FROM RISK TO GROWTH

Over the past five years, the volume of insurance transactions within the Azerbaijani market has exhibited a twofold increase. It is projected that the total premiums will exceed $1.4 billion by the end of the current year. Nevertheless, insurers still possess unrealized potential and opportunities to expand both the scale and depth of market coverage. In order to achieve this objective, the Central Bank of Azerbaijan (CBA) is implementing a series of reforms with the aim of expanding insurance services, optimizing the compulsory insurance segment, diversifying the reinsurance sector, and digitalizing industry mechanisms.

Sanitation Measures

As evidenced by the findings of the PricewaterhouseCoopers (PwC) Insurance Banana Skins research, the insurance and reinsurance industries are encountering heightened risks at an increasing rate. A survey of over 600 industry leaders from 47 countries indicated that climate change risks and an increase in the occurrence of natural disasters are among the most pressing challenges currently facing the insurance and reinsurance industries. This is further corroborated by research from the World Bank, which indicates that in 2023 alone, global capital markets—particularly the insurance sector—are projected to incur $300 billion in damages due to climate-related issues. Furthermore, PwC experts have observed a notable increase in cybercrime, which has led to a significant rise in cybersecurity costs for insurers. Additionally, low investment returns have contributed to a reduction in profitability for insurance companies. Furthermore, the inflationary pressures experienced in recent years have also exerted additional pressure on interest rates within the insurance market. Furthermore, the industry is confronted with mounting demands for human resources as artificial intelligence (AI), cloud computing, and other digital solutions lead to an increase in virtual workloads.

It is clear that these global challenges are also evident in Azerbaijan. Concurrently, the financial market has also experienced significant challenges, including an energy crisis a decade ago, the devaluation of the manat, banking defaults, and an economic recession caused by the pandemic a few years later. These fluctuations have had a significant impact on participants within the insurance market, resulting in a notable reduction in the number of insurance companies from 27 to existing 17.

In response to this unfavourable outcome, the CBA implemented a series of measures to revitalise the industry. The reinforcement of the legal and regulatory framework for the financial sector has resulted in an improvement in the prudential indicators within the insurance market. These improvements have contributed to the mitigation of prospective potential force majeure scenarios. The implementation of advanced international standards has also contributed to enhanced reinsurance and insurance provision, in addition to measures aimed at the development of reserves and the reinforcement of industry institutions. Consequently, the insurance sector in Azerbaijan has experienced a 34% growth in assets over the past three years, accompanied by an increase in participant capitalization of over 7%.

Despite the 2022-2026 socio-economic development strategy and the National Priorities of Socio-Economic Development of Azerbaijan until 2030 setting an annual growth target of 10% for the insurance market, the industry has exceeded this benchmark over the last two years. In particular, the insurance market exhibited a growth rate of 15% in 2022, which increased to 26% in 2023. These positive trends have continued throughout the current year. According to data from the CBA, between January and September 2024, insurance companies collectively collected premiums amounting to ₼1.024 billion, representing a 9.4% increase compared to the same period in the previous year. The Association of Insurers of Azerbaijan (ASA) projects that the total premiums from insurance companies will reach ₼1.4 billion by the end of this year, representing an increase of over 10%. In general, the CBA recognizes the increasing importance of the insurance sector within the financial system. Over the past three years, the proportion of insurance companies in total assets has increased from 3.2% to 3.8%.

Mandatory But Not Compulsory

Notwithstanding the considerable growth in premium accumulation in recent years, the Azerbaijani insurance market's share of gross domestic product (GDP) remains relatively modest. Consequently, in terms of penetration level—defined as the ratio of gross premiums to GDP—the sector's figures for the initial nine months of the current year were a mere 1.1%. In accordance with international standards, these parameters in the insurance sector are directly correlated with bank lending volumes to the private sector and household income levels. As these indicators increase, the ratio of gross premiums to GDP also rises. For example, in countries such as the United States, China, Japan, and within the European Union, these metrics are markedly higher. In this context, local insurance companies are motivated to pursue further growth, particularly within the compulsory insurance market.

In light of the aforementioned considerations, the CBA's strategy is to ensure comprehensive coverage for all five types of compulsory insurance. The market is developing at a gradual pace, with specific segments, such as compulsory motor third-party liability insurance (CMTPL), approaching a penetration rate of nearly 100%.

