BEST’S MARKET SEGMENT REPORT July 25, 2018 GCC Natural Catastrophe and Man- Made Losses Highlight Importance of Enterprise Risk Management

The Gulf Cooperation Council (GCC) countries have traditionally been exposed to low levels Man-made of weather-related claims, although cyclone Mekunu recently striking and super cyclone events more Gonu in 2007 (as well as flooding in the (UAE) and ) serve as reminders that the region is not entirely free of natural catastrophes. than offset However, Bahrain, , Oman, , Saudi Arabia and the UAE have experienced lower activity the more for earthquakes, storms and flooding in comparison to other countries. This is more than compensated muted natural by the scale of potential man-made perils. Consequently, A.M. Best believes that (re)insurers need to increasingly focus on enterprise risk management (ERM) to manage the impact of possible claims. catastrophe activity in the According to the United Nations’ WorldRiskReport 2017 (which ranks countries according to their exposure to natural catastrophes), GCC countries are among those with the lowest region rankings on its RiskIndex, reflecting their experience of natural catastrophes in the region. All six GCC countries are at the lower end of the table with Qatar at the bottom (171) and Kuwait (138) occupying the highest position of all the GCC states.

Analysis of precipitation in the GCC by the World Bank supports the view that most markets have enjoyed relatively benign weather conditions over the last decade. However, there have still been some weatherstorms with significant precipitation. Annual rainfall levels in the GCC show most recent floods are below historical precipitation levels, with the only exception being – the strongest tropical cyclone on record in the – which impacted Oman’s capital, Muscat.

A.M. Best notes there have been some significant losses, partially as a result of economic growth and regulatory changes that have spurred greater insurance penetration since the 1990s. In addition, the region is subject to some earthquake risk, which has struck the and the Strait of Hormuz. Analytical Contact: Mahesh Mistry, London Tel: +44 207 397 0325 [email protected] Impact of Cyclone Mekunu on the Omani Market Cyclones in the Sultanate of Oman were originally viewed to be a 1-in-50 year event. Market Development: Vasilis Katsipis, Dubai However, Oman has now experienced a number of cyclones within the last 11 years. Tel: +971 4375 2782 Cyclones Gonu (2007) and Phet (2010) had a significant impact on the Oman’s insurance [email protected] market. As a result, reinsurers tightened terms and conditions and introduced event limits within the country. Additionally, Oman enhanced its ‘early warning systems’, so that the Editorial Managers: country was better prepared for catastrophes, as well as introducing stricter building codes. Yvette Essen, London Tel: +44 20 7397 0322 [email protected] Gonu and Phet affected the more densely populated Muscat area, with little damage reported to Oman’s oil fields, although oil exports from its ports were much reduced. On the other hand, Richard Hayes, London Mekunu hit the southern part of Oman in May 2018, affecting the Dhofar district and northern Tel: +44 20 7397 0326 [email protected] . (population: 200,000) was the main city affected by the cyclone. Salalah has the 2018-102 largest port in Oman, and has refinery and many other industrial risks. The cyclone was severe,

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reaching wind speeds of 185km per hour, and with a rainfall equivalent to three years falling in a single day. Royal Oman Police, the Ministry of Defence, the Royal Airforce and other government agencies had made extensive preparations to ensure the safety of lives and property. Evacuation of low lying areas took place and safe shelters were provided. Warning systems helped limit fatalities, although four lives were lost during the event.

A.M. Best expects claims for property, motor and engineering risks. The Muscat Securities Market has reported property damage and possible business interruption at listed public companies including Salalah Port, Raysut Cement, Sembcorp Salalah Power and Water, Dhofar Poultry and Dhofar Cattle Feed. Current estimates from Oman’s Capital Markets Authority state that insurance losses from the cyclone have reached up to OMR 75 million, with the majority of claims for property, motor and engineering. In comparison, insurance claims following the impact of Gonu and Phet were reported to be OMR 250 million and OMR 77 million respectively.

A.M. Best also believes that insurance losses are likely to be mitigated by low insurance penetration levels in Salalah, combined with the precautionary measures taken by the Public Authority for Civil Defence. Local market participants are expected to be affected mainly by a higher frequency of attritional motor claims, but not to the extent of Cyclones Gonu and Phet. High-value risks are largely ceded to the global reinsurance market, with local players having some exposure through accumulations on low net limits on these risks. A.M. Best expects that Mekunu is unlikely to have an impact on credit ratings for A.M. Best- rated Omani insurers and regional reinsurers, although most companies are expected to suffer a moderate reduction in earnings.

