The prospect of a recession in South Africa continues to plague the country, as electricity load shedding and plans for electricity ‘rationing’ will continue to affect the country for the next five to six years.With current and projected resource levels insufficient to meet increasing demand, the impact of load shedding is a concern across all business sectors. The shut-down of mining operations has resulted in company profits continually being revised and economic growth forecasts being downgraded by multiple basis points. For players in the life insurance sector, this will prove to be yet another worry, placing projected sales under pressure.
Recently, life insurance companies have had to combat adversity on several fronts. Factors such as a contracting lending market, driven by the introduction of the National Credit Act and an increasing interest rate environment, the Life Office’s Association and South African Insurance Association credit insurance inquiry, the increased regulation of intermediary commissions on investment products and the Treasury’s ongoing review of the social retirement landscape have all created a tighter life insurance market. With the additional fears of slowed economic growth, due to electricity supply issues, the industry is preparing for a further tightening cycle.
A recession will impact the life insurance industry on a number of fronts. Disposable income becomes a scarce commodity and insurance premiums are invariably among the first items to face the ‘axe’ from household budgets. This results in higher insurance policy lapse rates for life insurance companies, with a resulting increase in operating cost, which will have a negative impact on financial results. New business sales will also decrease, further affecting life insurance company profits. Claims experience may also begin to deteriorate, with any price cross subsidies laid bare when the balance of risks in an insurance portfolio changes, due to higher lapses not necessarily being experienced across the board.
A more direct impact on claims experience will come from an expected increase in fraudulent claims. Times of recession invariably result in increased disability claims, with increased back and psychology claims showing a direct correlation to economic prosperity.Life insurance companies have reduced their premiums for this class of business after several years of good claims experience and economic growth. Another example of increased claims experience will be an increase in retrenchment business. Industry pockets will be severely affected by slowed economic growth, resulting in layoffs. Insurers will therefore be heavily exposed to retrenchment claims from these sectors.
The combination of higher lapse rates, increased fraudulent claims and an increase in valid claims will increase operating expenses, as insurance companies will have increased staff to deal with these operational and administrative demands. At a time when premium income is under pressure, expense ratios will become an even more critical measure and can be expected to cause further difficulties.
This negative scenario is based on rising interest rates further suppressing economic growth, a further dip in the housing market, which is already termed as “sluggish” according to a leading industry property confidence indicator, the continual load shedding eating into company profits resulting in downsizing, the infrastructural strain continuing to cause headaches for consumers and industry, the growing skills shortage and world markets taking a beating in the wake of a possible U.S. recession.
However, South Africa’s economic growth in 2008 is forecast between 3.4% and 3.9%, which is some way off a recession. Interest rates are also expected to level off as the demand for credit subsides. World markets, and increasingly South Africa, are no longer as dependent on the market fortunes of the U.S., as countries like India and China are experiencing periods of unprecedented growth.With investments like the Industrial and Commercial Bank of China Limited taking a 20% shareholding in Standard Bank, South Africa is quickly diversifying its exposure to Western markets, and as long as the 2010 Soccer World Cup preparation stays reasonably on track, job creation and foreign investment should stave off a recession until at least after the World Cup in 2010.
With so many variables at work in the economy at the moment, it is difficult to predict the exact extent to which the life insurance industry will be affected in 2008.However, should economic conditions deteriorate further we can expect a difficult year for the industry.