Exploring The Credit Characteristics of GCC (Re) Insurers

Exploring The Credit Characteristics Of GCC (Re)Insurers
Primary Credit Analyst: Ali Karakuyu, London (44) 20-7176-7301; ali.karakuyu@standardandpoors.com Secondary Contacts: Dina Patel, London (44) 20-7176-8409; dina.patel@standardandpoors.com Mohamed Damak, Paris 33144207320; mohamed.damak@standardandpoors.com David Laxton, London (44) 20-7176-7079; david.laxton@standardandpoors.com
Table Of Contents
Competition Is Challenging The Long-Established Players Capital Strength Supports Moderately Strong Financial Risk Profiles Anchoring Insurers' Credit Quality Risk Management, And Management And Governance, Are Mostly Neutral For Ratings Capital Strength Brings Stability Related Criteria And Research
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Low interest rates and increasing competition for market share are testing insurers and reinsurers in Gulf Cooperation Council (GCC) countries. Nevertheless, Standard & Poor's Ratings Services contends that the industry remains on a stable footing supported primarily by (re)insurers' very strong capital adequacy and generally adequate competitive positions. The average financial strength rating (FSR) for the 34 GCC (re)insurers that we rate remains adequate, at 'BBB+'. This is consistent with the average rating level for the sector in recent years. Currently, about 60% of our indicative stand-alone credit profiles (indicative SACPs; derived before taking sovereign risk and group support into account) on GCC-based (re)insurers are concentrated at the 'bbb+/bbb' level. By comparison, indicative SACPs for Western European (re)insurers center at 'a-', which is in line with the global median for insurance companies. This variation between GCC and European (re)insurers is mainly due to stronger competitive positions that result in stronger business risk profiles (BRPs). Fifty-five percent of European (re)insurers have at least strong BRPs, compared with less than 20% for GCC companies. No GCC (re)insurer has a BRP which we view as any better than strong. Overview Risk-based capital continues to be the key ratings strength of GCC-based (re)insurers. The average financial strength rating for the sector is 'BBB+', as has been the case for the past few years. Partially offsetting this strength are the industry's limited competitive position and exposure to high-risk assets.
Competition Is Challenging The Long-Established Players

Our view of the BRP of GCC-based (re)insurers generally supports the ratings (see chart 1). On average, the sector's insurers have satisfactory BRPs, which reflects our view that they face intermediate industry and country risk on average and have varying competitive positions from generally less-than-adequate to strong. But the dominant competitive position is adequate (see chart 2). Our Insurance Industry And Country Risk Assessments for GCC countries compare well with those of developed insurance markets. Excluding Oman, the factors that make up industry risk contribute positively to our overall view of GCC (re)insurers' BRPs. (see table 1).
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Chart 1
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Chart 2
Table 1
GCC-IICRA Table
Country Bahrain Kuwait Oman Qatar Saudi Arabia United Arab Emirates IICRA - final Moderate Risk Intermediate Risk Moderate Risk Intermediate Risk Intermediate Risk Intermediate Risk Country risk High Risk Moderate Risk Moderate Risk Intermediate Risk Moderate Risk Intermediate Risk Industry risk Intermediate Risk Intermediate Risk Moderate Risk Intermediate Risk Intermediate Risk Intermediate Risk
GCC--Gulf Cooperation Council. IICRA--Insurance Industry And Country Risk Assessment.
We assess many Gulf (re)insurers' competitive positions as adequate (in the case of 18 companies), although the range includes six companies that we consider have strong positions and 10 that we see as less than adequate. Those with strong competitive positions have leading positions in one or two markets, which enables them to post strong underwriting performance. Unlike rated European (re)insurers, GCC-based companies are generally limited in terms of geographic diversity. This is because for a non-domestic company, it's generally difficult to break through into profitable lines that are repeatedly renewed by established local players. Over the past few years we've seen a number
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of GCC insurance companies starting up takaful operations, notably in Kuwait and Bahrain, but note that they've found it difficult to avoid underwriting the fiercely competitive compulsory retail lines, such as medical and motor insurance, at a loss. In the face of increasing competition, the established players have managed to protect their profitable large-ticket businesses. However, for some companies this came at the expense of premium reductions caused by lower pricing and loss of business. Therefore, those companies with a less favorable (that is, less than adequate) competitive position typically have portfolios dominated by underpriced retail motor or medical business.
Capital Strength Supports Moderately Strong Financial Risk Profiles

