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Under pressure.

Byline: Sunil Kumar Singh

Summary: Dozens of insurers and reinsurers are competing in the GulfEos potentially lucrative market. The winners will need to demonstrate good risk-modelling and prudent underwriting to stay in front.

June was a nightmare for the global reinsurance giants. Two plane crashes in the same month E... one by the Air France into the Atlantic Ocean and the second by Yemen Airways in the Indian Ocean off the coast of the Comoro Islands E... are estimated to cost the global reinsurers who had underwritten the cover many millions of dollars.

According to market estimates, the Air France claim may cost as much as $700 million, by far the most expensive in almost a decade, forcing international giants such as Hannover Re, GIC Re, American Insurance Group, and Allianz to shell out millions each towards their share of the claim.

The loss of these two jetliners and its impact on the underwriters is just one example pointing to the catastrophe-exposed nature of the global reinsurance business. However, while reinsurers with operations in the Gulf region face few risks on that front, a pale shadow of what is plaguing global reinsurers is certainly visible in this part of the world.

Economic growth has slowed down in the region; many of the construction and property projects have been put on hold; marine cargo insurance has reduced because of slowdown in trade and re-exports from the region; and equity markets are bearish. All these factors mean there is less to insure for regional insurance companies, and consequently for reinsurance companies. As a result, lesser premium income and impairment of the values of their investments in equity markets have already started to affect their profits.

Take, for instance, this yearEos first-quarter financial results of Arab Insurance Group (Arig), one of the largest Arab-owned, professional reinsurance providers in the MENA region. ArigEos net profit slumped by half compared with $3 million in the same period last year. The company reported flat investment returns with a marginal deficit of $300,000. Gross written premium was down by 14 per cent owing to lower trading volumes in the cyclical engineering and marine line, the company reported. The only good sign, was that this is the first net profit Arig has recorded since a full-year loss in 2008. The latest results for the first six months of 2009 also show that ArigEos net profit declined to $8.8 million compared with $11.4 million in the first half of 2008.

But how will this affect the nascent reinsurance market, those companies that provide cover to the insurance companies themselves? It is first important to understand how the current slowdown is causing shrinking income, as well as dwindling returns on investment, for regional insurers, which in turn is affecting reinsurers.

Insurance companies deal with a variety of risks: liability risks, asset risks, and operational risks. Take, for instance, liability and asset risks. Not so long ago, the breathtaking pace of property and construction projects in the region generated huge cash flows for insurers. But as the growth clock turned backwards, stalling many of the property projects in the region and especially in the UAE, many insurers having exposure to this sector are now feeling the heat.

For one, cancelled projects means the insurance cover ceases to exist, and so does the premium payment E... a lucrative conduit of income for insurance companies. Paul Holmes, chief executive officer, Middle East, RSA, says: EAEThere is no doubt that the rapid expansion of the real estate sector across the GCC was one of the key contributing factors to the premium growth in the past. But with the economic slowdown, many of these planned projects have either been cancelled or put on holdEe On the back of robust growth, many insurers anticipated the high level of growth to continue and have structured resources accordingly. A substantial reduction in premium generation has a direct impact on the margin and, unless insurers take swift actions to manage those costs, they will pressurise their results.Eo

Jean-Louis Laurent Josi, chief executive officer, AXA Insurance Gulf & Middle East, says: EAEFor these companies that were not diversified in terms of lines of business, their main focus on the property market and the current delay of projects will impact them. This situation shows the importance of being well diversified for an insurer.Eo

If new or ongoing projects are delayed or cancelled, that places pressure on insurerEos balance sheets. To add to the woes, cancellation of projects may also trigger claims for premium refunds, increasing the pressure on insurersEo balance sheets.

Take the case of the insurance sector in the UAE. According to Global Investment House, corporate earnings of the UAE insurance sector declined by a whopping 59.95 per cent in 2008, the most of all sectors. EAEThe insurance sector was the top decliner, with total 2008 profits standing at $310 million from $777 million recorded in 2007.Eo The report adds: EAE2008 marked one of the most turbulent years for the insurance sector profitability. Twenty out of the 26 insurance companies in the sector posted losses.Eo

On the investment side too, the regional insurance sector has borne the brunt, mainly due to its overexposure to the regional equity markets. EAEInsurers that invested some of their assets in the stock markets saw the value of these assets plummeting. It goes without saying that the impact of this crisis was significant for the insurers that mainly relied on their financial results to be profitable,Eo says Josi of AXA Insurance.

