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Copyright 2011 by A.M. Best Company, Inc.ALL RIGHTS RESERVED. No part of this report or document may be distributed
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BESTS SPECIALREPORTOur Insight, Your Advantage.
Takaful
Market Review
July 11, 2011
SectorTakaful
Additional Information
Special Reports:GCC: Rich in Potential, But Hurdles
Remain
Top Middle East Markets Are Poised forTakeoff
Southeast Asia May Reward Shrewd Insurers,Punish the Careless
Criteria:Takaful (Sharia Compliant) InsuranceCompanies
Analytical Contact:
Vasilis Katsipis, London,
+(44) 20 7397 0278Vasilis.Katsipis@ambest.com
Writer:
Yvette Essen, London
+44 20 7397 0322Yvette.Essen@ambest.com
Takaful Poised for Growth, ButGreater Focus is RequiredTakaful operators in the Gulf Cooperation Council (GCC) andMalaysia are growing at a rapid pace and are enjoying strong capi-
talisation on a consolidated funds basis.
A.M. Best Co.s research compares the performance of takaful
operators to those of conventional insurers in the same markets.The findings indicate that:
Family business is more profitable than general takaful, and is
growing at a fast pace. Family takaful is also outpacing conven-tional life insurance, thereby representing the greatest opportu-
nity for profitable growth of takaful operators.
In general takaful, operators are growing quickly, but in mostcases this is a consequence of the rapid expansion of the insur-ance markets in these countries, as opposed to increased demand
for Sharia-compliant offerings.
Most general takaful operators tend to compete with conven-tional insurers on price because most start-up companies are fall-ing behind their original business plans. Takaful operators finan-
cial performance tends to be inferior to conventional insurers.
Most takaful companies are highly capitalised. This is partlythe result of many companies being in the early stages of opera-
tion and being capitalised at levels sufficient for when they wouldachieve operational maturity. In many cases, takaful funds havelow levels of excess resources as these are retained at the opera-
tor/shareholder level.
There are positive regulatory developments occurring in sev-eral markets, with the introduction of specific takaful regulation.
However, in most countries there is considerable uncertainty asto the priority of liabilities in the case of insolvency of a takafulcompany. This could prove critical given the typically low levels
of capitalisation of takaful funds.
A.M. Best believes takaful will continue to be among the fastest
growing segments of the GCC and Malaysian insurance markets.The ability of takaful operators to increase insurance penetrationis critical to their success. Family takaful currently presents thegreatest opportunity to achieve this because it provides the Mus-
lim population with alternative protection and investment oppor-tunities, and the takaful insurers with increased profitability.
To ensure its longer term viability, the sector needs to improve
its ability to retain earnings within the takaful fund and focus onproduct differentiation as opposed to competing on price.
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Special Report July 11, 2011
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To an extent, general takaful has beenbuoyed by increased demand for protec-
tion in growing economies where com-pulsory lines of insurance have beenintroduced. In most cases, markets where
takaful is offered are enjoying growthin gross domestic product (GDP) and
increased consumer wealth which, in turn,has resulted in significant increases in
insurance premiums for the market as awhole.
As a result, most takaful companies arecompeting with conventional insurers on
pricing for the same business, rather thanthrough a differentiated value proposition
based on the ethical values of takaful.
Competition within personal lines prob-ably will continue as the recent economic
turmoil has resulted in the postponementof capital-intensive projects. Customersare likely to continue to purchase the most
cost-effective product, as opposed to pay-ing extra for an offering that is Sharia com-
pliant.
Takaful contribution volumes have
increased sharply over the past few years;however, most takaful companies that have
started trading in the past five years havefallen behind their original business plans.
Companies with overly optimistic growthtargets have revised their projectionsdownward as an influx of new takaful com-
panies coincided with the downturn in eco-nomic conditions. Some are still struggling
to meet these new business plans.
