A.M. Best s TAKAFUL REVIEW 2012 EDITION

Transcription

1 A.M. Best s TAKAFUL REVIEW 2012 EDITION

2 Contents 2 FOREWORD By Vasilis Katsipis, General Manager, Market Development MENA, South & Central Asia 4 METHODOLOGY: RATING TAKAFUL (SHARI A COMPLIANT) INSURANCE COMPANIES 11 RELATED METHODOLOGIES 11 Assessing Country Risk 15 Understanding Universal BCAR 20 A.M. BEST S COUNTRY RISK TIERS 21 ARTICLE: COMPETITION DAMPENS TAKAFUL PROFITS 27 SAMPLE AMB CREDIT REPORTS 27 First Insurance Company 34 Al Fajer Retakaful Insurance Company K.S.C. (Closed) 41 GUIDE TO BEST S FINANCIAL STRENGTH RATINGS 42 GUIDE TO BEST S DEBT AND ISSUER CREDIT RATINGS 43 ABOUT US: A.M. BEST COMPANY AT A GLANCE 45 CONTACT US Copyright 2012 by A.M. Best Company, Inc. ALL RIGHTS RESERVED. A.M. Best s Takaful Review 2012 Edition 1

3 Foreword 2 A.M. Best s Takaful Review 2012 Edition The year 2011 was characterised by the continuing expansion of takaful insurers and, in many cases, of takaful operators beginning to come to grips with the impact of their expansion. All of the markets in which Islamiccompliant insurance products are offered are starting to come of age as evidenced by the very limited number of new ventures being established. There are at least three different categories of companies offering Islamiccompliant products. In the first category, in markets including Malaysia, Shari acompliant insurance products are well established and takaful companies have competed for years with traditional insurers. These takaful operators continue to be characterised by the relative stability of market shares, although takaful insurers continue to increase their market share slowly, and their profitability is in line with that of conventional insurers. In the Kingdom of Saudi Arabia, where Shari a-compliant insurance is allowed through the co-operative model, 2011 was characterised by extreme competition for new compulsory lines of business. As a result, many companies have recorded technical losses and in many cases erosion to their capital bases. Yet, abetted by the difficulty of establishing new companies in the KSA and unrealistic expectations of continuing growth in contributions, their market values have continued to appreciate. This kindles the misconception among many shareholders that insurance is a risk-free investment. The remainder of the markets fall into the third category, which is characterised by the fact that takaful is a relatively new development and Shari a-compliant insurers compete with traditional insurers. In these markets, takaful companies saw continuing rapid growth in their market shares. It appears that this growth has been at the expense of technical profitability. In most cases, the combined ratios of takaful companies are significantly higher than those of their traditional competitors. This, combined with some more aggressive investment strategies, has meant that several takaful companies saw their capital levels reduced and at the same time had to commit larger amounts from their diminished capital resources toward Qard Hassan. The latter development has attracted the attention of shareholders as they are concerned about the value of their investments. There are several calls for regulators to allow companies to start paying dividends (in cases where this is not permitted). While this will improve the valuation of some companies, it will not address the cause of the problem. The fact remains that most takaful operators are relative newcomers in highly competitive and congested markets. The inability of many companies to build their value-proposition around their ethical principles means that consumers are often selecting them purely on price. This is a strategy that plays on the advantages of the well-established traditional insurers, especially as most takaful companies have smaller operations and therefore higher marginal costs. Takaful operators continue to enjoy strong overall capitalisations, mainly due to the fact that they are in the early stages of their operations and lagging behind their original plans for growth. This is despite the fact that several takaful operators continue to suffer from technical losses and investment write-downs driven by their high exposures to real estate and equities. The uncertainties remain on the permanence of capital and its subordination to policyholder obligations in many cases, but there have also been initial steps by regulators to clarify their position. In 2012, A.M. Best issued an update to its A.M. Best s Rating Methodology for Takaful (Shari a Compliant) Insurance Companies, which reflects the regulatory framework within certain countries and the guidance papers that have been issued by the Islamic Financial Services Board.

4 The resolve and commitment of several new takaful operators is already being tested with lower-than-expected business volumes and low or negative investment returns. This is a time of tremendous opportunity to redefine the offering of takaful companies to their markets, with greater emphasis on what distinguishes them from traditional insurers. There are a few examples of companies that are already taking this path, and they are likely to be the winners of the future. n Vasilis Katsipis General Manager, Market Development MENA, South & Central Asia A.M. Best s Takaful Review 2012 Edition 3

5 Methodology PUBLISHED: JANUARY 10, 2012 Rating Takaful (Shari a Compliant) Insurance Companies This report highlights the main issues arising when applying A.M. Best s rating methodology to takaful insurance companies. Takaful insurance (or insurance compliant with Islamic beliefs) is clearly on the rise, particularly in the Middle East and Malaysia, and despite their many similarities with conventional mutual operating structures, A.M. Best believes there are distinctive issues with these companies that need to be highlighted. However, it is important to mention that the main principles on which A.M. Best s financial strength methodology are based remain unchanged, regardless of the type of company being analysed. As is discussed later, each takaful company must establish a Shari a board that sets the basic rules and principles governing the takaful company s activities, and ensuring that it operates within Islamic Shari a principles. A.M. Best will not specifically comment on takaful companies degree of compliance with Shari a. However, as part of the interactive rating evaluation, A.M. Best will discuss items such as: the organization s corporate and management structure; the type of takaful business model employed; corporate governance and the role of the Shari a board; and the insurer s performance versus key strategic and financial objectives. For further information on the breadth and depth of the rating evaluation, please refer to Appendix 1 Sample Takaful Meeting Agenda. The discussion that follows includes: a review of some of the key principles of takaful; how these principles are incorporated into a takaful company s business model; and how A.M. Best s rating methodologies are applied in the assessment of these organizations. ADDITIONAL INFORMATION Criteria: Rating European Mutual Insurers Understanding Universal BCAR A.M. Best s Perspective on Operating Leverage Risk Management and the Rating Process for Insurance Companies Assessing Country Risk Rating Members of Insurance Groups PRINCIPLES OF TAKAFUL The first takaful insurer was established in Sudan in 1979, and the market now has grown to comprise roughly 200 companies, including windows (operations affiliated with conventional insurers). Takaful includes both general (non-life) and family (life) products. The family product line includes life and health insurance plans, as well as education, accident and travel medical plans. The surge of takaful companies in recent times is a response to the commonly accepted incompatibility between Islamic beliefs and the conventional insurance model. Takaful insurance is essentially a cooperative risk-sharing program established for the well-being of the community. The purpose of this system is not to generate profit, but to uphold the Islamic principle of Al-Takaful bear ye one another s burden. As a result, takaful insurance is based on the concept of mutual cooperation, solidarity and brotherhood. Takaful participants contribute (donate) to help protect one another against the impact of unpredicted risk and catastrophe, whereas in the conventional insurance model, policyholders pay premiums to protect themselves, or their interests, from some form of risk. ANALYTICAL CONTACTS Carlos Wong-Fupuy, London +(44) Carlos.Wong-Fupuy@ambest.com Mahesh Mistry, London +(44) Mahesh.Mistry@ambest.com Moungmo Lee, Hong Kong +(852) Moungmo.Lee@ambest.com Other Islamic beliefs or principles that takaful operations intend to address are the avoidance of both uncertainty, particularly in terms of the amount and timing of claim payments to be made; and excessive profit (seen as usury), be it in the form of payments received in the event of death, or any form of financial interest (e.g., bond coupon payments). Underwriting and actuarial techniques apply in a similar manner as under conventional insurance, in that the takaful insurer evaluates the risk of potential loss and establishes a contribution (premium) base appropriate for that aggregate risk to protect the pool from undue losses. However, unlike the risk-based premium paid by a policyholder in a conventional insurance model (where each insured pays a rate commensurate with the assumed level of risk), each takaful participant shares equally in supporting the pool in recognition of the underlying principle of mutual cooperation. 4 A.M. Best s Takaful Review 2012 Edition

6 As to reinsurance, it also should be based on the takaful pooling concept. The reinsurer should act primarily as a risk manager (retakaful operator) and should not profit excessively from the underwriting results. However, because of the relative lack of capacity and quality of true retakaful carriers, reinsurance with conventional reinsurers may be permitted under certain specified conditions and limitations. TAKAFUL MODELS & STRUCTURES For takaful programs to be financially sound over the long term, as well as to provide incentive to takaful insurers to develop and promulgate these programs to provide Muslims with alternatives to conventional insurance, these operators to some degree must be rewarded through profits in a more traditional sense. However, profits are not the end goal of the operation. Muslims believe there is unity in diversity, so there is not one preferred operating model for takaful insurers. Shari a scholars generally agree on certain fundamental components that are required to be an accepted takaful company; however, operational differences are tolerated as long as there is no contradiction to any essential religious tenets. There are now three primary operating models. Ta awuni Model The Ta awuni model (cooperative insurance) practices the concept of pure Mudharabah in daily transactions, where it encourages the Islamic values of brotherhood, unity, solidarity and mutual cooperation. In the pure Mudharabah concept, the takaful company and the participant share the direct investment income, while the participant is entitled to 100% of the surplus, with no deduction made prior to the distribution. From the Ta awuni concept, there are two basic models, Al Mudharabah and Al Wakalah. In reality, there are many variations of these basic models, but these variations fundamentally follow one of these two conceptual frameworks. Al Mudharabah. This is a modified profit- and loss-sharing model. The participant and the takaful insurer share the surplus. The sharing of such profit (surplus) differs based on a ratio mutually agreed between the contracting parties. Generally, these risk-sharing arrangements allow the takaful insurer to share in the underwriting results from operations, as well as the favourable performance returns on invested premiums. Al Wakalah. This is a fee-based model. Cooperative risk-sharing occurs among participants where a takaful insurer simply earns a fee for services (as a Wakeel, or Agent ) and does not participate or share in any underwriting results. The insurer s fee may include a fund management fee and a performance incentive fee. Retakaful Capacity and Financial Security Issues Reinsurance following the same applicable Islamic principles as takaful insurance is known as retakaful. Reinsurance of takaful business through retakaful companies has been somewhat controversial within the Islamic insurance marketplace, as the growth of direct takaful writers has far outpaced the available capacity of retakaful. In addition, from a financial strength perspective, there have been ongoing concerns over the placement of reinsurance with lower or non-rated retakaful companies, as opposed to higher rated conventional reinsurers. As a result, takaful insurers in effect face issues with both retakaful capacity and financial security. This has caused takaful companies to develop alternate strategies, including reinsuring on a conventional basis, contrary to the preference of seeking retakaful support. In recognition of this market reality, the Shari a scholars have allowed takaful companies to seek support from conventional reinsurers under confined conditions. However, the preference still is to utilize retakaful companies whenever possible. Another manner in which takaful insurers have addressed the issue of retakaful capacity is to co-insure (a form of reinsurance) each other s direct takaful writings to reduce the heavy reliance on conventional reinsurance support. The shortage of retakaful capacity may inhibit the growth of the takaful industry; however, A.M. Best has observed that the issue of retakaful capacity has begun to ease recently as an increasing number of new retakaful companies are being established in response to the market demands. As part of the rating evaluation, as with any insurer, A.M. Best will review the takaful insurer s reinsurance program and the quality and diversity of its reinsurance providers, including the exposure to counterparty credit risk. A.M. Best s Takaful Review 2012 Edition 5

7 Methodology Waqf Model Unlike the Al Mudharabah and Al Wakalah models, Waqf operates as a social/governmental enterprise, and programs are operated on a nonprofit basis. Under the Waqf model, the surplus or profit is not owned directly by either the insurer or the participants, and there is no mechanism to distribute the surplus funds. In effect, the insurer retains the surplus funds to support the participant community. This model, with a single surplus fund, is most like a conventional mutual insurance model. As such, it is rated in a very similar manner to conventional mutuals. For further information on the rating dynamics of mutual insurance companies, please see A.M. Best s Rating European Mutual Insurance Companies. The remainder of the report will highlight the unique elements of takaful companies following the Ta awuni model, and how these factors are incorporated in the rating analysis. MAIN CHARACTERISTICS OF TAKAFUL COMPANIES Takaful insurers have certain unique characteristics that recognize the key principles of Al-Takaful and fundamental Islamic beliefs. The establishment of two separate funds: A takaful (or policyholders ) fund and an operator s (or shareholders ) fund. The takaful fund operates under pure cooperative principles, in a very similar way to conventional mutual insurance entities. Underwriting deficits and surpluses are accrued over time within this fund, to which the operator has no direct recourse. As a result, the takaful fund effectively is ring-fenced and protected from default of the operator s fund. Management expenses and seed capital are borne by the operator s fund, where the main income takes the form of either a predefined management fee (to cover costs) or a share of investment returns and underwriting results (or a combination of both). Solidarity principle and equal surplus distribution: Given the fact that the takaful fund is seen as a pool of risks managed under solidarity principles, it is not meant to accumulate surpluses at levels excessively higher than those strictly needed to protect the fund from volatile results and to support further growth. Likewise, any fees or profit shares received by the operator should be just sufficient to cover management and capital costs while keeping the company running as an ongoing concern. In case of financial distress for the takaful fund, the operator is committed to provide it with an interest-free loan, Qard Hasan, for however long it is deemed necessary providing an additional layer of financial security to the participants. The Qard Hasan is likely to be limited to the available capital in the operator s fund or a prescribed limit. The surplus distribution structure is expected to be managed carefully and in a balanced way, so that neither policyholders nor operator make excessive profits at the expense of the other party. Restricted investments: Shari a compliance refers not only to the operational structure of the company, but also to its investment policy. Takaful companies must avoid investing in traditional fixed-income securities (due to the coupon interest payment attached). Instead, they are allowed to invest in sukuk (or Islamic bonds, where coupon payments take the form of a profit share on a particular enterprise). Moreover, investments in stocks (in principle allowed) should avoid the financing of non-islamic activities (such as alcohol or gambling). In practice, these restrictions often translate into an excessive concentration in stocks (due to the relative scarcity of sukuk), lower than average credit ratings (increased counterparty exposure) and high geographical concentration. Establishment of a Shari a board: An essential component in a takaful company s corporate governance is the establishment of a Shari a board, in addition to the conventional board of directors. The Shari a board is made up of recognised Islamic scholars, who ensure the company s operational model, profit distribution policies, product design and investment guidelines comply with Islamic principles. The global shortage of recognised Islamic scholars in the insurance arena and lack of consensus in terms of what constitutes Shari a compliance is, in A.M. Best s view, a challenge for more rapid development of the industry. Having said this, the emergence of some inter-regional and government-supported initiatives in this respect, as well as the participation of individual scholars in more than one Shari a board, are positive signs of a gradual but slow trend toward convergence. 6 A.M. Best s Takaful Review 2012 Edition

