities towards the development of the sector, SBC and JBC should also come under the framework of rating.
Although the rating of insurance companies is a new phenomenon in the rating industry in
Bangladesh, it experienced tremendous response from the market participants including the insurers themselves. Many of the good rated insurance companies, particularly upper
investment grade entities, started using the rating as a ‘marketing tool’. They are also trying to improve their position based on report of the rating agencies. It has also been observed that the non-investment grade rated companies are asking for the surveillance rating to incorporate the latest developments in the surveillance report with the expectation of improvement in rating. The banks are now more interested in the rating report representing claim paying ability of the companies before assigning policies instead of bargaining for higher discount in premium. The above changes are expected to make positive transformation in the industry. Out of 62 companies, 51 companies have so far been rated constituting 82.26% of the total industry. Of the above, 90.91% are in general insurance industry and 61.11% are in life insurance industry. Credit Rating Information and Services Limited (CRISL), the premier credit rating company of Bangladesh, rated 35 insurance companies (including 9 life insurances) which constitutes 68.63% of the total rated entities. Again, among the rated companies, CRISL awarded rating of 65% general insurances and 81.81% life insurances. Over and above,
66.67% companies achieved investment grade (‘BBB-’ and above) while rest 33.33% obtained non-investment grade (‘BB+’ and below). While analyzing the industry-wise strength of rating, it was found that 81.81% life insurances and 62.60% general insurances achieved investment grade rating. Rating distribution of general insurance companies revealed that 35% companies were in ‘BBB’ category, followed by 32.50% in ‘BB’ category, 22.50% in ‘A’ category and 5% each in ‘AA’ and ‘B’ category. On the other hand, 54.55% of the life insurances achieved ‘A’, 9.09% ‘AA’ and 18.18% each in ‘BBB’ and ‘BB’ category.

Recent Development in the industry:

The insurance industry is now at the final stage of transition. It has been decided to replace the age old insurance laws with Insurance Regulatory Authority (IRA) Ordinance 2008 and Insurance Ordinance (IO) 2008. The Department of Insurance will be abolished by the fivemember Insurance Regulatory Authority headed by the Chairman not below the rank of Government Secretary. For further enhancing the solvency position, the paid up capital for general and life insurance companies have been raised to TK. 400 million and TK. 300 million respectively. The number of directors in the company has also been reduced to 15 from 20 with the participation from the policyholder directors. The new law also introduced mandatory solvency margin for the insurance companies. Besides, the insurance companies will be required to ensure international accounting standard, separate Islamic insurance from conventional ones and put a limit on commission expenses. Moreover, the life insurance companies will be required to make the valuation of liabilities on yearly basis to reveal the real strength of the company. The law also allowed foreign investment in general insurance sector. With the promulgation of the ordinances, the insurance industry will be under the Ministry of Finance from the Ministry of Commerce.

Evaluation Framework:
The credit rating reports of CRISL based on financials upto December 31, 2006 have been
taken into consideration as sample for the framework of evaluation. As said earlier, CRISL
rated 26 general and 9 life insurance companies which respectively constitute 59.09% of the general insurance industry and 50% of the life insurance industry. Out of the above, general insurance companies, 10 are 1st generation, 5 are 2nd generation and the rest 11 are 3rd generation companies. On the other hand, out of the life insurance companies, only 1 is a second generation company and the rest are 3rd generation companies. The appraisal specifically covers the areas of corporate governance, business profile, risk management, financial & operating performance, solvency and liquidity.