Holmes of RSA says: EAEInsurance companies that have driven their returns through investment in the stock markets will be affected by the economic downturn when they realise the risks associated with subsidising returns from non-core activities.Eo He adds: EAEGenerally, the insurance market is currently taking more risk at lower prices. Consequentially, in the absence of viable investment income, the exposure to capital is increasing substantially, which does not bode well for many insurers.Eo

RAYS OF SUNSHINE

So, has the role of insurance changed in the downturn? Is there more risk, less profit and more costs for clients?

EAEFrom the insurersEo point of view there is increased risk of fraud on policies as clients feel pressure, so insurers must be vigilant. There will be less profit as consumers shop around and business becomes harder to win. Prices (and ultimately profits) will be driven down. There is more work, and less return as insurers and brokers cut their costs to win business. The result will be poorer performing schemes, upwards pressure from reinsurers next year and high premium increases for the clients,Eo maintains Jon Carpenter, managing director, Morgan Price International Healthcare, a London-based health insurer with operations in the Gulf.

As the rules of the games have changed in the downturn, one of the major necessities for the regional insurers is to enhance their capacity-retention capabilities and to reduce their dependency on international reinsurers, believe analysts. In this scenario, when the retention ratio by local insurers is low, many of the global reinsurers would consider it less attractive to provide large reinsurance capacities. Low retention by regional insurance companies is also leading to there being no alignment of interests between insurers and their reinsurance partners, analysts say.

As Lukas Mueller, head, client management Middle East and Turkey, Swiss Re, says: EAEGiven that profit margins are marginal, and given the recurring losses under certain lines of business, providing large reinsurance capacities has become less attractive. Unless terms and conditions improve, and insurance companies are prepared to participate to a larger extent in risks (at the moment, an insurance companyEos typical net retention is below 2 per cent), diverging interests will jeopardise a sustainable and long-term commitment by major reinsurers.Eo

Gail Norstrom, chief executive officer, Gulf Reinsurance (Gulf Re), which provides reinsurance support to a range of sectors, as well as to many of the regionEos largest insurers, says: EAEIf companies want to add value and total returns to shareholders, they should be thinking about growing their balance sheets. And to do that they will have to retain more risks, engage in technical underwriting profits and put those profits on their balance sheets.Eo

Another stumbling block is that not all the regulatory laws of the region conform to the International Association of Insurance Supervisors (IAIS) standards, US, apart from in financial free zones such as Dubai International Financial City. EAECompanies in the DIFC have the benefit of a world-class regulator like Dubai Financial Services Authority. But the reinsurance market is largely unregulated, except by their home country regulator,Eo agrees Norstrom.

A further challenge for the regional reinsurers in the region is that the value of qualified underwriting, risk management and services is underestimated. Christian Kraut, chief executive officer, Munich Re MENA, says: EAEOne problem, new insurers in the Middle East are facing, is that growth in the insurance sector is far behind their business plans and many local insurance companies are seeking strong and reliable reinsurance security. Reinsurers will have to focus on underwriting profitability, as they cannot rely on returns from the volatile financial markets anymore.Eo

He adds: EAEA really underestimated challenge is the exposure to natural perils. There is a lack of risk perception and reinsurers in the region should try their very best to raise awareness, not only about natural catastrophe exposures, but also about risk-adequate prices and the importance of sufficient coverage.Eo

So where should regional insurers and reinsurers go from here when cash flow is tight, risk has multiplied and insurersEo own cost of capital has increased? Analysts believe the regional market has strong potential to go from strength to strength, mainly because new areas of growth. The Middle East insurance and reinsurance sectors have huge growth potential. The historically low insurance penetration levels in the region are attracting many international insurers, as well as reinsurers, to take advantage of opportunities in the region.

James Portelli, executive vice president and head of audit and risk management, Oman Insurance Company, says: EAEThere are opportunities even in the downturn. New classes of insurance have emerged like credit insurance, home insurance, medical and health insurance that will contribute to sustained growth in the market.Eo

Norstrom of Gulf Re says that the insurance penetration rates in the GCC region are still very low, at about 1 per cent of GDP, compared with an average of 3 per cent in other emerging markets. EAEIf regional penetration rates were to reach closer to the world average of 7.5 per cent, that could potentially generate over $15 billion of additional annual premiums for the industry,Eo she says.

Going forward, regional insurers and reinsurers have learned a crucial lesson from the economic downturn. But at the end of the day, there is no quick fix that will solve all the problems of the regionEos insurers and reinsurers. The silver lining, however, is that the region has still low insurance density and low insurance penetration rates compared with the global average. These have cushioned the impact of the downturn and will incentivise the sale of insurance as a financial product in the future.

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Publication:Gulf Business
Date:Sep 1, 2009
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