The South African short term insurance industry By Trevor Barsdorf, Analyst at Global Credit Ratings

Transcription

1 The South African short term insurance industry By Trevor Barsdorf, Analyst at Global Credit Ratings The South African short-term insurance industry was characterised by sound gross premium growth and improved levels of profitability in 21 and 211. However, increased claims frequency, as well as large catastrophe losses, in the most recent financial year are expected to have eroded a portion of underwriting gains, amidst a continued soft rate cycle. This has been further impacted by increased operational costs. The industry is currently experiencing a number of changes to the regulatory and reporting framework, aimed at enhancing the financial soundness of market participants at various operational levels. Gross written premium growth of 5.9 was registered in 211, which marked an improvement from the 4.9 growth recorded in 21, and equated to R8.3bn in gross written premiums*. Industry gross written premiums are forecast to have risen further to around R74bn in 2, with the growth rate accelerating to 7.2. This compares with the consumer price inflation ( CPI ) reading of 5.7 in December 2 (December 211:.1) and a yearly average of 5.7 in 2 (211: 5.), as well as sustained positive real GDP growth of 2.5 in 2 (211: 3.1). The consecutive strengthening in gross premium growth over the past two years is a function of increased demand for conventional cover, such as personal motor and household protection. This has been driven by domestic demand from households, with the subdued interest rate environment supporting household debt creation and consumption expenditure. In this regard, motor premiums expanded by.4 to R3.2bn in 211, accounting for 44 of the premium base, with above-inflation increases constrained by the competitive soft rates environment (despite improved vehicle sales). Given the class high weighting within the overall industry portfolio, industry growth was largely in line with that of motor during 211. Property gross premiums increased by 7 to R23.bn in 211, on the back of higher asset values given the flat rates and suppressed housing sales. Business volumes have, however, been constrained, given contained capital expenditure by government and large commercial entities, as well as the pressures exhibited in the productive sector. Against this backdrop, the overarching issue of strained economic conditions remains pertinent, as it continues to restrain broader uptake of insurance products across market segments. The South Africa short-term market is dominated by motor and property business, which has persistently represented in excess of the 7 of industry revenue. This compares to the European industry s average of approximately 5 for the two classes, which increases to 5 if health insurance is excluded (reflecting a similar industry structure to the local market). This notwithstanding, the combined weighting of motor and property premiums within the gross premium base has risen to 78 in 211 and 2, compared with 74 in 27, with less commoditised lines experiencing a relative premium contribution slide. This is further reflective of the broader slowdown in corporate activity that has persisted over recent years and softened the demand for less generic insurance products. Notably, this shift in business mix has coincided with the sustained soft rate cycle of the past four years, indicative of the limited ability of the personal market to absorb material price increases under prevailing economic conditions, and heightened levels of competition on the supply side. A turnaround in the economic environment, coupled with increased stability and market confidence, would have a two-fold impact on premium rates, namely the easing of economic pressures would allow for broad rate increases, while increased corporate activity would spur demand for more specialised products which tend to exhibit less premium rate sensitivity. R'm 8, 7,, 5, 4, 3, 2, 1, Premium distribution * Gross written premiums Net written premiums Retention ratio (RHS) * 2 figures are GCR estimates. * Statistics are based on GCR s sample of insurers (representing 9 of total industry premiums), with the respective financial years ending in 2.

