Thursday 02, March 2017 by Jessica Combes

S&P: Stringent regulation has helped transform Saudi insurance market

In the decade since Saudi Arabia's Cooperative Insurance Law came into full force, the kingdom has turned what was an unregulated industry into the largest non-life and health insurance market in the GCC region and the most actively regulated insurance market in the Middle East.

In the decade since Saudi Arabia's Cooperative Insurance Law came into full force, the kingdom has turned what was an unregulated industry into the largest non-life and health insurance market in the GCC region and the most actively regulated insurance market in the Middle East.

Domestic gross premiums written (GPW) for 2016 are valued at approximately $9.5 billion, based on the sector's most recent results, which are still unaudited, according to S&P. The sector's remarkable progress owes much to its principal regulator, the Saudi Arabian Monetary Agency (SAMA), which has regularly introduced new initiatives over the past decade. For example, since 2013, actuarial pricing has been strictly enforced. That is, tariffs must be approved by actuaries based on loss and expense expectations, so as to deliver an underwriting profit in normal circumstances across all compulsory lines, notably motor, group medical, and liability.

Consequently, unlike most neighbouring markets, Saudi Arabia has largely avoided excessive price competition in recent years, despite the often intense rivalry between the sector's 34 licenced insurance companies. Of these, Weqaya and Sanad, are currently closed to new business, with trading in their shares suspended.

Although GPW across the sector only grew by 0.5 per cent in 2016, net income improved by 139 per cent. Actuarial pricing and a sharp increase in yields on cash deposits over the past 18 months have enabled certain insurers to make striking gains. However, neither premiums nor profits are spread evenly across the sector. Despite the sector's overall underwriting profitability, S&P Global Ratings lowered its credit ratings on several Saudi insurers during 2016 due to company-specific factors, including product, process, and solvency issues.

Healthy sectorwide statistics obscure smaller insurers' struggles
The enforcement of actuarial pricing seems to have hit smaller insurers more than others, by largely removing their ability to compete on price. This has exacerbated the disparity between the market leaders and the rest. Larger companies generally enjoy compelling economies of scale. For example, some hospitals offer discounts of up to 50 per cent to medical insurers that direct large numbers of patients to them. These discounts and other economies enable large insurers to profitably undercut their smaller rivals.

Market leaders Tawuniya and BUPA Arabia enjoyed a combined market share of 44.7 per cent in 2016 and generated 57.4 per cent of the sector's total net income. The eight largest companies by premiums captured 73.9 per cent of total premiums and 66.2 per cent of total net income. Smaller insurers therefore struggled to achieve sufficient scale.

Smaller players have therefore been forced to seek competitive advantage by improving their service quality, product offering, or convenience of location. More dangerously, some have reduced their selectivity in writing particularly risky business.

Insurers have been insulated from the changes to Saudi Arabia's economy
Early in 2016, we lowered our rating on Saudi Arabia in response to the fall in oil revenues, which led to budgetary deficits. The government had to bridge these by cutting back on planned expenditure, by selling foreign assets, and by borrowing.

As a result, we saw a decline in infrastructure spending across the kingdom and a consequent fall in construction-related insurable activity. Premium volumes for construction-related lines such as engineering have declined.

Despite this, the average Saudi Arabia-based insurer has been little affected. Their main business lines are compulsory group medical and motor third-party liability (TPL) covers. Demographics, not GDP, largely determine how these lines grow. Saudi Arabia has approximately 20 million Saudi nationals and a further 10 million foreign workers and dependents and its population of insurance buyers is still growing. Medical premium volumes have declined as employers opt for cheaper, less-generous compulsory group medical covers for their staff, but motor premium volumes have held up well in 2016.

Enforcement of compulsory covers holds the key to growth
Some 55 per cent of the vehicles currently on Saudi Arabia's roads are not insured, which is illegal. A crackdown by the traffic police could therefore contribute to considerable growth in motor insurance premiums.

Similarly, Saudi authorities estimate that about 2.5 million Saudi nationals are working in the private sector without being provided with medical cover by their employers, in breach of regulations. Media reports suggest that, in addition, some 870,000 foreign workers and their dependents may lack the medical cover that their employers are supposed to provide. This figure excludes the 1.9 million foreign domestic staff employed by Saudi families, who are not yet required to have medical insurance.

