Volume of deals in the Middle East

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1 MENA The economic prospects for the Middle East remain bright with the Gulf Co-operation Council (GCC) dominating the IMF rankings with an average of 4% GDP growth across the region.

2 Many GCC markets continued to perform well through the global financial crisis, not least bolstered by the sustained high oil prices that have helped governments to build revenues. Demographic trends also confer an advantage on the Middle East. There is a youthful, educated and increasingly affluent population. Indeed, the average age in the region is less than 30, and with around just one to one-and-ahalf per cent currently aged 60 or over. Volume of deals in the Middle East H H H H H H H H H Governments across the region have continued to make significant investments to the value of an estimated USD 1.9 trillion in governmental projects. These are in part a natural effect of the region s on-going growth and healthy government finances, but other factors are at play. The football World Cup to be held in Qatar in 2022 is demanding significant preparation and across the Middle East governments are investing heavily in infrastructure and social welfare projects prompted, in part, by a desire to address the issues underlying the Arab Spring. The final factor is also the continuing development of mandatory health insurance being rolled out across the region. These factors underpin what we consider to be a positive picture for the future for the insurance industry s medium to long term future. As levels of wealth continue to rise, there is a corresponding increase in the awareness of and the need for insurance. In the GCC in 2012 combined gross written premium (GWP) in both life and non-life amounted to USD 16.3 billion, having grown at a CAGR of 11.8% since Projected growth for the period is estimated at 18.1% per annum a level outstripping the traditional developed: economies. However, this growth is from a low starting point. Insurance penetration, calculated as GWP as a proportion of GDP, was at 1.1% in the GCC in 2012 against a global average of 6.5%. In the

3 life sector, levels of penetration in the GCC are almost nonexistent, at a meagre 0.4%, so it is unsurprising therefore that there is a lot of interest in the sector. Despite this positive background, the insurance industry in the Middle East needs to overcome some fundamental challenges. Domestic markets are suffering from oversupply, a lack of skilled staff and expertise. The growth potential is attracting considerable foreign interest all of which should be leading to a growing number of transactions in the region. However, as the data above illustrates very clearly this is not the case. Industry consolidation Over the last decade the number of insurance companies has grown considerably but, despite high levels of competition and, in some lines, low profitability, industry consolidation is yet to gain momentum. Across the region, there are countries with too many insurers for the size of the market. For example, the UAE has 67 insurance companies writing USD 7.2 billion in GWP and Saudi Arabia has 35 companies writing USD 5.5 billion. Many insurers in the Middle East lack sufficient scale and expertise to endure in the medium-to-long term. This means that a situation has arisen whereby, if consolidation in the market fails to materialise, the result will be business failures. The regional regulators are unlikely to allow such failures due to the impact on the nascent insurance market in the region, and we anticipate that they will seek to encourage consolidation as a mechanism to alleviate this risk. Inbound investment The transactions that have taken place in recent years have been led by international players looking to establish a presence in growth markets to compensate for slow/nonexistent growth in their domestic markets. For example, between July 2012 and June 2013, there were two significant acquisitions by Japanese insurers ORIX Corporation acquired Bahrain s MEDGULF, while Tokio Marine & Nichido Fire bought Egypt s Nile Family Takaful Co SAE. Indeed, overseas transactions involving Japanese insurers have increased in the last couple of years on the back of a strengthening economy, a saturated market at home and the need to diversify risk portfolios in the fallout from the tsunami. The Middle East is a logical location for acquisitions as Japan has significant trading relationships across the region. For example, Japan recently overtook the US as Saudi Arabia s largest trading partner. Where Japanese businesses go, so do expatriate employees, presenting Japan s insurance companies with the opportunity to enter a new market via domestic relationships and gain access to a new customer base. Regional M&A Jordan, in recent years something of an anomaly in the region in terms of its high level of M&A in the insurance industry, saw just one small transaction in the period, suggesting a natural slow down. Takaful has long been highlighted as an area with significant potential for growth, albeit from a low base. The industry fared better during the global financial crisis than its traditional counterpart due to the nature of its investments being less volatile. However, as equity markets have recovered, takaful operations have not benefited to the same extent as their conventional counterparts for the same reason. An additional challenge is the fact that Islamic investment portfolios are inherently difficult to manage effectively; not least due to the lack of availability and diversity of Sharia-compliant instruments (especially in the life insurance sector, family takaful, which suffers from a dearth of medium long-term fixed income securities). Recent studies also suggest that shareholders in takaful operators on average receive a lower return on equity than with traditional insurance. It remains to be seen if this is an inherent aspect of the takaful structure or a reflection of the relative youth of the industry. Whether or not future growth will allow takaful operators to offset their initial start-up costs, it is a factor which is currently exerting additional pressure on the management of these operators. Despite these challenges, there have been a number of transactions. In Syria, Al Aqeelah Takaful Insurance was acquired by its compatriot, Hamed Mohammed Abbas Hajeya, while in another development in the Sharia sector Oman National Investment Corporation announced the acquisition of a 7.5% stake in Takaful Oman, the country s first takaful company, in June While these have been relatively small in terms of value, they are essentially longer-term strategic plays on the part of the purchasers.