8 ANALYSING A TAKAFUL COMPANY As with conventional mutual insurance companies, takaful insurers have certain limiting features inherent to their business model, such as a relative lack of financial flexibility compared with stock companies, or increased concentration risk compared with broadly diversified insurers. This section discusses some unique elements of takaful insurers and how these are assessed in the rating process. Two Separate Funds a Two-Stage Risk-Based Capital Approach Given that one of the key characteristics of a takaful operation is the existence of two separate funds (the takaful fund and the operator s fund), the starting point for assessing the financial strength of a particular insurance company is to apply Best s Capital Adequacy Ratio (BCAR) proprietary model to the takaful fund in a way very similar to a mutual company. This first-tier analysis compares the takaful fund s surplus to the capital required to support the fund s obligations to participants, per the BCAR model. The BCAR ratio for the takaful fund, as well as an analysis of the trends in the ratio and other key metrics, is the primary driver of A.M. Best s assessment of the takaful company s balance sheet strength. A second-tier capital assessment also is performed on the operator s fund. The second-tier analysis compares the surplus position of the operator s fund to the capital required to support the fund s obligations, per the BCAR model. An operator s fund with much higher financial strength than its corresponding takaful fund normally will enhance the capitalisation assessment in respect of the whole insurance operation, reflecting the increased financial strength provided to the takaful fund s participants. This enhanced financial strength stems from the operator s obligation to provide an interest-free loan (Qard Hasan) to the takaful or policyholders fund in situations of financial distress. In cases where such a loan has been made to the takaful fund, the loan will be considered part of the takaful fund s capital base. Additionally, in circumstances where the potential Qard Hasan (dependent on strength of regulation) is not sufficient to bring the takaful fund to a suitable capital adequacy level, consideration will be given for shareholders commitment to the takaful fund, such as ring fencing assets in favor of policyholders. This consolidated view of capital, in effect combining the takaful and operator s fund for analytical purposes, is particularly important in the assessment of takaful insurers in the early years of operation. Currently, it is not uncommon for the operator s fund to be in a stronger relative position, given the relatively short track record of most companies with the resulting low level of surpluses, if any, accumulated at a takaful fund level. An operator s fund with a weaker financial strength position may not detract from the overall analysis significantly, since the operator s fund cannot access the takaful fund surplus. However, in all cases, regardless of which fund is in a stronger relative position, it also is important to note that this two-tier analysis is supplemented further by a comparison of the capital accumulation trends in each of the separate funds to ensure an appropriate balance in the surplus distribution and fee structure. Main Drivers of Balance Sheet Strength in a Takaful Company Given the comparatively restricted investment policy of a typical takaful company; its consequent higher levels of counterparty risk; geographical concentration; and higher than average proportion of stock holdings, capital requirements in many cases are significantly larger than for a conventional company of a similar size. Exhibit 1 Basic Takaful Model Seed capital Management expenses Commissions Qard hasan (interest-free loan, if needed) Operator s Fund Policyholders (Takaful) Fund Administrative fees Share of investment returns and/or underwriting results) Claims A.M. Best s Takaful Review 2012 Edition 7

9 Methodology The limited classes of invested assets long have been a barrier to the growth of the takaful industry, as well as a limitation on the development of more long-term products, due to the difficulty in addressing asset-liability management issues. The current situation has improved as the capital markets in Islamic countries have begun to mature and more Shari a-compliant investment products are available in the market. However, demand is still higher than supply, resulting in increased expense for such investment products. In terms of insurance risk borne by takaful companies, the currently moderate exposures and relative specialisation on domestic and small to medium-sized corporate lines should be expected to keep the capital requirements (as per the BCAR model) modest. These factors, nonetheless, easily can be more than offset by rapid growth of business and excessive concentration in a few product lines, with resulting pressures on capital needs. Exhibit 2 Analysing a Takaful Company Risk-adjusted capitalisation Restricted investment policy Higher counterparty risk Geographical concentration Higher stockholding concentration ALM limitations Financial flexibility restricted to accrued surpluses and Qard Hasan Inadequate retakaful capacity Commitment provided by shareholders to support policyholder liabilities BCAR applied to policyholders fund (1st Tier analysis) BCAR applied to shareholders fund (2nd Tier analysis) Operating performance Potential for adverse selection due to crude pricing Need for operators to recoup expenses Typically higher expense ratios Lower investment yields due to restricted investment policy Balance between profit distribution and fee structure Market environment and regulatory environment So far restricted to personal and SME lines Uncertainty as to competitive advantages compared with conventional insurance Country risk may have negative impact due to early stages of development of market and regulatory environment Safeguards such as policyholders funds ring-fencing and interest-free loan from operator yet to be tested Strength of takaful regulation under which company operates Financial Strength Rating (FSR) An essential feature of all takaful models is participants sharing of the underwriting surpluses/deficits. Accurately determining the surplus/deficit is, therefore, fundamental to the accounting process. Setting aside a reserve for contingencies always raises the question as to which policyholders own it, i.e. the participants that helped set it up or later generations. This is relevant because the significance of the reserve in the initial years of takaful operations is likely to be substantially greater than in subsequent years. This effectively will result in earlier participants paying to stabilize underwriting results for later participants. Despite the possible inequity in a pure sense, the building up of a contingency reserve is desirable to enable stability in underwriting results and make it practical to expand the size of the risk pool (as there will be limits to what amounts the takaful operator will be able to provide as Qard Hasan in case of deficits). A.M. Best considers contingency reserves as part of the capital and surplus of a company when assessing balance sheet strength. As with conventional insurance operations, an important driving factor in the rating decision for a takaful company is its degree of financial flexibility (i.e. the company s ability to raise equity capital). As with mutual companies, the capital available normally would be expected to reflect significant surpluses accrued over the years within the takaful fund. This component of the analysis is focused mainly on the operator because of the mutual nature of the takaful fund and its inherent lack of financial flexibility. The assessment normally involves a detailed analysis of the ownership structure (and shareholders solvency) and the record of equity or debt issues. Furthermore, consideration needs to be given for shareholders capital commitment to the takaful fund. A.M. Best monitors carefully the quality of the reinsurance program to assess a takaful company s balance sheet protection through reinsurance. This is particularly relevant given the previously mentioned restricted retakaful capacity (and virtual nonexistence of retro-takaful), which may force direct insurers to compromise the security of their insureds. Operating Performance Issues In a Takaful Company In principle, any fees paid to the operator on average should be lower than the difference between premiums and claims. In other words, as long as the takaful fund continues to generate surpluses in the long term, there should be 8 A.M. Best s Takaful Review 2012 Edition

10 no major reason for concern. Having satisfied this condition, at a second level of analysis, A.M. Best believes that to ensure the ongoing existence of the whole insurance operation, it is important as well that the operator at least can cover its expenses from the fees received from the policyholders fund. For companies to achieve more secure ratings, it is important that the takaful fund generates profits and that there is a suitable balance of profit distribution between shareholders and policyholders, in addition to appropriate management fees to generate surpluses. During the past few years, takaful companies (particularly in the Middle East) have shown higher expense ratios than their conventional counterparts. The main driver is relatively high management charges and fees to the takaful fund, resulting in low surplus accumulation. However, some companies are adopting prudent fee structures and surplus accumulation to assure a suitable balance of profit distribution and charges is maintained. A.M. Best would expect the current gap to narrow in coming years as takaful business volumes continue to expand rapidly. In addition, A.M. Best expects that over time, the issue of higher expense ratios will be somewhat mitigated by higher customer loyalty and policy persistency driven by the participants belief in the principles of takaful. As for investment returns, given takaful companies constraints in asset management, higher concentration in shares and in a particular geographical region, and increased counterparty credit risk, A.M. Best expects, takaful funds on average to yield lower risk-adjusted returns, experiencing higher volatility and credit defaults. Despite the continuous growth in the supply of Islamic securities, A.M. Best believes the investment opportunities are bound to remain limited for years to come. Market Environment and Country Risk Despite the continued impressive growth of the takaful sector overall, rapid growth has not been experienced in all product lines, as the expansion of general or non-life business has outpaced that of the family or life product line. In addition, the typical size of a takaful company remains smaller than that of a conventional insurer. Takaful insurers tend to be smaller, in part due to their relative lack of operating experience (takaful insurers have only been in existence since 1979), and the more limited operating profile of takaful insurers when compared with conventional insurers that have diverse operating platforms and more than a century of operating history. Going forward, A.M. Best believes the main opportunities and challenges for the sector overall are the development of more robust life insurance platforms, and compulsory lines such as motor third-party liability and health within the non-life business (in particular countries). A growth area within the corporate product line is medium-sized business risk products within the energy and construction sectors, which continue to expand. In general, retention levels for corporate product lines have been improving gradually, providing a more stable base for growth, although the largest risks still are expected to be ceded to the international markets. A.M. Best believes it is not yet clear whether takaful companies offer any competitive advantage within this market environment. It is debatable whether there is actually an untapped demand (especially in family/life insurance business) due strictly to religious beliefs and whether this can be unlocked easily through the offer of takaful products. A material component of the rating process focuses on the market position of the company its diversification in terms of client base, business lines and distribution network. In particular for takaful companies based in the Middle East, all these factors are related closely to A.M. Best s country risk assessment. The early stage of development of complementary sectors or activities (e.g. Islamic bonds, bancassurance or Internet distribution and retakaful capacity) often may have a negative impact on the final rating assigned. Regulatory Environment and Risk Management Regulation is extremely important in A.M. Best s assessment of takaful companies. The strength of regulation varies significantly among jurisdictions, and the protection to policyholders is somewhat unclear. While regulation of takaful companies has developed and improved in recent years, there remains an inherent lack of transparency in certain jurisdictions, particularly concerning the liabilities on winding up a takaful company. Where regulation is deemed to be weak or unclear, benefit can be given for additional commitments to the takaful fund from shareholders in favor of policyholders, such as ring-fenced assets which will be made explicit in A.M. Best s analysis of a company. Additionally, A.M. Best will consider the role of the Shari a board within the organization and any potential differences with regulators on winding up a company. Moreover, in A.M. Best s opinion, some of the regulatory safeguards (e.g., ring-fencing of assets within the takaful fund, interest-free loans from operators in case of solvency difficulties, etc.) are yet to be tested. The development of A.M. Best s Takaful Review 2012 Edition 9

11 Methodology the Islamic insurance industry, including the regulatory environment, needs to keep pace with the rest of the financial industry in the region (especially banking). In A.M. Best s view, a robust regulatory regime is crucial for the development of a risk management culture. A.M. Best believes that given their constraints, takaful companies need to develop and demonstrate that they can apply an adequate risk-based approach to investment management (because of the reduced investment opportunities); capital adequacy and reserving (given the need for building up surpluses in the long term, especially for family/life business); and pricing/adverse selection control (given the restrictions on charging extra risk premiums for policyholders representing a greater risk of loss than the aggregate participant pool). Overall, one of the unique challenges facing takaful companies and A.M. Best as it endeavours to assess their financial strength is the need to ensure that the objectives set by their Shari a boards are consistent with key performance indicators based on conventional sound financial and risk management. That includes establishing processes to address all material risks, despite the challenges presented by the limited capacity of retakaful, and concentration risks presented by restrictive investment guidelines and the limited geographic diversity of the current takaful marketplace. RATING TAKAFUL WINDOWS AND TAKAFUL SUBSIDIARIES There has been an increasing use of takaful windows and takaful subsidiaries as companies seek to widen their offering and service clients. While contributions from the takaful operations are currently small, volumes are increasing and becoming more prominent within conventional insurers profiles. In addition to the takaful methodology herein, A.M. Best will also use Rating Members of Insurance Groups when rating takaful windows and subsidiaries. n 10 A.M. Best s Takaful Review 2012 Edition

12 PUBLISHED: MAY 23, 2011 Assessing Country Risk Related Methodology A.M. Best defines country risk as the risk that country-specific factors could adversely affect an insurer s ability to meet its financial obligations. Country risk is evaluated and factored into all A.M. Best ratings. As part of evaluating country risk, A.M. Best identifies the various factors within a country that may directly or indirectly affect an insurance company. In doing so, A.M. Best separates the risks into three main categories: economic risk, political risk and financial system risk. Given A.M. Best s particular focus on the insurance industry, financial system risk is further divided into two sections: insurance risk and non-insurance financial system risk. A.M. Best s evaluation of country risk is not directly comparable to a sovereign debt rating, which evaluates the ability and willingness of a government to service its debt obligations. Though country risk analysis does consider the finances and policies of a sovereign government, the final assessment is not guided by this sole purpose. Additionally, A.M. Best s country risk evaluation does not impose a ceiling on ratings in a given domicile. Exhibit 1 Relationship Between Ratings and CRTs Above Average Rating Average Rating Below Average Rating CRT-1 aaa aa+ aa aa- a+ a a- bbb+ bbb bbb- bb+ bb bb- b+ b b- CRT-2 aaa aa+ aa aa- a+ a a- bbb+ bbb bbb- bb+ bb bb- b+ b b- CRT-3 aaa aa+ aa aa- a+ a a- bbb+ bbb bbb- bb+ bb bb- b+ b b- CRT-4 aaa aa+ aa aa- a+ a a- bbb+ bbb bbb- bb+ bb bb- b+ b b- CRT-5 aaa aa+ aa aa- a+ a a- bbb+ bbb bbb- bb+ bb bb- b+ b b- A.M. Best s approach to country risk analysis employs a data-driven model that scores the level of risk present in a given country, plus a qualitative assessment of country-specific conditions that affect the operating environment for an insurer. Countries are placed into one of five tiers, ranging from CRT-1 (Country Risk Tier 1), denoting a stable environment with the least amount of risk, to CRT-5 (Country Risk Tier 5) for RELATED REPORTS Criteria Understanding Universal BCAR countries that pose the most risk and, therefore, the greatest challenge to an insurer s financial stability, strength and performance. The conceptual relationship between the relative level of country risk and the rating of an insurer is depicted in Exhibit 1 above. Risk Management and the Rating Process for Insurance Companies Rating Members of Insurance Groups RATING ANALYSTS Edward Easop, Vice President +1 (908) Ext Edward.Easop@ambest.com Andrea Keenan, Managing Senior Financial Analyst, Country Risk Group +1 (908) Ext Andrea.Keenan@ambest.com James Gillard, Senior Financial Analyst, Country Risk Group +1 (908) Ext James.Gillard@ambest.com In short, as country risk increases (measured by a higher assigned tier), the distribution of ratings migrates down the rating scale as the level of risk approaches CRT-5. This same relationship effectively applies to any significant category of risk an insurer faces, i.e. higher risk exposure pressures financial stability. Key elements of country risk can be managed or mitigated, effectively reducing the impact on an insurer s rating. As a result, it is possible that A.M. Best s highest ratings can be achieved in any country. Country risk is not a ceiling or cap on insurer ratings; it is one of many rating factors. Country Risk Tier assignments are reviewed annually, though significant events and developments are tracked continuously and may cause an interim change to a country s tier assignment. CRTs are assessments of the current conditions in a country, but they are designed to remain stable through the business cycle. Therefore, political and industry outlooks as well as economic forecasts are integrated into the assessment process. ELEMENTS OF COUNTRY RISK The three risk categories in A.M. Best s country risk assessment economic risk, political risk and financial system risk will be defined below, and some of the key variables used will be discussed (see Exhibit 2). A.M. Best s Takaful Review 2012 Edition 11