Although we recognize that average risk-based capital (measured using our model) is very strong, we believe that the small capital base of most GCC (re)insurers potentially makes them more vulnerable to losses than we assume in our capital model. We capture this negative credit factor in our capital and earnings assessment (see chart 4). Therefore we consider the financial risk profiles (FRPs) of the sector's insurers as moderately strong on average (see chart 3).
Chart 3
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Chart 4
One of the GCC (re)insurance sector's key strengths is its capital position, reflected in our average assessment of very strong capital adequacy. Indeed, 20 of the 34 (re)insurers we rate in the region have their risk-based capital assessed as extremely strong (that is, at the 'AAA' level; see charts 5 and 6). We recognize that some companies are in a growth phase, meaning they have yet to utilize their capital base. However as we explain above, the limited absolute size of these capital bases means that the favorable capital positions of these firms are diluted when assessing capital and earnings. This results from our assessment of whether or not our risk-based capital is reflective of a (re)insurer's inherent risk within its balance sheet. We consider this assessment, the representativeness of modelling, to be negative for 76% of GCC-based (re)insurers, with the remainder being assessed as slightly more favorable (that is, moderately negative). However, for insurers in Europe, the Middle East, and Africa as a whole (including GCC companies) we consider only 43% as negative, reflecting the larger capital base of rated (re)insurers in Europe that makes them less prone to losses.
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Chart 5
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Chart 6
Additionally, GCC (re)insurers' exposure to asset risk is much higher than underwriting exposure, by contrast with their European peers. This is partly a reflection of the fact that some companies have chosen not to distribute their profits. Rather, they choose to increase their asset base for investment activities. In our view, companies' capital is exposed to high asset risks, including equities and real estate. This partly reflects the limited investment options available and the underdeveloped capital markets in the GCC region. Some companies are dominated by shareholders that have higher risk appetites for their investment activities than for their underwriting, reflecting their wider interests outside the insurance business. The average ratio for high-risk assets to total adjusted capital is 57%, with some outliers reaching 100% or well above it. Although the Middle Eastern capital markets are growing fast, they are still relatively narrow and are heavily dependent on their respective domestic economies. This means that Middle Eastern insurers' investments, equities in particular, are often concentrated in sectors such as financials. Most companies tend to have high exposure to the financial services or real estate sectors, which on average account for about 45% of total invested assets. Exposure to individual investments tends to be high, too, at 20% of total invested assets on average. This is probably the most obvious concentration risk for Middle Eastern insurers, and usually involves exposure to an equity, deposits concentrated in a bank or, occasionally, to a property. Such exposure is often a very significant component of the
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investment portfolio, and raises questions about the portfolio's liquidity at times of stress. That said, generally companies have not so far had difficulties with their deposits heavily concentrated in a bank partly reflecting good creditworthiness and strong government support for banks. Despite the impact of high risk assets (captured under our risk position assessments, see charts 7 and 8) the very favorable capital positions and strong liquidity of the GCC (re)insurers, is generally enough to offset these risks. For example, if we improve the risk position of the aforementioned entities, it only enhances the FRP of a few companies.
Chart 7
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Chart 8
Anchoring Insurers' Credit Quality

