Too early to predict the end of crisis yet

The current global crisis has additionally deepened the unenviable position of the Croatian economy in the first months of 2010 caused by a bad macroeconomic policy pursued over the last two and more decades. Croatia lacked a long-term vision of development, and varied strategies and guidelines of economic growth and development were based on the so-called neoliberal economic policies seeing growth only in terms of the existing market mechanisms. About 10 years ago we thus became an open economy defined by fast growing imports and slow growing exports, and the process of deindustrialization which started more than three decades ago continued even into the period of 2000 to 2008, which was characterised by a good economic outlook. Hence, our macroeconomic politics was not proactive or counter-cyclical, which is also seen in the recent developments on the global financial markets.
The global financial crisis started in the main financial centres as early as at the end of 2007, expanding at the beginning of autumn 2008, and spilling over into the real sector, which is what led to the global economic crisis. Most developed countries which, among other things, use the category of fiscal and other domestic savings, promptly responded introducing measures aimed at maintaining their output capacity. They did not pay attention to the deficit limits set out in Maastricht!
Although severely indebted for years (and its indebtedness was at the expense of foreign, not at the expense of domestic savings), Croatia's spending exceeded the real limits of quantity and productivity. Croatia failed timely to respond not only to the clear signs of an emerging crisis two years ago, but also to the noticeable deepening of problems on the world financial markets towards the end of 2008. On the contrary, statements were made that Croatia was not in crisis. In spite of the visible signs of the weakening of fiscal sector liquidity, the budget adopted for 2009 was unrealistic, anticipating an economic growth of 2%. Fiscal politics did not find an appropriate solution, neither in economic nor in political terms, which would help reduce public spending, and neither did the anti-recession measures adopted by the Croatian Government in spring 2009 prove fully feasible and effective. In contrast to this, it was the monetary politics why the shaking banking sector was quickly stabilised, price and foreign exchange rate stability was maintained, and this contributed to the overall macroeconomic stability of the country.
As opportunities for foreign borrowings were increasingly shrinking in early 2009, the government used loans from domestic banks to service the growing budget deficits and the foreign debt. In spite of the release by the central bank of additional funds to domestic banks to avoid the effect of crowding out the private sector, this effect occurred and aggravated the liquidity of the real sector of economy. Although the demand of the government on the domestic financial market did not increase towards the end of the year, the banks lending activity to the private sector was markedly restrained despite good liquidity, so that in 2009 lending to households decreased by HRK 3.5 bn, and lending to corporations increased by only HRK 2bn relative to the end of 2008. Thus, due to the government's ineffective anti-recession measures and the unavailability and high price of credits, the whole burden of the crisis fell on the output sector of industry which had already been confronted with a rapid growth of insolvency.
Due to all this, a slowdown in the overall economic activity could be noticed as early as in the second quarter of 2008. In 2009, a negative trend of the gross domestic product (GDP) has been observed for the first time in 10 years, with its most pronounced negative developments recorded in the first quarter, while it only slightly improved in the second and third quarter. According to the Central Bureau of Statistics (CBS) estimate, in the third quarter of 2009, GDP saw a 5.7% decrease in real terms relative to the same period of 2008. When compared with the previous two quartals which experienced a decrease of 6.7% and 6.3%, respectively, the downward trend slowed down in the third quarter, which was anticipated mainly due to a low statistical base from the third quarter of 2008. The decrease in the overall economic activity at the entire 2009 level was -6%. This is attributable to a decrease in all categories of domestic demand, i.e. in personal consumption (decelerated wage growth, unemployment rate growth, contracted bank lending activities, decreased capital market yields) which accounts for 60% of GDP. All other categories of consumption also decreased, with the exception of government consumption, which rose by 1.5% seen on a cumulative level, in spite of a decrease in the third quarter. By production approach, GVA (gross value added) went down by 4%. A positive trend was observed only in three activity divisions, whereas all other divisions saw a decline, the sharpest decline being noticed in trade (14.6%), industry (9%) and construction (3.9%).
