The challenges and opportunities of Costa Rica’s insurance market

Author: | Published: 25 Sep 2012
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August 2012 marked four years since the opening of Costa Rica's formerly state-run insurance market to private competition with the enactment of the Insurance Market Act (Ley Reguladora del Mercado de Seguros, or IMA). The IMA is a direct result of Costa Rica's insurance market commitments under the Central American Free Trade Agreement (Cafta) entered into between the US, Central America and the Dominican Republic in 2006.

Regulatory developments

From a regulatory standpoint, in addition to the IMA there are other important regulatory developments that affect the functioning of the insurance market. The most important of those developments are the following:

The Insurance Contracts Act (Ley Reguladora del Contrato de Seguros, or ICA) was passed by the Legislative Assembly after its second reading on June 2 2011. This law replaced the Insurance Law of 1922 when it entered into force on September 12 2011. It governs all aspects of the insurance contract itself, seeks to provide a modern framework for insurance contracts and has a significant pro-consumer tendency in some areas.

The Regulations on Authorisations, Registrations and Operational Requirements for Entities Supervised by the Insurance Superintendent, also known as Sugese Regulation 01-08, were adopted in September 2008 and set forth the specific requirements to licence insurers, reinsurers and intermediaries (brokers and agents). They also provide the rules for mandatory policy form and rate filings.

Meanwhile the Regulations on the Solvency of Insurers and Reinsurers, known as Sugese Regulation 02-08, establish the rules to set and measure insurer and reinsurer capital adequacy and relate to issues such as reserving, investments, risk-based capital requirements, treatment of reinsurance and early warning mechanisms for insurer insolvency issues.

The authorities have also adopted the necessary accounting rules specific to insurers operating in Costa Rica by amending the existing financial sector accounting rules applicable to the banking, securities and pensions sectors.

These regulations are being reviewed by the regulator and are expected to undergo a significant overhaul in upcoming months.

The Regulations on Insurance Distribution, known as Sugese Regulation 03-10, govern the operations of insurance agents, insurance agencies and insurance brokerage firms, as well as those of mass-market insurance distributors not licensed as insurance intermediaries proper (operadores de seguros autoexpedibles).

Finally, the Regulations on Mandatory Insurances, known as Sugese Regulation 04-10, set forth the rules that will allow private insurers to offer mandatory workers compensation and third-party no fault automobile coverage. Before January 2011, this could be offered only by the state-owned Instituto Nacional de Seguros (INS). Although formally open, a constitutionality challenge has delayed private sector participation in this segment even though most private insurers have not shown an interest in these lines.

Other financial sector regulations (such as those related to corporate governance, anti-money laundering/terrorism financing and risk rating agencies, and consolidated financial information for financial holding groups and conglomerates) were updated to reflect the opening of the insurance market to competition.

What's next on the regulatory side?

From a regulatory standpoint, Sugese has announced that it is working to hold hearings in the next few months on the following proposed regulations, or amendments thereto:

  • amendments to the policy form and rate filing regulations contained in Sugese Regulation 01-08 (these were recently approved and are expected to enter into force shortly) which create a new category of contracts that are not subject to filing and registration;
  • amendments to Sugese Regulation 02-08 (insurer solvency);
  • new regulations on insurance claims handling;
  • new regulations affecting insurance contracts made necessary by the entry into force of ICA; and
  • new regulations on information technology risks.

It is also important to note that in May 2010 the Central American countries (including Costa Rica) concluded negotiations with the EU on the Central American Association Agreement. Once adopted by each of the signatory countries (which is expected to occur in 2013), it will permit European insurers to provide certain lines of insurance in Costa Rica on a cross-border basis (without having to establish themselves in Costa Rican through a locally-licensed and capitalised legal entity). These lines will include insurance relating to space launching of freight, maritime shipping and commercial aviation, retrocession and reinsurance, and services necessary to support global accounts (understood as "master policies" purchased by "multinational clients" outside Costa Rica the coverage of which extends to the multinational client's operations in Costa Rica).

Licensing of insurers and other market participants

To date there are 13 insurance companies licensed or provisionally licensed to operate in Costa Rica, including the state-owned INS. Of these new players, two are local investment (INS and Seguros del Magisterio) and the remaining companies are wholly or majority foreign-owned: MAPFRE | Seguros Costa Rica; ALICO Costa Rica (formerly owned by American International Group, acquired in 2010 by MetLife and again acquired by Pan American Life Insurance Group in 2012); ASSA Compañía de Seguros; Pan American Life Insurance de Costa Rica; Aseguradora del Istmo (ADISA); Seguros Bolívar Aseguradora Mixta; Quálitas Compañía de Seguros (Costa Rica); Best Meridian Insurance Company (the latter is a branch of the US entity); Atlantic Southern Insurance Company (also a branch of the US entity); Sagicor Costa Rica SCR; and Oceánica de Seguros (both Sagicor and Oceánica are provisionally licensed subject to completing the set up of their local company).

