Reinsurance to cushion ARC as Fitch predicts earnings to remain volatile

Business A.M

Reinsurance will help African Risk Capacity (ARC) Group to cushion a projected earnings volatility, Fitch Ratings has said. The cushion would come by way of helping the company limit its net exposure to losses, it said. Fitch said the parametric insurance provider to African sovereigns will see earnings continue to stay volatile due to the nature of risks it underwrites. At the moment, Fitch has assessed ARC’s financial performance and earnings as weak with ARC having a Fitch-calculated combined ratio of 280 percent in 2022 (2021: 174%, three-year average: 179%). ARC reported a net loss of $25.3 million in 2022 (2021: $5.3m net loss), mainly due to the large drought and tropical cyclone-related claims during the year. Net incurred claims increased to $29 million in 2022 from $18 million in 2021.

 Ratings upgraded

Fitch has upgraded ARC’s Insurer Financial Strength (IFS) to ‘A-’ from ‘BBB+’ and Long-Term Issuer Default Rating (IDR) to ‘BBB+’ from ‘BBB’. The outlooks are ‘Stable’. The upgrade reflects Fitch’s view of improved willingness of its sponsors to support due to ARC’s strong progress in meeting its development objectives, demonstrated by enhanced claim pay-outs to affected African sovereigns, product diversification and improving reach of its development activities. Strong progress in product diversification initiatives and the improving franchise have also led to a higher company profile score of ‘bbb’. The ratings continue to reflect the commitment and credit quality of ARC’s sponsors, ARC’s very strong capitalisation and leverage, good company profile and weak financial performance. Apart from financial performance, other key rating drivers for ARC include:

Ownership Positive for Rating: Fitch applies an uplift of two notches from ARC’s standalone credit quality due to its assessment of the sponsors’ willingness and ability to support ARC, supported by the company’s strong progress in meeting development objectives. ARC is sponsored by the German development bank KfW through the Federal Ministry for Economic Cooperation and Development (BMZ) and by the UK Foreign, Commonwealth & Development Office (FCDO). In addition to their capital contributions, KfW/ BMZ and the FCDO oversee ARC’s governance and development strategy, while also facilitating sovereign participation in the business through premium subsidy schemes.

Very Strong Capitalisation: Fitch views ARC’s capital position as a key strength for its rating. Fitch regards the end-2022 $68 million returnable capital provided by KfW/BMZ and the FCDO as fully loss-absorbing, and consequently treat it as equity capital when assessing capitalisation and leverage. On this basis, ARC scored “Extremely Strong” on Fitch’s Prism Factor-Based Capital Model based on end2022 figures, unchanged from 2021. Fitch expects further capital support could be made available as ARC continues to achieve its development goals. ARC’s regulatory capitalisation is strong, with a Bermuda enhanced capital requirement (ECR) ratio of 387 percent at end-2022 (2021: 796%). The reduction was mainly due to a fall in regulatory available capital due to large claim pay-outs during the year.

Good Company Profile: Fitch assesses ARC’s company profile as good, reflecting the company’s specialised nature as a parametric insurance provider to African sovereigns, improving franchise, and small size. Fitch believes that ARC’s strong record of paying out claims and improvements in product diversification and risk pool benefit the company’s franchise and our overall assessment of its company profile. ARC’s operating scale remains small, with reported gross written premiums of $23 million in 2022, a drop from $31 million in 2021 due to the non-renewal of some contracts during the year. However, premiums have strongly recovered so far in 2023 and Fitch expects the company’s growing reach and diversification initiatives to support growth in the medium term.

Improving Product Diversification: ARC introduced parametric insurance products to cover outbreak & epidemic risks in 2022 and subsequently insurance to cover flooding risks in 2023, in line with the company’s goal to diversify its product offerings. Prior to the recent product launches, ARC’s product portfolio consisted of drought and tropical cyclone insurance cover, with drought still dominating the overall product mix. Fitch views ARC’s geographic diversification as moderate, with the 2022/2023 risk pool covering 13 African sovereigns. ARC also offers insurance to non sovereign entities, although this segment remains relatively small. ARC has an ESG Relevance Score of ‘4’ for Exposure to Environmental Impacts due to underwriting/ reserving being exposed to natural catastrophe risks, with most of its product lines.