The European perspective of the Ukrainian reinsurance market

In light of the recent political events in Ukraine, a very important question is the existence of the reinsurance market in Ukraine, in particular, the placement of Ukrainian reinsurance risks.

Outward Ukrainian reinsurance usually has two directions when placing risks, which show on the reinsurance premium streams, namely: Russia - 38.7% or 632.1 m. UAH (≈ 57,5 ​​m. EUR) in transferred reinsurance premiums; and Europe - 49.3% or 805.2 m. UAH (≈ 73,2 m. EUR) (of which the share of major countries are: Germany - 251.0 m. UAH (≈ 22,8 m. EUR), or 15.4 %; United Kingdom - 238.8 m. UAH (≈ 21,7 m. EUR), or 14.6 %; Switzerland - 182.4 m. UAH (≈ 16,6 m. EUR), or 11.2 %; Austria - 90.3 m. UAH ( ≈ 8,2 m. EUR), or 5.5 %; France - 42.7 m. UAH (≈ 3,9 m. EUR), or 2.6%) [1].

Since the Ukrainian insurance companies must have confidence in the reliability of their reinsurers and their ability to meet their obligations, the issue of the interaction with the Russian reinsurance market is of special importance nowadays. Due to subjective factors, the economic relations between companies from the two countries may be blocked (both because of the limitations of internal government of each country and because of international sanctions). That is why Ukrainian companies will be forced to look for other options to accommodate their risk. Of course, a significant share of cooperation with the Russian market affects the state and trends on the Ukrainian market. Therefore, there are major issues for Ukrainian insurers:

1. Will Ukrainian companies continue to cooperate with Russia, and can they count on the payment of the reinsurer's share in insurance indemnity?
2. If Ukrainian insurers are not able to place risks in Russian companies, where will these reinsurance premiums go?
3. If Ukrainian companies have to look for an alternative to the Russian market, can it meet the demands of Ukrainian companies for reinsurance conditions?

In this article we will explore, for the most part, the latter question because the issue of the perspective and alternative for further development of the Ukrainian reinsurance market will always be an important one, regardless of the situations. In our opinion, the more alternatives, the more confident will feel the reinsurance market of Ukraine itself.

But first you need to understand whether these alternatives exist. According to practitioners on the reinsurance Ukrainian market, there are the following possible directions for placing Ukrainian risks: Europe, CIS countries, Southeast Asia, Arabian countries, Latin America. Europe is an especially close alternative reinsurance market in Ukraine (excluding CIS). This is evidenced by indicators of cooperation with the European market. In particular, Germany, UK, Switzerland, Austria and France altogether account for about 50% of Ukrainian reinsurance premiums to non-residents. Given this closeness of cooperation with the European market and its reliability, it is logical that Ukrainian companies will want to expand cooperation with this market. But the main question arising is: "Will the Ukrainian companies satisfy the conditions imposed by European reinsurers?"

First we need to understand that, in collaboration with both residents and non-residents, there are two methods used for transferring the risks to reinsurance: treaty and facultative. And in case of the transfer of treaty contracts few problems arise (the main issue in such a situation for European reinsurers is transmitted profitability of the portfolio), then facultative reinsurance may pose some problems. In order to emphasize the importance of this issue, we present statistical information. According to a survey by Ukrainian insurers, the average share of facultative reinsurance in the total amount of reinsurance to non-residents does not exceed 15-20 %. Overall, it follows that from the total number of premiums written by Russian reinsurers (632.1 m. UAH ≈ 57,5 ​​m. EUR), the amount of facultative reinsurance is 94.8 - 126.4 m. UAH (8.6 - 11.5 m. EUR) in reinsurance premiums . In our opinion, this amount is significant for the actual research topic on the concerns related to facultative reinsurance by Ukrainian insurers.

Given the above data, the main issues of the European alternatives Ukrainian facultative reinsurance risks identified are as follows:
  • 1. Ukrainian and European reinsurance rates differ significantly;
  • 2. European reinsurers do not take "big shares" of risks, as it was the case with Russia;
  • 3. European reinsurers are trying to cooperate only under treaty reinsurance, rarely using the facultative method. Facultative is more of a culture of the post-Soviet space;
  • 4. If a European reinsurer uses the facultative method of reinsurance, it is characterized in most cases by a non-proportional form, which is not suitable to Ukrainian insurers (playing the role of the reinsured) with their treaty Western reinsurers excluding compression.
The purpose of this article is to explore the main problems faced by the Ukrainian insurers concerning the alternative European placement of facultative reinsurance risks as well as possible solutions.

In order to understand the possibilities and prospect of the European reinsurance market, we should first analyse the sources of the price formation for reinsurance. It is known that reinsurance is the secondary redistribution of premiums. Therefore, the price of insurance depends on the price of reinsurance. For grasping the sources of the formation of insurance prices we should understand the main reasons influencing the mechanism of spending by the population. Indeed, that demand creates supply and in what concerns prices this axiom becomes: "The price of the product/service is just what people are willing to pay."

