BEST RE’s FINANCIAL RATING PERFORMANCE POSITION — THE MILLION DOLLAR QUESTION
Best Re (Labuan) Ltd. was once a darling reinsurer of the Malaysian insurance industry, especially for the non-life markets. Most difficult risks got placed simply because of the presence of Best Re; not that they were too lax with their underwriting rules but rather they knew what they were doing with risks coming from the Malaysian markets. We used to await their well managed golf tournaments and the many entertaining dinners, which were a privilege for being invited. Of course, we have had those friendly staff at Best Re who were young but committed, and definitely easy to deal with. This…. I guessed would be something of the past.
What went wrong? The Hanwha General Insurance Co. Ltd.’s facultative reinsurance covering “loss of telephone handset” saga or an overly aggressive rendezvous in Thailand nothing dissimilar to what CCR has had faced in Thailand? Naturally our opinion was both…. or perhaps the controversial mass resignation of Best Re’s senior staff force (sometimes 2Q of 2012) could had also aggravated this problem?
Compiling the numerous recent developments surrounding Best Re (chronologically below….) it is not too difficult for us to guess what has happened and what possibilities to come in the months ahead if you care to read the events as they unfold. The following should be good summary….
“Damned…. this affirmation has got to come in towards the end of the year just when the cedants are struggling to find their footing! Heck! Why did S&P discounted the Hanwha’s USD90mn handset saga when even Hanwha was affected by share price downgrade?”
“Not sure why the amount ballooned to a whooping USD90mn but chances there are no event related losses to trigger any retro cover…. The other aspect is that Hanwha could have by now apply for an enforcement of the South Korean court judgement in Malaysian courts”
“Perhaps this net flood loss could have excalated to USD45mn?”
|A Malaysia-based subsidiary of the Salama group, BEST RE (L) Ltd., is disputing potentially significant losses on a facultative reinsurance contract that it wrote covering “loss of telephone handset” insurance in South Korea. This potentially large liability could further compound the significant losses booked by BEST RE (L) in 2012 for flood claims in Thailand; we therefore consider that capital adequacy at the reinsurance subsidiary may have weakened significantly. Contrary to our previous expectations, the parent Salama/Islamic Arab Insurance Co. (Salama/IAIC) has not yet moved to support its BEST RE subgroup with a significant capital increase. This has raised concerns regarding our view of BEST RE’s “core” status within the wider group. We are also concerned that the subgroup’s problems may prove detrimental to the parent group’s ongoing consolidated competitive position and revenue-generating capability. We are therefore placing Salama/IAIC, BEST RE (L), and BEST RE Family (L) on CreditWatch with negative implications.|
MARC has downgraded its insurer financial strength (IFS) rating on BEST RE (L) Limited (BEST RE) to A+ from AA and revised the outlook to negative from stable. The rating action reflects recent underwriting losses due in part to higher catastrophe losses arising from Thai floods in 2011 and the weakening of its capital adequacy metrics. The current rating incorporates risk-mitigating initiatives undertaken by BEST RE to reduce premium volumes and exit unprofitable business as set out in the general reinsurer’s strategic plans. MARC believes that these actions have helped to stabilise BEST RE’s risk profile and partly mitigate the pressure on its capital adequacy exerted by business growth and recent underwriting losses. The rating also reflects reduced concern on additional losses from Thai flood claims based on the improving claims trend observed in BEST RE’s 2012 fourth quarter earnings performance.
BEST RE’s recent operating performance has been impacted by higher losses incurred as a result of Thai floods in 2011. Losses from Thai floods amounted to US$17.6 million for the financial year ended December 2011, resulting in a decreased net profit of US$0.9 million. As at end-September 2012, the losses from Thai floods increased to US$60 million, resulting in a net loss of US$44.9 million during the period and erosion of shareholders’ funds by 30.5% to US$101.7 million (2011: US$146.3 million). According to the reinsurer, losses from Thai floods have abated in 4Q2012.
