THE IMPACT AND EXPECTED CHANGES TO INSURANCE AND TAKAFUL AFTER DETARIFFICATION IN MALAYSIA

Transcription

1 THE IMPACT AND EXPECTED CHANGES TO INSURANCE AND TAKAFUL AFTER DETARIFFICATION IN MALAYSIA Ahmad Alrazni Alshammari Othman Ibrahim Altwijry Dauda A. Asafa ABSTRACT This paper illustrates the expected changes in the insurance and takaful sector after detariffication in Malaysia. Detariffication is an important approach that purposes to enhance efficiency, technical capabilities and fairness among industry s participants. It has various advantages such as encouraging innovative products, robust claims control and increased competition while the disadvantages of detariffication may lead to insolvency among small participants, and premiums may be unreasonably priced. The researchers used the markets reaction experience of post implementation of detariffication from India and China. They are regional neighbours and their experience with detariffication is relatively recent compared to Europe. The study found the common changes witnessed in the insurance industry include increasing competition, removal of cross-subsidisation, cutting expenses and that it was difficult to find coverage for bad risks. Keywords: Detariffication, Deregulation, Takaful, Insurance, Malaysia 1.0 Introduction Detariffication and deregulation are established practices in various sectors such as electricity, telecommunication and insurance (Gamble et al., 2009). These terms are commonly used as synonyms, especially in the insurance industry. In the global insurance market, many countries are fully deregulated which means no tariffs are imposed on insurers/takaful operators such as Hong Kong, Indonesia and Singapore. Some countries apply partial deregulation where some business lines have tariffs and others do not, which is the case in Malaysia. Malaysia is moving towards detariffing its motor and fire classes in July where these business lines represented around 65% of the general industry in 2015 (BNM, 2016). This has led to a national awareness campaign launched by Persatuan Am Insurans Malaysia (PIAM) and Malaysia Takaful Association (MTA) to enlighten consumers on what they need to know when renewing or buying a new motor policy starting 1 July. However, there is still uncertainty about the impact and changes that may happen in the Malaysian market. Hence, the experience of other countries help us identify the common changes that occur after deregulation, such as the experience of the UK and Germany studied by Hussels & Ward (2007), Korea, Philippines, Taiwan, and Thailand by Boonyasai et al. (2002), Austria by Ennsfellner et al. (2004), China by Mazumdar & Malattia (2013) and India by Mittal (2016). This paper aims to identify the impact and expected changes that may occur in Malaysian insurance and takaful sector after detariffication. Its contribution promises to benefit the public, academia and regulators. For the public, understanding the concept of detariffication is essential because it has a direct impact on their wealth. For academia, the paper discusses the common changes that may occur in the Malaysian insurance and takaful sector after adoption detariffication. Further, regulators seek stability of the industry and exploring the experience of countries that applied detariffication may highlight challenges during implementation. The paper is organised into five sections. After the introduction, the second section provides the background and overview of detariffication and the reasons for its adoption. Furthermore, this section shows the advantages and disadvantages of detariffing and its impact on efficiency. The third section illustrates the experience of China and India, especially in the early years after detariffication. In addition, Malaysian practice is included with comparing the old system with the new. The fourth section highlights the common changes that may occur in the insurance and takaful sector after applying detariffication before drawing to a close in the conclusion. 2.0 Background of Detariffication 2.1 Detariffication Reasons for its Adoption An insurance regulatory body plays a crucial role in ensuring fairness and professionalism by overseeing the insurance market activities. It aims to have stable and efficient market players that contribute positively to the economy (Nektarios, 2010). In some cases, a regulator may be imposing tight restrictions on insurance players. This is known as a regulated market where the tariff rate is a fixed schedule of premium rates stated by the regulator where policy terms and conditions are applicable to risks in a class of business (Mittal, 2016). All insurers must follow this schedule, and any breach of tariff could incur heavy penalties. In contrast, restrictions can be eased. This is commonly known as deregulation or detariffication (Skipper, 1996). It aims to bring about competition among insurers/takaful operators to increase the efficiency of the market and reduce prices (Gamble et al., 2009). Detariffication gives insurers the freedom to determine the pricing of its policies without any restriction from regulators 7

