How Arig might return from the grave

By Nick Henry in Manama

It's been a tough 12 months for the Arab Insurance Group (Arig), the Bahrain-based reinsurance specialist. It lost $88 million last year, largely as a result of September 11th. Arig's share price fell to just 20 cents, down from $1.60 at its flotation in 1997. And ratings agencies cut their all-important ratings on Arig Re, the group's reinsurance arm that chalked up most of the losses.

In isolation, 2001 would have been a difficult storm to weather. But it followed two years of similarly heavy losses. Such dismal performance was clearly unsustainable, and management reacted by announcing a major financial restructuring.

First, Arig Re was folded into the parent company. Second, financiers devised an innovative recapitalization in a bid to write off the group's losses and draw a line in the sand after three turbulent years.

"We started to have discussions with sovereign shareholders last year, long before September 11th," says Udo Krueger, the company's chief executive officer. "After September 11th, and the effect on our book of business, we had to increase the pace."
Mandates. This not the first time that Krueger has attempted to resuscitate the ailing group, the largest reinsurer in the Arab world.

The German national was hired in 2000, replacing the previous CEO, Abdul-Wahab Al Tammar. Krueger was given a very clear mandate from the board of directors: to revive Arig's flagging fortunes. Krueger devised a new strategy, which included withdrawing from aviation business, restructuring or divesting overseas subsidiaries, and developing income from business services and information technology. At the time, his new approach was roundly welcomed by analysts. So what went wrong?

"Unfortunately, September 11th caught up with us," says Krueger. "A change in direction does not work to quarterly results [in reinsurance]. There is a time lag of up to several years between receiving premium payments and the last payout on claims."

This reality was hammered home following the September 11th terrorist attacks and the American Airlines crash in New York on November 12th. Krueger had taken the decision to pull out of the aviation sector more than a year earlier. But the time lag meant that Arig Re's exposure to United Airlines and American Airlines had not expired by the time the incidents took place. And that lag, for Arig, proved extremely costly.

"Both were about to expire, American Airlines in two and a half months and United Airlines in six weeks," says Krueger. "We had already taken the decision not to renew all of our aviation accounts." Worse still, Arig Re had purchased retrocession cover to protect itself against aviation loss while the policies were expiring. But the company providing some of the cover, Fortress Re, collapsed, leaving ARIG heavily exposed. The incidents cost Arig a total of $62.8 million.

Poor timing. Analysts agree that the timing of the attacks, and the November crash, were extremely unfortunate for Arig. "They were a little bit unlucky," says Shahid Hameed, head of research at Securities and Investment Company (SICO) in Bahrain. "Their cover for United Airlines was just about to expire. They had been getting out of aviation business for some time. But it takes time to get out - you cannot exit overnight."
Bad luck rather than bad judgement may well have been the main culprit - but that did not change the precarious position in which Arig found itself. "Their problem was that their equity base had been shrunk and they were downgraded by a ratings agency, which had major negative implications for their business," says Shahid.

Despite some sympathy for Arig, international ratings agencies were left with little choice but to downgrade Arig Re in the wake of the troubles. In November, insurance ratings specialist AM Best lowered its financial strength rating of Arig Re to B+ from B++. While B+ is classed as a "very good" rating, it is outside the crucial A category, dealing a massive blow to Arig's ability to generate business. Ratings are used by clients to decide which reinsurance companies to place their business with. Arig has traditionally enjoyed an A rating, but when this fell, so did much of Arig Re's marketability.

Rather than endure a second-tier rating, Krueger took the decision to fold Arig Re into Arig - a move that meant Arig was without any rating. It was a bold step. "When you are not rated, it is very difficult for a reinsurer to go into the market and get new clients," says Hameed.

It is clear, then, that reinsurance - the group's core business - has certainly suffered. Sadly for Arig, so have some of the group's other operations. In the late 1990s, under previous management, Arig acquired significant stakes in a number of retail insurance companies operating throughout the Arab world, particularly Jordan and Morocco. These were ailing business that the previous management hoped to turn around and return to profitability. It was a costly mistake.

"With the benefit of hindsight we did not have the management resources or the capital to [make this work]," says CEO Krueger. "With the deteriorating results of Arig it became quite obvious that we were not able to manage direct operations from a distance. Morocco, for example, is more than 6,000 kilometers from Bahrain."

Dealing with this legacy was one of the central pillars of Krueger's new corporate strategy when he arrived two years ago. But as with reinsurance, it has taken time to sell or restructure the businesses. "We have already divested significantly," Krueger says. "But again, this is something you cannot accomplish within a short period of time. First of all you have to add value to the subsidiaries, then you can start looking for a partner."

Finally, Arig has been hit by the international capital markets slump. Arig holds significant assets in international portfolios, but returns have plummeted following the downturn in virtually all major equity markets. Investment income declined by $12.4 million to $36.8 million in 2001. "Interest earnings were affected by the prevailing low interest rate environment while lower dividend incomes reflected the drop in corporate earnings due to the global economic downturn," says Arig. "Depressed financial markets conditions led to losses on the equity portfolio."

