An extract from AM Best’s MENA Reinsurance Markets, September 2, 2020,
Regional reinsurers operating in the Middle East and North Africa (MENA) are no strangers to challenging operating conditions.
In recent years, the region’s reinsurance market has been characterised by competitive pricing pressures, overcapacity and increased incidence of large losses. In 2020, the fallout from COVID-19 and a volatile oil price environment have added to the challenges faced by local reinsurers.
Market Landscape Stabilising
The composition of the region’s reinsurance market is beginning to stabilise following turbulence in recent years. The renewal periods in 2019 and 2020 were the first to follow the high profile difficulties faced by Trust International Insurance and Reinsurance Co., and the exit of Arab Insurance Group from the market – formerly two of the region’s largest players. Prior to this, the region saw the run-off of a number of local reinsurers, including Asia Capital Retakaful MEA (Bahrain), Emirates Retakaful, and Takaful Re.
Following this shift in regional capacity offerings, cedants reshuffled their reinsurance panels, which allowed existing participants to cement their positions and provided others with new opportunities to gain access to market premiums.
Unsurprisingly, given the regional footprint and diversification drive of many MENA reinsurers and international reinsurers’ appetite to maintain a presence in the region, reinsurance capacity is plentiful and competition remains high.
Some MENA primary insurers also participate in the local reinsurance market, leveraging their balance sheets and rating levels to write inward facultative business. Despite losses incurred on inward facultative portfolios in recent years, capacity for this business appears readily available and primary carriers’ appetite to write this business persists, adding to overall competition. Certain markets, such as Algeria, have structural features to prioritise, or mandate, local reinsurance placements, however, in general the region as a whole remains open, with few reinsurance regulatory restrictions.
Strain on Underwriting Performance Persists
In general, MENA regional reinsurers have demonstrated resilience in a difficult operating environment. Aside from strong competition, the region’s reinsurers face performance challenges arising from a lack of both scale and diversification when compared with their international competitors. Additionally, they often participate as followers on reinsurance programmes, particularly those outside of their home market, which restricts their ability to dictate terms.
The strategies adopted by MENA reinsurers vary considerably. Certain reinsurers benefit from long-standing legal cessions in their domestic markets, while others focus on providing proportional capacity. Strategic shifts are ongoing, with some looking to increase non- proportional and facultative business, as well as improve regional and international diversification
It is not uncommon for reinsurers to report comparatively strong performance in their local market, reaping the benefit of local expertise and long-standing relationships with market participants. In contrast, attempts to diversify geographically are often accompanied by thinner margins and increased volatility, a function of smaller participations, “follower” positions and varied risk exposures, which differ from those in their home markets.
Consistent, strong underwriting returns appear to be the exception rather than the rule. Of the regional reinsurers presented in Exhibit 1, all but three have seen their non-life combined ratios swing above 100% at least once in the past three years.
An increasing volume of natural catastrophe losses has affected performance in recent years. The frequency of flooding in the region is increasing. While notable flood events have occurred recently in the United Arab Emirates (UAE), Bahrain and Kuwait, the risk is still not appropriately modelled and priced into policies despite recent improvements in regional catastrophe risk modelling. Oman has also seen several large cyclone losses, and the region is exposed to earthquake risk.
Despite general pressure on underwriting margins, overall returns have remained robust for MENA reinsurers, with returns on equity (ROE) largely sitting around the mid-single digits. Investment performance continues to be a core component of operating results. However, with the exception of Turkey and to a lesser extent Tunisia, interest rates across the region remain low, and volatility in the fair value of assets is prevalent. In the near-term, the economic fallout of the COVID-19 pandemic and low oil price environment are likely to add to the strain on investment returns and total operating earnings for regional reinsurers.
Firming Reinsurance Market
In line with the broader reinsurance market, there are signs and expectations of hardening reinsurance pricing across the MENA region. However, opinions diverge as to whether there will be material rate increases.
The extent and pace of rate increases – and the ability of regional reinsurers to benefit from them – will be dictated by a number of factors. With many MENA reinsurers typically acting as “followers” on programmes, this may inhibit their ability to drive extensive rate change, especially if lead markets are willing to accept only modest price increases.
Whether hardening or firming, the landscape appears to have shifted between the January 2020 renewals and the summer renewal period. This dynamic is perhaps best highlighted by the renewal experience of non-loss affected accounts. These saw discounts at the turn of the year, but rates appear to have stabilised, and in some cases increased, at the mid-year renewals.
COVID-19 and the Oil Price Environment
If firming reinsurance market conditions provide positive momentum for the MENA reinsurance sector, the COVID-19 pandemic and the current oil price environment provide fresh headwinds. A combination of these factors was instrumental in AM Best’s decision to revise its Market Segment Outlook for the Gulf Cooperation Council (GCC) – a significant, and largely oil-reliant, sub-section of the MENA region – to negative from stable in early June 2020.
In AM Best’s view, increased economic and investment risk pose a greater threat to MENA reinsurers than the expected underwriting hit from COVID-19. In many instances, state-led public health responses have borne the brunt of COVID-19 related medical costs. Additionally, mortality losses remain low – a function of life reinsurance being a small component of the market, coupled with strong virus containment measures in the region to date. Nonetheless, in recent months it has become standard to add explicit COVID-19 policy exclusions in primary and reinsurance contracts.
Many of the economies in the MENA region remain reliant on oil revenues. Oil prices took a steep negative turn in March 2020, given weakened demand due to the COVID-19-driven economic slowdowns and significant excess supply. Despite an agreement by OPEC+ to cut oil output in April 2020, prices have remained volatile below the fiscal break-even point of the region’s oil exporting nations. Oil price volatility has a direct impact on economic output and governments’ fiscal capacity across the region
For MENA reinsurers, the economic fallout of COVID-19 and the challenging oil price environment is expected to lead to reduced premium volumes. AM Best expects a regional contraction of premium in the near-term in the primary market, partly reflecting delays in implementation of mandatory product coverages, as well as reduced demand for non- compulsory insurance products. This primary market premium reduction will have a knock on effect in the reinsurance segment.
A reduction in public spending on infrastructure projects, given reduced oil revenues, is another area which may drive lower insurable risk opportunities for MENA reinsurers. These risks are typically heavily reinsured by the region’s insurers, and have provided profitable opportunities for MENA reinsurers. Although regional reinsurers generally cede a large portion of these participations to international reinsurance partners, they benefit from the associated commissions.
A reduction in reinsurance opportunities as a result of the COVID-19 pandemic and weak oil price environment has the potential to exacerbate already significant competition across the region and may slow the positive reinsurance pricing momentum.
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