13 Related Methodology Exhibit 2 Components of Country Risk Analysis Non-Insurance Financial System Risk: Economic Policy Banking System Macroeconomy Business Environment Vulnerability Economic Prospects Political Government Stability Financial Reporting Standards & Regulations Risk International Transactions Risk Social Stability System Sovereign Debt Government Finance International Diplomacy Risk Insurance Financial System Risk: Legal System Government & Legislation Supervisory authority Insurer Accountability Economic risk is the likelihood that fundamental weaknesses in a country s economy will cause adverse developments for an insurer. A.M. Best s assessment of economic risk evaluates the state of the domestic economy, government finances and international transactions, as well as prospects for growth and stability. Political risk is the likelihood that governmental or bureaucratic inefficiencies, societal tensions, an inadequate legal system or international tensions will cause adverse developments for an insurer. Political risk comprises the stability of a government and society; the effectiveness of international diplomatic relationships; the reliability and integrity of the legal system and business infrastructure; the efficiency of the government bureaucracy; and the appropriateness and effectiveness of the government s economic policies. Financial system risk (non-insurance) is the risk that financial volatility may erupt due to inadequate reporting standards, weak banking systems or asset markets or poor regulatory structure. Non-insurance financial system risk considers a country s banking system, accounting standards and government finances, and it assesses how vulnerable the financial system is to external or internal volatility. Basel II, World Bank Insolvency Principles and International Accounting Standards all are referenced in the analysis, as are the performances of banks, equity indices and fixed-income securities. Insurance risk is the risk that the insurance industry s levels of development and public awareness; transparency and effectiveness of regulation; reporting standards; and regulatory sophistication will contribute to a volatile financial system and compromise an insurer s ability to pay claims. Insurance risk, which A.M. Best considers as a distinct subsection of financial system stability, is addressed separately because of the importance of and A.M. Best s specific focus on the industry. The assessment is based heavily on the Insurance Core Principles (ICP) of the International Association of Insurance Supervisors (IAIS). A.M. Best employs a sizable subset of the 28 ICPs by organizing them into three categories: 1) government commitment to an open and well-regulated insurance industry, 2) adequacy of supervisory authority and its supporting infrastructure, and 3) insurer accountability. CALCULATING COUNTRY RISK The country risk assessment begins with the running of the Country Risk Model to generate a score. The score is a weighted average of the three risk categories. The main equation for calculating the Country Risk Score is as follows: Score = [ω E I E + ω P I P + ω FS (I FSi + I FSni )] 2 Where I E = Economic Risk I P = Political Risk I FSi = Financial System Risk (insurance component) I FSni = Financial System Risk (non-insurance component) ω = weight applied to each category of risk In special circumstances, such as where a given domicile has a particularly strong relationship with another such as Guernsey with the United Kingdom an additional calculation is added that integrates the larger domicile s influence on the stability of the smaller. The base equation is a simple weighted average of the three categories of risk used in country risk analysis. A country with a higher country risk score indicates a more risky environment as compared with a country that has a lower country risk score. The score then is squared, representing the non-linear relationship between the score and the actual country risk present in the country. 12 A.M. Best s Takaful Review 2012 Edition

14 The country risk score provides a baseline of evaluation for each country. After the model is run, the Country Risk Group evaluates additional qualitative factors that would influence the overall score, or one particular category of risk. COUNTRY RISK TIERS The assignment of CRTs to score ranges is based on A.M. Best s assertion that the risk in countries can be categorized loosely to provide a basis of comparison, provided that country-by-country differences are acknowledged. Therefore, CRTs can be classified, in a typical scenario, by the following: Exhibit 3 Country Risk Evaluation Process CRT Proposal with Impact Study Approved CRTs Published CRT-1: Predictable and transparent political environment, legal system and business infrastructure; sophisticated financial system regulation with deep capital markets; mature insurance industry framework. Rating Impact Study Conducted Global Report Released CRT-2: Predictable and transparent political environment, legal system and business infrastructure; sufficient financial system regulation; mature insurance industry framework. CRT-3: Developing political environment, legal system and business infrastructure with developing capital markets; developing insurance regulatory structure. Country Risk Group Evaluation Implied CRT Country Risk Model Output = Country Risk Score CRT-4: Relatively unpredictable and non-transparent political, legal and business environment with underdeveloped capital markets; partially to fully inadequate regulatory structure. CRT-5: Unpredictable and opaque political, legal and business environment with limited or nonexistent capital markets; low human development and social instability; nascent insurance industry. The characteristics of a country with a stable insurance industry environment that are favorable for an insurance company are highly correlated with those countries that are economically large, stable, diverse and efficiently regulated, with stable political regimes supported by a strong and credible legal system. ANNUAL AND EVENT-DRIVEN REVIEWS The Country Risk Model is updated on an annual cycle. Therefore, at a minimum, each country that is assigned a Country Risk Tier is reviewed annually. This review includes the model-driven score, the qualitative analysis and the committee process each year. During the interim period, the Country Risk Group continually monitors world events and developments and assesses their potential impact on any tier assignments. This process is facilitated through the maintenance of a watch list that identifies countries that are experiencing a significantly increased level of volatility that has the potential to impact the CRT. It is unusual for a country to be moved up or down the scale outside of the annual review cycle, as the CRTs are designed to move through the business cycle and are not subject to frequent upgrades or downgrades. Therefore, while recent developments are factored into the analysis of country risk, they often are not significant enough to warrant an off-cycle change in the tier assignment. In the event of a change in CRT, the ratings of the companies domiciled in that country will be subject to review. Exhibit 4 Incorporating Country Risk Management Team Peer Analysis/ Industry Composite Industry Trends & Analysis Company Rating Enterprise Risk Management Country Risk Capital Adequacy Exhibit 5 Rating Translation Financial Strength Ratings (FSR) and Issuer Credit Ratings (ICR) Secure FSR ICR FSR ICR A++ A+ A aaa aa+ aa aa- a+ a Investment Grade Vulnerable B bb+ bb C++ b+ b A- a- C+ b- B++ bbb+ bbb B+ bbb- C- C ccc+ ccc B- bb- ccccc Non-Investment Grade A.M. Best s Takaful Review 2012 Edition 13

15 Related Methodology APPLYING COUNTRY RISK TO RATINGS A.M. Best s ratings are an independent opinion based on a comprehensive quantitative and qualitative evaluation of a company s balance sheet strength, operating performance and business profile. Country risk is one of many factors considered in evaluating a company according to these three characteristics. The level of consideration given to country risk, i.e. the potential impact on the rating assignment for a company, is determined on a case-by-case basis for each insurer, based on its financial strength, position in the market and ability to mitigate or manage its exposure to country risk. A.M. Best s Country Risk analysis seeks to identify those aspects of a country that may create a difficult or unpredictable environment for an insurer. A wide array of issues is accounted for that can compromise predictability. For example, a poorly regulated banking system, poorly executed monetary policy or illiquid equity market would leave a financial system more prone to collapse. On average, most companies in CRT-1 or CRT-2 countries would not be impacted adversely by their operating environments (i.e. country risk). In CRT-3, CRT-4 and CRT-5, there is an increasing probability that environmental factors will affect a company s ability to fulfill policyholder obligations. A.M. Best employs neither a notching process nor a ceiling in applying country risk to ratings. Country risk is one of many factors that are integrated into a Best s Rating. It can be compared to other components of the rating analysis such as enterprise risk management (ERM); senior management discipline and track record; capital management; and competitive market position, among others, in how it is integrated into a rating outcome (see Exhibit 4). Analysts, in being informed of country risk issues, are able to apply the rating process to a company and ascertain what risks are of particular concern for a given insurer. To aid analysts in this process, the Country Risk Group offers internal briefings and mapping guides that serve as benchmarks when comparing insurers across countries and regions. n 14 A.M. Best s Takaful Review 2012 Edition

16 PUBLISHED: NOVEMBER 4, 2011 Understanding Universal BCAR Related Methodology The purpose of this report is to document the existing criteria and methodology related to A.M. Best Co. s Universal BCAR model, which is used on those companies that do not file U.S. or Canadian statutory statements. INTRODUCTION The objective of A.M. Best Co. s financial strength ratings is to provide an opinion of an insurer s financial strength and ability to meet ongoing obligations to policyholders. The assignment of an interactive rating is derived from an in-depth evaluation of a company s balance sheet strength, operating performance and business profile as compared with A.M. Best s quantitative and qualitative standards. For interactive ratings, A.M. Best believes the balanced approach of evaluating a company on both quantitative and qualitative levels provides a better analysis of a company and also makes possible a more discerning and credible rating opinion. RELATED REPORTS Criteria: Understanding BCAR For Property/Casualty Insurers Understanding BCAR for Life/Health Insurers Rating Health Insurance Companies A.M. Best s Perspective on Operating Leverage Analyzing Contingent Capital Facilities The Treatment of Terrorism Risk In the Rating Evaluation Risk Management and the Rating Process for Insurance Companies Tail Risk and the BCAR Catastrophe Analysis in A.M. Best Ratings Equity Credit for Hybrid Securities A.M. Best s Ratings & the Treatment of Debt A.M. Best s quantitative evaluation is based on an analysis of numerous key financial tests and supporting data. These tests, which underlie A.M. Best s evaluation of balance sheet strength and operating performance, vary in their importance depending on a company s characteristics. A company s quantitative results are evaluated on their own merits and also are compared with industry composites as established by A.M. Best. Composite standards are based on the performance of other insurance companies with comparable business mixes and organizational structures. These industry benchmarks are adjusted when needed to reflect changes in underwriting, economic and regulatory market conditions. BALANCE SHEET STRENGTH In determining a company s ability to meet its current and ongoing obligations to policyholders, the most important area to evaluate is its balance sheet strength, since it is the foundation for policyholder security. Performance then determines how that balance sheet strength will be enhanced, maintained or eroded over time. Balance sheet strength measures the exposure of a company s capital to its operating and financial practices. An analysis of a company s underwriting, financial and asset leverage is very important in assessing its overall balance sheet strength. Underwriting leverage is generated from current premium writings, reinsurance recoverables and loss reserves. In order to assess whether a company s underwriting leverage is prudent, a number of factors unique to the company are taken into account, including type of business written, quality and appropriateness of its reinsurance program, and adequacy of loss reserves. Rating Members of Insurance Groups 2011 Best s Briefing: Catastrophe Models and the Rating Process FAQ RATING ANALYST Thomas Mount, Vice President +1 (908) Ext Thomas.Mount@ambest.com Financial leverage is created through debt or debt-like instruments (including financial reinsurance) and is reviewed in conjunction with a company s underwriting leverage. An analysis of financial leverage is conducted at both the operating company and holding company levels, since debt at either level could place a call on the insurer s earnings and strain its cash flow, leading to financial instability. Asset leverage measures the exposure of a company s capital to investment, interest rate and credit risks. The volatility and credit quality of the investment portfolio, recoverables and agents balances determine the potential impact of asset leverage on the company s balance sheet strength. A.M. Best s Takaful Review 2012 Edition 15

17 Related Methodology A company s underwriting, financial and asset leverage also are subjected to an evaluation by Best s Capital Adequacy Ratio (BCAR), which allows for an integrated review of these leverage areas. The universal BCAR model calculates the Net Required Capital to support the financial risks of the company associated with the exposure of assets and underwriting to adverse economic and market conditions, and compares this required capital to economic capital. Some of the stress tests within BCAR include above-normal catastrophes, a decline in equity markets and a rise in interest rates. This integrated stress evaluation permits a more discerning view of a company s balance sheet strength relative to its operating risks. A company s BCAR result is extremely useful in evaluating its balance sheet strength, but BCAR is only one component of that analysis. In addition, balance sheet strength is only one component of the overall financial strength rating, which also includes operating performance and business profile. BCAR establishes a guideline for risk-adjusted capital requirements to support a rating, but other factors driving expectations of future balance sheet strength drive the rating as well. All of these factors are important to the overall rating process. OVERVIEW OF BCAR A.M. Best s capital formula uses a risk-based capital approach whereby net required capital is calculated to support three broad risk categories: investment risk, credit risk and underwriting risk. A.M. Best s capital adequacy formula also contains an adjustment for covariance, reflecting the assumed statistical independence of the individual components. A company s adjusted capital is divided by its net required capital, after the covariance adjustment, to determine its BCAR. INVESTMENT RISK Investment risk includes three main risk components: fixed-income securities, equities and interest rate. Capital charges are applied to different asset classes based on the risk of default, illiquidity and market-value declines in both equity and fixed-income securities. Additionally, higher capital charges are ascribed to affiliated investment holdings, real estate, below-investment-grade bonds and nonaffiliated, privately traded common and preferred shares because of the illiquid nature of the asset and/or the potential volatility of the reported value. A.M. Best s capital model incorporates an interest-rate risk component that considers the decline in market value of a company s fixed-income portfolio as a result of rising interest rates. The interest rate risk calculation will reflect the fact that companies writing life and annuity products will have an exposure to disintermediation and cash-flow mismatch risks, whereas a company writing property/casualty products will have an interest-rate risk exposure when a shock event occurs. Interest rate risk for annuity writers will vary based on the type of products offered and the source of that business. Investment risks are typically the main drivers of a life and annuity insurer s capital requirements. CREDIT RISK Capital charges are applied to different receivable balances to reflect third-party default risk. Credit risk factors are ascribed to recoverables from all reinsurers, including affiliates. Required capital for credit risk may be modified after taking into account acceptable collateral offsets for reinsurance balances; the quality of the reinsurers that participate in the company s reinsurance program; and the company s dependence on its reinsurance program. Also included in the credit risk component are charges for premium balances receivable; accrued retrospective premiums; deposits in pools and associations; funds held by ceding insurers; and other, miscellaneous receivables. UNDERWRITING RISK This category encompasses the risks associated with net loss and loss-adjustment expense reserves, net premiums written and net unearned premiums. The reserve component requires capital based on the risk inherent in a company s loss and loss-adjustment expense reserves, adjusted for A.M. Best s assessment of its reserve equity. The net premiums written component is a forward-looking component and requires capital based on the pricing risk inherent in a company s expected book of business for the upcoming year. The unearned premium component reflects the exposure to pricing risk on premium that was written in the past but is still unearned as of the current evaluation date. Required capital for the underwriting risk components may be increased to reflect an additional surcharge for excessive exposure growth. In addition, there is credit for a well-diversified book of business, but this credit is minimized for those companies that maintain small books of many lines of business and may not necessarily have expertise in each of them. For those composite companies that write both property/casualty and life insurance, the amount of diversification credit may be increased to reflect the additional benefits from diversifying across insurance sectors. 16 A.M. Best s Takaful Review 2012 Edition

