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COMMENTS

Insurance Industry And Country Risk Assessment: Kazakhstan Property/Casualty


Insurance Industry And Country Risk Assessment: Kazakhstan Property/Casualty

Overview
Strengths Risks and weaknesses
Solid property/casualty (P/C) insurance sector profitability comparing well with peers' from both developed and developing markets. Low insurance penetration and still immature market. The population spends on insurance far less than residents in developed and some developing markets.
Regulator's proactive approach to addressing fraudulent practices of local P/C insurers. Volatile premium growth depending highly on regulatory actions toward market participants and trends in the local banking sector where insurance is sold as a by-product.
Material exposure of local P/C insurers to the risks of the local banking sector in the investment portfolios.

Rationale

S&P Global Ratings assesses the industry and country risk of Kazakhstan's P/C insurance sector as moderately high.

Kazakhstan's P/C insurance market premiums have been reviving in 2019 after a 2.7% drop in nominal terms in 2018, when the regulator withdrew several licenses of local market players in response to their misbehavior and in order to clean up the market from fraudulent practices. However, we think that market growth prospects may continue to be volatile, depending on trends in the banking sector where insurance is sold as a by-product, as well as the macroeconomic developments. Despite intensifying competition among the local insurers, we expect that the sector's profitability will remain solid with return on equity (ROE) of around 15%-20%, which compares well with peers from both developing and developed markets.

Country Risk: High

We consider that country risks in Kazakhstan are currently high, similar to Russia, Turkey, Kenya, and Jordan, and we do not expect this to change during the next year. In our view, economic environment in Kazakhstan is putting pressure on its P/C insurance sector's operating conditions, which remain challenging.

Although we expect domestic real economic growth will remain steady at about 3.6% on average over 2019-2022, we consider that the real wealth of Kazakhstan's population remains low, with GDP per capita of around $9,400 as of end 2018. We note that the population primarily focuses on articles of prime necessity rather than insurance, and therefore doesn't always buy adequate insurance protection or doesn't purchase insurance at all. This, coupled with the problems of the low payment culture and poor financial literacy, hamper the development of the P/C insurance sector in Kazakhstan. As a result, simple products such as motor insurance dominate the local P/C insurers' portfolios (see chart 1).

Chart 1

image

The annualized spending on insurance was around US$70 per capita in the first half of 2019. Although it shows a positive trend from around US$54 per capita in 2018, it still remains far below figures for developed insurance markets. The insurance penetration ratio in Kazakhstan measured as sector gross premium written (GPW) relative to GDP was 0.5% in 2018 which is significantly below the 4.1% in Switzerland and 3.6% in Germany, but closer to the levels in India (see chart 2).

Chart 2

image

The banking sector weighs on the asset quality of Kazakhstan's P/C insurers. As of midyear 2019, local bank deposits comprise almost 35% of total invested assets of local P/C insurers that S&P Global rates. We assess the average creditworthiness of Kazakhstan's banks close to our 'B' rating category please see "Banking Industry Country Risk Assessment: Kazakhstan," Jan. 10, 2019. Although the regulator has exercised significant measures to clean up the banking sector over the past decade (See "Kazakh Banks Might Need Additional Provisioning Following The Asset Quality Review," published on Oct. 11, 2019, on RatingsDirect), we still assess problem loans at around 20% of the overall banking sector's loans as of midyear 2019. We note, however, that Kazakhstan's insurers tend to place a larger amount of funds with higher-quality sovereign and quasi-sovereign bonds and deposits of systemically important banks, which is stimulated by regulatory requirements for insurers capital and liquidity.

Industry Risk: Moderately Low

We assess industry risk for Kazakhstan's P/C insurance sector as moderately low, at the same level as in Italy, China, Israel, Korea, and South Africa. We note, however, that the P/C insurance sectors in these countries are at very different stages of development. Our assessment of Kazakhstan's P/C insurance sector reflects its sound profitability metrics and our view of the regulatory oversight as being effective. It also takes into account the volatile dynamics of the sector's premiums, which stem from the relatively immature stage of market development. In our view, Kazakhstan's P/C insurance sector growth depends highly on regulatory actions and the dynamics of the banking segments where P/C insurance is sold as a by-product, such as the mortgage and car-lending segments. We do not foresee any regulatory initiatives on the implementation of new P/C insurance products that could drive material new growth.

We think it is unlikely that our assessment of Kazakhstan P/C insurance industry risk will materially improve or deteriorate in the next 12-18 months.

Chart 3

image

Factors supporting profitability
  • The profitability of Kazakhstan's P/C insurance sector compares favorably with P/C insurance sectors in both developed and developing markets. The sector's reported 19.8% ROE was significantly above the peer average of 10.9% in 2018 (when we considered Italy, China, Israel, Korea, and South Africa as peers). We forecast Kazakhstan's P/C insurance ROE will be around 15%-20% in 2019-2020, supported by both favorable underwriting and investment performance. We expect local P/C insurers' combined (loss and expense) ratio will be below 100% and investment yield will be around 8%-10%, similar to the average level in 2017-2018, including revaluation gains.
  • We note, however, that the material asset-liability currency mismatch of the local P/C insurers may lead to earnings volatility. The share of foreign currency-denominated (mainly U.S. dollar and euro) instruments in the insurers' investment portfolios has been high since 2015, when the tenge was floated and experienced sharp devaluation. In 2018, foreign currency-denominated instruments accounted for roughly half of the investment portfolios of the Kazakhstani P/C insurers that we rate, and we do not expect this share to reduce significantly during the next year.