2 whereby the pricing is based on the analysis of the insurer and the perception of risk. Detariffication is not only related to removing restrictions on premium rates but also abolishing the standard policy wordings where insurers and takaful operators can use their policy wordings (Shah, 2016). Tucci & Baker (2007) and BNM (2016) state that adopting detariffication consists of various objectives. The core objective is to improve efficiency through promoting flexibility in calculating premiums/contributions which will enhance the industry s competitiveness. Consequently, the main reaction of insurers/takaful operator is to improve underwriting and claims management to provide the best quality service to customers. Secondly, enhancing technical capabilities and competencies through encouraging professionalism where detariffication shall increase the cooperation within the industry in activating a fraud intelligence system to detect fraud and pushing intermediaries to become more skilful in achieving an efficient firm. It also promotes fairness through pricing the premiums/contributions based on the underlying risks by determining charging associated with risk profiles. In other words, it is fair for both customer and insurers/takaful operators where safe drivers will pay cheaper premiums/contributions compared to dangerous drivers who are considered riskier. The fairness element is represented in matching the risks carried with the premiums paid. 2.2 Advantages & Disadvantages of Detariffication Subramanian (2011), Mittal (2016) and Cummins (2004) listed various advantages of detariffication for the insurance and economic system: 1) Detariffication can bring financial stability to insurers by employing efficient underwriting in the pricing mechanism. It would correct their role from being distributors of insurance products to assessing risk; 2) Unfair practices would be stopped once adopting detarifficaiton as the tariff rates system allows high-risk customers to enjoy artificially lower rates at the expense of low-risk customer, who are compelled to pay higher premiums, in the same class of risk band; 3) It enhances claims controlling and loss minimisation activities. Detariffication encourages any person with high risk to adopt loss mitigation tools which can influence the pricing of premiums; 4) Detariffication is a part of the reforms towards a liberalised economy and attracts more entrants to the market thereby making it a competitive market. This kind of market requires the players to improve their efficiency to sustain in the industry and improving efficiency would contribute positively regarding the reduction of premiums; 5) Detariffication enables insurers to produce innovative products where they operate in competitive markets that push them to more efficient. The disadvantages of detariffication include: 1) It may encourage insurers to raise premiums until they are priced at unreasonable levels; and 2) It is considered a form of having a free market which may lead to insolvency and non-stabilisation within the industry (Mittal, 2016). 2.3 Detariffication and Efficiency Detariffication or deregulation is an area that has been tested regarding efficiency in the insurance industry. It aims to improve the efficiency of the market by increasing competition as consumer choices are better in competitive rather than regulated markets (Boonyasai, Grace, & Skipper, 2002). However, this observation might be incorrect in some cases. Reducing efficiency may not be instigated by regulation (Hussels & Ward, 2007). The literature states that lowering the level of regulation would help improve efficiency whereby the administrative resources would be utilised in the output activities. Competition among firms would be strong due to the removal of price regulations (Hussels & Ward, 2007). From competition, we can find less efficient firms, which have three options: (i) improve their level of efficiency, (ii) move to a different position, or (iii) exit the sector. The European insurance industry has undergone three stages of implementing deregulation. The First-Generation Insurance Directives started in the early 1970s and the Third Generation in the early 1990s. In 1994, the Third Generation Insurance Directive allowed insurance firms to operate across boundaries. Meaning it is authorised to open branches and provide services under one licence. Due to this directive, the regulation would be removed on prices and products (Mahlberg & Url, 1998). Meaning the single market would create pressure on firms to be more innovative and adopting new technology that assists in improving the cost position. Hussels & Ward (2007) examined UK and Germany insurance industries pre- and post-deregulation. During the process of deregulation, it was expected that a highly regulated market would make a clear improvement in efficiency. However, the research finding does not support this assumption. Furthermore, they have not found evidence of a linkage between a deregulation and efficiency. Nevertheless, Mahlberg & Url (2000) affirmed that German insurance companies showed impressive growth productivity from 1992 to 1996 whereby the average firms increased by 13% as measured by the Malmquist index. In Austria, the insurance sector was examined by Ennsfellner et al. (2004) who found that insurers were more efficient after deregulation. Similarly, in Spain, Cummins & Rubio-Misas (2001) found the number of firms declined by 35 percent due to insolvency or liquidation. In addition, the average firm size increased by 275 percent due to mergers and acquisitions. Deregulation pushed insurers to improve efficiency to sustain in the market. Boonyasai, Grace, & Skipper (2002) examined the role of liberalisation and deregulation of improving the efficiency of life insurance in Korea, Philippines, Taiwan, and Thailand. The key point that is worthy to mention here is differentiating between liberalisation and deregulation whereby the prior refers to the reduction of a government s barriers towards foreign firms to access the market while the latter relates to decreasing national regulations. From the economic perspective, liberalisation is not a sole condition of having a competitive market because the legal system can restrict strong competition even if there is the 8

