VOL. XLVII

No 19

10-May-2004

 

Iraq’s Restructured Insurance Market: A Critical Review

 

By Misbah G A Kamal

 

The following article was written for MEES by Misbah G A Kamal, an executive of the London-based United Insurance Brokers Ltd, who previously worked for the National Insurance Co, Baghdad. The article reflects the author’s personal views.

 

In July 2003, BearingPoint Inc, formerly KPMG Consulting, an American firm secured a $9mn contract from USAID to begin work on transforming various aspects of Iraq’s economy. In 2004, it secured another contract for $240mn to develop a competitive private sector in Iraq. Part of the work to be carried out included an assessment of Iraq’s insurance market and the drawing up of a plan to restructure operations and privatize the state-owned risk carriers.

 

Information On The Proposed Restructuring Of The Market

There is no public information on the work that has been carried out or the extent of public debate and consultation with Iraqi insurance practitioners save for soliciting the support of the management of the companies to provide data to the BearingPoint’s insurance expert. What has surfaced, however, is a simple diagram showing the reform timeline that runs from 1 November 2003 to 1 December 2004 and the steps that are to be taken during this period.

 

As at the time of writing, the market is made up of three state-owned risk carriers: the National Insurance Company (NIC), Iraq Insurance Company (IIC) and Iraq Reinsurance Company (IR) and four privately-owned companies that were set up under Law 21 of 1997: Al-Ahlia Insurance, Al-Hamra, Dar Al-Salam and Al-Ameen. Efforts are underway for the establishment of other private companies.

 

The first phase of the proposed reform should have started in November 2003 with a full audit of the NIC, IIC and IR. The scope of this audit has not been published and it is not known, for example, if it includes identification of the three companies’ credit and debt balances and their outstanding obligations. What has become clear is that the cash assets of the three companies were seized under UNSC Resolution 1483 on the ground that they belonged to the state and should be used for the reconstruction of Iraq. Two elements of the audit, as shown in the diagram, include (a) training of staff of the companies and (b) allocation of their assets among four specialist insurance vehicles yet to be created.

 

This phase also includes the setting up of a common reinsurance program for the three companies and taking steps to recreate the office of the insurance regulator. By 1 January 2004, the first phase should have been completed by allocating the assets of the three companies to four specially created specialist risk carriers:

Between March-April 2004, these companies could apply to the office of the insurance regulator for licenses to write other classes of business. This phase should also have seen the creation of the Insurance Association of Iraq (IAI), with members including all the chief executive officers of the four licensed companies and the four private companies as well as other companies that may be established after the completion of the restructuring program.  It is assumed that no new companies are to be licensed during this restructuring period. IAI’s remit includes insurance education for the market and the country, designing insurance policies, reviewing premiums charged, protecting policyholders’ rights, overseeing local and cross border activities (the administration of the Orange Card, which is the equivalent of the Green Card in Europe).

 

By 1 November 2004 licenses should have been granted by the regulator and the companies have written their business plans to negotiate their own reinsurance programs.

 

The breaking up of the three companies into specialist vehicles is dictated by the overall policy of the Coalition Provisional Authority (CPA) to privatize the two direct companies in two stages and abolish the reinsurance company as part of the BearingPoint plan for restructuring the Iraqi economy. A tranche of 49% of the capital of the four newly created companies will then be offered for public subscription, when they are set up, with the remaining 51% held by the state.  Later in the year, the state’s holding will be offered for public subscription.

 

There is no public document describing the radical changes to be introduced or detailing the economic justification and arguments in support of the reform and the break up of the two state-owned direct insurance companies into four specialist insurance vehicles and the abolition of IR.1

 

Specialist Risk Carriers: Privatization Under The Guise Of Reform

The proposals are crafted to privatize the state-owned insurance companies and abolish the reinsurance company by a ‘revolutionary’ order to be eventually signed by the CPA Administrator, Paul Bremer. In this regard, the proposals are no more than temporary measures since the ‘specialist’ companies will also disappear by virtue of their application for licenses to write all classes of insurance.