Retakaful: Great Potential FailsTo MaterialiseIn general, retakaful has also failed to grow
as rapidly as initially expected. While therehas been tremendous growth in the prima-
ry takaful market over the past few years,
this has not translated into commensurateincreased retakaful demand because taka-ful operators have been utilising traditionalreinsurance capacity.
The majority of retakaful companies are con-
sequently engaged in traditional reinsurancebusiness. The growth of the retakaful market
depends on whether primary takaful opera-tors come under pressure to alter their rein-surance purchasing patterns and seek Sharia-
complaint cover for themselves.
Family Takaful RepresentsBest OpportunityIn general, life assurance is viewed as anopportunity for both conventional insurersand takaful operators. Family takaful busi-
ness is more profitable than general takafulbusiness, offering higher margins and sta-
bility, and is growing at a faster pace. Thisis a new market that is not served particu-
larly well by conventional insurers.
Exhibit 2 shows that family takaful premi-um of the sample companies grew by a 22%CAGR from 2004 to 2009 to USD 456 mil-
lion, in particular driven by GCC premiumdevelopment. Although this was from a low
initial base, it was at a considerably fasterrate than the conventional life market,
which grew by 5% over this period.
Family/Life Premium DevelopmentFamily takaful premiums have grown par-ticularly strongly in the GCC at an 86%
CAGR over 2004 to 2009. The Malaysianmarket has a more developed takaful
market and has experienced more stablegrowth in the past few years but again,takaful companies have outperformed tra-
ditional Malaysian life insurers.
Family takaful has also increased its pres-ence over this six-year period. In 2004, the
companies followed by A.M. Best in thesemarkets represented 5% of the total familytakaful and life market. In 2009, this figure
had more than doubled to 10.2%.
3
Exhibit 2
Takaful vs Conventional Family/Life GWP*Development (2002-2009)
0
1,000
2,000
3,000
4,000
5,000
TakafulConventional
20092008200720062005200420032002
USDMillion
s
*Gross Written Premium
Source: A.M. Best Co., BestLink
AMB
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Special Report July 11, 2011
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Family Takaful DeliversHigh Levels of ProfitabilityFamily takaful has tended to be more prof-itable than conventional life insurance (see
Exhibit 3). From 2002 to 2009, conventionallife insurers have delivered a return on lifepremiums of 7.2% to 9.4%. Profitability of
family takaful business tends to be morevolatile owing to more aggressive and con-
centrated investment portfolios.
As a result, traditional life insurers outper-formed their takaful competitors only dur-ing 2009 when return on life premiums was
7.3% for takaful operators, compared to9.4% for their counterparts.
This was not a consequence of takaful
operators risk selection, rather a resultof their asset composition with their
investments being concentrated in sukuks(Sharia compliant bonds) and private
equity investments, which were among thehardest hit by the global downturn. A.M.Best expects that in 2011, the financial per-
formance of family takaful operators willbe higher than that of the conventional life
insurers.
Higher profitability has been accompaniedby upstreaming of profits to the operators
funds, with takaful operators consistentlyoutperforming their conventional counter-parts. This, if continued, will enhance the
appeal of takaful business and its accep-tance among the insured public.
Financial Performance of GeneralTakaful Improves but VariedThe financial performance of takaful com-
panies has improved, although this variessignificantly between operators. Familytakaful is very profitable while the profit-
ability of general takaful depends on indi-vidual market and operator expertise.
In Malaysia, more stable growth hasenabled takaful companies to post greater
profits than takaful operators in the GCC.Malaysian takaful operators have also con-
sistently outperformed their traditionalcompetitors (see Exhibit 4), with com-bined ratios for takaful operators rangingfrom 93% to 74% in recent years.
Profitability of General InsuranceIn the GCCHowever, it has been a different picturefor the GCC market where general takaful
profitability has suffered from intense com-petition. The GCC has a younger takafulmarket, with most of the takaful companies
being in the early years of their operations.The influx of new capital for the establish-
ment of new takaful operators combined
with the economic slowdown of recentyears has meant that takaful operatorsneed to compete on price in order to buildup a presence and achieve the volumes
anticipated in their original business plans.
