Sep 18, 2016

Following the release of the H1’2016 results by insurance firms, we have carried out an analysis on Kenya’s insurance sector to decipher any material changes from our FY’2015 Insurance Report. In our analysis of the insurance sector, we offer our view on which insurance firms are the most attractive and stable for investment from a franchise value and from a future growth opportunity perspective. We also offer our view on the status and outlook for the sector. See our H1'2016 insurance report here.

The report is themed "Given transition in the banking sector, what next for insurance?", as the insurance sector still struggles with low penetration, slowing premium growth, increased cases of fraudulent claims and the required increase in capital following adoption of a risk based capital adequacy framework. In addition, with the recent interest rate caps, the financial services industry as a whole has been hit by poor sentiment and we expect increased regulation across the sector going forward.

On the back of a growing and stable economic environment in Kenya, the country’s insurance sector has also experienced robust growth over the years, with the financial services sector in Kenya currently contributing 10.1% to Kenya’s GDP growth, from a 3.5% contribution 10-years ago. This is as a result of (i) convenience and efficiency through insurance firms adopting alternative channels for both distribution and premium collection such as bancassurance and improved agency networks, (ii) advancement in technology and innovation making it possible to make premium payments through mobile phones, and (iii) a demographic boost in Kenya, such as a growing middle class, which has led to increased disposable income, thereby increasing demand for insurance products and services.

On valuations, insurance companies are trading at a price to book of 1.1x compared to the banking sector which trades at 0.9x. A direct correlation can be seen in the performance of insurance stocks with that of the Nairobi Securities Index.

Following the strong growth achieved by the insurance sector over the last decade, there is need for the sector to transition into a more stable and sustainable sector. The Insurance Regulatory Authority (IRA) is at the forefront of this initiative, pushing for the observance of prudential guidelines, better corporate governance of financial institutions, increased transparency in reporting of results, and using a risk-based approach to capitalization, with varying risk charges on respective investment options. As indicated in our H1’2016 Insurance Report, the key areas of focus in the sector include the following;

• Over-insured with Low Penetration:The number of insurance companies in Kenya amount to 51 firms, which equates to about 1.1 insurance company for every 1 million Kenyans, a similar ratio to Kenya’s banking sector. However, penetration still remains low at 3.0%, lower than the average of 3.5% in Africa, having remained at this figure for a number of years.

This shows that insurance companies will have to improve their strategies to increase penetration. The core issues we see is to innovate into more relevant products to improve uptake. Significant opportunities remain in the Kenyan insurance market, with growth areas identified especially in commercial lines such as oil, real estate and infrastructure,

• Revenue Diversity and product innovation: With an industry combined ratio average at 127.3%, insurance companies are not profitable from their core business and diversification of their revenues is key to profitability. This has seen more players venturing into real estate to further diversify their revenue streams. Furthermore, Insurance products are not tailored to the common consumer and lacks innovation to target customers with low disposable income. In order to increase penetration in the country, insurance firms must become more innovative with their products and distribution channels. Product innovation is the single biggest disruptive opportunity we see in the sector, and,
• Regulation & Emphasis on Compliance: With the new Insurance Act, there is going to be increased regulation on capital adequacy and risk charges on respective investment options. This will increase risk-based analysis on investments, improved supervision on internal practices and lead to a more regulated insurance sector, thereby improving investor sentiment.

Based on the Cytonn H1’2016 Insurance Report, we ranked insurance firms from a franchise value and from a future growth opportunity perspective with the former getting a weight of 40% and the latter a weight of 60%. The ranking is as follows;

The key take outs from the ranking were;

• Kenya Re and CIC tied at top position ranking top in the total return score category and franchise score category, respectively. A point to note is that CIC was ranked 4^th in the FY’2015 report hence the most improved insurance company, due to a strong franchise score on the back of a low expense and combined ratios well as a high underwriting leverage
• Sanlam retained its bottom position ranking bottom in both the total return score category and franchise score category

For more details on the ranking methodology, see our H1’2016 Insurance Report.

While the sector is struggling, we are of the view that insurance companies have a lot they can do in order to register considerable growth and improve penetration in the country. Foremost, we expect more synergy between banks and insurance companies to introduce bancassurance as well as the integration of mobile money payments to allow for policy payments through this increasingly preferred transaction medium. We also expect that there will be increased regulation in the sector, as well as increased consolidation to reduce duplication of products by insurance companies. These efforts will improve revenue channels for insurance firms and uptake of insurance as a lifestyle and necessary expense.

 

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.