The Geneva Papers on Risk and Insurance Vol. 26 No. 2 (April 2001) 252±258

The Insurance Industry in the development of the Czech Economy by Karel Zeman

The paper summarizes the basic features of (i) the development of the Czech insurance industry; and (ii) its preparations for E.U. accession. The insurance industry is a signi®cant part of ®nancial sector and plays an important role in market economies. Compared with the E.U., the Czech insurance market is not well developed, despite some positive advances. Its share of GDP is still smaller than in E.U. member states. The structure and quantity of insurance products offered is qualitatively changing fast, but the supply is still much less than in developed countries, and so is the quality of certain services. In the medium term, the objective is to develop the Czech insurance industry to make it competitive in providing a broad range of insurance services. A prerequisite for this is an improved legal and institutional framework that will enable more ef®cient regulation of the insurance market. 1.

The Czech insurance industry development trends at the end of the 1990s

The 1990s were a period of transformation and development for the insurance industry in market conditions. The passage of the Act on Insurance in 1991 paved the way to the establishment of new insurance companies and to competition. The next important step was the adoption of accounting regulations for insurance companies, and the Ministry of Finance decree stipulating the establishment, use, and manner of placing the means of technical reserves. The legal provision de®ning the scope and manner of doing business in insurance included the Commercial Code, the Civil Code, tax laws, and legal regulations relating to mandatory (ex lege) insurance ± liability for damage caused by the use of motor vehicles, and liability of employers for damage caused by injury at work and vocational diseases (workers' compensation). These legal arrangements from the ®rst half of the 1990s gave an undoubted boost to the sector. In 1998, the industry continued to develop on the legal foundations laid in the ®rst half of the 1990s. 1998 was a year of important decisions. It had been clear for some time that the market must be further liberalized, especially in motor third-party liability. The reasons why it is necessary to switch from ex lege to contractual obligatory insurance include the Czech Republic's future membership of the E.U., the monitoring public's dissatisfaction with the

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existing system that does not allow for individualized risk, and increased interest in ®nding a solution on the part of commercial insurers. Act No. 168/1999 Coll. on insurance against liability for damage caused by the use of vehicles eliminated the monopoly in this sector and opened up the market. The Act came into force on 30 July 1999, and is compatible with the E.C. directives. Liability insurance covers especially damage to health and damage to property. It is important that the Act introduced the direct claim of the damaged party against the insurer. It also provided for the establishment of The Czech Insurers Bureau as an autonomous organization of insurers, which is ®nanced by them. The second important legal Act, which the Parliament passed on 21 December 1999, is Act No. 363/1999 Coll. on Insurance. It signi®cantly approximates Czech insurance law to legislation valid in the E.U. The fundamental principle of this Act is the transition from ``material control'' by state supervision of insurance to control of ®nancial health and of management by insurance companies. The Act speci®cally stipulates that insurance or reinsurance operations in the territory of the Czech Republic can be pursued only by insurance or reinsurance companies which have been granted a licence by the Ministry of Finance. If they have their seat in the Czech Republic, they can have the form of either a joint-stock company or a co-operative. Insurance companies having their seat in other countries can have an organizational unit (branch) operating in the Czech Republic. The new Act on Insurance entered into force on 1 April 2000. Of key importance for product liability insurance was also the passage of the Product Liability Act (59/1998 Coll.), which sets forth the conditions under which manufacturers, importers, and suppliers bear liability for damage to health, death, or damage to other items intended and used principally for non-business purposes. Act No. 60/1998 Coll. amending the Act on State-Supported Export Insurance and Financing (58/1995 Coll.) clari®es and treats in more detail state support for insuring credit risk and ®nancing exports. In order to receive subsidised ®nancing and compensation for interest rate differences, exporters must be insured by the Export Guarantee and Insurance Corporation (EGAP). Another fundamental piece of legislation is the Act on Certain Conditions for Doing Business in Travel and Tourism, which requires travel agencies to be insured against bankruptcy. After several alternative approaches were considered, in 1998 it was decided to use insurance to protect travel agency clients. In the event of a claim, insurance companies offering the new type of insurance will ensure that all the failed travel agency's clients return home safety from abroad, so as to avoid a repeat occurrence of the problems encountered in 1997. These legislation changes moved the Czech insurance industry closer to ful®lling its key strategic objectives of compatibility with the insurance industry in the E.U. and, subsequently, full harmonization of Czech insurance laws with E.U. legislation. In addition to the key insurance laws whose preparation culminated in 1998, a number of other pieces of legislation that affect insurance company operations were passed. One of the important of these is the Act on the Czech Securities Commission (15/1998 Coll.), which also amends certain other laws. Pursuant to section 12(2) of the Act, insurance companies are subject to regulation by the Czech Securities Commission (CzSEC) in respect of their obligations when investing and trading in investment instruments on their own account. The CzSEC is required to exercise its regulatory powers in a manner that does not impinge on the Ministry of Finance's authority as insurance industry regulator pursuant to the Insurance Act.

