Ernst & young's the world takaful report 2012

In collaboration with

Dear Insurance Industry Leader,

It is with great pleasure that we present to you the 5th annual edition of the World Takaful Report, a ground-breaking original research project developed in collaboration with leading global professional services and advisory firm, Ernst & Young. With a principal focus on ‘Industry Growth and Preparing for Regulatory Change’, the World Takaful Report 2012 explores the key industry trends and the critical success factors guiding the global Islamic insurance industry to the next level of performance and growth.

We would like to take this opportunity to express our sincere gratitude to Ernst & Young and their world renowned Islamic Financial Services Team for investing their considerable talent and resources in developing the World Takaful Report 2012. The Report is exclusively launched on-site at a special plenary session of the 7th Annual World Takaful Conference (WTC 2012) where more than 350 industry leaders from over 150 leading organizations gather to chart the future of the Takaful industry.

Established as a critical reference resource for key industry players, thought leaders and policy makers in the international Shari’ah-compliant insurance industry, we hope that the analysis in this year’s Report will provide practical, constructive and valuable insights which will be useful in your own strategic planning activities and will assist your organization in its quest for success as the global Takaful industry enters the next phase of growth. To find out more on how your organization can play a part in this important research initiative in the future, please e-mail [email protected]

Yours sincerely,

David McLeanChief ExecutiveThe World Takaful ConferenceA MEGA Brand

MEGA Brands: Shaping the Future of the Global Islamic Finance Industry Since 1993P.O. Box 72045, Dubai, UAE | t. +9714 343 1200 | f+971 4 343 6003 MEGA Brands. MEGA Clients. Market Leaders. www.megaevents.net

7th Annual

16 & 17 April 2012, Dusit Thani Dubai, UAE

THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE

The World Takaful Report 2012 Industry growth and preparing for regulatory change

April 2012

Page 2 The World Takaful Report 2012 Industry Growth & Preparing For Regulatory Change

Disclaimer

The contents of the World Takaful Report 2012 are based on a combination of quantitative data and qualitative comments and hence provide a subjective assessment of the current Takaful market. All quantitative comments are based on published information wherever possible. Where published reliable data was not available, qualitative comments were made which may or may not reflect the true state of affairs. Information has been assimilated from secondary sources, including published country, industry and institutional information, and primary sources, in the form of interviews with industry executives.

We are not expressing any assurance on the accuracy or completeness of the information obtained. Although this report has been documented based on our understanding of Islamic finance and insurance activities to include only such activities that are deemed Shari‟a compliant, no Shari‟a opinion whatsoever has been taken on this report. Hence, the contents of this report, in terms of the activities to be carried out, might not necessarily be consistent with Shari‟a in all cases, and the opinion of a Shari‟a scholar(s) should be taken before any further steps are made to implement suggestions made in the report.

Whilst every care has been taken in the preparation of this report, no responsibility is taken by Ernst & Young as to the accuracy or completeness of the data used or consequent conclusions based on that data, due to the respective uncertainties associated with any assumptions that have been made.

This report is documented for the World Takaful Conference. No part of this document may be republished, distributed, retransmitted, cited or quoted to anyone without prior written permission from Ernst & Young.

2 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


Contents

Introduction

Industry Growth

Financial Performance

Business Challenges

Regulations for Growth

Appendices

► Executive brief ► Introduction to Takaful

3


Introduction to Takaful Takaful is the Shari‟a compliant alternative to conventional insurance

Takaful is based on the concept of social solidarity, cooperation and mutual indemnification. It is a pact amongst a group that agrees to donate contributions to a fund that is used to jointly indemnify covered losses incurred by the members. While the concept of Takaful revolves around mutuality and is founded on non-commercial basis, the operations and the fund are commonly managed by a Takaful operator on commercial basis.

Takaful

Source: Ernst and Young research and analysis

The company engages in investments that may derive their income from interest and/or prohibited industries. This process is akin to Riba (usury) and/or relates to Haram (prohibited) activities.

The company accepts premiums from the insured at a level which it anticipates will cover claims and result in a profit. This process of anticipation is akin to Maysir (speculation).

Conventional Insurance

(non-mutual)

The insured pays premiums to the company in exchange for indemnity against risks that may not occur. This process of ambiguity is akin to Gharar (uncertainty).

Ownership of the Fund - Donating their contributions to the Takaful fund, policyholders are owners of the fund and entitled to its profits (this varies slightly between the adopted models which are described later).

Mutual Guarantee - The basic objective of Takaful is to pay a defined loss from a defined fund. The loss is covered by a fund created by the donations of policyholders. Liability is spread amongst the policyholders and all losses divided between them. In effect, the policyholders are both the insurer and the insured.

Elimination of Uncertainty - Donations, causing transfer of ownership to the fund, are voluntary to mutually help in the case of a policyholder‟s loss without any pre-determined monetary benefit.

Management of the Takaful Fund - Management is by the operator who, depending on the adopted model, utilises either (or a combination) of two Shari'a compliant contracts, namely Mudaraba or Wakala.

Five Key Elements

Investment Conditions - All investments must be Shari‟a compliant, which prohibits investment in Haram industries and requires the use of instruments that are free of Riba.

Executive brief

Dear Takaful Executive

On behalf of Ernst & Young, we take pleasure in introducing to you the 5th annual edition of Ernst & Young’s World Takaful Report (WTR 2012). It is of great pride to us that the annual report has claimed its place as the leading reference tool for Takaful decision makers and industry e perts as ell as the broader Islamic finance ind str We are gratef l for the response and patronage recei ed from o and other ind strexperts, as well as the broader Islamic finance industry. We are grateful for the response and patronage received from you and other industryleaders who have provided their time and thoughts for finalization of this year’s much anticipated report.

