The sharp decline in yields on risk-free treasury instruments is dampening the investment returns of Nigeria’s insurers who are already struggling with the negative impact of the coronavirus pandemic.
Insurers around the world tend to pack policyholders money in investment securities when yields are favourable to compensate for underwriting losses brought on by spiralling claims and underwriting expenses.
However, the negative real interest rate on risk-free assets in Nigeria has made things complicated for insurers who are hard pressed to find investable assets with returns higher than inflation, according to two chief executive officers of leading insurance companies in Nigeria.
“The negative real return on risk-free investment assets has affected the insurance industry in no small way, as it has put pressure on our investment income,” one of the CEOs says during an exclusive interview with BusinessDay.
“It means we have to work harder to deploy policyholders’ money efficiently, and that is very difficult given the current state of the market,” the second CEO states. Interest rates in the fixed income market crashed last year following the central bank’s decision to ban some companies and investors from its Open Market Operations (OMO) market. Nigeria’s latest Treasury bill auctions show that Nigeria’s 364-day has reduced from a peak of 22 percent in 2017 to 3.75 percent.
The concerns of CEO and analysts are that the unfavourable investment environment means insurers could experience dividend income reduction for some of the assets in their portfolio.
That could lead to a sharp decline in profit for the insurers and lower returns to shareholders. In 2019, the largest insurers in Africa’s largest economy realised a combined N342.91 billion in investment income, an increase of 13 percent compared to 2018, according to data gathered by BusinessDay.
There was a 46.46-percent expansion in investment income in 2017 financial year, when the yields on short-term government securities were around 18 percent and 22 percent. The economic slowdown emanating from the pandemic is also driving interest rates even lower and increasing credit risk exposures from businesses facing possible default, according to analysts at Pricewaterhousecoopers (PwC).
“This raises the possibility of regulators asking for extraordinary solvency tests to ensure insurers can withstand the immediate and knock-on impacts,” say the analysts.
The expected economic downturn this year coupled with the low interest rate environment are two of the biggest obstacles in the way of insurers and other sectors that make up the entire economy this year.
The economy contracted by a record 6.1 percent in the second quarter of 2020, as the virus took a toll on economic activity.
While the economy may have fared better in the third quarter, it still faces the risk of sliding into a second recession in four years. A recession will subsequently result in lower disposable income for the average Nigerian and thereby, lead to poor renewal and uptake rates for insurance policies.
Commercial and retail customers are looking to cut down on spending as they have seen their income streams beaten down as the virus spreads.
In terms of reach, the Nigerian insurance industry continues to lag peers with low insurance penetration (Gross Premium Written/GDP) of 0.34 percent in 2019 compared with South Africa (13.4%), Morocco (3.9%), Kenya (2.3%) and Egypt (0.6%).
The industry is reeling from poor regulations, lack of trust in the claims process, religious beliefs, and economic downturn.
To avoid liquidity crisis and surmount the current macroeconomic headwinds, analysts say insurers will have to be cost efficient and focus more on cash management.
“Broader fallouts from the pandemic in terms of lower demand and investment returns, deterioration in the credit quality of fixed income securities and increased mortality rates from the virus could pressure earnings, reserves and profitability of the life insurance sector in 2020,” analysts at Afrinvest Securities Limited, note.
“For the non-life sector, a rise in Covid-19 related claims, premium rebates and lower interest rates could offset the increased demand for pandemic-related policies and reduce profitability,” the analysts say further.
