Insurance sector needs to 'go back to basics'

Growth for the Middlesea Group is expected mostly from outside Malta in the coming years, especially from the Euro-Med region, according to Middlesea Group chairman Mario C. Grech.

"Malta is our base," he told The Sunday Times, "but it has its limitations. One has to be prudent to use the underlying capital in the best way to create business with a geographic spread and business mix. We are seeking to grow in overseas primary markets with an objective of planned growth and maximising profitability for our shareholders."

Mr Grech answered questions related to the group's final 2004 results, the local operating environment, the Middlesea Group's position in the local and international markets, the scope for future expansion, and the pensions White Paper.

"The final results showed that the Middlesea Group registered an operating profit on ordinary activities before tax of Lm2.21 million (€5.1m) for the year, compared to Lm1.38 million (€3.2m) as at December 31, 2003," Mr Grech pointed out.

"Gross premiums written were sustained at Lm36 million (€83m). This strong performance was registered also as a consequence of our revisiting important decisions taken by the holding company over recent years."

Four group companies, Middlesea Insurance plc (MSI), Middlesea Valletta Life Assurance Co. Ltd (MSV), Progress Assicurazioni SpA (Progress) and International Insurance Management Services Ltd (IIMS), were highlighted, since their operations "contributed positively to the overall result".

Mr Grech went out of his way to attribute the successful results, including a 44% increase in after-tax profits to Lm1.6 million, "primarily to the high professional standards of all senior executives and members of staff, ably led by the general management of the group companies".

These he mentioned by name - Joseph M. Rizzo (MSI), David G. Curmi (MSV), Stephen Gauci (Progress) and Anne Marie Tabone (IIMS). "This dynamic management team was complemented by the guidance afforded by the boards of directors, who bring a varied and wide experience in finance, commerce and professional disciplines," Mr Grech added.

The group's consistent strategy continues to be focused on providing a broad range of products through multi-channel distribution, applying technically correct pricing, ensuring adequate reserving and pursuing growth with a territorial spread and portfolio mix.

This, coupled with a policy to improve cost efficiency and the results from effective technical operations, enabled the delivery of a strong performance across the entire group in 2004. "Our professional discipline has helped us to achieve our operational projections for the year in highly competitive markets," he said.

The group registered a "considerable improvement" in the net underwriting result (NUR) of its technical operations, particularly in the motor class. Mr Grech said the NUR in this class had swung from a Lm0.44 million loss in 2003 to a Lm0.71 million surplus last year.

"The NUR over all classes of business registered a surplus of Lm0.70 million, compared to the Lm0.56 million loss in 2003."

The current market pricing on property business, however, remained inadequate, Mr Grech said, particularly when considering the high catastrophe reinsurance costs. The liability class registered a loss "mainly as a result of higher court awards.

"Our disciplined approach to underwriting and pricing, coupled with efficient claims handling, strict cost control, product innovation and focused customer service will ensure sustainability of improved results in the future.

"Besides the technical results, investment returns to any insurer are of significant importance to the overall result in any financial year. This applies to both general and long-term operations.

"Indeed, the importance of the result from the underlying investments to a life assurer directly impinges on the ability to declare bonuses from year to year to policyholders.

"In the case of a general insurer, the investment return contributes to the overall result, which ultimately has an effect on the decision to pay dividends to shareholders. Our investment policy is based on security, liquidity and maximisation of return.

"What remains of fundamental importance is adequate capitalisation, positive cash flow, correct pricing, adoption of corporate governance principles together with the application of corporate social responsibility."

Asked on the group's operating costs as a proportion of total income, he said this was 21%. "This is reflected in the combined operating ratio, which improved from 102% to 98%."

The Middlesea Group is streamlining functions and improving corporate processes by outsourcing non-technical operations to IIMS. "Additionally, IIMS is focusing on the generation of third party business (non-risk income) in the field of risk management and the management of captive insurance and reinsurance companies operating from Malta."

Turning to the local operating environment, Mr Grech said the market has experienced "a significant change" in recent years from one in which foreign insurance principals dominated to one led by indigenous insurers.