18 For life and health insurers, underwriting risks are divided into mortality risks, longevity risks and morbidity risks. Mortality risks are based on volume of life insurance in force, net of reserves and reinsurance, with risk charges grading lower for higher amounts at risk. Longevity risks are present in annuities and certain types of pension plans, as plan participants are living longer than expected when payment amounts originally were determined. Morbidity risks vary by line of business and therefore warrant different charges. Generally, health care lines of business with long-tail risks (disability, long-term care) will have higher premium risk charges than shorter tail risks (medical, critical illness). For property/casualty insurers, underwriting risk is typically the largest risk category and usually accounts for twothirds of a company s gross required capital. REQUIRED CAPITAL Collectively, the investment, credit and underwriting risk components generate more than 99% of a company s gross required capital, with the business risk component generating minimal capital requirements for off-balance sheet items. A company s gross required capital, which is the sum of the capital required to support all of its risk components, reflects the amount of capital needed to support all of those risks if they were to develop simultaneously. However, these individual components then are subjected to a covariance calculation within the BCAR formula to account for the assumed statistical independence of these components. This covariance adjustment essentially says that it is unlikely that all of the individual risk components will develop simultaneously, and this adjustment generally reduces a company s overall required capital. A.M. Best recognizes the distortions caused by the square root rule covariance adjustment, whereby the more capital-intensive risk components are disproportionately accentuated while the less capital-intensive risk components are diminished in their relative contribution to net required capital. Nevertheless, by using other distinct capital measures, A.M. Best can counterbalance this apparent shortcoming. DETERMINATION OF AVAILABLE CAPITAL A.M. Best makes a number of adjustments to a company s reported capital within its universal capital model to provide a more economic and comparable basis for evaluating capital adequacy. Different accounting methods and regulatory requirements across the world require numerous adjustments to a company s reported capital. Goodwill and other intangible assets are eliminated. Pre-event catastrophe reserves are removed from the loss reserves and moved into available capital on a tax-effected basis. Adjustments for any embedded value in unearned premium reserves, loss reserves and fixed-income securities are made if the company has not already reflected these in its reported capital. Further adjustments are made to capital to reflect other non-balance sheet risks, including catastrophe exposures and debt-service requirements. Available Capital Components Reported Capital Equity Adjustments: Unearned Premiums Assets Loss Reserves Reinsurance Debt Adjustments: Surplus Notes Debt-Service Requirements Other Adjustments: Potential Catastrophe Losses Future Operating Losses Future Dividends Goodwill Other Intangible Assets A.M. Best s capital model emphasizes permanent capital and consequently will reduce a company s reported surplus for encumbered capital, which includes surplus notes and future debt-service requirements of an affiliated holding company. This reduction, in whole or in part, depends on the magnitude of, and dependence an insurance group has on, debt-like instruments and their associated repayment features. Both quantitative and qualitative factors are considered in the evaluation of debt. As part of the quantitative analysis, A.M. Best uses a separate model to assist in determining the amount of surplus credit given to surplus notes and debt instruments. The primary issue, which determines the level of credit given, is the term of the debt compared with the length of time needed to pay the bulk of the policy liabilities. Usually, more credit is given to longer term than to short-term debt. Another key determinant is the company s rate of return compared with the interest rate charged on the debt. A company should be earning more than its cost of capital to receive credit for the debt. On a qualitative basis, issues such as where the debt is held vs. where the cash is used; the existence of other sources of income to offset the cost of debt; fixed-charge coverage; and the overall level of debt relative to the organization s total capital all are considered. For example, when debt is issued at the holding company but the cash is held at the operating insurance company, even though the cash is given full credit in the BCAR analysis of the operating company, the actual rating of the operating company could be limited by the evaluation of the financial leverage and earnings coverage at the holding company. A.M. Best s Takaful Review 2012 Edition 17

19 Related Methodology FORMULA DRIVERS A company s gross capital requirement within A.M. Best s capital model is generated primarily from its investment, credit and underwriting risks. A company that maintains a more aggressive investment portfolio, is heavily concentrated in one asset or sector, or is heavily dependent on pyramided capital likely will generate a lower BCAR value. Companies that have excessive exposure to third-party credit risk or are heavily dependent on reinsurance likely will generate lower BCAR scores. The amount of required capital generated from the underwriting risk components is largely a function of the company s mix of business, amount of available capital, growth in exposure, stability of loss development, profitability, loss-reserve adequacy and length of claims payout. All other things being equal, the absolute BCAR score of a company will be lower because of higher capital requirements associated with greater indicated reserve deficiencies, as well as unstable or unprofitable business. In addition, the model can be adjusted in response to various market issues. Some examples of the issues that can impact capitalization include rate changes, the stage of the underwriting cycle, changing reinsurance products and reinsurance dependence. The ability of the model to respond to these market issues makes it a robust tool that assists in the evaluation of the company s balance sheet strength. The basis of risk measurement for some of the key drivers of required capital in the universal BCAR model is expected policyholder deficit. A.M. Best adopted the concept of expected policyholder deficit to better calibrate the model s loss-reserve and premium-risk factors, as well as other risk factors in the model. The concept of expected policyholder deficit allows risk charges to be calibrated to a specific level of insolvency risk and also takes into consideration the expected cost, or severity, of insolvency. BCAR IS AN ABSOLUTE MEASURE The universal BCAR model produces an absolute score, which is the ratio of the company s adjusted capital to its own net required capital. This company-specific capital ratio indicates whether its capital strength aligns with A.M. Best s Secure or Vulnerable rating categories and is based on the specific risk profile of a company s operations. A BCAR score below 100% would be considered vulnerable. Given strong, stable operating performance, sound risk management, high quality capital and strong financial flexibility, Exhibit 2 provides a reasonable guide for the BCAR levels needed to support A.M. Best s Financial Strength Ratings. ADDITIONAL STRESS TESTING A.M. Best also will stress a company s BCAR score for a second catastrophic event according to the procedures outlined in its criteria report titled Catastrophe Analysis in A.M. Best Ratings and its criteria report titled The Treatment of Terrorism Risk in the Rating Evaluation. The testing will incorporate natural catastrophes and/or man-made events such as terrorism to monitor how sensitive a company s balance sheet strength is to a second catastrophic event. Additional stresses may be employed when insurers accumulate large amounts of higher risk investments. CONCLUSION The tools to allocate capital and understand capital strength continue to evolve. These tools often vary in theory, purpose and outcome. It is important to remember that, while they can add significant value, they are only tools. A.M. Best s proprietary universal BCAR is one of those tools that look at capital needs well above financial solvency. A.M. Best will continue to enhance BCAR going forward to improve its accuracy in measuring balance sheet and operating risk. BCAR is important to A.M. Best s evaluation of both absolute and relative capital strength. Consistent with standards embedded within the universal BCAR model, A.M. Best would expect that well-managed and highly rated companies will maintain capitalization levels in excess of the risk-adjusted amounts indicated by the published guidelines to support their current ratings. A.M. Best is quick to caution, however, that although BCAR is an important tool in the rating process, it isn t sufficient to serve as the sole basis of a rating assignment. BCAR, like other quantitative measures, has some limitations and doesn t necessarily work for all companies. Consequently, capital adequacy should be viewed within the overall context of the operating and strategic issues surrounding a company. Business profile and operating performance are 18 A.M. Best s Takaful Review 2012 Edition BCAR Guidelines Implied Balance Sheet BCAR Strength Secure: 175 A A+ 145 A 130 A- 115 B B+ Vulnerable: 90 B 80 B- 70 C++ 60 C+ 50 C 40 C- <40 D

20 important rating considerations in evaluating a company s long-term financial strength and viability as well as the quality of the capital that supports the BCAR result. In addition, any holding company considerations also will play a key role in evaluating the financial strength of an insurance company. In closing, A.M. Best believes that well-managed and highly rated insurers will continue to focus on the fundamentals of building future economic value and financial stability, rather than on managing one, albeit important, component of A.M. Best s rating evaluation. n A.M. Best s Takaful Review 2012 Edition 19

21 A.M. Best s Country Risk Tiers A.M. Best defines country risk as the risk that country-specific factors could adversely affect the claims paying ability of an insurer. Country risk is factored into all A.M. Best ratings. A.M. Best s country risk methodology, Assessing Country Risk (see page 11), presents the country risk evaluation process and describes how country risk is integrated into Best s Credit Ratings. The 96 countries evaluated by A.M. Best are listed according to their Country Risk Tier in the table below. n Australia Austria Canada Denmark Finland France Germany CRT-1 Gibraltar Guernsey Isle of Man Jersey Luxembourg Netherlands Norway Singapore Sweden Switzerland United Kingdom United States Barbados Belgium Bermuda British Virgin Islands Cayman Islands Chile CRT-2 Hong Kong Ireland Italy Japan Liechtenstein Macau New Zealand Slovenia South Korea Spain Taiwan Anguilla Bahamas Bahrain Brazil China Cyprus Israel CRT-3 Kuwait Malaysia Malta Mexico Netherlands Antilles Oman Poland Qatar Saint Kitts & Nevis Saudi Arabia South Africa Thailand Trinidad & Tobago United Arab Emirates Antigua & Barbuda Argentina Brunei Darussalam Colombia Costa Rica El Salvador CRT-4 India Indonesia Jordan Kazakhstan Mauritius Morocco Panama Peru Philippines Russia Tunisia Turkey Algeria Belarus Bolivia Bosnia and Herzegovina Dominican Republic Ecuador Egypt CRT-5 Ghana Guatemala Honduras Jamaica Kenya Lebanon Libya Nicaragua Nigeria Pakistan Syria Ukraine Venezuela Vietnam 20 A.M. Best s Takaful Review 2012 Edition

22 PUBLISHED: JULY 11, 2011 Competition Dampens Takaful Profits The findings of this report are based on analysis of 131 takaful operators and conventional insurers operating within the Gulf Cooperation Council (GCC) the United Arab Emirates (UAE), Bahrain, Saudi Arabia, Oman, Qatar and Kuwait and Malaysia. All of the companies are followed by A.M. Best Co. and approximately one-third are takaful operators. The data examines eight takaful operators and 45 conventional insurers in Malaysia. Malaysia is the second-largest insurance market in Southeast Asia and an international financial hub for Shari a-compliant offerings. According to the insurance regulator, Bank Negara Malaysia, in 2010, general takaful contributions grew by 26.3% to MYR 1.4 billion (USD 454 million) while family contributions rose by 21.3% to MYR 3.3 billion (USD 1.1 billion). While the takaful market has existed for many years in Malaysia, it is a relatively new development in the GCC. All companies operating in Saudi Arabia use a cooperative model, equivalent to a takaful structure. In 2009, the GCC s takaful contributions were estimated at USD 4.9 billion. This report looks at 31 takaful operators in the region and 47 conventional insurers. There are significant market opportunities for takaful companies operating in the countries identified in this report. There are an estimated 17.1 million Muslims in Malaysia and 36.1 million in the GCC countries. TAKAFUL S MARKET POSITIONING The takaful market has grown significantly in recent years, benefiting from the introduction of compulsory covers in many of the countries it operates, and as clients gain a better understanding of its offerings. Governments in the GCC and Malaysia appear to support the concept of takaful, which provides Shari a-compliant cover to people who SECTOR Takaful ADDITIONAL INFORMATION Special Reports: GCC: Rich in Potential, But Hurdles Remain Top Middle East Markets Are Poised for Takeoff Southeast Asia May Reward Shrewd Insurers, Punish the Careless Criteria: Takaful (Shari a Compliant) Insurance Companies CONTACT: Vasilis Katsipis, London, +(44) (0) Vasilis.Katsipis@ambest.com WRITER: Yvette Essen, London Yvette.Essen@ambest.com otherwise may not have purchased conventional insurance. Takaful operators have enjoyed strong growth in contributions in both the nascent and mature takaful markets. The majority of takaful business is general insurance, with family takaful accounting for less than 25% of the contributions received. General takaful has grown at a compound annual growth rate (CAGR) of 27% from 2004 to Over the same period, family takaful has grown, on average, at a more modest 22%. However, when examining the performance of their conventional competitors in the same markets, which grew by only 5% annually over the same period, it is evident that family takaful operators are increasing their insurance penetration in their markets. STRONG GROWTH OF GENERAL TAKAFUL BUSINESS Exhibit 1 shows that the general takaful business of the companies in A.M. Best s sample grew by an average rate of 27% from 2004 to 2009, with gross contributions of USD 1.86 billion. This outperformed the 19% rise in total premiums for conventional insurers in these countries. The high growth rate of the sector is attributable in part to the market s growth from a low base. Takaful is a relatively new offering in the GCC, providing an option for a large part of the population that has previously been unable to purchase certain types of insurance owing to religious beliefs. To an extent, general takaful has been buoyed by increased demand for protection in growing economies where compulsory lines of insurance have been introduced. In most cases, markets where takaful is offered are enjoying growth in gross domestic product (GDP) and increased consumer wealth which, in turn, has resulted in significant increases in insurance premiums for the market as a whole. Article A.M. Best s Takaful Review 2012 Edition 21

23 Article As a result, most takaful companies are competing with conventional insurers on pricing for the same business, rather than through a differentiated value proposition based on the ethical values of takaful. Competition within personal lines probably will continue as the recent economic turmoil has resulted in the postponement of capitalintensive projects. Customers are likely to continue to purchase the most cost-effective product, as opposed to paying extra for an offering that is Shari a compliant. Takaful contribution volumes have increased sharply over the past few years; however, most takaful companies that have started trading in the past five years have fallen behind their original business plans. Companies with overly optimistic growth targets have revised their projections downward as an influx of new takaful companies coincided with the downturn in economic conditions. Some are still struggling to meet these new business plans. RETAKAFUL: GREAT POTENTIAL FAILS TO MATERIALISE In general, retakaful has also failed to grow as rapidly as initially expected. While there has been tremendous growth in the primary takaful market over the past few years, this has not translated into commensurate increased retakaful demand because takaful operators have been utilising traditional reinsurance capacity. The majority of retakaful companies are consequently engaged in traditional reinsurance business. The growth of the retakaful market depends on whether primary takaful operators come under pressure to alter their reinsurance purchasing patterns and seek Shari a-complaint cover for themselves. FAMILY TAKAFUL REPRESENTS BEST OPPORTUNITY In general, life assurance is viewed as an opportunity for both conventional insurers and takaful operators. Family takaful business is more profitable than general takaful business, offering higher margins and stability, and is growing at a faster pace. This is a new market that is not served particularly well by conventional insurers. Exhibit 2 shows that family takaful premium of the sample companies grew by a 22% CAGR from 2004 to 2009 to USD 456 million, in particular driven by GCC premium development. Although this was from a low initial base, it was at a considerably faster rate than the conventional life market, which grew by 5% over this period. FAMILY/LIFE PREMIUM DEVELOPMENT Family takaful premiums have grown particularly strongly in the GCC at an 86% CAGR over 2004 to The Malaysian market has a more developed takaful market and has experienced more stable growth in the past few years but again, takaful companies have outperformed traditional Malaysian life insurers. 22 A.M. Best s Takaful Review 2012 Edition Exhibit 1 Takaful vs Conventional General Insurance GWP* Development ( ) USD Millions 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, *Gross Written Premium Source: A.M. Best Co., 5,000 4,000 3,000 2,000 1, Conventional Conventional Takaful , Best s Statement File Global Takaful Exhibit 2 Takaful vs Conventional Family/Life GWP* Development ( ) USD Millions 2002 *Gross Written Premium Source: A.M. Best Co., , Best s Statement File Global