In order for us to explore a European perspective it is necessary to understand the difference in the formation of prices in Ukraine and Europe. Thus, we analyse the incomes of the two regions.

Population's income is a key determining factor of the citizens' living standard and an indicator of the economic well-being and social situation in the country. According to research carried out by the World Bank, Ukraine is a country with an average income of the population. In order to rank the countries in terms of the purchasing power per capita, the revenues that everyone earns in the country within a year after taxes were taken into consideration.



Fig. 1. Purchasing power of the European countries based on the GFK research company in 2013 [4].

The purchasing power of the population is the total amount of financial resources available to a citizen for the reporting period (year). It means that on this sum of money a person can buy all the things that will satisfy their needs for life. The average person's needs consist of food, non-food goods and services (clothing, footwear, housing , water, electricity, gas and other fuels, household items, household equipment and routine maintenance of housing, health, transportation, communication, recreation and culture, education, restaurants and hotels, various goods and services), non-alcoholic and alcoholic beverages, tobacco products, etc. Among all these needs, a place is held by insurance as one of the services that protect their interest.

According to the State Statistics Service of Ukraine, in 2013 insurance premiums per capita in Ukraine accounted for only 57 EUR while in the developed markets of Europe and the U.S. this figure varies between 2-3 thousand EUR (according to the rating agency «Fitch» [5, 6, 7]).

Since insurance is paid form the monetary resources of the population it is natural to see a difference in the cost of insurance that create a difference in prices for reinsurance between Ukraine and Europe.

As an example we provide a comparative table of the average basic property reinsurance rates offered by a European reinsurer and a Ukrainian insurance company.


      
When drawing up this table we compared the rate guide of Ukrainian and European companies (we do not indicate company names for ethical reasons). As the basis for calculations we took the following types of property: structural elements; interior outfit; equipment; manufacturing equipment, machinery; products in warehouse (in storage); electronic devices (computer equipment and home appliances). The main comparative value was the average rate for each group of assets that can be seen by comparing the difference in the test rates. To calculate the average rate paid, the minimum and maximum rates were used, the size of which depends on many factors (risks, deductibles, contract period, territory of the contract, etc.). The increase in rates depended on riskiness of each individual object of insurance.

These rates apply only to facultative reinsurance because on treaty reinsurance for reinsurers the overall volume of business written by the Insurer is more important than its original rates. A treaty reinsurance contract is estimated from the position of the overall profitability at the end of the reporting period. So this part will remain unchanged as the majority of Ukrainian insurers prefer to place treaty reinsurance contracts from Western reinsurers.

When drawing up this table we realized that this is a subjective calculation based on data from a limited number of subjects on the reinsurance market. But the main goal was to see the trend which is reflected in the difference in Ukrainian and European rates (last column of the table).

European rates exceed the Ukrainian ones by 5-15 times, which again points to the problem of facultative accommodation risks in Europe. On the other hand, such a difference in the pricing of reinsurance services indicates the need of the two investigative markets for compromise and implementation of joint projects in the facultative reinsurance, especially given the volume of Ukrainian facultative reinsurance premiums.

The previous analysis suggests that in the conditions of an urgent need on the European reinsurance market, Ukrainian companies may face different kinds of issues and especially that of the price of European reinsurance services. Therefore, while solving operational issues, the Ukrainian insurers will be forced to look for other alternatives to the European reinsurance market.

Based on this research, the following ways of Ukraine's approach with Europe on facultative reinsurance are possible:
  • Transition to the treaty reinsurance contracts with European reinsurers which allow compression risks. Thus, the number of reinsurers willing to take risks with Ukraine will grow and this will in turn increase competition and reduce reinsurance prices;
  • Taking into account the difference in prices for reinsurance, parties should undertake joint activities (presentations, seminars, trainings, etc.) that will help European reinsurers to get acquainted with Ukrainian risks more deeply. Undoubtedly, considering the size of the possible facultative free Ukrainian market (8.6 - 11.5 m. EUR), European companies will want to earn additional incomes under the form of reinsurance premiums. The only question is a real understanding of these risks. Earlier Europe did not want to work with Ukraine due to the lack of information on the objects of insurance and the inability to assess the risks adequately. In our opinion, if the Ukrainian insurers worked towards a better understanding of the actual insured risks, this could help reduce the prices of European Facultative reinsurance and increase the possibility of cooperation with the European market.
However, the European perspective is a long-term one because solving existing problems and differences require a certain time. In this case Ukrainian insurers have to address their operational tasks by placing risks now and for this reason we can follow alternative options for Europe:
  • The Ukrainian domestic reinsurance market. Currently the Ukrainian reinsurance market cannot fully meet the demands of Ukrainian companies in the amount of the available reinsurance capacity. The main issues of the Ukrainian reinsurance market are the following: 1. The insufficient capacity for various types of insurance; 2. The restrictions of the Ukrainian reinsurers to accept risks (the capacity of the domestic conditions Reinsurers formed predominantly, Western treaty programs which indicate a fairly broad list of restrictions for receiving inward reinsurance risks. This list is not a formality because it really narrows the ability to accept risks. Currently Western reinsurers are fearfully looking at the possibility of providing the Ukrainian side of their reinsurance capacities to the fullest creating a wide range of restrictions). In our opinion, way out of the situation of the lack of Ukrainian reinsurance capacity may be the organization of the reinsurance pools on the Ukrainian market or the creation of state Reinsurers. If reinsurance premiums remained in the country, they would increase the market capitalization, which in turn will enhance the financial stability and reliability of the insurance and reinsurance market in Ukraine. The capitalization growth will lead to an increase in the Ukrainian reinsurance capacity that can stimulate the inflow of foreign reinsurance premiums and the growth of the entire financial market of Ukraine;
  • 2. The states of the former Soviet Union (out of all the 15 countries of the former Soviet Union only Kazakhstan, Azerbaijan and Belarus may offer a more or less significant inward reinsurance capacity, while the rest of the country does not have a large reliable reinsurance capacity. Lithuania, Latvia and Estonia are considered as part of the EU). In order to understand the size of the CIS markets, we present the following comparative statistics:


The reinsurance market in Asia and Latin America. At the moment companies from these regions are presented with slight Ukrainian reinsurance risks. As a rule, Ukrainian risks in these regions are represented in small shares and placed by brokers. In fact, today the presence of Ukrainian risks on these markets includes minor risks and does not affect the general trends in the reinsurance market in Ukraine. Undoubtedly, the potential of the Asian and Latin American market is significant as evidenced by the statistics of the companies representing these regions. Among the top 40 global world reinsurers are the following companies: MS & AD Holdings, NKSJ Holdings, Tokyo Marine Group, Toa Re (all - Japan); Korean Re (Korea); GIC of India (India), IRB-Brasil Re (Brazil). Ukrainian companies will show a positive development of outward reinsurance in the region taking into account the financial capacity of its representatives. This will expand the geography of the Ukrainian cooperation with the international market, which has a positive impact on the tendency to increase the number of reliable partners, lower the prices due to increased competition and reduce the dependency of Ukrainian companies on the specified reinsurance markets.

Summarizing all the above we make a point that at the moment Ukrainian reinsurance is idle. Subjective factors in the form of political risks have a strong impact on the economic component of the relations both within the country and with the non-resident partners. Ukrainian insurers are private businesses that should take into account all the risks and carry out their tasks in parallel. Therefore, the question arises as a tool of finding alternatives to reduce the risks.

References

1. The informational portal of the National Commission, subject to the state regulation in the field of financial services markets / Results of the Insurance Companies for 2013 - [electronic resource] - Access mode: http://nfp.gov.ua/files/OgliadRinkiv/SK/sk_% 202013.pdf;
2. Information portal - insurance online magazine "Forinshurer" / Results of the insurance companies: The insurance market of Ukraine in 2013 increased by 33.3% to 28.7 bln. ($ 3.58 billion) - [electronic resource] - Access mode: http://forinsurer.com/news/14/03/26/30700;
3. Information portal - insurance online magazine " Forinshurer " / Reinsurance : What Ukrainian insurers engaged in the Russian insurance and reinsurance companies ? - [Electronic resource] - Access mode: http://forinsurer.com/news/14/03/31/30710;
4. Information portal - consulting company «SOCIUM» / Market Research: the purchasing power in Ukraine - [electronic resource] - Access mode: http://socium.com.ua/2013/11/purchasing-power/;
5. Information Gateway State Statistics Service of Ukraine / Structure of the total expenditure - [electronic resource] - Access mode: http://ukrstat.org/operativ/operativ2007/gdvdg_rik/dvdg_r/str_vut2006_r.htm;
6. Informational portal of the information agency "RIA RATING" - [electronic resource] - Access mode: http://riarating.ru;
7. Information portal of the rating agency «Fitch ratings» - [ electronic resource] - Access mode : http://www.fitchratings.com;
8. Information Portal of the Insurance magazine «Xprimm» / Reinsurance in the CIS - the main trends and forecasts for 2014 - [electronic resource] - Access mode: http://www.xprimm.com/%D0%9F%D0%B5%D1%80%D0%B5%D1%81%D1%82%D1%80%D0%B0%D1%85%D0%BE%D0%B2%D0%B0%D0%BD%D0%B8%D0%B5-%D0%B2-%D0%A1%D0%9D%D0%93-%D0%BE%D1%81%D0%BD%D0%BE%D0%B2%D0%BD%D1%8B%D0%B5--ru-articol-119-4490.htm.


Ievgenii Velychko
Graduated from Vadym Hetman Kiev National Economic University, master's degree in "Finance", specialization "Insurance Management" (2010). Since 2010, post-graduate student at Vadym Hetman Kiev National Economic University, Insurance Chair. The subject of PhD thesis is "System reinsurance risks in the property insurance industry."
Relevant professional experience in insurance is more than 6 years. Current place of work is "Illichivske" PrJSIC, reinsurance department.

 
Contact: cell phone: +380 66 326 53 23;
e-mail: e.velychko@gmail.com;
https://www.facebook.com/ievgenii.velychko

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