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Oct 2018

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Elusive consolidation

Source: Middle East Insurance Review | May 2018

Though the insurance industry in MENA has been prodded to go in for a high dose of M&A as a panacea for all its ills such as fragmentation, weaker players, lack of product innovation and tardy technology adoption, consolidation took a backseat in the past two years.
 
   M&A deals have historically been few and far between as larger insurers have been unwilling to expose themselves to weaker balance sheets, while the boards of targeted insurers have been unwilling to give up control, according to a Moody’s Investors Service CFO survey. Considering the fact that more than 200 insurance companies operate in the GCC, the pace of consolidation has been very slow. 
 
   “We haven’t seen consolidation on a large scale. But there are prospects because there is increased investor awareness and improved profitability, at least in motor and medical,” said Mr Mohammed Ali Londe, assistant vice president, analyst, EMEA Insurance, Moody’s.  
 
No real consolidation
Mr Sachin Sahni, associate, financial services, S&P Global Ratings said the need for consolidation in the GCC insurance markets has been a key point of discussion for a very long time now, but it is seldom followed by real action.
 
   “Many industry experts have repeatedly indicated that the GCC insurance markets are overcrowded and in order to maintain a healthy and profitable sector, the number of insurers must go down,” he said.
 
   However, the number conundrum and over-capacity continue. Some acquisitions should not be considered real consolidations – or mergers – as the number of players in the market remains the same. There have been only a handful of real consolidations in the GCC in the recent past, with a couple of deals in Oman in 2017 due to regulations requiring the minimum capital requirement to be doubled, and two or three others have been concluded – or are in the finalisation process – in other GCC states. 
 
   “There are too many companies, more than 60, for a small market such as the UAE. So there is a need for consolidation, but there are fewer deals. Activities (M&A) are going on elsewhere in the Middle East, but we don’t know if they will materialise,” said Mr Safder Jaffer, managing director and consulting actuary, Middle East, Milliman, which is already working with a few companies involved in deals. 
 
Select recent transactions in the GCC Insurance sector
 
Handful of deals
While there have been a few M&A deals in recent years, most of them are acquisitions – where one company buys or increases its stake in another company but both companies continue to exist and operate separately. 
 
   Major deals in the first quarter of this year include South Africa-based financial services group Sanlam and its general insurance subsidiary Santam acquiring a 53.37% stake in Morocco’s Saham Finances for $1.05bn.
In Egypt, Delta Insurance was acquired by Egypt Kuwait Holding for $19m.
 
   The market has seen a few more deals in the UAE, Bahrain and Kuwait in 2017. They include a deal in December last year to acquire Al Hilal Takaful from Al Hilal Bank by Takaful Emarat, with the merged entity becoming the largest Islamic insurer in the UAE. 
 
   Bahrain’s Al Ahlia Insurance was acquired by Solidarity General Takaful in August 2017, resulting in Solidarity Bahrain.
 
   In Saudi Arabia, Al Ahlia for Cooperative Insurance Company and Gulf Union Cooperative Insurance Co have extended their non-binding MoU for a potential merger. Walaa Insurance is in negotiation with two local insurers for a possible merger.
 
   In 2016, Oman Arab Bank acquired a minority stake in Falcon Insurance. Similarly, Bahrain Kuwait Insurance bought minority shares in Takaful International in 2015.
 
   Kuwait Reinsurance was acquired by Al-Ahleia Insurance in 2015.
 
The driving forces
Consolidation should ideally be a natural process for any industry with a large number of players jostling for market share. However, in the case of the insurance sector such a natural process has been absent for various reasons such as resistance from shareholders, the family-owned nature of businesses, a lack of regulatory push and profitability considerations. 
 
   What is driving consolidation is the additional operational procedures and expenses imposed by regulations. The stricter capital rules are forcing some insurers to exit certain business lines. 
 
   The fact remains that there has been resistance from shareholders, particularly that of family-owned companies.
 
   “I think there is change in the mindset of shareholders. It is partially driven by regulatory push and the companies are realising that the solvency requirements are solid and hence there is a need for pushing the agenda,” Mr Jaffer said.
 