24 Family takaful has also increased its presence over this six-year period. In 2004, the companies followed by A.M. Best in these markets represented 5% of the total family takaful and life market. In 2009, this figure had more than doubled to 10.2%. FAMILY TAKAFUL DELIVERS HIGH LEVELS OF PROFITABILITY Family takaful has tended to be more profitable than conventional life insurance (see Exhibit 3). From 2002 to 2009, conventional life insurers have delivered a return on life premiums of 7.2% to 9.4%. Profitability of family takaful business tends to be more volatile owing to more aggressive and concentrated investment portfolios. As a result, traditional life insurers outperformed their takaful competitors only during 2009 when return on life premiums was 7.3% for takaful operators, compared to 9.4% for their counterparts. This was not a consequence of takaful operators risk selection, rather a result of their asset Conventional Takaful composition with their investments being concentrated in sukuks (Shari a compliant Source: A.M. Best Co.,, Best s Statement File Global bonds) and private equity investments, which were among the hardest hit by the global downturn. A.M. Best expects that in 2011, the financial performance of family takaful operators will be higher than that of the conventional life insurers. Higher profitability has been accompanied by upstreaming of profits to the operators funds, with takaful operators consistently outperforming their conventional counterparts. This, if continued, will enhance the appeal of takaful business and its acceptance among the insured public. FINANCIAL PERFORMANCE OF GENERAL TAKAFUL IMPROVES BUT VARIED The financial performance of takaful companies has improved, although this varies significantly between operators. Family takaful is very profitable while the profitability of general takaful depends on individual market and operator expertise. In Malaysia, more stable growth has enabled takaful companies to post greater profits than takaful operators in the GCC. Malaysian takaful operators have also consistently outperformed their traditional competitors (see Exhibit 4), with combined ratios for takaful operators ranging from 93% to 74% in recent years. PROFITABILITY OF GENERAL INSURANCE IN THE GCC Exhibit 3 Takaful vs Conventional Return on Family/Life Premiums ( ) 15% % Exhibit 4 Takaful vs Conventional Malaysia General Insurance Combined Ratio ( ) 110% % However, it has been a different picture for the GCC market where general takaful profitability has suffered from intense competition. The GCC has a younger takaful market, with most of the takaful companies being in the early years of their operations. The influx of new capital for the establishment of new takaful operators combined with the economic slowdown of recent years has meant that takaful operators need to compete on price in order to build up a presence and achieve the volumes anticipated in their original business plans Source: A.M. Best Co., 2003 Conventional Takaful , Best s Statement File Global A.M. Best s Takaful Review 2012 Edition 23

25 Article While combined ratios have been below 100% since 2003, the financial performance of takaful operators is below those of conventional insurers in the GCC. In 2009, combined ratios were 87% for takaful companies, compared to 83% for conventional insurers (see Exhibit 5). It has been increasingly difficult to attract profitable business against the more established conventional insurers, which also benefit from high levels of reinsurance commissions received for the high risk business that they normally front. As a result, general takaful business has been experiencing approximately 10 percentage points higher acquisition expense ratios. This, combined with the higher management expenses especially among start-ups, has resulted in operating expense ratios of 25% in 2009, compared to 19% for traditional insurers. This expense gap has been higher in prior years and has previously reached 15 percentage points higher than their traditional competitors. Underwriting performance as measured by the claims ratio has remained remarkably close for conventional and takaful companies with a few companies in both sub-segments consistently deviating from the norm. The difficulties that newer takaful entrants face in delivering technical profits pose a question as to their long-term viability. The willingness of their shareholders to continue to support these companies indefinitely will be tested if returns continue to lag behind original expectations. Technical profitability will remain the most important driver for the viability and the rating of many takaful companies. However, with technical profitability lagging behind that of conventional insurers, investment performance becomes critical for the competitiveness of takaful operators. INVESTMENT PERFORMANCE GOOD BUT VOLATILE In terms of asset allocation, most GCC and Malaysian takaful operators appear to follow the pattern of their domestic markets, having very similar proportions of asset classes as conventional insurers but with emphasis on sukuk investments as opposed to conventional fixed income and a higher exposure to private equity. A.M. Best s analysis shows 57% of assets held by takaful operators were in higher risk investments such as shares (which include private equity), loans and real estate (see Exhibit 6). This is comparable to the asset mix of conventional insurers which have a similar investment in high-risk categories (61%); however, the conventional companies investment in private equity is markedly lower, representing 27% of their share portfolio, compared to 36% for takaful companies. INVESTMENT ASSET MIX OF TAKAFUL COMPANIES Takaful market participants additionally face more restricted investment policies compared with their conventional counterparts. The supply of sukuk products in the market is limited in comparison with conventional bond offerings. 24 A.M. Best s Takaful Review 2012 Edition Exhibit 5 Takaful vs Conventional GCC* General Insurance Combined Ratio ( ) 105% % Conventional *Gulf Cooperation Council Source: A.M. Best Co., Takaful , Best s Statement File Global Exhibit 6 Takaful Investment Asset Mix ( ) % % % Cash Sukuk Shares Real Estate Other Affiliates Loans Source: A.M. Best Co.,, Best s Statement File Global

26 Therefore operators have a higher concentration of assets in their investment portfolios. From 2004 to 2009, takaful companies have suffered greater capital losses, both realised and unrealised, in comparison to their conventional counterparts. Since 2006, conventional insurers in the GCC and Malaysia have delivered a better return on their investments (see Exhibit 7). In 2009, takaful companies had an investment yield of 3%, compared to a 5% return for conventional insurers in the sample. EXCELLENT CAPITALISATION OF TAKAFUL OPERATORS Exhibit 7 Takaful vs Conventional Investment Yield ( ) 9% % 2004 Conventional Source: A.M. Best Co., Takaful , Best s Statement File Global 2009 Both takaful operators and conventional insurers in A.M. Best s sample enjoy strong risk-adjusted capitalisations. In many cases, takaful companies have better capital adequacy than conventional insurers and local operations of international competitors. In part, this is a consequence of the early phase of their operating life and the fact that several start-up companies are failing to fulfil their initial business plans. At the same time, capitalisation of takaful funds is kept low in most cases, especially among new operators. Most new companies that are generating any underwriting profits are delivering these to the operator s fund, resulting in a minimal retention in the takaful fund. While this practice is viable in the short term, it creates uncertainty about the long-term prosperity of takaful funds. The building up of sufficient capital resources within the takaful fund is imperative for a secure A.M. Best rating, and the retention of earnings, especially in the early years of operation, is the only way for takaful funds to achieve their long-term viability. In many cases there is a continuous dependence 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 fore the uncertainty surrounding the priority of policyholder liabilities in many takaful markets. In many cases there is no clarity as to the priority of policyholder liabilities, and often there is neither provision nor jurisprudence that would indicate the prevailing legal system (temporal versus Shari a law) in case of the default of a takaful company. COUNTRY RISK IMPROVES IN TAKAFUL MARKETS A.M. Best expects the operating environment to improve for most of the countries covered in this report, with the main driver being the rebound of most economies. As part of A.M. Best s country risk rating methodology, countries are placed into one of five tiers, ranging from CRT- 1 (Country Risk Tier 1), denoting a stable environment with the least proportion of risk, to CRT-5 (Country Risk Tier 5) for countries posing the greatest risk. All GCC countries and Malaysia have an A.M. Best CRT-3, which is at the top end of the scale for emerging countries. A.M. Best considers there to be positive developments in several markets because of the introduction of takaful specific regulation and minimum capital requirements, including in the UAE, Saudi Arabia, Bahrain and Malaysia. As A.M. Best s primary focus is the assessment of financial strength and policyholders security, the rationale and financial incentives on which the allocation of profits between policyholders and shareholders is based is of particular interest. In many markets the seniority of policyholder claims remains unclear. Regulation has yet to be tested regarding the ring-fencing of assets within the takaful fund and the use of a qard hassan from operators, should the fund become insolvent. A.M. Best s Takaful Review 2012 Edition 25

27 Article An upstreaming of profits to the operator s fund by the younger takaful companies has resulted in several policyholder funds being significantly undercapitalised. Considering the continuing competitive nature of the market, in A.M. Best s opinion, this seems a precarious position. The Islamic Financial Services Board s (IFSB) publication of the Standard on Solvency Requirements for Takaful (Islamic Insurance) Undertakings in December 2010 is welcome. The key principles and standards set by the IFSB, if adopted by local regulators and takaful operators, will provide additional security and uniformity. It is still unclear for many countries as to whether Shari a or temporal law will take precedence in the event of a takaful operator becoming insolvent. Many markets where takaful companies operate are considering implementing International Financial Reporting Standards. A uniform accounting standard is particularly welcome, as this would improve consistency and transparency among companies. Takaful financial transparency has improved significantly over the past two years. However, there are still operators that fail to specify the financial performance of their funds. Furthermore, there is inconsistency as to how different funds are consolidated on the operator s balance sheet. n 26 A.M. Best s Takaful Review 2012 Edition

28 AMB CREDIT REPORT - INSURANCE PROFESSIONAL FOR FIRST INSURANCE COMPANY King Abdullah II Street, Amman, Jordan Web: Tel: Fax: AMB#: Report Revision Date: 02/15/2012 BEST S CREDIT RATINGS Best s Financial Strength Rating: B++ Outlook: Stable Best s Issuer Credit Rating: bbb Outlook: Stable Best s Financial Size Category: VI Sample AMB Credit Report RATING RATIONALE Rating Rationale: The rating of First Insurance Company (FIC) (Jordan) reflects its superior level of risk-adjusted capitalisation and good overall financial performance. The company s modest size offsets the rating, although is partially mitigated by the company s takaful and young nature. Risk-adjusted Capitalisation New takaful regulations outlined by the Jordanian regulator give A.M. Best confidence in the level of capital support offered by FIC s shareholders fund to its takaful fund. As such, A.M. Best believes that FIC s current level of risk-adjusted capitalisation is superior. Risk-adjusted capitalisation is supported by a low level of business leverage, a reinsurance programme of good credit quality and a conservative investment profile. In 2011, the company wrote gross premiums of JOD 15 million (USD 21 million) against a capital base of JOD 26 million (USD 36 million). Although risk-adjusted capitalisation is likely to decrease over the medium term as the company grows its premium base and increases risk-adjusted capital requirements, it is likely to remain at an excellent level. Business Profile FIC has successfully established itself within the Jordanian market since inception in 2007 and is growing into a medium-sized company. At the half-year 2011, FIC was the eleventh largest in the Jordanian market with a 3.73% market share, by premium income. FIC is one of only three takaful insurers in the Jordanian insurance market and is likely to become the largest if it continues to grow in line with expectations over the short to medium term. As is common throughout the market, FIC has a low level of retention for most business lines, with the exception of motor and medical, where retention is 75% and 50%, respectively. Financial Performance FIC s level of operating performance has been improving. The company s overall loss ratio improved from 83% in 2008 to 73% in 2011, and its combined ratio improved from 129% to 92% over the same period. Motor and medical lines together account for the majority of net premiums written and have operated at a marginal level, while property business has been the main contributor of underwriting profits. Although efforts are being made to improve the profitability of motor and medical business, any significant change is unlikely over the short term, given the prevailing competitive market conditions and regulatory issues. FIVE YEAR RATING HISTORY Date Best s FSR Best s ICR 01/24/12 B++ bbb BUSINESS REVIEW Established in 2007 with JD 24 million (USD 36 million) of share capital, First Insurance Company (FIC) is quoted on the local stock market. Solidarity Group (Bahrain) and Jordan Dubai Capital (Jordan) together own a controlling 51% stake (25.5% each) via special purpose vehicles (SPV) Al Somoud Investment Company (Jordan) and Al Moazarah A.M. Best s Takaful Review 2012 Edition 27

29 Sample AMB Credit Report Investment Company (Jordan). Solidarity Group owns a further 6% independently, making it the largest single shareholder. Other significant shareholders include Investment House Company (Jordan)(12.5%), First Finance Company (Jordan)(5.9%) and Jordan Dubai Financial (Jordan)(2.9%). The Jordan insurance market is competitive for key personal lines of medical and motor, with a large number of companies chasing a relatively small premium base. Despite this, FIC has successfully grown its business position since inception in FIC is one of only three takaful insurers in the Jordanian insurance market and at the half year 2011, was 11th largest in the overall market with a 3.73% market share, by premium income. At the same time, the two other Islamic insurers, Islamic Insurance and Al Baraka Takaful were placed 9th and 25th with market shares of 3.87% and 1.27% respectively. Around one quarter of premiums written in the Jordanian market are captured by the largest two companies, with another quarter captured by the next 5 largest companies and the remainder spread between 21 separate companies. FIC s gross premium income is relatively well diversified considering the nature of the local market and the company concentrates on the more profitable lines of business. Motor, property and medical business accounted for around 92% of GWP in Retention is low (often less than 10%) for all lines except motor (75% retention) and medical (50% retention). Business is significantly more concentrated after outwards reinsurance, with Motor business accounting for a little over three quarters of net written premiums, which is not expected to change as the company grows. FIC has successfully increased its premium base over its four years of operations, from USD 4.4 million in its first year to USD 21.1 million in Strong growth in gross written premiums in the region of 10%-15% is expected over the coming years as the company develops its local business profile. A.M. Best considers there to be a good chance that FIC will become the leading local takaful insurer over the medium term. Management will continue to target the local Islamic insurance market (including Islamic banks), for which demand is likely to continue rising. In 2010, FIC s gross written premiums were divided between the following business lines: motor (44%), property (35%), medical (13%), marine (3%), aviation (3%) and other non-life (2%). The split of gross written premiums by line of business is unlikely to change significantly over the medium term as the company grows. The takaful model employed by FIC requires Wakala fee payments from the policyholders fund to the shareholders fund that are based on a percentage of gross written premium by line of business. The percentage charged is decided upon by the company s Shari a board on an annual basis and is intended to cover all management costs. Furthermore, the shareholders fund receives the investment return from assets backing the shareholders fund, along with a percentage of the investment return from assets backing the policyholders fund. New takaful regulations issued in Jordan by the Insurance Commission (Takaful Regulation Instructions of 2011) apply to all locally registered takaful companies and appear to be relatively strong. They require takaful companies to provide the policyholder s fund with a goodwill loan (Qard Hassan) to cover the deficit up to the value of shareholder equity. Furthermore, from the 2011 year end the shareholders fund must provision for any Qard Hassan. All takaful contracts issued by FIC refer to its Takaful Condition, which clearly outlines the requirement of the company s shareholders fund to offer a Qard Hassan. FINANCIAL PERFORMANCE Overall Earnings: As per FIC s takaful model, its shareholders fund receives Wakala fees from the policyholders fund and investment income from shareholder and policyholder assets. FIC s shareholders fund has been profitable in all years and achieved a return on equity (ROE) of 3.9% in 2009 and 1.9% in In 2011 onwards FIC s shareholders fund is likely to generate a ROE of around 4% to 6%. Underwriting Income: The performance of FIC s policyholders takaful fund has been good, considering its start-up nature. The policyholders fund incurred a modest loss during its first year of operations and then marginal profits in the following two years. The combined ratio (Wakala fees acting as management expenses) improved from 129% in the company s first year to between 94%-96% in the subsequent 2 years. This was driven by a modest reduction in loss ratio and significant reduction in expense ratio. The combined ratio is expected to be a little over 90% in years 2011 through to The majority of FIC s business lines, with the exception of medical and motor, are retained at very low level and benefit from significant inwards reinsurance commission. FIC s property business (40% of gross written premiums but only 2% of net written premiums in 2010) was it s most profitable over the past three years. 28 A.M. Best s Takaful Review 2012 Edition

