Fitch says more M&As likely in Lankan insurance sector

• Sees further consolidation in highly competitive general segment 
• Says Higher capital requirements, split of composites to hasten consolidation 
• Believes non-life insurers can cope with extreme weather
• New Inland Revenue Act to weigh on life insurance sector profits 
• Insurance sector expected to grow with higher per capita income

Fitch Ratings sees further consolidation by way of mergers and acquisitions (M&As) in Sri Lanka’s insurance market, particularly in the general insurance segment, as the players continue to compete in a crowded market amid tougher operating conditions due to enhanced capital requirements. 

Insurance Regulatory Commission of Sri Lanka, the country’s insurance industry watchdog, initiated a programme in 2014 and directed composite insurers to segregate their life and non-life businesses and operate them under two separate entities, while increasing the regulatory capital required to stay in business.  
Both these developments triggered divestitures by some local players of their non-life businesses mostly to large foreign players so that they could focus more on profitable long-term life insurance business. “Further industry consolidation is likely, given the competitive nature of the non-life insurance market where some players are incurring underwriting losses.

“In addition, recent regulatory developments including higher capital requirements and split of composites have also hastened consolidation,” Fitch said in its ‘Sri Lanka Insurance Dash Board’ for the second half of 2018.

Among the recent deals, Fairfax Asia Limited bought 78 percent of the general insurance business of Union Assurance PLC in 2014 and the same company bought 100 percent stake in Asian Alliance General Insurance in 2016. 

Meanwhile, AIA Insurance sold its general insurance business to Janashakthi Insurance PLC in 2015 before the latter sold the 100 percent stake in their general insurance business to the local unit of the German insurance giant Allianze S.E. in February 2018. 

Meanwhile, Fitch Ratings believes the exposure of Sri Lanka’s non-life insurers to extreme weather-related events to be manageable due to extensive use of reinsurance. However, reinsurers are seen reducing ceding commissions to reflect the increasing risk of catastrophes.      

“Sri Lanka has seen a recurrence of extreme weather-related events – back-to-back floods in May 2018 and over the past two years, and a prolonged drought in several parts of the country, which we believe may raise long-term risks for insurers’ capital”, said the note authored by insurance industry analysts at Fitch, Rishikesh Sivakumar and Jeffrey Liew.

In any case, Sri Lanka’s insurance sector is expected to continue its growth momentum, driven primarily by the rising per capita income, growing awareness on insurance and considerably lower insurance penetration. 

According to Fitch, gross written premiums (GWPs) in life and non-life businesses in 2017 have grown by 13 percent and 22 percent, respectively, compared to 18 percent and 14 percent in 2016. 

However, Fitch expects the new Inland Revenue Act to weigh on the sector profits of life insurers as surplus distributions to shareholders from policyholder funds and investment income of shareholder funds (less allowable expenses) are taxed at 28 percent. 

“Earlier, most of the life insurers paid lower taxes under the ‘investment income minus management fees’ method, which resulted in a lower tax base. In addition, distributions to participating life policyholders, which were not taxed previously, are now taxed at 14 percent and will be increased to 28 percent from 2021”, the rating agency noted.