Milli Reasurans T.A.S.•Low dependence on brokers. •Faces moderate industry and country risk...

Milli Reasurans T.A.S.

Primary Credit Analyst:

Tufan Basarir, CFA, London (44) 20-7176-7126; [email protected]

Secondary Contact:

Ali Karakuyu, London (44) 20-7176-7301; [email protected]

Table Of Contents

Rationale

Outlook

Base-Case Scenario

Company Description: Local Reinsurer With A Considerable International

Presence

Business Risk Profile

Financial Risk Profile

Other Assessments

Accounting Considerations

Related Criteria And Research

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Rationale

Operating Company CoveredBy This Report

Financial Strength Rating

None


• Dominant competitive position in the Turkish reinsurance market.

• Low dependence on brokers.

• Faces moderate industry and country risk owing to its exposure to the Turkish insurance sector.

• International business adds some diversification.

• Marginal operating performance due to pricing inadequacy in the market and weak performance from the run

off of the Motor Third Party Liability (MTPL) business line.


• Capital adequacy will likely remain at least slightly below the 'A' (moderately strong) level.

• High risk position caused by risks associated with modeling earthquake risk and volatility of results, even in

years that were not affected by catastrophes.

• Marginal quality of investments from a global perspective.

Other Factors

• Moderately strategic to its parent, (Isbank). Ratings do not benefit from any support of the parent.

• Owns a majority share in Anadolu Sigorta, the third-largest insurance company in Turkey by gross premium

income.


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Outlook

Downside scenario

We could lower the ratings on Milli Reasurans T.A.S. (Milli Re) if the credit quality of its investment portfolio were

to weaken. Specifically, if we were to downgrade Isbank, we would take a similar rating action on Milli Re.

Upside scenario

We do not anticipate raising the ratings during the next two years because our ratings on Turkey and Isbank have

negative outlooks.

Although we consider this unlikely, we could raise the rating if we considered that Milli Re had improved the credit

quality of its investment portfolio and also maintained its moderately strong capital and earnings. Given Milli Re's

material exposure to local banks and government bonds, improving the credit quality of its investment portfolio

would likely only occur if we raised our ratings on Isbank, on other local banks where Milli Re holds deposits, and

on Turkey.

Base-Case Scenario

Macroeconomic Assumptions

• The outlook on the foreign and local currency ratings on Turkey remains negative given the fiscal risks

emanating from Turkey's uncertain growth prospects and against a backdrop of high net external debt levels.

There are also longstanding pressures on institutional checks and balances.

• Our base case scenario that annual GDP growth will average about 3% from 2015-2018.

• Milli Re's long-term premium growth potential could be affected by the weakness of Turkey's economy and its

investment income could become volatile.

• Interest rates will remain high during the next two years and the rate on Turkish 10-year government bonds will

remain at least 7%.

Company-Specific Assumptions

• Capital adequacy will likely remain at least slightly below the 'A' (moderately strong) level.

• Gross premium written (GPW) will grow by about 4% to around Turkish lira (TRY) 995 million in December

2015, mainly fueled by expected local market growth.

• Milli Re could offset 2015's modest growth, in 2016, by reducing its involvement in the local agriculture business

if this business line continues to underperform and the terms and conditions do not improve.

• A net combined (loss and expense) ratio of about 105%-110% over 2015-2017.

• After-tax operating income of around TRY35 million in 2015 and TRY45 million in 2016, assuming constant

exchange rates.

• Investment returns of TRY125 million-TRY135 million in the 2015-2016 financial years.




Key Metrics

(Mil. TRY) 2016* 2015* 2014 2013 2012 2011

Gross premiums written ~945^ ~995 958 925 1,031 992

Change in gross premiums

written (%)

~(5) ~4 3 (10.2) 4 16

Gross premiums written

(consolidated)

N/A N/A 3,868 3,597 3,185 2,829

Change in gross premiums

written (%)

N/A N/A 8 13 13 124

Net income 45 35 11 23 98 -145

Net income (consolidated) N/A N/A 92 100 39 -167

Net combined ratio stand-alone

(%)

110-105 110-105 113 113 107 132

Net combined ratio

consolidated (%)

N/A N/A 105 104 110 117

Net investment yield (%) 10-8 10-8 7 6 8 8

Standard & Poor's capital

adequacy

Strong Moderately strong Moderately strong Upper adequate Lower adequate Lower adequate

*Forecast data reflect Standard & Poor's base-case scenario on a standalone basis. ^Milli Re could reduce its involvement in the local agriculture

business if this business line continues to underprofrm and the terms and conditions do not improve. TRY--Turkish lira. N/A--Not applicable.