   Mr Londe agrees that some shareholders have been resisting M&A. That’s where regulations play a part as they require risk-based capital and solvency to be part of the companies’ filings because the required corporate governance and risk management need to be part of the procedures. It is now up to the shareholders to either take it on or start costing them. If they are not pricing or taking excessive amounts of underwriting risks it will affect their capital. 
 
   “How quick that will be done or whether that will be for the existing shareholders remains to be seen. We expect consolidation to happen because there might be some shareholders looking to exit or other shareholders might be willing to take on that risk,” Mr Londe said.
 
   Companies most keen on acquisitions will be driven by different strategic rationales, such as acquiring complementary businesses, growing existing business in a bid to strengthen market position, or even filling portfolio gaps. 
 
   “Non-core disposals by business groups and banks, for competitive and regulatory reasons, will also generate acquisition targets in the sector. The industry may see transformational deals with two large players merging to create a dominant industry player,” said Mr Rajiv Maloo, associate director with KPMG Lower Gulf Ltd.
 
Capacity matters
The consolidation route is one way for companies to become larger and achieve economies of scale. In an industry where scale and capital efficiency really matter, the fragmented nature of the market is likely to see smaller insurers being acquired by larger ones, helping them generate synergies across cost, compliance, distribution, reinsurance and underwriting. These synergies however will need to be large enough to justify an acquisition. 
 
   “The case for acquisitions, underpinned by economies of scale, is going to be stronger for larger insurers acquiring sub-scale or medium-sized insurance companies as the larger insurers may already be operating at scale resulting in limited cost and revenue synergies,” said Mr Maloo.
 
   When companies become larger in size and operations, the question arises whether there will be monopoly and price war. “At the end of the day, there is always the fear of price competition seeping in and the consolidated entities, with larger capital available, taking higher risks. That’s a highly possible scenario,” Mr Londe said. 
 
   With improved regulations, which give a lot of focus on risk management, some of the companies are becoming sophisticated. Even the consolidated entities will become more sophisticated in their risk management procedures. They are not just looking over their shoulders to price the products, but are actually looking at actuarial pricing, which should benefit the market.
 
   In MENA, a number of international and domestic insurers have opted to exit after suffering underwriting losses that have ramped up premiums to unsustainable levels.  
 
   “Now it’s a matter of consolidated entities managing the capital. From the underwriting side at least the prices have hardened, leaving some pressure there. So there might be some attraction for new investors or existing investors to consolidate on that part,” Mr Londe added.
 
Regulatory compliance
Whether it is happening at a desirable speed or not, the industry’s maturity and efficiency depend on how consolidation takes shape. “Consolidation is the way forward if insurers want to survive and grow profitably. Industry statistics have highlighted that larger insurers are generally more profitable as compared to smaller players due to economies of scale and relatively lower operating costs,” Mr Sahni said.
 
   A key concern which has been gaining trajectory is the rising cost of regulatory compliance. While it affects all insurers alike, the smaller players are finding it increasingly difficult to keep up with the pace of changing regulatory framework. The recent regulatory initiatives, whether it is risk-based solvency regulations in the UAE or doubling of minimum capital requirement in Oman or a stringent regulatory framework in Saudi Arabia, are placing additional pressures on insurers.
 
Subdued deals ahead
Going forward, the pace of consolidation will remain subdued. Additional costs associated with the updated regulations may prompt some form of market consolidation particularly for smaller insurers, or encourage them to focus on business lines that yield adequate returns. Both developments would reduce overcapacity and ease competitive pressures.
 
   There can also be cross-border acquisitions. “Global players are looking at this region for acquiring smaller regional companies. It’s starting, although multinationals are cautious about the region. They are certainly interested if there is something solid,” said Mr Jaffer. 
 
   With the application of new risk-based capital requirements in the region in a bid to align insurers more closely with their European counterparts that adhere to Solvency II, insurers in MENA are under pressure to drive consolidation.
As Mr Sahni predicts, the pace of consolidation will remain slow until there is a real push from regulators giving insurers only two options – comply or consolidate. M 
 
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