Q&A on the Nigerian Insurance Industry
In the exchange below Professor Ralph Koijen, the AQR Capital Management Professor of Finance at The University of Chicago Booth School of Business, and Babatunde Fajemirokun, CEO of AIICO Insurance PLC. and an alumnus of The University of Chicago Booth School of Business discuss the life insurance market in the US and Nigeria.
Ralph Koijen: In the US and across Europe, we’ve seen the life insurance market over the last decade being challenged by the low-rate environment. In the period leading up to the financial crisis, there has been strong demand for products with minimum return guarantees. Such products have been hard to manage during volatile times and periods with low interest rates. As a result, many life insurers have reduced the guarantees and have moved closer to asset managers. Tunde, how does this compare to the market in Africa, and specifically in Nigeria? Are you witnessing these trends or is the situation altogether different?
Babatunde Fajemirokun: Over the last year or so, demand and supply dynamics in the Nigerian fixed income market, driven by concerted actions by the monetary and fiscal authorities (Central Bank and Debt Management Office, under the Ministry of Finance respectively), have led to worse investment conditions relative to conditions in the more developed markets such as Europe, Americas, Japan, etc.
Nominal yields on fixed income securities/investments to below 7% p.a. for the 30-year government bonds, compared to consumer inflation rates of 12%+ p.a. leading to negative real investment yields/returns as at end of October 2020.
Like insurers everywhere, we are constantly looking for opportunities to earn sufficient investment yields to meet customer, operational and profit requirements. As a result, we have had to reduce investment guarantees to our customers as well, especially in the short-term savings and investment products.
Unlike the US and Europe, however, our financial markets in Nigeria are not mature, as the capital markets are not sufficiently deep. Equity markets, typically positively correlated to the state of the economy, are volatile in Nigeria and in a business where we provide guarantees, you can understand the predisposition to fixed income which have significantly outperformed equities in the last decade or so.
In addition, we have discovered that customers prefer shorter-term policies in Nigeria, especially during periods of economic uncertainty and other crises. This typically limits our ability to take advantage of possible term-dependent premiums in some investment opportunities. Additionally, reliance on investment returns to drive profitability will be a challenge for insurers going forward.
For us at AIICO, while we search for the right investment opportunities, we are focusing on win-win situations by exploring opportunities to deepen our relationships with customers, offering flexible products and options that fit their lifestyles, while covering the risks that they wish to transfer.
RK: Our research has shown that in the US and Europe, there are some important policy/regulatory interventions that can impact life insurance markets. In particular, a growing literature shows that when regulatory capital restrictions (almost) bind, insurers raise prices and may even exit certain lines of business. It suggests that raising additional equity is costly to insurers. As such, inefficient and overly lax or restrictive regulation may lead to significant distortions in insurance markets. Tunde, what more do you think can be done to increase penetration of life insurance within Nigeria and Africa?
BF: Within the Nigerian context, what we have are a few regulatory policies which are expansionary and targeted at driving growth in the retail segment. Remember, Nigeria’s insurance penetration has lingered within the 0.1- 0.34% range over time, with insurance contributing just 0.3% to National GDP (vs banking @ ~20%). In my view, I would say the inability to crack the burgeoning retail market has been a major contributor to the low penetration performance.
In response to this lingering issue, NAICOM (the insurance industry regulator) has established a number of polices aimed at fostering growth and promoting substantial uptake, I’ll mention just a few: bancassurance (potential to tap into the 80 million strong banking customer base), creating specific micro insurance licences with lower capital requirements to attract participation from tech driven start-ups who are likely to leverage mobile technology in reaching out to the millions of mobile users, Takaful insurance, and finally, and most importantly, compulsory insurance which has been key to driving penetration in several other notable emerging markets.
Although enforcement has been gradual, full enforcement will certainly bring insurance services to an estimated customer base of over 40 million. Already within the Nigerian life insurance industry, retail business contributes ~ 70% to total written life premiums, and with increasing inclusion, we expect these numbers to continue to rise and we foresee these successes being replicated in the non-life market, which is dominated by institutional and corporate accounts.