Corporate Governance:
Corporate governance is the set of processes, customs, policies, laws and regulations affecting the way a corporation is directed, administered or controlled to perform efficiently and generates long term economic value for its shareholders while respecting the interest of its stakeholders and the society as a whole. The specific areas covered are transparency in disclosure of relevant reliable financial and operational information, information on ownership and control, information on internal processing of management etc. Unlike banks and other financial institutions, the corporate governance in insurance industry is at very early stage of development. The specific areas are delineated below:
a. Ownership Structure, Board and Delegation of Power: The ownership structure of the industry as a whole is concentrated towards a small number of shareholders. The ownership of 34.61% general insurance was found highly concentrated followed by 26.92% moderately concentrated, 30.76% moderately diversified and rest well diversified. On the other hand, ownership structure of 55.56% life insurance companies was found concentrated, followed by 22.22% well diversified and the rest are is equally distributed
to highly concentrated and moderately diversified zone. Out of total 35 sample in the industry, 22 companies had gone for public offerings yet the same couldn’t make any significant breakthrough in the formation of the Board. In most of the companies, the sponsor shareholders dominate the board. Under existing law, the life insurance companies are required to have sponsor directors, shareholder directors and policyholder directors having equal participation in the Board to protect the interest of different stakeholders. However, none of the companies either comply with the law or the sprit
of the law. Most of the companies don’t have any policyholder directors in the board. Couple of companies have policyholder directors where the sponsors become eligible for the same through purchasing policies from the companies. In some instances, it has also been observed that sponsors become the shareholder directors by virtue of having shares from the secondary market. Board and its sub-committees have substantial involvement in operational affairs of the company in addition to formulating policy issues and strategic aspects. The board and its committees of 26.47% companies have high involvement, 58.82% have considerable involvement and rest 14.71% have little involvement in the operational affairs. The above over involvement of the board and its committees results to poor delegation of power to management. There are companies where even a claim of taka five thousand needs to be approved by the Board or its Claim Committee. In some instances, petty expenditures can’t be endorsed by the executives. The delay in decision making is a serious impediment to the growth of the organization. The inherent gap between the entrepreneurs and the professionals is the main obstacle to the growth of the insurance companies.

b. Management Structure and HRM:
Insurance is basically a technical business dependent to a great extent on the quality of
techno-human resources available to form a management team. The denationalization of the sector opened up a new avenue for the top and mid level professional of SBC and JBC to lead the newly established private sector insurance companies. Still, the top level management of many companies constituted of the professionals having exposure in two state owned corporations. Meanwhile, in the passage of evolution, a good number of people entered into the industry. However, the industry is in dearth of knowledgeable human resource base. The main reason behind this is that young qualified people are less interested to build career in the Page 4 of 9 sector as the profession is yet to be socially recognized. Moreover, the career growth depends, to a great extent, on the procurement of business which allows many mediocre people to reach to the peach. This ultimately results in vacuum of knowledgeable professionals in the mid and top level management. Unlike banks and other financial institutions, the human resource management activities of insurance companies aren’t up to the mark. Many of the companies do not have documented ‘service rule’ for its employees. The pay scale of most of the companies isn’t supported by the market scenario. Development of the employee is mainly dependent on ‘on-the-job’ training without having any prospective development plan. Human resource turnover in the industry, on an average, is very high.

c. IT Infrastructure in MIS:
Application of information technology in every phase of the insurance operation is very crucial for both general and life insurance companies. Integrated insurance software provides real time information to the management and technical personnel. Integrated software of underwriting, accounting, reinsurance, claim, etc. provides quick service to the related parties and also extends support for risk analysis, trend analysis of accident, claim behavior, that ultimately help management to take judicious decision. However, the use of IT infrastructure in MIS of the insurance companies is at the early stage of development. 23.53% companies don’t have any IT infrastructure, followed by 35.29% are at the initial stage of IT infrastructure, 32.35% are developing stage while rest 8.83% at advanced stage. Around 60% companies generate most of the MIS and regulatory reports through manual system which is obviously slow and most of the time fails to meet time requirement for fruitful decision making. Sound IT infrastructure requires substantial investment in IT platform that many of the companies are not interested although a modern insurance company can’t think of effective business management without having a well planned IT system.

d. Financial Disclosure:
An insurance company, being a PLC, has a large number of stakeholders including the
policyholders. The disclosure followed by the companies is at minimal and only to the extent required to comply with the regulatory requirement. All the insurance companies in the industry, by and large, follow uniform reporting structure, thus results to almost similar disclosures in the financial statements. However, in case of general insurance some additional disclosures like business class-wise breakdown of gross and net premium, business class-wise sum insured and re-insurance coverage, detailed disclosure of high valued risk assignments, major claims settled and intimated during the period, in-house business support etc. would ensure more accountability and transparency in the business operation. The real financial health of a life insurance company can’t be judged if the actuarial valuation of liabilities is not disclosed. However, most of the life insurance companies including some listed PLC depict the rosy picture of life fund growth without having any indication of liabilities generated against the same. This eventually places stakeholders in fool’s paradise.