3 flexibility of accessing the market. In this research, it is found that the Korean and Philippines insurance markets are more exposed to competition that leads the firms to be more efficient than Taiwan and Thai markets. This divergence justifies using liberalisation and deregulation together in Korean and Philippines markets while only liberalisation is used in others. 3.0 Experience of Detariffication in Different Countries Deregulation in the insurance sector has been implemented in various countries such as the UK, Spain, Germany, Austria, India, China and many others. This paper discusses the Indian and Chinese experience because they are in the same region as Malaysia and their adoption of detariffication was in 2003 and 2007 for China and India, respectively. These examples are more recent compared to Europe which underwent detariffication in the 1990s. 3.1 China Prior to 2003, the China Insurance Regulatory Commission (CIRC) regulated the general Chinese insurance market by imposing strict tariffs into both premium rates and policy wordings. This changed after 2003 where deregulation was applied across all business lines except motor third party liability, which is subject to pricing approval from CIRC (Tucci & Baker, 2007). Changing to detariffication by removing tariff premium rates affects premium rates significantly due to aggressive competition. Insurers cut their premiums to retain customers or increase market share. In addition, the competitive Chinese market caused insurers to pay more commissions to agents to bring business. This means insurers had to waive part of their margin for sustainability. At that time, the biggest business line in the Chinese market was motor vehicles which consisted of more than 50% of total premiums in the overall market and reached to over 80% in some small companies. From Figure 1, it can be observed that the combined ratio has dropped below 100% due to severe competition leading the industry to face a solvency dilemma, specifically for smaller insurers that depend on motor premiums for their survival (Kozlowski, 2009). The serious drop in insurance premiums pushed the regulator (CIRC) to consider re-tariffing mandatory third party liability for motor vehicles in 2007 where consumers must buy a minimum coverage and insurers must provide this coverage once it is requested. Figure 1: Statistics for the Chinese Market Source: Towers Watson (Mazumdar & Malattia, 2013) When the CIRC applied detariffication, it aimed to create a competitive market to provide detailed products to match the needs of clients. The CIRC s intention was to support the industry s players in terms of claims system. The objective of detariffication, unfortunately, did not succeed in the market because the segmentation of customers remained considerably large compared to other countries (Tucci & Baker, 2007). Hence, CIRC reapplied detariffication in 2006 to control for the losses experienced in the market. 3.2 India Mittal (2016) and Joo (2013) stated that the Insurance Regulatory and Development Authority (IRDA) applied Indian detariffication gradually through three phases: Phases 1 was initiated from 1 st of January 2007 by withdrawing premium pricing restrictions; Phases 2 started from the beginning of 2007 for two years where insurers were not permitted to changing coverage, terms, conditions, policy wordings. Their freedom was restricted to premium rates. Phase 3 granted insurers the flexibility to vary in coverage, terms, conditions, policy wordings. Figure 2: Key Regulatory Changes 9

4 Source: KPMG, TechSci Research It can be observed from Figure 2 that IRDA issued merger and acquisition guidelines in 2011 after the market witnessed a dramatic drop in profit before tax and underwriting due to severe competition after detariffication (Sen, 2012). This led some Indian firms to struggle in solvency matters where the Oriental Insurance Company, National Insurance Company and United India Company recorded 1.1%, 1.26% and 1.56% which are below or near the regulatory requirement of 1.5% in 2016 (Tiwari, ). The current situation pushed these three companies to merge where their total market share reached 34%. Mergers may be seen as positive in three circumstances, namely preventing unhealthy competition, reducing marketing expenses, and increasing saving foreign exchange (reinsurance) by increasing retention capacity (Middle East Insurance Review, ) Figure 3: Statistics for the Indian Market Rs. In bn Source: IRDA GDP PBT UW Results Figure 3 shows that premiums increased after detariffication while underwriting and profit before tax decreased. For this reason, insurance companies need to improve their efficiencies to sustain their business especially when we know that decreasing profit before tax reached negative figures indicating increased stress on the capital requirements of numerous firms (Subramanian, 2011; Tucci & Baker, 2007). 10

