By Santhosh V Perumal/Business Reporter
The Gulf insurance industry, which grew to nearly $16bn in gross premiums during 2012 on the back of strong economic growth, faces consolidation risks, mainly stemming from default by certain small players, according to global credit rating agency Standard & Poor’s (S&P).
Although consolidation makes economic sense, it appears to be going through the rough roads owing to hurdles, which include inflated valuations and reluctance to relinquish control, S&P said in its report ‘Barriers to Consolidation Heighten the Risk of Default for some Gulf Cooperation Council (GCC) Insurers’.
The GCC insurance market, where profits are “concentrated” at larger and more-established players and also has credit “implications” due to inherent bottlenecks for consolidation, however, continues to benefit from generally robust economic growth as considerable hydrocarbon wealth sustains their expanding economies, it said.
Observing that the region’s real GDP (real gross domestic product) growth was 6% in 2012, S&P said “we expect this growth momentum to continue in 2013 and beyond”.
Having found that the insurance industry had $16bn gross premiums written in 2012, averaging 10% growth in the largest risk cover market, the rating agency said ample capital is available within the industry to back the growth in premiums.
With regional and global investors looking for a slice of the business in view of growth potential, it said “this creates a highly competitive marketplace in which all companies are contending for profitable business and this ensuing competition puts pressure on margins.”
Although S&P estimates that the GCC insurance to be overall profitable, it said profits are concentrated at larger and well-established entities. In this regard, it found that in Saudi Arabia, three largest companies accounted for 80% of total sector profit in 2012 and nearly one-third reported losses.
Similar trends were visible in the UAE insurance industry, it said, adding inadequate profitability is more pronounced at the lower end of the market as smaller companies lack economies of scale and many of them do not have the critical mass - sufficient business volumes - to cover operating expenses.
“Over time, a lack of profitability erodes capital, leaving some companies with little prospect of finding a profitable niche. In our view, it is a matter of time before these companies start to face run-out of capital and face risk of default,” the rating agency said.
Highlighting that it made economic sense for some of these risk-prone risk cover providers to go in for consolidation, it said a merger could improve their economies of scale and offer them cost efficiencies.
However, S&P found that consolidation was hard to achieve as public stock market valuations, in many cases, do not reflect economic fundamentals, causing a “significant” valuation gap.
Moreover, integrating an acquired entity also carried execution risks because most of the risks written in the region have relatively a short claims tail, acquirers have few concerns regarding whether sufficient reserves have been set aside to cover old business, it said.
Stressing that reluctance to consolidation could have credit “implications”, S&P said “we anticipate that some smaller companies at the lower end of the market could see their creditworthiness diminished as continued losses cause their capital bases to deteriorate.”
This could force some companies abandon their sensible underwriting, which further erodes their profitability and “distort” pricing in the wider market, reducing profitability for other market participants, the report cautioned.
“In our view, the pricing developments exacerbated by a failure to consolidate, enhance overall insurance industry risks across the GCC region,” S&P said.