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Emerging Risk Strategies: Remember the past in considering whether to expand to Russia


In November 2006, the United States and Russia signed an 800-page trade agreement as a prelude to U.S. support of Russia's bid to join the World Trade Organization. Included in the concessions was an agreement to let foreign insurance companies operate in Russia through subsidiaries. This includes 100% foreign-owned property and casualty companies.

Only time will tell the real impact of the agreement. Western insurers need little help to recognize that Russia is a risky place for direct foreign investment. At the same time, Russia is a large emerging market. Let us examine past events, current opportunities and risks.

Prior to 1917, Russia had a large and strong insurance market. When the Bolsheviks seized power, the government nationalized insurance, which provided the only available coverage until 1988. At that point, the insurance monopoly was divided into two parts: Rossgostrakh was the domestic insurer and Ingostrakh handled insurance for foreign entities.

During the Soviet era, serious problems existed for insurance buyers. Private insurance was virtually nonexistent. State-run corporations were required to buy insurance; while commercial lines coverage was provided in a framework of regulations, the rules had a weak legal system to back them up.

In 1992, I presented the first post-Perestroika seminar in Russia about modern insurance. The seminar, encouraged by the World Bank and sponsored by the Academy of National Economy, attracted more than 50 representatives of potential and existing Russian insurance companies. One participant explained that "Strakh" in Russian "reminds people of a similar word which means secret. It fits, as our insurance companies took our premiums, did not issue a policy, did not tell us the extent of coverage and rarely paid claims after a loss."

The companies at the seminar were an interesting mix. Entrepreneurs all, they had capital of varying amounts. As a result of the ruble's devaluation, one company had capital of less than $10,000. Most people wanted to know how to make money by selling insurance. It is not clear they were serious about providing insurance. Other goals, such as tax avoidance and rapid collection of cash premiums, seemed important.

Insurance suffered a serious blow in 1998, when Russia defaulted on its debt. The country suspended payments on foreign loans at a time when the ruble traded at seven to the U.S. dollar. Within a week, the ruble reached 13 to the dollar, and by year-end it was 20 to the dollar. Inflation, which had been 11% in 1997, was 84% in 1998. The economy came close to a collapse. Existing insurance policies, even if paid, would not cover potential losses.

Insurance suffered another blow in 2003 when the Russian government alleged tax violations against Yukos, a large privatized gas company, and expropriated its stock. At the same time, it sentenced Mikhail Khodorkovsky, the company's CEO, founder and opponent of Russian President Vladimir Putin, to an eight-year jail term. Even as it negotiated WTO entry, the Kremlin nationalized a number of former state companies and forced out foreign investors.

Past events guarantee that carriers that are considering Russia will take a risk management approach to market entry. This has been the case for companies such as American International Group, ACE, Allianz and Zurich Financial Services Group, which already have a presence in Russia. The door opened wider in 2004, when Russia enacted legislation that many observers believed will improve the environment for insurance. Key changes included forbidding a single legal entity from offering both life and nonlife insurance and increasing minimum required capital.

These changes mirror other efforts by Mr. Putin since 2000 to move the Russian Federation toward a modern market economy. Important steps in the process were opening the market to foreign banks and, in recent months, to Western insurers. The results of these reforms can be seen in the growth of the Russian economy. The Russian insurance sector has benefited from good economic news combined with reforms that encourage the voluntary purchase of life and casualty coverages. Statistics show that more individuals and businesses are buying insurance for life, health, property and other risks.

Part of the opportunity lies in the Russian market's fragmentation. Russian insurers are relatively small. As of 2005, fewer than 1,200 companies divided $16 billion in premiums. Ten companies owned about one-third of the market. The rest of the premiums were widely dispersed. We can expect that a continuing consolidation along with a likely rapid growth in premium volume will create opportunities for Western insurers.

An important feature of the new climate is that the market is not intensely competitive. Russia's government and domestic insurers appear willing to accept foreign competition, partly so the economy and industry can improve and grow. Companies are making money and the return on invested capital has been reasonable given the level of risk. Russian employees are highly educated, ambitious and clever, while Russian consumers pursue quality and are knowledgeable about products and services. All in all, the insurance market is not likely to be ignored by the global insurers.

This is a sad time for companies seeking to do business in Russia, however. Last year saw three relatively isolated but highly visible murders--Andrei Kozlov, first deputy chairman of Russia's Central Bank, who sought to rid banks of corruption; Anna Politkovskaya, a U.S.-born Russian journalist and human rights activist who was known for her opposition to the Putin administration; and Alexander Litvinenko, a former KGB lieutenant colonel who publicly accused his superiors of ordering the assassination of Russian billionaire Boris Berezovsky. These killings emphasize that in Russia sometimes it's hard to tell who is in charge and who is controlling events.

For Western insurers, the opportunity is real, but it may take a long time to succeed. We might conclude that a modern business climate is emerging in Russia. Western insurers cannot ignore the country and should maintain a long-term perspective on doing business in Russia. The key is to go slowly, hold down expectations and take time to learn the rules of the game.