SL among highest-risk financial systems

SL among highest-risk financial systems
December 23, 2011, 7:12 pm

Sri Lanka is among the highest-risk financial systems in the Asia Pacific region Fitch Ratings said in a special report published earlier this week.

"While many advanced economies "de-lever", the speed of credit growth and rising asset prices has led to Asia-Pacific harbouring four of the world’s nine highest-risk financial systems according to Fitch’s macro-prudential risk framework. Hong Kong and China were joined by Indonesia and Sri Lanka in the December 2011 assessment, although Vietnam dropped out as credit growth eased," Fitch said.

The ratings agency also said Sri Lanka had a structural weakness in the balance of payments front, especially with regard to the current account.

"Strong and/or improving external balance sheets buffer most of emerging Asia from ongoing volatility in global investor risk appetite.

"India and Sri Lanka are the only Fitch-rated emerging Asian countries to run deficits on ‘basic balance’ (the current account plus net foreign direct investment).

"This structural weakness may help explain why the Indian rupee fell to a record low against the US dollar in December 2011, while Sri Lanka devalued its currency in November," Fitch said.

"Fitch upgraded Sri Lanka’s Long-Term Foreign-Currency IDR to ‘BB?’ with a Stable Outlook from ‘B+’/Positive in July 2011, reflecting the stabilisation and recovery of the economy under the authorities’ IMF programme and efforts to consolidate the chronic budget deficit. However, foreign direct investment has been surprisingly slow to recover after the end of the country’s long civil war in 2009, and the authorities devalued the Sri Lankan rupee by 3% in November 2011. Structural reforms to support longer-term growth prospects combined with further fiscal consolidation efforts would increase Sri Lanka’s chances of moving further up the ratings scale, the ratings agency said.

Fitch Ratings Sri Lanka has said that insurance penetration in Sri Lanka is low in relation to other Asian countries particularly because insurance is viewed as ‘a risk management tool rather than an investment vehicle’.

Another reason is that Sri Lanka’s relatively low per capita income. Total premiums/GDP is 1.2% versus a regional average of 6.2%3. The number of life policies/population was 10.9% at end-2010, and is rising.

It said the availability of a pension scheme for state employees has resulted in a lower appetite for insurance (investment policies) from this segment. However, investment-linked policies are gaining popularity, and the second-largest insurer in the market for life generated over 50% of its life premiums in 2010 from unit-linked products.

These comments came in the agency’s overview of Sri Lanka's life and non-life insurance sectors which it said is stable, indicating that most ratings are likely to be affirmed in the next 12-24 months.
This reflects the sound operational and financial performance of the insurers rated by Fitch, as well as their healthy capital position, while taking into account the challenges in maintaining market share and underwriting profitability in the non-life segment, the ratings agency said in a press release.

On improving capitalisation, Fitch said industry capitalisation should strengthen in the medium term; with capital requirements set to increase for existing companies, and mandatory listing requirements.
On intense competition in the motor sector, Fitch noted that as in most countries, price competition remains high in the motor segment, and new entrants have been eating into the market share of the larger, more established companies. As such, underwriting profitability remains under pressure, with many companies posting combined ratios1 of over 100%.

Aside from a contraction in non-life premiums in 2009, the sector has developed steadily over the preceding six-year period. In Fitch’s view, this growth is likely to be sustained due to the potential in the life segment. Life is still relatively under-penetrated, and prospects will brighten for the non-life segment with a sharp increase in new vehicle registrations – as well as overall economic prospects for the country.

On weaker capitalisation or solvency, the agency said a sharp decrease or sustained weakening in capitalisation or solvency ratios could lead to the outlook being revised to negative. On motor profitability, it said intensified competition in the motor segment which could further weaken underwriting profitability – owing to higher claims ratios – could be negative for ratings. Healthier competition with reduced pricing pressures and fewer concerns over market share, could be ratings positive.

Fitch said it believes that higher premium growth in 2010 and H211 is sustainable over the medium term given improving lapse ratios and growth potential in the life segment, as well as higher vehicle demand and trade activity supporting non-life growth prospects. Fitch’s forecast for GDP growth in 2012 is 7.5%-8.0% for 2012.

It said the Sri Lankan insurance market has seen steady (albeit slow) growth over the 2006-June 2011 period, with the exception of a contraction in 2009. Non-life premiums shrunk by 3.1% in 2009 owing to a weak macro economy, a slowdown in vehicle demand and weakening of import/export segments. However, with improved growth prospects since the end of the Sri Lanka civil war in mid-2009, lower interest rates and higher disposable income supported growth in both segments in 2010 and 2011.

It said in most countries, the motor segment is fiercely competitive – with competition mainly in price form. As such, underwriting profitability has come under pressure and claims ratios in this segment are the highest – averaging 64% in 2007-2010, with companies relying on investment income to compensate for underwriting losses. Investment income increased in 2009-2010, but is unlikely to be maintained at similar levels in 2011-2012. So pricing would need to improve to enable the sector to maintain non-life operating profitability at the current levels. Prices could stabilise as companies attempt to focus on a more service-oriented approach, and compete on other aspects of the product.

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