Opportunities in an evolving market

Transcription

1 KPMG IN RUSSIA AND THE CIS Opportunities in an evolving market KPMG survey of the insurance market in Russia 2011 INSURANCE

2 Contents Foreword 3 Executive summary and keynotes 4 KPMG survey of the insurance market in Russia Introduction 8 Market and strategy 9 Consolidation and M&A 17 IFRS and operations 20 Regulatory and tax 24 Conclusion 28 Appendix. Profile of companies 29

3 Foreword I am delighted to provide you with our second annual survey of the insurance market in Russia, Opportunities in an evolving market, for Like last year, our survey captures the views of senior executives at Russia s leading insurers on the economic and regulatory drivers affecting the ongoing transformation of the maturing market. The analysis provided is based on collated data from a questionnaire distributed to Russia s leading insurance companies. We would like to take this opportunity to thank them for taking the time to complete the questionnaire. The companies they represent have a market share of approximately 45% (compared to 40% in 2010) in terms of annual written premium. The market saw tangible recovery in 2010 and is poised for further growth supported by imminent regulatory measures such as the upcoming new compulsory insurance classes and mandatory IFRS reporting. Moreover, good potential remains for increasing penetration in the non-motor segments in light of the ongoing general economic recovery. Despite the positive outlook for growth in 2011 and beyond, profi tability on the whole is still comparatively low. This is mainly due to the ongoing pressure on rates, primarily from intense competition among players. To improve profitability and remain competitive in the market s next phase of development, companies must address their operational effi ciency and professionalism in service. We invite you to explore in more detail these and other themes covered in our survey. As always, my colleagues and I would welcome the opportunity to debate our fi ndings with you. Adrian Quinton Partner, Head of Insurance and Actuarial Services, Russia and the CIS June 2011 KPMG survey of the insurance market in Russia 2011 / June 2011 / 3

4 Executive summary and keynotes Growth outlook Executives expect the market to grow by 6-10% on average in Growth rates will differ substantially between the leading players and the rest of the market. 65% of respondents expect the top 10 companies to grow at a rate of more than 10%. Only 31% forecast a growth rate in excess of 10% for the other players. Most respondents (83%) agree that the other players will not be able to catch up with the top 10 in terms of growth rate in the foreseeable future. Increasing levels of credit and the upcoming introduction of new compulsory classes are expected to be the key contributors to growth by 89% and 83% of respondents respectively. The pace of future growth will be supported by regulatory drivers and the return of demand in light of the ongoing economic recovery. We expect that in future the top 10 will continue to increase their market share at rates consistently higher than those of the other companies due to significantly better positioning and scale. Profitability Most respondents argue that profitability remains low and is unlikely to increase in Non-motor segments are the main contributors to profit margins. Over 80% of the executives cited insurance rate cuts, high operating expenses, excessive commissions and operational ineffi ciency as the main drivers of poor profi tability. of respondents expect profi tability to remain at levels in Only 5% expect profitability to defi nitely increase in In 2011, most respondents expect combined ratios to exceed 100% for motor classes and be below 90% for the non-motor segments. We believe that profitability will remain low at least for the remainder of 2011 due to the following reasons: Companies will increasingly compete on quality, and substantial investment will be required to upgrade operations to enable this, which will in turn reduce margins. A new wave of competition for market share among the top 20 players is likely and this will add pressure on profitability. Rate cuts and insufficient reserving in will overshadow profitability despite the ongoing recovery in the premium. Distribution In view of excessive commissions, most executives intend to reduce reliance on external intermediaries. Direct sales and bancassurance are the preferred channels going forward. 83% of companies will increasingly make use of bancassurance. 78% will increase reliance on the direct insurance channel. 89% of respondents confi rmed that bancassurance will play a signifi cant part in the shaping and growth of the market. We expect that the companies will continue to reduce reliance on external intermediaries, particularly in the case of retail lines. Bancassurance remains largely untapped in Russia and represents a signifi cant lifeline for small and medium businesses. The development of the bancassurance market could take another 3-4 years, by the end of which the industry could see signifi cant unifi cation of insurance and banking services. Operational efficiency and professionalism Most of the companies intend to upgrade IT systems and core operations and improve staff professionalism. In 2011 the majority of respondents intend to upgrade IT solutions across most core operating areas. Operating expenses and acquisition costs are the main focus areas for 83% and 67% of executives respectively. 72% of companies plan to centralize operations and would like to improve procurement processes. 78% of respondents stated that their companies plan to focus on training and talent management. As much as 89% of executives will focus on Client Relationship Management. Though the crisis prompted the companies to reconsider the importance of quality operations, many were unable to fi nd resources to adequately address this. These factors will become increasingly important in the maturing market, as insurers will be required to operate leaner and customers will become more sophisticated. 4 / Opportunities in an evolving market