 

No such market arrangement was tried in other post-conflict markets. There are specialist insurance companies in developed markets and many continue to operate by selling a single product. The best example are life insurance companies and companies specializing in providing glass insurance (mainly local and these were common in the UK in the past); syndicates at Lloyd’s writing marine or aviation or non-marine business; and pools specializing in the insurance of land-based oil assets. Historically, the insurance industry in the UK evolved along specialist lines of insurance: boiler, fire, marine, life, etc before evolving to general insurance companies.

 

Insurance operations are based on the law of large numbers and in the absence of large discrete numbers, the outcome of underwriting might be ruinous to single-product insurers unless protective measures are taken in the form of selective underwriting, reinsurance protections and, where applicable, physical risk management.  Insurance density in Iraq,2 especially for personal lines, is low, one outcome of which is portfolio imbalance.  Unless the four specialist companies can develop sufficiently large portfolios within a short period, a series of large losses would lead to serious financial consequences and affect their solvency. This becomes a serious issue in the absence of reinsurance protection.3

 

A Critique Of Specialist Risk Carriers

Other considerations make specialist companies economically less desirable in the current Iraqi context.  In brief:

  1. Specialization has implications for the investment policy of a motor insurance company where frequency of losses and indemnification require high level of liquidity. Unlike other classes of insurance, the time lag in motor insurance between premium collection and claim payment is short. Thus, premiums cannot be quickly accumulated and made available for accumulating various reserves for claims payment and funds for investment – a source of additional revenue to insurers.
     

  2. Specialization deprives the company from cross subsidization. With multi-line insurance companies, when one class of business is hit by large losses and the reserves for that class is depleted, other more profitable classes can make up for the loss and maintain their solvency.
     

  3. The creation of specialist insurance companies deprives large clients from taking advantage of their bulk purchasing power that they can exercise when placing their insurance program with a multi-line insurer.  Such clients have to seek their insurance covers from more than one company and thereby adding to their administrative costs.
     

  4. The specialist insurance companies accentuate the imbalance in the market between the operating insurance companies: the private and the mixed companies that will be created (mixed in the sense of their ownership). The mixed companies, expected to inherit the rich reserves of the state-owned companies, will continue to be in a better position when competing with the privately owned companies.
     

  5. For shareholders, a multi-line insurer presents a better investment opportunity. A life insurance company has its own attraction because of the long term nature of the insurance contract and the actuarial control on the outcome of underwriting individual and group life policies. The same would not be true for the none-marine and aviation & marine companies. Motor insurance is amenable to a degree of actuarial control but under the present conditions of Iraq this is not possible.4
     

  6. The proposed creation of a life and pension insurance company is shortsighted. Demand for individual life insurance in Iraq has been historically low, reflecting, among other factors, the low level of disposable income available to the majority of the people. This is still valid in Iraq today and will continue for some time, but past experience suggests that a dedicated life insurance company has the potential to thrive within a few years. Pension insurance is a different proposition. At present there is no demand for private pension insurance policies. Presumably, this proposal is put forward in conjunction with ideas on the partial or total privatization of social security. Unless stability and security are restored and maintained, the pension scheme will remain dormant.
     

  7. The proposed motor insurance company presupposes the rewriting of the 1980 Law on Compulsory Insurance against Motor Accidents.5 As yet, no information on the rewriting of this or other insurance laws of Iraq has been published.

    This in itself raises serious questions about the intended reform of the market – that the reform is ill-thought, disregards economic realities of the country, ignores the past experience of Iraq’s insurance market during the past 50 years, the crippling impact of the decade-long UN sanctions,6 implicitly condemns the state-owned companies as failures. Furthermore, the period set for the restructuring of the market is unrealistic.
     

  8. A radical reform motivated by a drive towards privatization, as ideology and not economic necessity, ignores social implications in the form of the uncertainty it creates for those who are part of and dependant for their livelihood on the state insurance companies (managers and other staff). The economy is already in a crippled state and groaning under the scarcity of stability and security. One outcome of a speeded up privatization would be further redundancies that would add up to the already high level of unemployment.

    Additionally, if privatization coincides with opening up the sector to foreign investment, foreign capital will be in a much stronger position to outbid Iraqi capital for ownership.7 Iraq’s ‘capitalists’ need a breathing space to develop their resources to have an effective share in the equity of the state owned enterprises (in the industrial and service sectors) that are to be privatized.
     