In terms of intermediaries, there are 13 insurance brokerage firms licensed by Sugese and four more with authorisation granted conditional upon completion of final steps of the definitive licensing process. Interestingly, these last four are the insurance arms of financial services conglomerates including BAC Credomatic and Scotiabank. The licensed brokerage firms rely on a total of 121 individual brokers to provide their services. These companies come in addition to the 67 existing insurance agencies that operated in the pre-2008 monopoly era, which were grandfathered in the IMA and conserved their licences. These agencies add another 1,507 individual agents to the intermediary workforce.

In terms of distributors of mass-market insurance products (operadores de seguros autoexpedibles), there are 46 active distributors registered with Sugese, the majority of which are bank and non-bank financial institutions and most of which have been hired by state-owned INS. These distributors are permitted to offer simple insurance products without the need to be licensed as agents or brokers.

September 2012 marks the one-year anniversary of the chartering of the Asociación de Aseguradoras Privadas de Costa Rica (AAP), the private-sector trade association created by the newly licensed insurers to provide a single voice to the industry. This milestone will also help in strengthening the private sector's role and clout both with regulators and with civil society at large.

Key market indicators

According to the latest data published by Sugese (July 2012), since the opening of the market in 2008 the new private insurers have made important inroads in terms of enabling increased competition in the market.

Total premiums from January through July 2012 are $542.4 million. More importantly, this represents year-on-year growth of 16.3% with respect to 2011 and 28.8% with respect to 2012. Total premiums for fiscal year 2011 were $794 million and at this rate the figures for 2012 are expected to surpass that amount easily.

Interestingly and as most experts predicted, very significant growth has occurred in the personal lines segment of the market (life and health insurance mostly), with year-on-year growth of 47% to the end of July 2012. Personal lines now represent 25% of premiums. All but one of the new insurers are licensed at least in personal lines.

Mandatory workers compensation insurance, which is still sold only by INS pending a court decision on the constitutionality of opening up this particular line to competition, still represents another 25% of the market by premium income.

Despite very aggressive competition from the incumbent INS in the property and casualty lines, this segment of the market also saw 5% growth year-on-year for the same period. Property and casualty now represent 50% of premiums.

Claims paid to insureds dropped from 46% to 43% year-on-year as a percentage of premiums and from 19% to 18% as a percentage on technical reserves.

In all, new insurers now represent 9.9% of the market in terms of premium income. If adjusted to exclude mandatory workers compensation still sold only by INS, the new insurers' share of the market rises to 13%.

Key challenges for investors

On balance, the opening of the Costa Rican insurance market to private competition has been very successful so far: there is a new and independent market regulatory and supervisory agency (Sugese); there are new regulations in place that have enabled companies (mostly foreign capital) to obtain licenses to operate in the country; and consumers have opened their doors increasingly to private insurers, as evidenced by the market indicators noted above.

While the key market indicators go to show that Costa Rica is, and will continue to be, attractive to foreign investors, there are several important challenges that those investors must factor in their analyses if they aim at being successful in this market.

First, the regulatory barriers to entry remain relatively high, when one considers the size of the market and compares it to other markets in the region. Save Panama, which recently increased its minimum start-up capital for insurers to $5 million, the minimum requirement in Costa Rica is still relatively high: a single-category licence (either personal lines or P&C lines) requires US$4.725 million, while a combined licence (for all lines) requires slightly over $11 million. The upside for those insurers already present in Costa Rica is that, so far, this has kept the number of market participants relatively low (compare Costa Rica's 13 with Panama's 40+ insurers); the downside is that it may have kept important international players away for now. Legislators first, and regulators later, have noted that keeping a manageable level of market participants at this stage in the process has helped ensure a more orderly transition to open market, which they hope will pay off in the long run and for investors seeking to come in at a later stage.

Secondly, the structure and depth of the insurance distribution network is something that will require additional effort. Because of the manner in which existing insurance intermediaries were grandfathered in 2008 when their licences were validated to continue working as insurance agents tied to the state-owned INS, it has taken some time for new distribution models to appear and take hold. Brokerage firms, while increasing in number and sophistication, still represent a small percentage of the total number of intermediaries in the market. In addition to this, it has also been difficult to develop alternative channels such as bank and non-bank financial entities (bancassurance), even when this channel has proved successful in more developed markets. Fortunately, at least in terms of brokers, significant developments have been made in the right direction (for example, a 2010 regulation permitting existing insurance agencies to transform into brokers if they so wish).

The third challenge comes from the fact that incumbent, state-owned INS has fought back fiercely in the new market conditions. While this should have been expected and no one advocates that the state-owned company give away its market share, concerns have been raised regarding some of its business practices and policies that may run afoul of antitrust laws. For example, the government's antitrust enforcement commission, Coprocom, has been investigating INS' policy to "better any insurance quote" offered by its competitors. Given INS' dominant position in the relevant market, a policy such as this could be construed to violate Costa Rica's antitrust laws due to its obvious anticompetitive intent and effect. Four years into the opening of the market and while Coprocom's reaction has been slow, the expectation is that enforcement action will soon follow.