Business profile:
a. Business mix:

General Insurance:
Insurance Act permits all the general insurance companies to carry out insurance business
under fire, marine, motor and miscellaneous business categories. However, out of 26 sample companies, 14 companies were found concentrated in marine business with revenue contribution of 36.33% to 62.86% followed by 11 companies in fire business ranging from 32.90% to 55.57% and only one company in motor business having 60.47% contribution in the revenue composition. Among the business segments, fire and motor businesses are considered to be more risky due to high claim experiences. During the period, fire business reported highest average claim ratio (net claim to adjusted net premium) of 30.97%, followed by motor of 29.26%, miscellaneous of 19.06% and marine of only 12.20%. The average expense ratio is found highest of 119.84% in miscellaneous business followed by 93.50% in fire, 58.89% in marine and 57.70% in motor business segment. As per the existing Insurance Act, the management expenses are allowed to be charged on the gross premium rather than net premium. Even with the low retention ratio (net premium to gross premium ratio) in fire (average 37.81%) and miscellaneous (average 22.83%) business categories, the companies allocate management expenses based on the gross premium income resulting to high management expenses for which the segments suffer from underwriting losses. Thus, the combine ratio is dominated by expense ratio rather than the claim ratio. Out of total sample size, 18 companies reported underwriting losses in miscellaneous business, followed by 16 companies in fire business, 4 companies in motor business and 1 company in marine business However, above all, 23 companies reported overall underwriting profit mainly because of the
contribution from the marine segment.

Life Insurance:
Life insurance companies (LICs) offer a variety of products based on the market trend and
changes in demand. LICs, by dint of their business nature, absorb long tail liabilities of the
policyholders with a small amount of premium. Although different companies offer different
policies, more than 95% polices are with-profit policies where the policyholders will get profit along with deposited premium if he survives till the maturity period. The broad head of the product lines are individual life, group life, rural and health insurance. However, out of 9 companies in the sample, only 4 companies have comprehensive product lines including group life and health insurance policies. All the traditional life insurance companies (excepting two dedicated islami life companies in the sample), introduced islami products side by side with their traditional product lines. However, islami products fund were not found ring fenced. The new Insurance Ordinance will not allow the companies to operate traditional and Islami products simultaneously and thus press on a challenge to shift to a particular product within a stipulated time.

b. Marketing Strategy:
General Insurance:
Government regulation provides an unbeatable advantage to the general insurance companies and thus results in the emergence of as many as 43 companies in a small market. The private sector general insurance companies enjoy 50% of the public sector business (PSB) which is considered to be a good source of income. PSB contributed, on an average, 13.69% of the business revenue. Out of the above, 3rd generation companies enjoy the highest PSB of 18.13% (average basis) against revenue, followed by 13.03% by 2nd generation and 9.13% by the 1st generation companies. In-house business (business from the directors) is also found a considerable source of income for the companies. It has been found that 2nd and 3rd generation companies are mostly contributed by the in-house business respectively having 31.58% and 30.51% (on average basis) of the total business revenue. Despite the fact, too many companies in a very small market give rise to unhealthy and unsound competition among the participants which is being reflected in the marketing strategy. It has been observed that 76.45% companies follow aggressive marketing strategy for the procurement of business while 19.23% companies follow cautious strategy and rest only 3.84% companies are
stick to conservative marketing strategy.

Life Insurance:
Life insurance business, in our country, is based on marketing where door-to-door campaign strategy is in practice for collection of new policies as well as for renewal of existing policies. Under the above backdrop, the LICs are fully dependent on large number of field workers called Agents/Employer of Agents etc. appointed for each of the service offices all over the country to collect insurances business/proposals from the prospective clients. All the life insurance companies in the industry follow “selling concept” of marketing where the basic philosophy is “product will be sold not bought”.

Risk Management:
An insurance company, by virtue of its business nature, undertakes the risks of the
policyholders. Management of risks is very crucial as the same is highly correlated with the long run sustainability and operating efficiency of the insurer. Principally, the higher the risk management practice, the lower the risk and the more protection for the stakeholders. The risk management primarily deals with the fortuitous events and their impacts which basically come from the core business activities of the insurance company. In addition, some operational risks and market risks are also associated with, which also need to be addressed.

a. Business Risk Management
General Insurance:
General insurance companies of Bangladesh, by and large, follow traditional business
risk management tool. Most of the companies don’t have any underwriting Manual yet
follows common practice, rules and guidelines as framed by the regulatory authority.
Many of the companies have no regular risk inspection team before underwriting a
policy. Policies other than high valued risk (as framed by the management) are usually
underwritten based on the ‘principle of utmost good faith’. Excepting few instances,
policies underwritten at branch level aren’t turned down by the head office after
appropriate verification thereto, due to immense competition among the companies in
the industry.