NAICOM and PENCOM (the retirement benefits industry regulator) have recently jointly issued updated guidelines (with effect from 1 September 2020) which, with strict enforcement, are expected to increase group life’s share of total life insurance premiums.
The guidelines emphasize the need for employers making pension contributions to also secure group life arrangements, subject to minimum annual benefits for the same group of employees. This, with the increased awareness of, and the need to manage risk following the impact of Covid-19, portends a favourable outlook for the group life market.
Additionally, NAICOM had already taken initiatives to improve the pricing in the group life insurance market from 2018 onwards, with results evident in 2019, as group life’s share of total life insurance premiums is gradually rising.
The insurance industry in Nigeria is currently in a major recapitalisation phase, as life, non-life, and composite operators have been mandated to increase their paid-up capital bases by between 200-260%.
More capital will mean increased opportunities for much more targeted propositions as we see in countries such as India, Indonesia and South Africa, where life and non-life insurance is as important as a bank account and a key aspect of individual financial planning and risk management.
Resistance to the recapitalisation exercise has been noted from several shareholders. However, Nigeria’s banking sector is a good example of how a recapitalisation exercise, perceived to be excessive at the time, made the financial system much more resilient.
In 2005, capital requirements for banks were raised from 2 billion Naira to 25 billion Naira. At the time, there were 89 commercial banks in the country and at the end of the exercise, there were only 25. Today, there are about 22 commercial banks in the country (due to various mergers and acquisitions), but the financial system is much more stable than it was at the time.
RK: Our research has documented a recent trend in life insurance markets in the US that life insurers try to be more actively involved in the wellbeing of the policyholders. Traditionally, life insurers model the policyholders’ mortality, but are not aware of the wellbeing of policyholders between the time of underwriting and either the final date of the policy, or the policyholder’s death. In recent years, life insurers try to intervene more actively by, for instance, motivating healthy behaviour (gym membership, step counters etc.) and even facilitating access to certain medical treatments that may improve life expectancy. As such, life and health insurance, which traditionally have been separated, may be integrated in future years. Tunde, are such trends likely to be relevant in this market?
BF: Mortality and morbidity risks are positively correlated, especially today when lifestyle diseases are one of the leading causes of death and illness across Africa. It makes sense that competence in one area may lend itself and/or be transferable to the other. We have seen companies like Discovery Insurance in South Africa be very successful with its Vitality program; first in its health business and subsequently in its life insurance business.
Today, the program is offered with almost all the company’s products. Discovery has shown that interventions can be beneficial, not just for the insurer, but for the customer as well, therefore it will not be surprising if the Nigerian Insurance Industry jumps on this train.
Within AIICO, we have recognised the importance of understanding the customer beyond the traditional sense, to a more evolved approach where we become familiar with their lifestyles, essentially becoming their lifestyle partners. This is because in Nigeria, insurance is still largely “sold and not bought”.
The consumer market in Nigeria is quite vibrant and well established. In addition, it has a large youth population (+33 million Nigerians are youths), a proportion of which have recently become obsessed with health, nutrition and wellness. Markets across sectors have been responding with increased gym networks, healthy food outlets/franchisees, and campaigns around better health. Across the world we are also seeing companies paying increasing attention to the wellbeing of their employees through the use of ‘’Wellbeing Indexes”, which helps measure wellbeing across four pillars – Mind, Body, Purpose and Place, amongst other benefits.
Consequently, AIICO, through its internal wellness program, deployed a similar initiative where employees’ exercise activities, sleep, nutrition, and mental health habits were tracked, scored, and rewarded to effect healthy behaviour changes. This was a well-received project which had a direct impact on employee engagement and personal wellbeing. Having recognised the potential of such a program, we are now working towards fine tuning, with plans of launching to a subset of our wider life insurance customers as a strategy for retention and lowering mortality risks.
