The Saudi Arabian Monetary Agency (SAMA), which regulates
insurance in the Kingdom, actively aims to ensure the industry as a whole
develops positively. While insurance penetration remains low as a percentage of
GDP, it is growing fast and it is expected that as the economy grows, so will
the insurance sector. SAMA rigorously enforces its requirements for reporting
and disclosures, and demands that all insurance and reinsurance providers gain
operational licenses and product approvals. Its processes create a barrier to
entry for new participants, somewhat reducing the competitive pressures caused
by the presence of 33 insurers chasing a fairly small, if growing, market.
Despite these strengths, the overall institutional framework has yet to be
tested under stress.
Low interest rates present Saudi insurers with a
particular problem. Because they operate in an Islamic country that adheres to
Shariah law, all insurers must pay a "zakat" tax on their investments,
including 2.5 percent of the value of their cash investments. S&P estimates
that at year-end 2010, KSA insurers paid zakat of approximately SR190 million,
while their aggregate investment return was just SR159 million (about 2.1
percent). Therefore, until interest rates rise from their current low levels,
Saudi insurers must make an underwriting profit to break even, according to
Standard & Poor's.
Return on equity
S&P regards the profitability of the Saudi insurance
market as positive. According to data from SAMA, the weighted-average return on
equity (ROE) over the past three years has been approximately 13 percent. ROE
benefits from strong underlying underwriting profits. The overall loss ratio
stands at 69 percent and the net combined ratio at 87 percent.
Generally, the Kingdom’s insurers maintain large capital
bases that constrain their ROE. Many of them hold shareholder's equity balances
on their balance sheets that S&P considers large, given the amount of
premium they currently write. Thus, return on equity is reduced by the large
denominator.
Low interest rates mean very modest returns on bank
deposits -- currently just 0.7 percent a year. Thus, for Shariah-compliant
insurers, the obligation to pay zakat tends to limit the underlying ability of
earnings to enhance capitalization. Saudi Arabia levies zakat at a flat rate of
2.5 percent on cash holdings. S&P estimates that the overall zakat payment
for Saudi insurance companies at year-end 2010 exceeded their overall
investment returns by approximately SR30 million. However, as underwriting
earnings or investment returns increase, the zakat payment will consume a
decreasing proportion of the companies' profits.
Product risks
S&P assesses the potential for product risks to
trigger ROE volatility as moderate. Products sold in the Kingdom have
relatively predictable claims settlements and limited asset/liability mismatch
risks. Most of the business written in the Kingdom is short-tail — claims are
usually made during the term of the policy or shortly after the policy has
expired. Therefore, there is little uncertainty relating to claims amounts and
payment patterns. The Kingdom is not overly litigious, and S&P sees limited
scope for unpredictable liability settlements.
Short-tail business also means low exposure to
asset/liability mismatch risk. Insurers' balance sheets show no material
long-term liabilities, so the short-term bank deposit assets that comprise most
of the investment portfolios are broadly aligned with the duration of their
respective liabilities. Most claims are settled quickly.
However, some lines and regions have moderate exposure to
natural catastrophe risks. While exposure to natural catastrophe risks is low
across most of the Kingdom, damaging earthquakes can occur in the western
Jeddah region. Although this region is near a major plate boundary in the Red
Sea, S&P considers earthquake risk to be relatively remote. PreventionWeb,
a UN project that facilitates the sharing of information on disaster risk
reduction, ranks Saudi Arabia 105th out of 153 countries in terms of earthquake
exposure.
Jeddah, the second largest city in the Kingdom, has a
population of about 3 million people and is prone to severe floods. In 2009,
floods caused over 100 deaths and economic damages to infrastructure and homes
estimated by some at nearly $1 billion. Floods also occurred in December 2010
and January 2011.
The country is also exposed to potential civil commotion
losses, particularly in the Eastern Province. Geopolitical risks are elevated
as the Gulf region is the source of much of the world's oil supplies.
Institutional framework
S&P regards the institutional framework as a neutral
factor for the industry. This is based on assessment that oversight is
moderately strong, and transparency and governance are adequate.
SAMA and the Capital Market Authority (CMA) exercise
moderately strong regulatory oversight. They enforce it by requiring quarterly
reports and disclosures, and by licensing each insurer and approving all
products. However, the overall institutional framework is not seasoned and has
yet to be tested under significant levels of stress. The new framework provides
order to the market, enhances consumer protection, and prohibits anticompetitive
behavior, such as dropping rates. SAMA rigorously enforces rules and
regulations and has the authority to withdraw licenses if insurers consistently
fail to comply with those regulations. That said, the regulator is actively
engaged in dialogue with all of the market participants to ensure that the
industry as a whole develops positively.