Life Insurance:
Life insurances have underwriting rules and guidelines which are printed in the product
rate books. The underwriting requirements (for new policies and revival of lapse
policies) are based on age and sum assured and are consistent with the reinsurer’s
underwriting requirements. Policyholders up-to certain age enjoy taking policy up-to
certain amount of sum assured without having any special medical test; however, full
medical report (FMR) and pathological urine report (PUR) are required for
policyholders exceeding the certain age limit and sum insured. However, it has been
observed that rules and regulations regarding underwriting aren’t strictly followed in
practice. The field level workforces are less interested in proper investigation of the
policyholders as a significant portion of 1st year premium (new policy) is being
absorbed by them in the form of commission.

b. Internal Control Risk
Internal control procedure is an integral part of financial and business processes which
acts as the safeguard of the assets, promotes operating efficiency, and ensures
compliance with applicable policies and regulations and adherence to the prescribed
managerial policies. Most of the insurance companies follow centralized internal control
mechanism. Funding requirements of branches are approved by the head office.
67.64% of the companies have Board Audit Committee yet couples of which are nonfunctional. For establishing internal control mechanism, 91.18% companies have
established internal audit department, however, the function of the internal audit
department is found inadequate mainly because of insufficient human resource. Only a
few companies makes regular branch/service cell audit while a good number of
companies makes necessary inspection/audit as and when required basis.
Performance: Overall macro-economic slow down resulting from change of government, successive devastating natural calamities and price hike in the international market affected the whole insurance sector.

a. Financial Performance
General Insurance:
Overall financial performance of the general insurance companies was found
moderate. On analysis it was found that 15.38% companies revealed poor financial
performance, followed by 30.76% marginal, 46.15% above average and rest 7.71%
satisfactory financial performance. The average gross underwriting margin stood at
43.07% ranging from 59.32% to (43.92%) during the period. Considering the reserve
for unexpired risk, the average net underwriting margin was found at 8.78% ranging
from 24.58% to (77.27%). The average pre tax operating margin was 12.89% having
wide deviation among the companies. The average Return on average asset (ROAA)
and Return on Average Equity (ROAE) respectively stood at 5.54% and 7.98%. The
average return on average investment (ROAI) stood at 8.48% with a very small

Life Insurance:
Unlike general insurances, the financial performance of life insurances are measured
by the surplus generated from the gap between actuarial valuation of liabilities and life
fund. It has been found that average policyholders’ surplus to net premium was 6.66%
ranging from 18.76% to (2.44%). Average surplus on assets stood at 4.53%. Average
incremental surplus to incremental life fund during the period stood at 7.84% (ranging
from 20.79% to -0.02%) indicating moderate growth of surplus against the life fund
generation. Return on assets was also found moderate with an average of 7.82%
among the companies in the sample.

b. Technical/Operating Performance
General Insurance:
The overall technical performance of general insurance companies was also found
moderate. 19.23% companies revealed poor technical performance followed by
23.07% marginal, 42.30% above average and rest 15.38% satisfactory performance.
Average retention ratio was found 56.35% ranging from 30.77% to 78.04%. As we
know, the higher the retention ratio, the higher will be the basic earning power that
ultimately contributes towards profitability. Expenses ratio, on an average was found
70.31% varying from 34.25% to 118.76% among the companies. However, average
claim ratio was found in a tolerable level of 21.78% against the minimum of 0.13%
among the companies. Thus it is evident that combine ratio is mostly dominated by
the expense ratio rather than claim ratio.

Life Insurance:
The overall operating efficiency of life insurance companies depends, to a great extent,
on the control of management expenses, increment of life fund against net premium
written, employment of fund to earning assets, reduction of policy lapse etc. The
overall operating performance of the third generation companies wasn’t found up to
the mark. The average expenses ratio was 64.46% with a minimum of 52.94% to
maximum of 79.57%. The management expenses is found relatively high as most the
companies are passing through growing stage of operation and thus incurring huge
expenses for infrastructure development and promotional activities. Thus, incremental
life fund to net premium is yet to reach to an optimum level with an average of only
39.07%. On an average, 69.87% life fund of the companies is deployed to earning
assets. The situation has further been aggravated due to the discontinuation of policies
(policy lapse) which is considered to the major impediment of the life companies
towards smooth growth. Average policy lapse ratio was 48.87% while the same was
found more than 50% among the third generation companies. Dominance of 1st year
premium in the total premium mix is found acute (average 51.76%) in 3rd generation
companies mainly because of their business expansion and discontinuation of policies.