The Takaful industry continued to show double digit growth in 2011 albeit at a relatively slower rate of 19% as compared to previous years. Amongst key markets, Malaysia and UAE again achieved growth rates of over 24%, whilst Saudi Arabia saw its gross contributions increase by US$0.5b. The challenge was once again, maintaining growth with profitability in the current economic climate. There were positivedevelopments in the GCC with more operators showing profitability than previous years. The Saudi Cooperatives continued their growthdevelopments in the GCC with more operators showing profitability than previous years. The Saudi Cooperatives continued their growthperformance yet still struggled in generating shareholder returns. Overall, return on equity for the Takaful industry was lower than conventional counterparts, both in the GCC as well as in Malaysia. However, a significant contributing factor to this was the lower investment returns for the industry relative to returns yielded by conventional insurers. The industry has now obtained significant market share versus conventional insurance in most GCC countries as well as South East Asian markets. There are a number of drivers behind this growth but one that is becoming increasingly important is regulatory support through appropriate amendments in legislature to provide a level playing field with conventional insurance companies.

With operational efficiency still a key focus, we take a look at some of the regulatory changes that will impact and how some Takaful Operators may be forced to change their operating model and how forward planning is critical to save on considerable project and change management costs. The report also highlights the strong need for introducing greater standardization in regulatory frameworks across jurisdictions. Standardization will enhance clarity around Takaful, its business models and its unique selling proposition, hence allowing the industry to strive towards its true growth potential.

We hope that you will find this report informative and useful and it provides insight to align your strategic agenda.

Ashar M. NazimSenior Director & Global Head of Islamic FinanceErnst and Young

Justin BalcomeSenior Director & MENA Insurance LeaderErnst and Young

Page 4 The World Takaful Report 2012

Industry Growth & Preparing For Regulatory Change

Ernst and Young Ernst and Young



Introduction to Takaful Takaful is the Shari‟a compliant alternative to conventional insurance

Takaful is based on the concept of social solidarity, cooperation and mutual indemnification. It is a pact amongst a group that agrees to donate contributions to a fund that is used to jointly indemnify covered losses incurred by the members. While the concept of Takaful revolves around mutuality and is founded on non-commercial basis, the operations and the fund are commonly managed by a Takaful operator on commercial basis.

Takaful


The company engages in investments that may derive their income from interest and/or prohibited industries. This process is akin to Riba (usury) and/or relates to Haram (prohibited) activities.

The company accepts premiums from the insured at a level which it anticipates will cover claims and result in a profit. This process of anticipation is akin to Maysir (speculation).

Conventional Insurance

(non-mutual)

The insured pays premiums to the company in exchange for indemnity against risks that may not occur. This process of ambiguity is akin to Gharar (uncertainty).

Ownership of the Fund - Donating their contributions to the Takaful fund, policyholders are owners of the fund and entitled to its profits (this varies slightly between the adopted models which are described later).

Mutual Guarantee - The basic objective of Takaful is to pay a defined loss from a defined fund. The loss is covered by a fund created by the donations of policyholders. Liability is spread amongst the policyholders and all losses divided between them. In effect, the policyholders are both the insurer and the insured.

Elimination of Uncertainty - Donations, causing transfer of ownership to the fund, are voluntary to mutually help in the case of a policyholder‟s loss without any pre-determined monetary benefit.

Management of the Takaful Fund - Management is by the operator who, depending on the adopted model, utilises either (or a combination) of two Shari'a compliant contracts, namely Mudaraba or Wakala.

Five Key Elements

Investment Conditions - All investments must be Shari‟a compliant, which prohibits investment in Haram industries and requires the use of instruments that are free of Riba.

Executive brief

Dear Takaful Executive

On behalf of Ernst & Young, we take pleasure in introducing to you the 5th annual edition of Ernst & Young’s World Takaful Report (WTR 2012). It is of great pride to us that the annual report has claimed its place as the leading reference tool for Takaful decision makers and industry e perts as ell as the broader Islamic finance ind str We are gratef l for the response and patronage recei ed from o and other ind strexperts, as well as the broader Islamic finance industry. We are grateful for the response and patronage received from you and other industryleaders who have provided their time and thoughts for finalization of this year’s much anticipated report.

The Takaful industry continued to show double digit growth in 2011 albeit at a relatively slower rate of 19% as compared to previous years. Amongst key markets, Malaysia and UAE again achieved growth rates of over 24%, whilst Saudi Arabia saw its gross contributions increase by US$0.5b. The challenge was once again, maintaining growth with profitability in the current economic climate. There were positivedevelopments in the GCC with more operators showing profitability than previous years. The Saudi Cooperatives continued their growthdevelopments in the GCC with more operators showing profitability than previous years. The Saudi Cooperatives continued their growthperformance yet still struggled in generating shareholder returns. Overall, return on equity for the Takaful industry was lower than conventional counterparts, both in the GCC as well as in Malaysia. However, a significant contributing factor to this was the lower investment returns for the industry relative to returns yielded by conventional insurers. The industry has now obtained significant market share versus conventional insurance in most GCC countries as well as South East Asian markets. There are a number of drivers behind this growth but one that is becoming increasingly important is regulatory support through appropriate amendments in legislature to provide a level playing field with conventional insurance companies.

With operational efficiency still a key focus, we take a look at some of the regulatory changes that will impact and how some Takaful Operators may be forced to change their operating model and how forward planning is critical to save on considerable project and change management costs. The report also highlights the strong need for introducing greater standardization in regulatory frameworks across jurisdictions. Standardization will enhance clarity around Takaful, its business models and its unique selling proposition, hence allowing the industry to strive towards its true growth potential.