However, even this popular type of insurance market is not without its challenges. By the conclusion of 2024, it is anticipated that the loss ratio (defined as the ratio of claims to collections) for CMTPL insurance will reach approximately 80%. The CBA deems this level to be acceptable and generally aligns with global indicators. Notwithstanding, a number of local insurance companies have elected to exclude taxis and other forms of urban transportation within the corporate segment from their insurance portfolios. The argument is made that the current premium levels are insufficient to cover claims costs due to the elevated level of risk within the industry. In response to the withdrawal of several companies from the CMTPL market, CBA Director General Shahin Mahmudzade asserted that such decisions represent standard commercial practices: "If a company deems this type of insurance to be unprofitable, it has the prerogative to withdraw from the market. This is a commercially justifiable decision... It is essential that those currently providing MTPL services also offer CASCO (voluntary type). Insurers should not depend solely on compulsory motor insurance services for their financial stability but should actively develop voluntary types," he emphasised.

In a statement released in early November, Taleh Kazimov, Chairman of the Central Bank of Azerbaijan, underscored the ongoing challenges facing the insurance market. The decision to suspend accumulation life insurance for citizens employed in the public sector will result in a gradual reduction in insurance proceeds by 60% and a decrease in contracts by 50%. According to the Chairman of the Central Bank of Azerbaijan, this discrepancy will require the private sector to bridge over the next three years. It is noteworthy that in Azerbaijan, life insurance policies are primarily purchased by corporate clients for their employees, particularly in sectors such as oil and banking, where large firms are prevalent. Nevertheless, there has been a recent surge in interest among individual consumers in these products. It is noteworthy that insurance premiums and payments under this type of insurance are exempt from all forms of taxation. Moreover, in addition to receiving a capital sum if they survive until the end of their contract term, policyholders can also expect to receive additional investment income from placing premiums in a bank deposit account.

Significant efforts are necessary to develop compulsory property insurance as well. Notwithstanding the low loss ratio for real estate insurance (only 7%), the coverage levels in urban areas remain inadequate, while in rural areas, the coverage is nearly negligible. The purchase of compulsory property insurance packages is typically undertaken by citizens when planning to purchase a new home or re-register an existing property, in accordance with the requirements set forth by the relevant authorities. Previously, the development of this segment was impeded by a dearth of automation in digital control and information collection regarding property insurance processes by the State Real Estate Register Service.

The Central Bank of Azerbaijan has initiated efforts to enhance profitability within the compulsory real estate insurance sector, where there is a relatively low payments-to-collections ratio. Mr. Shahin Mahmudzade, in a report on financial stability for the first half of 2024, indicated that there are further increases in unprofitability within this sector on the horizon.

Future Plans

In accordance with the "roadmap," which considers the most effective practices from abroad, proposals have been developed to expand insurance coverage for risks associated with natural disasters in Azerbaijan. The introduction of ecological insurance and the enhancement of agricultural insurance mechanisms are currently under consideration. A further crucial task is the strengthening of instruments for universal and sustainable health insurance. Notable advancements have been achieved within this domain. During the initial three quarters of the current year, voluntary medical insurance premiums reached a sum of ₼765.4 million, reflecting a 12% surge in comparison to the corresponding period in the previous year.

The domestic insurance market is currently experiencing a period of growth; however, there is an urgent need for accelerated reforms across specific areas. In order to further enhance financial stability within the insurance sector, a new regulatory framework concerning reinsurance policies and operations has been established. The amendments to the Law on Insurance Activities, enacted on July 6, 2023, are designed to reinforce the role of independent experts in the provision of insurance services. They do so by introducing new requirements and establishing standards for their training and practice. A new procedure is being implemented for maintaining a register of professional participants in the insurance market. This register includes insurers and intermediaries—both local and foreign—engaged in auxiliary activities related to insurance. A review of CBA data reveals that the number of foreign brokers operating within Azerbaijan's reinsurance market has reached 92. The involvement of foreign specialists is of vital importance in assisting local insurers in securing new reinsurance programs from overseas partners under more favourable conditions while adhering to regulatory prudential requirements.

The primary objectives delineated in the Roadmap for Sustainable Finance 2023-2026 concentrate on guaranteeing the digitization of the insurance sector. The introduction of information technology innovations is acknowledged as a pivotal instrument for the provision of cost-effective and superior quality services. Furthermore, there is a necessity to further develop data resources, as a market player with an extensive database will remain at an advantage over competitors. Additionally, it is essential to enhance information security within Azerbaijan's local insurance market. Furthermore, the roadmap underscores the importance of human resources and infrastructure development, emphasizing the implementation of best practices aimed at increasing both the volume and optimisation of insurance services, as well as improving mechanisms related to compulsory insurance and raising public awareness surrounding voluntary types of insurance.