GCR affirms Constantia Insurance rating at A-(ZA); Outlook Stable

01 March 2017 Marc Chadwick, GCR
Marc Chadwick, Sector Head of Insurance Ratings at GCR.

Marc Chadwick, Sector Head of Insurance Ratings at GCR.

Global Credit Ratings (GCR) has accorded Constantia Insurance Company Limited an A-(ZA) rating, affirming the company’s outlook for the 2017 financial year as stable.

Constantia operates within niche segments of the insurance market, complemented by personal lines and smaller commercial market offerings. Underwriting Management Agencies (UMAs) are utilised as the predominant product distribution channels and are incentivised both on a fixed fee (as a percentage of gross premiums) and profit share arrangement.

“Constantia’s risk adjusted capital adequacy ratio is expected to register at strong levels over the rating horizon, underpinned by the capital management strategy in place,” says Marc Chadwick, Sector Head of Insurance Ratings at GCR.

The company is wholly owned by Constantia Risk and Insurance Holdings, with the shareholder having committed to inject additional funds to meet regulatory capital requirements, and support strong growth targets, offering the insurer a certain degree of financial flexibility in future.

In this regard, an additional R100 million was allocated to the subsidiary by its holding company in January this year, following its contribution of R30 million in the financial year to June 2016.

Key balance sheet liquidity measures remained at very solid levels during the last financial period. Cash covered net technical liabilities 3,8 times (2015: 3,7 times), while claims were covered by cash reserves by 20 months (2015: 27 months), as reported cash levels were slightly lower in 2016 compared to 2015.

Going forward, GCR expects liquidity metrics to remain sound, supported by the floors set by management in conjunction with the objectives outlined in their investment strategy.

“Constantia’s earnings capacity was volatile over the reviewed five-year period to 2016, largely as a function of certain products giving rise to loss ratio variability, which GCR expects to persist over the rating horizon.”

Furthermore, the insurer’s shift in strategic focus introduces further execution risk, and earnings pressure over the short term, largely as a function of higher operating costs to support business growth initiatives.

This notwithstanding, the demonstrated attainment of key growth factors in operations and diversification efforts in underlying investments may gradually support underwriting profitability, and GCR’s view of medium-term earnings capacity.

Exposure to listed equities is expected to increase to about 70% of capital by end 2017 (2016: 52%), representing an intermediate level of capital risk.

Nevertheless, strong risk adjusted capital adequacy levels contributes to GCR’s view that the insurer is positioned to absorb a degree of potential external shocks emanating from shifts in capital markets.

Furthermore, reinsurance arrangements are placed with highly rated counterparties, while the highest net retentions per risk and event are limited to levels viewed to be conservative relative to capital.

Management is in the process of shifting its business model, with increased focus on strategic engagement and relationship building with key partners, while pursuing new lines of business.

In this respect, the insurer aims to mitigate earnings volatility due to operations, while reducing revenue risk inherent in the concentrated client base (two key partners accounted for 60% of gross premiums in 2016).

As such, the ability of the insurer to successfully align incentives and performance objectives across key partners, while bedding down operations, may gradually strengthen the insurer’s business profile over the medium term.

The potential of a rating upgrade may follow a strengthening in the insurer’s business profile and establishing an improved and sustainable future earnings stream. This, however, would need to be supported by capital and liquidity levels remaining within strong ranges.

Conversely, a downgrade could result from a persistent deterioration in underwriting margins, coupled with risk adjusted capital adequacy ratios contracting below expectations.

“A further increase in revenue concentration, combined with the loss of one or more profitable underlying investment portfolios, and the non-replacement thereof impeding diversification efforts, could lead to negative ratings pressure,” Chadwick concludes.

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