Company Description: Local Reinsurer With A Considerable InternationalPresence

Milli Re is the only national reinsurer that operates in the Turkish insurance market. It was set up by its parent, Isbank,

to operate the compulsory reinsurance system in 1929. Milli Re has accepted business from the Turkish market since

1991.

The company has a market share of about 26% of Turkey's proportional reinsurance business and 9% of its

nonproportional catastrophe reinsurance business in 2015. International reinsurers take the remaining reinsurance

premiums in the local market.

Milli Re focused on the fire and engineering lines of business in 2014. Together, these accounted for 64% of the 2014

GPW of TRY958 million ($413 million). Nonmotor accident lines accounted for a further 11%, followed by agriculture

(8%), marine (7%), motor (5%), life insurance (3%), and health (2%). In 2014, 25% of the overall GPW was from the

international market and 75% from Turkey.

Business from Continental Europe and Lloyd's accounted for 33% while Middle East, Asia, North and Continental

Africa, Commonwealth of Independent States (CIS), and Eastern Europe generated 31% of international premiums. In

addition, the Singapore office, opened in 2007, has a portfolio that contributed 15% of international premiums,

Northern Cyprus business contributed 11%, and the remaining 10% of international premium was generated by

Federation of Afro Asian Insurers and Reinsurers (FAIR) and Economic Cooperation Organization (ECO) reinsurance

pools.




In 2014, 87% of premium came from proportional business and 13% from nonproportional business. The international

portfolio has a larger nonproportional content than the local business, which helped to increase the volume of

nonproportional business over the years. Around 93% of the GPW was sourced from treaty business; the rest is from

facultative accounts.

Is Bank, the largest commercial bank in Turkey, is the parent of Milli Re, owning 77% of the company.

Milli Re is the principal shareholder (57%) of Anadolu Anonim Turk Sigorta Sirketi (Anadolu), the third-largest non-life

insurance company in Turkey. Anadolu Sigorta and Milli Re have similar business and financial risk profiles, excluding

Milli Re's reduced exposure to the local motor and health businesses.

Chart 1


Insurance industry and country risk: Moderate, potentially volatile

Overall, we consider that Milli Re faces moderate industry and country risk because it is chiefly exposed to the Turkish

insurance sector. The assessment is comparable to a number of other property/casualty (P/C) markets, such as those

in Poland, Spain, and Italy (see "Insurance Industry And Country Risk Assessment Update: June 2015," published on




June 5, 2015).

Our assessment of country risk for Milli Re is moderate, reflecting the difficult operating environment for the Turkish

P/C insurance sector. We consider that the P/C sector is exposed to the country's relatively moderate level of income

and volatile economy, which contributes to the low level of insurance premium per capita. Mitigating these factors are

the central government's generally effective policymaking and institutions. We also anticipate that the P/C insurance

sector will continue to benefit from high interest rates in Turkey.

Our assessment of Milli Re's industry risk is moderate, primarily due to the high barriers of entry into the Turkish

market. This is offset by the negative product risk caused by the sector's exposure to earthquake risk, in our view. We

consider that there is significant potential for premium growth in Turkey, although the industry's profitability,

measured using return on equity, is likely to remain negative for the next two years. We view the institutional

framework in Turkey as neutral to our analysis, reflecting its adequate regulation and supervision. We view positively

the regulator's aim to implement the EU's Solvency II directive.

We do not expect our assessment of country and industry risk to change over the next two years.

Table 1

Industry And Country Risk

(Re)Insurance sector IICRA Business Mix (%)

Turkey P/C Moderate Risk 75.0

Global P/C Reinsurance Intermediate Risk 25.0

Weighted-average IICRA Moderate 100.0

IICRA--Insurance Industry And Country Risk Assessment. P/C--Property/casualty.

