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Sri Lanka’s Motor Insurance Changes to Hit Non-Life Sector: Fitch Ratings

A new directive that Sri Lankan non-life insurers remit 100% of motor insurance strike, riot, civil commotion and terrorism (SRCCT) premiums to state-owned National Insurance Trust Fund Board (NITF, BBB(lka)/Stable) should benefit NITF while the underwriting profitability of non-life insurers is likely to worsen, says Fitch Ratings.

However, the effect on non-life insurers’ profitability and risk-based capital adequacy ratios could be reduced if they are able to raise premium pricing. The impact will also depend on the level of commissions motor insurers receive from NITF for providing SRCCT cover.

Prior to 2024, industry practice was to remit only 12% of SRCCT premiums to NITF under a reinsurance arrangement, although a 2008 government gazette required full remittance. The SRCCT segment has generally been highly profitable in recent years due to relatively low claim incidence, though there were significant claims in May 2022 as a result of anti-government protests.

NITF has yet to renew its reinsurance cover with international reinsurers for the SRCCT segment following its expiration in July 2023, and we believe unforeseen losses faced by NITF without such cover could result in heightened volatility for its capital position and earnings. This, along with the non-renewal of its retrocession cover for its inwards reinsurance business, was a factor in our decision to downgrade its rating, from ‘BBB+(lka)', in October 2023. NITF’s combined ratio for SRCCT was 27% during the last five years, against its overall combined ratio of 78%, with ratios below 100% indicating an underwriting profit, which means a rise in premiums should boost profitability. Motor insurers previously had a maximum annual aggregate net retention of LKR10 million before passing on losses to NITF. This will no longer be the case under the new setup and NITF’s exposure will increase as a result.

We expect non-life insurers that have higher exposure to motor insurance to generally be more affected by the directive. The non-life industry’s combined ratio increased to 113% in 3Q23, from 109% in 2022, partly reflecting various factors that have eroded the underwriting profitability and market share of non-life insurers in the motor insurance segment in recent years. We estimate that the new requirements for SRCCT premiums may add 5pp-10pp to the non-life sector’s combined ratio, before accounting for any premium price adjustments and any commissions from NITF. This could weigh on the improvement in the combined ratio that we had expected for Fitch-rated non-life insurers in 2024.

Nonetheless, Fitch expects Sri Lanka's economic conditions to improve in 2024, with GDP growth recovering, inflation easing and external liquidity metrics improving. These factors should support vehicle demand and motor insurers may be able to raise premiums significantly faster than inflation, on average, over 2024. This would moderate the impact on profitability from full remittance of SRCCT premiums to NITF, although higher prices may dampen demand growth for SRCCT policies. The capacity of many insurers to pass on price increases will still be constrained by competition, and we expect most Fitch-rated non-life insurers' combined ratios to remain above 100% for 2024.

Investment and liquidity risks will likely remain the key downside risks for most of Fitch-rated Sri Lankan insurers in the near term, but poor profitability and capitalisation metrics could weigh on ratings over time. We revised the Outlooks on most of our rated insurers to Stable, from Rating Watch Negative (RWN), in October 2023 following the upgrade of Sri Lanka's Long-Term Local-Currency Issuer Default Rating to 'CCC-' from 'Restricted Default’ (RD) and the subsequent removal of the RWN on Fitch-rated banks.

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