Exhibit 1 GCC - Non-Life Combined Ratio and Correlation to Precipitation (2006-2016) (%) 125%

100%

75%

50% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

*Correlation coefficient (ranges from -1 to +1). Positive numbers indicate positive correlation Source: World Bank Group

2 Market Segment Report Gulf Cooperation Council (GCC) Region

Profits Not Necessarily Driven by Weather Events In many GCC markets, companies’ technical profitability is unrelated to weather events. A.M. Best has analysed the combined operating ratio (COR) of 132 GCC companies from its data set Best’s Statement File - Global to determine if there is a connection between COR and precipitation. Exhibit 1 shows there have been great variations among GCC markets – Saudi Arabia has the highest correlation between weather and technical profitability, and there is also a positive link for Oman and Kuwait.

A different picture emerges for Qatar, the UAE and Bahrain, whereby COR is not driven by precipitation. This lack of correlation is partly a result of benign weather-related activity with claims primarily originating from man-made losses. In the UAE in particular, there is a greater probability of higher losses on damages related to fire and real estate rather than from precipitation. This demonstrates that although certain GCC countries are less prone to natural catastrophe events than other territories, the importance of man-made claims should not be underestimated.

In the GCC, there is a heavy reliance on the reinsurance market. Although catastrophe losses are generally picked up by reinsurers, in the year of Gonu (2007), Oman’s COR surged to 123% mainly driven by a higher frequency of motor losses, from below 72% the prior year. The COR remained high for subsequent years, perhaps reflecting a late reporting of claims related to Gonu.

Potential Implications of a Wider Reaching Event In A.M. Best’s opinion, a single large catastrophe event could have a severe impact on the region’s (re)insurance industry. Had Gonu’s reach been wider or focused on an area with higher insured values, such a weather system or catastrophic event would have had profound implications. Based on A.M. Best’s data captured on 164 companies, a single event with the same severity as Gonu across the GCC would have resulted in an estimated third of all companies requiring recapitalisation (see Exhibit 2). However, none of the companies rated by A.M. Best currently would have an issue with their capitalisation even if they were impacted

Exhibit 2 GCC - Catastrophe Event with Severity Similar to Gonu* - Impact on Operating Profits and Capitalisation (Number of companies and USD billions)

180 1.4 160 1.2 140 40 USD 1 120 1.10 USD billions to 0.8 100 133 1.38 bn 80 0.6 60 124 0.4

Number of Companies 40 59 0.2 20 31 0 0 Capital required 2015 With 120% combined Companies requiring (USD billions) to capital injection reach MCR post event Profit making Loss making Companies requiring capital injection Minimum capital shortfall Maximum capital shortfall Notes: * Single event resulting in a non-life combined ratio of 120% Sources: – Best's Statement File – Global, A.M. Best data & research

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by a 1-in-250 year event as they are generally sufficiently capitalised to absorb a material catastrophe event based on current assumptions used by companies.

The data show that 124 companies posted a profit in 2015, but had a major event caused the non-life sector to post a combined ratio of 120%, then 133 would have been loss making. More than a third (59) would be below their minimum capital requirement (MCR) levels, resulting in a need to replenish capital. A.M. Best estimates the total capital injection could potentially amount to USD 1.38 billion – assuming that reinsurers did not default and would have been able to pay obligations on time, and that there was no decline in investment values.

International Reinsurers Continue to Support Domestic Market A.M. Best notes that the global reinsurance sector appears to be well placed to continue to support the GCC market, and capacity remains unchanged. While the hurricane activity in 2017 was an earnings event for major reinsurers, providers of convergence capital have been able to re-load their capacity. As global reinsurance capacity remains relatively unchanged, A.M. Best views this as a positive factor for GCC insurers given their high reinsurance dependence.

An examination of the purchasing trends in the UAE provides a good illustration of the heavy reliance on the international reinsurance community (see Exhibit 3). Markets have benefited from what appears to be inexpensive capacity, and after a period of decline whereby the cession ratio fell from 54% in 2007 to 43% in 2011, the cession ratio for the overall UAE market had returned to 54% by 2016.

