A Review of the Development of GCC Takaful Rating Fundamentals and Catalysts for Growth Over the Next Decade

10 th Anniversary The A Review of the Development of GCC Takaful Rating Fundamentals and Catalysts for Growth Over the Next Decade Mahesh Mistry Director - Analytics A.M. Best Europe Rating Services Ltd

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Why Do Insurance Companies Fail? Catastrophe losses, 7% Reinsurance failure, 3% Affiliate problems, 8% Significant change in business, 4% Deficient loss reserves (inadequate pricing), 42% Miscellaneous 8% Investment problems (overstated assets), 7% Alleged fraud, 8% Rapid growth, 13% Source: Property/Casualty Financially Impaired Companies Primary Causes (1969-2011) Source: 1969-2011 U.S. P/C Impairment Review, June 25, 2012 3

Key Rating Components Insurance Company Financial Strength Balance Sheet Strength Operating Performance Business Profile Enterprise Risk Management + Country Risk Rating 4

Takaful Developments Main developments Takaful contributions have significantly grown over the past decade, albeit from a low premium base Enhanced and developing regulatory frameworks Takaful has not reached the highs of Shari a compliant banking Contrast in market dynamics between Asian and Middle Eastern markets Influx of Takaful market entrants in recent years Some operators are generating surpluses and distributing profits Mutuality: aligning s/h and p/h interests 5

Overview of Selected Markets Select Middle East Countries - Key Facts (2013) Country Population (millions) Gross Domestic Product (USD billions) Total Gross Written Premiums (USD millions) Insurance Penetration No of Takaful / Retakaful Companies (2014) Gross Written Contributions (USD millions) Takaful Penetration of Insurance Market Bahrain 1.2 33 688 2.1% 6 101 15% Kuwait 2.9 195 952 0.5% 11 132 14% Oman 2.9 83 947 1.1% 1 47 5% Qatar 2.1 211 1471 0.7% 5 194 13% United Arab Emirates 9.1 396 7959 2.0% 13 649 8% Jordan 6.6 34 686 2.0% 2 62 9% Egypt 82.1 272 1851 0.7% 8 63 3% Sources: Swiss Re sigma No. 3/2014; MENA Insurance Directory 2015, A.M. Best research 6

Business Profile Takaful Considerations Competing in the same space as conventional insurers New Takaful entrants finding it difficult to establish themselves Fragmented markets with intense pricing pressure due to competition Limited franchise and market position Uncertainty of competitive advantage over conventional companies Limited product differentiation Lack of skilled professionals Developing a market profile is a key challenge 7

Operating Performance Takaful Considerations Understand the performance and balance of earnings between the s/h and p/h funds Ability to generate surpluses in p/h fund (competition, pricing pressure, high Wakala fees) Dependence on Qard Hasan Investment profiles can be concentrated and lack diversification Lower investment yield due to restrictive investment policy Over-dependence on investment income Important to adopt a suitable model so that surpluses are created within the Takaful fund, with an appropriate fee structure 8

Underwriting Ratios Underwriting Ratios of Takaful Operators Compared to the UAE Market 120% 100% 80% 60% 40% 20% 0% 2010 2011 2012 2013 Takaful expense ratio Takaful loss ratio UAE expense ratio UAE loss ratio Source AM Best Research Based on a sample of 14 GCC primary Takaful companies, 24 UAE conventional companies Wakala fees have been substituted for actual management expenses to derive true expense ratios for the insurance portfolios Market combined ratios have steadily increased Conventional insurers produced stronger combined ratios Loss ratios are comparable (sometimes stronger) for Takaful operators High expense ratio is the key area of concern Control over expenses is important to achieve improved underwriting performance 9

Wakala Fees Wakala Fees Compared to Actual Expenses USD millions 160 150 140 130 120 110 100 90 80 70 60 Wakala fee Expenses bourne by shareholders fund 2010 2011 2012 2013 Wakala fees should reflect expenses, plus the cost of capital Wakala fees can distort the actual underlying underwriting performance Growing divergence between Wakala fees and actual expense excessive fees charged to policyholder funds High wakala fees create greater pressure on performance and higher dependence on Qard Hasan Source: AM Best research. Based on a sample of 18 GCC re/takaful companies 10

Balance of Earnings Balance of Earnings Between s/h and p/h USD millionss 250 200 150 100 50 S/h funds are generating profit, whereas p/h funds are in deficit Accumulated deficit of p/h funds continues to rise Increasing dependence on Qard Hasan 0 50 100 2010 2011 2012 2013 Policyholder profit Shareholder profit Policyholder accumulated deficit Source: AM Best research. Based on a sample of 18 GCC re/takaful companies Suitable model and appropriate fee structure are critical to the sustainability of the model 11

Investment Risk Top Five Largest Takaful Companies- Asset Mix (2009-2013) Cash Equitiy Real Estate Bonds Other-including intercompany 15% 13% 12% 9% 11% 5% 8% 6% 5% 10% 22% 15% 22% 23% 14% 18% 20% 19% 17% 20% 43% 44% 41% 47% 41% 2009 2010 2011 2012 2013 Investment profiles are similar to conventional companies and can create volatility in overall earnings 12