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In this legal framework the number of insurance companies licensed by the Ministry of Finance rose from three at the end of 1991 to 42 to the end of March 2000. According to the Czech Statistical Of®ce and Czech National Bank (9), (10), of these 42 insurance companies six operated in the Czech Republic as organizational units of foreign insurers and 36 were joint stock companies. Of these, 20 were fully in Czech hands (two in state ownership), 13 fully owned by foreign capital and three partly owned by foreign capital. The insurance market was on the whole ®nancially stable. The only company which lost its licence in the 1990s due to serious economic dif®culties was PojioÈtovna MORAVA jointstock company. The other companies coped well with the consequences of the catastrophic ¯oods in 1997 and 1998, and over the two years paid relevant compensation to a total of CZK 10.3 billion. From 1998 competition intensi®ed in the insurance market, especially in insurance for the industry and business sector, and there was further expansion of the range of insurance products offered. The number of insurance products available exceeded 200. In certain areas, the Czech insurance industry strengthened its position in the national economy. In general, it ful®lled its role in dealing with the damage caused by the ¯oods of 1997 and 1998. During those two years Czech Insurance Association (CIA) member insurance companies paid out approximately CZK 10.4 billion in ¯ood-related claims. Life insurance technical provisions of CIA member insurers were up roughly CZK 4.2 billion to CZK 68 billion in 1998, bringing total technical provisions to nearly CZK 99 billion. This put insurers in a better position as institutional investors. In 1998, a year of increasing unemployment in the Czech Republic, the insurance sector created new jobs. The total number of people employed by insurance companies in the Czech Republic at the year end 1999 was 15,789 which is 2,344 more than in 1995. Approximately 19,000 full- and part-time intermediaries (insurance agents) and 260 insurance brokers co-operated with CIA member insurance companies. Besides creating new jobs, the insurance industry made a positive contribution to the national economy through increased taxes. These can be estimated from the sector's aggregate pro®t before taxation result of approximately CZK 1.9 billion in 1999, which is the best earnings performance the industry has seen in the entire decade of the 1990s. A slight improvement was seen in the overall insurance penetration ratio, which compares premiums written to the gross domestic product unadjusted for in¯ation. This indicator was 3.5 per cent in 1999, which, though higher than in previous years, still does not match the Czech insurance industry's potential. Table 1: Selected indicators of insurance institutions in the Czech Republic 1995 Average registered employment 13,445 Total revenues, CZK bn 53.73 Premiums written, CZK bn 33.40 GDP, CZK bn (in current prices) 1,381.10 Penetration, in per cent of GDP 2.4 Pro®t before taxation, CZK bn 0.574 Sources: (10), (11), (12), (13).

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1996

1997

1998

1999

14,972 15,927 15,989 15,789 87.07 148.95 209.28 275.25 40.83 53.90 55.38 63.41 1,572.30 1,668.80 1,798.30 1,836.30 2.6 3.2 3.1 3.5 ÿ2.215 0.365 1.836 1.912

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Table 2: Insurance penetration in selected countries (in per cent of GDP) Country Czech Republic Estonia Latvia Hungary Poland Slovakia Slovenia

1996

1997

2.6 1.8 1.5 2.2 2.1 2.4 4.8

2.9 ± 1.9 2.3 2.6 2.6 4.5

Sources: (4), (5).

