Fitch affirms HNB Assurance at ‘A’; Outlook Stable

Fitch Ratings Lanka has affirmed HNB Assurance PLC’s (HNBA) National Long-Term rating and its National Insurer Financial Strength (IFS) rating at ‘A (lka)’ with Stable Outlooks.

The ratings reflect HNBA’s adequate risk-based capital position, conservative investment strategy and stable profitability progression. The ratings also factor in Fitch’s expectations of continued support from HNBA’s parent – Hatton National Bank PLC (HNB; ‘AA-(lka)’/Stable), given the latter’s majority ownership in HNBA (60%) and the perceived strategic importance of the insurance subsidiary. However, the ratings are constrained by HNBA’s modest market share and increased competition in the local market.

The Stable Outlook reflects Fitch’s expectation that HNBA’s capital will improve with the announced Rs. 390.6m equity (38% of total equity at end December 2010) and that the company will maintain its sound operational and financial performance with emphasis on profitability and a conservative investment strategy amid improving macro-economic conditions.

HNB and HNBA share the common brand, and the latter contributed to 4.9% of the HNB group’s profit in 2010 (2009: 4.4%). HNBA benefits from its parent’s distribution network of 208 branches, as well as from cross-selling opportunities with over 40% of non-life premiums being derived via its ties with HNB.

Fitch takes comfort from the parent’s intention to take up its share of the capital infusion and also those which are not subscribed by other shareholders, thus reinforcing its commitment to the subsidiary.

HNBA’s regulatory solvency ratio decreased sharply at end-December 2010 (2.0x for non-life and 1.1x for life at end-2010, marginally above the regulatory 1x).

However, Fitch expects the company’s solvency position to recover to above 2.0x for both life and non-life, based on the proposed equity infusion in Q2CY11.

The agency takes comfort from HNBA’s stable profitability, lack of debt leverage and high rate of capital retention (average dividend payout of 23% over the last three years), and notes that HNBA’s return on average equity and return on average assets of 26.2% and 5.9% in 2010 are at the median level of the top seven players.

HNBA follows a conservative investment strategy, as indicated by its relatively low exposure to the equity market, and by the fact that government securities account for 70% of life investments and 62% of non-life investments. HNBA is also helped by the profit participation feature of the bulk of its life business. Fitch notes that the non-life combined ratio, which increased to 105% in 2008, has been gradually reducing (2010: 102.2%), driven by improving expense ratios. Reinsurance cover at HNBA is strong, with a high credit quality panel of reinsurers, rated at ‘A-’ or above.

Driven by competition in its motor and miscellaneous product classes, HNBA’s loss ratios remained weak at end-December 2010. Nevertheless, its operating ratios, averaging at 81.1% in 2008-2010, remained stable due to high investment income earned during the period.

However, due to the decline in interest rates since 2009, the company will face pressure to maintain its investment income level in addition to reducing the combined ratio given the current high levels of competition.

Although the rights issue is expected to strengthen HNBA’s overall capital position in Q2CY11, Fitch believes that the company will absorb this quickly for its growth. However, Fitch does not expect a significant increase in HNBA’s market share in the near-term due to the five largest players holding over 75% of market share and the strong competition within the industry.

The ratings may be upgraded by a notch, if HNBA can increase its market share while maintaining profitability and sustaining its solvency margins above 3.0x for life insurance and 2.5x non-life insurance; however, Fitch does not foresee an upgrade for HNBA in the near-term due to its modest market share and small asset base.

The ratings may be downgraded if HNBA’s solvency levels deteriorate to 1.5x for both life and non-life segments on a sustained basis, and its operating performance in non-life insurance weakens leading to a combined ratio of above 110% or the loss of market share.

 Additionally, a weakening of HNBA’s importance to its parent may also result in a negative rating action.

HNBA has an operating track record of 10 years. It has been profitable since inception and has below 5% market share in both life and non-life markets and accounted for less than 3% of total industry assets at end December 2010.