A Brief Overview of the Brazilian Life and Annuity Market by Michael Witt

Article from: International News

August 2009 – Issue Number 48

Michael Witt, FSA, MAAA, is a consultant with Milliman in Williamsburg, Va. and supports Milliman’s São Paulo office. He can be reached at Michael.witt@ milliman.com.

A Beautiful Opportunity: A Brief Overview of the Brazilian Life and Annuity Market By Michael Witt

razilians often refer to their style of playing soccer as “the beautiful game.” Earned Life Insurance Premium B They play with creativity and risk tak- (in R$ millions) ing that is unmatched by other countries and 600.0 the results are indisputable. Brazil has won five

World Cups, more than any other country. 550.0

In recent years, Brazilians have developed an- other thing of beauty, although it is nearly de- 500.0 void of creativity and risk–taking. Internal management, combined with external events, have 450.0 turned Brazilian life and annuity insurers into strong companies providing consistent results. 400.0

7 7 8 8 7 0 0 7 7 7 7 7 7 8 8 8 0 0 8 8 8 8 8 8 9 9 r- -0 r- -0 -0 ay- c ay- ul-0 v c Ap un-0 Jul-0 ug-0 ep-0 Oct-07 an-0 eb-0 Ap un-0 J ug-0 ep-0 Oct-08 an-0 eb-0 In light of the current turbulent economy, this Mar-0 M J A S Nov-0 De J F Mar-0 M J A S No De J F certainly represents a beautiful opportunity for Earned Premium foreign companies desiring to enter and take advantage of Brazil’s growing, stable insurance market. Brazil did not always have a low-riskUS approachDollar vs. Brazilian Real to their life insurance products. In the midExchange to Rate LIFE INSURANCE 2.90 late ‘90s, several companies began offering Life insurance products in Brazil are generally 2.70 ART products where the premium was constant simple for the customer and carry very little over2.5 0time. While this product had large margins mortality or investment risk for the insurer. in 2 the.30 early years, providing large profits, the The majority of policies sold are annually re- margins slowly deteriorated as policyholders newable term (ART) policies, so there are no 2.10 aged and premiums remained level. Many of long term reserves that would bring investment 1.90 these products are already producing losses, risk in the current economic environment. Be- and1. 7 the0 products that are still profitable now cause of strong distribution networks (generally are1 .expected50 to produce losses in the next few

through large banks), companies are also able 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 9 9 9 Call for Papers–Living to 100 Symposium IV years. 7 7 7 8 8 8 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 to price their products conservatively. This al- 200 200 200 200 200 200 / / / / / / / / / / / / / / / / / / / / / / / / 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / /

lows insurers to withstand moderate increases 4 5 6 7 8 9 1 2 3 4 5 6 7 8 9 1 2 3 To manage these products, 10 many11 12 companies 10 11 12 in mortality. have begun to establish reserves for the future USD-BRL losses and are consistently monitoring the per- The slowing economy seems to have had little formance of these blocks. Additionally, insurers effect on the sales of life insurance in Brazil. Annuity Assets Under Management have taken further steps to mitigate these risks. As can be seen in the following graph, the pre- (in R $ Billion) Some120.0 companies have developed new products mium growth has trended upwards over the last

two years, resulting in record profits for many 110.0 companies. CONTINUED ON PAGE 34 100.0

90.0 AUGUST 2009 | INTERNATIONAL NEWS | 33

80.0

70.0

60.0

7 7 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 8 9 9 0 0 -0 -0 0 0 -0 -0 r- y- v c r- y- v c a un-0 Jul-0 ug-0 ep-0 an-0 eb-0 a un-0 Jul-0 ug-0 ep-0 an-0 eb-0 Mar-0 Ap M J A S Oct-07No De J F Mar-0 Ap M J A S Oct-08 No De J F

AUM Earned Life Insurance Premium (in R$ millions) 600.0

550.0

500.0

45INTERNATIONAL0.0 NEWS

400.0

7 7 8 8 7 0 0 7 7 7 7 7 7 8 8 8 0 0 8 8 8 8 8 8 9 9 r- -0 r- -0 -0 ay- c ay- ul-0 v c Ap un-0 Jul-0 ug-0 ep-0 Oct-07 an-0 eb-0 Ap un-0 J ug-0 ep-0 Oct-08 an-0 eb-0 Mar-0 M J A S Nov-0 De J F Mar-0 M J A S No De J F

Earned Premium

US Dollar vs. Brazilian Real Exchange Rate A2. 9Beautiful0 Opportunity … | from Page 33 2.70

2.50

2.30

2.10 and encouraged customers to replace their cur- (AUM) in equities. During the current eco- 1.90 rent policy with one of the new products. Oth- nomic crisis, insurers have benefited from the 1.70 ers have changed their operational procedures, Brazilian annuity structure in two ways. First, 1.50 training call center representatives to not try the lack of guarantees has eliminated the market 9 9 9 8 8 8 8 8 8 8 8 8 7 7 7 7 7 7 8 8 8 7 7 7 to retain customers who want to cancel one of risk that is present in countries where variable 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 / / / / / / / / / / / / / / / / / / / / / / / / these policies. These management steps have annuities carry guarantees that have gone in the 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / / 1 2 3 1 2 3 4 5 6 7 8 9 4 5 6 7 8 9 11 12 10 11 12 10 generally served well to reduce the risk of the money under the current economic conditions. non-adjustable policies as they work them- Second, the fact that the majority of funds are in USD-BRL selves out of the companies’ portfolios. fixed-income options has resulted in continued AUM growth even though the stock market has Annuity Assets Under Management lost value. The average fund return during the (in R $ Billion) 120.0 last two years has stayed in the 10 to 12 percent range. This means that the fee income that is 110.0 based on AUM has continued to grow through- out the economic downturn. The following 100.0 graph shows the total AUM growth for the Bra- zilian market over the last two years. 90.0

