We affirmed our ratings on NSK because we believe that the company will be able to keep its competitive position as a midsize player on the Kazakhstan P/C insurance market and maintain its capitalization at the current level, despite the tightening operating environment and the higher-than-expected dividends paid in April 2020.
NSK's market share has been gradually increasing since the temporary restrictions on its licenses for compulsory insurance and inward reinsurance lines were lifted at the end of 2018. As of end-2019, NSK ranked No.5 by gross premium written (GPW) in Kazakhstan's P/C insurance sector with a market share of 4.3% (No.7 by GPW and 4.2% market share in 2018). The company continues to focus on the motor segment, which accounted for about 51% of its GPW in 2019. In addition, the company writes medical and personal accident (26% of GPW in 2019), property (8% of GPW in 2019), and liability (5% of GPW in 2019) insurance, with other lines accounting for the remaining 10% of GPW in 2019. We expect the portfolio structure to remain stable.
We expect that NSK's premium growth will be muted in 2020, due to the lower demand for insurance in the context of COVID-19 containment measures and economic contraction in Kazakhstan by our forecast of about 3% in 2020. In addition, we consider that the company's combined (loss and expense) ratio may increase to around 105% this year. In particular, we believe that the company's claims ratio may increase in those lines of business where claims payments are linked to foreign currency, such as the motor segment. A significant share of spare car parts are imported, pushing up the local currency cost of repairs, given that the Kazakhstani tenge (KZT) depreciated by 7.6% over the first five months of 2020. That said, we think that NSK is following reasonable underwriting standards and we expect a gradual improvement of operating profitability in 2021-2022 once the economic environment improves.
We expect that NSK will be able to sustain its capitalization at the current level despite significant dividend payments of KZT1.2 billion in April 2020 and weaker technical results than we expected previously. We understand that the shareholders' demand for dividends in 2019-2020 was linked to the financing of the acquisition of the company's shares last year. Our future forecast of capital adequacy implies that we do not expect future dividends to be as high, close to 50% of net income in 2021-2022. According to our capital model, the company's total adjusted capital was 2% redundant at the 'BBB' level on Dec. 31, 2019, and we expect it to remain in the same category (2019 already accounts for dividends paid in April 2020). The company's solvency ratio was 1.74x as of June 1, 2020, after dividend payout, comfortably above the minimum required level of 1x. That said, the company's capital in absolute size continues to be significantly smaller than international peers' (KZT4.8 billion, or about USD 12.6 million, at the end of 2019), which makes it more vulnerable to external shocks. Even if we see gradual improvements of the company's capital adequacy under our capital model, the absolute size of capital will continue limiting our overall assessment of capital and earnings until it exceeds the equivalent of USD 25 million, which we think will happen beyond our two-year rating horizon.
We see positively that the company is gradually improving the weighted-average credit quality of its investment portfolio, which is in line with market trends for other players on the market. Most of the company's investments (71% on April 1, 2020) comprise Kazakhstan government bonds and bonds and deposits of Kazakhstan's systemically important banks and government-related entities. Investment-grade instruments represented around 53% of the company's total investments on the same date (43% a year previously).
We believe that NSK has sufficient liquidity to meet its obligations in a stress scenario. Our liquidity ratio stood at 162% at the end of 2019 and we expect it will remain above 150% in the next 12 months.
We currently consider the company's governance as a neutral factor for the rating. However, we will monitor further the company's system of checks and balances. We think that while the company's capital buffers seem sufficient currently, the decision to pay high dividends in the tightening operating environment could constrain the company's ability to absorb unexpected risks.
The stable outlook reflects our expectation that in the next 12 months NSK will be able to sustain its market share and maintain its current capital adequacy, complying with regulatory capital requirements, despite the pressure from the tightening operating environment in Kazakhstan's P/C insurance market in view of COVID-19 containment measures and expected economic contraction. We also expect the insurer to maintain its conservative investment policy.
We could lower our ratings in the next 12 months if NSK's:
- Capital deteriorated for a prolonged period below the 'BBB' level according to our capital model, squeezed either by weaker-than-expected operating performance, very high premium growth, investment losses, or higher-than-expected dividend payouts; or
- We observed weakening of the company's governance procedures; or
- The company's competitive position weakened, as shown, for example, by a material decline in premium volumes signifying loss of market share.
We see a positive rating action in the next 12 months as remote, taking into account the company's weak business risk profile, volatile operating performance, and low capital in absolute terms.
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