We hope that you will find this report informative and useful and it provides insight to align your strategic agenda.

Ashar M. NazimSenior Director & Global Head of Islamic FinanceErnst and Young

Justin BalcomeSenior Director & MENA Insurance LeaderErnst and Young



Ernst and Young Ernst and Young

5


Introduction to Takaful Takaful uses a system of voluntary donations and mutual assistance to share risk, collectively, amongst a group of members

Takaful Cooperative insurance Mutual insurance

Contracts utilised

► Donation and mutual undertaking based on non-remunerative / non-commutative contract

► Not an exchange / commutative contract

► Mutual contract ► Mutual contract – considered

to be an exchange contract on principles of mutuality

Company’s responsibility

► Pay claims with underwriting fund

► Manage the participants‟ fund ► Pay claims from underwriting

fund ► Provide interest free loan to

underwriting fund in case of deficit

► Pay claims with underwriting fund

► Pay for deficits if any

Participants’ responsibility

► Pay premiums (and pay for deficits in some models) ► Pay contributions ► Pay contributions (and pay

for deficits in some models)

Capital utilised for underwriting

business

► Participating capital, accumulated surplus and guarantee capital (if applicable)

► Participants‟ funds and in case of shortfall, temporary access to shareholders‟ equity on a qard al hassan basis

► Participating capital and accumulated surplus

Investment considerations

► No restrictions except prudential

► Shari‟a compliance and prudential


Proprietary / commercial insurance

► Remunerative / commutative exchange contract

► Pay claims

► Pay premiums

► Shareholders‟ equity


Source: Ernst and Young research and analysis 6 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Global Takaful contributions grew by 19% in 2010, to US$8.3b

► Global Takaful contributions are expected to reach US$12b by 2012

► Saudi Arabia remained the largest market in GCC

7


The Insurance Authority issued a circular in September 2011 to all insurance and Takaful companies in the UAE setting out guiding rules which UAE insurance and Takaful companies should adhere to in distributing products through banks.

Allianz Takaful sold 75% shares to Medgulf for Bahrain and Qatar markets.

Allianz sold 75% of its Takaful business to Medgulf

GCC & MENA Bahrain

Tokio Marine sold all shares in its Malaysia Takaful joint venture, Hong Leong Tokio Marine Takaful Bhd., to its local partner Hong Leong Group.

Tokio Marine sold its stake in Hong Leong

Bhd

SA & SEA Malaysia

Securities and Exchange Commission Pakistan issued draft Takaful rules proposing significant changes in the Takaful regulatory framework. The changes shall allow conventional insurance companies to open Takaful windows.

SECP issued draft Takaful rules 2012

SA & SEA Pakistan

Malaysia‟s „Takaful Operational Framework‟ came into effect in January 2012. Its objective is to enhance Takaful business efficiency, ensure healthy and sustainable Takaful funds and safeguard participant‟s interest.

Takaful Operational Framework

SA & SEA Malaysia

Oman‟s Capital Market Authority (CMA) allowed Takaful products. The CMA is in the process of finalizing the regulations and standards required for Takaful operations.

The draft risk-based capital framework aims to address solvency requirements described in the IFSB “Standard for Solvency Requirements in Takaful Undertakings”.

Bank Negara Malaysia issued draft risk-based

capital framework for Takaful operators

SA & SEA Malaysia

Bancassurance regulations update

GCC & MENA UAE

Business events

Regulatory events

AAOIFI amended their ruling on sharing of Takaful surplus made five 5 ago. The ruling continued to refrain Shareholders from sharing in the underwriting surplus. However, the AAOIFI Shari‟a Appellate Bench (SAB) has proposed to allow surplus participation with the management team of the Takaful operator. A performance fee of up to 30% may be taken out of participant surplus for the management.

AAOIFI ruling on underwriting surplus

GCC & MENA Bahrain

Oman set to allow Takaful operators

GCC & MENA Oman

Summary of key Takaful events Significant events in the Takaful industry during March 2011 – March 2012


Global events affecting Takaful A number of political and economic events being witnessed around the world are likely to impact the Takaful industry

Europe The European crisis has dampened the prospects of Takaful making gains in that market. Increased solvency requirements add to the difficulty of launching Takaful, given the risk structure of Takaful and the favorable treatment of debt instruments in the capital adequacy calculation. It may also limit the appetite of European insurers for investing overseas, as the new rules apply at a group level as well as at insurer level.

MENA The Arab Spring has hurt the attractiveness of populous Muslim markets such as Sudan and Tunisia for foreign investment. Specifically Libya and Egypt were considered as high potential growth markets. A number of projects have been postponed or at least affected due to the prevailing situation in these countries.

Sudan Sudan is the largest Takaful market outside the GCC and Malaysia. The recent partition has resulted in the creation of two countries. Oil rich but under developed South Sudan does not support Islamic Finance and Takaful. North Sudan only allows Islamic Finance and Takaful. However, the partition has resulted in a steep drop in North Sudan‟s GDP growth due to loss of oil revenues. Overall slowdown of economy and reduced FDI will directly impact the growth of the financial sector, including that of Takaful. .

Saudi Arabia The Saudi Arabian Monetary Authority (SAMA) had directed all operators to align with the cooperative insurance model by year end 2011. Takaful operators had to adjust their internal accounting structures, remove the use of Wakala and Qard and amend product terms and conditions. Saudi is a huge Takaful market and this shift away from the pure Takaful model may have various affects on the industry which is already in need of regulatory harmonization.