The anticipated favourable impact of the previous year's base on the development of the industrial production did not appear in the fourth quarter, and relatively high annual decrease rates continued. A slightly slower decrease in the industrial production is only attributable to a growth of output in the energy sector, which was expected due to the beginning of the cold season. In the first eleven months, the volume of industrial production declined by 9.5%, which is a relatively high decline when compared to the same period of the previous year. The recession underlined the fact that the problem of investment production and its uncompetitiveness is a structural problem that needs to be solved by necessary reform action. For sustainable economic growth and development, it is essential first to solve structural problems in those sectors which are marked by low technological intensity, such as shipbuiliding and textile industry, and then to stimulate the development of higher value added sectors dependent on new technologies and know-how, i.e. those industries which will consequently encourage production and employment. This, however, further points to a need of the adjustment of the education system to the real sector of economy. A slowdown in industrial production could continue into the first two quarters of 2010. The beginning of a recovery cannot be expected before the second half of 2010, with a likely stronger impact from positive developments on the foreign markets.
A positive contribution to GDP development still comes from net foreign demand, although it is not as strong as in the previous two quarters. Goods and services exports saw a decline of 17.6% annually (which was also the case in the first half of the year). However, as goods and services exports are by far more significant in the third quarter than in other quarters of the year (because of the tourist season and a steep decline in tourist earnings), the negative impact on the overall GDP was even more pronounced. Concurrently, goods and services imports fell by 23.5%, which is slightly less than in the previous three months.
Since the high frequency indicators such as developments in retail trade, industrial production, or construction activities did not significantly change in the period from October to November when compared to the previous three quarters, we do not expect a significant recovery of domestic demand or changes in net foreign demand whose positive contribution to GDP should be slightly higher than was the case in the third quarter.
On the whole, all these GDP components are expected to show a slower decrease in the fourth quarter of 2009, in large part on account of a low statistical base from the same quarter of 2008. In mid 2009, when the crisis was at its most severe, no serious efforts existed at addressing the problems and showing the country the way out of the crisis. They first appeared with the third budget revision as late as at the end of July. Although they were primarily focused on stabilizing public finances, and not on alleviating problems enountered by local companies, and although they were introduced later than required, these measures managed to create a hiatus for the creation and implementation of a more effective approach to the reduction of public consumption, the easing of the crisis-ridden position of companies and the rescuing of more promising production divisions. With no scheme for the rescue of economy elaborated by the end of 2009, the budget for 2010 did not envisage in its structure and its size all the elements needed to pull the country out of the crisis.
The first steps of an economy rescue scheme were made at the beginning of this year, when the Government adopted measures focused on economic recovery and development, and made the decision to establish funds to promote economic co-operation. Although these measures have still not been worked out in detail, they managed to bring more optimism to companies. The signs of a recovery can be noticed on a global scale, but the end of the crisis cannot be predicted yet. The observable positive developments are mainly attributable to the government interventions in the economy of a large number of countries, which stimulated growth of budget deficit and foreign debt, but also heightened the risk of the crowding out effect for private investments. This is why personal consumption is highlighted as a prerequisite for a stable growth of GDP.
With all the problems which have been crippling the Croatian economy for years, it is difficult to say when the negative trends will be halted and when a recovery will begin. This depends on numerous factors, but, most importantly, on the moves of the government in respect of a new economic policy, on the speed of adjustment to global trends, the dynamics of implementation of reforms and the restructuring of economy. Naturally, it also largely depends on the recovery of the international market, because in Croatia many hopes are placed on the growth of goods and services exports. What activities, divisions, or companies will be successful in the new situation on the international market will largely depend on their know-how, and the capabilities and competence of their management.