For comparison, the average insurance penetration in the E.U. in 1997 was 7.6 per cent. Generally, insurance penetration in E.U. countries is in the 5 to 10 per cent range, with the exception of Luxembourg (32.4 per cent in 1997), Great Britain (11.7 per cent), and, at the opposite end of the spectrum, Greece (1.8 per cent). The Czech Republic's position among Central and Eastern European countries is relatively good. The Czech Republic's relatively good position among Central and Eastern European countries does nothing to change the fact that it is still considerably behind most countries of the E.U. This is a natural consequence of different economic strength as well as a number of other factors, both objective ± such as legislative bottlenecks ± and subjective, which can affect insurance companies. These subjective factors include citizens' insuf®cient understanding of the importance of insurance and their continuing dependence on the government, even though the economic environment and the government's role in society have changed fundamentally since 1990. A classic example is that, even after the ¯ood catastrophe of 1997, Czechs failed to exhibit any greater interest in insuring their property. A second example is the fact that life insurance premiums represented only 27.1 per cent of overall premiums written in the Czech Republic in 1998 (the average in the E.U. is 52 per cent). It is obvious that government should help build the public's awareness of aging issues and the necessity of life insurance by implementing one or more of the tax incentives used 18 OECD countries. According to premiums written in the Czech Republic in 1998, a total of CZK 55.38 bn was broken down into these classes of insurance: 35.0% 27.1%

Industrial and business risks Life and pension

4.5% 2.1%

17.2%

Motor vehicles ± ex lege third-party liability Accident

2.0%

Motor damage (individuals) Building and structures (individuals) Household contents

7.2%

Other

4.2%

The CIA member aggregate portfolio of long-term policies for individuals contained 11.8 million policies. This can be broken down by class of insurance as follows:

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4.3% 13.4% 11.3% 7.8%

Life Household contents Buildings Pension

6.4% 2.1% 15.7%

Accident Motor damage (individuals) Others

There is room for growth in non-life insurance as well. For example, household contents insurance penetration at 31 December 1998 was approximately 43 per cent (3.7 million homes; 1.6 million policies). Penetration in motor damage insurance was 10.8 per cent in 1998. Increasingly, development of the Czech insurance industry will be in¯uenced by globalization, E.U. compatibility and associated legislation, and the change in the government's role in society. There is reason to expect that the demonopolization of motor liability insurance will give private insurers a better footing and more room to manouevre. They are liability insurance, agricultural insurance, etc. 2.

The insurance industry's preparations for accession to the E.U.

The membership of the Czech Republic in the E.U. involves the need to harmonise the insurance law, i.e. to satisfy the spirit of the third generation Directives, and especially to apply the principle of a single licence and freedom to provide services. Amendments to the Act on Insurance are thus to be expected, as is the passage in 2001 or 2002 of an Act on insurance contracts, and an Act on insurance intermediaries. The insurance industry will also be affected by the harmonization of legislation relating to taxes, money laundering, securities, etc. Insurance companies must prepare themselves for E.U. membership in terms of business and commerce. Certain steps have already been taken, especially in the form of an amended insurance act. Over a period of roughly ®ve years, other steps towards the regulatory reform ought to materialize, as national legislation should be harmonized with relevant E.U. legislation. This necessitates the adoption of certain new Acts or amendments. It primarily concerns a brand new insurance Act that would fully incorporate the appropriate legislation in force in EU member states. Another important condition is the crucial change in the organization of state supervision of the insurance industry, already proposed by the amended insurance Act. Ef®cient application of state supervision, or its improvement, is an integral part of regulatory reform of the insurance industry. Increasing competitiveness of the Czech insurance industry so it is capable of withstanding pressure following the accession to the E.U. will necessitate restructuring of the insurance sector. Increased effectiveness of the insurance companies and reduction of their costs, is expected. This will be clearly associated with the process of identifying comparative advantages and partners in co-operative efforts. At the same time, capital additions and overall improvements of insurance companies' health will be needed. This is not possible to accomplish without a government policy focused on opening up the market and strengthening the competition. This involves the further removal of restrictions on insurance companies, and the total opening-up of the domestic insurance market to foreign insurance companies and capital. The authorities are considering a number of amendments designed to strengthen the regulatory framework for the sector and to ensure much greater compliance with E.U. directives. These would include: (i) ending the issuing of new licences to state-owned insurance companies; (ii) ending the licensing of universal insurers and limiting licensing to

