November 2014 Getting together the ASEAN Economic Community

November 2014 Getting together the ASEAN Economic Community Economic Research & Consulting 01 Executive summary 02 Introduction 03 ASEAN integration - the journey so far 12 Impacts of the AEC on insurance 20 Lessons from European insurance integration 25 Conclusion 27 Industry survey on the AEC 30 ASEAN statistics

Executive summary The ASEAN Community will be established at the end of 2015. The ASEAN insurance industry has experienced rapid growth in recent years, but significant variations between countries remain. The free flow of services will have the most direct impact on insurance while the free flow of goods can stimulate demand for certain insurance products. The free flow of investment and freer flow of capital will improve efficiency, generate higher returns and lower costs for insurers. The experience of insurance integration in the EU holds valuable lessons for ASEAN insurers and regulators. Insurers can position themselves to maximise the benefits from the establishment of the AEC. The establishment of the ASEAN Community at the end of 2015 will be an important milestone in ASEAN s history. The Community will comprise three pillars: the ASEAN Economic Community (AEC), the ASEAN Political-Security Community and the ASEAN Socio-Cultural Community. Of the three, the AEC will have the most direct impact on insurance, driven by the creation of a single market and production base. The ASEAN insurance industry has achieved strong premium growth in recent years. However, insurance penetration remains low, especially in the less-developed ASEAN member states. The insurance market structures and regulatory regimes of the different ASEAN countries also vary significantly, making any future integration process anything but smooth. Under the AEC, there will be free flow of goods, services, investment, skilled labour, and freer flow of capital. The free flow of services, including financial services, will have the most significant implication for the insurance sector, if insurers are allowed to provide cross-border services and establish presence abroad. Of the four different modes by which services can cross borders, cross-border supply is the most likely to be liberalised in the short-term in the form of bilateral agreement on simple insurance products. For consumption abroad, commercial presence and movement of natural persons, the status quo is likely to remain, at least in the short-term. The reduction in tariffs and non-tariff barriers to achieve free flow of goods is likely to stimulate trade within ASEAN in the short term. In the longer term, ASEAN s external trade will be boosted by the completion of regional trade deals such as the Trans- Pacific Partnership (TPP) and Regional Comprehensive Economic Partnership (RCEP). Demand for marine, trade credit, business interruption and product liability insurance are likely to increase, creating business opportunities for insurers. A more liberalised investment regime under the free flow of investment will enable insurers to better execute asset-liability management strategies and potentially generate higher returns. The introduction of ASEAN infrastructure as an asset class offers insurers an alternative way to invest, with benefits to the wider economy. A deeper and more liquid capital market, envisaged under the freer flow of capital, should allow insurers to reduce transaction costs and raise funds more cheaply. Direct comparison between ASEAN and the EU experience of liberalisation is difficult, but the EU integration process does hold valuable lessons for ASEAN insurers and regulators alike. Cross-border insurance flows in the EU were limited in the initial years after integration, given still-present barriers to entry such as consumer inertia and lack of brand awareness. As a result, many EU insurers decided to expand abroad through mergers and acquisitions. Using this logic, the next round of M&A activities in ASEAN could be triggered by liberalisation of insurance services. Despite industry consolidation, the EU experience suggests that competitive pressures will increase as consumers have freedom to choose from a wider set of insurance products and channels. In addition, for substantial integration to be achieved, ASEAN member-state regulators will likely need to reconcile to the idea of setting up a pan-regional insurance supervisory authority similar to the European Insurance and Occupational Pensions Authority. Integration in ASEAN insurance, when implemented, will create opportunities and challenges. Insurers with experience in online sales/marketing and bancassurance can benefit more from the liberalisation of cross-border supply. Meanwhile, in the face of foreign competition, product innovation will become more important, particularly for smaller insurers. Another outcome will likely be that Singapore, given its status as an international financial centre with free flow of capital, financial expertise and infrastructure, will become the regional hub for many insurers. Swiss Re Getting together the ASEAN Economic Community 1

Introduction Three ASEAN Communities will be established in December 2015. This will facilitate regional cooperation and integration. Of the three ASEAN Communities, the ASEAN Economic Community (AEC) will likely have most impact on insurance. This report will focus on the AEC and its impact on the regional insurance industry. The exact forms of liberalisation and deregulation are still subject to negotiation. The ASEAN Economic Community When the Association of Southeast Asian Nations (ASEAN) project began almost half a century ago, few would have envisaged the rapid development and cooperation that has been seen in recent years. On 31 December 2015, ASEAN will reach an important milestone with the official establishment of three ASEAN Communities Economic, Political-Security and Socio-Cultural. Since the signing of a Preferential Trading Arrangement in 1977, ASEAN has worked to improve trade and investment flows across the region. The ASEAN Communities will accelerate regional integration, bringing challenges and opportunities to businesses and communities alike. Yet, ASEAN leaders have made it clear that 2015 is not a target date for full regional integration. Rather, the three Communities will be another step in the move to closer cooperation over time. Regional integration, especially in financial services (including insurance), will continue well beyond 2015. Of the three ASEAN Communities, the ASEAN Economic Community (AEC) will likely have most impact on insurance. The creation of a single market and production base will stimulate intra-regional trade, benefiting insurance business lines such as marine, aviation and transport (MAT). The freer flow of capital 1 will allow insurers to diversify their investments into new regional asset classes, while the free flow of investment is likely to stimulate cross-border M&A. The eventual liberalisation of insurance services in the forms of cross-border supply and commercial presence 2 could have significant impact. Local insurers ability to compete with foreign players will depend on their preparation in the years leading up to market liberalisation. This report focuses on the AEC and the implications thereof for the regional insurance industry. The next chapter provides a brief overview of ASEAN and the journey towards the formation of the AEC. The expected impact of the AEC on the insurance sector, in particular the proposed free flows of goods, services, investment, skilled labour and the freer flow of capital, are discussed next. This is followed by a look at the experience of insurance integration in the European Union. The final chapter considers how ASEAN insurers can best position themselves for the future. The results of an industry survey are included in the appendix. The survey gauges insurers views about the opportunities that the AEC will create, which markets will benefit most, and potential regulatory changes and liberalisation measures. The findings of the survey support a number of the hypotheses of this report. Some of the more advanced ASEAN countries have already committed to partially liberalising their insurance sectors by 2015. However, the exact forms of liberalisation and deregulation are still subject to negotiation. To date, few decisions and announcements have been made, at least in public, and the analysis in this report is based on certain assumptions. Even so, given the imminence of the AEC, insurers will need to start thinking through plausible scenarios, and this report provides useful insights to that end. 1 While the AEC has pledged to allow free flows of goods, services, investment and skilled labour, it has only committed to freer flow of capital. 2 Cross-border supply is defined to cover services flows from the territory of one country into the territory of another (eg, consultancy or architectural services transmitted via emails). Commercial presence implies that a service supplier of one country establishes a territorial presence in another country to provide a service (eg, domestic subsidiaries of foreign banks or hotel chains). 2 Swiss Re Getting together the ASEAN Economic Community