A survey showed that 82% companies in Croatia are affected by the crisis, and the majority of the people surveyed (the survey included 1500 people) expects the crisis to end by 2012. Companies are struggling with the crisis in various ways, including the most common methods of employment freeze, salary cuts, lowering costs for education, and reducing budgets for individual departments. Almost all the people surveyed (94%) reported that the crisis also affected their personal lives, with the worst effects of the crisis being felt by the elderly. Young people, although losing their jobs more frequently, stay optimistic. «They have a better vision of future and are more likely to change unlike the elderly among the people surveyed», the survey says.
Tourism in 2009 did not perform badly, although the results achieved did not reach the planned levels. Negative trends on a cumulative level stem from the decreased number of tourist nights recorded for the most part of last year, i.e. November was just one of the seven months which saw a downward trend in tourist nights. In the first eleven months of 2009 the number of nights was 1.3% down from the number of nights recorded in the same period of 2008. Since the number of nights realised by foreign tourists remained the same, the negative trends obviously came from a sharp decline in nights spent by domestic tourists (-10.4%). The highest number of nights was achieved, as usual, by tourists from Germany, Slovenia, and Italy, and no significant changes were recorded with respect to other countries of residence as well. Also traditionally, the highest number of tourist nights was observed in the Counties of Istria, Primorje and Gorski Kotar, and Split-Dalmatia, with Istria being the only littoral county enjoying an increase in tourist nights by 1%. In other littoral counties, an average 2.5% decline is recorded. Most tourist nights were stayed in private accomodation facilities, hotels, and camping sites. While in hotels the number of nights declined by about 6%, an increase of about 2.5% was recorded in the number of nights spent in private accomodation and camping sites. However, these trends did not essentially affect the full capacity utilization which still amounts to around 60 days.
Physical indicators of tourist season showed that the tourist season in 2009 was more favourable than the grim outlook showed at the beginning of the year. However, according to the latest Central National Bank data, tourism revenues could hover around EUR 6.4bn, which is more than EUR 1bn down when compared to 2008. Indicators from the real sector pointed to a lower tourist spending, with retail trade showing a two-digit annual rate of decline rate even during the tourist season. In addition to this, the average number of nights per arrival also declined, and the prices of services were reduced with an aim to attract a larger number of guests. It will be necessary in future that tourism be well-positioned both in the context of the domestic economy and the global tourist supply. While the good results achieved in 2009 (in respect of the number of tourist nights and arrivals) are mainly on account of competitive prices and Croatia's geographic position, greater effort will be required to perform well in 2010, when the competition will certainly be tighter.
The trends prevailing in the previous months remained unchanged in the last month of 2009, with no unpredicted fluctuations in the exchange rate of the Croatian Kuna against the common European currency. Money (banking) market was primarily marked by a good Kuna liquidity and a good foreign currency supply. The Kuna liquidity remained good throughout the year, and the central bank intervened when it was required to maintain the foreign exchange stability. At year-end the slow trend of the Kuna appreciation was halted and its slight depreciation began.
The average Euro exchange rate for December stood at HRK 7.29, up 1.3% from the value in the same period of 2008, whereas the average Euro exchange rate for all twelve months was 1.6% higher. The foreign currency trend last year was different from the trends recorded in most previous years, which were generally marked by a slight Kuna appreciation.
The US Dollar exchange rate fluctuations in 2009 were slightly more dynamic, with the value of the US Dollar against the Kuna rising by 4.7%. Concurrently, the strengthening of the US Dollar against the Euro was attributable to the European Central Bank decision that interest rates be maintained at a low level from mid 2009, as well as to the good news from the US labour market and from the still not fully recovered global capital market.
