Mixed results: Premium price wars are hurting viability for some firms

The mixed results of the local insurance industry in 2013, which saw 18 of the 33 licensed companies post a net loss, has led to much speculation regarding the future of the sector. The last two years have seen increasing price competition as Saudi Arabia’s insurers have jostled for market share – which in some cases has led them down a path of cutting premiums at the expense of technical orthodoxy. This tendency has been exacerbated by the fact that the market is largely price-driven. “The Saudi Arabian market is more cost-sensitive than it is service-sensitive. Corporates tend to chase premium price, often moving from one company to another from one year to the next,” Abu Baker Shehab, the chief financial officer of Malath Insurance, told OBG.

TECHNICALLY SOUND: However, the days when insurers could seek to increase their market share by lowering premiums below levels that actuarial protocol would normally allow seem to be coming to an end. Aware of the potentially damaging price war that has been waged over recent years and keen to establish a more sustainable domestic insurance industry, the Insurance Supervision Department of the Saudi Arabian Monetary Agency (SAMA) has moved to introduce a more technically driven culture.

Its decision has been largely welcomed by market participants, with the more established players, in particular, keen to see the fight for market share played out around the issue of service, as it is in more mature markets. However, those players that have to date attempted to grow their client list by undercutting the competition are likely to find the adjustment to technically sound pricing a challenge. Many of these are small players – some 24 companies each hold less than 3% of the total market – which lack the cost efficiency of their larger counterparts that would allow them to effectively compete in a more technically sound market. The possibility of market consolidation, a talking point for the past few years in Saudi Arabia, has therefore once more come to the fore.

Central to the likelihood of any mergers or acquisitions in the insurance industry is the question of SAMA’s determination to effect market change. Its communication with the market over 2013 suggests that it has resolved to introduce actuarial-based pricing across the industry. A SAMA circular issued in April 2013 requires insurers to establish health and motor premium rates that are aligned with the findings of an independent actuary, and therefore represents SAMA’s boldest move to date with regard to establishing an industry based on sound technical performance. Also contained in the text was a clear warning to the market in the form of a reminder that, according to Article 21 of the Insurance Law, any person found to be either directly or indirectly involved in the issuance of a motor or medical policy that does not comply with the premium rates as determined by the actuary will be subject to a penalty. The threat of punitive action, therefore, hangs over both insurance companies and their brokers, and for clarity’s sake SAMA decreed that copies of the circular be sent to the insurance companies’ board of directors and employees, and that evidence of receipt and confirmation of compliance be provided.

SIGNIFICANT EFFECTS: SAMA’s recent realignment towards a more aggressive policing of the technical performance of insurers may have come too late to prevent the losses seen on balance sheets of 2013, but its effect has already been felt by the market. “SAMA asking companies to get actuaries to look at the books for motor and medical insurance was the big regulatory change of 2013, and there has certainly been a shift in pricing in both of these areas. However, it’s still not enough, and I expect SAMA will have to follow through on this later in 2014,” Gary Lewin, CEO of AXA Saudi Arabia, told OBG.

A robust application of SAMA’s recent circular is likely to provide fresh impetus towards merger and acquisition (M&A) activity in the insurance sector – a view which is shared by at least two of the major credit agencies. In its 2013 review of the Saudi insurance industry, Standard & Poor’s (S&P) concluded that the combination of market concentration, whereby 76% of primary premiums were claimed by the 10 largest companies in 2012, and SAMA’s enforcement of actuarial pricing might compel smaller firms to merge in order to survive. Players with modest market share, according to the report, will likely find themselves priced out of the market if they apply actuarial tariffs unless they can find a way to lower their cost base, and a merger with a larger firm a would present a possible solution. The analysis of S&P was echoed by that of Moody’s, which found that as a result of SAMA’s policy of actuarial pricing, smaller insurers that lack economies of scale would be forced to abandon their primary strategy of selling policies at a loss in order to gain market share.

For its part, much of the insurance industry is well aware of the need for consolidation. In his welcome speech at the opening of the second Saudi Insurance Symposium in February 2013, Tal Nazer, chairman of the industry's General Insurance Committee and CEO of BUPA Arabia, told attendees that he expected the industry to grow to $15.99bn by 2020, but that “there are issues to be dealt with in the coming years, including the need for mergers, especially important for companies which suffer tough financial conditions.”

However, while many of the larger players are open to the idea of expanding their client lists through acquisition, the troubled financial state of some struggling insurers makes them unattractive prospects. “The issue of consolidation has been discussed here for four or five years now. We’re certainly getting closer to that stage, and we would like to acquire companies here – we’re known for expanding that way in other markets. But the big question is, who would you buy? If you merge three bad apples, you only get one big bad apple,” AXA’s Lewin told OBG.

LEGAL FRAMEWORK: There are other barriers to consolidation in Saudi Arabia’s insurance market. The legal framework with relation to M&A activity is relatively undeveloped and a lack of judicial precedent in the area represents a potential challenge to companies looking to expand via acquisition. The Kingdom’s legal system differs from that of most of its neighbours, many of which have established civil code systems that incorporate the principles of sharia; in Saudi Arabia sharia exists as the fundamental form of jurisprudence. As a consequence, the nation’s courts have broad discretionary powers in their interpretation of business documents, which introduces an element of unpredictability to the legal process. To counter the challenge this system poses to contract enforcement, the authorities in 2010 began a process of sharia codification, an ongoing process the results of which have yet to be fully felt.

FAMILY OWNERSHIP: The fact that many insurance companies are owned by influential families is also a potential block to mergers, with dynasties unwilling to forego the boardroom privileges of proprietorship. However, while this is a regional characteristic, it recedes as a problem with each succeeding year as family-run operations expand to become more sophisticated, in doing so introducing better corporate governance and higher levels of service.

The years ahead, it seems, will be interesting ones for the Saudi insurance market. For those companies able to accommodate SAMA’s new pricing instructions, the opportunities for growth are sizeable. According to a 2013 report by Alpen Capital, the nation’s expanding economy and an increasing awareness of the benefits of insurance amongst its sizeable population could see it overtake the UAE in terms of gross written premiums. Whether this growth will be facilitated by M&A activity, however, is less clear. While market conditions certainly point to the likelihood of consolidation in the medium term, the obstacles are significant. For many, the much anticipated rationalisation of the market is more likely to come after some of struggling players have repaired their balance sheets and established themselves as more attractive propositions for their larger peers.