ASEAN integration the journey so far ASEAN was established in 1967 ASEAN was established in 1967 when Indonesia, Malaysia, the Philippines, Singapore and Thailand signed the Bangkok Declaration. The declaration was intended to promote political cooperation and regional stability, through the formation of an independent bloc not dominated by external powers which would have a stronger voice in addressing regional issues. Brunei Darussalam joined ASEAN in 1984, followed by Vietnam in 1995, Lao PDR and Myanmar in 1997, and Cambodia in 1999. Figure 1 ASEAN timeline ASEAN established Brunei Darussalam joined Vietnam joined Lao PDR and Myanmar joined Cambodia joined 1967 1977 1984 1992 1995 1997 1999 2007 2015 ASEAN Preferential Trading Arrangement signed ASEAN Free Trade Area (AFTA) agreement signed ASEAN Framework Agreement on Services (AFAS) signed Establishment of the three ASEAN Communities on 31 December 2015 Declaration on the ASEAN Blueprints to establish the three Communities by 2015 Source: The ASEAN Secretariat, Swiss Re Economic Research & Consulting. to promote political and regional stability; economic collaboration came later. Trade barriers among the member states have been dismantled over the years Economic collaboration was absent from the initial ASEAN agenda as the primary objective was regional peace, prosperity and geopolitical stability. Over time, there was recognition that economic cooperation could also yield benefits, and this led to the signing of the ASEAN Preferential Trading Arrangement in 1977. With this, the ASEAN member states agreed to cooperate on various trade liberalisation initiatives, such as the Common Effective Preferential Tariff (CEPT). Successive rounds of negotiation led to the signing of the ASEAN Free Trade Area (AFTA) on 28 January 1992, an area in which tariffs and non-tariffs barriers (NTB) among member states would gradually be eliminated. The CEPT scheme and AFTA have led to significant reduction in intra-regional tariffs over the last few decades. The more advanced economies (Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore and Thailand together the ASEAN-6) committed to reducing tariffs to 0-5% for imports originating within the ASEAN region. The less advanced economies (Cambodia, Lao PDR, Myanmar and Vietnam the CLMV) were given more time to comply with the tariff reduction. In 2013, the ASEAN-6 had virtually eliminated tariffs on imports from within the region, with an average tariff rate of just 0.04%. For the CLMV, the average tariff rate was 1.37%. Swiss Re Getting together the ASEAN Economic Community 3

ASEAN integration the journey so far which has facilitated growth in intra-regional trade. The reduction in tariffs and, to a lesser extent, non-tariff barriers has boosted merchandise trade both within ASEAN and externally (see Figure 2). Between 1995 and 2013, the total value of trade (sum of worldwide imports and exports) grew by more than four times from USD 615 billion to USD 2.5 trillion. Intra-ASEAN trade increased near fivefold from USD 124 billion to USD 609 billion in the same period. However, as a share of the total, intra-asean trade has remained stable at around 25%. That is low compared to other regional blocs. For example, in the European Union, trade among the member states accounts for more than 60% of total. Figure 2 ASEAN merchandise trade performance, 1995 2012 3000 2500 in USD bn 30% 25% 2 000 20% 1 500 15% 1 000 10% 500 5% 0 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 0% Extra-ASEAN trade (LHS) Intra-ASEAN trade (LHS) Share of intra-asean trade of total (RHS) Source: ASEAN Statistical Yearbook 2013, the ASEAN Secretariat, 2014. ASEAN has become more attractive to overseas investors. Regional prosperity and economic integration have made the ASEAN region more attractive for investors. Foreign direct investment (FDI) inflows increased by more than five times between 2000 and 2013, from USD 24 billion to USD 122 billion (see Figure 3). The global financial crisis in 2008 resulted in a sharp, but only temporary fall. FDI recovered strongly to reach its highest-ever level in 2013. One element in the establishment of the AEC will be free flow of investment, likely leading to more intra-asean FDI in the coming years. Figure 3 Annual FDI inflows into ASEAN, 2000 2012 140 120 100 80 60 40 20 0 in USD bn 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Intra-ASEAN Rest of World Source: ASEAN Statistical Yearbook 2013, the ASEAN Secretariat, 2014. 4 Swiss Re Getting together the ASEAN Economic Community