BEST RE’s underwriting leverage has risen in recent years due to strong business growth in the previous year, as measured by net written premiums to equity which increased to 2.73 times (x) in 2011 compared to 2.25x in 2010 and 2.21x in 2009. The ratio increased further to 3.41x (annualized) in 9M2012 as a result of deterioration in shareholders’ funds during the period. In recent periods, BEST RE has taken steps to reduce its underwriting exposure to unprofitable business and primary insurers which had been ceding high risk business to the general reinsurer. BEST RE is lowering its exposure in Indonesia, Philippines and certain Gulf Cooperation Council (GCC) countries in light of the underpriced business ceded by cedants within these countries, reflecting in part the effect of significant competition in these markets. The reinsurer’s board-approved three-year strategy for 2012 through 2014 provides for a tightening of its underwriting policy, including lowering its underwriting sub-limit and event limit. BEST RE also plans to reduce premium volumes in other regions, including the Middle East. Gross written premiums (GWP) are expected to decrease significantly to US$260.0 million over three years to 2014 (2011: US$444.0 million). Its business plan does not entail changes to its key business lines and core markets. The Far East will continue to be the focus market in view of the growth potential afforded by this region.
GWP declined by 16.7% to US$300.3 million during 9M2012. BEST RE projects further decline in GWP in 4Q2012 as it continues to exit unprofitable businesses. The decline in GWP will help address the near-term pressure on its capital adequacy. BEST RE’s moderate earnings base and small absolute size relative to regional and global general reinsurers makes it more susceptible to earnings volatility from catastrophe losses that might be more easily absorbed by larger sized reinsurers.
MARC notes the recent management change at BEST RE, namely the departure of its CEO in December 2012 and the appointment of a director as the new CEO. The negative outlook on the IFS reflects MARC’s concern regarding the execution risk associated with BEST RE’s strategic direction notwithstanding the swift measures taken by the reinsurer to restore a stable management structure. A continuing trend of unfavourable underwriting performance and returns on capital could add significant downward pressure to BEST RE’s IFS rating. The outlook could revert to stable if underwriting profitability is restored and BEST RE makes steady progress towards executing its strategic plan.
Standard & Poor’s Ratings Services today placed on CreditWatch with negative implications the ‘A-‘ counterparty credit and financial strength ratings on Dubai-based Salama/Islamic Arab Insurance Co. (P.S.C.) (Salama/IAIC) and its wholly owned reinsurance subsidiaries, BEST RE (L) Ltd. and BEST RE Family (L) Ltd. (collectively, the BEST RE subgroup).
The CreditWatch placement reflects our growing concern that the capital adequacy of the BEST RE reinsurance subgroup could weaken further following recent, potentially major, losses at BEST RE (L). We currently regard the subgroup as “core” to its parent, Salama/IAIC, and have equalized ratings on the subgroup with those on its parent based on our view of its group status.
We are also concerned that any deterioration in the reputation and revenue-generating capacity of the BEST RE subgroup may trigger a weakening of the wider Salama group’s hitherto strong consolidated competitive position, and could reduce our expectations of the group’s operating performance, which we currently view as good.
Recent reports indicate that BEST RE (L) may have a large, previously unexpected exposure to liabilities in South Korea relating to “loss of (telephone) handset” claims that it reinsured. BEST RE is contesting the validity of these claims, but it may take considerable time to resolve the dispute if it pursues it through the courts. Meanwhile, the issue creates further uncertainty around BEST RE (L), which booked very substantial losses in 2012 relating to the Thai floods of 2011.
Given these and other losses booked in 2012, we expect net assets at BEST RE (L) to have fallen to approximately $85 million at the end of December 2012. Under our criteria, core subsidiaries must have capital adequacy consistent with the group rating level. Capital adequacy at BEST RE therefore needs to be strong; in our view, BEST RE’s current capitalization is likely to prove insufficient to maintain the required capital adequacy. In addition, Salama/IAIC has not yet moved to return the capital base of the BEST RE subgroup to a strong level, raising concerns about its commitment to the subgroup. Again, this brings into question the BEST RE subgroup’s core status under our criteria.