South East Asia Indonesia is emerging as a significant Takaful market, overtaking several of the GCC countries in Gross Written Contributions (GWC). Along with Malaysia and Brunei, the other two important Takaful markets in South East Asia, the region accounts for USD 2b in total GWC. With Saudi regulators disallowing the pure Takaful model, the primary hub for Takaful may well shift from the GCC, to South East Asia.




Global events affecting Takaful A number of political and economic events being witnessed around the world are likely to impact the Takaful industry

Europe The European crisis has dampened the prospects of Takaful making gains in that market. Increased solvency requirements add to the difficulty of launching Takaful, given the risk structure of Takaful and the favorable treatment of debt instruments in the capital adequacy calculation. It may also limit the appetite of European insurers for investing overseas, as the new rules apply at a group level as well as at insurer level.

MENA The Arab Spring has hurt the attractiveness of populous Muslim markets such as Sudan and Tunisia for foreign investment. Specifically Libya and Egypt were considered as high potential growth markets. A number of projects have been postponed or at least affected due to the prevailing situation in these countries.

Sudan Sudan is the largest Takaful market outside the GCC and Malaysia. The recent partition has resulted in the creation of two countries. Oil rich but under developed South Sudan does not support Islamic Finance and Takaful. North Sudan only allows Islamic Finance and Takaful. However, the partition has resulted in a steep drop in North Sudan‟s GDP growth due to loss of oil revenues. Overall slowdown of economy and reduced FDI will directly impact the growth of the financial sector, including that of Takaful. .

Saudi Arabia The Saudi Arabian Monetary Authority (SAMA) had directed all operators to align with the cooperative insurance model by year end 2011. Takaful operators had to adjust their internal accounting structures, remove the use of Wakala and Qard and amend product terms and conditions. Saudi is a huge Takaful market and this shift away from the pure Takaful model may have various affects on the industry which is already in need of regulatory harmonization.

South East Asia Indonesia is emerging as a significant Takaful market, overtaking several of the GCC countries in Gross Written Contributions (GWC). Along with Malaysia and Brunei, the other two important Takaful markets in South East Asia, the region accounts for USD 2b in total GWC. With Saudi regulators disallowing the pure Takaful model, the primary hub for Takaful may well shift from the GCC, to South East Asia.


9


Global Takaful contributions growth Global gross Takaful contributions reached US$8.3b in 2010 and continue to depict healthy growth. US$4.3b of these contributions came from Saudi cooperatives

Saudi Arabia requires all insurance companies to operate under a cooperative business model. Similarities exist between the cooperative model and Takaful, so that most re-Takaful operators are permitted to conduct business with them. In fact, various regional Takaful operators have subsidiaries in Saudi working under the cooperative model. However, as the model is different from Takaful practiced in other regions, we are treating it in separation to the pure Takaful industry.

Global Gross Takaful Contributions – including Saudi cooperatives (US$m)

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis

CAGR 2005-2009

2010 growth

Africa 20%

South East Asia

28%

GCC- (excluding Saudi)

54%

10%

32%

33%

Levant 23% 102%

Indian Sub- continent

122% 5%

Saudi cooperative

38% 12%

924 1,833

Global Takaful - excluding cooperative contributions (US$m)

2,402 1,219 3,079 3,959 35% 29% Pure Takaful

1,065 1,850 2,289

2,912 3,896 4,370

2005 2006 2007 2008 2009 2010

8 17 181 544 173

11 18 256 695 238

1,988

3,068

4,122

5,315

6,975

8,329

76 22 276 901 557

123 33 295 1,110 842

193 39 377 1,480 990

202 79 413 1,951 1,313

CAGR (2005 - 2009) = 29% Growth (2010) = 19%

(e)

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis10 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


1,065 1,850

2,289 2,911

3,896 4,370

2005 2006 2007 2008 2009 2010 (e)

GCC Takaful contributions growth Overall, the GCC experienced relatively slower growth this year post implementation of compulsory medical in Saudi and Abu Dhabi during the last two years

CAGR 2005-2009

Gross Takaful Contributions in the GCC – including Saudi cooperatives (US$m)

2010 growth

Bahrain 55%

Qatar 41%

UAE 98%

Kuwait 11%

Saudi Cooperative

38%

17%

91%

28%

4%

12%

CAGR (2005 - 2009) = 41% Growth (2010) = 16%

1,238

2,088

2,846

3,753

4,886

5,683

15 34 42 83

34 50 65 90

41 53 369 95

71 128 542 101

87 136 640 128

102 260 818 133

Saudi Arabia requires all insurance companies to operate under a cooperative business model. Similarities exist between the cooperative model and Takaful, so that most re-Takaful operators are permitted to conduct business with them. In fact, various regional Takaful operators have subsidiaries in Saudi working under the cooperative model. However, as the model is different from Takaful practiced in other regions, we are treating it in separation to the pure Takaful industry.

173 557

GCC Takaful - excluding cooperative contributions (US$m)

842 238 990 1,313 55% 33% Pure Takaful

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis11


172 244 262 281

340 363 4

4 65

105

166 166

31

37

48

67

104

165

2005 2006 2007 2008 2009 2010 (e)

207

285

375

453

610

694

Other markets Takaful contributions growth Sudan is the most significant market outside GCC and SEA. Jordan and Egypt have just under US$50m in gross Takaful contributions but are showing strong growth

Gross Takaful Contributions in Other Markets (US$m)

CAGR 2005-2009

2010 growth

Others

Bangladesh

Sudan

35%

154%

19%

59%

0%

7%

CAGR (2005 - 2009) = 31% Growth (2010) = 14%

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis Page 12 The World Takaful Report 2012


412 553

701 889

1,158 1,441

75 80

133

150

251

314

2005 2006 2007 2008 2009 2010 (e)

