Insurance companies are facing hard times ahead with the impending introduction of draconian capital requirements whose impact will be to funnel billions of shillings in industry funds into government debt.
Industry insiders said the proposals, which are expected to become law in June, could further pull the lever on trading at the Nairobi Securities Exchange (NSE) even as they tap an extra Sh200 billion to Sh400 billion into government debt this year alone.
The new regulations have been prompted by the instability in Kenya’s insurance industry, which has long been under-capitalised, leading to multiple company failures and consequent losses to insurance buyers.
The scale of the change looks set to deliver a seismic shock to the insurance industry itself, with an impact analysis from the Association of Kenya Insurers indicating that 49 per cent of insurers will be unable to meet the minimum conditions set by the new rules, and that just 11 per cent will be sufficiently capitalised to be free of regulatory intervention.
The hurdle for most insurers is the unusually high level at which the capital adequacy ratio has been set. The ratio is calculated as the percentage of ‘available capital’ compared to the ‘capital needed’ to run the business.
The new rules have set the ratio at 200 per cent, meaning insurers could from June be required to have twice as much capital as they need to cover their insurance risks. This ratio far exceeds the norms in countries such as Canada, South Africa and Malaysia.
Hidden in the fine print are structures for calculating the capital needed and for determining the available capital that build-in unusually high risk deductions.
The requirements have been set at high levels by global standards for assets such as property and equity investments, with some risks like interest rates additionally double counted.
For insurance companies adding up asset values to calculate ‘available capital’, the risk factor assigned to property is 40 per cent, meaning that only 60 per cent of its value can be counted.
This makes Kenyan property apparently among the riskiest in the world, with most other nations setting a risk factor of 20 per cent or lower on property.
This is despite the fact that Kenya’s real estate prices have been far more resilient than in most other markets due to limited availability of debt financing, and the general property shortage.
Equities listed on the NSE also carry a somewhat higher than normal risk factor, at 30 per cent, but government bonds, despite their current B rating, which defines them as high risk, carry no risk factor at all under the new regulation, and can be counted at full value.
Elsewhere in the world, the risk attached to government bonds is aligned to their credit risk ratings from the international credit risk agencies such as Standard & Poors, so that debt that is deemed as risky as Kenya’s would normally carry its own risk factor.
Under the new regulations, and for insurers struggling to make the 200 per cent bar, equity and property holdings are set to become a distinct burden, worth 30 to 40 per cent more if they are sold and the money is rerouted into government debt.
For most insurers, property represents a long term investment, and few have yet reduced their portfolio holdings of property, although the regulation has already seen some retreat from new property investments.
But the industry, which now holds more than 40 per cent of its Sh370bn of investments in government debt, has been selling off its equity investments and shifting funds to government bonds.
From March to September, the industry moved some Sh11 billion from equity to government debt.
However, this conversion of equity to debt may not depress the stock market for much more than another year, with last year’s sell-off having already reduced the industry’s total equity holdings to around Sh42 billion by September after fair value losses.
Industry insiders also suggest insurance companies remain reluctant to sell off further equity holdings in current market conditions.
Nonetheless, the sell-off appears to have continued since September, and many insurers that will fall under the minimum capital adequacy ratio of 100 per cent of their capital needs in June will have little choice but to convert their equity assets into government debt to gain 30 per cent in their available capital sum.
Another channel open to insurers to improve their capital ratios is to eliminate large numbers of premium debtors, meaning that many firms are now moving to withdraw cover where consumers are behind in paying their premiums.
However, the biggest effect of the new regulation is set to be a substantial inflow of funds to government debt from new insurance industry capital.
The options for insurance companies to raise new capital span the issuing of new shares and the raising of debt through corporate bonds. There has been a rush to the corporate debt and equity markets for new money. Moreover, the majority of insurers are privately owned.
Many insurers might therefore be forced to raise corporate bonds that are expensive to stay in business, and invest the new funds into government debt, with low returns, resulting in considerable extra financial pressure.
“It is difficult to see the point in prescribing the capital adequacy ratio at 200 per cent, at twice the minimum level, or why such speed,” said one industry insider.
However, such funds will come at an opportune time for the government in meeting its still growing debt appetite. Government debt rose to 52.8 per cent of GDP last year, from 44.2 per cent in 2014, as the government added as much as Sh50 billion a month to its total borrowings.
In recent weeks, it has been pursuing the possibility of new rounds of borrowing through another Eurobond, Islamic financing, and new funds from China.
But pricing has moved up sharply for such debt, from around six per cent at the time of the government’s first Eurobond to almost 10 per cent currently.