4 Deal in Middle East by country: 2009 June Jordan Kuwait Morocco Bahrain Turkey Israel Oman Syria Barriers to transactions There are a number of factors stifling transaction activity in the insurance industry across the region: The business landscape across the region is characterized by the proliferation of family businesses, many of which are large conglomerates with operations spanning a range of diverse industries. Inevitably, a level of rivalry exists, with any one family business reluctant to enter into a transaction with another that may result in, or be perceived as, conferring a potential advantage or being otherwise harmful to their reputation. Another issue is whether any vendor is prepared to agree to a realistic valuation for their shares in a local insurer. In some markets, notably the United Arab Emirates (UAE) and Saudi Arabia (SA) as the two largest insurance markets in the GCC, the insurance legislation requires that all domestic insurance companies have to be publicly listed. Start-up insurance companies are required to conduct an IPO prior to commencing trading as part of the establishment process. As each new insurer listed, its share price initially surged but typically there has been an absence of on-going trading in its stock. The result has been a misalignment between the market value of the business and what a buyer thinks is appropriate to pay based on the book of business written and what the vendor thinks it is worth. This makes it difficult to reach an agreement on price. Should the pricing issue be overcome, an additional hurdle is the difficulty of obtaining meaningful due diligence necessary for a successful transaction. The information that companies provide is generally of poor quality, which presents potential buyers with a challenge as they attempt to accurately gauge the risk profile of a target company. In addition, the regulatory regimes in the region require further development to facilitate such transactions if they are to occur on a meaningful scale.

5 Breaking the log jam Regulators across the region are aware of the issues and in many cases are taking positive steps to address this issue. In Saudi Arabia for example, up until 2004 the market was monopolised by a single state owned insurance company. A change in the law saw the market take off around 2007, with the creation of dozens of insurance companies. The regulator is now seeking to avoid over-saturating the market and is putting pressure on potential new entrants to the insurance market to do so via acquisition, rather than through the creation of a start-up business. In addition, capital requirements are expected to go up putting further pressure on smaller insurers to consolidate. In May 2013, nearly a decade after it was first discussed, the UAE s Federal National Council passed a new companies law bill that should go some way towards clarifying and simplifying transactional processes. In addition, the UAE has seen capital requirements rise for brokers and in 2015 new legislation will come into place that will mandate the segregation of composite insurance companies, splitting out life and non-lie operations into separate entities. It is anticipated that this will lead to an increase in M&A as many local composite insurers may not have the necessary expertise, experience or desire to meaningfully grow stand-alone life insurance businesses. With domestic consolidation remaining tricky due to the political complexities of dealings between large families, many of these transactions will be cross-border in nature. Indeed, a number of international life companies are hovering in the wings, poised to enter the market, with joint ventures likely to be the most popular route. Others, for example in India, are looking to pre-empt the legislation by getting in early to seize a stake and gain firstmover advantage. Elsewhere in the region, the Capital Market Authority in Oman is in the process of updating the country s insurance regulatory framework and new regulations for the conventional insurance and takaful markets are likely to be implemented in the near future. This is expected to have a positive impact on the overall market structure, and bring the legislative environment closer to international standards, clarifying the process for transactions. In addition, there have been positive regulatory developments in Qatar with new legislation passed in December 2012 establishing the Qatar Central Bank as the single regulator for all banking, insurance, and financial services companies located within Qatar (other than those established in the Qatar Financial Centre), The details on the new regulatory structure for the insurance industry are in the process of being developed and are expected to be published shortly. Reinsurance While these regulatory developments may take some time to impact the M&A market, international players looking for opportunities in the region may choose to establish a foothold via fronting arrangements with local insurers. There are clear benefits for doing so. Fewer restrictions are in place for fronting arrangements and the regional financial centres offer hubs for foreign companies looking to set up regional operations. In contrast, in order to write insurance business, a separate licence is needed for each individual country in the region due to the absence of any passporting arrangements a costly and time consuming process. Fronting arrangements can, if properly structured, offer a way into the market and allow the international player to second staff, develop products for regional markets and build regional brand recognition.

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