KEY RATING DRIVERS
The revision of the Outlook follows the downgrade of Azerbaijan on 26 February 2016 to Long-term foreign and local currency Issuer Default Ratings (IDR) 'BB+' from 'BBB-'. The Outlooks are Negative.
The weaker macro-economic environment is likely to undermine AzInsurance's ability to generate underwriting profit both due to sector-wide and idiosyncratic challenges as well as exacerbate the significant concentration risk in the insurer's investment portfolio. The affirmation of the rating reflects the insurer's strong market position and a significant cushion in its underwriting profitability.
Fitch expects Azerbaijan's real GDP to contract by 3.3% in 2016, with the non-oil activity to contract by 4%, as the government cuts back on spending, bank lending comes to a stop and consumer confidence and purchasing power fall. However, much of the fall in spending should be absorbed through a reduction in imports.
For the Azeri insurance sector, these developments are likely to result in a contraction in voluntary insurance and bancassurance segments. AzInsurance faces additional risk related to the reduction in imports, as cargo insurance, mainly focused on imported goods, accounted for 34% of the insurer's net written premiums in 2010-2014 and has been a consistently strong contributor to the insurer's underwriting result.
Apart from the recession, the insurance sector is also impacted by the manat devaluation of 30% in February 2015 and a further 50% in December 2015. The devaluation has led to the upward revision of insurance liabilities related to FX-denominated commercial risks and may put pressure on the underwriting result of insurers with high levels of net retention in 2015 and 2016. AzInsurance is fairly resilient to the FX-driven revaluation, as the insurer has made intense use of FX-matched reinsurance for large commercial property and casualty lines.
The devaluation is also likely to put pressure on the profitability of new policies. Given the low capacity of the local insurance sector and its high dependence on outwards reinsurance purchased abroad, it may be difficult to pass the increased costs of outwards reinsurance to local commercial policyholders in full. Therefore, the margins in the commercial lines may decline, presenting a challenge to the sector, including AzInsurance.
On the asset side, the devaluation has helped AzInsurance generate significant FX gains, as 69% of the insurer's portfolio was placed in USD-denominated instruments at end-2015.
Fitch expects that the weakness of the banking sector, which Fitch's Banking System Indicator rates at 'b', will be exacerbated by the manat devaluation and shrinking economy. For AzInsurance this means that the rise in concentration risk in the investment portfolio further undermines the insurer's risk-adjusted capital strength. To date, the insurer has achieved only a modest reduction of the concentration risk with 48% of investments placed with a related party bank at end-2015 compared with 56% at end-2014.
Based on the insurer's unaudited annual results, net profit improved to AZN17m in 2015 from AZN13m in 2014, supported by FX gains on investments. The combined ratio stood at a very strong 64.8% in unaudited 2015 (audited 2014: 63.6%), although the written premiums fell 11% both on a gross and net basis.
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