5 Consolidation and M&A Respondents expect consolidation to be supported by market conditions and regulatory measures. Participants expect M&A activity from both domestic and foreign insurers to remain idle in Respondents said that consolidation would be sustained through absorption of business by the leading players (94%), withdrawal and bankruptcy of the less fi nancially stable insurers (83%) and rising capital requirements (78%). Most of the companies (over 70%) do not expect to carry out any M&A activity in % of participants are of the view that valuation multiples will not exceed 2.0 times premium in Consolidation is a key trend of the Russian insurance market, and we expect consolidation to continue but not as rapidly as expected due to the following reasons: Companies appear to have been resilient to the crisis, as the percentage of businesses withdrawing in 2010 was 13%, up slightly on in 2009 (FSIS data) 1. The current market recovery will mean some underperforming insurers remain afl oat. The closure process for companies that do not meet the increased statutory charter capital requirements due to come in effect on 1 January 2012 may take longer than expected. 1 Inbound M&A is possible in the remainder of 2011 but is likely to be low due to a cautious outlook by foreign players. Furthermore, the share of foreign capital across the entire insurance industry as at 1 January 2011 has reached 23%, and the current quota is 25% (referent.ru). Regulation A good majority of executives are genuinely supportive of the new regulatory measures and also would like to see regulation progress towards that of the European solvency regime for insurers. 78% of respondents agree that the upcoming requirement for IFRS reporting will benefi t the industry and most stakeholders. would prefer to delay implementation of IFRS by 2-3 years to allow time for preparation and roll-out. of executives support the introduction of the new compulsory classes but say that this is not the only initiative required to promote market growth. Only of respondents agree that the current regulations do not require signifi cant changes. of participants stated that they would like to see regulation converge with the solvency regime practiced in Europe Many respondents commented that they would oppose the potentially excessive tariff regulation of the new compulsory classes. IFRS will soon become mandatory for all insurers that prepare consolidated accounts. At the same time, the expected introduction of the new compulsory classes signals a strong intent by the government to raise the profi le of the insurance industry. We believe that the regulatory measures will bring progressive changes that will in the long run outweigh some of the challenges that may arise, such as the uncertainty over profi tability of the new compulsory classes. Penetration Respondents cite the general economic recovery as the main factor that will close the penetration gap, particularly in the non-motor segments. Over 80% of respondents view general economic growth and economic reform and the potential regulation of insurance coverage as the key contributors to improving insurance coverage penetration and density. Judging by the comments received, most executives would like to see additional tax incentives to stimulate penetration further. Commercial and industrial risks are closely linked to Russia s most successful industries, offering signifi cant potential for closing the insurance penetration gap. In addition, there remains ample opportunity for upgrading existing insurance products and broadening the range of associated services. FSIS Federal Service for Insurance Supervision KPMG survey of the insurance market in Russia 2011 / June 2011 / 5

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7 KPMG survey of the insurance market in Russia 2011

8 Introduction Over the years the Russian insurance market has evolved to represent a formidable industry ranked 11th in the world in nominal premium terms based on data (Lloyds) 2. The market contains 625 insurers as at January 2011 and is fairly concentrated, with the top 20 and top 10 holding a 69% share and 54% share respectively as at 2010, a trend that is gaining momentum. The insurance industry (excluding Obligatory Medical Insurance) contracted by 12% in late 2008 and 2009, putting signifi cant fi nancial pressure on businesses. The unfavourable conditions led to severe cost-cutting measures being put in place while companies strove retain business at all costs, reducing rates and increasing commissions to prohibitive levels at times. In 2010 the industry experienced a convincing recovery echoing that of the general economy, and the market surpassed 2008 levels in nominal terms. To attain recovery in real terms, though, the market requires consistent growth at rates above 10% for at least the next 3 years. Various regulatory measures in the pipeline will support the growth outlook; these are covered in more detail below: A four-fold increase in statutory charter capital requirements, effective from 1 January 2012 The implementation of the new law on consolidated reporting, under which insurers that prepare consolidated accounts are expected to compile IFRS accounts as early as 2012 or 2013 The upcoming introduction of the new compulsory classes such as Carrier TPL, Fire and Agriculture The extension of OSAGO limits, with a corresponding correction to tariffs We explore the views of our respondents on these and other key themes, in the following sections: Market and strategy; Consolidation and M&A; IFRS and operations; Regulatory and tax. 2 ondon.co.uk 8 / Opportunities in an evolving market

