What can be done to unlock the role of insurers in developing African capital markets? 

Shortly after the onset of the COVID-19 pandemic, local currency portfolio outflows from emerging economies reached an unprecedented scale of more than USD100 billion. Although this pronounced shock was quite short-lived, capital was already in scarce supply in Africa: the total infrastructure financing gap for 2016 to 2018 was estimated at USD52 billion to USD92 billion per year. By enabling stable and sustainable investment and infrastructure development, closing this gap has the potential to contribute to sustainable development and long-term growth objectives in sub-Saharan Africa (SSA). Moreover, well-functioning capital markets – understood here to mean “the demand and supply of capital” and not just exchanges – play a crucial role in developing economies by enabling funding to be raised and efficiently allocated for spending and productive investment by businesses and governments[1].

 Insurers, and the insurance industry as a whole, can play an important role in the development of capital markets via their role as institutional investors. There are three main mechanisms through which the insurance industry can directly contribute to promoting the growth and proper functioning of capital markets:  

• Mobilising: Insurers collect and retain premiums – building up their own asset base in the process. They can also act as sellers or distributors of longer-term savings products (such as pensions and endowments). Beyond the direct ways in which the insurance sector mobilises capital, insurers also mobilise longer-term capital indirectly by making it possible for businesses and governments to lend and invest in support of productive opportunities that involve considerable risks, such as entrepreneurship and trade.
• Pooling: The insurance sector brings many small savings contributions together to make up bigger pools of funds. Relative to individual investors of small amounts, these bigger funds can be managed and invested more efficiently because of their scale. 
• Allocating: The insurance sector can also better allocate capital to productive opportunities, in comparison to small individual investors. Insurers can invest over longer time horizons, using the skills and data at their disposal to identify opportunities and reduce the costs and expenses associated with investment (such as contingency capital). This means more liquidity for banks, deeper credit markets and a greater availability of funds for government borrowing. 

In addition to these direct roles, the insurance industry has an indirect role in capital market development. Insurers, as institutional investors, help to build and improve capital market institutions. They do this by pushing for enhanced professionalism and the adjustment of ethical standards and skills, governance, auditing and accounting requirements. Ultimately, this institution-building boosts trust and investor confidence in capital markets.

But what does this role look like in practice in the developing country context? Between 2018 and 2019, we participated in a set of in-depth insurance diagnostics in Ghana, Kenya, Nigeria and Rwanda as part of a partnership between DFID, the World Bank, FSD Africa and Cenfri. One of the diagnostics’ main objectives was to explore the role of the insurance sector in capital market development, which meant that we were able to test the extent to which the insurance sector’s theoretical role is enacted in our focus countries.  

We found that, in comparison to what the insurance sector can do to contribute to capital market development, insurance sectors across SSA play a relatively limited and modest role. Across our four focus countries, we see small, undeveloped insurance markets. Compared to other financial services providers, insurers mobilise limited capital. In 2016, the combined total insurance assets across all four focus countries were less than USD10 billion, which is smaller than the total assets owned by the South African insurance sector alone. This can change as the industry starts helping to mobilise, pool or allocate long-term savings through pensions, annuities and similar policies. This can also change as the shift to longer-term savings occurs, as has been the case in the Kenyan insurance sector, where USD5.3 billion worth of assets is channelled into its economy – an increasing proportion of which is represented by life insurance companies.   

Of the assets mobilised in our focus countries, very little is invested in higher-risk and -return and long-term investments; instead they are held in government debt, property and bank deposits, given the lack of appropriate alternative instruments, limited professionalisation of insurer investment processes and conservative regulatory behaviour and requirements to safeguard solvency. We found that almost 50% of insurance assets in Ghana are allocated to cash and deposits, followed by Rwanda (38% of total assets), Nigeria (22%) and Kenya (10%).

So, what can be done to bridge the gap between what is and what could be? In the absence of fiscal policies encouraging long-term savings, a bigger pot of such savings and appropriate and accessible long-term investment instruments, there is only so much room for the insurance sector to improve its ability to boost capital market development. Despite – and in response to – these structural challenges, we have identified the following opportunities:  

• Coordinate towards long-term policy objectives. Close cooperation and coordination are needed among policymakers, regulators, market players and development partners to change the investment mix of insurers by improving the underlying market fundamentals. Policymakers have a key role to play in bringing stakeholders together, as well as to ensure that market development is explicitly incorporated into the regulator’s mandate so that the regulator is empowered to actively encourage innovation.  
• Incentivise long-term savings to build insurers’ asset base (liabilities) by, for example, seeking to strengthen links between the pensions and insurance industries. This entails recognition by the policymaker of the role of the insurance sector in increasing efficiencies in mobilising, pooling and allocating funds. 
• Enable the efficient allocation of capital through the adjustment of capital rules to ensure that they are sufficiently risk–sensitive. Regulators have the responsibility to gradually start shifting away from rules-based supervision towards the implementation of risk-based supervision.  
• Encourage the development of investment instruments that are appropriate and longer-term, such as infrastructure bonds and real estate investment trusts (REITs). These instruments will allow insurers to allocate capital to a more extensive range of economic activities. 

Ultimately, if this gap is to be bridged, policy leadership is needed, with long-term support from development partners. If not, the insurance sector’s considerable potential contribution to developing the demand and supply of capital in SSA is likely to remain hidden. The current COVID-19-induced capital market volatility provides a good opportunity for kick-starting the conversation about what it would take to reform capital markets in a way that best leverages the role of insurers as institutional investors. 

[1] DFID. (2013). Funding the frontier: Developing capital markets for growth in Sub-Saharan Africa. Working paper.

This work forms part of the Risk, Remittances and Integrity programme, a partnership between FSD Africa and Cenfri.