544

901 695

1,110

1,480

1,951

South East Asian Takaful contributions growth Indonesia and Brunei are becoming increasingly important Takaful markets. Together with Malaysia, they account for US$2b in gross Takaful contributions

Brunei

Thailand

Indonesia

Malaysia

Gross Takaful Contributions in South East Asia (US$m)

CAGR 2005-2009

2010 growth

3%

5%

35%

29%

393%

0%

25%

24%

CAGR (2005 - 2009) = 28% Growth (2010) = 32%

27 30

30 32

32 35

32 38

32 38

158 38

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis 12 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


172 244 262 281

340 363 4

4 65

105

166 166

31

37

48

67

104

165

2005 2006 2007 2008 2009 2010 (e)

207

285

375

453

610

694

Other markets Takaful contributions growth Sudan is the most significant market outside GCC and SEA. Jordan and Egypt have just under US$50m in gross Takaful contributions but are showing strong growth

Gross Takaful Contributions in Other Markets (US$m)

CAGR 2005-2009

2010 growth

Others

Bangladesh

Sudan

35%

154%

19%

59%

0%

7%

CAGR (2005 - 2009) = 31% Growth (2010) = 14%

Source: World Islamic Insurance Directory 2012 (Reproduced with permission from Takaful Re Limited), Ernst & Young analysis 13


Takaful contribution concentration centres The GCC has a high number of Takaful operators and relatively low average contributions per operator. 77 operators grew their contributions by an average of US$10m in 2010

Levant

Avg. contributions per operator: US$9m Takaful growth 2010: 102%

GCC


Source: World Islamic Insurance Directory 2012, Global Insights, Alpen Capital – GCC Insurance Industry Report 2011,Ernst & Young analysis

Saudi Arabia


Takaful Contributions per operator


Growth 2010

WTR12 Forecasts for Global Gross Takaful Contributions – including cooperatives (US$m)

Sources: World Islamic Insurance Directory 2012, Ernst & Young analysis

► The World Takaful Report 2011 forecasted total contributions to reach US$9.1b by 2011.

► The results have been lower (US$8.3b) due to industry slow down in core markets relative to the high growth rates seen in previous years. The anticipated compulsory medical insurance regulation in Dubai and other UAE emirates was not rolled out either.

► Current growth trends would suggest US$12b in gross contributions by 2012.

► Excluding Saudi cooperative contributions, total Takaful contributions are expected to be reach US$7b by 2012.

Note: Forecast is based on respective growth rates in 2010, adjusted for emerging trends.

Global Takaful forecast Continued steady growth in core markets and the emergence of new fringe markets such as Indonesia, Brunei and Bangladesh suggest a US$12b industry by 2012

Africa

South East Asia

GCC- (excluding Saudi)

10%

32%

33%

Levant 102%

Indian Sub- continent

5%

Saudi cooperative

12%

3,896 4,370 4,902 5,498

990 1,313

1,741 2,310

1,480

1,951

2,572

3,390

2009 2010 2011 2012

6,975 193 39 377

202 79 413

8,329 211 160 452

10,039

469 197 544

12,407

3,079 3,958 5,137 6,910 Takaful – excluding Saudi cooperatives

(e) (f) (f)



Takaful contribution concentration centres The GCC has a high number of Takaful operators and relatively low average contributions per operator. 77 operators grew their contributions by an average of US$10m in 2010

Levant


GCC



Saudi Arabia



15


Takaful contribution concentration centres Malaysia has a relatively high ratio of average gross written contributions per operator. The 14 operators in Malaysia grew their contributions by an average of US$20m in 2010

Africa


Malaysia



Indian Sub-Continent





Key business lines Medical Takaful has become a major business line in GCC. Family Takaful is the dominant business line in Malaysia. Marine and Aviation Takaful business activity remains minimal

Source: World Islamic Insurance Directory 2012, Ernst & Young analysis

53

20 16 7

32

18

16 13

13

16

27

59 69

76

48

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Iran GCC and Levant South East Asia Indian sub - continent

Total

Family and medical Marine and aviation Property and accident Motor

Key Takaful business lines in major markets (2010)

3

5

2

4

4

17

Page 18 The World Takaful Report 2012 – “Takaful Regulations for Growth, Equity and Stability”

Potential Takaful markets There are large Muslim population centers throughout the emerging markets of MENA and Asia. Many of these markets hold great potential for Islamic Finance and Takaful

100m +

50 - 100m

10 – 50m

5 – 10m

1 – 5m

Estimated Muslim Populations in 2010

India Population: ~177 m Per Capita income: $3,194 Insurance penetration: 5.1%

Indonesia

Population: ~213 m Per Capita income: $4,094 Insurance penetration: 1.5%

Pakistan


Bangladesh


Turkey


Egypt


Nigeria Population: ~75 m Per Capita income: $2,241 Insurance penetration: 0.5%

Algeria Population: ~35 m Per Capita income: $7,100 Insurance penetration: 0.8%

Morocco


Global Estimated Muslim Populations in 2010

Under 1m

Source: Global Insights (Per Capita Income is based on PPP of individual markets), Pew Forum

Russia Population: ~ 16 m Per Capita income: $15,756 Insurance penetration: 2.3%

China Population: ~ 23 m Per Capita income: $7,503 Insurance penetration: 3.8%

CIS Region Population: ~ 61 m Per Capita income: $ 10,715 Insurance penetration: N/A



Takaful’s untapped potential The Takaful industry is currently concentrated in limited markets, segments and business lines. However, there is immense unrealized potential that can be achieved

Potential market

space in Takaful

hubs

► Share of Islamic Finance in GCC and Malaysia is 25% and 22% whereas Takaful market share is 15% and 10% respectively.