Competitive position: Adequate, with a dominant position in Turkey and international diversification

Although the company has a dominant position in the Turkish reinsurance market, it is heavily exposed to the pricing

inadequacy and fierce competition in the local market. Also, the Turkish insurance market is becoming more litigious.

We expect Milli Re to maintain its dominant competitive position in the Turkish reinsurance market over the medium

term. An improvement in the Turkish insurance environment would positively influence our assessment of the

company's competitive position. However, its concentration on Turkish earthquake risk is a relative weakness (partly

mitigated by the sound retrocession program) compared with its peers.

The company has limited its exposure by increasing its international business and substantially reduced its exposure to

the worst-performing domestic sectors like motor and health. Also, Milli Re could reduce its involvement in the local

agriculture business if this business line continues to underperform and the terms and conditions do not improve. We

view this positively, as this line of business became unprofitable in recent years. However, Milli Re's earnings are still

being undermined by prior years' claims relating to bodily injury claims stemming from its motor portfolio (in common

with the Turkish non-life insurance sector).

Compared with some of its regional peers in Central Europe and the Middle East, Milli Re enjoys a dominant position

in a market which is relatively material by premium income and has significant potential for growth. That said, the

policy environment in Turkey is becoming less predictable and this could weigh on the economy's resilience and




long-term growth potential.

The company's international business adds some diversification, although it is somewhat dependent on a few

companies; just five companies contribute about 42% of the related premium.

Unlike most of its peers, Milli Re's dependency on brokers is low. Only 15% of the total premium is garnered this way;

the remainder is directly written.

Milli Re's premium income increased by 4% in 2014 compared with 2013. The 2014 slowdown in the growth of the

Turkish non-life insurance market was reflected in Milli's results (nominal growth of 22% in 2013 compared to 2014's

9%). The company's results were also affected by the merger of two major cedants and their intra-group cession, the

scaling down of Milli Re's liability business in response to deteriorating results, and a further trimming in Milli's

international portfolio. Milli Re's growth levels are below market levels because it has minimal exposure to motor

insurance, which is the biggest contributor to the market. For 2015, our base-case scenario assumes that Milli Re's

gross premium income is likely to increase by about 4%, to about TRY995 million. Local market growth of up to 12%,

combined with some improvement in pricing property (especially fire) lines of business, will support this growth, as

will a slight increase in the international account. However, Milli's modest growth in 2015 could be offset in 2016. Milli

Re could reduce its involvement in the local agriculture business if this business line continues to underperform and

the terms and conditions do not improve

Table 2

Competitive Position

--Year ended Dec. 31--

(Mil. TRY) 2014 2013 2012 2011 2010

GPW 958 925 1,031 992 855

Change in GPW (%) 4 -10 4 16 4

Net premiums written 823 799 927 906 773

Change in net premiums written (%) 3 (14) 2 17 2

Reinsurance utilization - premiums written (%) 14 14 10 9 10

Business segment (% of GPW)

P/C reinsurance 97 98 98 98 98

Life reinsurance 3 2 2 2 2

TRY--Turkish lira. GPW--Gross premium written. P/C--Property/casualty


Capital and earnings: Moderately strong capital and earnings based on improved investment incomeprospects

Our view of Milli Re's moderately strong capital and earnings is supported by its currently moderately strong level of

risk-based capital, which is likely to improve through retained earnings over 2015-2017.

In recognition of the poor performance of its motor portfolio, Milli Re has significantly reduced its exposure to motor

business over recent years (5% of total premium in 2014, compared with 42% in 2006). Despite this, however, Milli




Re's earnings are still being weakened by prior years' claims relating to bodily injury claims stemming from its motor

portfolio (this is common in the Turkish non-life insurance sector). Milli Re reported a loss ratio of 78% in 2014, of

which 8 percentage points were caused by reserve strengthening from the run-off of the motor business. However, we

take a more positive view on the improvement in net underlying loss ratios, which is evident on underwriting year

basis over the last three years.

