Brazil: Growing Pains In A Newly "Opened" Reinsurance Market

Last Updated: 10 March 2010
Article by M. Machua Millett

Over the last year, we have discussed in detail the operation of "cession limits" and "right of first refusal" such that the "opening" of the Brazilian reinsurance market clearly had its limits. Even after the "opening," certain clear benefits remained in favor of the government-owned former monopoly holder and other insurance and reinsurance companies willing to establish locally. In 2009 and early 2010, several regulatory changes occurred to affect both of these requirements, some planned, others instituted in reaction to emerging market conditions:

  • Brazilian law previously imposed a 10% limit on total annual premiums that a local insurer could cede to an occasional foreign reinsurer. In April 2009, however, SUSEP relaxed that limitation significantly, but only as to two lines of business. By Resolution No. 203/09, published in the Diario Oficial on April 29, 2009, SUSEP raised the cession limit to occasional foreign reinsurers to 25% for surety and petroleum risk business. Resolution No. 203/09, which became effective as of its publication date, did not indicate the reason for the special treatment of the surety and petroleum risk lines or indicate whether or not any similar relaxation of the cession limit can be expected in any other lines. Despite the lack of official comment, the resolution is likely the result of pressure from the local market due to insufficient reinsurance capacity for petroleum risk and surety lines from local and admitted insurers. The move brought some comment from local observers that cession limits should be relaxed as to other lines of insurance as well. No such further relaxation of cession limits occurred through the end of 2009, but raises interesting issues about the relationship between lobbying efforts by local companies and the interests of foreign reinsurers.
  • As of Sunday January 17, 2010, foreign reinsurers are now permitted access to a larger portion of the Brazilian reinsurance market as local reinsurers' right of first refusal was reduced from 60% of risks in the market to only 40%. The change was automatically triggered by the passage of three years since the enactment of Supplemental Law 126, which first opened the Brazilian reinsurance market to foreign competition. Among the issues to watch in regard to this fundamental change in the market (more than half of risk was previously subject to the right of first refusal as opposed to less than half as of January 17), is the effect upon the profitability and competitiveness of IRB Re-Brasil and the other local reinsurers.
  • In the Fall of 2009, SUSEP also released Circular No. 392 confirming the requirements for purchase of foreign insurance and which lines of insurance may be purchased in foreign currency. SUSEP confirmed that foreign insurance may not be purchased by a Brazilian company unless it has previously received ten (10) declinations from Brazilian insurance companies. In the case of lines of business in which fewer than ten Brazilian insurers offer cover, the Brazilian company must obtain declinations from each of the Brazilian insurers offering such cover. SUSEP also reiterated that the proposal rejected by the local insurers must mirror the proposal presented to the foreign insurer. Circular No. 392 also confirms that certain lines of insurance may be purchased with foreign currency, including the following: export credit; aviation; satellite; international transport; marine hull (with some limitation); petroleum risks; certain engineering risks concerning public projects; and certain types of civil responsibility, including Directors and Officers liability insurance, "green card" (obligatory insurance of owners and drivers of vehicles), international transport liability, product liability and recall insurance concerning foreign products and hangar cover.

In an unrelated, but interesting move, one expressly designed to stimulate competition and reduce prices for personal lines insurance, the Brazilian government removed the previously existing prohibition against life insurers selling home and personal casualty insurance. The regulatory change is the first step in the implementation of the "Minha Casa, Minha Vida" (My House, My Life) program created by Article 79 of Law No. 11.977. Further implementing regulations are expected to be published in the Diario Oficial de Uniao in the coming days. This initiative is further evidence of SUSEP's willingness to make fundamental regulatory changes where supported by local players as representing a benefit for local consumers and companies.

Taken together, these regulatory pronouncements indicate that any further liberalization of the Brazilian insurance and reinsurance market is likely to come slowly and in response largely to local market realities rather than foreign pressure. SUSEP appears committed to its position regarding 10 declinations before accessing direct foreign cover, which essentially acts as a barrier to any real level of excess and surplus-lines type insurance in Brazil. Furthermore, no further liberalizations are mandated by the existing reinsurance regulatory framework and SUSEP has made no indication that it intends to undertake any further relaxing of cession limits or the right of first refusal. Therefore, absent a need dictated by the local insurance and reinsurance market, any further regulatory changes in favor of foreign insurers and reinsurers seem unlikely in the near term.

