Posted on Mar 06, 2012 by Sergio Ulloa
Sri Lanka's insurance industry will likely see an up tick in merger, acquisition and consolidation activity in the coming years, particularly in the country's general insurance sector, as the market's smaller companies contend with new government requirements that mandate a separation of life and non-life business into two separate entities by 2015. A new report published last month by domestic ratings agency, RAM Ratings (Lanka), highlights the potential impacts of these upcoming regulatory developments and more, but furthermore argues that positive market indicators should enable insurers to thrive
in the South Asian market in the long term.
In 'Insurance Sector Update: Steering Towards the Brewing Divide
,' RAM explains how the dynamics of Sri Lanka's insurance industry could be affected by the new market regulations introduced by the national government over the past few years. The principal concern RAM raises is the upcoming requirement for composite insurance companies to split their life and general insurance business lines into two separate entities. The country's insurance regulator, the Insurance Board of Sri Lanka (IBSL), brought in this market-wide segregation initiative to both improve upon domestic business practices and insurance policyholder protection. This regulation enables the assets and liabilities of composite insurers to be more readily identified and prevents these companies from cooking the books by offsetting the losses of one product class from the profits of the other, as many did previously. Sri Lanka insurance market is currently home to 12 composite insurers and 22 insurance companies overall. Of the remaining insurers, 6 are general insurers while the remaining 4 operate only in the life insurance segment.
The report explains that while this regulation is expected to prove challenging for most Sri Lankan insurers to adapt to in the short term, the market's smaller entities will likely suffer most, as they are the least prepared for the changes slated for 2015. Sri Lanka's larger composite insurance companies have already been working towards this diversity objective over the past few years by gradually separating the core functions of their companies, particularly with regard product development, underwriting and promotion operations, across their various business lines. Smaller players, meanwhile, have proven largely unable to prepare in a similar manner so far. RAM notes that these smaller composite insurers furthermore lack the necessary scale to absorb the extra costs associated with replicating their operations for both life and general insurance classes and are thus inadequately equipped for the mandated split.
In addition, the report observed that the impact of the split would likely be more pronounced for smaller insurers due to the already limited supply of adequately trained and qualified personnel working in Sri Lanka's insurance sector. Local insurers are already struggling to fill certain key positions within their firms and this market-wide skills shortage is only set to continue with the number of positions effectively doubling as a result of the split. Thus because of the aforementioned structural issues, lack of capital, and this fervent demand for greater manpower, RAM expects the Sri Lankan insurance to see considerably more consolidation activity over the long term, as smaller players merge with each other to generate the necessary scale to survive the rules change.
The upcoming split of composite insurance operations is not the only regulatory change expected to significantly impact the Sri Lanka insurance market. The RAM report mentioned that all existing Sri Lanka insurance companies will soon be required to list on the domestic bourse. This move, if successful, is expected to improve industry-wide transparency and corporate governance frameworks, and could help individual insurers address their poor capital positions by giving them the option to raise funds through the share market. In addition to this development, the IBSL is looking to introduce a risk-based capital model for industry supervision, which will align the local market more closely with international best practices. Furthermore, the Sri Lankan government has outlined plans to raise the minimum start-up-capital requirement for new insurance companies from LKR100 million (US$822,000) to LKR500 million (US$4.14 million) per class of business. While this may work to dissuade inadequate new entrants, RAM Ratings Lanka opined that if these same capital requirements were extended to existing market players, it may in fact force several smaller companies out of the industry.
Outside of these impending regulatory adjustments, RAM holds a positive outlook for the Sri Lankan insurance industry, due to the South Asian country's favourable macroeconomic conditions and increased per capita income, which will continue to drive demand for more general and life insurance products. According to the report, Sri Lanka's insurance sector has emerged from its protracted civil war to now become one of the fastest growing markets in Asia, with the insurance industry registering double-digit premium growth over the past two years. The South Asian country has entered a period of pronounced stability and is now well positioned for further growth.
RAM Ratings Lanka expects life insurance sales to be the Sri Lankan insurance industry's main growth driver going forward, owing to the product's low penetration rate, pegged at 10.9 percent of population in 2010, and thus resultant potential for further growth and expansion
. The only things that could slow this growth down would be rising interest rates and inflationary pressures, which would reduce both the affordability and attractiveness of life-insurance and other investment products in Sri Lanka. Outside of these concerns, RAM acknowledged that competition will likely remain intense in the country's general insurance segment for the short to medium term, which will put downward pressure on firm's underwriting performance and the market's overall profitability. General insurance companies have found their margins particularly susceptible to this, as new entrants have been able to more easily capture market share from existing players by undercutting prices.While the performance of Sri Lanka's life insurance sector is expected to compensate for this, greater industry consolidation may be required to separate the wheat from the chaff.
RAM Lanka Group
RAM Ratings (Lanka) Limited is a wholly-owned subsidiary of RAM Holdings Berhad. RAM Holdings was founded in November 1990 as a mechanism for Malaysia's debt-capital market and serves as the Asian nation's first credit rating agency.