Sukuk Opportunities USD billions 30 25 20 15 10 5 Total Outstanding (as at Jan 2015) by Country 30 25 20 15 10 5 Number of issuers Bahrain Kuwait Oman Qatar United Arab Emirates Jordan Egypt Saudi Arabia 0 Total outstanding (USD bn) Number of issuers Uncharacteristically low appetite for sukuk investments (compared to bonds in mature markets) Small amount of sukuk issuances, which are limited to a few financial institutions Investment policies generally restricted to home country 13

Balance Sheet Strength Takaful Considerations Strength of regulatory framework is a key component - Commitment from s/h fund to p/h fund - Permanence of Qard Hasan - Uniformity of regulation Strength of Takaful fund can be limited due to: Low surplus accumulation; High wakala fees charged to Takaful fund Over dependence on Qard Hasan to cover deficit Insufficient Retakaful capacity Unleveraged balance sheets Adequacy of loss reserves 14

Enterprise Risk Management A few questions What are the main risks or threats to a company? How does a company control and mitigate risks effectively? How embedded is ERM throughout the organisation? How has ERM assisted in decision making? What role does ERM play when considering capital adequacy? Risk Management capability should be viewed relative to a company s risk profile A few observations Given the added complexity of Takaful companies; ERM plays an important role within companies; particularly to gain a competitive advantage over peers Corporate governance is important, particularly for start-up Takaful companies, given the higher level of execution risks Companies tend to manage risk on a silo basis. Further integration is required to reach enterprise-wide risk management Risk management is only valuable if it is conducted by company management to protect and strengthen the key fundamentals of the company, and not meet requirements of outside parties 15

Catalysts for Future Growth Final Remarks High growth markets - Introduction of compulsory covers - Product differentiation Demonstrate the value added benefit of the Takaful model: - Emphasise mutuality: alignment of interests between s/h and p/h - Appropriate balance of earnings between s/h and p/h - Wakala fees closely reflect actual expenses - Lower dependence on Qard Hasan - Evidence of surplus distribution Developments of Shari a compliant investment markets - Greater investment opportunities - Reduced concentration risk Regulation - Uniformity across markets - Improved transparency - Actively police the market Demonstrating the financial health of Takaful operators The International Takaful Summit 2015 17 February 2015 16

A.M. Best MENA Ratings Issuer Credit Rating Outlook / Outlook / Country Company Name Implication Country Company Name Implication Algeria Compagnie Centrale de Reassurance bbb Stable Qatar Qatar General a Stable Bahrain ACR Re Takaful MEA B.S.C. (c) a Stable Qatar Insurance Company (Q.S.C.) a Stable Arab Insurance Group (B.S.C) bbb+ Stable QIC International LLC a Stable Bahrain Kuwait Insurance Company a Stable Q Re LLC a Stable Life Insurance Corporation (International) bbb+ Stable Qatar Islamic Insurance Company Q.S.C. bbb+ Stable Bahrain National Insurance bbb+ Stable Doha Insurance Company Q.S.C. a Stable Trust International a Stable Saudi Arabia Saudi United Cooperative Insurance Co bbb Stable Medgulf Bahrain a Stable Medgulf Saudi Arabia a Stable Solidarity General Takaful bbb Stable Tunisia Societe Tunisienne de Reassurance bbb Stable Egypt Arab Misr Insurance Group bbb Negative Turkey Milli Reasurans Turk Anomin Sirketi bbb Negative Jordan Arab Orient Insurance Company bbb+ Stable UAE Abu Dhabi National Insurance (PSC) a Stable First Insurance Company bbb Stable Abu Dhabi National Takaful bbb+ Stable ARABIA Insurance Company Jordan bbb Stable Al Sagr National Insurance Company bbb Stable Jordan Insurance Company Plc bbb+ Stable Alliance Insurance (PSC) a Stable Middle East Insurance Company Plc bbb Stable Orient Insurance Company (PSC) a Stable Kuwait Gulf Insurance Group a Positive Dubai Insurance Company bbb+ Stable Gulf Life Insurance Company a Positive Emirates Insurance Company P.S.C. a Stable Kuwait Reinsurance Company KSC a Stable Gulf Reinsurance Limited a UR/Neg Lebanon Al Ittihad Al Watani bb Negative National General Insurance Company a Stable Arab Reinsurance Company S.A.L. bbb Stable National Takaful Company (Watania) bbb Stable ARABIA Insurance Company bbb+ Stable Oman Insurance Company (PSC) a Stable Medgulf Lebanon bbb+ Stable Emirates Retakaful bbb+ Stable Morocco Societe Centrale de Reassurance bbb Stable International General Insurance (Holding) bbb Stable Oman National Life & General Insurance bbb Stable Union Insurance Company P.S.C. bbb Positive Muscat Insurance Company SAOC bbb Stable Muscat Life Assurance Company SAOC bbb Stable Takaful Companies in Green 17 Issuer Credit Rating

Questions? 18