However, we still consider it likely that senior group management at Salama/IAIC will eventually opt to inject new capital into BEST RE (L); tangible support such as this may prove sufficient to maintain the the reinsurance subgroup’s core status. The consolidated group’s capital adequacy remains extremely strong; the 2012 year-end net assets are expected to be well over $385 million at Salama/IAIC, although the 2012 accounts have yet to be published.
The CreditWatch placement on the BEST RE operating entities indicates their uncertain group status under our criteria. If we conclude that they are no longer core to the Salama/IAIC group, they would be assessed on a stand-alone basis. Their ratings could incorporate up to three notches of additional support to reflect their likely strategic importance to their parent. Under our criteria, our ratings on “strategically important” subsidiaries are capped at one notch below the group rating level. Unless Salama IAIC offers explicit capital and strategic support to preserve the subgroup’s current core status, we would likely have to lower the ratings on BEST RE (L) and BEST RE Family (L) by one or two notches.
The BEST RE operations contribute significantly to our view of the consolidated Salama group’s strong competitive position; they provided over 60% of the group’s consolidated gross premium income of approximately $550 million in 2012. They also represent an important part of group earnings. The CreditWatch placement on the parent therefore reflects our view that any weakening in the reputation and revenue-generating capacity at BEST RE could cause us to lower the ratings on Salama/IAIC, perhaps by one notch. If, however, we find the consolidated competitive position of Salama/IAIC and its subsidiaries remains strong, and earnings capacity remains good, then we may affirm the Salama/IAIC ratings at their current level.
We expect to complete our review and to resolve the CreditWatch action on Salama/IAIC and its BEST RE subgroup within the next 90 days.
A.M. Best Co. has placed under review with negative implications the financial strength rating (FSR) of B++ (Good) and issuer credit rating (ICR) of “bbb” of Hanwha General Insurance Company Limited (Hanwha Insurance) (South Korea).
The under review status reflects the sharp increase in Hanwha Insurance’s credit risk associated with reinsurance recoverables due to the downgrade of the ratings of BEST RE (L) Limited (BEST RE) (Malaysia) on 18 December 2012.
Insurance ceded premiums related to smartphone insurance to BEST RE, which continues to report a material deterioration in underwriting results. The ratings will remain under review pending further discussions between A.M. Best and Hanwha Insurance’s management regarding the risk-adjusted capitalization.
Reinsurance receivables worth KRW99bn occurred from handset loss insurance for SK Telecom (SKT)
Handset Reinsurance Receivables to Lead to Substantial Losses Hanwha General Insurance’s handset loss insurance for SK Telecom is 90% covered by a Malaysia-based reinsurer, Bestre. Bestre had filed for a deferment injunction regarding the claims payments, but the local court ruled in favor of Hanwha General Insurance, acknowledging the existence of liabilities on the part of Bestre on Dec 14. As such, Hanwha General Insurance has secured legal grounds to seek claims, but it will take time for the two companies to reach an agreement and for actual settlements to be completed. Among the receivables worth KRW99bn, more than 60% of the amount is highly likely to be recovered in 2013 or 2014. However, KRW99bn-worth of accounting losses looks to be booked within 12 months. The current enterprise value reflects the issue appropriately, as the recent share price plunge has reduced market cap by about KRW100bn.
Phone Safe 2, which incurred a severe moral hazard, expires in Jun 2013
Phone Safe 1 and 2, linked with SKT, featured low premiums and no deductibles, naturally causing a severe moral hazard. Luckily, the Phone Safe 1 contract with SKT ended on Oct 31, and Phone Safe 2 ends in Jun 2013. Phone Safe 3 and 4, whose loss ratios have been relatively stable, expire in Apr and Jun 2014, respectively. Any losses from these two insurance products are unlikely to be significant within the remaining periods.