Chart 4

image

  • We consider that Kazakhstan's regulator effectively oversee local P/C insurers. In our view, the regulatory framework has strengthened over the past decade and the regulator has been proactive in its reaction to some players' misbehavior and manipulation of financials. In the past two years, the regulator has suspended the licenses of seven P/C insurers. Two licenses were subsequently withdrawn (IC Salem, IC Kompetenz) and one insurer surrendered its license voluntarily (IC Standard). We understand that, following this intense sector clean up, the regulator has softened its approach toward local P/C insurers in 2019.
  • In addition, we note that Kazakhstan was the first in the Commonwealth of Independent States to introduce tight regulatory requirements for insurance companies' solvency margins, disclosure, and financial indicators. We also understand that the regulator plans to introduce the Solvency II approach by 2024.
  • Kazakhstan regulation does not explicitly limit new market entrants into the P/C insurance segment. However, the tightening regulatory approach has led to noticeable market consolidation over the past two years, which we expect to continue. The number of P/C insurers decreased to 20 as of midyear 2019 from 25 two years ago. In addition to three license withdrawals, the P/C sector has also witnessed two intragroup mergers (IC Halyk-Kazakhinstrakh JSC merging with IC Kazkommerts-Policy and Victoriya merging with Nurpolis). We expect that one more company (Alliance Policy) will leave the market in 2019 because it has already surrendered its insurance license. Consequently, the concentration of the segment has increased with the top three P/C market players accounting for around 62% of the sector's GPW in the first half of 2019 (47% two years ago).
  • The size of foreign investments in local P/C insurers capital has decreased gradually over the past decade. In 2019, the Russian shareholders sold their stake in Oil Insurance Co. JSC. We do not expect foreign players will revise their strategies and return to Kazakhstan, despite a World Trade Organization directive to grant foreign branches access to Kazakhstan's insurance market. This is due to the dominance of particular local players in a relatively small market and a lack of scale for international players.
  • We consider that Kazakhstan P/C insurance companies' product risks remain moderate. We expect that simple products will continue dominating the local P/C insurers' portfolios, with motor insurance accounting for around 25%-30% and property insurance adding around 25% of the overall sector's GPW.
  • We note that Kazakhstan is exposed to the risks of natural catastrophes, such as earthquakes and droughts. However, local insurers limit the related risks by either excluding them from the scope of insurance contracts they sell or ceding these risks to foreign reinsurers. That said, we note that local companies are only starting to develop models to properly assess risks and the statistics on earthquake frequency and potential damages from them in the Almaty region is still limited.

Factors limiting profitability
  • We consider that Kazakhstan's P/C insurance premium dynamics may be volatile in the future. Although sector premiums increased by 6.6% in the first half of 2019 in nominal terms, real growth adjusted for inflation was only around 1%. The growth was supported by increasing average price and penetration in the obligatory motor insurance segment, as well as the increasing retail lending, especially, mortgages, where insurance contracts are sold as a by-product. We are not sure, however, whether these growth drivers are sustainable in the longer term. In 2018, sectorwide GPW decreased by 2.7% because the regulator prohibited P/C insurers from reinsuring employer's liability risks and because of the regulator's efforts to clean up P/C insurers' portfolios from fraudulent schemes. The latter led to significant decline of GPW in several business lines, especially liability, property, and cargo insurance.
Adjustment factor
  • We consider that the Kazakhstan P/C insurance sector has shown more resilience against macroeconomic challenges than other sectors, for example the Kazakh banking sector. That is why we apply a positive adjustment factor to reflect our view that the impact of high country risks on our overall assessment of the P/C insurance segment is limited.

Related Criteria

  • Insurers Rating Methodology, July 1, 2019
  • Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

Related Research

  • Insurance Industry And Country Risk Assessments Under Our Revised Criteria, July 5, 2019
  • Research Update: Kazakhstan 'BBB-/A-3' Ratings Affirmed; Outlook Stable, Sept. 6, 2019
  • Banking Industry Country Risk Assessment: Kazakhstan, Jan. 10, 2019
  • Kazakh Banks Might Need Additional Provisioning Following The Asset Quality Review, Oct. 11, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Ekaterina Marushkevich, CFA, Moscow (7) 495-783-41-35;
ekaterina.marushkevich@spglobal.com
Secondary Contacts:Ekaterina Tolstova, Moscow (7) 495-783-41-18;
ekaterina.tolstova@spglobal.com
Victor Nikolskiy, Moscow (7) 495-783-40-10;
victor.nikolskiy@spglobal.com
Additional Contact:Insurance Ratings Europe;
insurance_interactive_europe@spglobal.com

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