Zeti Akhtar Aziz: Transforming the East Asian insurers - time for action
now
Keynote speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
26th East Asian Insurance Congress "Transforming the East Asian insurers - time for action
now", Kuala Lumpur, 30 October 2012.
* * *
It is my great pleasure to join you this morning at this 26th East Asian Insurance Congress. It
was almost 24 years ago in 1988 that Malaysia hosted this event. Since that time, the global
and regional financial and economic landscape has been dramatically transformed. During
this period the world has also experienced more than a hundred financial crises, with the
recent global financial crisis being the most severe. This has prompted wide ranging financial
reforms by the international community to strengthen the resilience of the financial sector.
The enhancements to the regulatory and supervisory frameworks have also had a far
reaching and fundamental impact on how insurers manage risks in their businesses. In this
highly dynamic and more challenging global environment, the insurance industry has
continued to evolve and develop with the broadening of the product range and greater
diversification of the distribution system.
In Malaysia, the insurance industry, including the Takaful sector has also progressed
significantly during this period, both in terms of growth and development. In this more recent
decade, the penetration rate, as measured by the number of life policies to total population,
increased significantly to 55 percent, from 31 percent in 2000. Total premiums to GDP
increased from 4.1 percent to 4.5 percent over the same period. Structural reforms
undertaken has also transitioned the industry towards more market-based pricing
mechanisms in key market segments, improved efficiencies in the insurance eco-system,
and a strengthened framework for consumer protection. These trends have also been
reinforced by liberalisation measures which aim to support and catalyse the further
development of the industry. A proposed new legislation for our financial sector is also now
well advanced and will provide a solid foundation for the insurance industry going forward.
This event is taking place at a time of significant change and in a period of transition into a
new era for the financial services industry. We can reflect on these developments in the
industry and take the opportunity to learn from the different experiences in the region. While
we face different challenges and priorities, the insurance industry in the East Asian
economies share three important common goals - sustaining growth and performance under
more challenging economic and financial conditions, strengthening the capacity to support
and drive economic transformation, and building resilience to withstand future shocks and
economic cycles. As we turn our minds to these goals, the question before us is: how should
the insurance industry in East Asia, in the period ahead, respond to these demands?
In envisioning the future direction of the industry in our own region, it would be constructive
for us to reflect on the evolution of the modern insurance industry and contextualise it to our
own prevailing and prospective environment. The modern insurance industry came with the
maritime expansion which accompanied cross-border trade activity, and the rapid
urbanisation which saw significant human and economic losses experienced during the
Great Fire of London. This led to the establishment of the first fire insurance company and
the invention of the building blocks for life insurance as we know it today. Then, as societies
became more affluent, endowment and with-profit policies grew in significance as
instruments for savings. As industrialisation and urbanization intensified, the break down of
traditional systems of social protection prompted the expansion of insurance products that
covered retirement, accident, medical care and unemployment.
Throughout the 20th century, business models have continued to evolve in tandem with the
higher levels of financial literacy, rising consumer expectations and advancements in
technology. As competition compressed margins, there was a migration beyond tied-agency
and commission-based distribution models to include fee-based financial advisors and direct
marketing. Bancassurance and the participation of retailers in insurance distribution have
also allowed insurers to significantly expand their reach with lower cost structures, while
specialisation along the value-chain enabled even greater efficiencies. This more diverse
landscape has enabled a much wider and deeper penetration of insurance in the advanced
economies.
While these trends are shaping the evolution of the East Asian insurance industry today,
several other factors also need to be taken into account. First is the much faster pace at
which these forces of change are taking place in East Asia. Second is the significantly more
demanding regulatory environment in which insurers now operate. And third is the impact of
climate change. This thus calls for a greater urgency in responding to these developments.
Allow me to elaborate on these factors given their potential to have an important bearing on
the industry's focus and priorities in navigating its future growth path in the region.
On the first point, the growth trajectory for the demand for insurance products and services in
East Asia over the medium term will be much higher than the path that history implies. The
global volume of cross-border trade has almost tripled since 2000. In addition, intra-regional
trade within Asia is projected to account for an increasingly larger share of this expanding
world trade. Further liberalisation and greater regional economic and financial integration in
Asia will reinforce this trend. This presents substantial opportunities for East Asian insurers
to support the growing trade activities. After decades of strong growth, the Asian region is
also now the home to a middle income population of 500 million. This number is projected to
increase by more than six-fold to 3 billion by 2030. The OECD also projects that by 2020,
Asian consumers will account for 40 percent of global consumption.
Within Asia, structural reforms have also increased the importance of domestic sources of
growth. Asia's rising domestic demand needs to be supported by the development of a much
broader range of financing options for healthcare, education and retirement. This will result in
the reduced need for high levels of precautionary savings, which in turn will contribute
towards strengthening domestic demand. In addition, with rapid industrialisation, Asia is also
experiencing an unprecedented rate of urbanisation. Between 1990 and 2010, Asia-Pacific's
urban population increased from 29 percent to 43 percent. It is projected that another
1.1 billion people will be living in cities over the next 20 years, increasing the urban
population to 55 percent by 2030.
The region will also be faced with an ageing population in the years ahead, with Asia
accounting for 62 percent of the global elderly population by 2050. This transition is already
experienced in countries like Japan, South Korea and Hong Kong. But other countries in the
region are also converging at a fast rate. Fundamental reforms in social and economic
policies are now being pursued by most governments in the region to avert the risk that
Asia's population will "grow old before growing rich". Such reforms seek to achieve higher
levels of income needed to sustain adequate provisions for welfare as the effects of ageing
on the workforce and as rising healthcare and pension costs begin to set in.