9 Market and strategy Market dynamics premium A third () of the respondents believe that the top 10 have fully recovered from the crisis, while none shared this view for the other players. How would you describe the state of the market across segments Top 10 companies and Other companies in 2011? This contrasts with the pessimist outlook of the 2010 study when only 21% of respondents expected premiums to increase, while the remaining majority forecast further contraction. How much will the market grow by in 2011 compared to 2010 in terms of the gross written premium (excluding Obligatory Medical Insurance)? Top 10 Other The peak of the crisis has passed and the market has just started to recover The crisis has not passed, but recovery is expected soon The market has fully recovered from the crisis and is showing signs of stable growth The crisis continues to adversely impact the insurance market and recovery is not yet to be seen Top 10 Other Above 10% Between and 10% Less than 5% Difficult to say Most participants (83%) believe that the top 10 players will grow at rates consistently above the rest of the market. How would you describe future expectations of market growth across market tiers? 83% The top 10 players will grow at a rate consistently above the rest of the market and other companies stand little chance of catching up with them in the foreseeable future Outlook The crisis encouraged the migration of business towards the established brands. The top 10 and top 20 companies held 54.4% and 68.5% of the market respectively by the end of 2010, with the total market share of the top 10 up further from 52.5% in The top 10 have distinct advantages of scale and reach and are far better positioned to withstand competitive pressures. Therefore, we expect that the leading group will continue to concentrate their market share and to increase premium levels at rates higher than that of the other companies. The top 10 players and players ranked above top 10 could achieve similar growth rates in the future, as mid-tier entities will reposition themselves as leaders in certain insurance sectors It is difficult to say how the grow rates will vary between players in the future as the market continues to evolve to a significant degree In providing their outlook for premium growth in 2011, 65% respondents stated that the top 10 would grow at rates above 10%, whereas only 31% predicted this for the other players. KPMG survey of the insurance market in Russia 2011 / June 2011 / 9

10 Growth drivers Increasing levels of credit and the upcoming introduction of the new compulsory classes were cited as playing a signifi cant part in the market recovery by 89% and 83% of executives respectively. Interestingly, improvement in the insurance culture is seen as a strong driver by only of respondents this year compared to a much higher 79% in the 2010 survey. In addition, the respondents provided their own suggestions for measures to boost market growth and appeal: Expansion of the client base A favourable economic climate Establishment of real tax incentives for life and savings products Reduction in the repetitive monitoring of insurers and bancassurance arrangements by the FSIS and the FAS respectively Return of foreign investment, expertise and technology Improved fi nancial transparency Liberalisation of the OMTPL (OSAGO) segment Although the introduction of the new compulsory insurance classes will raise awareness and demand for insurance, their excessive tariff regulation may hit profi tability. Which factors are instrumental to drive growth and the attractiveness of the market (strong/not strong influence)? Strong Not strong a) Introduction of new compulsory classes of insurance 83% b) Increase in real insurance rates (above inflation) c) Improvement in the demand structure 67% d) Increase in the volume of bank lending 89% e) Rebound in demand for insurance f) Customer preferences and the insurance culture 72% g) State-driven reform of the insurance market h) Implementation of accounting in compliance with IFRS i) Implementation of statutory actuarial audit 72% 10 / Opportunities in an evolving market

11 Market profitability Insurance profitability in Russia has been historically low due to the high level of investment in business infrastructure and comparatively high commissions. The recent economic downturn eroded profits further, resulting in a return on equity of only based on 2010 data (Expert RA) compared to the global average for insurers of 12.7% (Dow Jones). Most respondents to our survey cited the following as the main reasons for the lower than otherwise profitability: Market-driven insurance rate cuts (94%) Excessive operating expenses (78%) High commissions (67%) Ineffi cient operations () Some of the respondents added that the regulator needed to pay more attention to the downward spiral of price-cutting, which is resulting in destructive competition. They explained this by referring to a situation where reputable insurers were being displaced from the market in favour of risky players who offered prohibitively low rates insuffi cient to meet obligations. What are the key reasons for the lower than otherwise profitability of the insurance market in Russia (high/low)? High Low a) Excess claims due to fraud b) Excess claims due to shortcomings in the risk management framework c) Effi ciency in business processes d) High costs of new business placement (for example sales commission) 67% e) Excessive costs of other non-insurance expenditure 78% f) Actual state of the market, for example the recent discounting of insurance rates g) Regulation of the market 94% In view of the above factors, of respondents expect margins to remain low and similar to levels, while only 5% expect profi tability to increase. How might the profitability of insurance business in Russia change in 2011 and onwards? 5% Outlook During the crisis, rates fell signifi cantly while expenses continued to increase, all the more so in the case of commissions. This often caused loss-making business to be written, and the 2010 market recovery, in our view, has not been extensive enough to counter the effect. Therefore, profi tability will continue to be overshadowed at least for the remainder of Continue to decrease Remain on a level similar to that experienced during Likely to increase Defi nitely will increase KPMG survey of the insurance market in Russia 2011 / June 2011 / 11