Whatever the situation, however, insurers, he pointed out, cannot take unquantifiable risks. "The bottom line is the deployment of an efficient capital structure to register a satisfactory technical net underwriting result to ensure a regular flow of profits," he said.

"By ensuring that it receives adequate premiums commensurate with the risk it carries, in essence the insurance sector has to adapt to continuous changes which will continue to affect technical and financial results of these indigenous insurers."

These changes include:

a) unlimited reinsurance protection is no longer available. Indeed, it has been withdrawn over recent years;

b) the terms and limitations of catastrophe reinsurance protection are constantly hardening;

c) reinsurers are shying away from proportional treaty business and are concentrating more on non-proportional business;

d) the international market has, over the years, experienced a strong consolidation of top quality reinsurers;

e) the introduction of a new International Financial Reporting Standard for insurance accounting and the updates of the International Accounting Standards; and

f) increased focus on risk management and capital adequacy (Solvency II).

"Therefore, the insurance sector no longer has an option: it has to go back to basics if it is to achieve the desired results," Mr Grech affirmed.

Both the local and international operating environment remain "highly competitive", he constantly stresses. This is even more so now with the "ease of cross-border transactions, complemented by the freedom of services within the European Union".

The Middlesea Group is no newcomer to the international market. It first became active as a reinsurer in London in the 1980s. This, Mr Grech said, helped create a professional image, gaining it respect in the international community.

"The reason why we decided to acquire a majority holding in Progress Assicurazioni SpA in 2000 was that this company was registered in an EU member state. We could not afford to wait for decisions to be taken at a political level in Malta and this investment has served as a platform to enter the EU.

"The operation has grown steadily and the intention is to continue to develop general business, and eventually long term business, in Italy and Sicily. Currently, 60% of the company's portfolio is generated from the South of Italy, and the remaining 40% from Sicily.

We believe that there are certain niche areas on the European mainland; indeed we are actively researching the development of such markets." One area, which MSV was researching, was life insurance. Mr Grech spoke with great enthusiasm of the growth prospects, referring to the current share of the Italian market as "a drop of a splash".

With regard to expansion into other areas of the Euro Med region, including North Africa, he said the group was continually seeking opportunities, which were tied to developments in the legislative base of these markets, pointing to the legislation introduced since 1994 to establish Malta as an international financial centre of high repute under the regulation of the Malta Financial Services Authority.

Middlesea Insurance's involvement in the international market made it closely examine its shareholding. From a situation where the initial shareholders were "predominantly parastatal companies and the Government, apart from the public, the shareholding has changed to one in which the main shareholders are financial institutions". Bank of Valletta has the largest chunk (21.65%), followed by the public (20.74%).

Spanish giant Corporación Mapfre has increased its shareholding to 20.69% after it acquired shares from the Government and Air Malta. Munich Re is next with 12.73%, the Government owns 7.93%, Assicurazioni Generali of Italy has 4.67%, various SICAVs own 9.79%, and Swiss Re Italia SpA and the Qatar Insurance Company owning 1% and 0.8%, respectively.

Middlesea In-surance plc's performance on the local stock market has to be put into the context of an exchange in which the volume of business is "thin", re flecting the size of the local capital market.

Mr Grech pointed to the company's sustained dividend payment over the past 21 consecutive years, a market capitalisation of Lm40 million (€92m) and Middlesea Group assets of Lm100.2 million (€230.6m) as at December 31, 2004.

The term "social impact" came up with regard to both motor insurance and pensions. With motor insurance internationally being compulsory, Mr Grech said it had become accepted that the management of the risk be transferred to the private insurance sector, which already operates in a free market.

Both the EU's fourth and fifth Motor Directives reflected this. "In the main, primary insurers use this difficult class of business as a spin-off for other types of personal insurances. In itself, motor insurance has always presented considerable challenges in attaining acceptable technical results."

In Malta, Mr Grech said there was an added limitation of size due to a lack of economies of scale. He pointed to the efforts of the Malta Insurance Association, which were instrumental in upgrading the professional level of the stakeholders in the sector through the Motor Insurance Repairs Efficiency (MIRE) project.

