Reinsurance helps Sri Lankan insurers absorb volatility

Sri Lankan non-life insurers should be able to absorb near-term volatility and the effects of adverse weather-related events given their extensive use of reinsurance, Fitch Ratings said in a report called Reinsurance Keeps Sri Lankan Insurers Afloat Amid Floods.

However, frequent occurrence of major catastrophic floods could affect insurers’ capital, especially that of the state-owned local reinsurer, the National Insurance Trust Fund (NTIF).

Changing weather patterns have increased the frequency and severity of errant rainfall, raising long-term risks for insurers and highlighting the need for more rigorous pricing and assessment of such risks in Sri Lanka’s highly competitive non-life sector, the report said.

Reinsurance premiums paid by primary insurers are also likely to increase. The credit profiles of Sri Lanka’s non-life insurers—Sri Lanka Insurance Corporation, HNB General Insurance and Continental Insurance Lanka—are likely to remain intact despite these challenges.

Sri Lanka experienced back-to-back floods and landslides in May 2016 and May 2017. NITF estimates claims of around Rs4 billion ($26 million) from the May 2017 floods, which mainly affected suburban and rural areas, significantly lower than claims of around Rs17 billion ($112 million) from the May 2016 floods, which predominantly affected industrial areas, with a handful of large commercial claims accounting for a large share of the total.

However, despite these large claims, Fitch estimates the net impact on non-life insurers due to the May 2016 floods to have been around Rs0.5 billion to 0.6 billion, mainly from retention and reinstatement costs. These costs were likely to have added around 70bp to non-life insurers’ loss ratios in 2016. The floods, which left hundreds of people dead, damaged homes and disrupted businesses, were the country’s worst natural catastrophe since the 2004 South Asian tsunami.

Local regulations require 30 percent of all non-life reinsurance be ceded to NITF, with the balance ceded to the international reinsurance market. NITF’s reinsurance portfolio is protected via retrocession cover, which has helped contain losses from the record-high flood-related primary insurer claims.

NITF has provided the Sri Lankan government with natural disaster coverage since April 2016: the National Natural Disaster Insurance Scheme (NNDIS) covers all households, small businesses and relief work stemming from natural disasters.

Cover was increased to Rs15 billion for 2017/2018, from Rs10 billion, with total claims of around Rs3.8 billion in 2016 and Rs1.6 billion in 2017. NITF recovered Rs2.6 billion in 2016 via NNDIS’s reinsurance cover that was in place for 2016/2017; that is, after a deductible of Rs0.5 billion, which was retained by the company, as well as NITF’s share of claims on NNDIS’s reinsurance cover.

However, a delay in government approval meant NITF’s reinsurance cover for NNDIS for 2017/2018 came into effect only after the May 2017 floods, resulting in a Rs600 million loss, as the deductible (company retention) was raised to Rs1 billion. NITF, as a state-owned entity, must go through a state procurement committee to obtain reinsurance, which can be time-consuming.

NITF has satisfactory capital buffers to absorb flood-related net losses of Rs2.2 billion for 2016 and Rs3.1 billion for 2017, with a high regulatory risk-based capital ratio of 558 percent at end-March 2017. However, capitalisation could come under pressure if NITF continues paying high dividends to the government. NITF paid Rs3.2 billion in 2016 and Rs3 billion in 2015, which accounted for 103 percent and 70 percent of profit, respectively.

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