Announcements Insurance Rating Alerts

GCR downgrades Sizwe’s national scale financial strength rating to A+(ZA) following erosions of the scheme’s financial profile; Evolving Outlook

Rating action

Johannesburg, 30 September 2020 – GCR Ratings (“GCR”) has downgraded Sizwe Medical Fund’s (“Sizwe”) national scale financial strength rating to A+(ZA) from AA-(ZA), and revised the outlook to Evolving.

Rated Entity / Issue

Rating class

Rating scale

Rating

Outlook/Watch

Sizwe Medical Fund

Financial strength

National

A+(ZA)

Evolving Outlook

The rating action follows a reduction in the South African country and medical schemes sector risk assessments.

The South African country risk score was lowered to 7.0 from 7.5 previously, in a market alert released on 27th May 2020. Click here to access the link. On 14th July 2020, the South African medical schemes sector risk score was also lowered to 7.75 from 8.00 previously. Click here to access link.

Combined, the above country and sector risk scores comprise the operating environment score, which is a key input into GCR’s ratings.

Rating rationale

The downgrade of Sizwe’s national scale financial strength rating reflects the erosion of the scheme’s financial profile, driven by earnings which significantly deteriorated over the last two years. Consequently, capitalisation and liquidity were assessed within a moderately strong range in FY19, compared to strong levels achieved between FY15 and FY17. However, note was taken of the short-term improvement in earnings in 1H F20 and the potential amalgamation with Hosmed Medical Scheme (“Hosmed”), although it was opposed by the regulator who applied to put the scheme under curatorship. As such, the Evolving Outlook was accorded to capture the potential for the scheme’s credit profile to improve, if the transaction with Hosmed is approved and if earnings can materially build capital and liquidity over the next 12-18 months. Meanwhile, further negative regulatory action may also trigger more negative rating movement.

Earnings moderated within an intermediate range, underpinned by spikes in net claims payments over the past two years. This exerted additional pressures on contribution levels given the scheme’s limited membership scale and low average contribution increases (FY19: 7% and FY18: 5%). As a result, the net healthcare loss deepened in FY19 to R296m (FY18: R277m loss), compared to the average surplus of R42m between FY15 and FY17. Net profitability simultaneously deteriorated to a R194m loss (FY18: R170m loss; FY15-FY17 average: R140m surplus), despite sound investment income (FY19: R93m; FY18: R85m). Over the medium term, we expect the scheme’s earnings to remain under pressure, especially when benefit utilisation will normalise, while accrued economic challenges due to the COVID-19 pandemic will exacerbate earnings pressures notably on contribution levels and investment income. However, we believe that accumulated reserves still provide loss absorption capacity to the scheme, albeit this could be rapidly eroded if earnings weaknesses persist.

Capitalisation remained a key rating strength, despite reserve utilisation over the past two years. In this regard, GCR CAR and statutory solvency measured within moderately strong ranges, at 1.7x and 37% respectively at FY19 (FY18: 2.1x and 47% respectively), adequately catering for relatively stable aggregate risks. However, capitalisation could moderate further over the medium term, given expected earnings pressures in the midst of the COVID-19 pandemic, which may counterbalance initiatives to stabilise reserve levels. Therefore, the ability to manage capitalisation within rating sufficient levels will represent a key consideration going forward.

Liquidity was also assessed within a moderately strong range, following cash absorptions by operating activities, which resulted in a 17% contraction of the investment portfolio to R1.0bn at FY19 (FY18: R1.3bn). Consequently, cash and stressed financial assets coverage of average monthly claims and operational cash requirements equated to 4.2 months and 0.9x respectively (FY18: 5.6 months and 0.9x respectively), compared to a very strong respective average of 7 months and 1.0x achieved between FY15 and FY17. Going forward, liquidity could also further moderate despite a consistently prudent asset allocation, constrained by expected earnings strain amidst economic challenges.