5 3.3 Malaysia Bank Negara Malaysia (BNM) started applying partial detariffication in July 2016 in line with its liberalisation roadmap after having discussed detariffication with industry players since 2013 (PIAM, 2016). July is the effective date of liberalising the pricing of premiums/contributions which are determined by individual insurers and takaful operators. The following table shows the key points of the liberalisation of motor and fire classes. Table 1: Phased Liberalisation of Motor and Fire Classes Motor Class Fire Class Prior to 2016 All available products are defined in motor and fire tariffs and are subject to tariff rates. Gradual adjustments to tariff rates for identified risk groups onwards New products and new optional add-on covers can be offered at market rates. onwards Disapplication of tariff rates for Motor Comprehensive and Motor Third Party Fire and Theft. Gradual adjustments to tariff rates for Motor Third Party for identified vehicle classes. Gradual adjustments to tariff rates for identified risk groups onwards Assessment of the state of readiness of the industry and consumers for further liberalisation Source: The Financial Stability and Payment Systems Report 2015 In Malaysian practice, we may compare the calculation of motor insurance premiums between the old system before detariffication and the new system after detariffication. Insurance premiums rates are controlled by the collaboration between the General Insurance Association of Malaysia (PIAM) and Bank Negara Malaysia (BNM) under the Insurance Act of The main factors of premium calculation in the old system relied on two: 1) market value of the vehicle which is commonly called sum insured/sum covered. The sum insured is the maximum amount that the insurer/takaful operator is liable to cover. The higher the sum insured, the higher the premium paid. This amount should be in line with the market value to avoid underinsurance; 2) vehicle engine capacity in CC. Furthermore, calculation premiums/contribution should consider the Non-Claims Discount (NCD) and loading. Insurers and takaful operators may have freedom from BNM s restriction where loading is an extra amount charged commensurate with the risk borne by them, i.e. vehicle older than 10 years old, drivers younger than 25 years old or roadside assistance service like towing but still the increases are tied with the regulator (Luke, 2015; Selina, ). The new system no longer imposes a tariff structure on all players. Insurance companies and takaful operators have the freedom to apply any calculation method in premiums through using risk-based pricing method which is beyond tying premiums to market value and engine capacity. It might be seen that risk-based pricing method consists of an element of fairness where the premiums are tailored based on your carrying risk, and the higher risk you carry is reflected in higher premiums and vice versa (Selina, ) Selina () remarks that insurers and takaful operators may consider the following factors to determine the premiums price and they have more flexibility to consider any factor perceived to be influencing premiums/contribution: 1) Age of the driver is an important factor where the players may preserve that younger drivers are less experienced drivers and the probability of an accident is higher; 2) Gender might be seen as a factor to differentiate between male and female drivers where females are commonly more careful in driving; 3) Martial status is considered by the insurer/takaful operator where it is assumed single drivers are more dangerous compared to married drivers who have kids and a wife who rely on them; 4) Occupation may give an assumption that a person who pursues his education might drive more carefully which is reflected in the risk and premium; 5) Claims history has a high influence on premiums where past claims show higher risk; 6) Type and make of vehicle such as luxurious and high performance cars normally carry high risk which is reflected in premiums calculation; 7) Usage of car might have an indicator on the frequency of the car being on road, i.e. using the car to deliver the kids to school rather than using the car for a daily commute or using the car mostly in weekend and using the public transportation in a daily routine; and 8) Location might be a factor in increasing the likelihood of an accident where driving daily in a crowded city may be considered in calculation the premiums/contributions. 3.0 The Common Situation after Detariffication & Successful Implementation Detariffication has been implemented in various countries, and from their experiences, we may predict the situation in the industry. Kozlowski (2009) states that detariffication causes many changes in the market. The following are the common changes that may occur: 1) Increased competition among market participants where detariffication removes pricing restrictions and allows for freedom in policy writing; 2) Removal of cross-subsidization, e.g. fire insurance/takaful is a profitable business line traditionally having high margins. With cross-subsidization insurers/takaful operators can cross-subsidise with another nonprofitable business line, e.g. motor business line. With eliminating the effect of cross-subsidization, insurers/takaful operators 11

