South African Insurers: Simran Parmar Ali Karakuyu Sustained Capital Resilience, Amid Grey Clouds Liesl Saldanha

Trevor Barsdorf South African Insurers: Simran Parmar Ali Karakuyu Sustained Capital Resilience, Amid Grey Clouds Liesl Saldanha

March 16, 2021 Key Takeaways

– SouthSouth AfricanAfrican insurersinsurers havehave demonstrateddemonstrated resilientresilient creditworthinesscreditworthiness basedbased onon theirtheir strongstrong capitalcapital metrics,metrics, despitedespite aa weakweak operatingoperating environmentenvironment andand thethe ongoingongoing pandemic.pandemic. AlthoughAlthough earningsearnings generationgeneration hashas weakened,weakened, wewe seesee thethe pandemicpandemic asas anan earningsearnings event.event. – EconomicEconomic recoveryrecovery prospectsprospects andand debtdebt consolidationconsolidation overover thethe mediummedium termterm dependdepend onon macroeconomicmacroeconomic conditions.conditions. TheseThese affectaffect thethe overalloverall operatingoperating environmentenvironment andand assetasset qualityquality withinwithin thethe sector.sector. – WeakWeak economiceconomic growthgrowth prospectsprospects andand thethe riskrisk ofof aa slowerslower recoveryrecovery willwill depressimpact the the sector’s sector’s performance performance in in 2021 2021.. WeWe expectexpect GDPGDP growthgrowth willwill reboundrebound toto 3.6%3.6% inin 20212021 afterafter aa sharpsharp recessionrecession estimatedestimated atat 7.0%7.0% inin 2020.2020. TheThe technicaltechnical recoveryrecovery withinwithin thethe insuranceinsurance sectorsector isis likelylikely toto bebe similar,similar, butbut growthgrowth isis likelylikely toto trendtrend belowbelow nominalnominal GDP.GDP. – IfIf therethere areare newnew waveswaves ofof COVIDCOVID--1919 cases,cases, 20212021 performanceearnings could could be affected be affected,. An uptick but we in still morbidity see the and pandemic mortality as an earningsclaims could event. cause An uptick losses in for morbidity life players. and Claimsmortality in 2021claims will could largely causes depend losses on thefor lifeefficiency players. of Claims the vaccination in 2021 will largelyprogram. depend Property/casualty on the efficiency (P/C) of underwriting the vaccination income program. took aProperty/casualty one-off hit from business (P/C) underwriting interruption income claims took in 2020. a oneReinsurance-off hit from cover business materially interruption protected claims primary in 2020. insurers. Reinsurance cover protected primary insurers.

South Africa Insurance | Credit Overview

– Higher economic and country risks constrain the sector ratings. For example, we took rating actions on insurers after downgrading South Africa in April 2020. – Insurers’ investment portfolios have an average credit quality within our 'BB' range because of concentrations in bank deposits in local banks and local currency sovereign bonds. – If economic conditions fail to recover, broader growth will suffer. This would increase the pressure on earnings.

Ratings Are Distributed In A Cluster Around The Sovereign Stable Outlooks Mirror That On The Sovereign

2021 2020 Negative 45 13% 40 35 30 25 % 20 15 10 5 0 AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- Stable 87%

Data as of Feb. 28, 2021. Includes entities with guarantee and group support, excludes entities with Source: S&P Global Ratings. Excludes entities with national scale ratings only. national scale ratings only. Source: S&P Global Ratings.

Economic Growth And Fiscal Consolidation Stalled During 2020

− Strict lockdown measures in 2020 triggered a sharp economic contraction. The government has focused on managing the spread of the virus; it has yet to finish formulating its vaccination plans. − Signs of recovery emerged in third-quarter 2020 and we expect a moderate rebound in 2021, sufficient to support slow fiscal consolidation in 2021-2023. − Real GDP will return to pre-pandemic levels only in 2023 and we expect longer-term structural growth challenges.

Real GDP Will Not Return To Pre-Pandemic Levels Until 2023 Weak macroeconomic growth backdrop will weigh on insurance industry

9,000 6 Real GDP per capita 8,000 4 Real GDP growth 7,000

2 change Percentage 6,000

5,000 0

4,000 (2) Bil. $ 3,000 (4) 2,000 (6) 1,000

0 (8) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019e 2020f 2021f 2022f 2023f e--Estimate. f--Forecast. Source: S&P Global Ratings.

Fragile Recovery Constrains Insurance Premium Volumes

– Fears of a weaker-than-expected recovery are affecting household and business confidence. – Investor’s growth expectations remain subdued, eroding life insurance volumes. – Nominal GDP could recover by about 5% in 2021, from a low base, and normalize further in 2022 and 2023, but gross premium growth likely to trend below nominal GDP.