RK: Studies have suggested that there might be a link between uptake in life insurance and economic development. Tunde, is there a connection between increased uptake in life insurance and economic development that you could point to in developing economies like Nigeria?
BF: The link between life insurance and economic development is an assertion that is difficult to dispute, and is driven by the perception that insurance is a discretionary rather than an essential purchase or need. The evidence of this is somewhat mixed – for example, when we look at the BRIC and CIVETS nations, what we see is clear evidence of insurance growth preceding economic growth. As nations become wealthier, middle income citizens begin to amass more wealth. What follows are individuals seeking out means of protecting wealth, raising savings, while securing their financial future.
In the same light, within the Nigerian context, the slow growth of the industry has preceded the slow GDP growth. There has not been a sustained period of economic growth for Nigeria like we have seen with China; the economic performance has been volatile, largely due to our exposure to commodities as our primary source of foreign exchange and revenues for the fiscal authorities. Although per capita income has risen consistently for the last 5 years, the increments have been marginal (stayed within the $2000s).
However, this is changing. Increasing rural urban migration combined with a rapidly evolving digital ecosystem, which is increasing financial distributing occurring through digital means, is likely to fast track the pace of growth. Insurance can certainly be leveraged as a tool for driving economic fortunes, by reducing uncertainty and volatility, smoothing the economic cycle, and reducing the impact of crises on the micro and aggregate macro level.
With increased awareness and better appreciation of risk, there is growing demand for protection against losses of property caused by crime, violence, accidents, illness, and hospitalisations (made real for most by Covid-19), etc. The knowledge of insurance has certainty grown beyond relieving the fear of risk-averse individuals in buying cars or acquiring real estate.
To strengthen this link, AIICO has been adopting what we call a ‘sector-led growth strategy’, where we monitor economic developments in sub sectors (e.g. SMEs), and design products that match the particular needs of individuals and businesses within the subsector. As more and more members of the mass market segment become included in the financial services sector, insurance is likely to become more dominant, not only amongst the middle-income segment, but across all strata of the income pyramid.
RK: We’ve studied the impact of the pandemic on insurance markets in Europe and US, and we’ve seen that insurers have been significantly stressed. Equity prices of life insurers feel more than the market and even more than the banking sector, highlighting the risks associated with minimum return guarantees and the low for long environment. Tunde, has there been a similar impact in Nigeria or has the insurance market responded differently? Why do you think this is?
BF: I believe the Nigerian experience has not been a unique one. As with other global economies, we were hit by a twin shock – the pandemic and oil price crises. As the effects of the pandemic hit the crude oil market around March, the Nigerian stock market joined the rest of the world in a global financial market crash, falling more than 20% by the end of the first quarter of 2020. As a result, sentiments towards equities weakened, impacting all major sectors especially in Q1.
In terms of the stress levels for life insurers, it will largely depend on the product mix, level of digitalisation, and distribution strategy. Life insurers with long term liabilities, with guarantees, must manage the liabilities and the assets backing these liabilities effectively, especially in the lower interest rate environment.
However, there is also a general increased risk perception for mortality and morbidity risks. So, while the margins for investments products have reduced for new businesses, there is also demand for risk-based products that have a lower dependency on investment income.
Generally, companies with a higher saving/ investments and retirements products portfolio, will have increased stress levels than those with mainly risk-based products. That being said, insurance penetration is still very low in Nigeria, and there is significant room for growth.
As of September 2020, the banking sector had a year-to-date return of -13.02%, while the insurance sector had returned 10.32%. The insurance equity prices have responded differently. This might not be due to the underlying economics of the business. Many companies embarked on corporate actions this year to meet the ongoing recapitalisation deadlines of the regulator.
Additionally, the banks have more market liquidity that is widely held by the foreign institutional investors, therefore, when there’s negative information on the Nigerian macros, the banking stocks and consequently the sector, will suffer more than most.
It is also worth highlighting that insurance stocks in Nigeria have generally traded at discounts to book value for a variety of reasons, including complexity of insurance operations and financials. It tends to be less liquid, and as a result, there is less price movement opportunities.