30 FIC s motor business (39% of gross written premiums and 77% of net written premiums in 2010) has generated a loss in all years. Motor third party liability (TPL) products are underperforming throughout the market and it is unlikely that FIC will be able to reduce volumes of this business given local regulations. However, along with actions of local regulators to liability benefit payments, FIC is taking action to reduce the cost of claims and expects profitability to improve. Motor business is expected to produce a minor underwriting loss in 2011 and approach a breakeven level in Medical business (13% of gross written premiums and 18% of net written premiums in 2010) generated a small profit in 2010 and a combined ratio of 97%. The company is looking to improve the performance of its medical business as the line grows. However, the local medical market remains competitive and any significant improvement will be challenging. In 2011, a minor underwriting loss is expected from this line. Wakala fees charged to the policyholders fund have been relatively flat since inception ( JD 1.1 million in 2010, JD 1.0 million in 2009, JD 0.8 million in 2008) and represent a decreasing proportion of gross written premiums in each year (2010: 10%, 2009: 11%, 2008: 25%). Although FIC s shareholders fund appears to have incurred a modest loss from Wakala fees (i.e. Wakala fees minus operating costs), Wakala fees are expected to cover operating expenses from 2011 and onwards. A.M. Best considers that the modest Wakala fees charged have allowed for a good balance of earnings between the shareholders and policyholder s funds. Furthermore, the fees are likely to be adjusted in future years in order to ensure that a balance of earnings between the two funds remains. Overall underwriting performance is expected to gradually improve as the company grows, benefitting from better economies of scale, improving cost management and selective underwriting. Investment Results: FIC s investments are largely concentrated in cash and deposits, with lesser exposure to equity and real estate investments. As such, FIC s investment return is heavily influenced by local interest rates and the company has avoided any significant unrealised losses from swinging asset values over the past four years. At the third quarter of 2011, FIC s investment portfolio of JD 23 million was split as follows: cash & deposits (66%), real estate (12%), quoted equities (9%), Islamic Bank Fund (6%), Sukuk (6%), unquoted equities (1%). Deposits are divided between 4 separate banks, with the most significant holding 31% of total deposits. Listed equities are divided between banking, telecommunications, industrial and trade industries, with telecommunications the most significant, accounting for 31%. Overall investment return was around 4% in 2010 and given that there has been no material change to the portfolio in 2011, a similar result is expected again when FIC s assets are segregated into two separate funds; its policyholders and shareholders funds. Policyholders funds back insurance liabilities and are invested conservatively in cash and deposits. CAPITALIZATION Overall Capitalization: Given the improved takaful regulations within Jordan, A.M. Best s assessment of risk-adjusted capitalisation focuses on the consolidated policyholders and shareholders funds. Specifically, credit is given for shareholder capital due to the obligatory Qard Hassan. As such, FIC s level of risk-adjusted capitalisation is excellent. The company has a low level of business leverage, a reinsurance programme of good credit quality and a conservative investment portfolio. In 2011, FIC wrote gross premiums of JD 15 million, net premiums of JD 6 million, against a capital base of JD 25 million. Although FIC s level of risk-adjusted capitalisation will be reduced as the company grows its premium base and accepts new risks, it is likely to remain at an excellent level. It is unlikely that FIC s capital base will increase over the medium term given the company s already strong level of capitalisation and the obvious challenges that come with servicing it. Dividend payments equal to annual profits can be expected over the medium term. The Qard Hassan (deficit with the policyholders fund) that was established during the company s first year of operation is expected to be paid off by year end 2011 from profits generated within the takaful fund. Although it is likely that surpluses will be distributed from the takaful fund over the medium term, the mechanism for this has not been finalised and a small reserve of retained earnings is expected to develop. Catastrophe assessment and probable maximum loss (PML) calculation is unsophisticated. FIC s main catastrophe exposure is an EQ in Jordan. The company s PML is calculated using a percentage of sum insured of policies subject A.M. Best s Takaful Review 2012 Edition 29

31 Sample AMB Credit Report to natural perils and is based on advice by leading international reinsurers. Some conservatism is factored into the company s assumptions which are used to purchase reinsurance protection. Reserve Quality: FIC s reserves are assessed annually by external actuarial consultants. The most recent assessment of reserve adequacy was based on the 2010 year end and suggested that reserves are adequate and include some degree of conservatism. LIQUIDITY Overall Liquidity: FIC s level of liquidity is strong given its relatively large capital base and conservative investment portfolio. The company s cash and deposit holdings alone are well in excess of technical reserves and other liabilities. Source of Information: Audited Financial Statement Summarized Accounts as of December 31, 2010 US $ per Local Currency Unit = 1 Jordanian Dinar (JOD) STATEMENT OF INCOME Technical account: 12/31/2010 JOD(000) 12/31/2010 USD(000) Gross premiums written 11,652 16,563 Reinsurance ceded 7,315 10,398 Net premiums written 4,337 6,165 Increase/(decrease) in gross unearned premiums Increase/(decrease) in reinsurers share unearned premiums Net premiums earned 4,069 5,784 Other technical income Total underwriting income 4,089 5,812 Net claims paid 2,971 4,223 Net increase/(decrease) in claims provision Net claims incurred 3,174 4,512 Management expenses 1,298 1,845 Acquisition expenses Net operating expenses 704 1,001 Total underwriting expenses 3,878 5,512 Balance on technical account Non-technical account: Net investment income 1,060 1,507 Realised capital gains/(losses) Unrealised capital gains/(losses) Exchange gains/(losses) -4-6 Other income/(expense) Profit/(loss) before tax Taxation Profit/(loss) after tax Dividend to shareholders 1,440 2,047 Transfer to reserves Retained Profit/(loss) for the financial year -1,029-1,463 Retained Profit/(loss) brought forward 2,099 2,984 Retained Profit/(loss) carried forward 1,070 1, A.M. Best s Takaful Review 2012 Edition

32 MOVEMENT IN CAPITAL & SURPLUS 12/31/2010 JOD(000) 12/31/2010 USD(000) Capital & surplus brought forward 26,350 37,455 Change in distributable shares Change in other reserves Profit or loss for the year Capital gains or (losses) Dividend to shareholders -1,440-2,047 Total change in capital & surplus ,289 Capital & surplus carried forward 25,443 36,166 ASSETS 12/31/2010 JOD(000) 12/31/2010 % of total 12/31/2010 USD(000) Cash & deposits with credit institutions 16, ,957 Bonds & other fixed interest securities 4, ,686 Shares & other variable interest instruments 2, ,012 Liquid assets 22, ,654 Unquoted investments Real Estate 2, ,780 Other investments Total investments 25, ,945 Reinsurers share of technical reserves - unearned premiums 2, ,679 Reinsurers share of technical reserves - claims 1, ,515 Total reinsurers share of technical reserves 4, ,193 Insurance/reinsurance debtors 1, ,792 Other debtors Total debtors 2, ,680 Fixed assets Prepayments & accrued income Other assets Total assets 33, ,714 LIABILITIES 12/31/2010 JOD(000) 12/31/2010 % of total 12/31/2010 USD(000) Capital 24, ,115 Paid-up capital 24, ,115 Non-distributable reserves Other reserves Retained earnings 1, ,520 Capital & surplus 25, ,166 Minority interests Gross provision for unearned premiums 3, ,633 Gross provision for outstanding claims 2, ,299 Total gross technical reserves 6, ,932 Insurance/reinsurance creditors 1, ,864 Other creditors Total creditors 1, ,385 Accruals & deferred income Other liabilities Total liabilities & surplus 33, ,714 REINSURANCE FIC has quota share and surplus cover for its property, general accident, engineering and marine business lines. Medical and travel lines are protected by quota share cover, while the motor, personal accident, workers compensation and A.M. Best s Takaful Review 2012 Edition 31

33 Sample AMB Credit Report third party liability lines are protected by non-proportional cover. Additionally, FIC has whole account non-proportional cover to provide protection in case of any catastrophe event. Capacity and retention for proportional cover varies by line of business. Reinsurers are generally of a good credit quality (equal to or higher than A.M. Best s B+ Financial Strength Rating) and the core programme is lead by a leading international reinsurer. BALANCE SHEET ITEMS JOD (000) 2010 JOD (000) 2009 JOD (000) Liquid assets 22,269 22,499 22,216 Total investments 25,991 26,228 24,975 Total assets 33,567 32,268 28,660 Gross technical reserves 6,284 4,624 2,147 Net technical reserves 1,927 1, Total liabilities 8,124 5,918 3,354 Capital & surplus 25,443 26,350 25,306 INCOME STATEMENT ITEMS JOD (000) 2010 JOD (000) 2009 JOD (000) Gross premiums written 11,652 9,129 3,099 Net premiums written 4,337 2,962 1,363 Balance on technical account(s) Profit/(loss) before tax 701 1,282 1,932 Profit/(loss) after tax 487 1,002 1,438 LIQUIDITY RATIOS (%) Total debtors to total assets Liquid assets to net technical reserves Liquid assets to total liabilities Total investments to total liabilities LEVERAGE RATIOS (%) Net premiums written to capital & surplus Net technical reserves to capital & surplus Gross premiums written to capital & surplus Gross technical reserves to capital & surplus Total debtors to capital & surplus Total liabilities to capital & surplus PROFITABILITY RATIOS (%) Loss ratio Operating expense ratio Combined ratio Other technical expense or (income) ratio Net investment income ratio Operating ratio Return on net premiums written Return on total assets Return on capital & surplus A.M. Best s Takaful Review 2012 Edition

34 A Best s Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance obligations. The ratings are not assigned to specific insurance policies or contracts and do not address any other risk, including, but not limited to, an insurer s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Best s Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor do they address the suitability of any particular policy or contract for a specific purpose or purchaser. A Best s Debt/Issuer Credit Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. These credit ratings do not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities. The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor do they address the suitability of any particular financial obligation for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. Any and all ratings, opinions and information contained herein are provided as is, without any express or implied warranty. Visit for additional information or for details on the Terms of Use. A.M. Best s Takaful Review 2012 Edition 33

35 Sample AMB Credit Report AMB CREDIT REPORT - INSURANCE PROFESSIONAL FOR AL FAJER RETAKAFUL INSURANCE COMPANY K.S.C. (CLOSED) Non-Life Business P.O. Box 21650, Safat 13077, Kuwait Web: Tel: Fax: AMB#: Report Revision Date: 07/29/2011 BEST S CREDIT RATINGS Best s Financial Strength Rating: B++ Outlook: Negative Best s Issuer Credit Rating: bbb+ Outlook: Negative Best s Financial Size Category: VIII RATING RATIONALE Rating Rationale: The ratings of Al Fajer Retakaful Insurance Company K.S.C. (Closed) (Al Fajer Re) are based on a strong level of risk-adjusted capitalisation for the combined Shareholder and Retakaful Fund and a business profile improving in line with expectations. Offsetting factors include a weaker than anticipated level of risk-adjusted capitalisation within the Retakaful fund and weak overall underwriting profitability. Risk-adjusted Capitalisation A.M. Best considers that the level of risk-adjusted capitalisation within Al Fajer Re s combined fund (which consists of the company s Shareholders Fund and Retakaful Fund) has deteriorated. It is, however, likely to remain strong and supportive of the current rating as the company grows over the coming years. Risk-adjusted capitalisation is supported by an outwards reinsurance programme of good credit quality, relatively new investment guidelines that require the company to invest free assets into low risk investments and a capital base of KWD 50 million (USD 180 million). Offsetting the company s level of risk-adjusted capitalisation are accumulated underwriting losses of KWD 6.7 million (USD 23.5 million), exposure to the The Investment Dar (TID) which defaulted in 2009 and accounts for nearly 30% of the company s asset base, in addition to increasing capital requirements from a growing insurance portfolio and higher than anticipated losses. A.M. Best considers that the recent restructure agreement with regards to Al Fajer Re s TID investment provides more clarity and reduces future uncertainty somewhat. The level of risk-adjusted capitalisation within the Al Fajer Re s Retakaful Fund on a stand alone basis has also deteriorated. Although still supportive of the current rating level, A.M. Best considers that it is now at a more marginal level. Capitalisation within the Retakaful fund is supported by a trust deed amounting to half of Al Fajer Re s paid capital, in addition to the Qard Hassan (an interest-free loan) provided by the shareholders to cover participants losses. Provisioning for the TID investment and higher than anticipated accumulated underwriting losses have had a negative impact. Business Profile Al Fajer Re has successfully grown its book of reinsurance business during the 2010/2011 financial year in line with its business plans. Gross premium income increased by 28.5% to KWD 16.5 million (USD 58.3 million). The company has maintained a well diversified portfolio with risks spread throughout the Middle East and North Africa, the Far East and Europe. A.M. Best anticipates that a good level of diversification will be maintained over the coming two years while the company targets further growth somewhere in the region of 30%. Underwriting Performance A net exposure of USD 4.25 million to the Japan earthquake in the 2010/2011 financial year has had a significant negative impact on Al Fajer Re s underwriting results; increasing the company s expected combined ratio by 14 percentage points to 114%, which corresponds to an underwriting loss of KWD 3.1 million (USD 9.7 million). A.M. Best anticipates a significantly improved underwriting performance in the 2011/2012 financial 34 A.M. Best s Takaful Review 2012 Edition