2 On a net written premium basis, a growth rate of 7.4 was recorded in 211 (21: 5.4) exceeding GWP growth by 1.5 percentage points. This is largely due to the increased weighting of traditional business, specifically motor, and accompanying higher net retention within the industry portfolio. As such, the retention ratio (NWP relative to GWP) increased to 75.5 in 211 (21: 74.5). With the same growth pattern evidenced in 2 (accelerated growth of the domestic motor-property book), the average retention rate is forecast to have edged upwards, with the industry risk base rising by 7.5 in 2. Notably, owing to the shift in the business mix, there has been a reduced demand for reinsurance capacity. This excess of supply over demand is also reflected in the international reinsurance market where the current reinsurance capital base is estimated to be in excess of US$5bn (the highest level ever achieved, widening the gap between demand and supply). As such, the soft market cycle evidenced in recent years is not expected to abate in the short term. This is compounded by the relative attractiveness of the South African market from the perspective of international reinsurance groups, offering enhanced geographical diversification and a limited CAT exposure profile relative to a number of established markets. Furthermore, healthy profitability at the underwriting level (as discussed below) also suggests the absence of supply-side pressures. Countering factors, which may come into effect in the medium term, are the potentially higher cost of capital charge under the Solvency II and SAM frameworks, the continuation of the subdued interest rate environment and volatility of the equity market, which places increased emphasis on the sustained (and increased) profitability of the underwriting account. Earned loss ratio * Earned loss ratio USD-ZAR (RHS) R/$ * 2 figures are GCR estimates. The industry has generated an average loss ratio of over the past two years, which is substantially below the average of 5 recorded over the ten years prior, with a number of factors seemingly at play (both external and internal elements). Firstly, and most notably, the industry s loss ratio has evidenced a high degree of correlation with the Rand-Dollar exchange rate over the past four years. This can be attributed in part to increased motor compartmentalisation, with the impact of the exchange rate pass-through to import costs impacting on motor claims. Secondly, the increasing use of risk-based actuarial underwriting techniques in motor (allowing, in turn, for enhanced price-adaptability), has enhanced loss ratio controls. Lastly, the active focus on the procurement channel and stream-lining of claims handling costs, as well as increasing use of technology, has further contributed to the improvement. Within the property class, an absence of large claiming years (with the exception of 29) has seen the loss ratio trend below the five year average of 4. Both the motor and property loss ratios were, however, impacted by weather related claims in the second half of 2. The adverse motor losses are due to the claims from the multi-million Rand hail storms in Gauteng, the weaker Rand, as well as an uptick in the overall claims frequency and crime-related losses. This has coincided with a preceding period of competitive rate dynamics, which has further impacted on the loss ratio. Within the property class, the St Francis fire claims and weather-related losses within the corporate and commercial property segment have impacted on insurers net accounts. Accordingly, the industry s earned loss ratio is forecast to have deteriorated to 1 in 2 (211: 59). Notably, given the skewed timing of the high severity claims experiences in 2 (the bulk of which were clustered in the final quarter of the year), the industry s annual loss ratio will be impacted by timing differentials within analysis samples. Assessing the industry s net loss ratio based purely on a rolling months basis (and ignoring individual insurer s year-ends) sees the loss ratio rise by 4 percentage points year-on-year, to approximately 2. This notwithstanding it is GCR s view that over the medium term, a culmination of factors is likely to see the loss ratio trend higher. The motor loss ratio s two primary exposures in the short term will continue to be exchange rate fluctuations, and incremental rises in claims frequency. Other systemic issues have been fairly well addressed in pricing, as reflected in the motor loss ratio in recent periods. Property loss ratios may improve in 213, based primarily on the fact that the CAT losses in 2 were significant outliers relative to base-case scenarios, with a recurrence of such events (or events with similar severity levels) deemed unlikely. * Statistics are based on GCR s sample of insurers (representing 9 of total industry premiums), with the respective financial years ending in 2.