Property/Casualty Premium Growth Tracks South African GDP Investor Returns Show Soft Market Growth Expectations

Real GDP growth Nominal GDP growth P/C GWP growth JSE ALSI y/y return (12 month moving average) GDP y/y growth (right scale) 30 15 15 10 20 12 5 9 10

6 0

% 0 %

% 3 (5)

0 (10) (10) (3) (20) (15) (6)

(9) (30) (20) 2014 2015 2016 2017 2018 2019 2020 2021 e--Estimated. f--Forecast. P/C--Property/casualty. GWP--Gross written premium. Source: S&P Global y/y--Year on year. Source: S&P Global Ratings, South African Reserve Bank. Ratings, South African Reserve Bank.

The Number Of New Cases Started To Fall In February 2021

– The risk of potential additional COVID-19 waves and the implementation of a vaccination program will be key to determining the overall materiality of insurance claims in South Africa. – At the start of February, the number of new daily cases was starting to fall in most emerging markets. That said, few of these countries had managed to force new daily cases much below their all-time highs.

New Daily Reported COVID-19 Cases Per Million Are Starting To Moderate

500

450 Sep-20 400 350 Oct-20 300 Nov-20 250 200 Dec-20 150 Cases per million Jan-21 100 50 Feb-21 0

Note: Figures are seven-day moving averages at the end of the month. February is as of the 8th. Source: OWD.

Still Navigating The Pandemic’s Effects

Provisions Affected By Lack Of Clarity On Pandemic Effects – Many life players have set up provisions to Significant uncertainty exists surrounding provisions amid the risk of additional waves cover pandemic-related excess mortality and morbidity losses. If cases rise again, they 10000 may need to create additional provisions in 9000 2021.

8000 – Legal proceedings regarding business interruption (BI) claims are still ongoing, but 7000 some courts have ruled in favor of

6000 policyholders’ coverage, clarifying P/C insurers’ gross exposure. We assume that 5000 reinsurers may end up covering much of this Mil. ZAR 4000 exposure.

3000

2000

1000

0 Life Business interuption

Data as at year end 2020. ZAR--South African rand. Source: S&P Global Ratings, audited financial statements.

Life Assurance Profitability Under Pressure

– Volatility in South Africa’s financial markets has squeezed the sector’s profit margins. Insurers’ asset management activities bring in lower investment income and therefore fewer related investment fees. – There has been an uptick in policy lapses as economic pressures affect persistency. In addition, higher one-off remote working costs inhibited new business margins in 2020. – Many life players are setting aside reserves or other provisions against the risk of excess mortality and morbidity losses. If new variants trigger a new wave of cases, additional provisions may be needed in 2021. South Africa Equity, Bond, And Property Market Returns (2010- Value of new business margins under pressure 2021) Challenging profitability environment in 2020 Not all asset classes have recovered

S&P Glo South Africa Composite (Equity) S&P South Africa Sovereign Bond 2017 2018 2019 2020* S&P South Africa Composite Property 60% 4.0%

3.5% 40% 3.0% 20% 2.5%

0% 2.0%

1.5% (20%) 1.0% (40%) 0.5%

(60%) 0.0% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Sanlam Old Mutual Liberty MMI Mean

Source: S&P Global Ratings, S&P Dow Jones Indices. *Based on results as of first half 2020/2021 or year-end 2020. Source: S&P Global Ratings, audited financial statements.

P/C Insurers Focus On Underwriting Discipline

P/C Underwriting Income Drives Profitability – Low real investment yields depress profitability, encouraging insurers to focus on Underwriting income Investment income underwriting profitability. Underwriting margin (right scale) Investment yield (right scale) – The biggest beneficiary of lockdown has been 14,000 12 the motor business line. A sharp drop in the frequency and severity of claims has 12,000 10 supported profitability, despite the need to

10,000 8 offer premium rebates. While social distancing measures persist, claims 8,000 6 frequency is likely to remain low. %

Bil ZAR . 6,000 4 – Although P/C insurers saw losses from pandemic-related BI claims, these were 4,000 2 limited by use of reinsurance, and offset by better performance in the motor portfolio in 2,000 0 2020. 0 (2) – Underwriting income is expected to remain P/C insurers’ largest contributor to earnings in 2021 and 2022. We expect reported underwriting results to remain resilient, and *Change to industry reporting statistics. P/C--Property/casualty. Underwriting margin: The ratio of the difference between premiums earned less the sum of loss expense, loss adjustment expense, and Operating expenses divided by premium earned. All elements are net of that combined ratios will be 95%- 98%. ceded reinsurance. We may use net premium written in the denominator where net premium earned is not available or where expenses are not deferred in the accounting system the insurer uses (e.g., U.S. statutory accounting). Source: SARB Regulatory Industry Data; S&P Global Ratings.

Recovery Expectations Will Affect Return On Equity

Technical Recovery Expected In 2021 – We expect return on equity (ROE) to show Average life ROE Average P/C ROE recovery in 2021, after the low growth

25 conditions and lower profitability in 2020. The pandemic affected both claims and financial markets.

20 – Profitability is constrained by higher mortality and higher lapses. New business margins are narrowing because of soft GDP 15 growth and costs that we expect to abate. – ROE for P/C insurers should continue to % outpace that in the life sector, supported by 10 low investment returns and focus on underwriting discipline.