  9. The creation of four specialist companies is not an end in itself aimed at benefiting from specialization, eg make up for shortage in skilled staff by combining the skill resources of the three state companies; pose a challenge to the existing private insurance companies to raise standards in open competition for business (after ending the exclusivity of state-owned companies in insuring state enterprises and transforming them into commercial entities8); contribute to the growth of the specialist classes of insurance they are assigned to undertake.
     

  10. The restructuring proposal has not taken on board the economic and management cost of creating the four specialist companies, allocating their assets, following up liabilities and reconciling accounts. It seems that the experience of merging insurance companies in the early 1960s has been forgotten.

Further Reflections

Based on the limited information available, as outlined above, it is difficult to pass judgment without knowing the full reasons behind this ambitious scheme in terms of its apparent radicalism and the timeline set for its achievement – a mere 12 months. The fundamental questions that should be asked is why this reform and for whose interests?

 

One does not know why Iraq Re is to disappear. One can be critical of the company but, as a past major regional reinsurer, it has played a role in the development of the Iraqi insurance market, eg additional facultative capacity and trained staff. Furthermore, during the 13-year UN sanctions, it has worked out an arrangement to provide a modest reinsurance protection to the other companies including the privately owned companies.  It has, like the other companies, lost qualified and trained staff to other markets in the Arab world, but that in itself is not a reason to abolish it. Is it too much for Iraq to have an integrated insurance market made up of direct and reinsurance companies and, in due course, supported by other services in the areas of insurance broking, valuation and loss adjusting? If the existing laws regulating the role of Iraq Re were oppressive, vis-à-vis the direct insurance companies, for example, they can be revised in line with the liberalization of the economy and its ownership reviewed: de-nationalized or become a mixed company.

 

The restructuring proposal is not aimed at developing an integrated insurance market; it is a simple means, making use of the UK model of privatization of public utilities, for privatizing the state owned insurance companies; an act which is fraught with legal implications under international law.  The restructuring has a limited objective, viz, privatization. The creation of the office of regulator (currently exercised by the Ministry of Finance) and the Insurance Association of Iraq (a logical development in markets with multiple insurers) does not lend greater support or justification to what is intended.  Indeed, by the time the reform period comes to an end, a mere 12 months when they become privately owned, the four specially created companies would be expected to operate as general insurance companies writing other classes of business.

 

The changes to be introduced do not arise from the requirements of the insurance market itself, pressures from the insured, the failure of the state owned insurance companies from honoring their commitments. They are ideologically driven and remind one of the programs of revolutionary parties of the past: revolution, destruction and rebuilding from scratch. Part of that program was achieved by the wonton destruction of swathes of the country’s infrastructure and other physical assets and the looting and asset stripping that followed. It seems that the state insurance companies have now to be ‘destroyed,’ in a fashion, to re-build them.

 

The CPA and those who support its policies are at fault if we apply the tests of democracy and liberal economy.  Changing institutions without proper public debate might be ‘revolutionary’ but is not consistent with democratic practice. The powers that be have wrested the right to determine the future of Iraqi institutions to themselves without meaningful participation, in this case, from members of the insurance community (the insured, insurers, reinsurers, economists and others concerned with public issues). Of equal significance is the role of market forces in determining the existence of companies and the outcome of competition, which are now to be replaced by ‘revolutionary orders’ from above.

 

The prime function of insurance is to provide protection against the financial consequences of contingent probable natural and man-made risks. The issue of ownership is secondary. In a previous paper,9 I referred to setting the scene for fair competition between the public and private insurance companies before embarking on privatization. Rehabilitation of the state owned insurance companies should contribute to raising their value, and hence upon their privatization the state would realize greater revenue from their sale that can make a small contribution to reducing the state’s budget deficit. In this regard, no alternatives have been put forward and assessed. A public debate among those concerned with the conditions and future of the insurance industry is bound to generate options.

 

The approach of the CPA, the effective ruler of Iraq, reminds one of the debates one used to have in the late 1960s and early 1970s over the issue of parliamentary process versus so-called revolutionary legitimacy.  The latter was thought to be fast and effective in transforming existing arrangements for the better compared with the slower democratic parliamentary process.  The consequences of that attitude have been disastrous to the Iraqi economy.10 The CPA appears to be acting in the manner of the discredited revolutionaries.  The neo-conservatives are in a rush to transform the world, paying little heed to unintended consequences.