The ASEAN Framework Agreement on Services (AFAS) to promote liberalisation in services sectors was signed in 1995. The Asian financial crisis in 1997 and subsequent rise of China and India had prompted ASEAN leaders to accelerate regional integration. The AEC is one of the three pillars of the ASEAN Community framework. The CEPT and AFTA have helped to spur strong growth in trade in goods. However, regional trade in services only came onto the agenda in 1995 with the signing of the ASEAN Framework Agreement on Services (AFAS). The agreement was designed to progressively liberalise trade in services and targeted 12 sectors, including financial services. The Asian financial crisis in 1997 caused significant slowdown across the region s economies. In the wake of the crisis, and to keep up with the emerging economic powerhouses of China and India, in 2007 the leaders of the ASEAN member states resolved to accelerate regional integration. The establishment of the ASEAN Community by the end of 2015 is part of that drive. The ASEAN Community will comprise three pillars: the ASEAN Economic Community (AEC), the ASEAN Political-Security Community (APSC) and the ASEAN Socio-Cultural Community (ASCC). The AEC can be seen as the end goal of economic integration, the convergence of member state interests to build a more open, outward-looking and inclusive market economy in the ASEAN region. The aims of the APSC are peace, democracy and the rule of law in the region, while the ASCC will promote human development and quality of life through sustainable development. Each pillar has its own blueprint with a roadmap and timetable for the execution of concrete actions to establish the ASEAN Community by 2015. Table 1 The three ASEAN Community pillars Community pillar ASEAN Economic Community ASEAN Political-Security Community ASEAN Socio-Cultural Community Key characteristics Single market and production base Competitive economic region Equitable economic development Integration into the global economy A rules-based community of shared values and norms A cohesive, peaceful, stable and resilient region with shared responsibility for comprehensive security A dynamic and outward-looking region in an increasingly integrated and interdependent world Human development Social welfare and protection Social justice and rights Ensuring environmental sustainability Building the ASEAN identity Narrowing the development gap Source: The ASEAN Secretariat. Swiss Re Getting together the ASEAN Economic Community 5

ASEAN integration the journey so far ASEAN has combined GDP of USD 2.4 trillion and population of 618 million. ASEAN today The ASEAN member states had combined gross domestic product (GDP) of USD 2.4 trillion in 2013, not far behind some of the world s largest economies, and a population of 618 million (see Table 2). It is the world s fourth largest trading entity, with USD 1.3 trillion in exports and USD 1.2 trillion in imports in 2013. Table 2 ASEAN s world ranking by GDP (USD billion) and population (million) Rank GDP 2013 US =100 Rank Population 2013 China =100 1 US 16 879 100 1 China 1 379 100 2 China 9 263 55 2 India 1 265 92 3 Japan 4 904 29 3 ASEAN 618 45 4 Germany 3 642 22 4 US 316 23 5 France 2 809 17 5 Indonesia 250 18 6 UK 2 523 15 6 Brazil 201 15 7 ASEAN 2 406 14 7 Pakistan 183 13 8 Brazil 2 242 13 8 Nigeria 171 12 9 Italy 2 072 12 9 Bangladesh 154 11 10 India 1 759 10 10 Russia 143 10 Source: Swiss Re Economic Research & Consulting. Overall, the region has achieved rapid economic growth over the past decade but it has turned into a three-tiered economic area. Overall, the average annual rate of economic growth across the ASEAN countries was 8.8% between 1990 and 2013. 3 GDP per capita, meanwhile, increased from USD 800 to almost USD 4 000. Despite the overall strong growth, the level and pace of economic development varies significantly among the member states (see Figure 4). Indeed, diversity is a defining characteristic of ASEAN. The member countries vary significantly in size and in stage of economic, political and social development, as well as in industrial structure. With the expansion of ASEAN membership to Cambodia, Lao PDR, Myanmar and Vietnam in the 1990s, ASEAN transitioned from a two- to three-tier regional structure, encompassing high, middle, and low-income countries. In 2013, GDP per capita in Singapore, for instance, was more than 30 times that in Lao PDR, and more than 50 times higher than in Cambodia and Myanmar. 3 Nominal GDP growth rate of the ten ASEAN economies; Source: Swiss Re Economic Research & Consulting 6 Swiss Re Getting together the ASEAN Economic Community

Figure 4 GDP and GDP per capita of ASEAN member, 2013 1 000 800 in USD bn in USD 60000 48 000 600 36 000 400 24 000 200 12 000 0 0 Indonesia Thailand Malaysia Singapore Philippines Vietnam Myanmar Brunei Darussalam Cambodia Lao PDR GDP (LHS) GDP per capita (RHS) Source: Oxford Economics, Swiss Re Economic Research & Consulting. The ASEAN member states have different demographic and industrial structures. The population of the ASEAN countries is relatively young compared to China and Japan. But demographics vary within member states. For example, in Singapore and Thailand, more than 40% of population is above 40 years of age while in Lao PDR, the Philippines and Cambodia, less than 25% is. ASEAN member states also have different industrial structures (see Figure 5). Agriculture is virtually non-existent in Singapore, where the service sector dominates. Brunei Darussalam has the largest share of GDP from industry (due to large oil & gas and petrochemical sectors), while Myanmar derives a relatively large share of its GDP from agriculture. Figure 5 GDP composition by economic sector, 2012 100% 80% 60% 40% 20% 0% Brunei Darussalam Thailand Vietnam Indonesia Malaysia Singapore Philippines Lao PDR Cambodia Myanmar Industry Services Agriculture Note: Agriculture includes fishing and forestry, industry includes mining, quarrying, manufacturing, construction and utilities, services include wholesale & retail trade, transport & storage, information & communications, accommodation & food services, finance & insurance, business services and others. Source: ASEAN Statistical Yearbook 2013, the ASEAN Secretariat, 2014. Swiss Re Getting together the ASEAN Economic Community 7