12 Impact of crisis on strategy Over two-thirds of the companies (67%) surveyed have stuck to their long-term strategy and altered only their short-term strategy to meet the challenges imposed by the crisis. The contracting market resulted in companies rapidly undertaking cost-cutting exercises, under which price and commission were most often the only strategic options available. The situation compelled players to revisit the previously ignored exorbitant operating expenses and increase professionalism to achieve strategic differentiation on factors other than price. Most respondents confirmed that they would prioritize the following areas of their businesses in the short term: Client relationship processes (89%) Talent management and staff training (78%) Risk management, including the actuarial and the underwriting functions (67%) Cost management and operations (67%) How would you describe the influence of the financial crisis on your company s strategy? 67% 5% The crisis did not really impact our company s strategy The crisis impacted our short-term strategy, but not our long-term strategic outlook Both the short-term and the long-term strategy were influenced by the crisis In view of the crisis, which areas of your business, based on the list below, do you intend to focus on in 2011 in terms of higher priority or lower priority? Higher Lower a) Finance and accounting b) Investments and asset-liability management c) Risk management including the actuarial and the underwriting functions d) Cost management 67% 67% e) Distribution f) Products g) Customer relationship management 89% h) Fraud and forensics i) Talent management 78% j) Tax and regulatory compliance k) Strategy and capital Outlook Qualified and trained staff and client-oriented service are a major competitive advantage, and this is what the industry has lacked historically. We were pleased to see businesses putting the development of these areas at the top of their agenda and believe that those who succeed will secure a leading competitive edge. 12 / Opportunities in an evolving market

13 Risk areas Insurers faced multiple risks associated with the adverse economic climate. The liquidity crisis and credit risks eventually led to the withdrawal of 89 players in 2010 (FSIS data) 3. In 2011 most of the companies surveyed (72% and 67% of respondents respectively) will address operational risks and claims risks as a priority. This is sensible since these two risk categories directly impact the bottom line. a) Premium risk b) Reserve risk In terms of risk management, which risks do you intend to concentrate on to a greater or lesser degree in 2011? Greater Lesser c) Claims risk 67% d) Currency risk e) Operations risk 72% f) Fraud risk g) Reinsurance risk h) Market risk i) Litigation risk Outlook The other risk areas should not be discounted. The market recovery provides a good opportunity for the companies to modernize core functions such as risk management, actuarial, fi nance and treasury. Risk management capabilities in these will become increasingly important. 3 KPMG survey of the insurance market in Russia 2011 / June 2011 / 13

14 Distribution management Distributors eroded the value of insurance business during the crisis as many players were pushed into paying unreasonable commissions to retain business. Insurers had to reduce their dependency on external intermediaries and turned to direct sales and tied agents. Most respondents will increase the use of banks (83%), direct sales (78%) and tied agents () as the principal distribution mechanisms in the near term. The tendency to improving tied distribution networks was also confi rmed in the previous study, when 47% of respondents intended to develop direct sales capabilities. Which distribution channels are you planning to use more of/less of or completely stop using in the near future (more/less/stop)? More Less Stop a) Direct sales 78% b) Banking channels 83% c) Car dealers d) Own agents e) Brokers f) Independent agents Outlook Although direct connection with the end client is a major buying factor in Russia, distribution requires further optimization. A good example of this is the growing bancassurance market, which remains largely untapped, with motor and homeowners representing signifi cant growth potential. 14 / Opportunities in an evolving market

15 Segments The Russian insurance market is dominated by motor insurance, which also happens to be the least profi table segment on average (KPMG analysis) 4. This is partly explained by the regulation of OMTPL (OSAGO) tariffs and the highly competitive nature of the voluntary car insurance (CASCO) market, one of the fi rst segments to develop. Most respondents believe that non-motor classes (except voluntary medical insurance (VMI)) will be profi table in 2011, while CASCO and OSAGO will remain less profi table. The lower margins VMI are explained by the sharp reduction in spending on employee benefi ts by the companies during the crisis, which led to signifi cant price reductions. Which insurance classes are expected to be the most profitable/least profitable for your company in 2011? Most profi table Least profitable a) Voluntary Car Insurance (CASCO) b) Compulsory Motor Third Party Liability Insurance (OSAGO) c) Voluntary Medical Insurance d) Casualty and accident insurance e) Retail property insurance f) Corporate property insurance g) Life insurance h) Construction Risks insurance i) Liability insurance j) Financial Risks insurance k) Agriculture l) Aircraft, Marine, and Space insurance Outlook Russia s car market could grow to 50 million units by 2015 (Autostat) 5 potentially making Russia Europe s biggest auto market. Growth in car sales supported by the recovery of credit will boost motor insurance growth in the medium term. In early 2010 we predicted that as much as 40% of overall growth would be attributed to the motor segment over the next 4 years (KPMG analysis). It will be up to the players to manage administration costs and streamline operations to recover additional profits from the business intake. For non-motor segments, the quality of risk coverage is likely to be aligned towards global best practice and this may reduce the historically higher margins of these under-penetrated classes. 4 The Russian Insurance Market review. KPMG analysis, November KPMG survey of the insurance market in Russia 2011 / June 2011 / 15