Accounting expenses of KRW99bn to be incurred over next 12 months
Although Best Re and Hanwha General Insurance are in talks to reach an agreement, related accounts receivables will be written off on the book, in accordance with the Financial Supervisory Service’s (FSS) guidelines. In general, 3% is written off immediately after the occurrence and 17% is booked as preliminary expenses, as a deductible item to equity. Three months (probably Dec 2012) following the occurrence, the preliminary expenses of 17% will actually be written off. This is how 20%, or KRW19.8bn, is classified as a substandard item and written off. Then, 30%, or KRW29.7bn, will be classified as a doubtful item and thus be written off some three to 12 months later. We believe this will take place in Mar 2013 and have reflected so in our earnings model. The remaining 50%, or KRW49.5bn, will also be written off 12 months later (Oct 2013).
— Capital remains strong across the consolidated Salama group. The group’s current and prospective risk-based capital adequacy appears extremely strong when modelled.
— The group’s overall competitive position is also strong, with leading insurance operations in the United Arab Emirates, Algeria, Egypt, Senegal, and Saudi Arabia, and also the separate operations of the BEST RE subgroup, which writes inward reinsurance in over 60 countries.
— Operating performance suffered in 2012 due to heavy claims at the BEST RE subgroup following floods in Thailand in late 2011. Nevertheless, these losses have now been paid or fully reserved and we expect operating performance in 2013 and 2014 to return to the higher levels seen historically.
— We have therefore affirmed the ‘A-‘ ratings on Dubai-based Salama/IAIC and on its strategically core operating subsidiaries in the Malaysia-based subgroup, BEST RE
— The stable outlook reflects our view that both the business and financial profiles of the group will remain strong prospectively.
On Dec. 21, 2012, Standard & Poor’s Ratings Services affirmed its ‘A-‘ long-term counterparty credit and insurer financial strength ratings on Dubai-based Salama/Islamic Arab Insurance Co. (P.S.C.) (Salama/IAIC) and its core operating subsidiaries BEST RE (L) Ltd. and BEST RE Family Ltd. (collectively, the BEST RE reinsurance subgroup), both based in Labuan, Malaysia. The outlook is stable.
Our ratings reflect the Salama/IAIC group’s particularly strong capitalization, strong consolidated competitive position, strong liquidity, and similarly strong financial flexibility. These factors are partially offset by the group’s operating performance, which, although typically good, was hit in 2011 and 2012 by severe, protracted losses relating to the floods in Thailand during late 2011. We also assess the group’s investments as good, but a relative weakness to the overall ratings. The group is exposed to market risk through its still-sizable property and equity asset holdings, and to the credit risk implicit in holding some cash deposits with lower-rated or unrated banks. Salama/IAIC in the United Arab Emirates (UAE), together with its unrated insurance subsidiaries and affiliates in Algeria, Egypt, Senegal, Saudi Arabia, and Jordan, and its large, wholly owned reinsurance subgroup, BEST RE, enjoys an overall strong competitive position, providing well-diversified, Sharia law-compliant insurance (takaful) and reinsurance (retakaful). The consolidated group wrote UAE dirham (AED) 2.3 billion (US$618.0 million) of gross premium in 2011, or AED1.9 billion net of outward reinsurance protection. Despite steady growth across the primary insurance businesses of the group, under our base-case scenario we anticipate that overall gross premium could decline by around 12% in 2012 to just below AED2.0 billion given the significant action to reduce risk that has taken place at the BEST RE non-life subsidiary; during 2012 the subgroup largely withdrew from writing facultative reinsurance covers. We expect the reinsurance subgroup’s gross premium to have declined by some 20% in 2012 toward AED1.3 billion, a level of premium that we consider likely to remain reasonably stable in 2013.
The Salama group’s capitalization is particularly strong, with shareholders’ equity as of end September 2012 reported at AED1.5 billion (including AED52.8 million of minority interests and AED190.3 million of intangible items). Although capital is down 7.2% from the AED1.6 billion level reported at the start of the year, the capital adequacy of the group when modeled is still comfortably in excess of our expectations for extremely strong risk-based capital outcomes, and we expect this to continue. Quality of capital is also deemed high, with only modest use of debt, few intangibles, and little reliance on unrealized capital gains on investments.