80.0 As with the life insurance products, annuities in Brazil were not always low-risk. In the early 70.0 years of the private annuity market, annuities carried rich interest guarantees, the most com- 60.0 mon of which was a guarantee of inflation plus 7 7 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 8 9 9 0 0 -0 -0 0 0 -0 -0 r- y- v c r- y- v c a un-0 Jul-0 ug-0 ep-0 an-0 eb-0 a un-0 Jul-0 ug-0 ep-0 an-0 eb-0 six percent. When these products were devel- Mar-0 Ap M J A S Oct-07No De J F Mar-0 Ap M J A S Oct-08 No De J F oped in a high interest rate environment, it AUM seemed unlikely that the guarantee would ever come into play. However, over the last five ANNUITIES years, interest rates began to drop dramatically, Annuity products in Brazil are also simple and and insurers were forced to make changes. First, represent little risk to the insurer. The policy- most companies began to develop more robust holder is offered a number of funds and as- asset/liability management (ALM) practices to sumes all of the investment risk for their fund immunize their portfolio and lock in high inter- allocations. However, regulations require that est rate returns for as long as possible. Secondly, the funds cannot invest more than 49 percent companies began aggressive campaigns to con- of their assets in equities, with the remainder of vince policyholders to replace their guaranteed the assets invested in fixed income instruments annuity with a non-guaranteed annuity, usually (generally, federally issued inflation linked offering some benefit if the policyholder con- government bonds). In practice, the policyhold- verted. As a result of these management tac- ers still overwhelmingly choose fixed income tics, most of the guarantee annuities are “under options, so companies have (on average) about control,” and are not expected to present large 10 percent of their assets under management losses in the future.

34 | INTERNATIONAL NEWS | AUGUST 2009 Earned Life Insurance Premium (in R$ millions) 600.0

550.0

500.0

450.0

400.0

EXTERNAL EVENTS Earned Premium In addition to the internal events that have strengthened and stabilized Brazilian insurers’ US Dollar vs. Brazilian Real profits, external events over the last two years Exchange Rate have made it more attractive for foreign insur- 2.90 ers to enter or expand their presence in the Bra- 2.70 zilian market. The Brazilian real has weakened 2.50 during the economic crisis, making it cheaper for foreign companies to invest in Brazil. The 2.30 following graph shows the exchange rate for 2.10 the U.S. dollar and the Brazilian real over the 1.90 last two years. 1.70

1.50 Additionally, several foreign companies have 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 9 9 9 7 7 7 8 8 8 ran into difficulties and decided to exit the Bra- 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 200 / / / / / / / / / / / / / / / / / / / / / / / / 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / zilian market. Last year, AIG and Tokyo Marine / 4 5 6 7 8 9 1 2 3 4 5 6 7 8 9 1 2 3 10 11 12 10 11 sold their portions of Brazilian joint ventures to 12 their partners. It is possible that other foreign USD-BRL companies might look to sell their stakes in Brazilian insurers in order to raise capital, and Annuity Assets Under Management it may be possible to acquire these stakes at be- CONCLUSION (in R $ Billion) low market prices. 1The20.0 management and regulatory culture in Bra-

1zil10. 0 has produced life and annuity companies Existing companies are generally solid, the mar- that have remained extremely profitable during ket is stable, and currency rates are favorable, 1the00.0 current economic downturn. Current sales but entering the Brazilian market is not without have continued to grow for products that repre- its challenges. The market is currently dominat- sent90.0 little investment risk to the company, and ed by insurance sold through large banks, and risks80.0 on existing blocks of business have large- these banks seem to be shying away from joint ly been mitigated. External events such as the ventures. So entering into this type of arrange- weakened70.0 Brazilian real and troubled foreign ment may be more difficult or costly than ac- owners have produced companies that can be quiring a stand-alone insurer. But the traditional acquired60.0 at relatively low values. It is clear that 7 7 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 8 9 9 0 0 -0 -0 0 0 -0 -0 distribution channels through smaller banks in this troubledr- y- economic environment,v c Brazil- r- y- v c a un-0 Jul-0 ug-0 ep-0 an-0 eb-0 a un-0 Jul-0 ug-0 ep-0 an-0 eb-0 have eroded as these smaller banks have been ianMar-0 lifeAp andM annuityJ insurersA S Oct-07 representNo De Ja beautiF Mar-0- Ap M J A S Oct-08 No De J F acquired by the large banks. So a new entrant in ful opportunity for foreign companies that want AUM the market will have to demonstrate some cre- to enter the market. o ativity in developing a distribution system that will allow it to penetrate the insurance market outside of bank channels.

AUGUST 2009 | INTERNATIONAL NEWS | 35