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It is rare for a local investment bank to expose an entire commercial market as a compound of tax-avoidance schemes, phony revenue statements, paper transfers and intentionally misleading valuations. But that is what the United Financial Group (UFG) manages to do for the Russian insurance market with a new report titled “Russia’s Insurance Industry: Enter the Man from Ru.”

Starting with an initial estimate of $9.5 billion in insurance premiums officially reported as paid in Russia in 2001, roughly half – $4.7 billion – should be disregarded as insurance at all, UFG concludes, because it represents one- to five-year policies paid out as tax-free annuities that are, in reality, tax-free income. This pseudo-life insurance is a well-known feature of the Russian market that is expected to dwindle from next year, when the annuities will be taxed as income for the first time.

Of the $4.8 billion in insurance premiums that remain, genuine life insurance is a minuscule fraction – just $48 million. As we shall see, there is an enormous opportunity there. But according to the UFG calculation, insurance premiums paid by consumers to insurance companies at arm’s length total no more than $820 million. The arm’s length qualification is necessary, because of the large volume of premiums recorded as paid between companies that are directly related to one another by shareholding and other ties. These insurers are known as “captives,” which the author of the UFG report, Ilan Rubin, describes as “pocket insurance companies of major Russian corporates. Insuring property with yourself is not insurance. Rather, it is a means of writing off expenses in order to avoid taxes.”

Most major Russian corporations operate such insurance units. Some, like Sogaz of Gazprom, claim to be moving beyond their chains. Others, like Ingosstrakh after its acquisition by a group of shareholders linked to Russian Aluminum and Sibneft, have been moving in the opposite direction.

Because it’s next to impossible to quantify how much insurance coverage paid for by Russian corporations to their captive insurers would have to be bought in the marketplace, if that existed, Rubin deducts just $800 million from last year’s official non-life premium total of $4.7 billion. Thus, somewhere between a minimum of $820 million and a maximum of $3.9 billion is what the genuine insurance market is worth at the moment. By international standards, that is somewhere between nothing and almost nothing.What it may be worth in the future is more promising, but not in the way the insurers themselves like to claim. For example, the UFG report argues against the widespread conviction among Russian insurers that the terms set by the WTO represent a major threat to the domestic insurance industry. In recent weeks, it has become clear that WTO members are demanding the dismantling of barriers to entry for foreign insurance companies. But according to Rubin, whether the industry resists or accepts is irrelevant.

“We do not consider WTO entry in 2006-7 to be a major problem for [Russian] insurance. First, by the time WTO entry actually happens, the vast majority of unviable companies will already have disappeared. Secondly, the appearance of foreign companies in the life insurance sector will not threaten domestic companies, as the life insurance sector does not currently exist, and will never be serviced by domestic companies anyway, due to the unwillingness of the population to trust Russian private financial institutions,” he said.

While the report accepts that some Russian insurers have developed sound reputations and brand names with which to compete in the compulsory insurance sector, Rubin also predicts that the 20 to 30 Russian companies he expects to survive will be able to do so only by finding Western capital and Western expertise.

Life insurance, the report forecasts, will come to be dominated by foreign insurers, and after the disappearance of “the vast majority of insurance companies, those with the best chances of survival are the ones that will seek foreign partners.”

The report is especially sanguine about American International Group (AIG) in the Russian market. After describing the rise in the Polish insurance market of AIG, Rubin claims that AIG “would be one of the best-positioned companies to milk the real insurance sector in Russia, once it grows.”

One reason for that, argues Rubin, is that the Russian government has already dismantled the potential competition that a state-owned insurer could provide in the sector, comparable to Poland’s PZU, thereby allowing foreign companies like AIG to capture most of the profit for themselves. You will search in vain through the accumulated statements of the All-Russia Insurance Association, the industry lobby group, and never find a statement as blunt as that.

Through its U.S. government contacts, as well as directly and through a number of well-known Russian insurance figures, AIG has been one of the most active lobbyists in Moscow for deregulating the insurance-sector rules that limit foreign ownership, as well as the right of foreign insurers to write long-term life-insurance policies. On the surface, you might judge this effort to have been relatively unavailing.

However, as calculations in the UFG report reveal for the first time, the price for foreign entry into the Russian insurance market has been exceptionally cheap – so cheap that it is tempting to infer that the Finance Ministry, which regulates the industry, a handful of Russian investors, and the major foreign insurers have quietly rigged it. By projecting the premium data and sales margins of 10 major Russian insurers, applying a 20 percent discount, together with a conservative share-price-to-sales ratio, Rubin estimates a value of $159 million for ROSNO. Accordingly, he reports that the $30 million price paid by Allianz of Germany to acquire a 45 percent stake in the company two years ago was “very low” – less than half the $72 million valuation estimated by UFG. The report also suggests that Rosgosstrakh, the big state insurer that is in process of privatization, was undervalued before a consortium of still undisclosed buyers led by Troika Dialog of Moscow acquired a 49 percent stake for $40 million. UFG values the stake at $83 million.

The government-ordered valuation of Rosgosstrakh was done a year ago by the Moscow office of KPMG, which recommended a price of $78 million. Early this year, Reuben Vardanyan, the Troika Dialog executive who has since become chief executive of Rosgosstrakh, claimed that was too high. “While the new shareholders of Rosgosstrakh paid $40 million for 49 percent of shares of the company, and the official valuation was $78 million, the real value of the company is lower than that,” Vardanyan said.

According to UFG’s calculation, the capital value of the entire non-life Russian insurance market as a whole is just $3.3 billion. Projecting what Russians will spend on non-life insurance on the growth of GDP, it is predicted that non-life premiums will jump in 10 years to $21.3 billion. Life-insurance spending will rise to $14.2 billion, a more dramatic increase fuelled by the development of private pension funds. These figures promise a huge profit for the handful of foreign insurers who can afford to wait for the takeoff – and on the few Russian insurers, or their shareholders, who see the opportunity in capturing assets cheap and selling dear.

Capturing opportunity is risky business, because government statistics are worthless, and corporate accounts no better. According to Rubin, published balance-sheet data for Russian insurers identify only about 63 percent of their assets. The remainder, he claims, “may not be invested in stable, low-risk assets that insurance companies require in order to ensure that they can protect their customers from default.” He believes that Russian insurers are either placing their funds in high-risk investments that could trigger defaults; or else the missing money does not exist at all, because “large sums of premiums ‘paid’ do not really exist, being no more than paper figures used in salary and captive schemes.”

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