# 2001 The International Association for the Study of Insurance Economics.

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separate life, non-life and reinsurance subsidiaries; (iii) replacing the security deposit by minimum capital requirements; (iv) applying a ``®t and proper'' test on the founders, directors and senior of®cers of insurance companies; (v) eliminating the prior approval of policy conditions; (vi) spelling out in detail the content of business plans; (vii) applying the standard E.U. solvency margins, separated into life and non-life; (viii) introducing the ``prudent man rule'' for asset management; (ix) strengthening disclosure requirements and noti®cation of management changes; (x) eliminating the discriminatory treatment of brokers acting for a foreign insurance company; (xi) requiring the employment of an actuary and independent audits; and (xii) strengthening supervision. The proposed amendments should be implemented without delay, as they would address most of the problems affecting the sector, and would bring the regulatory framework much closer to the E.U. directives. The authorities should also consider the following additional measures: (i) abolishing monopolies in motor third-party liability (MTPL) and workers' compensation (the problem caused by the inadequaaused by the inadequacy of reserves for MTPL could be handled by a one-off transfer from the state budget, or by imposing a special tax on motor insurance); (ii) offering tax incentives for long-term life insurance (to be determined in conjunction with the redesign of the tax treatment of pension funds); (iii) strengthening consumer protection by the creation of an ombudsman of®ce or similar body, and by promoting the use of insurance company ratings; and (iv) adapting regulation and supervision to the growing presence of ®nancial conglomerates (this would require implementing the co-operation agreement between the central bank, the securities commission, and the insurance supervision department, and might also require amendments to insurance, banking and securities legislation to allow the supervisory authorities from the three sectors to exchange information and co-operate between themselves and with supervisors in other countries). Insurance protection will be improved in all respects at the beginning of the millennium. There will be new insurance products such as response to changes in demand, introduction of new technologies and information systems. What can be expected is demand for integrated insurance and ®nancial services, the development of bank insurance, sale on the Internet, and so on. Competition will increase. Entrepreneurial caution will be needed in the different classes of insurance, such as motor TPL insurance, as will attention to ®nancial stability, and avoiding dumping. Mergers of insurance companies will become common. Premiums written should rise more rapidly than GDP, and there should be an increase in the share of life insurance in total premiums in the Czech Republic. Large groups of the population should become aware of the importance of insurance. Much will depend on economic policy, the rate of economic growth, and some conceptional decisions of importance to the whole of society ± pensions reforms and health insurance. Sources (1) HOLSBOER, J.H., 1999, ``Reposition of the Insurance Industry in the Financial Sector and its Economic Role'', The Geneva Papers on Risk an Insurance Issues and Practice, 24, No. 3, July. (2) MESRSÏMID, J., 2000, ``New Impulses to the Development of Czech Insurance Industry'', Czech Business and Trade, No.3. (3) ZEMAN, K., 1999, ``Regulation in Financial Services: The Case of the Czech Republic'', Paper for the 15th Progress Seminar, Geneva, 16±17 September. (4) Czech Insurance Market, 2000, ``The Czech Insurance Industry in 1998'', Czech Insurance Association News, Prague.

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(5) ``European Insurance, Complete 1998 Data, in Figures'', CEA 2000. Â , P. 2000, ``Insurance Industry Development Trends in the Czech Republic'' (in Czech), Statistika, (6) SÏTIÂPOVA No. 4. (7) OECD, ECONOMIC SURVEYS, 2000, ``Czech Republic'', Paris: OECD. (8) Economic Strategy of the Accession to the European Union: Growth ± Competitiveness ± Employment ± Solidarity, Approved by the Government of the Czech Republic on 17 May 1999. (9) WORLD BANK, 1999, ``Czech Republic Toward EU Accession'', Main Report, World Bank Country Study, Washington D.C., September. (10) CNB Prague, 2000, ``Survey of Financial Sector Development in the Czech Republic'', March. (11) CSO, 2000, ``Economic Results of Insurance Companies and Pension Funds on 4Q and Year 1999'', Prague, 30 March. (12) CSO, 2000, ``Estimate of GDP Formation and Use, 4th Quarter of 1999'', Prague, 22 March. (13) CSO, selected years, ``Economic Results of Insurance Companies and Pension Funds'', Prague.

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