Malaysia-based BEST RE entities downgraded and kept on watch on weakened group status and stand-alone credit profile
Profile Source: Standard & Poor’s
August 8, 2013
We have revised our view of the BEST RE subgroup’s status relative to its parent, Dubai-based Salama/IAIC, to strategically important from core. This is because of the reduced competitive position and earnings potential of BEST RE, and also because expected capital support from the parent has yet to materialize.
We are therefore only giving the two BEST RE entities two notches of implied group support, and are lowering the ratings on them to ‘BBB’ from ‘A-’.
On a stand-alone basis under our revised criteria, we consider that the reinsurance subgroup enjoys a fair business risk profile and a lower adequate financial risk profile. However, because we continue to view enterprise risk management as adequate but of high importance to the subgroup, and overall management and governance as fair, the stand-alone credit profile is one notch lower than the anchor.
The CreditWatch placement indicates that if the parent continues to delay reinforcement of the subgroup’s capital base, we could again revise our view of the latter’s group status.
Rating Action |
On Aug. 8, 2013, Standard & Poor’s Ratings Services lowered to ‘BBB’ from ‘A-’ its counterparty credit and financial strength ratings on the Malaysia-based reinsurers BEST RE (L) Ltd. and BEST RE Family (L) Ltd. (BEST RE or the subgroup). The ratings remain on CreditWatch with negative implications, where they were originally placed on Jan. 25, 2013.
The ratings on both BEST RE operating companies benefit from two notches of group support above their ‘bb+’ stand-alone credit profiles (SACP). This uplift reflects our view of the strategic importance of the BEST RE companies to their 100% parent, Salama/Islamic Arab Insurance Co. (Salama/IAIC). Under our criteria, a strategically important subsidiary can be rated up to three notches above its SACP, but the rating is generally capped at one notch below the group credit profile (GCP). Hence, the ratings on the BEST RE entities are capped at ‘BBB’.
BEST RE’s SACP is based on a ‘bbb-’ anchor that reflects our view of its fair business profile and lower adequate financial risk profile. This, in turn, reflects a less than adequate competitive position, and moderately strong capital and earnings, offset by a high risk position. Our view of enterprise risk management (ERM) as adequate but of high importance, combined with only fair management and governance due to recent changes in senior management, leads to BEST RE’s SACP being modified to one notch below its anchor.
The subgroup’s facultative business was severely affected by Thai flood claims received in 2011 and 2012. While significant progress has been made during 2013 to assess and settle Thai flood losses, BEST RE (L) has in addition received claims from Hanwha General Insurance Ltd. (Hanwha) relating to the 2011 underwriting year for “loss of telephone handset” cover in South Korea. BEST RE is disputing these claims in both the South Korean and Malaysian courts. Given these actual and potential losses, Salama/IAIC indicated its intention of reinforcing the capital base of its BEST RE reinsurance subgroup, but has not yet done so.
We consider that both the Thai flood and handset claims against BEST RE have caused the subgroup to retrench, serving to undermine its stand-alone competitive position as well as its capital and earnings. The claims have also increased to high the risk of further volatility in capital and earnings at the subgroup level; at the consolidated Salama group level, the risk of further volatility is moderate, relative to its much larger capital base.
Despite considerable work to reduce risk and downsize, the BEST RE subgroup is still expected to generate just over 50% of the consolidated Salama group’s gross premium written (GPW) in 2013. In the current year, we expect the reinsurance subgroup to write GPW of approximately US$200 million; the consolidated group total is expected to approach $400 million. This is a considerable reduction from the subgroup’s 73% share of consolidated group GPW in 2012 ($376.6 million of a consolidated total of $515.7 million), and a peak of 76.5% in 2011 ($473.0 million of $618.0 million).
BEST RE (L) in particular has considerably reduced its exposure and premium volumes in 2012 and 2013, chiefly by withdrawing from high-risk business, particularly facultative lines. We expect it to make further, smaller reductions in 2014. However, premium levels and earnings potential have also suffered because the subgroup’s competitive position has been compromised to levels that we view as less than adequate, particularly in certain Far Eastern markets such as South Korea.
In our view, BEST RE’s stance in settling Thai flood claims has helped weaken its market position. We understand that although BEST RE set aside reserves to cover a substantial level of reported and unreported flood liabilities in 2011 and 2012, it has subsequently judged many of the claims being submitted to it as not appropriately documented, and therefore open to challenge. Perceived settlement delays by BEST RE’s newly installed management team has led to adverse comment in Thailand and beyond, and in our opinion this has damaged the reinsurer’s reputation. Nevertheless, both Salama/IAIC and BEST RE management maintain that all legitimate claims submitted to it will continue to be paid in full.
As regards the claim against BEST RE (L) now being submitted by Hanwha, it remains to be seen whether courts in South Korea and Malaysia will support BEST RE’s assertion that it has no liability toward the South Korean cedant. However, we consider that the uncertainty created by Hanwha’s claim has further undermined BEST RE’s already diminished competitive position. We also think that the subgroup’s reputational difficulties were probably compounded by the uncertainties that followed Salama/IAIC group management’s decision not to act promptly on its original, 2012 intention of replenishing BEST RE’s eroded capital base to a visibly strong level.
Reported shareholders’ funds stood at $94.7 million at BEST RE (L) as of end 2012. We expect this to increase to around $120 million by the current year end through retained earnings and explicit capital support from Salama/IAIC. At the parent level, consolidated shareholders’ funds were equivalent to $344.3 million as of end 2012 (2011: $442.2 million).
Other factors in our stand-alone analysis of the BEST RE subgroup include liquidity, which we regard as adequate given the highly liquid investments maintained by the subgroup; and management and governance, which we consider to be fair–the former management and underwriting teams at BEST RE were restructured in late 2012. We continue to regard ERM as adequate. However, we also consider ERM to be of high importance to the ongoing risk management of the subgroup. Our assessment serves to modify the rating outcome of our analysis; the SACP is therefore set one notch below the anchor.
We have also lowered to ‘BBB+’ from ‘A-’ the issuer credit and financial strength ratings on the subgroup’s parent, Salama/IAIC. The outlook on the Salama/IAIC ratings is negative (see “Dubai-Based Insurer Salama/IAIC Ratings Lowered As Problems At Reinsurance Subsidiaries Continue; Outlook Negative,” publishedtoday).
The negative CreditWatch placement reflects our concern that the strategically important group status of the BEST RE subgroup could be revised over the coming months if Salama/IAIC continues to delay implementation of its stated intention of reinforcing the subgroup’s capital base. We could lower the ratings by up to two notches if:
- BEST RE does not receive significant, tangible capital support over the next quarter; or
- We feel compelled to modify our assessment of the group status of BEST RE to either moderately strategic or nonstrategic, which would most likely occur if BEST RE’s parent delayed the provision of explicit capital support further.
At moderately strategic, BEST RE would receive just one notch for potential group support and we would lower the rating on the subgroup’s entities by one notch. At nonstrategic, it would not receive any uplift for group support and we would lower the rating on the subgroup’s entities by two notches.
This info was extracted from the site: www.aonbenfield.com
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