► Takaful has at least 10% of the known Shari‟a inclined market that they have not yet tapped.

► As the industry matures and establishes stronger distribution capabilities, this additional market space will be captured.

Untapped customer segments

► Takaful, with its Shari‟a appeal, is predominantly retail driven in most markets.

► Corporate business is attracted through a value proposition based on the operators reputation, history, product suite, service standards, relationships and pricing.

► For Takaful, the corporate customer segment has significant room for growth.

► Focus on underwriting capabilities, service standards and product offering, together with stronger market relationships will allow Takaful to tap the corporate segment.

GCC’s untapped business

lines

► The GCC Takaful market predominantly comprises of general Takaful business with family Takaful accounting for as little as 5% in certain markets.

► With high disposable income average and low market penetration, the GCC presents potential for family Takaful.

► Focus on customer research to understand needs and expectations, in addition to focus on customer education and distribution capacity building shall allow tapping into this market.

1

2

3

19


Global market

potential

► Conventional insurance has penetrated a small percentage of the 1.6b Muslims market globally. Whether this is due to religious inclinations, inadequate insurance distribution or lack of education around insurance products, the untapped segment provides huge potential for Takaful.

► Focus on customer research to understand needs and expectations, in addition to focus on customer education and distribution capacity building shall allow tapping into this market.

Frontier market

potential

► Large Muslim markets such as Libya, Egypt, Bangladesh, Indonesia and Brunei are opening up to Takaful.

► Recent regime changes in MENA countries including Egypt, Libya and Tunisia have brought forward Islamist governments that are encouraging Islamic finance.

► Bangladesh, Brunei and Indonesia are emerging as important frontier markets for Takaful, showing healthy growth.

► Establishment of separate regulatory frameworks for Takaful will accelerate growth in these markets. Technical and financial assistance from IDB and other facilitating organizations are important

Potential of dormant markets

► India, China, Russia, Turkey and CIS countries have immense potential for Takaful based on the size of their Muslim populations and the growth in their economies.

► Takaful has not been permitted and / or facilitated in these markets until now. However, these markets hold considerable potential for Takaful should there be encouragement from their governments.

► Local insurers need to encourage their regulator / government to facilitate Takaful.

► Lobbying by IDB / OIC to create awareness and acceptance for Takaful in these markets is important.

4

5

6




Micro-Takaful

► A sizable portion of Muslim populated countries are characterized by having low income / lower-middle income households (Indonesia, Pakistan, Bangladesh, Sudan). They are also characterized by having low insurance penetration rates.

► This may be due, in part, to religious views towards conventional insurers but is also due to the unavailability of products suitable to the low income target market.

► Micro Takaful products can allow tapping into the large low income and lower-middle income segments characterizing most Muslim populated countries.

Distribution and reach

► There is limited awareness of insurance products, savings and retirement plans in most Muslim majority countries. The market is there for risk mitigation tools but traditional mechanisms are relied upon.

► Conventional distribution channels are being used to target the Takaful market. Direct sales force, agencies, bancatakaful partners have limited training on Takaful and its unique selling proposition.

► Greater Takaful awareness amongst religious scholars and mosque Imams will promote acceptability and awareness in the market.

► Focus on Takaful training for sales channels will enhance sales productivity.

Potential of value driven

segment

► Shari‟a compliance offers an advantage over conventional insurers in targeting the Shari‟a inclined Muslim segment. However, no significant disadvantage hinders Takaful from targeting non-Muslims. In theory, Takaful has a larger potential market than conventional insurance as Takaful is able to tap the additional Shari‟a inclined market segment.

► The value driven, Shari‟a neutral market holds significant potential, specially in under penetrated markets.

► With maturity and scale, Takaful operators should be able to establish efficiencies, service quality, product variety, distribution strength to compete for the value driven, Shari‟a neutral segment.

7

8

9


21


Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Insurance companies continued to yield higher returns than Takaful. Saudi cooperatives struggled to show positive returns

► Investment yields for Takaful were again lower than their conventional counterparts, in both Malaysia as well as the GCC



Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Insurance companies continued to yield higher returns than Takaful. Saudi cooperatives struggled to show positive returns

► Investment yields for Takaful were again lower than their conventional counterparts, in both Malaysia as well as the GCC


Company RoE

Combined Operating Ratio

Claims Ratio Commission Ratio Expense Ratio

Reinsurance Ratio

Investment Results

Investment Composition Returns

Notes: 1. Data used for the analysis is based on the annual reports of a sample of Takaful operators, cooperatives and conventional companies covering the GCC, Saudi Arabia and Malaysia. 2. Annual reports of some of the companies for the year 2011 were not available at the time of publishing. In such cases, data has been annualized. 3. Numbers may differ from those reported in previous reports as the sample size has been enhanced and Saudi Arabian cooperative insurance entities have been excluded from pure Takaful companies.

Saudi Arabian cooperatives includes certain companies that are branded as Takaful operators. 4. Refer to Appendix for complete list of operators and companies included in our sample.

Insurance Investments

(Page 24)

(Page 30-1)

(Page 26) (Page 27) (Page 28) (Page 30) (Page 31)

Breakdown of financial performance Insurance companies and Takaful operators generate shareholder returns through a number of key drivers

(Page 25) (Page 29)

23


89% 92% 91% 92% 87%

72% 59%

70% 61%

78%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2007 2008 2009 2010 2011

91%

107%

86% 86% 90%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2007 2008 2009 2010 2011

78% 81% 87% 81%

77%

90% 90% 91% 89% 102%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2007 2008 2009 2010 2011

GCC Sample Saudi Arabian Sample Malaysian Sample

Notes: 1. Where possible, publicly available corporate information has been used. 2. Quarterly results have been used in 2011 to approximate data where annual accounts were not available. 3. GCC Takaful sample excludes Saudi operators in this report. Therefore, the graph shows a significant variation from

WTR 2011. 4. Combined Operating Ratio = Net Claims Ratio + Net Commission Ratio + Net Expenses Ratio.

