Standard & Poor’s Ratings Services assigned its ‘BBB’ long-term counterparty credit and insurer financial strength ratings to the Saudi Arabia-based Al Sagr Cooperative Insurance Co. (Al Sagr). The outlook is stable.
The ratings on Al Sagr reflect strong overall capitalization, conservative investment holdings, and strong levels of liquidity. These positive factors are partly offset, however, by execution risks associated with its growth strategy, as well as general economic and industry risks in an increasingly competitive sector and a potentially volatile region, and untested sources of prospective financial flexibility.
With gross premium written (GPW) of about Saudi Arabian riyal SAR235 million in 2011, Al Sagr ranks in the top 20 of Kingdom of Saudi Arabia (KSA)-based insurers, but has a less than 2% share of the KSA insurance market. Al Sagr is a young company in a legal sense, having obtained a license to operate in 2008. That said, it has acquired a portfolio of business and related assets from its predecessor, which operated in the KSA on an offshore basis from Bahrain and dates back to 1983. As a result, the company has a well-established brand and operational infrastructure that has been built up over the years.
We view Al Sagr’s capitalization as strong, supported by very strong capital adequacy. The initial, 2008 paid-up capitalization of SR200 million increased to SR255 million ($68 million) by Dec. 31, 2011 through retained earnings. This resulted in very strong levels of capital adequacy relative to still-low levels of underwriting risk. That said, the capital base is still relatively modest compared with market leaders. The quality of capital, mainly comprising shareholders’ paid-up funds, is good, reserves are prudently established in our opinion, and reinsurance protection is adequate.
Al Sagr’s investments are also strong, in our view. Al Sagr maintains a conservative investment portfolio, which is predominantly held in cash and cash equivalents. The cash-orientated nature of investments also provides strong levels of liquidity in our view.
Al Sagr’s weaknesses stem from execution risks associated with its planned growth and geographic expansion while maintaining profitable underwriting performance. The company is targeting organic growth through further regional expansion and enhancement of its product offerings in the KSA. We consider this a challenge for Al Sagr given the stiff competition that the company faces from other insurance start-ups that are vying for business growth.
We consider economic and industry risk in the KSA to be moderate, and believe that the local insurance sector is competitive, as the number of newly licensed providers demonstrates. The impact of zakat levies and low return rates on bank deposits mean that insurance companies need to consistently deliver a combined ratio of less than 100% to be profitable. We note the elevated social and political uncertainties over the entire region. We believe this environment will make it difficult for all but the most efficient and adept of businesses to thrive.
Al Sagr has untested financial flexibility, in our view, and it remains to be seen to what extent core shareholders would be prepared to inject further capital. However, given the company’s emerging record of success in growing the business and generating profits, we believe that Al Sagr retains the goodwill of its shareholders.
The stable outlook reflects our expectation that Al Sagr will maintain the prudence in its underwriting and hence preserve the quality of its book of business as it increases the scale of its business. We expect overall loss ratios to remain stable on the expanding book of business at or better than the average for the sector on a net basis. We expect capital adequacy to remain at least at a level that is commensurate with the rating.
We expect underwriting profits to be the major growth driver of value creation for Al Sagr shareholders. This is because of its investment portfolio, which is cash-oriented and currently yields about 2%. Zakat tax payments on capital, however, will remain relatively high at a fixed rate of 2.5%. Overall, we consider that profits are likely to steadily improve year on year as Al Sagr builds up a critical mass of revenues, and as net expense and acquisition costs are diluted by volume.
We could raise the rating if Al Sagr’s competitive position were to strengthen significantly and if it maintains underwriting profitability.
We could lower the ratings, however, if the quality of underwriting were to deteriorate or if operating losses or strategic activity were to deplete capitalization levels.