 

A Concluding Remark

Reform should aim at integrating the insurance market with the financial sector (currently confined to banking and an underdeveloped stock exchange).  Together with banks, the insurance sector should play a role in financial intermediation: accumulating funds for economic development after meeting commitments to the insured. The insurance sector plays a more important role, other than financial intermediation, in protecting assets against the financial consequences of natural, legal and other liabilities and man-made disasters.  In this regard, the investible funds at the disposal of insurance companies should be accorded special consideration.

 

The Iraqi insurance market should be helped to reemerge from its stagnation irrespective of the form of company ownership, to respond to the challenges of insuring risks under the adverse conditions of the country, to be part of the planned reconstruction activities and to lay a solid foundation for the market’s growth and development. The apparently resigned attitude of the managers of the state owned insurance companies has meant that no meaningful debate is taking place on the future direction of the market.  Being under occupation does not mean resigning one’s independent line of thinking.  The terms for reforming Iraq’s insurance market should not be the exclusive preserve of highly paid foreign consultants.  Iraqi insurance practitioners should be properly consulted and have a say in the future direction of their market.

 

1. Email contacts were made with USAID and the insurance expert of BearingPoint in Iraq in this regard but to no avail.

 

2. Insurance density is an economic category denoting individual expenditure on buying insurance protection.  In effect, it expresses the aggregate of insurance premium income in a country relative to the size of the population.  This is contrasted with another indicator of current and potential state of an insurance market known as insurance penetration which measures the percentage of insurance premiums in the gross domestic product.

 

3. At present, and since 1990, the entire Iraqi insurance market has been operating without reinsurance support from the international market.  A promise has been made by a London-based American broking firm in December 2003 to negotiate a reinsurance program apparently for the state-owned companies but so far no concrete results have been achieved.  Another London-based broking from has developed a Marine Facility, which is supported in the Lloyd’s market and is operational, for the entirety of Iraq’s insurance market offering protection for the following risks: marine cargo risks, land transit risks, war risks, war on land risks and static terrorism risk.

 

4. No actuarial studies on motor insurance have been carried out in Iraq or for any other class of insurance.  Even the life tables used for life insurance in Iraq were not home grown but donated by a European professional reinsurance company in the early 1950s.

 

5. This law was based on the advanced concept of presumptive liability of motor vehicle users that goes beyond the no fault concept in that it replaces the contractual relation with legal relation between the insured and the insurer.  In 1988, the law was amended to allow for the collection of the insurance premium by a levy on the price of petrol bought by the motorists.  The administration of claims was assigned to the National Insurance Co.  The role of the latter has become the subject of criticism.

 

6. Misbah G A Kamal, ‘Insurance in Iraq and UN Sanctions,’ in Studies on the Iraqi Economy, a collection of papers in Arabic and English by several writers, published by the Iraqi Economic Forum (London 2002) pp 73-96.

 

7. One hastens to add that CPA Order Number 39 of 19 September 2003 regulating foreign investment in Iraq excluded the insurance sector from its provisions under Section 6: Areas of Foreign Investment.

 

8. The involvement of the state as a commercial party in insurance activities under the emerging open market conditions, contrary to past practice, mandates the legal separation of their activities from government policies and guarantees.  In effect, the state companies should become neutral vis-à-vis the state and should not enjoy a monopoly position at the expense of privately owned companies and should be governed by the regulatory regime applied to all insurers operating in the market.  Without such arrangement the market for insurance continues to be imperfect.
 

9. ‘Fragmentary Notes,’ for a seminar organised by the International Financial Services London, for the Iraqi Financial Services Delegation, London 2 December 2003.

 

10. On the broader level of the Iraqi economy, Dr S Z Al-Saadi has thrown light on the ‘voluntarism’ of the defunct dictatorship and its disregard for ‘economic laws’ in many of his studies, some of which have been published in MEES.  One can refer in particular to his ‘Economic Project for the Transformation of Iraq: the Alternative for the management of oil, development and democracy’ Al-Thakafa Al-Jadida, issue No 300/301 May-August 2001 and No 302 September-November 2001 and his latest contribution a monograph in Arabic: A Model of Economic Growth and Distribution in Iraq: Oil Wealth, Management of the Economy and Social Justice (Baghdad: Dar Al-Adeeb 2004)