The combination of an insurer's BRP and FRP results in an initial assessment of creditworthiness that we describe as the anchor. The average initial assessment among GCC (re)insurers is 'bbb+/bbb' (see chart 9), compared with 'a-' for Western European peers.
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Chart 9
Despite the capital strength of the sector as whole, those companies in a growth phase are likely to place pressure on their risk-based capital prospectively. Nevertheless, 10 companies have FRPs that are stronger than their BRPs, and we attribute this to their limited scale and geographic and product diversification.
Risk Management, And Management And Governance, Are Mostly Neutral For Ratings
Historically, we've identified GCC (re)insurers' enterprise risk management (ERM) practices as sufficient and generally assessed them as adequate, in line with the majority of rated insurers worldwide. Given the straightforward nature of GCC insurers and the level of excess capital that the companies have relative to risks accepted, we generally consider ERM to have low impact (that is, low importance) on the ratings for the sector. That said, ERM carries high importance for those companies that are exposed to complex risks or have exposure to catastrophe-prone areas. We note that companies have generally improved their ERM practices, and some have gone as far as developing internal capital models to facilitate their day-to-day strategic decisions. We view this as positive. Unlike most of their European peers, we consider GCC-based (re)insurers to be less advanced in terms of management
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and governance, giving them a fair assessment compared with European insurers' more favorable assessment of satisfactory. This, in some cases, reflects a reactive approach of GCC companies' management to market conditions and less-defined tolerances for the level of risks that they wish to take, notably in respect of investments. In our view, while it's important for management to be aware of competitors' strategies, strategic decisions should be made based on what's most appropriate for the insurer and its risk appetite. For example, despite investment risk being one of the key risks on their balance sheets, some companies have no predetermined limits for asset allocation, or such allocations are unconnected to the level of capital available. In fact, the final rating on five of the 34 companies we rate is lower than their initial assessment due to a combination of their ERM and management and governance assessments (MGAs). The distribution of FSRs for Gulf-based (re)insurers is concentrated at the 'BBB+'/'BBB' level (see chart 10), which is slightly lower than the distribution of the anchors. This is partly due to the ERM/MGA modifier as mentioned above. For four companies we have used the holistic adjustment for various reasons.
Chart 10
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Capital Strength Brings Stability

Looking ahead, we expect our ratings on GCC (re)insurers to remain stable over the next 12-24 months due to their capital strength. We base our view on the stable outlooks assigned to 27 of the 34-strong portfolio (see chart 11), which reflect the companies' generally very strong capital adequacy and strong technical earnings. Although all GCC insurance markets are competitive, the majority of primary insurers maintain favorable underwriting margins due to the strengths of the core business and the willingness of global reinsurers to continue providing capacity to the GCC sector. However, we see signs that the type of reinsurance cover purchased by local companies is changing.
Chart 11
The general extremely strong to strong risk-adjusted capital adequacy ratios exceed our expectation for their respective rating levels. Even so, their capital base is small by global standards, and therefore they are forced to rely heavily on global reinsurers to insure large, capital-intensive risks, albeit in return of high commissions. And while most insurers have a long-term relationship with their reinsurers, there are signs that these relationships are being tested. For example, we have seen a global reinsurer reducing its exposure to emerging markets, prompting some of primary GCC insurers to change their lead reinsurer. In addition, a few companies have had to reduce or even switch their quota share arrangement to excess of loss because of the difficulty of finding cost effective quota share
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arrangements, further exposing their capital. So far, these moves have not proved difficult thanks to the excess capital available to most companies. In common with insurers worldwide, the GCC insurance industry faces increasing competition (partly driven by excess capital) and low investment returns. In our view, those long-established companies that enhance their product offering and level of service will be better placed to maintain their competitive positions.
Related Criteria And Research

Related criteria:
Insurers: Rating Methodology, May 7, 2013
Related research:
Differentiating Between A Weak And An Adequate Enterprise Risk Management Assessment For Insurers In Developing Markets, Jan. 8, 2014 Saudi Arabian Property/Casualty Insurance Sector Carries An Intermediate Industry And Country Risk Assessment, Nov. 13, 2013 Kuwaiti Property/Casualty Insurance Sector Carries An Intermediate Insurance Industry And Country Risk Assessment, Nov. 6, 2013 S&P's Insurance Industry And Country Risk Assessments Offer A Global View Of The Forces Shaping Insurance Markets, May 22, 2013 Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.
Additional Contact: Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com
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