Announcements Insurance Rating Alerts

GCR downgrades Emeritus Re Zambia’s national scale financial strength rating to CCC+(ZM) on solvency reduction due to elevated credit impairments; Outlook Negative

Rating action

Johannesburg, 01 October 2020 – GCR Ratings (“GCR”) has downgraded Emeritus Reinsurance Zambia Limited’s (“Emeritus Re Zambia”) national scale financial strength rating to CCC+(ZM), from B(ZM), with the outlook accorded as Negative. Simultaneously, GCR affirmed the international scale financial strength rating of CCC-, with the outlook accorded as Stable.

Rated Entity / Issue Rating class Rating scale Rating Outlook/Watch
Emeritus Reinsurance Zambia Limited Financial strength International CCC- Stable Outlook
National CCC+(ZM) Negative Outlook

Rating rationale

The national scale rating of Emeritus Re Zambia has been downgraded on account of a significant reduction in capitalisation following a steep loss recorded during the review year. The loss was driven by a high impairment of reinsurance receivables after the initial adoption of IFRS 9. In this respect, risk adjusted capitalisation lowered into a vulnerable range, with potential for earnings to remediate the shortfall in solvency capital requirements viewed to be limited over the rating horizon.

Emeritus Re Zambia posted a net loss of ZMK7.7m, reducing capital to ZMK12m at FY19. Accordingly, the GCR capital adequacy requirement (“CAR”) ratio reduced drastically to well below 1x, after considering the further depressive impact of inadmissible assets. While a positive trend in internal capital generation emerged in 1H F20 trading, capacity for the capital deficit to be met from operations is limited. In this regard, risk adjusted capitalisation is likely to be maintained within a vulnerable range over the rating horizon, barring a capital injection.

As per the aforesaid, earnings are credit negative with legacy exposures to receivables likely to weigh down profit margins, given high operating leverage. The reinsurer’s underwriting margins measured within a negative range over the past five years with the review year impairment of premium receivables depressing the metric to a review period low of -57% (FY18: -28%). The adoption of premium warranty clauses to control credit losses is largely expected to cure the adverse receivables trend, although in GCR’s view earnings drivers are cemented within a range that constrain a material turnaround in profitability. GCR projects the reinsurer’s total expense ratio at above 65% (FY18: 107.3%; FY17: 78.7%), requiring the loss ratio to measure below a highly demanding 35% (prior two-year average: 49%) over the medium term. Therefore, exhibited margin headroom reduces prospects for a sustainable turnaround in underwriting performance over the medium term, given pressured commission structures in the market. Furthermore, investment income is likely to remain constricted by low investment portfolio scale, despite a prudent asset mix and high yields, reducing uplift to bottom-line earnings.

Liquidity was maintained within an intermediate range, with cash and stressed assets covering net technical liabilities by a stable1.1x. The reinsurer’s investment portfolio is largely invested in low risk – high yielding fixed income securities (98% of invested funds), which could combine well with credit risk containment strategies to enhance overall cash extraction and preservation but remain subject to scale limitations. In this respect, liquidity metrics are unlikely to strengthen to a rating adequate range over the rating horizon.

The ratings consider Emeritus Re Zambia’s limited business profile. The reinsurer holds around 3% of domestic premium cessions and is viewed to lack competitiveness in markets outside Zambia, following the group’s regionalisation strategy. Furthermore, the overall business profile reflects very low premium scale per line of business, constraining the factor’s assessment.

Overall, Emeritus Re Zambia shares the same branding with Emeritus Reinsurance (Private) Limited, the parent domiciled in Zimbabwe, as well as technical platforms that increase access to the group’s credit strengths. In GCR’s view, such support is more likely in a stressed scenario, taking into consideration a previous capital injection in FY17 and the recent capitalisation initiatives at Emeritus International Reinsurance Company Limited, the intermediate non-operating holding company domiciled in Botswana.