While combined ratios have been below100% since 2003, the financial performance
of takaful operators is below those ofconventional insurers in the GCC. In 2009,combined ratios were 87% for takaful
0%
3
6
9
12
15%
TakafulConventional
20092008200720062005200420032002
Exhibit 3
Takaful vs Conventional
Return on Family/Life Premiums (2002-2009)
Source: A.M. Best Co., BestLink
AMB
Exhibit 4
Takaful vs Conventional Malaysia
General Insurance Combined Ratio (2002-2009)
70%
75
80
85
90
95
100
105
110%
TakafulConventional
20092008200720062005200420032002
Source: A.M. Best Co., BestLink
AMB
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Special Report July 11, 2011
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companies, compared to 83% for conven-tional insurers (see Exhibit 5). It has beenincreasingly difficult to attract profitablebusiness against the more established con-ventional insurers, which also benefit from
high levels of reinsurance commissionsreceived for the high risk business that
they normally front.
As a result, general takaful businesshas been experiencing approximately
10 percentage points higher acquisitionexpense ratios. This, combined with thehigher management expenses especially
among start-ups, has resulted in operatingexpense ratios of 25% in 2009, compared to
19% for traditional insurers. This expensegap has been higher in prior years and has
previously reached 15 percentage pointshigher than their traditional competitors.
Underwriting performance as measuredby the claims ratio has remained remarkably
close for conventional and takaful companieswith a few companies in both sub-segments
consistently deviating from the norm.
The difficulties that newer takaful entrants
face in delivering technical profits pose aquestion as to their long-term viability. The
willingness of their shareholders to contin-ue to support these companies indefinitely
will be tested if returns continue to lagbehind original expectations.
Technical profitability will remain the mostimportant driver for the viability and the
rating of many takaful companies. However,with technical profitability lagging behind
that of conventional insurers, investmentperformance becomes critical for the com-petitiveness of takaful operators.
Investment Performance GoodBut Volatile
In terms of asset allocation, most GCC andMalaysian takaful operators appear tofollow the pattern of their domestic mar-kets, having very similar proportions of
asset classes as conventional insurers butwith emphasis on sukuk investments as
opposed to conventional fixed income anda higher exposure to private equity.
A.M. Bests analysis shows 57% of assetsheld by takaful operators were in higher
risk investments such as shares (whichinclude private equity), loans and real
estate (see Exhibit 6). This is comparableto the asset mix of conventional insurerswhich have a similar investment in high-
risk categories (61%); however, the con-ventional companies investment in private
equity is markedly lower, representing 27%of their share portfolio, compared to 36%
for takaful companies.
Investment Asset MixOf Takaful CompaniesTakaful market participants additionally
face more restricted investment policiescompared with their conventional counter-
parts. The supply of sukuk products in themarket is limited in comparison with con-
ventional bond offerings.
Therefore operators have a higher concen-tration of assets in their investment portfo-
Exhibit 5
Takaful vs Conventional
GCC* General Insurance Combined Ratio (2002-2009)
75%
80
85
90
95
100
105%
TakafulConventional
20092008200720062005200420032002
*Gulf Cooperation Council
Source: A.M. Best Co., BestLink
AMB
Exhibit 6
Takaful Investment Asset Mix (2002-2009)
Source: A.M. Best Co., BestLink
AMB
0%
10
20
30
40
50
60
70
80
90
100%
2002 2003 2004 2005 2006 2007 2008 2009
Cash Sukuk Shares Real Estate Other Affiliates Loans
57%
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lios. From 2004 to 2009, takaful companieshave suffered greater capital losses, both
realised and unrealised, in comparison totheir conventional counterparts.
Since 2006, conventional insurers in theGCC and Malaysia have delivered a better
return on their investments (see Exhibit7). In 2009, takaful companies had aninvestment yield of 3%, compared to a 5%return for conventional insurers in the
sample.
