Zimbabwe’s insurance and pensions sector is developing new derivatives that will contribute to both the broadening and deepening of the country’s capital markets.
A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset.
And capital markets are where these financial products (for example, equities and debt securities) are traded.
Equity investment is the most common capital markets product in Zimbabwe, with insurance firms and pension funds already significant players on the Zimbabwe Stock Exchange (ZSE).
Last month Insurance and Pensions Commission (IPEC) Commissioner Dr Grace Muradzikwa said over half of investments on the local bourse were accounted for by insurance companies and pensions funds.
“Insurance companies and pensions funds are a significant institutional investors on the ZSE. I think at some point we were estimating that 60 percent of investments on the ZSE were actually from insurers and pension funds,” she said.
But the country’s capital markets are not as well developed as in some advanced economies, a fact that is acknowledged by capital markets regulator, Securities Exchange Commission of Zimbabwe (SECZ).
“Capital markets investments typically cover a wide range of products. But locally, our market is not that well developed and is dominated by shares although one can invest in collective investment schemes or unit trusts and other privately sold funds,” says SECZ chief executive Tafadzwa Chinamo.
Through the trading of equity and debt instruments, capital markets can work to channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, governments and individuals.
It is clear then, why insurers and pension funds would have a vested interest in improving the state of the local capital markets.
The Insurance and Pensions Commission (IPEC)— which is also a member of the Financial Stability Committee that includes the Reserve Bank of Zimbabwe (RBZ) and SECZ — is working towards the issuance of sector-specific derivatives and other instruments.
“To increase the diversity of products available to insurers and pension funds, the Commission held engagements with the Zimbabwe Stock Exchange to facilitate the issuance of Real Estate Investment Trusts, Electronic Traded Funds and commodity derivatives,” said IPEC in its 2019 Annual Report.
“The Commission also held engagements with Government on the development of attractive prescribed asset instruments such as inflation-indexed instruments and direct project financing by the industry into projects of national interest under a Public-Private Sector arrangement, with such investments being accorded prescribed asset status.”
The insurance and pensions industry is fundamentally underpinned by the principle of investment, as players in the sector are naturally inclined to ensure that accumulated monies give out the best returns at the de-accumulation or pay-out stage. Investment is therefore a critical element in the sector’s business model.
Said economic analyst Persistence Gwanyanya: “Insurance firms have to invest their premiums in a mix of investment assets including both money and capital markets instruments.
“Strong capital markets attract investible capital, that is, monies that are then spread into the wider economy. And if the risk-adjusted returns on the capital market is high, then their investments can yield significant returns.”
The securitisation route
But there are other ways in which players in the industry can benefit from an efficient capital market. For instance, in cases where an insurer can issue debt in the market place as an alternative to using reinsurance. That is, an insurance firm can securitise insurance risk by transferring underwriting risks to the capital markets by transforming underwriting cash flows into tradeable financial securities.
“It is not always that an insurer can get reinsurance cover.
“An insurance company can at times fail to secure coverage from a reinsurer at the right time and an appropriate cost due to the latter’s internal limitations or any number of factors prevailing in the external environment,” said economist Rongi Chizema.
This is where insurance derivatives can come in. These can come in the form of futures contracts, forward contracts, swaps, options, credit derivative and mortgage-backed securities.
But sometimes things do not always go according to plan. The 2008 Global Financial Crisis is pregnant with lessons in this regard. It is widely believed that excessive risk-taking by banks combined with the bursting of the United States housing bubble caused the values of securities tied to US real estate to fall rapidly.
Nonetheless, if carried out effectively and with strong oversight, capital market offerings can help boost the economy as insurance firms and pension funds get increased opportunity to raise long-term funds.