Weak operating conditions heighten risks of insurers: Fitch

• Fitch places 7 companies under negative rating watch on multiple risks  
• Some insurers have Fx exposure via investments in SLDBs and deposits with banks

Fitch Ratings said Sri Lanka’s insurers would face elevated risks from the challenging operating conditions caused by the macroeconomic challenges, which stemmed from the persistent foreign exchange shortages and hotter inflation.  

Fitch last week placed seven Sri Lankan insurers on rating watch negative and downgraded Sri Lanka Insurance Corporation Limited’s Insurer Financial Strength rating to ‘CC’, from ‘CCC+’ and placed the rating watch negative on probability of ceased or interrupted payments on the company’s foreign currency obligations, due to weak foreign currency liquidity in the local banking system.

The most recent note on the sector, which was released yesterday, highlighted these multiple risks facing the insurers, as the high investment and liquidity risks, pressure on regulatory capital positions and a likely worsening financial performance.

“The recent negative rating actions on the Sri Lanka sovereign and various financial institutions underscore the risks to domestic insurers, whose investment portfolios are dominated by fixed-income securities issued or guaranteed by the government and deposits and securities issued by local banks, non-bank financial institutions and corporations,” the rating agency said.

Fitch downgraded Sri Lanka’s sovereign rating to ‘C’, from ‘CC’, on the announcement of the suspension of most foreign currency debt payments on April 12 and it prompted the rating agency to place Sri Lanka’s banks on rating watch negative. The rating agency’s last week actions on insurers came as “some insurers also have foreign-currency exposure via investments in Sri Lanka development bonds and deposits with local banks”, which gives rise to other risks.

Hence, the rating agency forecasts this heightened investment risks and earnings pressure, coming from the challenging operating conditions, could affect the insurers’ regulatory capital profile.

“A significant deterioration in the credit profiles of financial institutions could lead to lower regulatory risk-based capital (RBC) ratios, as investments will be subject to incremental risk charges according to local regulatory RBC rules,” it added. The rating agency also thinks that the weak foreign currency liquidity in the local banking system could limit the insurer’s ability to meet foreign currency obligations, including premium payments to foreign insurers and other costs that are typically sourced from overseas.

Meanwhile, the prolonged weak operating environment would put pressure on the insurers’ earnings with the continued ban on vehicle imports – the largest non-life premium contributor, “as Fitch expects the government’s ban on auto imports, imposed in 2020 to control currency depreciation, to continue”.

“In addition, underwriting profits will be squeezed by rising motor spare-part costs, due to currency devaluation, while overall costs will climb with rising inflation,” it added.

Further, Fitch also said there is limited room for the insurers to reprice policies, due to the dent in consumer disposable incomes. Highlighting another risk, Fitch said, “Sri Lankan non-life insurers rely on international reinsurers to mitigate risks in their non-motor businesses.

“Fitch thinks any material changes to reinsurance structures upon renewal amid rising reinsurance costs could undermine insurers’ risk management practices and ability to write new business,” it added.