Under our base-case scenario, we forecast a profit of around TRY35 million in 2015 and TRY45 million in 2016 and

around TRY55 million in 2017, assuming constant exchange rates. We forecast a net average combined ratio of around

105%-110% over 2015-2017, mainly due to the continued difficulties in the Turkish insurance market. Nonetheless, we

consider Milli Re's capital and earnings are likely to remain moderately strong because we expect it to retain most of

its earnings, supported by high investment income prospects in Turkey. We think this will improve its risk-based

capital to the strong level.

Table 3

Capitalization Statistics


(Mil. TRY) 2014 2013 2012 2011 2010

Total reported capital 753 702 658 447 799

Change in total reported capital (%) 7 7 47 (44) 4

TRY--Turkish lira.

Table 4

Earnings Statistics


(Mil. TRY) 2014 2013 2012 2011 2010

EBIT adjusted 11.1 23.0 98.0 (145) 76.0

Net income (attributable to all shareholders) 11.1 22.6 98.3 (144.5) 64.0

Return on total reported capital (%) 1.5 3.3 17.8 (23.2) 8.2

Net expense ratio (%) 35.6 35.2 30.2 29.9 28.4

Net loss ratio (%) 78.8 77.6 76.3 102.7 79.3

Net combined ratio (%) 113.4 112.8 106.5 132.5 107.7

TRY--Turkish lira.

Risk position: High risk position mainly due to high investment leverage and earthquake modelingrisk

The key factors affecting our view of the company's risk position are its high investment leverage (mainly below

investment-grade bond holdings and bank deposits) under our strict definition; the volatility of results even in

noncatastrophe years; and the risks associated with modeling earthquake risk, which has yet to be tested (like other

reinsurers operating in Turkey). Our assessment is consistent with our assessment of risk position for Milli Re's global

reinsurance peers. We base our assessment on their exposure to potential capital and earnings volatility through

catastrophe risk. To partly mitigate this, Milli Re has expanded outside Turkey. We note that this partly helps to reduce

the volatility due to local market conditions, gives Milli Re the ability to alter the business mix in desired composition,

and also gives Milli Re the ability to benefit from global cycles and products which would not be accessible to it




otherwise. However, Milli Re's majority ownership of Anadolu, the second-largest insurance company in Turkey by

gross premium income, reduces the diversification benefits it received by expanding outside Turkey.

Milli Re has considerable exposure to earthquake risk in Turkey. It assesses its exposure using an internal model

developed by an external consultant, and utilizes Risk Management Solutions Inc.'s (RMS) earthquake model output.

The risk of fire following an earthquake is not been incorporated into the model. This limits the accuracy of the result,

which is made worse by the granularity of the exposure data. That said, Milli Re has purchased additional reinsurance

to mitigate the potential impact. By using its modeled exposure (using a one-in-250 return period), Milli Re has been

able to reinsure almost all of its gross exposure (its net exposure fell in 2014). Furthermore, the strong quality of the

company's reinsurers mitigates its potential credit-related risk.

On the investments side, Milli Re holds most of its investments in fixed-income bonds such as government bonds (15%

of total investments excluding investment in Anadolu), corporate bonds (6%) or as cash (60%). Milli Re's exposure to

local banks, through its short-term deposits and government bonds, creates some credit risk. The company invests in

well-established institutions to mitigate this risk (all of the bank deposits are in banks we view as highly systematically

important). The company's main exposure to market risk is through interest rate and currency risk. Of the liquid

portfolio, 88% is invested in Turkish lira-denominated instruments, while the rest is in foreign currency to match its

international liabilities. About 8% of the total portfolio is invested in equity investments in listed Turkish companies.

Table 5

Risk Position


(Mil. TRY) 2014 2013 2012 2011 2010

Total invested assets 1,682 1,524 1,410 1,157 1,307

Change in total invested assets (%) 10 8 22 (11.43) 4

Net investment income 115 89 104 93 130

Net investment yield (%) 7 6 8 8 10

Portfolio composition (% of general account invested assets)

Cash and short-term investments (%) 44 40 48 50 29

Bonds (%) 15 22 16 19 30

Equity investments (%) 14 11 9 8 8

Real estate (%) 2 3 3 4 3

Investments in affiliates (%) 24 25 23 20 30

TRY--Turkish lira.