3 Delivery costs * Management expense ratio Commission ratio Delivery cost ratio (RHS) 2 * 2 figures are GCR estimates. The South African insurance industry reflected a stable and predictable management expense ratio between 22 and 29, averaging 17, and not deviating by more than two percentage points in either direction. The past two years, however, have seen a consistent escalation in the relative cost base of the industry, which amounted to a high 22 in 211. The primary components of the industry s general administration cost base are staffing and IT expenses, accounting for anywhere between 5 and 8 of expenses. These two items have increased considerably due a number of factors, such as above inflation wage growth, the upgrading of multiple systems, increased marketing and technological spend, as well as escalating regulatory compliance costs. GCR anticipates that, in line with the rising inflationary pressures, the management expense ratio is likely to trend upwards, to 23 in 2. Despite the increased volumes, the net commission expense ratio was largely unchanged at 9 in 211, with higher commission recoveries (relative to reinsurance cessions) keeping the net commission expense ratio contained (as improved loss ratios facilitated more favourable commission recovery rates). GCR expects the net commission ratio to remain stable in 2, with the greater prominence of non-intermediary models offsetting the cost pressures at the broker level, as well as the reduced commission recoveries. Overall, the delivery cost ratio of 31 recorded in 211 is expected to have increased further to 32 in 2. Notwithstanding the cost pressures evident, the favourable loss experience sustained into 211 saw the underwriting result increase to R5.3bn (21: R5bn), which translated into an underwriting margin of 1.2 in 211 (four-year average: 7.7). However, on the back of the pronounced deterioration in the claims experience in 2, the underwriting margin is expected to have narrowed to 7.5 in 2. This marks a softening in underwriting profitability amid the downward movement within the rate cycle. Accordingly, over the medium term, underwriting profitability is likely to remain in single digit territory. Underwriting profitability * GWP growth U/w margin (RHS) * 2 figures are GCR estimates. * Statistics are based on GCR s sample of insurers (representing 9 of total industry premiums), with the respective financial years ending in 2.

4 On the back of improved risk appetites, overall equity exposures (including preference shares and unlisted shares) rose moderately to 34 of total assets in 211 (21: 33), while the allocation towards bills and bonds reduced to 17 in 211 (21: 18). Given the low interest rate environment, investment returns remained constrained with investment income declining further by to R3bn (21: R3.2bn). This equated to a lower 34 of NPBT in 211, compared to 42 in 21 and a review period high of 71 in 28. Despite the persistently low interest rate environment, the gains evidenced in the equity market are likely to have ensured that the investment income component (from a fair value perspective) improved in 2. This will help mitigate the losses sustained at the underwriting level. Overall, the industry ROaSA improved to 9.5 from 9.3 previously, while with respect to the ROaSE, a higher 24.7 return was generated in 211 (21: 23.5). These rates are envisaged to have remained flat or deteriorated marginally in 2. Profitability R'm 8, 7,, 5, 4, 3, 2, 1, Total industry assets ROaA * 2 figures are GCR estimates. ROaE (RHS) The Financial Services Board continues to develop its proposed new risk-based solvency regime. Board Notice 19, which took effect at the start of last year, outlines the new prescribed interim measures for the calculation of the value of assets, liabilities and capital adequacy requirement. These interim statutory solvency requirements adopt a more risk-based approach relative to existing regulatory calculations and are being introduced prior to the full implementation of SAM. Solvency Assessment and Management ( SAM ) is largely based on the Solvency II capital adequacy, risk governance, and risk disclosure regime for European insurers and reinsurers. The primary purpose of SAM is to protect policyholders and beneficiaries, with the planned implementation date 1 January 21. The incoming regulation will utilise the same three pillar structure of capital adequacy (Pillar I), systems of governance (Pillar II), and reporting and disclosure requirements (Pillar III). Both SA QIS 1 and SA QIS 2 (South African Quantitative Impact Studies) have been completed during the course of the past two years and have afforded the FSB with insight into the readiness and implications of the new solvency approach. The studies have allowed for the calibration of the Standard Formula for calculating the Solvency Capital Requirement, which all registered insurers and reinsurers will be required to apply (should an internal FSB approved model not be built and utilised by the participant). Under SA QIS 2 in terms of Pillar I, around two thirds of the 3 participants indicated they were fully prepared (in respect of Data & Methodology) with regards to Own Funds (Capital Resources) and the Minimum Capital Requirement (MCR), while only 4 and 24 respectively were prepared with the Solvency Capital Requirement and Technical Provisions. The latest survey also showed that most short-term insurers have a lower free surplus under SA QIS2, compared to that under the interim measures. In this regard, the overall Capital Requirement increased to R33bn under SA QIS 2 (SA QIS 1: R2bn), while the Available Capital increased to R5bn from R39bn. This notwithstanding, the Capital Coverage Ratio remained unchanged at 1.5x. Going forward, SA QIS 3 will require compulsory participation by all insurers and reinsurers operating in South Africa and will explore the implications of SAM on financial reporting. Particular attention will be given to the design and further development of the insurers and reinsurers Own Risk and Solvency Assessment (ORSA) reporting and financial reporting, in terms of investor focus and in relation to IFRS 4 Phase II. In this regard, a large number of reporting templates are currently being developed and proposed, which are likely to require careful scrutiny and consideration. Pillar III could give rise to a number of challenges about data, systems capabilities, the effectiveness of internal controls and the need to implement new reporting and governance processes to meet these requirements. The industry is currently waiting for further guidance from the FSB as to the proposed SAM Parallel Run expected to take place in 214. Notwithstanding the associated cost increase, the new regulatory solvency framework should result in improved risk management and more efficient use of capital. In terms of SAM preparations, while larger insurers typically have sufficient resources to formulate risk policies, smaller insurers may face a particular challenge in aligning their businesses with SAM due to limited history in devising such risk controls and instilling strong a risk management culture. * Statistics are based on GCR s sample of insurers (representing 9 of total industry premiums), with the respective financial years ending in 2.