Outlook statement

Given likely delays in capitalising Emeritus Re Zambia in view of competing demands for capital within the wider group, the GCR CAR ratio is expected to measure around 0.5x and the liquidity coverage ratio around 1.1x after factoring in a modest turnaround in earnings during FY20. The forecast levels of solvency and liquidity metrics could result in a further downgrade of the national scale rating as they are below rating adequate ranges. However, potential exists for the group to remediate the small capital shortfall required in absolute terms and possible regulatory risk over the medium term. The Outlook on the international scale rating is stable as the reinsurer is believed to be capable of honouring obligations above levels implied by lower rating ranges over the medium term.

Rating triggers

The Outlook may revert to Stable over the medium term if risk adjusted capitalisation metrics improve to around 1x and the liquidity coverage ratio to above 1.3x, while other factors remain supportive of the current rating. On the other hand, the national scale rating may be downgraded if (1) the operating environment is reassessed downwards; (2) risk adjusted capitalisation and liquidity metrics remain within the current range or compress further; and (3) the envisaged earnings turnaround does not materialise.

Analytical contacts

Primary analyst Godfrey Chingono Deputy Sector Head: Insurance Ratings
Johannesburg, ZA GodfreyC@GCRratings.com +27 11 784 1771
Committee chair Susan Hawthorne Senor Credit Analyst: Insurance Ratings
Johannesburg, ZA SusanH@GCRratings.com +27 11 784 1771

Related Criteria and Research

Criteria for the GCR Ratings Framework, May 2019
Criteria for Rating Insurance Companies, May 2019
GCR Ratings Scales, Symbols & Definitions, May 2019
GCR Country Risk Scores, May 2020
GCR Insurance Sector Risk Scores, July 2020

Ratings history

Emeritus Reinsurance Zambia Limited

Rating class Review Rating scale Rating class Outlook/Watch Date
Claims paying ability Initial International B Stable November 2009
Initial National BBB+(ZM) Stable November 2009
Financial strength Last International CCC- Stable Outlook December 2019
Last National B(ZM) Negative Outlook December 2019

Risk score summary

Rating Components and Factors Risk score
Operating environment 4.75
Country risk score 2.00
Sector risk score 2.75
Business profile (2.00)
Competitive position (1.50)
Premium diversification (0.50)
Management and governance 0.00
Financial profile (3.25)
Earnings (0.50)
Capitalisation (2.00)
Liquidity (0.75)
Comparative profile 1.00
Group support 1.00
Government support 0.00
Peer analysis 0.00
Total Score 0.50

Glossary

Premium The price of insurance protection for a specified risk for a specified period of time.
Provision The amount set aside or deducted from operating income to cover expected or identified loan losses.
Rating Horizon The rating outlook period
Rating Outlook See GCR Rating Scales, Symbols and Definitions.
Reinsurance The practice whereby one party, called the Reinsurer, in consideration of a premium paid to him agrees to indemnify another party, called the Reinsured, for part or all of the liability assumed by the latter party under a policy or policies of insurance, which it has issued. The reinsured may be referred to as the Original or Primary Insurer, or Direct Writing Company, or the Ceding Company.
Retention The net amount of risk the ceding company keeps for its own account.
Risk The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.
Securities Various instruments used in the capital market to raise funds.
Security One of various instruments used in the capital market to raise funds.
Senior A security that has a higher repayment priority than junior securities.
Short Term Current; ordinarily less than one year.
Underwriting The process of selecting risks and classifying them according to their degrees of insurability so that the appropriate rates may be assigned. The process also includes rejection of those risks that do not qualify.
Upgrade The rating has been raised on its specific scale.

SALIENT POINTS OF ACCORDED RATINGS

GCR affirms that a.) no part of the rating process was influenced by any other business activities of the credit rating agency; b.) the ratings are based solely on the merits of the rated entity, security or financial instrument being rated; and c.) such ratings are an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

The credit ratings have been disclosed to the rated party. The ratings were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings. The rated entity participated in the rating process via virtual management meetings, and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible.

The information received from the entities and other reliable third parties to accord the credit ratings included:

  • Audited financial results as at 31 December 2019;
  • Four years of comparative audited financial statements to 31 December
  • Full year company budgeted financial statements for 2020;
  • Unaudited company interim results to 31 May 2020;
  • Reinsurance cover notes for 2020; and
  • Other relevant documents.
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