Transparency is adequate. S&P views accounting as
broadly transparent. SAMA requires that all insurance companies prepare their
financial accounts in accordance with International Financial Reporting
Standards (IFRS). Companies report results on a cooperative basis, and thus
have separate income statements and balance sheets for policyholders' funds and
shareholders' funds. Standard & Poor's combines these statements in our
analysis. Financial accounts are required to have at least two independent
external auditors. Quarterly accounts are also obligatory and are available on
the Tadawul stock exchange website.
The adequate level of transparency is confirmed by Transparency
International, which measures the perceived levels of public sector corruption
in 178 countries around the world. It ranks Saudi Arabia 50th in its Corruption
Perception Index, which is calculated based on surveys conducted among country
experts (such as the Economist Intelligence Unit, Freedom House, the World
Bank, and others), as well as countries' business leaders.
Corporate governance is sufficiently strong. SAMA
requires companies to have independent board members, approved by SAMA. It also
mandates the use of external consultant actuaries and the appointment of risk
managers, which further strengthens the governance framework.
The regulator
The Saudi market underwent significant change in 2008,
following a royal decree that required all insurance companies to be domiciled
in the Kingdom and to comply with new regulations that created significant
regulatory, economic, and operational hurdles to establishing new insurance
companies. The high barriers to entry protect existing market participants from
new entrants to a certain extent, and thus mitigate the negative pressures of
increasing competition as the market becomes more crowded.
As the regulator, SAMA has developed a rigorous process
for approving new licenses for insurers. Its regulations impose requirements
for all insurers to develop a credible business plan to gain a license to
operate, to be publicly listed with a wide shareholder base, and to publish
audited financial accounts. The regulator exercises a substantial level of
authority over the market participants, and in the long term aims to foster and
develop a successful insurance industry. As a result, all KSA insurers are now
publicly listed and at least 40 percent of the shares in each were sold through
an IPO listing on the Riyadh Tadawul stock exchange.
Insurers also suffer moderate operational and legal
barriers to entry, in our view. Operational barriers include the need for local
offices. Many of the insurance companies are well represented in the three key
cities of the Kingdom — Riyadh, Jeddah, and Dammam — but are still expanding
their distribution networks to other cities and more remote areas of the
Kingdom. This process requires time and resources.
A lack of qualified technical staff in the local market,
especially at the senior management level, presents another operational hurdle,
as does SAMA's requirement that at least 30 percent of staff be Saudi
nationals. As few Saudis know about or show an interest in insurance, the
staffing requirement can be a major concern for new insurers in the Kingdom;
they could incur the additional cost of having to train up the required number
of local staff.
There are also moderate legal barriers — newly established
companies have to comply with the Capital Market Law for an initial public
listing, namely submit proper documentation and gain approvals from the CMA.
Despite all the hurdles, the Kingdom’s marketplace now
has 33 licensed insurers and one licensed specialist reinsurer. Perhaps a
further half-dozen insurers are still working through the set up process.
Overcrowded market
Many of the insurance companies operating in the Kingdom
are recent start-ups with low or zero premium volumes. The marketplace is
crowded and getting ever more competitive. Most energy business risks are ceded
outside of the Kingdom and therefore domestic insurers have little access to
the petroleum sector, which accounts for roughly 80 percent of the Kingdom's
budget revenues, 45 percent of GDP, and 90 percent of export earnings. The
state-owned monopoly Saudi Arabian Oil Company (Saudi Aramco), in particular,
cedes its energy risks to its captive Stellar Insurance Ltd. (AA-/Stable),
which is domiciled in Bermuda.
As a result, too many companies are chasing the same few
profitable risks, which places rates under significant downward pressure.
Bearing in mind the importance of underwriting profitability in a Shariah-compliant
market, soft pricing conditions hinder companies' profitability. The market
reported a 96 percent net combined ratio for the first half of 2011, indicating
that technical profitability has deteriorated slightly compared with prior
years.
Penetration is low
S&P views the insurance penetration trend in Saudi
Arabia as positive. It has nearly doubled to over 1 percent of total GDP in
2010, from 0.53 percent in 2006. SAMA also calculates penetration as a
proportion of nonoil GDP (up to 2.08 percent in 2010 from 1.15 percent in
2006).)
S&P expects growth to fall to around 10 percent
annually over the next five years. Average premium per capita remains modest,
at approximately SR600 (or $160) compared with an average of about $1,900
across Europe and $4,000-$5,000 in the mature markets of Western Europe.
Economic growth
As the insurance market continues to grow, the pressure caused
by the overcrowding should ease. With more profitable business available,
market participants will be able to expand organically without taking market
share from their competitors.