The UAE is an example where the purchase of reinsurance (often driven by the higher proportion of high-value risks) is more pronounced, reflecting the large scale urban-focused risks, particularly for high-rise buildings. Nevertheless, A.M. Best notes that many other local markets have benefitted from declining reinsurance rates and increased their cession rates – particularly for large-value items such as energy risks. As part of their ERM practices, insurers

Exhibit 3 United Arab Emirates - Reinsurance Cessions and Cost of Reinsurance (2006-2016) (%) 75% 1.80

1.60 Cost of Reinsurance of Cost 1.40 50% 1.20

1.00

Cession ratio 25% 0.80

0.60

0% 0.40 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Cession ratio Cost of reinsurance Notes: Cost of Reinsurance is defined as: Ceded Claims Reserves / Ceded Premiums Sources: – Best's Statement File – Global, A.M. Best data & research

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should be questioning whether counterparty risk has remained stable throughout the period and should ensure reinsurance buying is linked to risk appetite. This also brings to the fore the need for companies to evaluate the viability of their business model in case reinsurance capacity were to be reduced drastically or the average counterparty was to deteriorate significantly.

Cat Losses Need Not be Caused by Natural Events In A.M. Best’s opinion, although historically traditional losses caused by nature are less of a feature of the GCC markets, man-made risks such as outstanding balances can be regarded as hidden sources of peril. Saudi Arabia has been driving an overall improvement in the GCC market as the regulator, the Saudi Arabian Monetary Authority, has limited the admissibility of long outstanding balances. Consequently, A.M. Best’s analysis shows that across the six countries, the average time that premiums remain outstanding has fallen from an estimated 273 days in 2006 to 158 days in 2016 (see Exhibit 4). Meanwhile, the UAE has the highest level of premiums outstanding. This reflects market practices and is on an upwards trend. Outstanding premiums have risen steadily from 264 days in 2006 to 294 in 2016.

To further compound the challenges faced by UAE insurers, in 2006, the UAE accounted for almost half of the cash flow of the GCC insurance industry, but as Exhibit 5 illustrates, a decade later this had fallen to below 10%.

As late payments impact cash flow, questions have focused on the high levels of outstanding premiums, and whether all these amounts are recoverable. Furthermore, what would happen if balances were written-off. Such an event could occur as a result of the implementation of more stringent accounting standards. A.M. Best considers that adopting a more prudent approach to writing off outstanding balances would have more severe implications on the UAE insurance market’s capitalisation than a natural catastrophe on the scale of Gonu. Furthermore, A.M. Best expects cash flow issues in the region to have been further exacerbated since the roll-out of Value Added Tax across the GCC countries from January 1, 2018.

Exhibit 4 GCC and United Arab Emirates - Days Premiums Remain Outstanding (2006-2016)* (Number of days outstanding) 350

300

250

200

150

100

Number of days outstanding 50

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Gulf Cooperation Council United Arab Emirates Notes: *: Balances oustanding based on net written premiums. Sources: – Best's Statement File – Global, A.M. Best data & research

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Exhibit 5 GCC and United Arab Emirates - Cash Flow Generated (2006-2016)

4

3.6

3

2.8 2.5 2.6

2 2.1 2.0

1.5 1.6 1.4 Net Written Premiums 1 1.2 1.0

0.66 0.68 0.57 0.59 0.47 0.47 0.47 0.24 0.44 0.26 0.26 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Gulf Cooperation Council United Arab Emirates

Sources: – Best's Statement File – Global, A.M. Best data & research

Shares and real estate investments could present another possible source of artificial catastrophic losses. Over the last decade, there has been a significant de-risking of investment portfolios in the region, although insurers in many markets, especially the UAE, do continue to take more investment risk than their counterparts in other parts of the world. There is a high correlation between the value of shares and real estate within the Middle East, as was demonstrated in the period 2009-2010 when both asset classes experienced declines.

A scenario similar to that experienced during the 2009 crisis would again result in higher losses than a major natural catastrophe such as Gonu. The market remains vulnerable to investment write downs, particularly given the high correlation between local stocks and real estate values.

Growing Importance of ERM While, the GCC has lower levels of exposure to natural catastrophes, cyclone activity in Oman and flooding in areas such as the UAE and Jeddah in Saudi Arabia demonstrates that these countries are not entirely free from weather-related losses.

A.M. Best considers man-made events such as damages to high-value asset risks, premium collection and investment risk more than offset the more muted natural catastrophe activity in the region. It is A.M. Best’s opinion that insurers will need to re-examine their risk appetite and strengthen their ERM practices to ensure risks are appropriately managed.

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Exhibit 6 Gulf Cooperation Council (GCC) Region – A.M. Best-Rated Companies Ratings as of Jul. 18, 2018.