16 Operating results In light of the interplay between lower insurance rates and excessive commissions in and the rising claims, the average combined ratio for the market exceeded 100% for all classes in the fi rst half of 2010 (Expert RA). Most respondents expect the combined ratios for the non-motor segments to be below 90%, while for the CASCO segment the majority predicts the combined ratios to exceed 100% in Most executives have not seen any signifi cant changes in this indicator over 2010 and 2011 across all segments, while a minority expects the combined ratio to improve in the VMI and Property classes. Outlook The combined ratios will remain under pressure in 2011 as the impact of lossmaking business and inadequate reserving during has not yet been fully absorbed by the market. Please select ranges, based on best expectations, for the IFRS combined ratio per insurance class in (<90%/90 to 100%/>100%) a) Combined portfolio (excluding OMI) b) Voluntary Car Insurance (Casco) c) Compulsory Motor Third Party Liability (OSAGO) d) Voluntary Medical Insurance e) Retail property insurance f) Corporate Property insurance g) Liability insurance h) Other classes (excluding those listed above) < 90% 90% 100% > 100% 16 / Opportunities in an evolving market

17 Consolidation and M&A The market has been consolidating steadily over the years but remains largely fragmented, with 625 insurers registered as at January 2011 (FSIS data). The insurance boom period of saw many foreign players enter the market. The onset of the crisis prompted international insurers to reconsider their risk positions, and pipeline acquisitions were put on hold as a result. One would have expected the diffi cult economic climate to displace a substantial number of the smaller and less fi nancial stable players. However, the proportion of registered insurers decreased by 13% in 2010, up slightly on in 2009, implying that some businesses may have been kept artifi cially afl oat. Almost all respondents expect that consolidation will be supported by the migration of business towards established players (94%), withdrawal and bankruptcy of the less fi nancially stable insurers (83%) and rising capital requirements (78%). Please rank the below trends in 2011 as unlikely, in-between or very likely (likely/neutral/not likely) a) Entry of new foreign players on the market b) Absorption of market share by larger domestic players through M&A c) Absorption of market share by larger players through the loss of business by smaller insurers 94% d) Withdrawal of licenses and the bankruptcy of less financially stable insurers 83% e) Withdrawal of insurers due to anticipated non-compliance with the new charter capital requirements 78% f) No significant changes in market activity referred to above, relative to % Not likely Neutral Likely KPMG survey of the insurance market in Russia 2011 / June 2011 / 17

18 Interestingly, based on 2010 data Expert RA 6 predicts that about 100 (approximately 15% of the market) will not meet the new minimum capital requirements when these come into effect on 1 January We feel that consolidation, though a prominent trend in the market, will not be as rapid as expected, due to a combination of the following factors: Companies appear to have been resilient to the crisis judging by the lower than expected number of withdrawals. The current market recovery will mean underperforming insurers remain afl oat. The closure process for companies that do not meet the new capital requirements may take longer. The leading players see no real need for M&A and prefer organic absorption of new business to paying over the odds at times for potentially loss-making portfolios. For the majority, this view was unchanged from the previous survey, and many players do not expect to carry out any M&A activity in M&A in insurance was idle in 2009 and 2010 relative to the pre-crisis period. M&A activity continued in the form of the consolidation under a single legal entity of affi liates of leading universal players as well as a few in-bound transactions. The most prominent of domestic deals was Rosgosstrakh s buy-out of a 13.1% government stake in October Which of the below M&A options is your company likely to consider in 2011 (very likely/neutral/less likely)? Likely Neutral Not likely a) Acquisition of smaller Moscow-based companies 67% b) Acquisition of smaller regional companies 67% c) Acquisition of smaller companies offering niche insurance products 67% d) Acquisition of distressed companies 72% e) Potential merger with comparable company 67% f) Outbound M&A in nearby markets 72% g) Other opportunistic acquisitions in insurance h) No M&A activity Outlook There will not be signifi cant open bid transactions among domestic players in the remainder of 2011 given the sentiments expressed by the respondents. With regard to cross-border transactions, foreign investors have reassessed the risks and may remain cautious on entering the market in light of the current volatility of the economy. In addition, the share of foreign capital across the entire insurance industry has reached 23% as at 1 January 2011, which may be an additional barrier given the current quota of 25%. It remains to be seen whether the quota limit will be lifted on its own or in connection with Russia s planned entry into the World Trade Organization / Opportunities in an evolving market

19 Valuation multiples In light of the weakening of the market, the premium valuation multiples decreased from 2.9 in June 2008 to a range of during April 2010 to October 2010 (KPMG analysis) 7. Over 90% of respondents do not expect multiples to exceed 2.0 times premium while only believe that a top 10 company would receive a valuation of higher than 2.0. The outlook for 2011 is similar to the respondents retrospective opinion of valuation multiples for 2010 shown below. Please enter a value for your indicative assessment of the ratio (multiple) Market Value of the Company/GWP for insurance companies in based on their size (0 to 1/1 to 2/above 2) > a) Top 10 ranked companies b) Companies ranked 11 to 30 c) Companies ranked 30 and below 78% 67% Outlook While premium volume remains a dominant factor in the valuation, other factors such as profitability and financial stability are becoming increasingly important, reflecting the maturity of the market. Due to the relatively heterogeneous nature of insurers it is difficult to forecast multiples, as the deals conducted in may not have been fully representative of the value (KPMG analysis), and each transaction should be taken on its own merit. Based on our observations (KPMG analysis) we expect that the valuation will not exceed a range of times the premium for the remainder of 2011 in view of the volatility present in the recovering market. 8 The Russian Insurance Market review. KPMG analysis, November KPMG survey of the insurance market in Russia 2011 / June 2011 / 19

