Shari’ah-Compliant Insurance and Re-Insurance in the GCC in 2016 as Oil Prices Remain Low
David Anthony addressed the issue of why oil prices have fallen and remain low and what that means for insurers generally and Shari’ah-compliant insurers in particular.
Brent crude was at a high of $115.7 in June 2014, but by the end of 2015 it was down to £36.6 and in February 2016 it was $33. This is a fall 71.5%. Basically what has happened is the US has become self sufficient in oil. That means that countries such as Saudi Arabia, Algeria and Nigeria that used to export most of their oil production to the US have had to find new customers elsewhere and mainly they have looked to Asia. At the same time Asia has had reduced demand, as has Europe. There are also new sources coming back on stream – Iraq, Iran, Libya and Russia, for example. The strength of the dollar has also had an impact, as have the record levels of production in OPEC countries and Russia.
Standard & Poor’s has been trying to keep up with this. Last year, for example, Citibank predicted that oil prices could go as low as $25 a barrel. There was a lot of scepticism at the time, but they were not wrong. Standard & Poor’s are currently working on the assumption that during 2016 oil will be on average $45 a barrel then rising and flattening out at around $50 a barrel.
In the good old days most GCC governments were working on the assumption they would get at least $80 a barrel and their budgets were all based around this. They are now having to tighten their belts and having to learn to live with oil prices at half their expected rates.
The winners are obviously the energy importers – China, Japan, Europe, the UK, Egypt, Jordan and the Far East. Consumers are not necessarily seeing the benefit, however, because governments are taking the opportunity to increase the tax on petrol. Among the losers are around 250,000 oil workers who have found themselves out of a job over the last 18 months. It is, however, mainly the oil-producing countries that have lost out, particularly those with high-cost oil production such as Oman, Bahrain, Dubai, Iran, Iraq, Libya, Algeria and Russia. There are also some win/lose situations. For example Egypt is a winner as an oil importer, but has lost out on the subsidies they used to receive from oil producing countries in the GCC.
Saudi Arabia is a loser. They have enjoyed huge oil revenues, but they have been big spenders and are now in a deficit position. As a result Standard & Poor’s reduced Saudi Arabia’s credit rating to A- in February 2016. It used to be in the AA range alongside countries such as Kuwait and Qatar. Mr Anthony commented that was quite shocking to see Saudi Arabia at the bottom end of the A range.
Other countries have also suffered. Oman has a lot of fixed costs such as government salaries and subsidies, so they are down at BBB-. Bahrain is at a non-investment grade of BB.
There is a pattern in all of this. The outlook for all of these countries is stable, which means that Standard & Poor’s do not think the situation will get worse, but they are borrowing and they are making the assumption that this is as bad as it gets. It will, however, take time for them to recover.
What will make the oil price recover? Basically it will be an increase in demand, which depends on the economic situation in China and Europe improving.
How Does This Affect Shari’ah-Compliant Insurers and Reinsurers?
Governments in the GCC are cutting back on prestige expenditure; they are liquidating some of their foreign assets and they are borrowing. Debt does create instruments such as sukuk, in which insurance companies can safely invest. It is better to invest in government bonds than in equities and properties.
This does not affect takaful companies that much. Most of the companies are relatively small and most are by and large oriented towards the retail sector such as group health and motor. They are not really involved in the big ticket commercial and industrial lines. In the short term in the retail sector the demographic is creating demand. A lot of young people are buying homes and cars that need to be insured.
Clearly, if oil prices stay low in the long term there will be fewer expats in the region so fewer cars on the road and less compulsory medical insurance for foreigners. In the long term this could mean a downturn for insurance, but in the short term they are not being affected very much.
One or two companies in the UAE specialise in fronting business, whereby they pass on the risk, often nearly 100%, to the international reinsurance community in exchange for an inward reinsurance commission, so perhaps some of those takaful companies will see slightly less inward commission.
If the dollar is strong, and a lot of the GCC countries are linked to the dollar, then that should mean car repairs are cheaper, because many of the cars in the Middle East are Japanese or European. Mr Anthony said, however, that he had not yet found an insurer that has said they are in fact cheaper. Garages are apparently getting increasingly expensive. There appears to be a level of inflation that has no relation to the economic situation.
