Future Capital Kenya

Could Insurance industry's future profit levels be the same as each fans visibility?

When each person watching a football game decides to stand up to get a better view, the end results are usually disastrous. Everyone stands up and his view is made worse by the tall guy sitting right in front of him. What he thought was a brilliant individual move turned out to be collectively dumb. Could this same scenario be at play in Kenya's insurance industry?.

To this discussion, I would urge anyone who does not have an understanding of the insurance industry to read a previous post on the economics of the insurance industry. However, the recent developments have lead me to worry about it's future profitability.

Just yesterday, Resolution Health announced the sale of  a 25% stake in the company to German Private Equity firm African Development Corporation (ADC). The sale left Resolution Health with Kshs 187 million that it will use for its expansion into East Africa. This bodes well for Corporate Kenya's image and for Resolution Health as good management is now being rewarded with deep pocketed investments that enable growth.

Nevertheless, I am slightly concerned by this trend in the insurance industry. Resolution Health has joined a list of other insurers that have recently raised capital for non-regulatory purposes. AAR last year raised 750 million from selling a 20% stake to a Private Equity firm from Netherlands. CIC insurance last year also raised capital and in fact doubled its capital base to 1.2 billion shillings from 600 million shillings. Old Mutual is seeking to raise 700 million shillings and Real Insurance is also seeking to raise a sum in that region.

My last blog post on insurance mentioned two things that work to malign the insurance industry. A commodity product and excess capacity. A commodity product simply means that people's insurance choices are mostly defined by price rather than any unique product specifications. Although this works more in general rather than health insurance. The second issue of excess capacity stems from the fact that insurers simply produce more by either raising capital or a willing underwriter. In this case the former will inevitably lead to the latter.

All the aforementioned organisations are making brilliant financial decisions if viewed from individual analysis. However, they could be making very unwise decisions if viewed from an industry perspective. The increased capital of approximately 3 billion shillings will lead to lower priced premiums and probably lower returns on capital.

The reason I avoid the use of the word profit is because Corporate managers tend to hide behind the implicit nuances that exist within that word. Profit should not be analysed from an absolute perspective but rather a relative perspective. Let's say a company earns 400 million shillings from a capital base of 2 billion and then decides to double its capital to 4 billion. It is expected to earn a profit of 800 million shillings assuming similar management techniques, the owners of that company have not improved performance even though they have injected more capital. The same could play out in Kenya, even though this time the profits are not going to increase proportionately to the capital. In fact they will increase by a lower factor than the capital.

I am adamant about this point simply because the current insurance penetration ratio of 2.5% is more of a demand constraint rather than a supply constraint. If you increase supply (add capacity) via raising more capital, then you will have more money chasing the same demand. Increased supply in the face of static demand equals bad economics. In the Capitalistic society that we live in, the insurers are faced with two options; either follow the route that leads to hell or the road that leads to death either way try and make a smart choice. They can either stick to the maxims of good economics and maintain their current capacities and lose market share or increase capacity and be less profitable. I wouldn't want to be the one making that choice.

Watching Kenyan news this last week has really vindicated my beliefs that Kenyan's have a serious case of amnesia. 10,000 litres of milk were poured out with impunity and just yesterday Maize was rotting in Rift Valley. The milk case was just horrible because as my dear aunt told me on Friday evening. It would even have been more prudent for the milk to be put outside the factory gates for the public to come and consume to their discretion. However before I rant further which is clearly not in the spirit of this blog, one must ask themselves; what's the matter? Analysing this can be voluminous, but I'd like to try with some of John Locke's wisdom.

In the Wealth of Nations by Adam Smith, John Locke is quoted as saying;

All other moveable goods are of so consumable a nature, that the wealth which consists in them cannot be much depended on; and a nation which abounds in them one year may, without exportation, but merely by their own waste and extravagance, be in great want the next. Money on the contrary, is a steady friend, which though it may travel about from hand to hand, yet if it can be kept from going out of the country, is not very liable to be wasted and consumed

The meaning of all this is that commodity dependent countries are not good candidates for sustained growth. Due to the consumable nature of commodities especially in countries where impunity and corruption is rife (KENYA!!!), waste and extravagance will stifle growth. This is nothing new in Africa. However, this is not to say that commodity rich countries cannot thrive, this is merely to say that money, and not commodities is the main driver of growth. John Locke then concludes by stating that "increasing money is the great object of a country's political economy". 

I still feel that this is too shallow an analysis, I will thus follow this post up with part 4 of the Future Capital Series. However, it is something to digest, we should stop with the notion that the more food, copper, gold and oil we have, the more we'll grow. It's a bit like saying that a person with 100 beers worth 80Ksh each is better off than the person with Ksh 6,000. The consumable nature of the beers is no match to the multipliable nature of the Ksh 6,000.

Image courtesy of Daily Nation Online Edition