Foreign direct investments in Croatia in the first nine months saw a downward trend for the second consecutive year. In the first three quarters of last year, they amounted to EUR 1.7 bn, or 28.2% lower relative to the same period in 2008. The highest investments during this period were recorded in 2007, when they reached as high as EUR 2.9 bn. In 2009, the highest investments in Croatia came from the Netherlands (EUR 839.1 mio), followed by Austria (EUR 502 mio), and Luxembourg (EUR 136 mio), and it was invested mainly in wholesale trade and trade intermediation (EUR 707.5 mio), as well as in monetary intermediation, excluding insurance and pension funds (EUR 677.5 mio).
In the period of 1993 to 30 September 2009, overall foreign investments in the Republic of Croatia stood at EUR 23.6 bn, with, for example, investments amounting to EUR 79.1 mio in 1995, and in 2008 reaching a high of EUR 4.19 bn. Of total foreign direct investments, 75.5% were made by six countries (Austria 26.6%, the Netherlands 17.5%, Germany 11.5%, Hungary 9.0%, France 5.7% and Luxembourg 5.2%), while other countries individually invested less than 5%. Highest investments were made in monetary intermediation, excluding insurance and pension funds (EUR 8.4 bn), as well as in wholesale trade and trade intermediation (EUR 2.6 bn). Concurrently, Croatia's direct investments abroad totalled EUR 3.9 bn for the same period, with a record of EUR 962.5 mio investments realised in 2008.
Labour market is a segment of the economy last to reflect the recession-related trends, and accordingly, labour market will also be the last to show the signs of economic recovery. The number of unemployed persons has grown relatively fast within the previous months and is now close to the number of 300,000. The sharp increase in unemployment reflects numerous negative trends in economy. A slowdown in industrial production led to a decreased demand for labour. Manufacturing, trade, and construction are the most severely crisis-affected economic divisions, and the number of job-losses is also the highest in these divisions. In addition, some enterprises seek to reduce their operating costs and avoid bankruptcy by decreasing the number of labour and reallocating their capacities. This is also underlined by the fact that the highest growth of unemoployment rate is recorded in the age group of 20 to 29 years, consisting mainly of first time job seekers. The expected unemployment growth in the forthcoming period will have an adverse impact on personal consumption due to a reduced disposable household income, leading to a further slowdown of our economy which so heavily depends on consumption. A decrease in the assets of open-end investment funds which started in early 2008 was halted in 2009, so that the total assets of funds stood at HRK 11.406 bn at the end of 2009. The lowest figures were reached in February last year, when assets sank to a low of HRK 8,136 bn, but ever since March they have enjoyed a continued growth.
Due to the conditions on the money market and an increase in interest rates, good yields given by money market funds attracted more investors, leading to a considerable increase in the assets of funds. Thus, at the end of 2008 the assets amounted to HRK 3,907 bn, but enjoyed an increase by as high as 54.70% over the course of 2009, exceeding HRK 6 bn. The assets of bond funds saw a rise of 10.84% during 2009, which shows that more conservative types of funds became more popular in this period of economic unstability. At present, there are 10 bond funds active on the market, with the assets of HRK 554.761 bn under management at the end of the year.
The only group of funds which saw a fall in the assets are balanced funds. Last year saw a decline in their assets by 10.28%, to HRK 1.929 bn, down from HRK 2.150 bn in 2008.
Equity funds enjoyed an increase in their assets by 4.12%, closing the trade at HRK 2,878 mio at year-end. This is, on the one hand, primarily attributable to the recovery of domestic market, and, on the other, to the attraction of funds focused on emerging markets, such as Brasil, Russia, India and China, giving very high yields of more than 60%, which, at least partially, fuelled investor optimism.
At the end of 2009, the Standard & Poor's rating agency affirmed Croatia's long-term rating at BBB and short-term credit rating at A-3. According to the Agency's report, the estimate is based on a relatively high GDP per capita, stabilization policy of the Croatian monetary authorities and reforms related to EU accession. At the same time, the downsides stated include high indebtedness of the private sector, slow structural reforms to increase competitiveness and fiscal system, as well as great interdependence between economy and tourism.
«In spite of certain pressures, the Croatian National Bank reacted efficiently to maintain Kuna/Euro exchange rate, which was, among other things, facilitated by substantial foreign currency reserves. However, the financial system and the economy remain vulnarable», the statement says. The Agency estimated that the negative GDP trend would continue into this year.