ASEAN integration the journey so far Exports remain a major growth driver. Exports are an important growth driver for ASEAN. The total value of regional exports was 53% of GDP in 2013, but the extent of trade openness varies among the different member states. Singapore is the most open economy, with exports reaching almost 140% of GDP in 2013 (see Figure 6). By contrast, Myanmar has an export-to-gdp ratio of less than 20%. The composition of exports also differs. Electronics and machinery equipment are important export categories for Malaysia, the Philippines, Singapore and Thailand, while textiles and clothing are important for Vietnam (see Figure 7). Agriculture is a big export earner for Indonesia, Thailand and Vietnam. Figure 6 Merchandise exports as % of GDP, 2013 140% 120% 100% 80% 60% 40% 20% 0% Singapore Vietnam Malaysia Brunei Darussalam Thailand Cambodia Lao PDR Indonesia Philippines Myanmar Source: ASEAN Statistical Yearbook 2013, the ASEAN Secretariat, 2014. Figure 7 Merchandise exports by category in the six largest ASEAN economies, 2013 100% 80% 60% 40% 20% 0% Indonesia Malaysia Philippines Singapore Thailand Vietnam Machinery and transport equipment Fuels and mining products Agricultural products Others Textiles and clothing Source: International Merchandise Trade Statistics, WTO. 8 Swiss Re Getting together the ASEAN Economic Community

The business mix of the insurance sector differs across the region ASEAN insurance industry today In 2013, insurance premiums in ASEAN overall were USD 76.0 billion, of which 73% came from the life sector and 27% from non-life (see Figure 8). Insurance penetration (premiums as a percentage of GDP) in the region was 3.2% of GDP, compared to an emerging market average of 2.7% and a global average of 6.1%. The business mix of the insurance sectors in the different member states varies. In the more developed ASEAN economies, life insurance contributes most of the premiums while in the less developed countries, non-life tends to dominate. In Cambodia, the government only began issuing licences for life insurance operators in 2012. Figure 8 ASEAN member state insurance sector premiums mix, 2013 100% 80% 60% 40% 20% 0% Singapore Philippines Indonesia Thailand Malaysia Vietnam Brunei Darussalam Myanmar Lao PDR Cambodia Life Non-life Note: Data excludes premiums from Takaful insurance in Malaysia, Sharia insurance in Indonesia, and offshore insurance premiums such as the Offshore Insurance Fund in Singapore. Source: National insurance regulators, Swiss Re Economic Research & Consulting. but overall, insurance premiums have been growing strongly in all the ASEAN markets. The insurance sectors are at different stages of development but generally speaking, the markets in all the ASEAN member states are growing fast. Over the last decade, premiums grew by an average annual rate of 13.0% in ASEAN, compared to 14.9% in emerging markets and 4.5% globally (see Figure 9). Within ASEAN, Lao PDR experienced the fastest average premium growth of 26.0% a year, while at 8.9% Brunei Darussalam was the slowest growing market. Figure 9 Nominal growth in insurance premiums, 2004 2013 30% 25% 20% 15% 10% 5% 0% 5% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ASEAN Emerging markets World Source: Swiss Re Economic Research & Consulting Swiss Re Getting together the ASEAN Economic Community 9

ASEAN integration the journey so far The structure of the insurance sectors in the member states varies. Industry structure and competition also differ significantly (see Table 3). At one extreme, the markets in Indonesia and the Philippines are the most fragmented, having the highest number of insurance companies and a relatively low Herfindahl index. 4 At the other, the region s less developed markets such as Lao PDR, Brunei Darussalam and Myanmar have a mostly oligopolistic structure. Table 3 Insurance industry structure in ASEAN, 2012 13 Non-life Life No. of players Herfindahl Index No. of players Herfindahl Index Brunei Darussalam 6 2 434 3 N/A Cambodia 6 2 131 0 N/A Indonesia 80 382 41 1 005 Lao PDR 6 6 944 4 N/A Malaysia 26 586 15 1 409 Myanmar 4 N/A 8 N/A Philippines 81 540 34 965 Singapore 53 585 19 1 466 Thailand 63 577 24 1 314 Vietnam 29 1 255 14 2 349 Source: National regulators, Swiss Re Economic Research & Consulting. Insurance penetration is generally low across ASEAN. There is generally a positive correlation between insurance penetration and income level, measured by per capita GDP, in ASEAN (see Figure 10). The exception is Brunei Darussalam where per capita GDP is boosted significantly by the country s oil production. Insurance penetration is very low in the less developed ASEAN countries at present, but the anticipated sustained economic growth in the coming years will likely boost demand and penetration. Figure 10 Positive correlation between insurance penetration and GDP per capita in ASEAN 7% Insurance penetration 2013 (premiums as % of GDP) 6% Thailand 5% Singapore 4% Malaysia 3% 2% Philippines 1% Vietnam Indonesia Brunei Darussalam Cambodia Lao PDR 0% Myanmar 1000 10 000 100000 GDP per capita 2013 (USD), log-scale Source: Swiss Re Economic Research & Consulting. 4 The Herfindahl index is a measure of industry concentration and can range between 0 and 10 000. A Herfindahl index of 10 000 means the industry is a monopoly, whereas an index closes to 0 indicates a large number of industry players and nearly perfect competition. 10 Swiss Re Getting together the ASEAN Economic Community

