RHB Research PP 7767/09/2012 (030475) 25 March 2013 TABLE OF CONTENTS

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1 MARKET DATELINE MALAYSIA EQUITY Investment Research The Research Team Sector Update Insurance NEUTRAL Key Points In BNM, IMF Reports The insurance and takaful industry saw a boost in profitability in 2012, spurred by improving premiums growth and healthier combined ratios in the general insurance/takaful sectors. Despite notable increases in equity exposure and concerns on interest rate risk, insurers risk exposure remains reasonable. BNM intends to tighten scrutiny of the insurance/takaful industry, as recommended by the IMF Country Report. We remain NEUTRAL on the sector. Better The life insurance and family takaful sector reported a 38.2% increase in net income or excess income over outgo, backed by premiums/contributions growth of 11.2%. Meanwhile, the general insurance and takaful segment s operating profits surged by 72.6% to RM2.9bn on the back of premiums/contributions growth of 11.1%. The general insurance and takaful industry also benefited from a low combined ratio of 96.9% (vs 104.7% in 2011). Regulations tighten their grip. The industry s capital adequacy ratios (CAR) leveled at 222.3% (vs 222.5% in 2011), well above Bank Negara Malaysia (BNM)'s supervisory target capital level (STCL) requirement of 130%. The IMF Country Report acknowledges the strength and comprehensiveness of the local insurance regulatory measures versus the international framework. Meanwhile, the country s cross-border operations are still small relative to the industry, which we believe may have prompted BNM to relax cross-border financial activities for resident insurers and takaful operators. The central bank intends to enhance the existing prudential requirements with the Financial Services Act (FSA), as well as other measures which may include containment of systemic risks and cross-border risks. This should boost the sustainability of the industry, which being liberalised. NEUTRAL. We retain NEUTRAL on the sector, with our Top Picks being Syarikat Takaful for its exposure to the takaful industry, and LPI Capital for its robust business model and solid underwriting strength. Source: Company data, RHBRI estimates 1

2 TABLE OF CONTENTS TABLE OF CONTENTS... 2 HIGHLIGHTS FROM THE FINANCIAL STABILITY AND PAYMENTS SYSTEM REPORTS ADDITIONAL HIGHLIGHTS FROM IMF COUNTRY REPORT

3 11.0% 9.0% 7.0% 5.0% 3.0% 1.0% -1.0% -3.0% -5.0% 65.0% 55.0% 45.0% 35.0% 25.0% 15.0% 5.0% -5.0% RHB Research PP 7767/09/2012 (030475) HIGHLIGHTS FROM THE FINANCIAL STABILITY AND PAYMENTS SYSTEM REPORTS 2012 Improvement in premiums growth and combined ratios for GI boosted profitability Rebound in profitability. Malaysia's insurance industry saw a solid rebound in profitability in terms of net income (net underwriting and investment income). Based on BNM's Financial Stability and Payment Systems Report 2012, the life insurance and family takaful sector reported a 38.2% increase in excess income over outgo to RM17.6bn on the back of premiums/contributions growth of 11.2%. The general insurance and takaful sector's operating profits accelerated by a higher 72.6% to RM2.9bn, on the back of premiums/contributions growth of 11.1%. The general insurance and takaful industry also benefited from a low combined ratio of 96.9% (vs 104.7% in 2011). Figure 1: Life insurance (LI) and general insurance (GI) industry premiums p LI Net Premium GI Earned Premium LI Premium Growth (%) 7.0% 2.3% 5.8% 10.0% 4.7% 9.2% GI Premium Growth (%) 2.9% 2.0% 8.8% 8.1% 4.9% 10.5% Source: BNM, PIAM Figure 2: Family takaful and general takaful industry contributions p Family Takaful Contributions General Takaful Contributions Family Contributions Growth (%) 60.3% 19.3% 14.5% 24.7% 9.2% 23.3% General Contributions Growth (%) 13.3% 18.1% 29.9% 16.2% 17.5% Source: BNM, MTA 3