Although these reports suggest that considerable potential for market growth in 2017 exists, the actual level of growth will depend upon the speed and effectiveness with which the authorities clamp down on uninsured drivers and on employers who fail to provide their staff with proper medical insurance.

strong>Better pricing and expense ratios have bolstered the bottom line
At the top line, the sector story is now one of slow growth, with year-end 2016 total insurance GPW across all lines rising by just 0.5 per cent to SAR35.8 billion. Growth in motor was almost offset by a contraction in group medical premiums. However, the bottom line tells a different tale; the sector's net income for 2016 rose 139.2 per cent to SAR2.5 billion.

Pricing on medical improved, despite falling volumes, and motor tariffs nearly doubled during 2015 and 2016. Until the end of 2015, the effect of improved pricing was depressed by residual losses and unexpired risk reserving from the 2013 and 2014 underwriting years. In effect, it was only high expense and tax ratios that prevented many companies from reporting strong results last year, as loss ratios were generally satisfactory.

Not only did more insurers turn a profit in 2016, the sector's net income also more than doubled. We expect these trends to continue in 2017. Of the 33 insurers that were operational in 2015 and 2016, 14 reported net losses totalling SAR707.7 million. The remaining 19 reported profits totalling SAR 1,751.2 million. By contrast, only six insurers reported net losses in 2016, totalling SAR244.7 million. The remaining 27 reported combined profits of SAR 2,741 million.

Total shareholders' funds for the sector increased by approximately 17.6 per cent in 2016, to SAR13.7 billion. Although retained earnings and the revaluation of some investments contributed to this growth, we consider that it largely stemmed from the industry's many insurance rights issues over the past couple of years. Even if we assume a conservative sector average for shareholders' funds of about SAR13.5 billion in 2016, we calculate that the indicative average post-tax return on equity would be about 18.5 per cent. This implies strong performances in a market where prevailing returns on three-to-six-month cash are now about 3.5 per cent.

strong>High accident rates amplify actuarial rates in motor lines
Actuarial pricing significantly constrains the flexibility of motor insurers' pricing. Tariffs, which are highly regional, now reflect the high cost of car repairs, a persistent undercurrent of fraudulent claims, and the still-growing number of incidents on the Kingdom's roads. Although it depends on the provider, in 2016, the typical cost of compulsory third-party liability (TPL) cover rose to about $213-$400 a year. This indicates that many insurers have implemented massive increases in recent years and are charging consumers double the average price prevailing in some neighbouring markets, for an otherwise similar risk.

Saudi Arabia has about 12 million vehicles on its roads and is expected to have reported 1.1 million accidents and about 7,000 road deaths in 2016. By contrast, the UK has 36.5 million licenced vehicles and in 2015 it reported 140,086 serious road accidents and 1,732 road deaths.

Consumers, local media, and now the authorities are pressuring insurers to bring in more rapid claims payments, and discounts for loyal customers and drivers that have made no claims over a number of years. It is therefore possible that motor insurance prices may fall slightly in 2017, after increasing for several years.

That said, such moderation may be short-lived. The Ministry of Health has proposed that "at fault" motorists be obliged to pay the medical costs of their road accident victims, through their insurers. As SAMA has pointed out, Saudi hospitals do not yet have the technology to bill drivers for their victims' medical costs. However, hospitals could introduce the necessary systems by early 2018, if the government passed such a directive.

Saudi Arabia faces two clear problems relating to motor insurance: the unacceptably large number of uninsured vehicles, and the equally unacceptable number of serious road accidents. For motor insurers, solving the first could bring considerable growth. Prompt and effective action by the traffic police could raise the proportion of insured vehicles on the road to 90 per cent, a level typical of neighbouring markets. This would double the number of insured vehicles.

Motor premiums would then comprise nearly half of total GPW, up from around a third. However, unless driving skills improve dramatically, insurers could see an equally steep rise in claims costs, especially if drivers are required to pay for victims' medical costs.

SAMA is likely to initiate the next change in the market, consolidation
Saudi Arabia has too many insurance companies, notably too many which are too small to compete effectively with their larger peers, which is a concern. If insurers were to consolidate, their greater size would help dilute the impact of high fixed costs, and would likely help promote greater competition across the whole market.

However, the complexity and occasional ambiguity of local law and regulation mean that economic logic alone may not be sufficient to support the case for consolidation. We therefore anticipate that the government will agree to act as a facilitator. SAMA, as regulator, has taken this role in the past, successfully promoting the consolidation of the domestic banking sector to just 12 banks.


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