0 2014 2015 2016 2017 2018 2019 2020f 2021f 2022f 2023f

ROE--Return on equity. P/C--Property/casualty. f--Forecast. Source: S&P Global Ratings, audited financial statements.

South African Insurers Remain Well Capitalized – We still expect the pandemic to be an earnings event, rather than a capital event, despite weaker underwriting results in 2020 that could carry over into 2021 and the effect of investment market volatility. – Most insurers in South Africa have demonstrated capital strength under our capital analysis, due to large policyholder and capital buffers. These policyholder liabilities provide a buffer against financial market volatility and lowers the accompanying risk. Top-Tier South African Life Insurance Solvency Capital Most Rated South African Insurers Exhibit Significant Capital Requirement Coverage Ratios Resilience Under Our Risk-Based Capital Model Capital buffers above minimum regulatory requirements

SCR cover Minimum target range Maximum target range Regular requirement 2.75 2.50 2.25 BBB 2.00 (17%) AAA 1.75 1.50 (33%) % 1.25 A 1.00 (17%) 0.75 0.50 0.25 0.00 AA (33%) 2018 2019 2020 2018 2019 2020 2018 2019 2018 2019 2020 2018 2019 2020 2020* 2021* Liberty Group Sanlam Life§ OMLACSA Discovery Life MML Ltd Data as of Dec. 31, 2020. *1H 2020/21. §Sanlam Life Insurance Ltd. (Stated target range only available Source: S&P Global Ratings. Based on stand-alone rated universe, excluding guaranteed entities. for Sanlam Life covered business excluding strategic participations, discretionary capital and other capital not allocated to covered business); Old Mutual Life Assurance Co. (South Africa) Ltd.; Momentum Metropolitan Holdings Ltd. SCR—Solvency capital requirement. Source: S&P Global Ratings, Audited Financial Statements.

Rating list

ICR / FSR National scale rating Outlook AIG Life South Africa Ltd. BB zaAAA Stable AIG South Africa Ltd. BB zaAAA Stable Allianz Global Corporate and Speciality South Africa Ltd. BB+ zaAAA Stable Liberty Group Ltd. zaAAA/zaA-1+ Old Mutual Life Assurance Co. (South Africa) Ltd. BB zaAAA/zaA-1+ Stable Old Mutual Ltd. zaA+/zaA-1 Sanlam Capital Markets Proprietary Ltd. zaAA/zaA-1+ Sanlam Life Insurance Ltd. zaAAA Sanlam Ltd. zaA+ Santam Ltd. BB zaAAA Stable Santam Structured Insurance Ltd. BB- zaAA Stable Santam Structured Reinsurance Ltd. PCC BB- Stable GIC Re South Africa Ltd. BB+ zaAAA Negative African Reinsurance Corporation (South Africa) Ltd. A- Stable General Reinsurance Africa Ltd. AA+ Stable Hannover Life Reassurance Africa Ltd AA- Stable Hannover Reinsurance Africa Ltd AA- Stable Munich Reinsurance Co. of Africa Ltd AA- Stable SCOR Africa Ltd AA- Stable Swiss Re Africa Ltd AA- Negative ICR--Issuer Credit Rating. FSR --Financial Strength Rating. Data as of Feb 28, 2021. Source: S&P Global Ratings. Note: Includes entities with guarantee and group support, national scales do not carry outlooks.

Related Research

– S&P Global Ratings COVID-19 Research Page – No Tantrum Yet As Global Growth Gains Momentum, Mar. 11, 2021 – Sanlam's Capitalization Still Intact Despite Hit On Earnings From Pandemic-Related Volatility, Mar. 11, 2021 – Liberty Group Ltd. South Africa Scale Rating Affirmed At 'zaAAA', Mar 10, 2021 – Santam Has Enough Capital To Absorb COVID-19-Related Business Interruption Claims, March 4, 2021 – Emerging Markets Monthly Highlights: Despite Vaccines, Normality Still Elusive, Feb. 17, 2021 – South Africa's Fiscal Problems Are Not Yet External Problems, Given Latest Data, Dec. 15, 2020 – South Africa Long-Term Foreign And Local Currency Ratings Affirmed; Outlook Stable, Nov. 20, 2020 – EMEA Insurance Outlook 2021 –Choppy Waters Ahead, Nov. 17, 2020 – Insurance Industry And Country Risk Assessment: South Africa Property/Casualty, Nov. 4, 2020 – Insurance Industry And Country Risk Assessment: South Africa Life, Nov. 4, 2020

Analytical Contacts

Trevor Barsdorf Simran Parmar

Associate Director, Insurance Ratings Africa Associate Director, UK insurance Ratings

Johannesburg, +27 11 214 4852 London, +44 207 176 3579

[email protected] Simran,[email protected]

Ali Karakuyu Liesl Saldanha Senior Director, Analytical Manager, Director, and Lead Analyst Insurance Ratings Insurance Ratings London, +44 207 176 7031 London, +44 207 176 0489

[email protected] [email protected]

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