20 IFRS and operations In view of the ongoing transition towards IFRS in Russia, a new law, On consolidated fi nancial statements, was adopted on July 27, The Law requires that consolidated fi nancial statements be prepared in accordance with IFRS, as of the end of the year following the year of offi cial endorsement of IFRS in Russia. The Law directly affects insurers, fi nancial institutions and listed entities that prepare consolidated statements. As of February 2011 IFRS has been endorsed by a government decree as the accepted framework for accounting in Russia. Implementation, however, remains subject to the fi nalization of the adoption procedures, notably the approval of an expert committee yet to be established. Depending on the progress with the adoption procedures, there are reasonable expectations that insurers that prepare consolidated accounts could be mandated to prepare IFRS reporting from as early as 2012 or An earlier study by us in 2009 revealed that up to 40% of the top insurers had not prepared IFRS statements for the 2008 reporting period (KPMG analysis) 9. This implies that penetration in IFRS reporting in the insurance industry remains comparatively low relative to banks, and the regulatory measures described above are set to bring about signifi cant reform of the fi nance function. We asked our participants to share their views on the upcoming introduction of IFRS reporting. A good majority (60%) agree that IFRS will benefi t all stakeholders in the insurance community, from shareholders to the regulator. Please select who you think will derive more benefit from the introduction of mandatory IFRS accounting (more benefit/less benefit)? More benefi t Less benefi t a) Shareholders b) Regulator c) Group/Company management 78% 83% 89% d) Clients e) Business partners At the same time feel that implementation will be a costly process requiring signifi cant organizational change. In your opinion, are the following statements True of False, with due account of the impending implementation of mandatory IFRS accounting? True False a) IFRS implementation is a costly exercise b) IFRS implementation will speed up market consolidation c) IFRS is a key measure for the market, but not the only measure 72% d) IFRS will not lead to significant market changes e) Market is not yet at the required state of readiness for IFRS f) Most stakeholders will benefit from IFRS implementation 78% 9 The Russian Insurance Market review. KPMG analysis, November / Opportunities in an evolving market

21 This year even more executives (78% compared to 68% in the previous study) agree that IFRS will benefi t most stakeholders. In view of the costs and preparation involved and the requirement to fi nalise adoption procedures, more than half of respondents () would prefer to defer implementation to What do you consider to be the best time for introducing mandatory IFRS accounting in view of the recently passed law on consolidated reporting? 5% As soon as possible ( ), as the market is reasonably ready Outlook IFRS reporting will bring major benefi ts including greater corporate governance and fi nancial transparency alongside uniformity of fi nancial presentation. Importantly, IFRS implementation will support the functioning of the capital market and widen the scope of opportunities for attaining additional capital. Access to fresh capital is a key factor considering the need for the Russian insurance industry to upgrade systems and operations. The adoption of IFRS requires thorough preparation, resources and specialist expertise and the insurance market needs to gear up for IFRS deployment. The longer term benefi ts will be substantial, however, and will by far outweigh the initial hurdles to implementation. Between , as the market is partially ready but more time is needed for preparation After 2015 as the market needs to evolve further and significantly more time is needed for preparation KPMG survey of the insurance market in Russia 2011 / June 2011 / 21

22 IFRS 4 Phase 2 A lengthy and challenging process has been undertaken by the international accounting industry to create a truly global standard for insurance reporting. The new IFRS 4 will provide a more robust platform for accounting for insurance contracts. Implementation will bring fundamental changes to the measurement of contractual cashfl ows, incorporating advanced cashfl ow modelling, and life businesses will be particularly affected. It is expected that the fi nal standard will be published in the third quarter of 2011 and become effective no earlier than In response to our question on the level of awareness of the new reporting framework, only 13% of our respondents stated that they are currently familiar with the provisions of the Exposure Draft IFRS 4. The implementation of the new standard requires specialist expertise, predominantly that of actuaries, and we encourage companies to become familiar with the issues soon to allow suffi cient time for preparation. Please describe your Company s awareness of Exposure Draft IFRS 4 (IFRS 4 ED), which are currently being considered by the International Accounting Standards Board (IASB) 81% 13% Very familiar Aware of the general principles being introduced Less familiar Operational efficiency The level of non-insurance costs in Russia is one of the highest in Europe (KPMG analysis) 10 and companies require serious operational redesign, notably upgraded IT, to streamline activities and curb operating expenses. As responses show, most respondents intend to modernize most areas of their operations in terms of IT. Please select which IT solutions in your company you intend to introduce or modernize or keep unchanged in 2011 (no solution in place, keep unchanged/keep unchanged/introduce or modernize) No solution in place Keep uncharged Introduce or modernize a) Finance and accounting systems b) Risk management systems c) Claims and policy administration systems 78% d) Customer relationship systems 78% e) Cost management and cost allocation systems f) Fraud and forensic systems The penetration of IT systems is low in Russia, and many companies do not yet have reasonably centralized electronic accounting and claims processing systems. The players that take advantage of the recovering market and allocate resources to address their operational needs in good time will gain a signifi cant strategic advantage. In terms of additional streamlining options, 72% of companies plan to centralize operations and would like to improve procurement processes. 10 The Russian Insurance Market review. KPMG analysis, November / Opportunities in an evolving market

