Inflated valuations and a reluctance to relinquish control are preventing smaller insurers in the GCC from consolidating, and in a move to avoid reporting losses, they could distort market pricing for all, a report said.

A small number of well-established insurers are reaping the benefits of the fast-growing insurance markets in the GCC region, added the RatingsDirect analysis from Standard & Poor's Ratings Services.

Insurance in the GCC region continues to benefit from generally robust economic growth because the considerable hydrocarbon wealth of the GCC states sustains their expanding economies.

“Real GDP growth in the region was nearly 6 per cent in 2012, and we expect this growth momentum to continue in 2013 and beyond,” said Anvar Gabidullin, primary credit analyst with S&P Rating Services.

The GCC insurance sector grew to nearly $16 billion in terms of gross premium written and we observed growth rates of over 10 per cent in the region's largest insurance markets in 2012. Ample capital is available within the industry to back the growth in insurance premiums.

Both regional and international investors are looking for a slice of the business because of the growth potential. This creates a highly competitive marketplace in which all companies are contending for profitable business.

The ensuing competition puts pressure on margins, Gabidullin said.

Concentrated profits

“Although we estimate that the GCC markets are profitable as a whole, the profits tend to be concentrated at larger and more-established entities. For example, in Saudi Arabia, the three largest companies reported 80 per cent of all profits in 2012; meanwhile, nearly a third of Saudi insurers reported losses,” Gabidullin said.

“We observed a similar trend in the United Arab Emirates (UAE)--again, the three largest companies reported over 80 per cent of the market's profits in 2012.

“Even if we exclude takaful companies, this figure is still over 50 per cent. Results for UAE takaful companies were significantly skewed by losses at Salama/Islamic Arab Insurance,” he added.

Inadequate profitability is more pronounced at the lower end of the market because smaller companies lack economies of scale. Many of them lack the critical mass--sufficient business volumes--to cover their operating expenses, according to the S&P analysis.

Over time, a lack of profitability erodes capital, leaving some companies with little prospect of finding a profitable niche. In our view, it is just a matter of time before these companies start to run out of capital and face a risk of default. Therefore, for some companies, consolidation makes economic sense. If companies merge, it could improve their economies of scale and offer them cost efficiencies.

“Acquirers tend to be more successful entities, indicating that they are better-managed or that they have larger resources at their disposal. Consequently, an acquired entity may benefit from the resources, know-how, and technical expertise of its new management team,” Gabidullin added.

Why firms resist consolidation

The S&P Ratings Services noted that several factors prevent companies from consolidating.

“In many cases, public stock market valuations do not reflect economic fundamentals, causing a significant valuation gap,” Gabidullin said.

“Existing shareholders and incumbent management teams are reluctant to relinquish control because their positions and status could be diminished or eradicated within the larger entities.”

Thirdly, the risk of business churn is significant, Gabidullin noted. – TradeArabia News Service