5 The international solvency margin rose to 53.2 in 211 (21: 51.8), supported by the stronger NPAT of R.5bn reported. Similarly, the statutory solvency ratio strengthened to 42. from 41.1 in 21. In light of the more stringent statutory capital requirements implemented, elevated levels of prudency could see the international and statutory solvency margins remain around current levels in 2. The industry financial base ratio (including technical reserves) rose to 111 (21: 19), exceeding the four year average, and is expected to have fallen marginally in 2, given the deterioration in the claims experience. From a ratings perspective, the industry s international solvency margin remains moderate to strong, underpinned by a healthy profitability track record, which also displayed resilience in the face of high CAT losses in 2. The industry s capital strength relative to its underwriting risk base is augmented by the comparatively low product risk, with the continued growth of traditional motor and household cover lending a degree of stability to this risk positioning going forward. 14 Protection measures * International solvency margin Financial base ratio * 2 figures are GCR estimates. The global macro-economic conditions evidenced over the past year are likely to continue in 213. In this regard, concerns surrounding the economic stability within Europe, flat US growth and the strength of the demand in China look set to persist, which will hold implications for trading activity between South Africa and key trading partners. National Treasury forecast domestic economic growth of 2.7 and 3.5 for 213 and 214 respectively (compared with the prior budget of 3. and 4.2 respectively). The persistence of challenging economic conditions is likely to ensure corporates remain focussed on expenditure minimisation and earnings protection. With household consumption growth slowing, it is expected that any acceleration in this area will be modest as higher trending inflation, lower wage settlements and a weak job market dampen disposable income. Household credit will provide key support, albeit concurrently worsening the vulnerability of consumer balance sheets. This notwithstanding, demand for traditional mainstays should ensure industry growth is aligned with inflation, albeit to a lesser degree. With regards to the loss ratio, the exchange rate has had an overall positive impact on the industry s loss ratio over the past three years (21 to 2). However, the deterioration in the value of the Rand in Q1 213, as well as the cautionary currency outlook, point to a likely uptick in the motor loss ratio in 213, which will impact on the overall loss experience within the industry. As such, the broader soft rate cycle is expected to persist, as strong competitive forces continue to dominate the pricing outlook. Note is taken of the increased domestic CAT claims experience in 2. This may see a revision of rates pertaining to loss-affected risks on a selective basis, and hence impacting only on an isolated risk segment. Following the losses sustained in the second half of 2, the focus for 213 will rest on robust underwriting practices in order to protect underwriting profitability. Margin protection may also emanate from cost saving initiatives given the increased regulatory cost pressures, with the insurance industry contending with a number of regulatory measures and reporting changes coming into force. In this regard, the industry will be affected by the implementation of Treating Customers Fairly ( TCF ) and SAM, which will bode well for the heightened protection of policyholders and beneficiaries. For further information, please contact the insurance division at GCR on * Statistics are based on GCR s sample of insurers (representing 9 of total industry premiums), with the respective financial years ending in 2.