36 year based on actions taken by management to limit exposure within the company s facultative book of business, in addition to the improving performance of underlying business. FIVE YEAR RATING HISTORY Date Best s FSR Best s ICR 07/27/11 B++ bbb+ 07/26/10 B++ bbb+ 12/01/09 B++ bbb+ 06/18/09 B++u bbb+ u 01/14/09 A- u a- u 06/30/08 A- a- BUSINESS REVIEW Al Fajer Retakaful Insurance Company K.S.C. (Closed) (Al Fajer Re) is a start-up company licensed in Kuwait providing capacity to takaful and conventional insurers. The company commenced its operations in June 2008, covering territories predominately in the Middle East and North Africa, the Far East and Europe. Al Fajer Re s main shareholders are the Dubai Islamic Investment Group (DIIG), Twenty Fourth Project Management Company WLL (TFPM) and Global Investment House KSCC (GIH). DIIG, the global Shari a compliant investment company of the Dubai Group holds a 51% stake in Al Fajer Re. TFPM controls a 21% stake and is a limited liability company incorporated in the state of Kuwait with the sole purpose of holding shares in Al Fajer Re. GIH is a leading investment bank in the Gulf region, holds 20% of the shares of Al Fajer Re and acts as a custodian for TFPM. The balance of the shares is held by minority shareholders. During 2009, 49% of TFPM was sold by GIH (until then owner of 99.99% of TFPM) to Global MENA Financial Assets Limited (GMFA), a Guernsey incorporated investment company, whose 29.99% ownership is held by GIH itself. In December 2008, GIH defaulted on the repayment of a syndicated loan facility triggering cross-default provisions in the group s other indebtedness. On 10 December 2009, a debt restructuring plan was agreed to by all of GIH s lending banks and is now in the execution phase. In addition to this, approximately 30% of Al Fajer Re s overall financial assets are invested in securities issued by The Investment Dar Company (TID), which defaulted in May In June 2011, after some ongoing difficulties, Kuwaiti Courts accepted TID s latest restructuring plan and accordingly placed it under the auspices of the Kuwait Financial Stability Law. Al Fajer Re is expecting a significant portion of their TID investment to be returned over the short term, with the remainder paid over a six year period. In the 2010/2011 financial year, Al Fajer Re achieved a growth of gross written contributions of around 30% to KWD 16.5 million (USD 59.5 million); which was in line with A.M. Best s recent expectations. Looking into 2012 and 2013, A.M. Best anticipates that Al Fajer Re will continue to grow at a similarly strong level. Al Fajer Re has a high level of geographical diversification within its portfolio and A.M. Best s anticipates that this will be maintained over the coming years as the company grows. The Middle East and North Africa (MENA) region is the company s main originator of business, accounting for around 46% of the business written, followed by the Far East (around 35%) and Central and Eastern Europe (CEE) (around 19%). Al Fajer Re has also established a branch office in Labuan, Malaysia. Al Fajer Re underwrites takaful and conventional business on a Shari a compliant basis. The company is mainly focused on proportional treaties (accounting for around 70% of the overall reinsurance portfolio), followed by nonproportional treaties (around 23%), with facultative business accounting for less than 10% of the company s written contributions. In terms of business lines, the reinsurance portfolio is dominated by property and engineering lines, accounting for approximately 73% of the overall exposure, whereas the other lines of business are motor, marine and accident, each representing less than 15% of the company s exposure. Although a retakaful company, in line with its broader market, the majority of Al Fajer Re s cedants are of a conventional nature. FINANCIAL PERFORMANCE Overall Earnings: According to the preliminary financial accounts for the financial year ended March 2011, Al Fajer Re has reported net losses of KWD 0.4 million (USD 1.4 million) on a combined basis, due largely to foreign A.M. Best s Takaful Review 2012 Edition 35

37 Sample AMB Credit Report exchange losses following a significant weakening of the US Dollar against the Kuwaiti Dinar. Although around two thirds of the company s business is denominated in USD, the company continues to report in KWD due to the composition of its asset base, with around 17% of shareholder assets denominated in USD at the balance sheet date. A.M. Best considers that any further significant movement in exchange rate between the KWD and USD is likely to have a notable impact, either positive or negative, on Al Fajer Re s overall earnings. The marginal overall loss in 2011 compares favourably to the KWD 5.7 million (USD 19.8 million) of losses incurred in 2010, which were driven by provisioning for the company s TID investment. Assuming no further provisioning for Al Fajer Re s TID investment, A.M. Best anticipates that overall profits will emerge from However, with management fees not charged to the ReTakaful Fund until the Qard Hassan (loan from Shareholder s Fund to ReTakaful Fund to cover accumulated underwriting losses) is fully paid, A.M. Best expects overall earnings to be reliant on investment returns until Future dividend payments of 70% of net profit arising from the shareholders fund are expected. This is likely to consist of 100% of the investment income associated with the shareholders and Shorouk funds and Wakalah (5% of gross written contributions) and Mudarabha (50% of investment income) fees. Wakalah and Mudarabha fees from the Retakaful fund will only be payable when Al Fajer Re posts a technical profit and Qard Hassan has been repaid. Underwriting Income: Al Fajer Re s technical performance during its first three years of operations has been below A.M. Best expectations, with a combined ratio peaking in 2011 at116.2%. However, in 2011 Al Fajer Re had a significant exposure to the Japanese earthquake, which added around 13 percentage points to the company s loss ratio. Given that the majority of Al Fajer Re s insurance business is transacted in USD s, A.M. Best s analysis has also taken into account the impact of exchange movements on the reported figures. Underwriting results presented in USD s present a marginally better combined ratio of 114% for the 2011 financial year. Excluding the impact of Japanese losses, Al Fajer Re s underwriting performance was broadly in line with A.M. Best s expectations. Given the performance of the company s underlying business, A.M. Best is expecting a profitable underwriting account for the 2011/2012 financial year. A.M. Best considers that while Al Fajer Re remains a relatively small reinsurer, exposure to natural catastrophe events exposes the company s underwriting portfolio to potential volatility. Nevertheless, the company has taken steps to reduce its exposure, particularly with regards to its facultative book. Investment Results: In 2009, Al Fajer Re s asset portfolio was highly concentrated. After the default of TID, Al Fajer Re reported an impairment of 20% on its overall exposure to TID s securities. This provision was later increased to 50% in The company has now established clearer and more prudent investment guidelines and limits and started the reallocation of all of its investments into liquid instruments (with the exception of TID) until further notice. In line with the plan, Al Fajer Re has almost finalised the transfer of all of its investments (excluding TID s securities) to cash and deposits. In order to reduce its credit risk, Al Fajer Re has also extended its panel of banks to at least 10 counterparties having a secure rating. While the new investment strategy pursues the protection of the company s capital and limits its exposure to risky investments and to the volatility of capital markets, the return on investments is limited. Al Fajer Re s investment yield is expected to be around 2% for the coming year. CAPITALIZATION A.M. Best believes that Al Fajer Re has a good level of risk-adjusted capitalisation on a combined basis (shareholders plus policyholders funds), benefiting from the initial capital injection of KWD 50 million (approximately USD 175 million). However, the company s level of risk-adjusted capitalisation in 2011 is significantly below A.M. Best s earlier expectations, primarily driven by the provisioning of investments and weaker than expected underwriting results. On a stand-alone basis, the policyholders fund is protected by the Qard Hassan (interest-free loan from the shareholders fund to the policyholders fund), available to cover any underwriting loss. A further protection is provided by the Shorouk trust (holding half of the paid up capital under a trust arrangement based in the Cayman Islands), which will be available as additional Qard Hassan, should the shareholders fund become depleted. The level of risk-adjusted capitalisation within the policyholders fund remains supportive of the current rating, however, at a more marginal level. A.M. Best anticipates that risk-adjusted capitalisation within the policyholders fund is likely to become increasingly pressured as the company grows. Al Fajer Re benefits from the zero corporate tax rate in Kuwait and only pays its applicable contribution to the Kuwait Foundation for the Advancement of Sciences and Zakat. 36 A.M. Best s Takaful Review 2012 Edition

38 Reserve Quality: Al Fajer Re s claims reserves and its IBNR reserves are calculated internally and then reviewed by an internationally recognised actuarial firm on an annual basis. Al Fajer Re uses Global CRESTA and Synergy programmes for mapping and identifying its risks and to calculate its probable maximum loss (PML) exposure. Al Fajer Re s expected maximum PML exposure on a 250 year return basis is from a Chinese earthquake. LIQUIDITY Overall Liquidity: Al Fajer Re maintains a strong overall liquidity on a combined basis (policyholders fund plus shareholders fund). The combined liquidity position also benefits from the decision to place all funds upon maturity in banks with governmental guarantees. In A.M. Best s view, Al Fajer Re s current liquidity ratio (total investments to total liabilities less shareholders fund) is likely to increase to over 200% in the next year. Nevertheless, in A.M. Best s view, the current strong liquidity position could deteriorate in the medium term, should Al Fajer Re significantly increase its business while maintaining the present proportion between reinsurance receivables and written contributions. Source of Information: Audited Financial Statement Summarized Accounts as of March 31, 2011 US $ per Local Currency Unit = 1 Kuwaiti Dinar (KWD) STATEMENT OF INCOME Technical account: 03/31/2011 KWD(000) 03/31/2011 USD(000) Reinsurance premiums assumed 16,539 59,501 Gross premiums written 16,539 59,501 Reinsurance ceded 1,293 4,652 Net premiums written 15,246 54,850 Increase/(decrease) in gross unearned premiums 3,466 12,469 Net premiums earned 11,780 42,380 Total underwriting income 11,780 42,380 Net claims incurred 9,760 35,113 Management expenses 2,056 7,397 Acquisition expenses 3,031 10,904 Net operating expenses 5,087 18,301 Total underwriting expenses 14,847 53,414 Balance on technical account -3,067-11,034 Non-technical account: Net investment income 388 1,396 Unrealised capital gains/(losses) Exchange gains/(losses) ,525 Other income/(expense) 2,996 10,779 Profit/(loss) before tax ,360 Profit/(loss) after tax ,360 Retained Profit/(loss) for the financial year ,360 Retained Profit/(loss) brought forward -5,395-19,409 Retained Profit/(loss) carried forward -5,773-20,769 MOVEMENT IN CAPITAL & SURPLUS 03/31/2011 KWD(000) 03/31/2011 USD(000) Capital & surplus brought forward 44, ,595 Profit or loss for the year ,360 Total change in capital & surplus ,360 Capital & surplus carried forward 44, ,235 A.M. Best s Takaful Review 2012 Edition 37

39 Sample AMB Credit Report ASSETS 03/31/2011 KWD(000) 03/31/2011 % of total 03/31/2011 USD(000) Cash & deposits with credit institutions 34, ,176 Liquid assets 34, ,176 Unquoted investments 8, ,105 Other investments 3, ,102 Total investments 45, ,384 Total reinsurers share of technical reserves 1, ,357 Insurance/reinsurance debtors 17, ,729 Other debtors 1, ,882 Total debtors 19, ,611 Fixed assets Prepayments & accrued income 4, ,585 Other assets 6, ,119 Total assets 77, ,857 LIABILITIES 03/31/2011 KWD(000) 03/31/2011 % of total 03/31/2011 USD(000) Capital 50, ,882 Paid-up capital 50, ,882 Non-distributable reserves Retained earnings -5, ,773 Capital & surplus 44, ,232 Gross provision for unearned premiums 14, ,522 Gross provision for outstanding claims 13, ,007 Total gross technical reserves 27, ,529 Other liabilities 5, ,096 Total liabilities & surplus 77, ,857 MANAGEMENT Despite the fact that the management team members are well experienced in the Middle East and Far East regions there was a substantial lack of control of investments in the first year of the company s operation. Since the departure of the managing director (who had responsibility as chairman of the investment committee for the investment strategy) in September 2008, which also coincided with a deterioration of the financial health of various Kuwaiti corporations, Al Fajer Re had demonstrated weak corporate governance, with regard to its investments, by its management not being involved in a proactive fashion to resolve serious investment-related issues that have affected the company. This non-involvement was decided by the board of directors (comprising the main shareholders). A new corporate governance structure was implemented during 2009 with the introduction of the management finance and investment committee (MFIC), in charge of all the investment decisions (in accordance with new guidelines and limits). The board level risk committee has now taken the responsibility for high-level investment strategy. It is also involved in the investment decisions in the case of a potential breach of investment limits/guidelines. A.M. Best believes that risks related to underwriting are being dealt with and controlled more closely. This has been achieved through putting in place a natural perils exposure framework and catastrophe modelling. An individual is expecting to occupy the position of chief risk officer imminently, following the position being vacant for over a year. Al Fajer Re s board of directors comprises five members, three of whom are representatives from DIIG and two from GIH. To ensure that Al Fajer Re conforms to Shari a law, the company has appointed Al Mashora and Al Raya for Islamic Financial Consultancy (Al Raya) as it s Shari a Supervisory Board, which is composed of three scholars. TERRITORY Kuwait 38 A.M. Best s Takaful Review 2012 Edition

40 ANALYSIS OF GROSS PREMIUMS WRITTEN KWD (000) 2011 KWD (000) 2010 KWD (000) Accident & health Automobile 2,144 1,043 1,148 Marine 1, Property 12,239 10,365 8,035 Total non-life 16,539 12,866 10,439 REINSURANCE In , Al Fajer Re s net retention was 92% and is projected to be around 95% going forward. Almost all accepted retrocessionaires have an A.M. Best Financial Strength Rating of A - or above. Exceptions are allowed for shorttailed cover and always with reinsurers having a secure rating. The company has retrocession programmes for property, accident, motor and marine. Al Fajer Re s maximum retentions on property risks are USD 4.25 million per event and USD 1.25million per risk, while the cover limit amounts to USD 17 million. For motor and accident the maximum retention is USD 1.10 million per risk, with a cover limit of USD 2.5 million. Maximum retention for marine is USD 0.35 million per risk and per event, with a cover limit of USD 0.7 million. Al Fajer Re has unlimited bodily injury protection in excess of USD 2.5 million. BALANCE SHEET ITEMS KWD (000) 2011 KWD (000) 2010 KWD (000) Liquid assets 34,238 35,279 32,298 Total investments 45,970 45,388 49,641 Total assets 77,789 65,744 61,959 Gross technical reserves 27,943 17,667 8,869 Net technical reserves 26,454 17,667 8,869 Total liabilities 33,529 21,105 11,623 Capital & surplus 44,260 44,639 50,336 INCOME STATEMENT ITEMS KWD (000) 2011 KWD (000) 2010 KWD (000) Gross premiums written 16,539 12,866 10,439 Net premiums written 15,246 12,145 10,139 Balance on technical account(s) -3,067-1,782-1,828 Profit/(loss) before tax , Profit/(loss) after tax , LIQUIDITY RATIOS (%) Total debtors to total assets Liquid assets to net technical reserves Liquid assets to total liabilities Total investments to total liabilities A.M. Best s Takaful Review 2012 Edition 39