Equity. All this has inevitably taken its toll on Arig's share price. The company floated 50.5 percent of its shares in late 1997, at a price of $1.60 (the remaining equity was kept by the three co-founders, the governments of Libya, Kuwait and the United Arab Emirates). In spring this year the price fell to just 20 cents on the Bahrain stock exchange.

"Arig shares have been traded actively, and have lost 80 percent of their value since IPO in 1997," admits Krueger. "This was a clear vote of non-confidence by shareholders, refusing to support the previous management and the strategy of the past." Not surprisingly, many are unhappy. "There was a lot of disappointment," says SICO's Shahid. "A lot of people got into the stock at $1.60 at the IPO."

Arig has clearly reached a low ebb. But there are genuine signs that the tide may be about to turn. Major shareholders have backed the restructuring plans. The share price has rallied in recent weeks. And there are signs that Krueger's new strategy - implemented in 2000 - is finally paying off.

In July, Arig got approval from shareholders to press ahead with its recapitalization. Two of its three major shareholders, the governments of the UAE and Libya, have agreed to support the rights issue (the third, Kuwait, has opted out, but is retaining a shareholding). Many private investors, who have bought shares since flotation, have also agreed to support the issue. Analysts agree that the fact Arig can afford to allow a five-year deferred payment for these new shares underlines that, even after three years in the red, the company remained fundamentally sound.

Many investors clearly believe the worst is over for Arig. "Now you are seeing some people getting into the stock," says SICO's Shahid. "It is still trading at a discount to book value. And two of the three major shareholders are supporting the rights issue." The share price rose to above 30 cents in early August - still a long way from its floatation price, but at least it has reversed its slump.

Most important of all, CEO Krueger's corporate strategy is finally beginning to pay off. Indeed, clear signs of a turnaround were visible as early as spring 2001. "The new CEO has come and last year we saw some good turnaround signs, and had it not been for September 11th they would have done a lot better," says SICO's Shahid.

First half results in 2001 were promising, before September 11th wiped out any chance of profit for the year. First quarter results from 2002 are also encouraging, with Arig recording a small profit of $100,000. Given that there are no more aviation skeletons in the closet, this should be sustainable.

Ratings. Arig has found a solution to working without a rating. "Rating is important, but I believe that at this particularly step, it is secondary for Arig," says Krueger. "Ninety percent of our business is in Arab and North African markets. In this environment, a visible sign of support from three governments is at least equally as important and capable to substitute a rating." For once, fortune may be on his side. After three dismal years, there are signs that the reinsurance sector is picking up, with premiums rising and increasing demand for niche players such as Arig.

"In the medium-term, once our business has stabilized, rating will become an option again. At this time and based on our past performance it is unlikely that we'll get the rating required to open up the Asian markets. So we will concentrate on our core markets this year and next year, to demonstrate that we can stabilize the performance on a healthy level." Even regional retail insurance subsidiaries are coming round. "We are making significant progress," insists Krueger.

For these reasons, he is extremely bullish about the group's prospects. "We intend to successfully occupy a regional niche . . . even if this means only having two-thirds of the revenue as in the past. As long as we are a profitable operation, it is better than being among the top 50 reinsurance companies in the world and making losses." He is full of praise for the attitude of the Arig board since he joined, applauding their openness, frankness and unwavering support.

Krueger, of course, is paid to put a positive spin on Arig's outlook. Crucially, though, his optimism is shared by independent analysts. "The company's management looks a lot better now," says SICO's Shahid. "The company has got out of several businesses that had incurred losses in the past. The strategy going forward looks good to me." N

Arig's recapitalization has two motives: raising money to plug the financial gap left by three years of losses, and sending out a message to its clients that it still has the confidence of shareholders. Under the first stage of the plan (a capital reduction), the company will cancel existing shares and replace them with new shares. Shareholders will get five new shares for every 12 shares they held.

Many investors have already lost heavily, especially those who have held the company's stock since its initial flotation in 1997. But analysts say that the recapitalization is a good deal for shareholders.

"We believe the capital reduction is merely a book entry and does not affect shareholder value in a negative manner," says a recent report by the Securities and Investment Company (SICO) in Bahrain. "However, shareholders would benefit in the future as the capital reduction would allow Arig to start with a clean slate [and] start paying dividends to shareholders much earlier."

The second stage (a rights issue) involves Arig issuing $100 million in new shares. Partly, this is to raise cash, but mainly to gain a vote of confidence from shareholders. Shareholders can either buy the new shares outright or, crucially, defer payment for five years.

"The [deferred] payment option is an innovative one and is new to the regional financial markets," says SICO. Krueger confirms that the group is looking more for high-profile expressions of shareholder backing than a short-term cash injection. "What's important," he says, "is a visible sign of support."