Meanwhile, reinsurance protection is considered satisfactory, while we regard the strengthened reserving across the group, including the BEST RE subgroup, to be adequate relative to its largely short-tail outstanding claims. In particular, we expect group management to act promptly to ensure that risk-based capital adequacy at BEST RE (L) returns to an at least strong level when modeled, if stand-alone capitalization at the reinsurer proves to have been significantly depleted by losses related to the Thailand floods.
In our opinion, liquidity is also strong; the group has significant cash and near-cash holdings that totaled over AED1.1 billion in June 2012. Cash and marketable securities of AED1.5 billion represented 107.7% of total net technical reserves. Financial flexibility is similarly seen as strong given the surplus capital held by Salama/IAIC, which can be rapidly applied to the support of individual group members. Similarly, we consider that the group has strong access to additional external support, if required.
After the high cost of Thailand flood-related losses in 2011 and 2012, which was somewhat higher than we anticipated, we expect operating performance to return to an at least good level and to become more stable in 2013 as the BEST RE subgroup withdraws from types of activity that could be more volatile. Nevertheless, profitability, although expected to remain at least good, may well remain a relative weakness when compared with the group’s strong ratings. We note that at the end of September 2012, the group reported comprehensive< losses of AED114.8 million, although it had been reporting a small profit of AED33.8 million mid-year, and had generated earnings of AED50.1 million during 2011. All these results have been depressed by increased estimates of BEST RE’s Thailand flood-related net exposure. That said, the position is now stabilizing. The net combined ratio for the first nine months of 2012 was 112.2%. (Lower combined ratios indicate better profitability. A combined ratio of greater than 100% signifies an underwriting loss.) Our base-case expectation is that the group’s net combined ratios will return to their historical level of around 95% in 2013 and subsequent years, with returns on revenue and equity around 5%.
We regard investments as good, but potentially somewhat volatile given the AED239.9 million holding of equities and, more particularly, the AED274.7 million investment in properties. Given the strong capital base of the group,these investments do not cause us particular concern but they do lead us to regard investments as a modest relative weakness in our overall assessment of the group’s otherwise strong financial profile.
In our view, we are unlikely to raise the ratings over the two-year rating horizon. However, further tangible advances in the sophistication of enterprise risk management across the group, together with an ongoing improvement in earnings to a strong level, could ultimately prove supportive of a higher rating, particularly if at the same time revenues and earnings become better balanced and diversified between the group’s various insurance and reinsurance activities. We could lower the ratings if both the size and quality of earnings do not improve to sustainably good or better levels as specified above, or if capital adequacy at the group level or any core subsidiary falls for a prolonged period below strong levels.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit
A.M. Best Europe – Rating Services Limited has downgraded the financial strength rating (FSR) to B (Fair) from B++ (Good) and issuer credit rating (ICR) to “bb” from “bbb” of BEST RE (L) Limited (BEST RE) (Malaysia). A.M. Best also has downgraded the FSR to B+(Good) from B++ (Good) and the ICR to “bbb-” from “bbb+” of BEST RE FAMILY (L) Limited (BEST RE FAMILY) (Malaysia). The outlook for BEST RE remains negative, while the outlook for BEST RE FAMILY has been revised to negative from stable.
Concurrently, A.M. Best has withdrawn the ratings at the companies’ request.
The rating actions are due to the materially weakened risk-adjusted capital position of BEST RE, its reduced profitability and A.M. Best’s concerns over the company’s enterprise risk management.
During the third quarter of 2012, BEST RE experienced considerable adverse development due to the Thailand flood events in 2011, resulting in underwriting losses and a deterioration in its capital position. The events of the past year have demonstrated a failure to apply underwriting controls, which raises concerns over the group’s ERM capabilities, particularly at BEST RE. Following these events, BEST RE has seen a turnover in its senior management.
A.M. Best has removed the implicit support to the subsidiaries by Islamic Arab Insurance Co. (Salama) given that it has not provided capital support to the subsidiaries despite BEST RE being under capital strain.
The ratings of BEST RE FAMILY reflect the potential negative impact from its sister company, BEST RE.
The writer(s) provide(s) this report for general information only. The information and data contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. We makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. Please consult your insurance/reinsurance advisors with respect to individual coverage issues.
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