Foreign insurers have been more pro-active in the region since the early 2000s. Local insurers are expanding into neighbouring ASEAN markets... but much work still needs to be done to harmonise insurance regulations in the region. Foreign insurers have a long history of operating in the ASEAN markets. In the early 2000s, they stepped up their efforts by acquiring local insurers or forming joint ventures with local partners. In 2012, around 60.5% 5 of premiums in the six biggest markets (Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam) were collected by foreign insurers or foreign-owned JVs, up from 52.3% in 2009. 6 Local players have also been expanding their regional footprint. They are expected to benefit from economic integration and the establishment of the AEC, and their expanded presence in neighbouring ASEAN countries could give them an edge when the markets open up. Insurance regulations differ significantly across ASEAN (see Table 4). There are differences in licensing requirements, minimum capital/ solvency requirements and foreign ownership limitations, among others. Myanmar has the highest capital requirement in ASEAN, and no foreign ownership is permitted there. Countryspecific regulations will need to converge over time to build a fully-integrated market under the AEC or else a scenario of regulatory arbitrage will persist. Table 4 A snapshot of insurance regulations across ASEAN member states Minimum capital Country Current regime requirements (local currency/usd) Foreign equity participation Brunei Darussalam Solvency margin BND 8m/USD 6m 100% Cambodia Solvency margin SDR 10m/USD 15m 100% Indonesia Risk-based capital IDR 100bn/USD 8m 80% Lao PDR Solvency margin LAK 16bn/USD 2m 100% Malaysia Risk-based capital MYR 100m/USD 31m 70% Myanmar Solvency margin MMK 46bn/USD 46m Not specified Philippines Risk-based capital PHP 1.3bn/USD 29m 100% Singapore Risk-based capital SGD 10m/USD 8m 100% Thailand Risk-based capital THB 500m/USD 15m 49% Vietnam Solvency margin VND 600bn/USD 28m 100% Note: SDR = Special Drawing Rights; the minimum capital requirements apply to primary composite insurers (except Thailand and Vietnam where requirements for life insurers are shown). Foreign equity participation is not the only barrier to entry which restricts market access for foreign insurers. Regulations on foreign direct investment, tax and government s willingness to issue new licenses are also important. In Myanmar, foreign insurers can establish representative offices. It is expected that Myanmar will open its insurance sector to foreign insurers by around 2015, once local players have had time to establish. Source: National insurance regulators, Swiss Re Economic Research & Consulting. 5 Source: Swiss Re Economic Research & Consulting 6 Ibid. Swiss Re Getting together the ASEAN Economic Community 11

Impacts of the AEC on insurance The free flow of financial services, when implemented as part of the AEC, will have significant impact on insurance. The free flow of goods, investment and freer flow of capital will have a more indirect impact. Five priority services sectors, not including insurance, will be liberalised by 2015. Liberalisation in financial services will be subject to national policy objectives and development. The cornerstone of the AEC is the creation of a single market and production base comprising five core elements: (1) free flow of goods; (2) free flow of services; (3) free flow of investment; (4) freer flow of capital; and (5) free flow of skilled labour. The free flow of services, including financial services, will have the most impact on insurance, for instance, by allowing insurers to provide cross-border services and set up fully-owned operations in fellow ASEAN member states. The other liberalisation measures will also impact insurance, in some cases indirectly. The free flow of goods is expected to boost both intra- and extra- regional trade, and this could increase demand on a number of non-life insurance products. At the same time, the free flow of investment and freer flow of capital could enhance insurers risk-adjusted investment returns by offering a more open and competitive investment regime. And, while the free flow of skilled labour is unlikely to have material impact in the short -term, 7 in the longer term it could promote diffusion of knowledge and standardisation of professional standards across the insurance sector in the ASEAN region. Free flow of services: transforming the ASEAN insurance sector According to the AEC Blueprint, five priority services sectors will be liberalised by 2015, namely air transport, e-asean (including e-commerce, information infrastructure), healthcare, tourism and logistics. In these sectors, the restrictions on all four modes of services supply will be removed (see Figure 11 and Table 5 for an explanation of different modes of services supply). In addition, foreign equity participation in these priority sectors will be raised in increments to 70%. Negotiations over the financial services sector, led by respective finance ministers, central bankers and regulators, are still at an early stage and full liberalisation in the insurance sector is not expected any time soon. In addition, ASEAN leaders have stated that any liberalisation in financial services will be subject to national policy objectives and take into consideration the different stage of member states economic and financial sector development. Therefore, liberalisation in financial services, especially in the less developed ASEAN countries, is expected to be slow and gradual. The ASEAN minus X formula will likely be applied, by which countries ready to liberalise can proceed, to be joined by others later. This flexible approach will give countries time to prepare their financial sectors for liberalisation, without holding back other member states ready for more liberalisation and integration. 7 According to the AEC Blueprint, workers in eight industries will be able to move freely across borders in search for work after the establishment of the AEC. These professions are: doctors, dentists, nurses, engineers, architects, accountants, surveyors and tourism service providers. 12 Swiss Re Getting together the ASEAN Economic Community