Sample: No. of Companies 2007 2008 2009 2010 2011

GCC – Insurance 23 24 26 20 21

GCC – Takaful 9 9 10 6 6

Saudi Arabia – Cooperative Insurance 1 3 12 14 19

Malaysia – Insurance 5 5 3 6 6

Malaysia – Takaful 7 7 7 3 3

Source: Companies’ annual reports, Ernst & Young analysis

Combined operating ratio Malaysian Takaful operators have better COR than conventional peers while the reverse is true for the GCC

Insurance Companies Takaful Operators Cooperative Insurance Companies

COR for a sample of Takaful operators, insurance companies and cooperatives



Average return on equity for a sample of Takaful operators, insurance companies and cooperatives

Notes: 1. Where possible, publicly available corporate information has been used. 2. Quarterly results have been used in 2011 to approximate data where annual accounts were not available. 3. GCC Takaful sample excludes Saudi operators in this report. Therefore, the graph shows a significant variation

from WTR 2011. 4. RoE = Net profit / Shareholders’ equity.

14%

11%

14%

10%

17%

5% 4%

-2%

6% 4%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011

18%

9% 8% 9% 9% 10%

-2% -2%

4% 4%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011

GCC Sample Saudi Arabian Sample Malaysian Sample 18%

-10% -12%

-1%

-7%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011



GCC – Takaful 11 11 12 6 6





Return on equity Insurance companies continue yielding higher returns than Takaful. Saudi cooperatives have struggled for profitability since after the financial crisis

► Shareholder returns on insurance operations are higher than Takaful shareholder returns, both in the GCC and Malaysia. Insurers, having more long term / short term investment options, have made higher investment income than Takaful operators. Their scale, longer operating history and market relationships have allowed them to build a more profitable business mix while Takaful has relied predominantly on retail business and relatively fewer product classes.

► Saudi cooperatives have struggled for profitability. Most Saudi operators are new in the market and are absorbing their pre-incorporation costs. The market is dominated by three players with the remaining operators incurring high expense ratios and loss ratios in their effort to quickly build market share.




89% 92% 91% 92% 87%

72% 59%

70% 61%

78%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2007 2008 2009 2010 2011

91%

107%

86% 86% 90%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2007 2008 2009 2010 2011

78% 81% 87% 81%

77%

90% 90% 91% 89% 102%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2007 2008 2009 2010 2011



WTR 2011. 4. Combined Operating Ratio = Net Claims Ratio + Net Commission Ratio + Net Expenses Ratio.








Combined operating ratio Malaysian Takaful operators have better COR than conventional peers while the reverse is true for the GCC


COR for a sample of Takaful operators, insurance companies and cooperatives

25


0%

10%

20%

30%

40%

50%

60%

70%

2005 2006 2007 2008 2009 2010 0%

10%

20%

30%

40%

50%

60%

70%

2005 2006 2007 2008 2009 2010

Average claims ratio - Family

Notes: 1. Data for Bahrain and Malaysia is specific to the Takaful industry, while data for Saudi Arabia and UAE covers the insurance industry as a whole. 2. Data for Life/ Family and General Takaful are provided separately for UAE and Malaysia. For Saudi and Bahrain, only combined data was available publically. 3. Claims ratios for UAE, Saudi and Bahrain are provided on gross claims basis. Data for Malaysia was available on net claims basis. 4. Claims Ratio = Claims incurred / Earned contribution.

Claims ratio Malaysian operators show lower claims ratios on general and family Takaful lines

Source: CBB Insurance Market Review 2011, Bank Negara Malaysia Annual Takaful Statistics 2010, UAE Insurance Authority Annual Statistics 2009, SAMA Insurance Review 2010

UAE life insurance

Malaysia family Takaful UAE general

Malaysia general

Life

Bahrain

Saudi Arabia Com

bine

d

Gen

eral

► Malaysian general Takaful operators yielded significantly lower claims ratios compared to GCC counterparts in previous years. 2010 saw higher than expected claims in motor for the Malaysians. Malaysian family Takaful claims ratios were slightly lower compared to GCC operators as well.

► Overall, year 2010 saw a rise in claims in both, GCC and Malaysian markets.

Average claims ratio - General

Source: CBB Insurance Market Review 2011, Bank Negara Malaysia Annual Takaful Statistics 2010, UAE Insurance Authority Annual Statistics 2009, SAMA Insurance Review 2010




WTR 2011. 4. Average Commission Ratio = Net Commission / Net Earned Premium.

-10%

-7% -4% -5%

-8%

9%

14%

17%

9%

4%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011

6% 8%

10%

16% 14%

18%

12% 12% 13% 13%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011

7%

11% 11% 11%

6%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011









Average commission ratio Takaful operators pay higher net commission than conventional insurers, both, in Malaysia and the GCC


► In the GCC, conventional insurers are net commission earners. Their scale allows them to obtain favorable terms with reinsurers and brokers. Most GCC Takaful operators are less that 5 years old and still in the process of achieving scale. These operators are paying higher commissions to build market share.

► In Malaysia, Takaful Operators have historically paid more net commissions than conventional counterparts. However, by building market share, they have managed to reduce this difference in recent years.

► Saudi Arabian insurance sector is dominated by 3 players. A large number of new cooperatives have recently entered the market and are competing aggressively for market share.