6 shall customize the premiums based on the risks absorbed. Thus, the premiums/contributions received from fire business line will decrease; 3) Cutting expenses is a common reaction within insurers/takaful operators to ensure giving the best price to customers in this competitive market; 4) Changes in distribution systems where high competition renders the role of brokers more valuable in bringing business; 5) Insurers/takaful operators will focus more on top-line than bottom-line ; 6) Bad risks may find it difficult to obtain coverage from insurers/takaful operators that aim to avoid undesirable risks; 7) Good risks are favourable and have high demand to be covered by insurers/takaful operators which create a competitive market; 8) The underwriting process becomes better defined once detariffication is applied where the determinants of premiums/contributions will be clearer. Having a well-established regulatory authority is considered a core element of a successful detariffication system. The regulator must be concerned with the commissions and discounts given by insurers/takaful operators as it was one of the causes of the failing Chinese experience. Due to competition, both insurers and takaful operators offer attractive discounts to generate more business flows to ensure its sustainability in the industry and provide high incentive/commissions for its agents, distributors and brokers. Furthermore, Indonesia witnessed a disappointing experience with detariffication and returned to the tariff regime due to lacking in regulation aspects. However, the Malaysian experience might be different where the BNM has prepared for detariffication for some time now and issued Risk Based Capital (RBC) Frameworks for insurers and takaful operators in 2012 which assist them in facing the intensity of price competition. The premium brands are a way to protect the industry from full detariffication where it aims to prevent and mitigate the industry of the risk of underpricing. Ignoring this aspect may lead to repeating the situation of Indian and Chinese motor insurance when the premiums were abolished in the absence of strong regulatory capital enforcement. 5.0 Conclusion Regulators apply detariffication within the insurance industry to improve efficiency, enhance technical capabilities and promote fairness. However, these objectives require a robust regulatory infrastructure to ensure its success. It seems Indian and Chinese experiences do not reach the optimal objectives of detariffication where their insurance industries faced severe competition leading to solvency issues. However, BNM is aware of such matters and issued Risk Based Capital (RBC) Frameworks. Additionally, insurers and takaful operators cannot give a discount more than 10%. This prevents the severe competition and protects the position of small players. The foremost expected situation that may happen in the Malaysian insurance and takaful sector after detariffication is increased competition, removal of cross-subsidization, cuttong expenses and the difficulty of finding coverage for bad risks. References BNM. (2016). The Financial Stability and Payment Systems Report Malaysia : Bank Negara Malaysia. Boonyasai, T., Grace, M.F. and Skipper Jr., H. D. (2002). The effect of liberalization and deregulation on life insurer efficiency. Working Paper No. 02-2, Center for Risk Management and Insurance Research, Georgia State University, Atlanta., (August 2015). Cummins, J. D. (Ed.). (2004). Deregulating Property-Liability Insurance: Restoring Competition and Increasing Market Efficiency. Brookings Institution Press. Cummins, J. D., & Rubio-Misas, M. (2001). Deregulation, consolidation, and efficiency: evidence from the Spanish insurance industry. Ennsfellner, K. 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7 Mittal, A. (2016). IMPACT OF DETARIFFING OF INSURANCE SECTOR ON THE INSURANCE BUSINESS. International Journal of Information Research and Review, 03 (03), Nektarios, M. (2010). Deregulation, insurance supervision and guaranty funds. The Geneva Papers on Risk and Insurance-Issues and Practice, 35(3), PIAM. (2016, June 10). PIAM answers about detariffication. Retrieved July 1,, from Selina. (, Jan 11). All You Need To Know About De-Tariffication of Motor Insurance in Malaysia. Retrieved June 14,, from Sen, S. (2012). Growth of Indian Insurance Industry and Determinants of Solvency. 2nd OECD-Asia Regional Seminar on Insurance Statistics: Enhancing Transparency and Monitoring of Insurance Markets. Thailand. Shah, H. (2016, March 23). Motor insurance tariffs in Malaysia to be liberalised risk-based pricing of premiums to be phased in soon. Retrieved June 26,, from Subramanian, V. (2011, Dec. 8). IMPACT OF DE-TARIFFICATION ON PROFITABILITY OF NON-LIFE INSURERS. Retrieved June 12,, from Tiwari, D. (, Feb 23). Oriental Insurance, National Insurance and United India Insurance likely to be merged to fetch better valuations. Retrieved June 18,, from Tucci, J., & Baker, V. (2007). A look at some rapidly growing general insurance markets in Asia. Biennial Convention New Zealand : Institute of Actuaries of Australia. Ahmad Alrazni Alshammari PhD Candidate Institute of Islamic Banking and Finance (IIiBF), International Islamic University Malaysia (IIUM) Kuala Lumpur, Malaysia a.alrazni86@gmail.com Othman Ibrahim Altwijry Assistant Professor Qassim University Saudi Arabia uth123@gmail.com Dauda A. Asafa PhD Holder Institute of Islamic Banking and Finance (IIiBF), International Islamic University Malaysia (IIUM) Kuala Lumpur, Malaysia daxasafa@yahoo.com 13