Best's Long- Term Best's Issuer Financial Credit Strength Best's ICR & Best's ICR Rating Rating Rating FSR & FSR Effective AMB # Company Name Domicile (ICR) (FSR) Action Outlook Date 91291 ACE American Insurance Company (Bahrain Branch) Bahrain aa+ A++ Affirmed Stable 5-Oct-17 85013 Arab Insurance Group (B.S.C.) Bahrain a- A- Affirmed Stable 22-Nov-17 85489 Bahrain Kuwait Insurance Company B.S.C. Bahrain a- A- Affirmed Stable 6-Jul-18 94316 FAIR Oil & Energy Insurance Syndicate Bahrain bbb- B+ Upgraded Stable 22-Feb-18

77623 Life Insurance Corporation (International) B.S.C. (c) Bahrain bbb B++ Downgraded1 Negative 9-Apr-18 92458 Saudi Arabian Insurance Company B.S.C. (c) Bahrain a- u A- u Under Review2 Negative 24-Jan-18 91539 SNIC Insurance B.S.C. (c) Bahrain bbb- B+ Affirmed Stable 13-Jul-17

88717 Solidarity Bahrain B.S.C. Bahrain bbb B++ Assigned Positive3 4-Dec-17 87928 The Bahrain National Insurance Company BSC (c) Bahrain bbb+ B++ Affirmed Stable 22-Nov-17 86326 Trust International Insurance & Reinsurance Company B.S.C. Bahrain a- A- Affirmed Stable 25-Aug-17 (c) Trust Re 86804 Al Ahleia Insurance Company S.A.K.P. Kuwait a- A- Affirmed Stable 27-Apr-18 90950 Gulf Insurance and Reinsurance Company K.S.C. (Closed) Kuwait a A Affirmed Stable 6-Jul-18 90842 Gulf Insurance Group K.S.C.P. Kuwait a A Affirmed Stable 6-Jul-18 85585 Kuwait Reinsurance Company K.S.C.P. Kuwait a- A- Affirmed Stable 27-Apr-18

78110 National Life and General Insurance Company SAOG Oman bbb+ B++ Upgraded1 Stable 2-May-18 93609 Oman Reinsurance Company SAOC Oman bbb- B+ Assigned Stable 29-Aug-17 78636 Doha Insurance Group Q.P.S.C. Qatar a- A- Affirmed Stable 14-Sep-17 85452 Qatar General Insurance & Reinsurance Company QPSC Qatar a- A- Affirmed Stable 8-Feb-18 78335 Qatar Insurance Company S.A.Q. Qatar a A Affirmed Stable 21-Dec-17 78631 Qatar Islamic Insurance Company Q.S.C. Qatar bbb+ B++ Affirmed Stable 8-Mar-18 92612 QIC International LLC Qatar a A Affirmed Stable 21-Dec-17 90708 Abu Dhabi National Takaful Company P.S.C. United Arab Emirates a- A- Affirmed Stable 24-Aug-17 78732 Alliance Insurance (PSC) United Arab Emirates a- A- Affirmed Stable 8-Sep-17 90714 Al-Sagr National Insurance Company P.S.C. United Arab Emirates bbb- B+ Affirmed Stable 8-Sep-17 93336 Asia Capital Reinsurance Group Pte. Ltd. (Dubai Branch) United Arab Emirates a- A- Affirmed Negative 7-Dec-17 90584 Dubai Insurance Company (PSC) United Arab Emirates a- A- Affirmed Stable 19-Apr-18 90716 Dubai National Insurance & Reinsurance P.S.C. United Arab Emirates bbb+ B++ Assigned Stable 14-Sep-17 85401 Emirates Insurance Company P.S.C. United Arab Emirates a- A- Affirmed Stable 20-Jul-17 93386 General Insurance Corporation of India (Dubai Branch) United Arab Emirates a- A- Affirmed Stable 28-Feb-18 90718 National General Insurance Company (P.S.C.) United Arab Emirates a- A- Affirmed Stable 6-Apr-18 92651 National Takaful Company (Watania) PJSC United Arab Emirates bb+ B Affirmed Stable 25-Apr-18 90644 Noor Takaful Family PJSC United Arab Emirates bb B Assigned Stable 30-Jan-18 90591 Noor Takaful General PJSC United Arab Emirates bb B Assigned Stable 30-Jan-18 78177 Oman Insurance Company P.S.C. United Arab Emirates a A Affirmed Stable 24-Aug-17

78593 Orient Insurance PJSC United Arab Emirates a A Affirmed Positive3 27-Jun-18 90357 Union Insurance Company P.J.S.C. United Arab Emirates bbb B++ Affirmed Stable 17-Aug-17 Notes: 1: FSR Affirmed 2: Affirmed Under Review 3: FSR Outlook Stable

Source: – Best's Statement File - Global, A.M. Best data and research

7 Market Segment Report Gulf Cooperation Council (GCC) Region

Market Segment Report

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