23 Please select the additional options relating to the operations that you intend to implement in 2011 a) Direct cost cuts, like office downgrade b) Optimization of procurement processes c) Outsourcing of certain activities (for example, a call-center) d) Centralization of certain services (for example, through a shared service center) e) Decentralization of certain services (for example, the relocation of certain services from head office to regions) 72% Operating expenses and acquisition expenses will be the major focus areas for the companies according to 83% and 67% of respondents respectively. Please highlight which of the areas below you intend to manage to a greater or lesser degree in 2011 Greater Lesser a) Acquisition costs 67% b) Claims handling expenses c) General operating expenses 83% d) Reinsurance costs e) Investment income Technology in insurance is a major competitive differentiator. We are pleased to see that most of the companies surveyed intend to modernize core operations to improve their competitive edge. KPMG survey of the insurance market in Russia 2011 / June 2011 / 23

24 Regulatory and tax The government has been promoting insurance as an important mechanism for socio-economic development. Recent improvements in the supervisory monitoring of insurers, concrete plans to introduce new compulsory classes, as well as the quadrupling of the minimum charter capital requirements (to 120 million RUB as at 1 January 2012) are some of the main examples of this. More than half () of respondents agree that the introduction of the new compulsory segments is an important initiative but not the sole measure required to boost the insurance market. We share their view, as the new compulsory segments will undoubtedly raise the profile of the industry and boost demand not only for the compulsory classes but also for associated voluntary products. Excessive tariff regulation, however, may have an undesired effect, and the regulator should set tariffs on a realistic actuarial basis and allow reasonable margins to counter the risk spread. Most respondents are also generally supportive of some of the other key regulatory measures to be implemented in the near term. What is your opinion of the impending introduction of new compulsory insurance classes? New compulsory classes are an imperative measure and can be regarded as the single key factor that could significantly contribute to market improvements New compulsory classes are an important measure, but should not be regarded as the sole factor The introduction of such classes will act only as a temporary measure and in due course such classes must become voluntary The implementation of new compulsory classes will not really contribute to the market s development What is your feeling on the regulatory initiatives below (positive/neutral/not so positive)? Positive Neutral Not so positive a) Increase in minimum charter capital requirements 94% b) Implementation of IFRS accounting 72% c) Introduction of new compulsory classes 72% d) Increased focus by the FSIS (Federal Services for Insurance Supervisory) on the financial stability of insurers e) Introduction of statutory actuarial audit f) Public disclosure of the shareholder structure of insurers 67% g) Moves towards regulating the terms and conditions of insurance agreements Based on the comments received, the participants are in favour of: Supervision of solvency Monitoring of reserve adequacy Addressing fi nancial stability 24 / Opportunities in an evolving market

25 However, they oppose: Excessive tariff regulation Repetitive FSIS monitoring Rigid regulation of the conditions of insurance contracts for mass-market products Interestingly, the respondents were divided on the suggestion of introducing a mandatory actuarial audit, with supporting this. The requirement for a third party actuarial audit is signifi cant and is widely practiced in other jurisdictions. As in the previous study, the mood of most respondents is that regulation could be improved further. Only agree that the current regulatory practice does not require signifi cant changes, while a good majority () would like regulation to converge with the solvency regime practiced in Europe. What are your views on potential improvements to the regulation of the insurance sector in Russia? a) Regulation does not require significant changes other than ongoing ad-hoc improvements b) Regulation should be updated to incorporate elements of a risk-based capital regime c) Regulation should be updated to be more in line with the European Solvency regime d) Regulation should be updated to incorporate the applicable elements practiced in other comparative emerging markets, for example, reasonable regulation of prices and commissions in voluntary insurance e) Regulation on the whole requires significant redesign in order to better fit the market The European Solvency 2 framework will bring about major improvements to the architecture of the regulatory and operational environment for insurance in Europe. Due to multiple revisions to the framework the deadline for implementation is likely to be postponed to 1 January 2013 (source: European Comission) 11. Although the regime largely does not affect Russian insurers, it will be useful for the industry players to implement non-market-specifi c directives to improve their competitive standing KPMG survey of the insurance market in Russia 2011 / June 2011 / 25

