August 3, 2009 Presentation on Takaful Investments Dr. Omar Clark Fisher, PhD Takaful 8/11/2009 1
Agenda Investment Objectives & Asset Classes permitted under Shariah Examples of Islamic Assets available for Takaful Companies What Takaful companies are doing now What rating methodology says about Takaful Challenges Ahead for Asset management Conclusions Disclaimer The opinions herein are those of the author and do not necessarily reflect those of Unicorn Investment Bank BSC nor t azur bsc nor does this presentation contain any investment advice or solicitations to invest. Some information is simplified as between Life and Non-Life insurers as this is meant to be an overview presentation only. As many Takaful Operations are composite, including both Life and Non-Life programs, and fall under varying insurance regulatory regimes, this information is descriptive and neither definitive nor normative. 8/11/2009 2
Scope of Islamic Insurance 133 Takaful companies in +26 countries yet only 4 OIC countries have specialized Takaful regulatory framework(malaysia/sudan/bahrain/pakistan) Gross revenues/premiums were $3.7 Bil* (2007) up from $600 Mil (2002)- growth rate is +25% annually [compared with $4 Tril conventional gross premiums]; GCC Takaful revenues ~$2.0 Bil Conventional multi-national brand name insurers [AIG/Allianz/Axa ] entering Takaful will heat up competition Absence of benchmarks to judge excellence in Takaful operations Wide scope for prudential rules on Islamic securities and investments Improvement needed in Customer Services instill excellence Limited supply of trained Takaful/Insurance experts- especially as actuaries, accountants, underwriters, direct sales, etc. Development/application of new IT technologies systems and products Utilization of Re-Takaful capacity remains constrained perhaps fulfilling 15% of Takaful primary gross premiums written [~ $555 M] Large number of operating insurers (366): Domestic 191/Foreign+120/ Takaful Operators 55 *Note: accounts only 5-6% of Iran s total premiums as Takaful contributions. 8/11/2009 3
Key Objectives for Takaful Investments Golden Triad- Safety, Security and Liquidity Asset diversification Geographical dispersion Avoid concentration in volatile currencies FX risk Adequate matching of Assets and Liabilities in support of solvency ratios Sharia h compliance is added challenge for Takafuls According to Swiss RE : Insurance performance is a reflection of capital Without adequate capital an insurer cannot retain risks Minimum capital and solvency ratio is a regulatory requirement for license Operations are managed using key indicators insurance leverage [technical reserves/equity]; solvency [equity/ net premium earned]; ROE [profit/equity] and weighted cost of capital. Note --that more Equity Capital reduces ROE 8/11/2009 4
Sharia h h Aspects of Assets under Management strategy Strategy should reflect: Separation of Sources and Uses of Capital (eg. Shareholders Funds separate from Policyholders Funds; Premia/Contributions separate from Investment accounts; Reserves separate from Surplus; etc) Separation of risk exposures into pools AAIOFI standards for expense accounting and disclosure of fees Matching Assets and Liabilities short-term/long-term Linkage to Contract-Product specifics for Life Insurers ie. Pooled investments vs. Unit-Linked investments 8/11/2009 5
Asset Classes permissible under Sharia h Whatever is not prohibited is allowed Screening investments can be done in stages: Permitted types of activities this excludes armaments, alcohol, illegal, gambling, etc. Permitted structures this excludes heavy debt, leveraged or nonasset-backed transactions Permitted format for transaction excludes non islamic contracts or agreements 8/11/2009 6
Viewpoint of Rating Agency According to AM Best s Rating methodology * the starting point for assessing financial strength of a particular insurance company is Best s Capital Adequacy Ratio (BCAR), which in the case of a Takaful company is applied to a) Policyholders funds (1 st tier) and to b) Shareholders funds (2 nd tier). Findings 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 similar size. * Best s Rating Methodology- Takaful Insurance Companies, Feb. 2008 8/11/2009 7
Viewpoint of Rating Agency-2 Takafuls have inherent lack of financial flexibility * (ie. Ability to raise equity capital) hence investment portfolio and quality of re- Takaful/reinsurance programmes assume high importance In general, Takaful investment returns on average are lower than conventional insurers (espec. on risk-adjusted basis) when taking into account increased counterparty risks, concentration of asset classes, exposure to equities and potential of volatility and credit defaults.* When compared to conventional insurers (which are larger, more experienced management, with geographic spread of risks and decades of operating history), Takafuls offer only a limited operating platform, limited track record and limited scope of investments- resulting in significant and material competitive disadvantages in the rating process. Note: Investment of policyholders premiums and of shareholder capital is a critical component in financial stability of the Takaful model, operating performance, claims paying capacity as well as rating determination. * Best s Rating Methodology- Takaful Insurance Companies, Feb. 2008 8/11/2009 8
Observations# about GCC Insurers- Takafuls Data on cash, deposits and cash equivalents as liquidity measures is mostly unavailable Govt. Paper, Bonds, Loans seem under- represented and some samples are less than one-half OECD figures Domestic equities/shares seem over-represented among GCC insurers with some allocations 2X OECD values (74% vs. 33%) Real Property assets seem over-represented among GCC insurers with some allocations 10X the relative OECD values (42% vs. 4%) Islamicly managed funds among GCC insurers cannot be compared as no such category exists among OECD data Foreign assets and Other Equities seems over-represented among GCC insurers with some allocations ranging from 3X to 9X (27% vs. 8%) which may be partly explained by limited scope of listed public shares in some countries #Source: OFisher PhD 2005 to be updated in 2009 8/11/2009 9