There are four different modes of services supply across borders. Different ways of supplying cross-border services The General Agreement on Trade in Services (GATS), a treaty of the World Trade Organisation (WTO), came into force in January 1995 after the Uruguay Round negotiations. The GATS distinguishes between four modes of supply of services: Mode 1 cross-border supply; Mode 2 consumption abroad; Mode 3 commercial presence; and Mode 4 - movement of natural persons. 8 Figure 11 The different mode of services supply Country X Country Y Mode 1 Supplier A Service crosses border Consumer B Cross-border supply Mode 2 Supplier A B Consumer crosses border Consumer B Consumption abroad Mode 3 Supplier A Supplier A establishes a commercial presence in Country Y A Consumer B Commercial presence Mode 4 Supplier A Services supplied by sending a person from Supplier A to Country Y Consumer B Movement of natural persons Source: WTO, Swiss Re Economic Research & Consulting. Table 5 Definition and status quo of each mode of service supply in ASEAN insurance sector Mode of service supply Definition Mode 1 cross-border supply Mode 2 consumption abroad Mode 3 commercial presence Mode 4 movement of natural persons Service provided by Supplier A flows from Country X into Country Y for local Consumer B (eg, consultancy or architectural services transmitted via emails). Consumer B crosses the border from Country Y to Country X to obtain a service from Supplier A (eg, medical tourism). Supplier A establishes a presence in Country Y to provide a service to local Consumer B (eg, domestic subsidiaries of foreign banks or hotel chains). An employee representing Supplier A enters Country Y to supply a service to local Consumer B (eg, accountants, doctors or teachers). Status quo in ASEAN Generally not allowed but with exceptions, eg, cross-border insurance services for Vietnamese enterprises with foreign investments, or to foreigners working in Vietnam. Generally allowed, particularly popular in health insurance (eg, Indonesians, Malaysians going to Singapore to buy health/medical insurance). Generally allowed, but subject to foreign ownership rules, and these could be more restrictive than the country s WTO commitments and national licensing requirements. For example, Thailand has a de facto moratorium on new insurance licenses. Overseas (including ASEAN) insurers wishing to enter Thailand have to wait for an invitation from the regulator before they can apply for a license. Generally not allowed. Source: WTO, Swiss Re Economic Research & Consulting. 8 A natural person is defined as a living human being, as opposed to a legal person which may be a private (company) or public (government) entity. Swiss Re Getting together the ASEAN Economic Community 13

Impacts of the AEC on insurance ASEAN member states have identified the insurance sub-sectors which will be subject to liberalisation by 2015. According to the AEC Blueprint, ASEAN member states have identified the insurance sub-sectors which will be subject to liberalisation by 2015 (see Table 6). However the exact mode and timing of liberalisation for these sub-sectors is still subject to negotiation. Given the lack of public announcement by the ASEAN Secretariat and national insurance regulators to date, it is looking increasingly unlikely that the original target of 2015 can be achieved. Three key questions face the insurance industry today: (1) which insurance product lines will be subject to liberalisation? (2) which restrictions or which mode of service supply will be liberalised? and (3) how will the free flow of insurance be granted bilaterally or multilaterally? Table 6 Insurance services sub-sectors identified for liberalisation by 2015 Insurance sub-sectors Primary life insurance Primary non-life insurance Reinsurance and retrocession Insurance intermediation Services auxiliary to insurance Member countries committed to liberalisation Indonesia, the Philippines Brunei Darussalam, Cambodia, Indonesia, Malaysia, the Philippines, Singapore and Vietnam Cambodia, Malaysia, Indonesia, the Philippines, Singapore and Vietnam Cambodia, Malaysia, Indonesia, the Philippines, Singapore and Vietnam Brunei Darussalam, Cambodia, Indonesia, Malaysia, the Philippines, Singapore and Vietnam Source: Annex 1, ASEAN Economic Community Blueprint, the ASEAN Secretariat, 2008. The status quos of consumption abroad, commercial presence and movement of natural persons are unlikely to change. Cross-border supply is likely to begin with bilateral liberalisation on simple products. It is difficult to predict exactly when, where and how liberalisation will take place. What is known is that the status quos of Mode 2 (consumption abroad), Mode 3 (commercial presence) and Mode 4 (movement of natural persons) are unlikely to change, at least not in the short term. Consumers can already purchase insurance when travelling abroad and therefore this mode of supply has already been liberalised. Likewise, insurers in the region are already allowed, in theory, to open branches or form joint ventures in any ASEAN country, except Myanmar. With respect to the movement of natural persons, the differences in insurance qualification standards and language issues would make mutual recognition arrangements (MRAs) difficult. For instance, insurance agents are unlikely to be allowed to move across borders to sell insurance for their employers. The movement of natural persons in insurance will hence likely remain generally not allowed. Regarding cross-border supply (Mode 1), the liberalisation process is likely to be gradual and begin on a bilateral basis for simple insurance products. For example, a non-life insurer based in Singapore would be allowed to sell motor insurance in Malaysia, and a life insurer in the Philippines to sell term life insurance in Indonesia. Although the pace of liberalisation may seem slow, the potential implications are significant. Using the life insurer example, by being able to sell term life in Indonesia, the Philippines insurers could potentially reach 250 million more customers in addition to the 100 million in their home market. 14 Swiss Re Getting together the ASEAN Economic Community

ASEAN regulators will need to agree on a number of key issues before liberalisation can take place. Convergence in insurance regulation is already happening in some ASEAN countries. AEC and insurance regulation: impacts and challenges ASEAN s insurance regulators have a key role in facilitating insurance liberalisation and financial integration. However, with the different levels of market development and diverse regulatory regimes among the member states, negotiations are not straight forward. Regulators will have to tackle the following issues before any agreement can be reached. Synchronisation of regional insurance regulations, particularly in terms of capital and solvency requirements, to avoid regulatory arbitrage. Establishment of a cross-border consumer protection framework with effective supervision and enforcement. Ensure that financial penalties imposed on offending foreign subsidiaries are honoured by the parent company, and the regulatory violations are shared with the home regulator. Put in place a resolution regime to empower the host regulator to step in and offer protection to local policyholders, if a foreign subsidiary fails. Gradual harmonisation of regulations is necessity as ASEAN works its way towards a partially and ultimately fully integrated insurance sector. For insurers to be able to operate across the region, they will need a consistent set of regulatory requirements in all markets. This has already happened in those ASEAN countries which have transited from Solvency-I type to risk-based capital (RBC) regime. Some of the smaller and less developed insurance markets, though, still operate on solvency margins that measure capital requirements based on the size of premiums or claims. Given where these less developed markets are today, the uniform adoption of international best practices in terms of solvency regimes across the whole of ASEAN could take years, if not decades. Swiss Re Getting together the ASEAN Economic Community 15