26 Will amendments to the Russian Tax Code in respect of transfer pricing and in particular, provisions on the disclosure of related party transactions, which are expected to come in force in , impact your business? 5% Yes, the planned changes will impact transfer pricing issues at our Company No, the initiatives will not have any direct effect Not sure With regard to tax legislation, the government plans to introduce amendments to the Russian Tax Code concerning transfer pricing in The main changes are expected to cover the defi nition of related parties and controlled transactions, as well as oversight and reporting for such transactions. The amendments will primarily affect medium and large holding groups, including insurance companies. At present, just 5% of respondents believe the amendments will affect their activities. At the same time, found it diffi cult to answer this question, and therefore we recommend that companies that have not yet familiarized themselves with the imminent amendments do so soon. 26 / Opportunities in an evolving market

27 Other questions In 2009 Russia spent about 3% of GDP on insurance, which is comparable to the other BRIC countries but signifi cantly lower than the average for Europe of 6.1% (KPMG analysis). The corresponding insurance density expressed as penetration per capita was almost eightfold lower than the European average in 2009 (source KPMG analysis). Commercial and industrial risks are closely linked to Russia s most successful industries, presenting signifi cant opportunities for closing the insurance penetration gap. Most respondents believe that general economic growth (83%), regulation of insurance cover taken out by businesses (78%), and upgrading Russia s infrastructure () are the key drivers to increasing the take-up of commercial and industrial insurance. Which factors in your view will stimulate to a greater or lesser degree the impetus to the growth in penetration and depth of types of coverage of commercial and industrial insurance in Russia (for example, loss of profit, financial risks, industrial risk)? Greater Lesser a) General economic growth and economic reform 83% b) Capital adequacy and on-shore capacity of insurers c) Availability of quality industry data d) Customer perceptions, the culture of insurance and education e) Level of foreign direct investment f) Input from foreign brokers and intermediaries, such as Lloyds 78% g) Upgrading of Russia s infrastructure h) Regulation of insurance cover taken by organizations and businesses 78% i) Regulation of activities of brokers and intermediaries j) Regulation of insurers and the insurance sector In addition, the executives provided their own suggestions for additional drivers of insurance market growth: Improvement of tax incentives for insurance Less monitoring from the FSIS Convergence of the regulatory framework with that of Europe Liberalisation of CMTPL (OSAGO) tariffs Additional capital Another important driver is improvement in insurance culture, which was highlighted as a prominent factor by respondents to our survey last year. Outlook Alongside the good potential for broadening the product range in the non-motor segment, the appetite for niche and specialist insurance is also likely to grow as businesses develop and require more sophisticated types of insurance to meet operational needs. The rest of the development is likely to come from regulatory measures, such as the new compulsory classes, which will stimulate demand and awareness of insurance. Lastly, the return of economic stability is likely to reignite interest in retirement and life products, which have traditionally had a low take-up. KPMG survey of the insurance market in Russia 2011 / June 2011 / 27

28 Conclusion As the market continues its steady recovery, both businesses and the regulator face multiple challenges to improve further insurance penetration and insurance culture in Russia. Going forward, profi tability will largely be determined by the companies professionalism of service and quality of operations, and risk management. Despite the challenges that remain, the local insurance industry has evolved comparatively quickly into a sizeable market by world standards without too much external help. This means that the market has what it takes to take development to the next level and we look forward to seeing how the dynamics of the market unfold over the next 3 years, also in light of the upcoming regulations. 28 / Opportunities in an evolving market

29 Appendix. Profile of companies Classification Most the companies surveyed (74%) write non-life business. The distribution of companies surveyed is about even between the top 20 and the rest of the market. Companies classified by business segment Companies classified by market position 2 74% Life Non-life 53% 47% Top 20 Other KPMG survey of the insurance market in Russia 2011 / June 2011 / 29

30 Contact us Adrian Quinton Head of Insurance and Actuarial Services Partner T: + 7 (495) F: + 7 (495) E: aquinton@kpmg.ru Mikhail Klementiev Financial Services, Tax and Legal Partner T: + 7 (495) F: + 7 (495) E: mklementiev@kpmg.ru Alexander Pyatkov Performance and Technology Director T: + 7 (495) F: + 7 (495) E: apyatkov@kpmg.ru Eduard Cherkin Transactions and Restructuring Associate Director T: + 7 (495) F: + 7 (495) E: echerkin@kpmg.ru Philip Sementsov Actuarial services Senior Manager T: + 7 (495) F: + 7 (495) E: psementsov@kpmg.ru Natalia Kozhevnikova Financial Services, Audit Senior Manager T: + 7 (495) F: + 7 (495) E: nkozhevnikova@kpmg.ru The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation ZAO KPMG, a company incorporated under the Laws of the Russian Federation, a subsidiary of KPMG Europe LLP, and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Russia. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.