Weak operating conditions raise risks for Sri Lankan insurers

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High investment and liquidity risks, pressure on regulatory capital positions and a likely worsening in financial performance have increased the near-term downside risks to Sri Lankan insurers’ credit profiles, says Fitch Ratings.

Fitch recently placed the national ratings of all of its rated Sri Lankan insurers on Rating Watch Negative. See Fitch Places Seven Sri Lankan Insurers on Rating Watch Negative and Fitch Downgrades Sri Lanka Insurance Corp’s IFS to ‘CC’; Places IFS, ‘AA(lka)’ National IFS on RWN. The recent negative rating actions on the Sri Lanka sovereign and various financial institutions underscore the risks to domestic insurers, whose investment portfolios are dominated by fixed-income securities issued or guaranteed by the government, and deposits and securities issued by local banks, non-bank financial institutions and corporations. Fitch downgraded Sri Lanka’s sovereign rating to ‘C’, from ‘CC’ and had placed the ratings of several financial institutions on Rating Watch Negative. Some insurers also have foreign-currency exposure via investments in Sri Lanka development bonds and deposits with local banks.

We think the weak foreign-currency liquidity in the local banking system could limit insurers’ ability to meet foreign-currency obligations. This includes premium payments to foreign reinsurers and other costs that are typically sourced from overseas. Foreign-currency denominated insurance contract obligations vary by insurer, but tend to be small and limited to certain non-motor classes. Fitch-rated insurers do not have any local- or foreign-currency denominated debt in their capital structures. Fitch believes the recent five-day closure of the Colombo Stock Exchange undermines the liquidity of listed investments, especially if such closures occur frequently. Most Fitch-rated insurers have little to no exposure to listed equities in their investment portfolios.

We believe the heightened investment risks and earnings pressure could affect insurers’ regulatory capital profiles. A significant deterioration in the credit profiles of financial institutions could lead to lower regulatory risk-based capital (RBC) ratios, as investments will be subject to incremental risk charges, according to local regulatory RBC rules. The RBC ratios of Fitch-rated insurers have been generally better than the industry average in recent years.

Fitch expects the weak operating environment to affect insurers’ earnings. Growth in motor insurance – the largest contributor to non-life premiums for most insurers – is likely to remain subdued, as Fitch expects the government’s ban on auto imports, imposed in 2020 to control currency depreciation, to continue. In addition, underwriting profits will be squeezed by rising motor spare-part costs due to currency devaluation, while overall costs will climb with rising inflation. Insurers also have limited ability to reprice policies, given the dent in customers’ disposable incomes. The underwriting profitability of most Fitch-rated insurers have improved in recent years on lower claims frequency due to pandemic-related movement restrictions.

Sri Lankan non-life insurers rely on international reinsurers to mitigate risks in their non-motor businesses. Fitch thinks any material changes to reinsurance structures upon renewal amid rising reinsurance costs could undermine insurers’ risk management practices and ability write new business.