Croatian Insurance in 2009

According to the Croatian Insurance Bureau (CIB) data, 27 insurance companies in Croatia wrote a gross premium of HRK 9.411 bn in 2009, or 2.7% down from the gross premium written in 2008.
In non-life insurance business segment, the gross written premium stood at HRK 6.922 bn (a 2.9% decline when compared to 2008), accounting for 73.55% of the total premium (73.73% in 2008). The most common line of insurance in this segment, motor vehicle third party liability insurance, wrote a gross premium of HRK 2.922 bn. Gross written premium in this line of insurance remained unchanged respective to prior year, with a share of 42.21% in non-life insurance premium and a share of 31.05% in total premium written. In contrast to this, in mandatory automobile liability insurance, the premium written was HRK 2.886 bn, which is the same amount as two years ago. It is noteworthy that the number of insurance contracts declined by 38,307, or 1.9%, resulting in an increase in average premium to HRK 1483 from HRK 1453.
In non-life insurance segment, a decline in premium was also recorded in casualty (0.1%), health insurance (3.6%), motor hull insurance (13%), insurance of vessels (2.3%), and of goods in transport (22.7%). Lines of insurance which also saw a downward trend include other types of property insurance (1.2%), as well as aircraft liability insurance (16.3%) and other types of liability insurance (3%). The sharpest decline was seen in credit insurance (35.6%), and suretyship insurance (40.9%).
In contrast to this, some lines of insurance experienced an upward turn. According to the CIB data, premium went up in insurance of railway vehicles (91.1%), insurance against fire and natural disasters (3.6%), and vessel liability insurance (6.3%). An upward trend was also observed in travel insurance (6.5%), while the most interesting upsurge was noted in insurance against various financial losses (14.7%).
Life insurance business segment saw a 2% decline last year. Gross written premium in this segment was HRK 2.489 bn, with a share of 26.45% (26.27% in 2008) in total premium, while the number of insurance lines remained unchanged when compared to the year earlier.
Analysed by structure, the traditional life insurance has the largest share with a premium of HRK 2.144 bn (like two years ago). This type of insurance makes up an 86.14% share in life insurance segment, whereas its share in total premium totals 22.78%. Annuity insurance delivered a gross written premium of HRK 7.910 mio last year, 7% down when compared to the previous year. In additional life insurances, premium written amounts to HRK 163.997 mio, which is a 1.5% increase over 2008.
Unit-linked life insurance delivered a gross written premium of HRK 163.182 mio in 2009, which is a decline of 27.1% annually.


International environment

The economic and financial crisis did not leave insurance and reinsurance industry intact. Reinsurance market looked into its own resources in seeking the way out of the financial crisis by which it was hit in late 2008. Various methods were applied, with the aim of arriving at recovery as soon as possible. The way to recovery was favoured by slightly better investment conditions and money cost price, as well as by the absence of high catastrophe losses.
The balance sheets of reinsurers were not hit by big catastrophe losses as hard as in the previous years. Catastrophe losses in 2009 were lower than those in 2008, which is, among other things, attributable to the benign North Atlantic hurricane season. Viewed by number, there were 850 registered cat losses in 2009, exceeding the average of 770 for the last ten years. The total economic loss stood at USD 50 bn, which is considerably lower than the ten-year average of USD 115 bn, whereas insured losses amounted to USD 22 bn, which is also below the average of USD 36 bn. The year 2008 saw economic losses of USD 200bn, and insured losses of USD 50 bn. The number of victims claimed in natural catastrophes was 10,000 in 2009, whereas the ten-year average number of victims is higher and amounts to 75,000.
Yet, these data for 2009 should not mislead us, because, in spite of the absence of hurricanes and other big disasters, the losses in 2009, although relatively moderate by size, were greater by number.
There remains a problem in the mismatch between the results achieved in reinsurance and those achieved in primary business, with insurers failing to increase their premium income in conditions of the global recession. The absence of premium growth generates a great pressure on their costs, also affecting their demand for reinsurance.


Our business performance in 2009

In 2009 Croatia Lloyd steered its business in an unstable environment of the financial market, both in the country and across the globe. Our business was conducted in conditions of pronounced insolvency both in insurance market and the economy as a whole.
However, the existing portfolio of the company remained very stable, and part of our portfolio of incoming business from abroad even climbed to 12.25% of the Company's total premium.
The results achieved in 2009 were in line with our plan. Premium income remained unchanged from the year earlier. Premium income earned from reinsurance activities for Croatia osiguranje declined by 2.5 index points, equalling the decline in premium on the insurance market in Croatia. At the same time, premium earned from incoming business from abroad was up 24.3 index points relative to prior year. This is a great step forward for a company without rating.
Investment income increased by 17.5%, thus contributing to a 2.97% overall income increase. In the same period, losses increased by 5.5.%, with a 20% decline in losses collected from retrocession, and a 43.5% increase in retained losses. Total expenditures increased by 10.22% in 2009 over 2008. It is especially noteworthy that our loss reserve was augmented by HRK 11,408,442, in accordance with the requirements of the profession and positive rules and regulations. All this results in a gross profit of HRK 35,923,239, which is slightly less than anticipated. The crisis took its toll.
Our performance in 2009 in figures:

Technical result (%) 2008 2009

Net loss ratio 89.98
Gross loss ratio 62.74
Loss ratio, incoming business from abroad 53.93

Combined loss ratio 95.39 98.93


Technical reserves (HRK) 2008 2009

Outstanding loss reserve 326,126,679
Reserve for unearned premium 56,760,607
Equalisation reserves 27,509,775
Premium return reserves 197,146

Net technical reserves 399,185,765 410,594,207


Ratios (%)

Net technical reserves / retained earned premium 223.88
Gross technical reserves / retained earned premium 272.81
Retained earned premium / net reserves 44.67

Capital
The Company's capital without last year's profit increased by 1.44% in 2009 over the previous year, totalling HRK 230,439,838.98. It consists of (in HRK):

HRK

Paid up capital 116,060,800.00
Revaluation reserves 18,378,703.25
Free reserves 70,000,000.00
Undistributed profit 26,000,335.73
Capital without current year profit 230,439,838.98
Net profit in 2009 28,099,089.62
Capital including current year profit 258,538,928.60

We have been deprived of a large portion of our most liquid assets representing part of the Company's capital. In July 2009, Croatia Lloyd's Supervisory Board resolved that the Company invest HRK 100,000,000 in Hrvatska poštanska banka (the Croatian Postal Bank) in the form of hybrid deposits to strengthen the capital of the bank and to fulfill the Croatian National Bank requirements. These funds will not be at our disposal for the period of 5 years. Although the funds are invested to bear interest, the Company lacks them in the discharge of its daily duties and liabilities. The Company's capital structure has been seriously undermined, although we still own enough capital to meet minimum legal requirements. Together with the debtor, we should seek ways to claim back the funds, especially in view of the approaching implementation date of Solvency II and its new solvency requirements.

Ratios (%) 2008 2009

Capital including profit / retained earned prem. 174.18 140.97
Net profit / gross premium 9.04 5.82
Net profit / retained earned premium 28.05 15.32
Gross profit / gross premium 11.43 7.45
Gross profit / retained earned premium 35.45 19.58

In view of the given environment, continued measures implemented by the Company as part of its cost discipline, are one of the contributors to our good result. The total Management expenditure was at an acceptable level of 4.7% in relation to total premium earned in 2009. The share of gross wages in the Management expenditure in 2009 totalled 44.65%.


Management expenditure

2008 2009

(administrative, in HRK) 25,449,459 22,686,293

It decreased by 10.86% in 2009


Ratios (%) 2008 2009

Management expenses / total premium 5.28 4.70
Management expenses / retained earned prem. 16.37 12.37
Garantee fund / retained earned premium 146.13 125.65

We expect that our cost reduction measures will lead to further savings in 2010.

Return on assets (fixed/current) 3.27%
Return on equity 10.9%

Reviewing the results achieved under the tough circumstances in our immediate and wider business environment, the Management regards the business operations of the company in the reference period as very good.
As of 1 June 2009 Croatia Lloyd became an owner of the winery Plančić d.o.o, with an ownership share of 51%. The decision to enter the „wine business“ was made following due diligence and a study conducted to assess profitability of planting wine grapes in the region of Poljica on the island of Hvar. This is the Company's foray into the real sector, with multiple investment returns expected within five years. During 2009, 10 hectares of new vineyards were planted, and the plantation of additional 10 hectares is underway. Our final goal is to plant 35 hectares of new vineyards in total.
Although hampered by numerous hardships, the winery succeeded in delivering a profit of HRK 200,000 for the financial year 2009.
The company Croatia MIROVNI DOM is wholly owned by Croatia Lloyd, and it finally, after four and a half years, managed to get a building permit for the construction of a rest home for the aged and the disabled. As this company has not delivered any income so far, it finished the year 2009 with a loss of HRK 154,000.
Croatia Lloyd's consolidated balance sheet looks quite good. The Group's gain after tax amounts to HRK 28,185,564 and is very satisfactory.
Croatia Lloyd shares were listed on the Zagreb Stock Exchange in the past period. Although not marked by very good liquidity, our share quoted very well, and its price of HRK 3,250.00 remained stabile throughout 2009. We regard this as excellent, considering the fact that the market value of our share represents slightly more than four times its nominal value. Unlike the majority of domestic shares listed in CROBEX and traded on the stock exchange, and a great majority of shares of professional reinsurers across the globe, Croatia Lloyd shares did not fall in value. Hence, we can conclude that it was profitable to purchase our shares in the period under review.


