Costa Rica premiums set to grow in 2021

Costa Rica’s insurance industry has taken a hit in 2020 with the pandemic, and its 2021 outlook will depend on whether the sovereign can avoid a downgrade and if unemployment and credit growth improve, according to a major ratings agency analysis.

Fitch Ratings associate director María José Arango said the agency sees the sector outlook worsening next year. She said Fitch believes the economic crisis “will affect domestic demand,” adding, “a reduction in premium generation is expected for year-end.”

In the report, Arango said, “the ability to reverse this in 2021 will be directly linked to a recovery in unemployment and private credit growth [measured at 2% in September 2020].” 

Fitch sees unemployment hitting 18% this year, with a direct impact on mandatory unemployment insurance lines.

The agency expects Costa Rica will experience a 5% GDP contraction this year with rebound of only 2.2% in 2021, to be reflected in premium growth of roughly 4.5% for insurers. 

The reduction in premiums this year has been offset to some degree by positive performance in certain business lines, including health, auto and workers’ compensation, which gained as a result of local lockdowns in the first months of the pandemic, according to Fitch.

The agency said health lines remained strong, growing at an 11% annual rate in September compared to 8.9% in the same month of 2019, which should support full-year results in health lines.

However, Fitch added, a more prolonged health crisis could generate negative effects mainly in life and unemployment claims, “which as of September 2020 did not have a major impact on the insurance sector’s performance and profitability levels.” 

Claims, such as those in auto lines, should resume normal levels with the restoration of mobility as expected vaccinations roll out and infection rates begin to be controlled.

Fitch added innovation will be key to boosting competition in business lines.

Operating costs and profit

Costa Rican insurers had already begun in 2019 to absorb the pass-through effects from the nation’s major 2018 fiscal reform, which raised tax rates on life premiums and increased operating costs for local competitors, “especially for those developing their strategies in personal lines given the large opportunities in this segment.”

The higher costs, however, have been compensated by higher financial income in 2020, which contributed 49.9% of earned premiums as of September, helped by beneficial FX movements.

High income has also helped offset the profit decline tied to poor business generation, and some insurers have seen support from lower operating costs associated with work-from-home policies – a benefit the agency does not expect to continue in 2021.

Fitch projects the sector-wide combine ratio to fall to 98.3% this year from around 104.7% in 2019, but sees it operating at a loss again in 2021 at 104.8%.

The agency believes the sector’s overall net loss ratio will be pushed higher by the gradual incorporation of as-yet unreported life claims which will push net loss ratio for the segment higher, with gross loss ratio in life at 51% in September, as well as by rising medical claims (39.9% gross loss ratio in September) and auto (40% in September) with the resumption of mobility and economic activity.

Ratings outlook 

The pandemic’s impact on local rated insurers is limited in Fitch’s base case scenario, thanks in large part to the sector’s stable and adequate capital position that stands out in the region, being reinforced by stricter local regulations. 

Ratings agencies, however, would need to reassess individual insurer profiles in the event of a sovereign ratings downgrade, which would spur a deterioration in the operating environment, in issuers’ business profiles and potentially in the credit quality of individual insurer investment portfolio’s, with some firms more exposed than others. 

Costa Rica is currently working on a proposal to the IMF for a US$1.75bn emergency loan package to grapple with a fiscal crisis exacerbated by COVID-19. 

And Fitch Ratings, in a comment last week, said “Costa Rica's wide fiscal deficit, high borrowing costs and post-pandemic economic recovery challenges could increase pressure on debt sustainability even if the country secures an IMF deal.” 

Without external financing, the country is being forced to rely on the domestic market for budget financing at higher borrowing costs and a steadily increasing debt burden, all of which are driving the sovereign’s interest bill on a steep incline, according to the agency.

On the current track, Fitch now forecasts interest payments reaching 38% of central government revenues in 2020, or 21.4% of general government revenues. 

But Fitch said that with the right reforms the government could reach a primary surplus of 2.5% of GDP by 2025 – enough to stabilize the debt ratio.

Reinsurance rates 

The agency also sees the possibility of higher international reinsurance prices adding pressure to non-life lines, as the global reinsurance sector has entered “a hard market stage with rising prices and changes in terms and conditions” spurred by recent natural disasters and the coronavirus pandemic. 

“This will affect the sector as a whole and will be reflected in prices for some insurance products, reducing fierce competition in some business lines that rely on reinsurance protection, mainly non-life lines for their reinsurance contracts renewals in the first semester of 2021,” said Fitch.