Impacts of the AEC on insurance Free flow of goods: new opportunities from a boost in trade Reduced tariffs and NTBs are key to achieving free flow of goods. There is a positive correlation between trade and marine insurance premiums. The creation of a single market of goods is one of the most important aspects of economic integration. The removal of tariffs and non-tariff barriers for goods traded within the region will improve ASEAN s production capacity and help it become an important link in the global supply chain. Increased trade in goods has implications for the insurance sector. Data from 1997 to 2013 show a strong positive correlation between the volume of trade (measured by the sum of imports and exports) and insurance premiums from marine insurance in the six largest insurance markets in ASEAN (Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam). The growth in trade has led to an increase in marine premiums in most years, with the notable exception of 2009 when both trade and premiums fell following the global financial crisis (see Figure 12). Figure 12 Marine insurance and trade flows, 1997 2013 2 500 2 000 in USD m in USD bn 2 500 2 000 1 500 1 500 1 000 1 000 500 500 0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Premiums from marine insurance, USD m (LHS) Total trade from the six largest ASEAN economies, USD bn (RHS) Source: ASEAN Statistical Yearbook 2013, the ASEAN Secretariat, 2014, CEIC, national insurance regulators, Swiss Re Economic Research & Consulting. Intra-ASEAN trade will grow significantly as the AEC takes shape Along with extra-asean trade, this could spur more demand for trade credit and product liability insurance and also (contingent) business interruption insurance. Intra-ASEAN trade will increase markedly as the AEC takes shape over the coming years. At present, intra-regional trade accounts for just 25% of total trade. In the short-term, countries already dependent on trade (eg, Singapore and Malaysia) are expected to benefit most. Over the longer term, the less developed countries in the region will benefit from increased trade also, as they catch up economically and leverage their competitive advantages in labour and natural resources. Insurance lines such as marine (and, to a lesser extent, aviation and transport insurance) and trade credit insurance are expected to benefit from more trade in goods. If regional trade deals such as the TPP and RCEP materialise, ASEAN exports to advanced markets like the US, Japan and Korea will rise tangibly. This could generate extra demand for product liability insurance as manufacturers and exporters seek protection against litigation actions that may arise from the consumption of faulty products in these advanced markets. As the 2011 Japan earthquake and Thai flood demonstrated, a natural catastrophe in one region can cause significant disruption to the supply chain of global manufacturing operations. As ASEAN establishes itself as an important link in the global supply chain, demand for business interruption and contingent business interruption insurance will also likely increase. 16 Swiss Re Getting together the ASEAN Economic Community

ASEAN is already an attractive destination for investors Free flow of investments: better returns for insurers? Attracting a strong and sustainable flow of investment is essential if ASEAN is to maintain a high rate of economic growth. Individual ASEAN member states are already an attractive destination for investment. According to the United Nations Conference on Trade and Development (UNCTAD), three ASEAN countries are ranked in the top 10 most favoured destinations for investment by multinationals in 2014-16: Indonesia (3rd), Thailand (8th) and Vietnam (9th). 9 Figure 13 Spilt of FDI inflows into ASEAN countries (2000 2012 cumulative ) Singapore 51.7% Thailand 12.7% Indonesia 11.0% Malaysia 9.8% Vietnam 8.0% Philippines 3.0% Myanmar 1.3% Brunei Darussalam 1.2% Cambodia 0.9% Lao PDR 0.3% Source: ASEAN Statistical Yearbook 2013, the ASEAN Secretariat, 2014. but the distribution of investment flow is uneven. ASEAN needs to remain competitive if it is to continue to attract investment for sustainable economic growth. There are plans to improve investor protection, and investment regulations will be harmonised and further liberalised. However, looking at the FDI data by countries reveals the uneven distribution of inflows. More than 85% of FDI inflows were destined for four ASEAN countries: Singapore, Malaysia, Indonesia and Thailand (see Figure 13). The less developed states (eg, Lao PDR and Cambodia) received only around 1% of total inflows. The lack of capital account convertibility, restrictive FDI regulations and an uncertain business and legal environment have all contributed to the small inflows to the less developed countries. This also highlights the difficulties ASEAN leaders face in creating a more open and competitive ASEAN-wide investment destination for foreign investors. Despite ASEAN s strong economic performance in the past decade and the promising outlook, there s no room for complacency. As monetary policy in advanced economies begins to normalise, foreign investors may start to scale back their investment in emerging markets, including in ASEAN countries, to focus instead on stronger economies and greater returns at home. The financial market volatility in emerging markets in 2013 reflected the fragility of markets with economic imbalances, and this is something ASEAN s leaders need to remain cognisant of. According to the AEC Blueprint, ASEAN leaders have agreed a set of measures to improve investor protection, for example, by establishing a proper dispute settlement mechanism and the strengthening of systems for the transfer and repatriation of capital, profits and dividends. However, this is subject to individual country s capital controls. Progressive liberalisation of investment regimes, harmonised regulations and streamlined investment applications will be put in place to create a more transparent, consistent and predictable investment framework. Meanwhile, ASEAN will increase promotion and raise the awareness of the region as an integrated investment area, and also encourage more investment from the ASEAN-6 to CLMV. 9 World Investment Report 2014, UNCTAD, 2014 Swiss Re Getting together the ASEAN Economic Community 17

