RAM Ratings Lanka releases insurance sector update

RAM Ratings Lanka has come up with its latest insurance sector update titled ‘Bright Prospects Despite Regulatory Changes’.

According to the update, the Sri Lankan insurance sector has been gradually recovering from the economic slump in 2008/09. Premiums in the general segment, which had contracted in 2009, staged a strong rebound in the first half of 2010.

Similarly, the life-insurance industry had picked up pace, recording a double-digit growth in premiums over the same period as opposed to the relative standstill a year earlier. Notably, the growth has been supported by the general improvement in macroeconomic conditions.

Going forward, RAM Ratings Lanka envisages the industry to keep up this positive trend, supported by more robust economic growth and greater penetration in the northern and eastern regions of the country.

The insurance sector accounted for a relatively small portion of the domestic financial industry, making up only 3.2% of the entire system’s financial assets as at end-December 2009. Moreover, the insurance penetration rate is also lower than those of other Asian countries, with total premiums per capita coming up to a mere US$ 30.10 as of end-December 2009 (end-December 2008: US$ 29.40).

We observe that several new players entered the insurance arena last year. At the same time, the more established players have shifted from price-based competition to focus more on service quality.

With the industry poised for growth, the Insurance Board of Sri Lanka is in the process of enforcing a new regulatory framework. Mainly, composite insurance companies will be required to split their existing general and life businesses into separate legal entities. Listing on the local stock exchange will also be made mandatory, with the incumbents and new entrants given a respective five years and three years to comply.

Meanwhile, the rules on solvency margins have been revamped, with a view to broadening the classification of assets recognised as admissible.

Through these initiatives, the regulator intends to bring the local insurance sector more in line with international norms; they would also support a more vibrant investment market.

RAM Ratings Lanka envisages the changes in classification to improve the existing players’ solvency margins, as many of them presently exclude these investments. Meanwhile, the IBSL has also permitted foreign-currency investments. These moves will provide insurers more avenues for investment.

Over the medium term, the regulator intends to implement risk-based capital supervision - currently practiced by banks. While these changes are viewed positively, we note that the new regulations will expose insurers to operational and foreign exchange risks.

Meanwhile, the industry’s general insurance claims have remained relatively stable, hovering at around 62% for the general segment. Additionally, the combined ratio for this segment has been kept above 100%, signifying that general insurance companies have been incurring underwriting losses. Consequently, they have been relying on investment returns for profits.

Nonetheless, RAM Ratings Lanka notes that most general insurance companies in other South Asian markets are also reporting underwriting losses.

Going forward, claims in the general segment are expected to increase due to the heavy floods in 2010 and early this year. At the same time, we note that its impact on insurers’ bottom lines may be offset by an expansion in premiums, supported by the more conducive economic climate.

Conversely, the life segment has experienced an increase in claims among RAM Ratings’ rated companies as well as listed companies. This has been mainly due to policy lapses brought on by the harsh economic landscape.

Unlike the general segment, most life insurers are currently earning underwriting profits as the life market has yet to mature and claims will only arise over the long-term.

Given the low penetration rate in the life insurance market, we believe that there is still room for growth. We expect claims in this segment to ease over the medium term, as the sector expands against the backdrop of the improving economic conditions while replenishing maturing contracts.

In terms of financial performance, insurance companies have been shifting their investments to the booming equity market to maintain their investment income as interest rates taper. Traditionally, investment income has mainly stemmed from fixed-income securities, buoyed by the previously high interest rates. As such, insurance companies have been able to maintain their financial performance.

With regulations permitting a wider range of investments, investment appraisal and monitoring will play a greater role within each company. In the medium term, overheads may experience upward pressure as insurance companies seek to expand their branch networks into the northern and eastern provinces of Sri Lanka.