This has three objectives:

1. managing increased costs for repairs and spare parts;

2. improving the quality and upgrading standards of repairers with a focus on the important element of health and safety; and

3. improving the professional level of motor vehicle surveyors.

The association is in the process of transferring the duties of an approved system and licensing to the appropriate authorities with the aim of registering further improvement in these important areas.

"It is important to note that through the intervention of the association, capping was introduced in both the Civil Code and the Motor Vehicles Insurance (Third Party Risks) Ordinance," Mr Grech said. "These changes together with the EU Motor Directives were expected to impinge on future results for the overall liability class of business in Malta.

"Injury awards need to reflect economic reality and sustainability; otherwise, national competitivity will suffer."

On pensions, Mr Grech said the Middlesea Group's first foray was in April 1993 when it held a seminar on welfare gap problems entitled 'The Demographic Time Bomb'. The current Pensions White Paper provides good grounds for discussion with the stakeholders, he added.

"The main issues to be address are adequacy and sustainability," he said. "This is directly related to economic activity. It appears there is a consensus on this fundamental issue."

Mr Grech drew a distinction between the social aspect arising from solidarity in pensions and the "quasi-contractual relationship currently existing between the State and the citizens (contributors and pensioners)".

"Non-contributory pensions and related benefits are the main areas within the 'pensions concept' where the principle of solidarity applies. Indeed, this requires to be actuarially evaluated separately with the objective to ensure the redistribution of wealth to avoid anyone falling below the poverty line."

Looking at the three-tier model mentioned in the White Paper, Mr Grech said the first of the three-tier model must ensure the attainment of a revised, sustainable national pension (safety net) with the following considerations:

¤ special consideration for existing pensioners and those nearing retirement age;

¤ an increase in pensions based on price rather than wage inflation;

¤ the introduction of the same pensionable age for men and women (65), based on a steady transition over a period of years;

¤ enforcement to reduce abuse;

¤ computation to include in the model the effect of "years of service" and "level of contribution"; and

¤ a defined benefit (ceiling).

The second tier, tax-incentivised funded occupational pension could be optional initially. He suggested that collective agreements could be used as a medium for this optional introduction. Changes for consideration are:

¤ an optional entry approach;

¤ collective negotiation;

¤ removal of the National Insurance Act disincentive;

¤ a defined contribution basis; and

¤ a defined benefit (ceiling).

"It is important to note that while the second tier should be introduced, it may be optional in the initial years to give the opportunity for collective bargaining, with the removal of the disincentive within the current National Insurance Act relating to supplementary pensions over and above the first tier," Mr Grech said. "The fact that Government is the largest single employer carries further economic implications."

The third tier would be for personal retirement enhancement plans (through life savings and investment planning). Such 'retirement plans' are already in existence and should be retained and encouraged, he said.

Mr Grech stressed the distinction between pensions and annuities. "Pensions do not fall solely into the domain of the insurance sector but are offered by all financial institutions, while annuities are offered by licensed insurance providers.

"Advances in the medical field have assisted in increasing longevity. Thus we need to manage our wealth according to our circumstances ensuring sustainability of a standard of living throughout our lifetime.

"These changes will impact on the economy as a whole. Creating real economic wealth is the key to a workable, sustainable national pensions system. This is an issue that will affect us all in the long term and I am still of the opinion that a consensual approach from the highest level of Parliament to the various structures of society should take a direct interest in this important dialogue.

"It is encouraging to note that the White paper is giving utmost importance to the introduction of adequate statutory and regulatory considerations."

Looking ahead to the short and medium term, Mr Grech said the dynamism of the insurance sector both locally and internationally will continue to present challenges. "Middlesea's future direction is based on its clear strategy and absolute resolve to succeed," he said.

"This encourages us all to achieve further improved results, while remaining constantly on our guard to deal as best as we can with a continually changing scenario and its imponderables."

The Middlesea Group will continue to seek growth overseas. It already has a branch office in Gibraltar and Progress in southern Italy. "Now, more than ever, insight into tomorrow is the difference between success and failure. The past should only be looked at as a platform for learning purposes as the future should attract our attention.

"We should adopt a positive outlook by focusing our endeavours to maximise on positive opportunities which will continue to present themselves through the continuous process of 'change'."