General Insurance:
Overall solvency position of general insurance companies was found moderate. On
analysis, it was found that 15.38% companies have poor solvency position followed by
23.07% marginal, 42.30% above average and rest 19.23% have satisfactory solvency
position. Solvency position is usually determined by a good number of indicators like
equity base, exceptional loss reserve, technical reserve, internal capital generation,
underwriting leverage etc. The new insurance ordinance re-fixed the minimum paid up
capital of TK. 400 million which will have to be met within a stipulated timeframe.
None in the industry is at comfort zone regarding capital as per new law. A few 1st
generation companies together with the listed third generation companies have paid
up capital of TK. 150 million or more. However, couple of 1st generation companies
enhanced their equity base through generating exceptional loss reserve. Exceptional
loss reserve is a safeguard against big unforeseen losses in future and tax authority
leaves maximum 10% of net premium as the said reserve out of tax net. Many
companies took the advantage, however, average exceptional loss reserve to net
premium ratio stood at 5.61%. Average unexpired risk reserve to net claim stood at
13.97 times indicating sufficient backup of regulatory reserve against net claim.
Internal capital generation is found low with an average of only 8.06% as most of the
companies declared cash dividend during the period. Technical reserve is found below
standard with an average 40.84%. Underwriting leverage (internal funds and external
support against total sum insured), on an average, was found 44.43% indicates
moderate backup against risk underwritten.

Life Insurance:
Unlike general insurances, life insurances absorb the liabilities of the policyholders till
the maturity. Thus, the prerequisite for long run sustainability of a life company is the
creation of life fund from the premium income. An actuary makes the valuation of
future liabilities of the policyholders. The third generation companies are yet to
consolidate their position due to excessive management expenses and policy lapse.
The new insurance ordinance fixed the paid up capital of TK. 300 million to protect the
interest of the policyholders. This will press on a new challenge for the companies. The
actuarial valuation of liabilities to life fund ratio is the most crucial determinant of
solvency. On an average, the ratio was found 93.25% indicating moderate backup.
The average incremental net liabilities to incremental life fund was 91.97% indicating
higher growth life fund than that of liabilities. However, in case of few 3rd generation
companies, the ratio exceeded 100% which is a matter of concern.

The overall liquidity position of the industry, as a whole, is sound. Insurance companies are required to maintain their investment portfolio as per insurance law. The significant portion of the investment portfolio is usually kept with different banks as FDR under different maturity bucket which serves the purpose of liquidity. Insurance industry, as a whole, contributed 4.84% of the total FDR mobilized by the banks as on December 31, 2006. In addition, the companies keep a considerable amount in STD and current account. Couple of companies actively trade in the secondary market and started making profit.

Present and Beyond:
Insurance industry, as said earlier, at the final stage of its transition. Government has taken several steps for revitalizing the sector to make it more vibrant and operationally sound. However, amendments and initiatives can’t make an overnight change in the sector. As we know the Department of Insurance is going to be replaced by an Independent Regulatory Authority yet the same will not be fruitful until the authority is equipped with technocrats at the policy level and adequate human resources at the operation level to take control over the sector. The new regulatory body should discover some mechanism to eradicate underhand commission to reduce the high procurement cost in general insurance business. Professionalism at every level of management is very crucial for overall development in the sector. For efficient and prompt decision making, management should be given sufficient delegation of power. The board should only involve in strategic and policy aspects of the company without looking into the day to day operation. All the insurance companies should have a sound HR policy that will attract the qualified people to choose the profession as a ‘career’ not a mere ‘job’. HR development program should be a part and parcel of regular business operation for the enhancement of skills and development of professionalism. A good number of companies are still struggling for their survival, thus huge cost of IT infrastructure is an additional burden for them. However, awareness should be built for effective use of IT infrastructure in MIS that ultimately will bring positive results in future.
Last but not the least; it is not the responsibility of the regulatory body alone to make
revolutionary change, rather the respective board, the management team and above all the insured should come forward to bring the sector to the global standard. The sooner it
happens; the better is for the stakeholders in particular and the country in general.

The End The author is a Senior Financial Analyst and the Head of Insurance Sector of CRISL.

The author is a Senior Financial Analyst and the Head of Insurance Sector of CRISL.



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