The Role of IRB-Brasil Re

Another question surrounding the opening of the Brazilian reinsurance market was what impact it would have upon the IRB-Brasil Re, which formerly held a monopoly over the industry. Early in 2010, the president of IRB-Brasil Re, Eduardo Nakao, reportedly commented that the reinsurance market opening had had less impact than expected, with the IRB maintaining 90% of its business since the opening in April 2008. Nakao reportedly further stated that the IRB maintained a significant market advantage based upon its history and experience in the market and that the company intended to compete with recent foreign entrants to the market by improving customer service and developing new and tailored solutions. The confident declaration was a bit misleading at the time given that, although the market was technically opened in April 2008, the IRB continued to benefit from a marked advantage through the end of December 2008 in that it was permitted to retrocede to any foreign reinsurer, while other participants could only retrocede to reinsurers authorized by the Brazilian regulator.

Nonetheless, the IRB did actively fight to maintain its dominant market share in 2009, releasing a variety of new products and seeking to compete with its new foreign competitors on price and service. In the first half of the year, the IRB released three new products providing personal health and provide coverage for daily expenses during hospital stays, discounts for good health and an early-pay-out in the event of serious illness, respectively. The company also announced plans to release new products in the areas of credit, D&O, energy and mortgage lending, as well as to expand its agricultural reinsurance offerings. In conjunction with its announcements, the IRB continued to indicate that it intended to continue to fight aggressively to protect its market share against the new crop of foreign competitors. Asked about the released health products, Mr. Nakao reportedly stated that "IRB understands that it's natural to lose relative market share, given the entrance of new competitors, but [it] can't ignore the growth in [the personal lines] segment, which comes as a result of better income distribution and pent-up demand for some products."

Indeed, the IRB was largely successful in 2009 in maintaining its market share, seeing its position decline only to 90% of the local market in 2008, 80% in the first five (5) months of 2009 and 78.5% after the first 8 months. These efforts, however, appear to have come at a significant negative impact to the IRB's bottom line:

  • In the first half of 2009, the IRB's earnings totaled only US$ 25.6, down 55.7% from the first half of 2008. This decline occurred despite the IRB's earned premiums increasing 6.24% for the same period. The decline was largely attributable to the company's increased loss ratio, which reached 89.1% for the period, nearly 20 points higher than its loss ratio for the first half of 2008. The IRB attributed the increased loss ratio to several large claims related to factory fires and industrial engineering.
  • For the first 8 months of 2009, the IRB reported that its profits were down 58.5% when compared to the same period in 2008. A major contributor to the trend was the tremendous growth in claims seen by the IRB. Over the first eight months of 2009, IRB's claims totaled R$ 910 million, up 31.4% over the first eight months of 2008. By comparison, IRB's earned premiums grew only 1.9% over the same period. Of the other local reinsurers in the Brazilian market, Munich Re Brazil led the way with 9.3% of the local market, followed by J. Malucelli Re (5.7%), XL Re Brazil (3.7%) and Mapfre Re Brazil (2.7%).

In early 2010, reports emerged that the Brazilian federal government has decided to reduce its control of the IRB in a move that some have been referring to somewhat misleadingly as "privatization" of the entity. The government would reportedly maintain significant control of the entity through a "golden share" arrangement, but would reduce its equity position in the entity below the majority ownership that it currently maintains. Furthermore, under the reported plan, the federal government's majority interest in IRB Re Brasil would be transferred to the Banco do Brasil, which is also federally-owned. It is not at all clear that the private interest in the entity, currently at 41% split among a number of private insurance companies, would change at all, though there is some discussion in media reports of "greater private participation" in the entity in IRB Re Brasil in the future.

Despite these ongoing discussions about Banco do Brasil taking a position in IRB, the negative earnings/profit results heightened perceptions that the IRB may not be able to profitably compete in the long run with foreign competitors in the absence of a significant overhaul of its underwriting practices. The central question is whether shifting of control to Banco do Brasil will lead to such changes aimed toward maintaining profitability rather than simply market share.

Merger Mania

Another trend in the Brazilian market that continued in 2009 was high numbers of mergers and cooperative agreements. These transactions took principally three forms, each interesting for their own reasons: (1) mergers of local companies; (2) acquisition of full or partial interests in local companies by foreign interests; and (3) cooperative agreements between foreign companies and local companies.