The membership profile is viewed to be credit negative, a function of a limited membership base, coupled with concentrations to select corporate entities exposing the scheme to members’ volatility. GCR notes that the membership base stabilised in FY19, reflecting the marginal impact of aggressive marketing initiatives. Medium term organic growth could be hindered by the current economic environment, with the scheme’s membership base and diversification expected to improve upon amalgamation with Hosmed. However, uncertainty remains regarding the timing of the amalgamation, with the regulator’s opposition and application to put Sizwe under curatorship. Despite the counter case from Sizwe, GCR negatively views such regulatory action, adjusting management and governance downward to cater for related risks like reputational damage. The adjustment could become more negative and result in deterioration of the scheme credit profile, if the regulator takes further negative action against the scheme.

Outlook statement

The Evolving Outlook is premised on the potential merger with Hosmed, which if approved is likely to support a rating upgrade, especially if the short-term increase in earnings can be maintained over the next 12-18 months. Meanwhile, further negative regulatory action against the scheme may result in a further deterioration of the scheme’s credit profile, especially as this coincides with additional challenges due to COVID-19 pandemic risks.

Rating triggers

Positive rating movement may follow the removal of negative regulatory action against the scheme and approval of the merger with Hosmed and/or longer term earnings performance leading to improved capitalisation and liquidity. Conversely, additional negative regulatory action against Sizwe is likely to trigger further downward rating movement. Moreover, negative rating pressure may follow sustained earnings weakness that reduces solvency and/or liquidity below expectations.

Analytical contacts

Primary analyst

Fleur Ngassa

Analyst: Insurance Ratings

Johannesburg, ZA

MarlaineN@GCRratings.com

+27 11 784 1771

     

Committee chair

Matthew Pirnie

Group Head of Ratings

Johannesburg, ZA

MatthewP@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 South Africa Medical Scheme Sector Risk Score, July 2020

Ratings history

Sizwe Medical Fund

Rating class

Review

Rating scale

Rating class

Outlook/Watch

Date

Claims paying ability

Initial

National

A+(ZA)

Stable

July 2015

Financial strength

Last

National

AA-(ZA)

Stable

November 2019

Risk score summary

Rating components & factors

Risk scores

 

 

Operating environment

14.75

Country risk score

7.00

Sector risk score

7.75

   

Business profile

(2.00)

Membership profile

(1.75)

Management and governance

(0.25)

 

 

Financial profile

1.25

Earnings

(0.25)

Capitalisation

1.00

Liquidity

0.50

   

Comparative profile

0.00

Peer analysis

0.00

   

Total score

14.00

Glossary

Rating Outlook

See GCR Rating Scales, Symbols and Definitions.

Rating Watch

See GCR Rating Scales, Symbols and Definitions.

Release

An agreement between the creditor and debtor, in terms of which the creditor release the debtor from its obligations.

Reserve

(1) An amount representing actual or potential liabilities kept by an insurer to cover debts to policyholders. (2) An amount allocated for a special purpose. Note that a reserve is usually a liability and not an extra fund. On occasion a reserve may be an asset, such as a reserve for taxes not yet due.

Reserves

A portion of funds allocated for an eventuality.

Risk

The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.

Settlement

Full repayment of an obligation.

Solvency

With regard to insurers, having sufficient assets (capital, surplus, reserves) and being able to satisfy financial requirements (investments, annual reports, examinations) to be eligible to transact insurance business and meet liabilities.

Statutory

Required by or having to do with law or statute.

SALIENT POINTS OF ACCORDED RATING

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

Subsequent to an appeal by the rated entity, the Outlook on the national scale financial strength rating was revised as reflected in the announcement. The credit rating has been disclosed to the rated party. The rating was solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the rating. 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 entity and other reliable third parties to accord the credit rating included:

  • Audited financial statements to 31 December 2019;
  • Four years of comparative audited financial statements to 31 December;
  • Full year budgeted financial statements to 31 December 2020;
  • Unaudited management accounts to 30 June 2020;
  • Other relevant documents
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