Unlike in the corporate sector, where the pandemic led to widespread downgrades in 2020, our credit ratings on Islamic (Takaful) and conventional insurers in the Gulf Cooperative Council (GCC) have remained broadly stable over the past 18 months, supported by relatively strong capital buffers. Indeed, we have taken several positive rating actions on Takaful companies so far this year. Our outlook on the sector for the next 12 months remains stable. However, given that risks related to the pandemic persist, we could take rating actions in the event of a sharp decline in asset prices, unexpected and severe technical losses, or governance and internal control failures.

We expect an economic recovery in the GCC in 2021, supported mainly by the increase in oil prices--S&P Global Ratings recently revised its oil price assumption to $65 per barrel for 2021 from $60 previously--and the vaccine rollout. However, slow vaccination progress in some parts of the world and new variants could dampen the recovery. An uneven recovery, ongoing cost-saving measures in many industries, and a shift to less (business) travel has further increased the pressure in key sectors such as real estate, retail, transportation, and hospitality. We believe these factors, combined with very intense competition in the insurance sector, are weighing on growth prospects for gross written premiums/contributions of Takaful insurers, which recorded a modest increase of about 1.5% in 2020 and about 1.0% in first-quarter 2021 according to our calculations.

Very high competition in the overcrowded GCC insurance industry will continue to weigh on earnings in 2021. Despite a recent material improvement in profitability in Saudi Arabia's insurance sector, more than one-third of insurers continue to report losses. Pressure on solvency and certain regulatory incentives have led to a number of mergers in Saudi Arabia over the past year and we expect this trend to continue throughout 2021. A new insurance law with higher reserving requirements due to come into force over the next year, could also increase pressure on small and unprofitable Takaful players in Kuwait that will need to raise capital to meet these requirements. Overall, while we expect growth in the sector, we think it'll be unevenly spread, with larger conventional insurers taking more of the gains.

Competition Has Further Intensified During The Pandemic

Gross written premium/contribution growth will likely remain weak in most GCC markets in 2021. Amid weaker economic conditions, gross written premium/contribution growth has been relatively modest in most GCC markets, partly from lower business activity and increased competition among Takaful and conventional insurers in recent years. This has particularly been the case in motor and medical lines, which together make up about 80% of total premium income in Saudi Arabia and more than 60% in most other markets in the region. Slowing population growth across the GCC, ongoing pressure on rates, and a drop in new car sales by about 16% in Saudi Arabia and 35% in the United Arab Emirates (UAE) and in other markets in the region in 2020 led to reduced insured values. Based on current market conditions and first-quarter 2021 results, we expect this downward trend to continue throughout the year.

Saudi Arabia, which generates about 85% of total gross written premiums of all Islamic insurers in the GCC, experienced declines in premium income in motor business by 2.9% in 2020 and 6.8% in first-quarter 2021, due to falling new car sales. Despite this, we anticipate that premiums in Saudi Arabia will increase by up to 5% in 2021 absent any major lockdowns. This will likely be driven by higher premium volumes for medical business through an extension of existing and new covers and if public hospitals--which historically have not charged insurers for their services--start billing insurers and some existing covers are extended to a wider population.

Although the UAE, home to the second-largest Takaful market in the GCC, is experiencing a noticeable increase in consumer confidence due to higher oil prices, the rollout of vaccines against COVID-19, and changes in visa requirements to attract more talent, we anticipate that premium income in the market will be flat in 2021 from ongoing pressure on motor and other rates. A pickup in tourism and the start of Expo in Dubai in October 2021 could lead to additional business, but we believe some of the larger conventional insurers will benefit more than many of the smaller takaful players. We also expect that gross written premiums/contributions will overall be relatively flat or even slightly decline in the remaining GCC markets in 2021, due to weaker demand.

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Strong Improvements In Profitability Are Likely Not Sustainable

Both Takaful and conventional insurers in the region have benefited from either no or only modest exposure to COVID-19-related claims. This led to strong improvement in operating performance in 2020, since most governments in the GCC cover pandemic-related medical claims. At the same time, movement restrictions led to fewer nonessential hospital visits and motor claims. Based on our calculations, Takaful insurers in the GCC recorded a significant improvement in net income of about 67% in 2020 compared with 2019. This improvement was mainly driven by stronger underwriting results.

The resumption of nonessential medical treatment has caused claims to rise to more normal levels in the first part of 2021, and we expect this to continue over the next year. For example, the loss ratio for medical business in Saudi Arabia increased to 88.3% in first-quarter 2021 from 85.9% for the same period in 2020. Nevertheless, the net income for the industry in Saudi Arabia improved by 27% and about 36% for the whole Takaful industry in the GCC in first-quarter 2021 year on year. Unlike in 2020, when profitability was mainly driven by underwriting results, this improvement was largely supported by stronger investment returns, which for example improved by about 55% or Saudi Arabian riyal 100 million (about $26.7 million) for first-quarter 2021 year on year. Although underwriting results will likely remain overall profitable in 2021, we expect a decline in earnings.

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We expect that growth and earnings will not be evenly distributed, because the trend from recent years suggests large insurers are getting larger in terms of premiums, market share, and profits. For example, the top 5 insurers in Saudi Arabia generated about 68% of total premiums and almost all net profits in 2020. Smaller insurers have often been pushed to compete on price, which has hampered their profitability somewhat.

Potential Asset Volatility Remains A Key Risk

We consider asset volatility from investment results and a potential increase in premium receivables as a key risk for the earnings in the sector in 2021. Financial markets recovered in the second half of 2020 after as sharp drop following the COVID-19 outbreak, meaning that most Takaful companies could largely reverse some of the unrealized investment losses of up to 20% of shareholder equity for some entities that they accumulated earlier in the year. A decline in interest rates has prompted some Takaful players to further increase their exposure to equities or other high-risk assets in search of higher yields. Although equity markets had a strong start in most GCC countries in the first part of 2021, a potential return of volatility in capital markets could negatively affect earnings and capital of insurers with significant exposure to market risk.

A slow collection of receivables could also become an increasing issue for some insurers, depending on their portfolio and client mix. We anticipate that premium collections will remain slow for some insurers as businesses and governments delay their payments in an attempt manage cash flows. This will lead to increased receivables and potential write-offs, further stressing liquidity, earnings and capital, and, consequently, credit conditions for some insurers.

Industry Consolidation Could Accelerate Further

High valuations, ongoing shareholder support even for lossmaking companies, and the absence of regulation that supports mergers or runoffs has hindered consolidation among insurers in some GCC markets. However, intense competition, stricter regulations, and certain regulatory benefits will result in further consolidation in the sector following mergers in a number of markets in recent years, in our view. Although scale is no guarantee for profitability, it helps, for example, insurers to dilute some fixed costs, which for many companies in the sector are relatively high. Following some recent merger announcements in Saudi Arabia, we expect further consolidation in the sector in 2021, given that about one-third of the 30 active primary insurers are still posting losses. While only two of nine listed Takaful operators in the UAE recorded a net loss in 2020, we estimate that one-third of Takaful player in the country does not meet the solvency regulations that were adopted in early 2018 and that these companies will need to take action to restore their capital levels in the near future. Similarly, companies in Kuwait will need to fully implement all aspects of the new insurance law within a year of its publication in March 2021. This law makes it likely that higher reserving requirements will put further pressure on many smaller and unprofitable Takaful operations to comply with applicable regulations. Like in previous years, we expect that some insurers with weaker capital buffers will need to either raise additional capital or consolidate.