Looking ahead

Many countries have already made or are still working on a revision of their legal regulations in an effort to incorporate into them a risk-based approach.
The following processes should thus be implemented:
- training of regulators' staff must be focused on the understanding of market, rather than on the understanding of rules
- companies must change their rule-adherence culture into a risk management culture
- the emphasis should be shifted from strict, detailed rules to a principle-based approach that will provide good operating companies with a room for assessment and calculation of the required quantity of capital.
In light of the widening globalization of insurance and reinsurance industries, there is an increasing need for the unification of supervisory and regulatory standards.
The harmonisation of qualitative and quantitative regulatory systems is an imperative which will be in the interest of all industry participants insurers, reinsurers, and insureds. The implementation of a single set of standards would free the resources from following multiple regulatory requirements, which has been the case so far.
A system is needed to establish solvency standards across the world and across Europe which is working towards the implementation of its directives under the name Solvency II by the end of 2012. Solvency II encompasses quantitative requirements (capital requirements and principles for the calculation of technical provisions), and qualitative requirements (obligations and rights of supervisory authorities, and risk management requirements).
Solvency II is founded on 3 pillars:
- The first pillar sets out minimum capital requirements to be established in accordance with a standard formula or by the use of company's own internal model for the valuation of assets and liabilities.
- The second pillar includes the identification and management of risks to which companies are exposed in their business operations, and the identification of the company's need for capital and for the maintainance of the level of capital.
- The third pillar involves the disclosure of the companies' key information of significance to all market participants. The Solvency II rules are focused on public disclosure of financial information and on disclosure of information to clients through regular reporting to the supervisory authority.
The global approach and the efforts of the industry at establishing a framework of supervisory and regulatory standards to be commonly accepted by all insurance and reinsurance companies, regardless of where they come from, or where they plan to do their business.
Companies failing to comply with the regulatory requirements have the following options:
- to redesign their products with an aim to employ their capital in the best way possible;
- to limit the scope of their risk underwriting, or to abandon capital intensive lines of insurance;
- to diversify their underwriting;
- to increase the use of their reinsurance;
- to relocate their place of business to a jurisdiction with less stringent capital requirements. This will only be possible if the company is allowed by regulations to do business operations offshore.
In Croatia we have also been immersed in this process of the unification of rules in accordance with the European Solvency II Directive. The fact that Croatia's accession to the EU is drawing near together with the Solvency II implementation date, makes our efforts even greater. This means that we also should be prepared for the implementation of the Directive by 31 October 2012, along with all other companies operating on the EU teritorry that have been gearing up for the implementation for years.
It is obviously a complex task involving a comprehensive and interdisciplinary approach, and, given our small personnel, we have to put in our greatest efforts to make it a success.
We are working towards the quantitative impact study exercise, now already finalized in the EU, in anticipation that this experience will provide us with, at least to an extent, an equal footing to enter the next round of the exercise announced in the EU for the second half of 2010. We are getting acquainted with a very comprehensive material and are exploring best strategies that would lead us to to our goal. Revisions of our rules of regulations and other in-house documentation are underway. In addition, we are compiling a new document which will be called The Risk Management System. This will be a comprehensive but easy-to-use document intended as a guide in the identification, measurement, and management of risks, including clearly defined procedures and responsibilities for all levels of our personnel, from individual units to the management.
The new system will also likely challenge us with major tasks in our IT system. In this respect, we are currently involved in the upgrading of our existing IT system and, with the support of external consultants, we are enhancing the functionality and availability of our present data. We expect that this will facilitate the introduction of new procedures and improvements to our IT system in time for the definition of the final requirements of the new Directive.