41 Sample AMB Credit Report LEVERAGE RATIOS (%) Net premiums written to capital & surplus Net technical reserves to capital & surplus Gross premiums written to capital & surplus Gross technical reserves to capital & surplus Total debtors to capital & surplus Total liabilities to capital & surplus PROFITABILITY RATIOS (%) Loss ratio Operating expense ratio Combined ratio Net investment income ratio Operating ratio Return on net premiums written Return on total assets Return on capital & surplus A Best s Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance obligations. The ratings are not assigned to specific insurance policies or contracts and do not address any other risk, including, but not limited to, an insurer s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Best s Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor do they address the suitability of any particular policy or contract for a specific purpose or purchaser. A Best s Debt/Issuer Credit Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. These credit ratings do not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities. The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor do they address the suitability of any particular financial obligation for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. Any and all ratings, opinions and information contained herein are provided as is, without any express or implied warranty. Visit for additional information or for details on the Terms of Use. 40 A.M. Best s Takaful Review 2012 Edition

42 A Best s Financial Strength Rating is an independent opinion of an insurer s financial strength and ability to meet its ongoing insurance policy and contract obligations. The rating is based on a comprehensive quantitative and qualitative evaluation of a company s balance sheet strength, operating performance and business profile. Secure Rating Descriptor Definition A++, A+ Superior A, A- Excellent B++, B+ Guide to Best s Financial Strength Ratings Financial Strength Ratings Good B, B- Fair Assigned to companies that have, in our opinion, a superior ability to meet their ongoing insurance obligations. Assigned to companies that have, in our opinion, an excellent ability to meet their ongoing insurance obligations. Assigned to companies that have, in our opinion, a good ability to meet their ongoing insurance obligations. Assigned to companies that have, in our opinion, a fair ability to meet their ongoing insurance obligations. Financial strength is vulnerable to adverse changes in underwriting and economic conditions. C++, C+ Marginal Assigned to companies that have, in our opinion, a marginal ability to meet their ongoing insurance obligations. Financial strength is vulnerable to adverse changes in underwriting and economic conditions. Vulnerable C, C- Weak D E Poor Under Regulatory Supervision Assigned to companies that have, in our opinion, a weak ability to meet their ongoing insurance obligations. Financial strength is very vulnerable to adverse changes in underwriting and economic conditions. Assigned to companies that have, in our opinion, a poor ability to meet their ongoing insurance obligations. Financial strength is extremely vulnerable to adverse changes in underwriting and economic conditions. Assigned to companies (and possibly their subsidiaries/affiliates) placed under a significant form of regulatory supervision, control or restraint - including cease and desist orders, conservatorship or rehabilitation, but not liquidation - that prevents conduct of normal, ongoing insurance operations. F In Liquidation Assigned to companies placed in liquidation by a court of law or by a forced liquidation. S Rating Modifiers Positive Negative Suspended Modifier Descriptor Definition u pd Stable Under Review Public Data Assigned to rated companies when sudden and significant events affect their balance sheet strength or operating performance and rating implications cannot be evaluated due to a lack of timely or adequate information. Indicates the rating may change in the near term, typically within six months. Generally is event driven, with positive, negative or developing implications. Indicates rating assigned to insurer that chose not to participate in A.M. Best s interactive rating process. (Discontinued in 2010) s Syndicate Indicates rating assigned to a Lloyd s syndicate. Outlooks Indicates potential direction of a Financial Strength Rating over an intermediate term, generally defined as 12 to 36 months. Indicates possible rating upgrade due to favorable financial/market trends relative to the current rating level. Indicates possible rating downgrade due to unfavorable financial/market trends relative to the current rating level. Indicates low likelihood of a rating change due to stable financial/market trends. Not Rated Designation NR: Assigned to companies that are not rated by A.M. Best. Rating Disclosure A Best s Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance obligations. The ratings are not assigned to specific insurance policies or contracts and do not address any other risk, including, but not limited to, an insurer s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Best s Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best s Terms of Use at Best s Financial Strength Ratings are distributed via press release and/or the A.M. Best Web site at and are published in the Rating Actions section of BestWeek. Best s Financial Strength Ratings are proprietary and may not be reproduced without permission. Copyright 2012 by A.M. Best Company, Inc. Version A.M. Best s Takaful Review 2012 Edition 41

43 Guide to Best s Debt and Issuer Credit Ratings A Best s Debt/Issuer Credit Rating is based on a comprehensive quantitative and qualitative evaluation of a company s balance sheet strength, operating performance and business profile and, where appropriate, the specific nature and details of a rated debt security. Long-Term Credit Ratings A Best s Long-Term Debt Rating, assigned to specific issues such as debt and preferred stock, is an independent opinion of an issuer/entity s ability to meet its ongoing financial obligations to security holders when due. Rating Descriptor Definition Investment Grade Non-Investment Grade aaa Exceptional Assigned to issues where, in our opinion, the issuer has an exceptional ability to meet the terms of the obligation. aa Very Strong Assigned to issues where, in our opinion, the issuer has a very strong ability to meet the terms of the obligation. a Strong Assigned to issues where, in our opinion, the issuer has a strong ability to meet the terms of the obligation. bbb bb b ccc, cc, c d Adequate Speculative Very Speculative Extremely Speculative In Default Assigned to issues where, in our opinion, the issuer has an adequate ability to meet the terms of the obligation; however, the issue is more susceptible to changes in economic or other conditions. Assigned to issues where, in our opinion, the issuer has speculative credit characteristics, generally due to a moderate margin of principal and interest payment protection and vulnerability to economic changes. Assigned to issues where, in our opinion, the issuer has very speculative credit characteristics, generally due to a modest margin of principal and interest payment protection and extreme vulnerability to economic changes. Assigned to issues where, in our opinion, the issuer has extremely speculative credit characteristics, generally due to a minimal margin of principal and interest payment protection and/or limited ability to withstand adverse changes in economic or other conditions. Assigned to issues in default on payment of principal, interest or other terms and conditions, or when a bankruptcy petition or similar action has been filed. A Best s Long-Term Issuer Credit Rating is an opinion of an issuer/entity s ability to meet its ongoing senior financial obligations. When assigned to an insurance company, the Long-Term Issuer Credit Rating descriptors are as follows: (aaa) - Exceptional; (aa) - Superior; (a) - Excellent; (bbb) - Good; (bb) - Fair; (b) - Marginal; (ccc and cc) - Weak; (c) - Poor; (rs) - Regulatory Supervision/Liquidation. Ratings from aa to ccc may be enhanced with a + (plus) or - (minus) to indicate whether credit quality is near the top or bottom of a category. Short-Term Credit Ratings A Best s Short-Term Debt Rating is an opinion of an issuer/entity s ability to meet its financial obligations having original maturities of generally less than one year, such as commercial paper. Investment Grade Non- Investment Grade Rating Descriptor Definition AMB-1+ Strongest Assigned to issues where, in our opinion, the issuer has the strongest ability to repay short-term debt obligations. AMB-1 Outstanding Assigned to issues where, in our opinion, the issuer has an outstanding ability to repay short-term debt obligations. AMB-2 Satisfactory Assigned to issues where, in our opinion, the issuer has a satisfactory ability to repay short-term debt obligations. AMB-3 AMB-4 d Adequate Speculative In Default Assigned to issues where, in our opinion, the issuer has an adequate ability to repay short-term debt obligations; however, adverse economic conditions likely will reduce the issuer s capacity to meet its financial commitments. Assigned to issues where, in our opinion, the issuer has speculative credit characteristics and is vulnerable to adverse economic or other external changes, which could have a marked impact on the company s ability to meet its financial commitments. Assigned to issues in default on payment of principal, interest or other terms and conditions, or when a bankruptcy petition or similar action has been filed. A Best s Short-Term Issuer Credit Rating is an opinion of an issuer/entity s ability to meet its senior financial obligations having original maturities of generally less than one year. Rating Modifiers Both Long- and Short-Term Credit Ratings can be assigned a modifier. Note: The public data modifier did not apply to Short-Term Credit Ratings, which are only assigned on an interactive basis. Modifier Descriptor Definition u pd Indicates the potential direction of a Credit Rating over an intermediate term, generally defined as 12 to 36 months. Positive Negative Under Review Public Data Indicates the rating may change in the near term, typically within six months. Generally is event driven, with positive, negative or developing implications. Indicates rating assigned to a company that chose not to participate in A.M. Best s interactive rating process. (Discontinued in 2010) i Indicative Indicates rating assigned is indicative. Outlooks Indicates possible rating upgrade due to favorable financial/market trends relative to the current rating level. Indicates possible rating downgrade due to unfavorable financial/market trends relative to the current rating level. Stable Indicates low likelihood of a rating change due to stable financial/market trends. Not Rated Designation The Not Rated (NR) designation may be assigned to issuers or issues that are not rated. Rating Disclosure A Best s Debt/Issuer Credit Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. These credit ratings do not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities. The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best s Terms of Use at Best s Debt/Issuer Credit Ratings are distributed via press release and/or the A.M. Best Web site at and are published in the Rating Actions section of BestWeek. Best s Credit Ratings are proprietary and may not be reproduced without permission. Copyright 2012 by A.M. Best Company, Inc. Version A.M. Best s Takaful Review 2012 Edition

44 About Us A.M. BEST COMPANY AT A GLANCE A.M. Best is a leading provider of ratings, news and financial data with a specialist focus on the worldwide insurance industry. Best s Credit Ratings are recognised by users as the benchmark for assessing the financial strength of insurance-related organisations and the credit quality of their obligations. Established in the U.S. in 1899 and pioneered the concept of financial ratings in 1906 Worldwide headquarters in New Jersey, U.S.; regional offices in London (serving Europe, Middle East and Africa) and Hong Kong (serving Asia and Oceania) Full-service global ratings capabilities Over 4,000 ratings in approximately 65 countries worldwide Approximately 130 rating professionals undertaking full insurance industry geographical and sector coverage Extensive marketing and publishing capability to promote corporate ratings in local and international markets A.M. Best Co. is a Nationally Recognised Statistical Rating Organisation (NRSRO) registered under the provisions of the United States Securities Exchange Act of 1934 MARKET COVERAGE Insurance-related companies operating in various markets, including: Property/casualty (non-life) insurers Lloyd s and its syndicates Life insurers and annuity writers New company formations ( start-ups ) Health insurers including managed Alternative risk-transfer (ART) care, health maintenance organisations vehicles (including captives, pools Reinsurers and risk-retention groups) Title insurers Catastrophe bond issuers and other Mutual insurers and Protection & Insurance-Linked Securitisations (ILS) Indemnity (P&I) clubs COMPETITIVE STRENGTHS Only international rating agency dedicated to the financial services, primarily insurance, industry World s leading provider of insurer Financial Strength Ratings (FSRs) by company coverage Leading position in the global reinsurance segment Leading position in international (re)insurance hubs including comprehensive coverage of Lloyd s/london market, Bermuda, Zurich Dominant position in insurance, reinsurance and health care ratings in the U.S. market Leading rating agency for ART and captives coverage Key rating agency used by global broker security teams Data and research covering 10,500 companies worldwide Largest and most comprehensive insurance database providing unique insights by segment and line of business RESEARCH & RATING METHODOLOGY Publishers of numerous specialised reports on the issues, sectors, companies and geographic locations related and connected to the global insurance industry Methodologies reflecting key industry developments and the rating of entities in specific sectors and regions, including: Members of Insurance Groups Enterprise Risk Management Lloyd s Syndicates Captives Sidecars Health Insurance Companies New Company Formations European Mutual Insurers Takaful (Shari a Compliant) Insurance Companies Closed-Block Monetisations Natural Catastrophe Bonds Funding Agreement Backed Securities Life Settlement Securitisation A.M. Best s Takaful Review 2012 Edition 43

45 About Us BEST S CREDIT RATINGS: THE GLOBAL SYMBOL OF FINANCIAL STRENGTH Best s Credit Rating Scales Rating Definitions Best s Financial Strength Ratings (FSRs) provide an opinion of an insurer s financial strength and ability to meet its ongoing insurance policy and contract obligations. Best s Issuer Credit Ratings (ICRs) provide an opinion of an entity s ability to meet its ongoing senior financial obligations. Best s Debt Ratings (DRs) provide an opinion as to the issuer s ability to meet its ongoing financial obligations to security holders when due. Secure Vulnerable Translation of FSR to Credit Market Scale FSR ICR/DR A++ aaa aa+ A+ aa aa- A a+ a A- a- B++ bbb+ bbb B+ bbb- B bb+ bb B- bb- C++ b+ b C+ b- C ccc+ ccc C- ccccc D c E, F d Investment Grade Non-Investment Grade A rating by A.M. Best is based on a comprehensive evaluation of an insurance company s financial strength, operating performance and market profile. A.M. Best also regularly publishes Impairment Studies, which evaluate rating performance over time. BestMark for Secure-Rated Insurers Financial Strength Rating A M BEST Secure The BestMark provides a recognisable visual symbol of an insurer s financial strength. The value of a Best s Credit Rating is enhanced by market penetration. Best s Credit Ratings reach: More than 150,000 insurance industry professionals via A.M. Best s publications (BestWeek, Best s Review, BestDay, BestWire ) Thousands of financial professionals worldwide via news vendors such as Reuters, Dow Jones and NewsEdge More than 1,400,000 professionals who have registered to gain access to Best s Credit Ratings online Best s Credit Ratings and related financial information provide powerful tools for insurance decision making and market research for insurance agents, brokers, risk managers, bankers, insurance executives, policyholders and consumers. The Best s Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance obligations. The ratings are not assigned to specific insurance policies or contracts and do not address any other risk, including, but not limited to, an insurer s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Best s Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best s Terms of Use at A Best s Debt/Issuer Credit Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. These credit ratings do not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities. The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best s Terms of Use at 44 A.M. Best s Takaful Review 2012 Edition

46 Contact Us For more information about A.M. Best s ratings of Takaful insurers, please contact: NICK CHARTERIS-BLACK Managing Director, Market Development EMEA +44 (0) nick.charteris-black@ambest.com Market Development Team: CLIVE THURSBY Senior Director, Market Development EMEA & South Asia +44 (0) clive.thursby@ambest.com VASILIS KATSIPIS General Manager, Market Development MENA, South & Central Asia +44 (0) vasilis.katsipis@ambest.com A.M. Best s Takaful Review 2012 Edition 45

47 Notes 46 A.M. Best s Takaful Review 2012 Edition

48 Notes A.M. Best s Takaful Review 2012 Edition 47

49 Founded in 1899, A.M. Best Company is the world s oldest and most authoritative insurance rating and information source. For more information, visit Copyright 2012 by A.M. Best Company, Inc. ALL RIGHTS RESERVED. A.M. Best Company, Inc. Ambest Road Oldwick, New Jersey Phone: +1 (908) Fax: +1 (908) A.M. Best Europe Rating Services Ltd. 12 Arthur Street, 6th Floor London, UK EC4R 9AB Phone: +44 (0) Fax: +44 (0) A.M. Best Asia-Pacific Ltd. Unit 4004 Central Plaza 18 Harbour Road Wanchai, Hong Kong Phone: Fax: A.M. Best MENA, South & Central Asia Office 102 Currency House, Tower 2 DIFC PO Box Dubai, UAE

50 A