Financial flexibility: Adequate, with limited capital needs

Financial flexibility (defined as the ability to source capital and cash relative to requirements) is adequate, in our

opinion. Our base-case scenario assumes that retained earnings will remain the principal source of capital growth in

the next few years. Under severe stress scenarios, we anticipate that Isbank would support Milli Re if necessary. Based

on our forecasts, we do not expect the company to require external long-term capital or short-term liquidity over the

next three years.




Other Assessments

Milli Re's enterprise risk management (ERM) and management and governance practices are neutral factors for the

rating.

Enterprise risk management: Adequate, exposure to earthquake modeling risk is the main obstacle

Milli Re has ERM processes and models in place to assess the risks it faces. The key risks are sovereign risk and the

knock-on effect this could have on Milli Re's investment portfolio, and catastrophe risk from concentrated exposure to

earthquakes in Turkey. We consider that ERM is of high importance to the rating on Milli Re because, despite its

simple business model, its high exposure to government bonds and catastrophe risk may significantly affect the

financial strength of the company.

Management and Governance: Clear strategy and experienced management team

Milli Re has a clear strategic plan agreed by the management and the board. In our view, Milli Re's strategy is

consistent with its organizational capabilities and market conditions. In Turkey, Milli Re is focusing on providing

capacity for profitable lines of business such as fire, while withdrawn from others, such as motor and health, which

have historically yielded negative results. Also, management could reduce its share in the government-subsidized

agriculture scheme from 2016. However, its majority ownership of Anadolu means that Milli Re still has exposure to

these lines on a consolidated basis.

In our opinion, Milli Re's management team is competent, stable, and experienced, and has successfully maintained

the company's dominant position in Turkey. The senior management team is well-established and long-standing.

Milli Re operates independently of its parent. However, it reports to Isbank quarterly on matters of budget and risk

management. It also has six representatives from Isbank on its board of directors and can call on the expertise of its

parent when necessary. Its parent does not set specific financial targets, for example, in terms of return on equity or

combined ratio.

Financial management appears adequate and aims to sustain the company's current financial position. The company

has a clear business plan. Its long-term dividend policy is to pay a minimal level, determined by Milli Re's results.

Shareholders have not set financial targets.

Liquidity: Strong, with available liquidity sources

We regard the company's liquidity as strong, owing to the strength of available liquidity sources--mainly premium

income and an asset portfolio that contains around TRY1.2 billion in cash and marketable securities.

In our view, the company will meet its liquidity needs if it incurs a modeled major claims event, owing to its risk

profile. There is no debt to be repaid over the next 12 months.

Accounting Considerations

Milli Re is regulated by The Insurance Supervisory Board (the primary insurance regulator in Turkey) and its accounts

comply with Turkish generally accepted accounting principles.




We treat equalization reserves as equity. All of the figures in this report refer to Milli Re's financials only, unless stated

otherwise. Although our analysis is largely based on Milli Re's stand-alone credentials, we do bear in mind the

potential benefit/threat that Anadolu could pose, notably through its exposure to Turkish earthquake and the

unprofitable motor and health business, which could deplete Milli Re's consolidated capital. Our assessment of

stand-alone capital model results writes off Milli Re's holdings in Anadolu (2014: TL407 million). However, our

assessment of Milli Re's capital also considers the risk-based capital model output of Milli Re consolidated with

Anadolu.

Related Criteria And Research

Related Criteria

• Insurers: Rating Methodology, May 7, 2013

• Group Rating Methodology, May 7, 2013

• Enterprise Risk Management, May 7, 2013

• Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012

• Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance

Capital Model, June 7, 2010

• Use of CreditWatch and Outlooks, Sept 14, 2009

• General Criteria : S&P's National and Regional Scale Mapping Tables, Sept. 30, 2014

• Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions , Nov. 19, 2013

Ratings Detail (As Of July 17, 2015)

Operating Company Covered By This Report


Counterparty Credit Rating

Turkey National Scale trAA+/--/--

Domicile Turkey

*Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable

across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and

debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees.

Additional Contact:

Insurance Ratings Europe; [email protected]




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