MARC has downgraded its insurer financial strength (IFS) rating on BEST RE (L) Limited (BEST RE) to A+ from AA and revised the outlook to negative from stable. The rating action reflects recent underwriting losses due in part to higher catastrophe losses arising from Thai floods in 2011 and the weakening of its capital adequacy metrics. The current rating incorporates risk-mitigating initiatives undertaken by BEST RE to reduce premium volumes and exit unprofitable business as set out in the general reinsurer’s strategic plans. MARC believes that these actions have helped to stabilise BEST RE’s risk profile and partly mitigate the pressure on its capital adequacy exerted by business growth and recent underwriting losses. The rating also reflects reduced concern on additional losses from Thai flood claims based on the improving claims trend observed in BEST RE’s 2012 fourth quarter earnings performance.

BEST RE’s recent operating performance has been impacted by higher losses incurred as a result of Thai floods in 2011. Losses from Thai floods amounted to US$17.6 million for the financial year ended December 2011, resulting in a decreased net profit of US$0.9 million. As at end-September 2012, the losses from Thai floods increased to US$60 million, resulting in a net loss of US$44.9 million during the period and erosion of shareholders’ funds by 30.5% to US$101.7 million (2011: US$146.3 million). According to the reinsurer, losses from Thai floods have abated in 4Q2012.

BEST RE’s underwriting leverage has risen in recent years due to strong business growth in the previous year, as measured by net written premiums to equity which increased to 2.73 times (x) in 2011 compared to 2.25x in 2010 and 2.21x in 2009. The ratio increased further to 3.41x (annualized) in 9M2012 as a result of deterioration in shareholders’ funds during the period. In recent periods, BEST RE has taken steps to reduce its underwriting exposure to unprofitable business and primary insurers which had been ceding high risk business to the general reinsurer. BEST RE is lowering its exposure in Indonesia, Philippines and certain Gulf Cooperation Council (GCC) countries in light of the underpriced business ceded by cedants within these countries, reflecting in part the effect of significant competition in these markets. The reinsurer’s board-approved three-year strategy for 2012 through 2014 provides for a tightening of its underwriting policy, including lowering its underwriting sub-limit and event limit. BEST RE also plans to reduce premium volumes in other regions, including the Middle East. Gross written premiums (GWP) are expected to decrease significantly to US$260.0 million over three years to 2014 (2011: US$444.0 million). Its business plan does not entail changes to its key business lines and core markets. The Far East will continue to be the focus market in view of the growth potential afforded by this region.

GWP declined by 16.7% to US$300.3 million during 9M2012. BEST RE projects further decline in GWP in 4Q2012 as it continues to exit unprofitable businesses. The decline in GWP will help address the near-term pressure on its capital adequacy. BEST RE’s moderate earnings base and small absolute size relative to regional and global general reinsurers makes it more susceptible to earnings volatility from catastrophe losses that might be more easily  absorbed by larger sized reinsurers.

MARC notes the recent management change at BEST RE, namely the departure of its CEO in December 2012 and the appointment of a director as the new CEO. The negative outlook on the IFS reflects MARC’s concern regarding the execution risk associated with BEST RE’s strategic direction notwithstanding the swift measures taken by the reinsurer to restore a stable management structure. A continuing trend of unfavourable underwriting performance and returns on capital could add significant downward pressure to BEST RE’s IFS rating. The outlook could revert to stable if underwriting profitability is restored and BEST RE makes steady progress towards executing its strategic plan.

Contact:
Sharidan Salleh, +603-2082 2254/ sharidan@marc.com.my.