What Avenues are Open to Takaful Players? Local and International Equities Sukouks Real Estate and REITs Private Equity Mutual Funds Cash and money market instruments However, what are Takaful investments now? 8/11/2009 10
Asset Classes available for Islamic investments Rapid growth of Islamic Equity and other funds overshadows limited non-equity instruments such as leased assets, sukouks and Money market funds. Source: World Takaful Report, 2009 and Eurekahedge Islamic funds. 8/11/2009 11
Takaful Distribution by lines of business Keep in mind that Motor, Marine/Aviation, Property/Accident and Medical are typically one year renewable policies- only Family Takaful (<25%) represents multi-year policies (requiring LT investments). 8/11/2009 12
Asset Allocations OECD vs. GCC Insurers OECD Insurer Allocations Cash/Deposits 4% Govt.Paper/Bonds 33% Loans/Borrowers 13% Equities/Shares 33% Real Property 4% Foreign Assets 8% Other 5% GCC Insurers Allocations Cash/Deposits na Govt.Papers/Bonds 4% - 29% Equities/Shares 25% - 74% Islamic Funds 15% - 70% Real Property 2% - 42% Foreign Assets 27% - 71% Source: OECD Report of Investment funds and Pension Funds, Source: OFisher PhD October 2005 2000. 8/11/2009 13
Asset Allocations Samples of GCC Insurers 8/11/2009 14
Investment Allocations of Malaysian Takafuls Takaful Sector Allocations Cash/Deposits 16% Govt.Paper 19% Corp Bonds 56% Equities 3% Real Property 5% Other Foreign.Assets 1% Sample Takaful Allocations Cash/Deposits 10% Loans 20% Borrowers/PH 5% Quoted Shares 35% Prop. In Trust 10% Real Property 20% Source: Bank Negara Annual Takaful Report, 2003 Source: Takaful Operator, 2000 8/11/2009 15
Comparison of GCC Insurers and G-6 G Benchmark Sample UAE Insurers show strong (net) underwriting results, due to reliance upon reinsurance [which is a substitution for capital] Investments in GCC fuel more that 2/3 of profits in recent years due to favorable stock markets and other economic conditions (2006-2007) Enterprise Risk Management specifically Asset Liability matching --is limited, which exposes the insurer to liquidity and other risks Compared to G-6 Benchmark, many GCC insurers appear to be more Asset management/investment companies than Risk-Taking Insurers % net p rem ium s earn ed 120 100 80 60 40 20 0 G6 Typical UAE company Investment income (incl realized & unrealized capital gains), in % NPE Underwriting result, % of NPE Pre-tax return on equity + capital gains(%) *Source : Robert Wiest, Swiss RE Opportunities and Challenges in GCC Insurance Sector, speech, Doha March 2008 8/11/2009 16
Stock market Performance 2006- mid 2007 Regional Stock markets lost $1 Trillion dollars since 2006 and such volatility is a major challenge for insurance companies investing in local Equities. Source: E&Y 2007 Report on Islamic Funds & Investments 8/11/2009 17
Growth of Bond-equivalent securities While more Sukouks are being issued globally, the pool of bond-like securities in GCC remains small ($15-$25 Bil since 2004) and mostly nontraded securities; such unlisted securities potentially represents a liquidity risk. 8/11/2009 18
Conclusions and Challenges Ahead for Premiums Investment Dominance of Short-tail personal lines risks which generate high cash flows are being channeled largely into short-term (i) Equity-based investments and (ii) real estate projects The axiom of Risk-Return rewards states that high Returns relate to high Risks as 2006-08 market collapses serves to remind Thus, insurers so exposed may be vulnerable to (i) high volatility in assets valuations (due to equities exposures) and in projected earnings, especially over time and (ii) an illiquidity crunch if a severe correction were to occur in either stocks or land/ real estate prices. 8/11/2009 19
Conclusions and Challenges Ahead-2 Also, GCC Insurers, especially Takaful Operators, may not be wellpositioned to innovate and develop Family Takaful Life Plans which are Long Term because of limited capacity to match long term Liabilities with long term, secure Islamic assets/investments with predictable cash flows Allocation of investment assets seems to be over-weighted in Stocks and Real Estate/Property for regional insurers Finally, note that rating agencies typically apply a higher capital charge to insurers with over-weighing in equities and illiquid assets, such a risky assets profile reveals limited ERM practices and weak corporate governance 8/11/2009 20
Thank you for your attention on this topic. For more information contact: Dr. Omar Clark Fisher Omar.fisher@gmail.com 8/11/2009 21
Background Islamic finance principles include: No interest (fixed premium/riba) charged or paid No benefit from another s uncertainty (gharar) trading on risk or sale of unknown quantity or quality Investments must be halal/acceptable and Shari ah compliant as to activity and contractual agreements. Prohibited are: alcohol, pork, gambling, weapons, munitions, lewd entertainment, tobacco. Investments should conform to specific financial ratios re liabilities and be asset-backed Impermissible income must be cleansed Zakat must be acknowledged and paid annually Governance should be informed by Islamic rules and ideally a Shari ah audit occur at least annually 8/11/2009 22
Background -2 Islamic finance is NOT: Against private property ownership Contradictory to profit only the hoarding of goods/services to manipulate price Exclusive to Muslims but inclusive of all members of community Against capitalism nor shareholder s rights Note: Islamic finance can be symbiotic with capitalism- viz HSBC, UBS, Deutsche Bank, Tokio Marine and Calayon Group all have Islamic divisions. 8/11/2009 23