Impacts of the AEC on insurance A liberal investment flows regime can help insurers better execute asset-liability matching and generate higher returns. Infrastructure, which currently forms a small part of ASEAN insurers investment portfolio, can offer insurers stable returns. Ongoing measures to liberalise investment flows will help insurers better execute their asset-liability management strategies and reduce risks of currency and duration mismatches. The availability of more investment instruments could also help insurers achieve better returns, due to increased market competition and efficiency. The benefits can be shared with consumers through, for example, higher declared yields on life participating products. A wider selection of investment funds could also increase the attractiveness of investment-linked products. Insurers play a key role in providing stable and long-term investment for sustainable economic growth. The ultra-low interest rates of the last few years have prompted insurers around the world to look for better ways to invest their capital. Infrastructure projects are seen as an attractive alternative asset class, given their stable cash flows and inflation-linked returns which are uncorrelated with other assets. Institutional investors such as life insurers and pension funds have the advantage that their liabilities are long-term, and can only be properly matched by equally long-term assets like infrastructure. Even so, alternative asset classes (including infrastructure) currently constitute just a minor part of ASEAN life insurers investment portfolios (see Figure 14). Figure 14 Balance sheet of life insurers in selected ASEAN countries 100% 80% 60% 40% 20% 0% Singapore (2013) Malaysia (2013) Thailand (2013) Vietnam (2012) Fixed income instruments Equity Cash/deposit Other assets including infrastructure Fixed assets Note: For Malaysia, the BNM does not separate insurers investments in fixed income instruments & equity. We have apportioned using Thailand as an example. Source: National regulators. ASEAN insurers can play an important role in funding regional infrastructure projects. The current infrastructure in ASEAN is in dire need of upgrade. The member states have just a fraction of the roads and railways on a per capita basis compared to the OECD average, and the Asian Development Bank (ADB) estimates that the infrastructure sector needs annual investment of USD 60 billion until 2020. With such a large sum required (2.5% of ASEAN s annual GDP), insurance companies can play an important role in intermediating the financial need for infrastructure investment. For example, they could invest in the ASEAN Infrastructure Fund (AIF), a fund set up by the ADB in 2012 to channel investment into construction projects. 18 Swiss Re Getting together the ASEAN Economic Community

Capital market development varies significantly across the ASEAN countries. Liberalisation in capital markets will be orderly and gradual. A deeper and more liquid capital market would reduce transaction costs and enable business to raise funds more cheaply. The Asian Bond Markets Initiative and ASEAN Trading Link are designed to accelerate regional capital market integration. Professionals in eight designated industries will be able to move freely across borders in search for work but immigration controls will remain in place for other professionals and unskilled labour. Free movement for insurance professionals is unlikely in the near future. Freer flow of capital broader and deeper regional capital markets The free flow of capital, alongside the free flow of goods, services and investment, is essential to create a single market. In ASEAN, the development of capital markets varies significantly across countries. Singapore is the most financially open economy and Myanmar the most closed, while there are capital restrictions in Lao PDR and Vietnam. There are no capital restrictions in Cambodia and Brunei Darussalam but their relatively small size means their economies can be destabilised by large capital in- or outflows. Recognising these key differences, ASEAN leaders agreed that capital market liberalisation should be orderly and gradual, and should be consistent with a country s national agenda and readiness of the economy. As such, the aim is to have freer (rather the free ) movement of capital by December 2015, although specific measures have yet to be announced. For the less developed countries, safeguards will be put in place to ensure macroeconomic stability and minimise systemic risk when restrictions on capital flows are removed or relaxed. A more liberalised capital regime could stimulate the development and integration of the ASEAN capital markets, and underpin AEC s aspiration for free flow of investment. By allowing capital to flow more freely, liquidity and the depth of the regional equity and bond markets should increase. This more-developed market will help insurers reduce transaction costs by executing trades on a timely and cost effective manner. Insurers wishing to raise capital via the stock and bond markets will also benefit by being able to raise funds more cheaply. Several measures, though not directly under the AEC framework, have been announced to speed up the development and integration of the regional capital markets. Examples include the Asian Bond Markets Initiative (ABMI) and the ASEAN Trading Link. The ABMI was launched in 2005 with the aim of developing and deepening the local currency bond markets in ASEAN+3 countries (ASEAN, China, Japan and Korea). The ASEAN Trading Link is designed to strengthen cooperation between stock exchanges and make ASEAN equities a unique investable asset class. Free flow of skilled labour limited impacts on insurance, for now For efficient business transactions, professionals engaged in cross-border trade and investments need to be able to move within ASEAN freely. Under the free flow of skilled labour element of the AEC, ASEAN countries will increase the mobility of skilled labour in eight professions (doctors, dentists, nurses, engineers, architects, accountants, surveyors and tourism service providers). The issue of visas and work permits for professionals in these sectors will be eased, and there will be MRAs so that the qualifications gained in one country are recognised in the others. Similar to the flow of capital, the flow of labour will not be completely free. It is highly unlikely that ASEAN citizens will be able to live and work in another member state country without any work permit or visa requirements in the near future, freedoms currently enjoyed by citizens of the European Union member nations. The vastly different size, economic structure and stages of development make it impractical and politically unviable for ASEAN governments to fully open up their borders. Also, the threat of brain drain, when educated or professional people emigrate from less to more developed countries in search of better jobs and lives, could hold back the development of those less developed economies. There has been no announcement of any plan with regard to the free movement of professionals in the ASEAN insurance sector. The differences in culture, customer behaviours, languages and qualifications make it unlikely that insurance professionals such as agents would be allowed to move across ASEAN freely to look for work. For now, companies with skill shortages (eg, actuaries in Indonesia), will need to import labour using conventional channels such as sponsoring foreign workers in their application for visas and work permits. Swiss Re Getting together the ASEAN Economic Community 19