During this recent two decades, there has also been a discernible shift towards voluntary
private provision for healthcare and retirement, including defined contribution pension
schemes, given the rapid increase in life expectancy and medical care costs. This trend will
become more pronounced as the need to broaden the coverage of welfare is taking place in
an environment in which fiscal consolidation is being pursued. As of 2009, the value of
private pension funds in 19 OECD countries was almost 50 percent of aggregate national
income. Despite this, the IMF estimates that global pension liabilities could be
underestimated by up to 50 percent of 2010 GDP. Efforts to close this gap will need to
include measures that result in greater risk sharing between governments, pension providers
and individuals, the development of capital markets to better support the increasing
longevity, and extending the retirement age to be in tandem with the longer life span. While
these trends present enormous opportunities for the insurance industry, it also presents the
important challenge of building the capacity to support new, larger, more complex and more
concentrated risks within a much more compressed timeframe. Risk management, product
development and underwriting capabilities will be particularly important at the institutional
level while at the system-wide level, closer attention will be needed to enhance the financial
safety nets for the protection of policyholders and to avoid economic and social dislocations
in the event of large-scale insurance failures. In the advanced economies, the insurance
industry built such capacity over four centuries. Asia will have a much shorter time to achieve
the same, in order and to ensure that the growth does not outstrip the industry's capacity to
manage the associated risks.
This brings me to the second point which relates to the impact that the global financial crisis
and the ensuing international regulatory reforms are having on the insurance industry. While
insurance companies have generally held up well through the crisis, the industry now finds
itself at the intersection of major regulatory developments. The crisis has also delivered a
major blow to confidence in financial institutions. This needs to be regained. Both these
factors will have an important influence on the way in which the industry responds to new
insurance and asset accumulation opportunities in Asia. We can expect that the
characteristics of growth in the industry going forward will therefore differ in some respects
from the historical experience.
The changes in the capital rules and related accounting standards aim to achieve a more
risk-based and market consistent valuations of insurance assets and liabilities. While this
should improve understanding and accounting for the risks inherent in insurance business, it
will also require insurers to more carefully manage risk and capital, while recognizing the
prospect for increased short-term volatility. Going forward, innovations in insurance solutions
will also need to take into account the higher regulatory expectations for more transparency,
stronger financial buffers against unexpected losses and the requirements to do more to
ensure that products offered are suitable to the different customer segments. Regulators will
also be applying a much higher level of scrutiny on complex insurance products that increase
risks to financial stability. Simplifying insurance products and institutional structures, and
creating a strong risk culture in which managing risks is a shared responsibility within
institutions, will be important goals to ensure that the risks facing an insurer are well
understood and effectively managed.
The third point concerns the far reaching implications of climate change for the insurance
industry. This also calls for the industry to pursue a different path from what history has
shown in determining the growth strategies for the future. Climate change has been
described as one of the biggest risks to the insurance industry. The cost of climate change,
without action, is estimated to be at least 5% of global GDP each year, not to mention its
significant impact on human society. Some of the effects of climate change are already being
felt in increased frequency and severity of weather related natural disasters, water scarcity
and crop failures. Asia's exposure to climate change effects is also anticipated to increase. In
2011, Asian countries accounted for 70 percent of 380 billion US dollars in economic losses
from natural disasters, however only a quarter of that was insured. The recent floods in
Thailand in 2011, was one of the costliest catastrophes in history. As insurance penetration
rises across Asia, property insurers will face greater concentration of exposures to natural
disasters. Life insurers will also be impacted in other ways, including higher incidences of
diseases while also experiencing pressures on long term returns on investment.
The insurance industry therefore needs to be able to manage such exposures as well as act
as a catalyst for societies to adapt to such climate change. Risk management systems in
particular, needs to be able to capture and aggregate exposures to such event risks in a
timely manner. Also important is to incentivise efficient energy use through innovative
product design and pricing. In addition, the industry needs to come together to seek out
opportunities to partner with government and non-governmental organisations to facilitate
improvements in urban planning, infrastructure design and building codes.
The integration of environmental and social considerations in insurers' corporate strategies
and operations will clearly become increasingly important to long-term sustainability. This
must also include a sustained focus on financial inclusion to achieve balanced and equitable
growth. Important is to ensure that all households continue to have meaningful access to
financial products and services and that even for those that currently have financial access
that they do not become financially excluded especially in an environment where financial
products and services are becoming increasingly unaffordable or complex.
It is estimated that up to 4 billion people worldwide require low-cost insurance protection. The
low-income population in the Asia-Pacific accounts for about 70% of the global low income
population. The need for protection from illnesses, natural disasters and other perils is more
acute for this vulnerable segment. Although Asia now accounts for most of the global
microinsurance market, covering between 350 to 400 million people the overall participation
rate is still low due to liquidity constraints in this segment of households, low financial literacy
and business models that are not inclined towards such low-income segments. Innovative
solutions and continued efforts to improve financial education will be needed to achieve
greater inroads in this area.
The trends that are shaping the socio-economic landscape in East Asia suggest continued
positive growth prospects for the insurance industry. This is despite a more modest outlook
for the global economy. Indeed, the insurance industry will assume a much larger role in
providing the essential financial underpinnings for economic activity and social development
in Asia by addressing the wide range of risks that businesses and individuals face in this new
and more challenging environment. While historical experience in the development of
modern insurance presents a path for the future growth of the insurance industry in East
Asia, there are also other important ingredients for sustainable growth going forward. The
ability of insurers to internalize the new realities of the business and to execute strategies
that are aligned with these realities will provide the strongest assurance for growth with
stability as the industry looks ahead to the future. With a clear view of the important role that
insurers have in serving and supporting the economy, there is every potential for this to be
realised.