South African insurers face a difficult time in 2017 due to creeping economic growth – but solid balance sheets will likely keep the market resilient despite the difficult operating environment.
Ratings firm S&P Global has released its ratings assessment for South Africa’s insurance market, noting that, in line with modest economic growth of 1.4% projected for 2017, the country’s insurance sector will see moderate profitability.
A slow economy means household spending will remain restrained, leaving little room for insurance premiums to grow. Insurance premiums are expected to remain muted, growing in line with nominal GDP in 2017 and 2018, S&P said.
But despite the negative backdrop, the industry remains resilient, and overall profitability for property/causality insurers should remain robust with annual return on equity of around 15%-20%, the firm said.
“Although adjusting for the cost of capital in South Africa ROE levels look less impressive, profitability for the large rated insurers is nevertheless expected to remain well above their respective hurdle rates, on average. This is primarily due to continued support from lower but still strong investment returns,” it said.
For life insurers, weaker economic prospects, increasing competition, higher lapse rates, and increased capital market volatility is dampening sales and profitability with compression of new business margins evident in 2016.
“That said, the major life insurers are reasonably positioned to navigate these conditions with their strong market position, broad product offering, extensive distribution networks, and significant risk-sharing mechanisms within investment products,” S&P said.
The rating firm pointed to three main areas where the insurance sector will face its biggest challenges in 2017:
The biggest risk is from external factors such as the implications of the weak macroeconomic outlook for South Africa’s sovereign ratings. F
or both life and property insurers, economic conditions in South Africa have led to increased asset risk in their balance sheets due to their significant exposure to South African rand-denominated government bonds or other financial assets in the highly concentrated domestic market.
“However, the major South African insurers have sound balance sheets and resilient profitability despite difficult operating conditions,” S&P said.
More stringent regulations
Insurers have started to adapt business models and product offerings to a more stringent regulatory framework but this has yet to evolve fully.
South Africa is moving to adopt a ‘twin peak’ regulatory environment, with prudential regulation under Solvency Assessment And Management (SAM) and and conduct of business regulations under the Retail Distribution Review (RDR) framework.
“We expect these regulatory changes to encourage a gradual shift to more capital-light and less complex products,” S&P said.
Small steps to expand outside SA
Incremental international expansion and some domestic consolidation for growth are underway but are unlikely to be game changers for the overall business mix of the large insurers.
Larger South African insurance groups are pursuing expansion opportunities in other markets, in particular in the rest of Africa where insurance penetration remains low. For now, these are not large, transformative ventures.
“We do not view these ventures as game changers from the perspective of insurers’ overall business profiles, as they will likely constitute a small portion of total revenues, profits, and capital consumption for the foreseeable future,” S&P said.