Fourthly, the policy form and rate filing and registration process, while envisioned by law as a straightforward file and use system, has been turned into a prior approval process by regulatory practice. By law and with the exception of mandatory workers compensation and third-party auto liability coverage, insurance rates do not require the approval of the insurance regulator even if rate information must be filed with the regulator. Similarly, the law provides expressly that insurers may sell a product as soon as they have filed with the regulator the relevant policy forms. Nonetheless, by way of administrative regulation and regulatory practice, the policy form and rate filing process has become a "prior approval" process focusing mainly on the policy form provisions. The regulator has taken a very active role in reviewing policy forms and requesting revisions to reduce what it views as unclear policy language. The result has been that although an expeditious file and use system was conceived in the law, the process has become much less expeditious, sometimes requiring weeks or even months to obtain a registration. Although they have the law on their side, insurers have chosen to tread cautiously given that they are new to the market and have not wished to pursue available legal challenges to this regulatory practice, the result being a slower than optimum process in getting to market.

The final main challenge is that, although international standards require insurers and insurance intermediaries to abide by anti-money laundering and terrorism financing laws and regulations, Costa Rica has been slow to adapt its laws and regulations on the subject to the specific peculiarities of the insurance sector. The result has been that many regulations and procedures in this field have been imported wholesale from the banking sector, where the risk of money laundering and terrorism financing is significantly greater. Enforcing these laws and regulations in the insurance sector has come with additional operational cost and has also favoured the position of the incumbent in the market, since the perceived or actual difficulty in obtaining all relevant forms, background information and compliance requirements from prospective customers has been enough to put off some of those customers from switching insurer when presented with the opportunity. Of course, no one favours not complying with anti-money laundering and terrorism financing controls, but the process of adapting such controls to the special needs of the insurance sector has been somewhat slow. On the positive side, the regulator has been very open to hearing suggestions from the industry and the necessary adjustments are now underway.

Recipe for success

Although Costa Rica's insurance market is small by most standards (with annual premiums of nearly $800 million), it remained until 2008 one of the few that was still fully controlled by the state. Although the state-owned insurer INS continues to report slightly over 90% of the market's insurance premiums, the significant number of new players and the high profile of those players (such as MAPFRE, AIG and Pan American Life) are telling of the market's potential for growth. The key market indicators referred to above are evidence of that potential already translated into actual premiums. The newly-formed private sector has already made very significant inroads in the market.

As with any market going through an about-face (from a monopoly to competition), there have been and continue to be some important challenges. These challenges must be factored into any plans for investing in the Costa Rican insurance sector if the investor is to be successful. Those challenges are manageable and by now easily anticipated, perhaps thanks in part to those new participants that came first in the process.

In this light, all players (both regulators and participants) must strive to achieve a regulatory environment that balances the primary objectives of regulation (insurer solvency, good corporate governance, consumer protection) and the development of healthy competition to promote entrepreneurship and growth in this market. The Costa Rican insurance market is poised to continue to grow and offer up opportunities to those investors willing to make the long-term investment required to be successful in this sector.

Neftalí Garro
 

BLP Abogados

Neftalí Garro is a founding member of BLP Abogados and partner since 2005. He heads the insurance and reinsurance practice and also has significant experience in corporate and business law. He was an associate at KPMG in Costa Rica and a foreign associate with White & Case. He also served as a legal consultant on insurance matters for the United Nations' World Food Programme in Rome. He heads the Legal Affairs Committee of the Costa Rican Association of Private Insurers and presides over the Costa Rican Chapter of the Association Internationale de Droit des Assurance. He has also advised the Costa Rican Federation of Private Sector Trade Associations, the Chamber of Banks and Financial Institutions, the Costa Rican-American Chamber of Commerce and the Costa Rican Chamber of Exporters on insurance issues. He is among the arbitrators appointed by Costa Rica to serve on Cafta financial services arbitrations. He represented the Costa Rican private sector in drafting proposals to amend Costa Rican insurance laws.

Garro represents clients in all segments of the insurance market (insurers, reinsurers, intermediaries and providers of services auxiliary to insurance), both in regulatory and corporate matters. Among his representative clients, he has acted for American International Group, American Life Insurance Co, MAPFRE, Assicurazioni Generali, Swiss Re and Zürich. He has also acted in insurance matters for banks and non-bank financial entities, including BAC | Credomatic, Scotiabank, the Overseas Private Investment Corporation and the Inter-American Development Bank.

Garro speaks frequently at specialised industry venues, including meetings of the Inter-American Federation of Insurers and the Pan-American Confederation of Insurance Producers. He teaches civil law and insurance law courses at the University of Costa Rica.


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