4 500.0% 400.0% 300.0% 200.0% 100.0% 0.0% % RHB Research PP 7767/09/2012 (030475) Figure 3: Life insurance (LI) and general insurance (GI) industry profitability p LI Excess Income over Outgo GI Operating Profit LI Premium Growth (%) 17.2% -45.2% 50.0% 16.1% -11.6% 36.2% GI Premium Growth (%) -8.3% -54.4% 202.6% 3.3% -23.6% 80.0% Source: BNM, PIAM Figure 4: Family takaful and general takaful industry profitability p Family Takaful Contributions General Takaful Contributions Family Contributions Growth (%) 69.9% 7.1% 14.1% -14.2% 9.6% 51.9% General Contributions Growth (%) -68.4% 426.1% 53.5% -6.5% 16.8% 26.5% Source: BNM, MTA Industry CAR ratios remain robust despite stronger premiums growth Capitalisation remains robust. The industry s capital adequacy ratios (CAR) was levelled at 222.3% (vs 222.5% in 2011), well above BNM's supervisory target capital level (STCL) requirement of 130%. This was partially sustained by higher retained profits which boosted total capital available (TCA). In addition, BNM has made it mandatory for insurance companies under its purview to have CAR exceeding the company's own internal target capital level (ITCL), based on its risk exposure, at all times. BNM also mentioned that insurance risk remained the largest risk component to the ITCL, comprising 50.7% of total capital required (TCR), while market risk accounted for 30.6%. 4

5 Figure 5: Industry CAR trend Source: BNM TCA (LHS) TCR (LHS) CAR (%) (RHS) (%) The increased allocation for equity investments did not adversely raise market risk Slight increase in equity exposure. Equities investment increased from 18% of total investment in 2011 to 19% in Private debt securities (PDS) still accounted for the bulk of the conventional insurers and takaful funds, at 37.9% of total assets in 2012 (vs 37.3% in 2011 and 17.1% of Malaysian government bonds). Nevertheless, the PDS are considered low-risk due to the concentration within high-grade ratings or at 'AA' and above. The overall market risk exposure of insurers improved slightly to 12.2% of the capital base (vs 12.6% in 2011) despite the higher equity exposure. Equity and interest rate risk collectively formed 83.3% of total market risk exposure. Life insurers investment yields higher than average Life insurers investment yields rise. Investment yields among the life insurers rose to 7.3% in 2012 compared with the historical five-year average of 5%-6%. BNM was concerned that the prolonged low interest rate environment may prompt life insurers to hold more capital, which was the case for some global insurers. Future claims exposure could have heightened when insurance funds were left with no choice but to invest in low-yield fixed income securities, thus creating a mismatch when the insurance products were priced under the assumption of higher returns. Fortunately, the increased total contributions from investment-linked (IL) and other forms of non-participating products which are less capital-intensive, as well as the healthy investment yields helped to limit exposure to interest rate risks. We expect this trend to continue moving forward. 5

6 Figure 6: Composition of LI products Source: BNM Low retention in large, specialised business classes. We continue to see low retention levels for business lines with lumpy, large contract sizes. For instance, the aviation, oil and gas (O&G) and engineering class of premiums saw latest reported reinsurance ratios at 94%, 93% and 56% respectively. Retention levels for the motor premiums lines remained high at around 90%. Figure 7: Reinsurance ratios by GI business segments Source: BNM 6

7 MORE HIGHLIGHTS FROM IMF COUNTRY REPORT BNM is expected to enhance prudential measures Tightening capital requirements. Moving forward, we believe BNM will enhance the CAR requirements. We expect the central bank to expand the capital adequacy assessments to insurance groups via the provisions in the Financial Services Act (FSA). This is a positive move as the current Risk-Based Capital (RBC) framework only considers company-specific risks. Also, the IMF in its Country Report said the current RBC framework may not adequately address interdependencies between risk categories. BNM recognizes this and may be expected to formulate more guidelines to fully capture such correlation effects in order to prevent spillovers and systemic risks. We believe any cross-border crisis can be easily contained given consistent supervision by BNM as well as the relatively small size of the industry Cross-border operations remain small. Malaysia's domestic insurers' cross border operations comprised assets of approximately RM959.9m in 2012, which translated to 0.4% of total insurance industry assets. We note that this was a contraction of about 2% from 2011's figures of RM979.8m, which represented about 0.5% of total industry assets. The cross-border operations spanned to only three countries, compared to four countries as at 2011 (which were countries within the range of Malaysia's borders, namely Indonesia, Singapore, Thailand and Brunei). Only four insurance groups have such operations, as BNM currently restricts certain forms of cross-border operations. The sizes of these remain insignificant, at <8% of the total industry premiums (as of 2011). We believe this could be part of the reason why BNM had relaxed the limitations on resident insurers or takaful operators to carry out cross-border financial activities, as long as the investment is within the capital risk requirements. Given these reasons, we believe any risk of cross-border crisis is relatively contained. However, we are not discounting the possibility that BNM may still propose guidelines for an official contingency plan, as recommended by the IMF Country Report. 7

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