Excellent Capitalisation of TakafulOperatorsBoth takaful operators and conventional
insurers in A.M. Bests sample enjoy strongrisk-adjusted capitalisations. In many
cases, takaful companies have better capi-tal adequacy than conventional insurers
and local operations of international com-petitors. In part, this is a consequence ofthe early phase of their operating life and
the fact that several start-up companies arefailing to fulfil their initial business plans.
At the same time, capitalisation of takafulfunds is kept low in most cases, especially
among new operators. Most new compa-nies that are generating any underwriting
profits are delivering these to the opera-tors fund, resulting in a minimal retention
in the takaful fund.
While this practice is viable in the short
term, it creates uncertainty about thelong-term prosperity of takaful funds. The
building up of sufficient capital resourceswithin the takaful fund is imperative for a
secure A.M. Best rating, and the retentionof earnings, especially in the early years of
operation, is the only way for takaful fundsto achieve their long-term viability.
In many cases there is a continuous depen-dence on the qard hassan (benevolent loan
from the operator to the takaful fund).This can only be a short-term solution
and at the same time, it brings to the forethe uncertainty surrounding the priority
of policyholder liabilities in many takafulmarkets. In many cases there is no clarityas to the priority of policyholder liabili-
ties, and often there is neither provisionnor jurisprudence that would indicate the
prevailing legal system (temporal versusSharia law) in case of the default of a taka-
ful company.
Country Risk ImprovesIn Takaful MarketsA.M. Best expects the operating environ-
ment to improve for most of the countriescovered in this report, with the main driver
being the rebound of most economies.
As part of A.M. Bests country risk rating
methodology, countries are placed into oneof five tiers, ranging from CRT-1 (Country
Risk Tier 1), denoting a stable environmentwith the least proportion of risk, to CRT-5
(Country Risk Tier 5) for countries posingthe greatest risk. All GCC countries andMalaysia have an A.M. Best CRT-3, which
is at the top end of the scale for emergingcountries.
A.M. Best considers there to be positive
developments in several markets becauseof the introduction of takaful specific regu-lation and minimum capital requirements,
including in the UAE, Saudi Arabia, Bahrainand Malaysia.
As A.M. Bests primary focus is the assess-ment of financial strength and policyhold-ers security, the rationale and financialincentives on which the allocation of prof-
its between policyholders and sharehold-ers is based is of particular interest.
In many markets the seniority of policy-
holder claims remains unclear. Regulationhas yet to be tested regarding the ring-fenc-ing of assets within the takaful fund and
0%
1
2
3
4
5
6
7
8
9%
Conventional Takaful
200920082007200620052004
Exhibit 7
Takaful vs Conventional Investment Yield (2004-2009)
Source: A.M. Best Co., BestLink
AMB
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the use of a qard hassan from operators,should the fund become insolvent.
An upstreaming of profits to the operatorsfund by the younger takaful companies
has resulted in several policyholder fundsbeing significantly undercapitalised. Con-
sidering the continuing competitive natureof the market, in A.M. Bests opinion, this
seems a precarious position.
The Islamic Financial Services Boards(IFSB) publication of the Standard on Sol-vency Requirements for Takaful (Islamic
Insurance) Undertakings in December2010 is welcome. The key principles and
standards set by the IFSB, if adopted bylocal regulators and takaful operators, will
provide additional security and uniformity.It is still unclear for many countries as to
whether Sharia or temporal law will takeprecedence in the event of a takaful opera-
tor becoming insolvent.
Many markets where takaful companies
operate are considering implementingInternational Financial Reporting Stan-
dards. A uniform accounting standardis particularly welcome, as this would
improve consistency and transparencyamong companies.
Takaful financial transparency hasimproved significantly over the past two
years. However, there are still operatorsthat fail to specify the financial perfor-
mance of their funds. Furthermore, thereis inconsistency as to how different
funds are consolidated on the operatorsbalance sheet.
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