In the first category, local insurers combined to increase their reach and diversity to compete in the market and local banks acquired local insurance interests in order to participate in the booming insurance industry. In addition to the Banco do Brasil/IRB deal discussed above, another example is the Porto Seguro/Itau Unibanco deal:

  • One of Brazil's largest insurers, Porto Seguro S.A. ("Porto Seguro"), and one of the country's leading private banks, Itau Unibanco Holding S.A. ("Itau Unibanco"), agreed to merge their residential and auto-insurance operations. The merged entity, which will retain the Porto Seguro name, will be controlled by a new holding company to be called Porto Seguro Itau Unibanco Participacoes (PSIUPAR). It will become Brazil's largest auto and residential insurer, with more than three million auto policies and more than one million residential policies, and the third largest Brazilian insurer overall, behind Itau Unibanco's life-insurance unit and the insurance units of private bank Bradesco. The merger occurred despite the fact that Porto Seguro had just ended similar merger negotiations with Bradesco in a dispute over who would control the venture. Under terms of the merger agreement, the current controlling shareholders of Porto Seguro will hold a 57% stake in PSIUPAR. Itau Unibanco will hold the remaining 43%. PSIUPAR will retain a 70% stake in Porto Seguro, with the remaining 30% to be made available to the market. Announcement of the deal promptly drove up the share price of rival insurer Sul America on speculation that it would be involved in the next major Brazilian insurance merger, possibly with Bradesco.

In the second type of transaction, foreign companies acquired full or partial interests in local insurance companies so as to enter the market without having to build their Brazilian operations from scratch. Two examples are Sompo's acquisition of a 50% interest in Maritima and Santander's

  • In May 2009, Sompo Insurance Japan Inc., through its subsidiary Yasuda Seguros S.A., purchased 50% of Maritima Seguros S.A., Brazil's tenth-largest insurer by premium, for US$ 178.5 million. The transaction represents Sompo's largest-ever investment in an overseas insurance company. The company's press release recognized that among the primary benefits of the acquisition for Sompo was Maritima's "well-established brand in Brazil and a robust sales network of brokers and banks."
  • In March 2009, Spain's Santander bank purchased the remaining 50% of Real Tokio Marine Vida e Previdencia for US$ 284 million. Santander already owed the other 50% of the company through its Brazilian subsidiary ABN Amro Brasil Dois Participacoes. Santander also announced that it intends to invest some US$ 1.25 billion in its banking and insurance operations in Brazil in 2009 and 2010.

In the third type of deal, foreign companies entered into agreements with local companies that will permit the foreign companies to leverage local companies experience and name recognition in the local market, while permitting local partners to benefit from the international experience and larger stables of products offered by the foreign companies. These transactions also some times permitted the foreign companies to overcome certain Brazilian regulatory hurdles and limitations, no small factor in a system that maintains an impressive level of bureaucracy. The following are two examples:

  • Local Brazilian reinsurer JMalucelli Re and foreign admitted reinsurer Hannover Life Re announced early in 2009 that they had entered into a cooperation agreement to offer life and health reinsurance in the Brazilian market. The move had reciprocal benefits for the two companies: (1) Hannover Life Re can now, through the relationship, overcome certain of the market share limitations imposed by Brazilian regulations in the form of cession limits for foreign reinsurers and a "right of first refusal" in favor of local reinsurers; and (2) JMalucelli Re, which previously operated only in the area of guarantee reinsurance, will receive substantial know-how and technical support from Hannover Life Re in developing its life and health reinsurance business.
  • In December 2009, MAPFRE and Banco do Brasil announced plans to enter a strategic alliance to cooperate in the two entities' personal, general and auto insurance businesses in Brazil.

As a whole, these transactions reflect the tremendous interest in the opportunities evident in the Brazilian insurance and reinsurance market, and reflect a trend we expect to see continue into 2010 and beyond.

Looking Forward

As noted above, Susep predicted near the end of 2009 that the Brazilian insurance market will grow by an additional 16-20% in 2010. As discussed below, Brazil is expected to implement microinsurance legislation in 2010 that would make insurance products available to more than 20 million new customers. A number of other broader economic events during 2009 indicate that healthy growth can be expected in the near and long term:

  • After some stagnation in 2009, the overall Brazilian economy is expected to see a recovery in 2010. Any concern that the broader economy might hold back the growth of the nation's insurance market should therefore abate.
  • During 2009, the Brazilian government announced a series of large infrastructure development projects representing some of the most ambitious public improvement initiatives in the country's history. These projects will entail unprecedented levels of construction work in the coming years.
  • In October, Brazil was named as the host of the 2016 Summer Olympics, coming almost two years to the date from the announcement that the nation had been chosen as the host of the 2014 FIFA World Cup. Hosting these events will likewise require tremendous public and private investment in infrastructure and tourism.

Given these factors, and Brazil's already dominant position in the Latin American insurance market, there is little doubt that the country will remain a principal focus and entry point to the region for many foreign companies for years to come.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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