Probably the biggest impact of the oil price on the Shari’ah-compliant insurance sector is going to be on the asset side of the balance sheet. Rightly or wrongly many takaful companies in the search for Shari’ah-compliant assets have tended to look to equities and property. Traditionally these have been good investments and many people thought the markets would only ever go up, but the reason Standard & Poor’s call equities and property high-risk assets is because they do not always go up. They come down and that is what is happening at the moment.
The Stock Market
The state of the stock markets is quite dire. For example, the Saudi stock market has gone down 37.5% over the last year. Qatar is down 28% in the last six months. Apart from Abu Dhabi, which has only fallen by just less than 10%, other stock markets in the region are down by about 20% over the last 12 months. Many of the investors in equities are, of course, insurance companies.
Looking specifically at the insurance sector, the performance of stocks is reasonably in line with the market downturn. Saudi Arabia has been particularly badly hit. The only mitigating factor is that the Saudi stock market had risen massively on the back of the Saudi stock market being opened up to foreign investment in mid 2015. In fact the flood of new foreign capital never arrived. This downturn is, therefore, something of a correction. The Kuwaiti insurers are the only ones in the region that have bucked the trend.
Saudi Arabia and the UAE
The two most important markets in the region are Saudi Arabia and the UAE. Saudi Arabia represents 50% of gross written premiums in the global Shari’ah-compliant insurance sector according to Hannover Re. Gross written premiums in Saudi Arabia in 2015 were up just less than 20%, which is excellent growth. This follows a similar increase in 2014. At the net level, premiums were up 24%. The only potential problem is that the gross written premium is very concentrated. The top three companies of the 34 companies in Saudi Arabia, BUPA, Tawuniya and MedGulf, are writing 52% of all the premiums in the marketplace. There are, therefore a lot of smaller companies that are finding it difficult to cope with the leftovers from the larger players. The top 10 companies control 75% of the total premiums.
Saudi Arabia is not getting the same level of oil revenues anymore, but it is still spending. There is a 10% return on equity, which is not bad given the low level of interest rates and insurance capital rose by 25%, so capital is keeping pace with risk exposure. The only bad news is that a lot of that capital growth has not come from retained earnings, which would be preferable; it has come from rights issues, which tend to be unpopular with shareholders. There were 11 rights issues in Saudi Arabia in 2016 and quite a few more to come in 2016.
Most of the bigger companies are doing reasonably well, apart from MedGulf, which is losing money due to internal, operational reasons. Last year most companies increased their tariffs between 15-30%, so prices went up significantly, some companies still cannot make a profit.
The UAE is difficult for analysts because the only published information is for listed companies. There are 29 listed companies in the UAE out of a total of 61. Gross premiums for the listed companies grew by 8% in 2015. The good news for the takaful sector is that gross premiums appear to have grown by about 29%. The market share for takaful is slowly creeping up and the takaful companies seem to be gaining a good foothold in health.
The only problem is that many of the takaful companies are small and many are troubled by the minimum insolvency requirements.
The market needs more, bigger and better-established Shari’ah-compliant companies, not more small players. In terms of profitability, there is an overall deficit in the sector and lot of that deficit is coming from the takaful sector. They may be making great market share progress, but they are not making any money at it yet, so there is some degree of underwriting loss. On investment losses, many of the takaful companies have been too adventurous on the investment side and wiped out their hard-earned technical results.
There is a need to rethink the takaful model. Mr Anthony said he was a fan of the Saudi cooperative model, which avoided the stresses and strains between policyholders and shareholders that often plague the traditional takaful model. On paper mutuals are perfect, but in practice they seem to underperform, so they are probably not the answer.
There is also a lot to be said for listing, because it tends to bring
transparency. In a number of countries such as Saudi Arabia and Oman, insurance companies have to be listed. That means these companies are subject to not just insurance regulations, but also regulation by the capital markets authority. It also means accounts have to be published quarterly and independent board members are required. It seems to be healthier and to work and if it works it should be seriously considered.
Takaful regulation seems to be improving steadily across the region. Standard & Poor’s used to be a little worried by regulation in the UAE and Qatar, which seemed to be lagging behind the best standards in the region, but they are catching up.
Takaful accounting can be opaque. This does need to be reviewed.
Commercial lines tend to have better margins, so this is an area that takaful needs to get into and away from the commodity retail business. To do that, however, it takes a long time to build up the scale, a strong balance sheet, the lines of business and distribution.
Cheap capital and expanding markets have made it too easy to set up too many takaful companies. Whether or not the market will see consolidation or more companies closing the door remains to be seen. Above all, it takes time.