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Salama/Islamic Arab Insurance Co. Outlook Revised To Stable On Improved Operating Performance; ‘BBB-‘ Ratings Affirmed

          DUBAI (S&P Global Ratings) Aug. 21, 2018--S&P Global Ratings today revised to stable from negative its outlook on United Arab Emirates (UAE)-based Salama/Islamic Arab Insurance Co. (P.S.C.) (Salama). At the same time, we affirmed our 'BBB-' long-term issuer credit rating on the company. 
          The outlook revision reflects an improvement in Salama's overall capital and earnings, resulting in the revision of our assessment of capital adequacy to extremely strong, with redundancy at 'AAA' as per our risk-based capital model. The improvement in capital adequacy was due to the combined effects of an improved operating performance, retained profits, and reconsolidation of Best Re Holding Ltd. (Best Re).
          Salama's operating performance improved in 2017 and in the first quarter of 2018, after remaining volatile throughout 2015-2016. This improvement stemmed from corrective measures taken at the beginning of 2016, when Salama decided to materially reduce exposure to its loss-making UAE motor portfolio, and introduced some changes at senior management level. In 2017, Salama posted a profit of Emirati Dirham (AED) 38 million, compared with an AED175 million loss in 2016. The 2017 result also captures losses of AED65 million from Best Re, indicating that profit from normal operations was AED103 million. The combined ratio (losses and expenses over premiums) for 2017 was reported at 91% (2016: 134%) and we expect that it will remain at about 97% for the next two-to-three years, with Salama delivering modest underwriting results.
          As a result of Salama's efforts to control earnings volatility, the group's exposure in terms of gross premiums from Algeria, Egypt, and Senegal has increased proportionately, thereby exposing the group to more industry and country risk, in our opinion. While the situation slightly improved in 2017, exposure to these African markets still exerts moderately negative pressure on the industry and country risk exposure faced by the group. We believe this situation will gradually improve when Salama resumes writing a significant volume of UAE motor business, which was deliberately reduced during 2015-2016 as part of corrective action to improve operating performance.
          The results of Salama's efforts to move away from unrated and speculative-grade instruments have strengthened the group's asset quality compared with previous years. However, while there has been a marked improvement, the average asset quality still falls marginally short of our 'BBB' category, as per our methodology, leading us to assess Salama's financial risk profile as less than adequate. That said, we believe if management continues to further de-risk its investment portfolio by continuing to increase its exposure to investment-grade instruments, we could reassess the group's financial risk profile, potentially triggering a positive rating action. 
          Of the AED538 million in total investments in bonds and deposits as of Dec. 31, 2017, AED273 million (51%) is invested in investment-grade bonds and deposits. AED265 million (49%) is held in unrated or speculative-grade instruments which, although still a high level of exposure, is an improvement on the 56% of previous years. Nevertheless, we take into consideration that Salama holds about AED143 million (26.6% of total bond and deposit investments) in sovereign bonds from Egypt and Algeria, which is a regulatory requirement in these countries, whereby insurers are obliged to keep investments in government instruments. 
          Salama's liquidity has also improved as a result of management's efforts to liquidate its unrated investments and through changing its speculative-grade instruments to investment-grade bonds and deposits. As per our liquidity model, we calculate that total stressed assets covered 176% of the total stressed liabilities as of end-December 2017, compared with 123% a year earlier. We expect that Salama's liquidity will further improve if management continues to de-risk its investment portfolio by investing in higher-rated banks, while further reducing exposure to private-equity investments.
          We continue to assess Salama's risk position as high, predominantly due to its holdings of high risk assets (equities, real estate, and unrated and speculative-grade bonds and deposits), relative to its capital position. Although we note the improvements in Salama's investment portfolio, the proportion of high-risk assets remains high relative to the group's levels of shareholder equity. 
          The stable outlook reflects our opinion that Salama will maintain its improved operating performance, extremely strong capital adequacy, and strong liquidity. Also, we expect that Salama's exposure to North African insurance markets, which carry high industry and country risk, will remain contained at current levels and gradually decline over the coming two years. 
          We would consider an upgrade over the next two years if Salama further improves the credit quality of its investment portfolio for a sustained period by moving away from speculative-grade bonds and deposits. This would not only improve its average asset quality, capital adequacy, and liquidity, but also reduce its proportion of high-risk assets in comparison to its capital.
          We would consider a downgrade over the next two years if, contrary to our expectations:
          - We lowered our assessment of Salama's business profile to fair as a result of material earnings volatility or increased exposure to higher country risk markets.
          - Salama's exposure to Algeria or Egypt in terms of its invested assets increases to a level which could potentially trigger linkages to the sovereign ratings of these countries.