Fitch affirms Russian National Reinsurance Company's IFS at 'BBB-'; Positive Outlook

Fitch Ratings has affirmed Russian National Reinsurance Company's (RNRC) Insurer Financial Strength (IFS) rating at 'BBB-' with a Positive Outlook.

The rating and Outlook continue to mirror Russia's Long-Term Local-Currency Issuer Default Rating (IDR) and reflect strong financial support made available from the Central Bank of Russia to RNRC and RNRC's exclusive position in the local reinsurance sector, underpinned by regulation.

KEY RATING DRIVERS

The rating reflects RNRC's 100% ownership by the Central Bank of Russia, its strong risk-adjusted capital position, as well as the weak underwriting profitability earned on an immature portfolio and high concentration of investment assets in government bonds. The Central Bank of Russia has made available RUB49.7 billion additional contingent capital, which would be injected into RNRC in case any underwriting losses on the portfolio of risks under sanctions start to erode the reinsurer's share capital of RUB21.3 billion.

RNRC is close to meeting the business volume target rather accurately (101% of the target achieved in 2017 and 93% in 9M18), but failed to forecast the loss performance of its yet immature portfolio. It was the impact of a claims case reserve made for a single contractors' all risks loss that brought RNRC's loss ratio to 132% and its combined ratio to 152% in 2017. The reinsurer saw a notable release of RUB1.9 billion in 9M18, but had to set RUB5.7 billion of reserve for new single large claims. These single large claims were the key factor behind the 95% loss ratio and the 109% combined ratio in 9M18.

During its start-up phase, RNRC budgets only attritional losses and not single large losses, particularly on the portfolio of sanctioned risks, where the net retentions are often high. Fitch therefore believes that until the reinsurer achieves a larger, more balanced and more mature portfolio, its underwriting profitability will continue to be severely exposed to volatility in the portfolio for risks under sanctions.

RNRC's financial performance was far below the reinsurer's expectations in 2017 with net profit of RUB89 million and ROE of 0.4% versus the expected RUB2.8 billion and 12%, respectively. The company earned RUB2.1 billion investment income, which was just enough to offset an equivalent underwriting loss. In 9M18 the reinsurer reported a RUB1.1 billion net profit, significantly below the targeted RUB4.1 billion.

From a capital adequacy perspective, Fitch considers that RNRC is strongly capitalized. The company's capital strength is due to its relatively small business volumes. Fitch notes that due to its statutory purpose, there is a risk that RNRC may have to assume portfolios falling under sanctions with high net retentions and very limited or no access to retrocession capacities. Therefore, the reinsurer may not be able to price adequately to reflect concentration risk and his limited ability to form a sufficient pool of risks. The potential capital vulnerability to losses embedded in these portfolios is difficult to quantify and predict. However, a strong mitigating factor is the availability of additional contingent capital from RNRC's shareholder.

RNRC has prudent investment policies. Government bonds accounted for 71% of RNRC's investment portfolio at end-9M18. Of these government bonds, 34% was categorized as 'available-for-sale' and the remaining 66% as 'held-to-maturity' at end-9M18. The introduction of a new set of sanctions in early April 2018 caused some volatility in the Russian government bond market and showed that RNRC's capital is exposed to concentration risk and unrealized losses on its available-for-sale portfolio of government bonds.

RNRC was founded in August 2016 to increase the reinsurance capacity of the local sector and offer coverage to the local risks falling under sanctions. Regulations oblige local primary insurers to offer 10% of any reinsured business to RNRC. However, it is only obliged to accept risks related to sanctioned businesses.

RATING SENSITIVITIES

RNRC's IFS rating will likely follow any changes in Russia's Long-Term Local Currency IDR. RNRC's rating could also be downgraded if its strategic role in the Russian reinsurance sector or its ownership structure were to weaken.

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