Average commission ratio for a sample of Takaful operators, insurance companies and cooperatives

2007 2008 2009 2010 2011

Source: Companies’ annual reports, Ernst & Young analysis27


Notes: 1. Where possible, publicly available corporate information has been used. 2. Quarterly results have been used in 2011 to approximate data where annual accounts were not available. 3. GCC Takaful sample excludes Saudi operators in this report. Therefore, the graph shows a significant variation from WTR

2011. 4. Average Expense Ratio = General and Administrative Expenses / Net Earned Premium.

23% 24% 23% 23% 26%

37%

22% 22%

16%

26%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2007 2008 2009 2010 2011

27% 28% 27%

24% 23%

35%

25%

31%

28%

33%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2007 2008 2009 2010 2011

18%

23%

28%

38%

21%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2007 2008 2009 2010 2011








Average expense ratio Takaful operators in the GCC have higher expense ratios than GCC insurers as well as Malaysian Takaful operators



Average expense ratio for a sample of Takaful operators, insurance companies and cooperatives

► Characterized by relatively young market players, the GCC Takaful industry has yielded higher expense ratios than insurers operating in the same market. These expense ratios are also higher than those of Malaysian Takaful operators who concentrate more on family Takaful business as opposed to general Takaful.

► Malaysian Takaful operators are at par with conventional counterparts in their expense ratio yields. This indicates the degree of maturity that the Takaful industry has achieved in the country.

► Saudi cooperatives have seen their expense ratios rise over the past few years. However, there is a significant decline in 2011.

Source: Companies’ annual reports, Ernst & Young analysis28 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE



WTR 2011. 4. Reinsurance Ratio = Insurance premium ceded / gross premium written.

18% 22%

23% 23% 25%

6% 9% 8%

12%

20%

0%

10%

20%

30%

40%

50%

60%

2007 2008 2009 2010 2011

52% 50% 47%

52% 50%

42% 45%

47%

34% 34%

0%

10%

20%

30%

40%

50%

60%

2007 2008 2009 2010 2011

42% 40%

32%

37%

27%

0%

10%

20%

30%

40%

50%

60%

2007 2008 2009 2010 2011








Reinsurance ratio Takaful operators generally retain more business, which reflects a focus on less complex business lines



Reinsurance ratio for a sample of Takaful operators, insurance companies and cooperatives

► Takaful operators, in both GCC and Malaysia, retain more business than conventional counterparts. This may be a reflection of their business mix, with Takaful operators predominantly relying on less complex retail business.

► GCC Takaful operators, having predominantly general Takaful business, have significantly higher reinsurance ratios than Malaysian counterparts that have majority family Takaful business.

► Saudi cooperatives have seen a decrease in their reinsurance ratio in recent years.

Source: Companies’ annual reports, Ernst & Young analysis29


4% 5% 8% 5% 5%

68% 66% 37% 37% 38%

11% 19%

22% 31% 31%

16% 10%

32% 28% 26%

0%

20%

40%

60%

80%

100%

120%

2007 2008 2009 2010 2011 6% 5% 2% 3%

25% 27% 27%

20% 20%

44% 40% 48%

56% 57%

31% 28% 20% 22% 20%

0%

20%

40%

60%

80%

100%

120%

2007 2008 2009 2010 2011

Malaysian Sample

Equity Real Estate Deposits Sukuk

Notes: 1. Where possible, publicly available corporate information has been used. 2. GCC and Saudi Arabian sample includes cooperative insurance companies. 3. Quarterly results along with discussions with industry leaders, have been used in 2011 to approximate data where annual

accounts were not available..

GCC and Saudi Arabian Sample


GCC and Saudi Arabia 6 9 6 5 5

Malaysia 3 4 2 3 3

Investment composition Investment strategies have remained largely unchanged over the last couple of years


Average investment portfolio composition for a sample of Takaful operators, insurance companies and cooperatives



Notes: 1. Where possible, publicly available corporate information has been used. 2. Quarterly results have been used in 2011 to approximate data where annual accounts were not available. 3. GCC Takaful sample excludes Saudi operators. Therefore, the graph shows a significant variation from WTR 2011. 4. Average Yield on Investments = Total Investment Returns / Total Investment.

6%

9%

6% 5%

12%

3% 4% 3%

4% 6%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011

15%

9% 8% 10%

11% 13%

-2% -4%

5% 6%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011

14%

2% 1%

2% 2%

-10%

-5%

0%

5%

10%

15%

20%

2007 2008 2009 2010 2011




GCC – Takaful 10 10 11 6 6




Investment returns GCC Takaful operators have experienced high volatility in investments. Overall, conventional insurers have achieved better investment returns



Average return on investments for a sample of Takaful operators, insurance companies and cooperatives

31


Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Rising competition and evolving regulations and shortage of Takaful expertise were identified as key risks in both GCC and South East Asia


Key Strategic Issues Financial performance remains a challenge for Takaful operators in many markets

Efficiency in operation Solvency and capital requirements

Quality of underwritten business 1 2 3

► Most Takaful operators are yet to achieve critical business volume, despite incurring substantial establishment costs over formation years.

► Expense ratio remains higher than conventional peers in the GCC market, although improvements have been made in the Malaysian market.

► Distribution capabilities, along with service quality remain a key challenge to better performance for Takaful operators.

► Most takaful operators are startups or small players, limiting their access to quality customers which negatively impacts their loss ratios.

► There is concentration of business in the retail segment. Access to potentially lucrative commercial lines is limited due to underdeveloped broker relationships, limited operational history and scale.

► Complex risks are not well understood and potentially mispriced.

► Stricter solvency and capital requirements will make it harder for smaller players to achieve profitability. Young Takaful players will need to either quickly build scale or consider mergers to meet these requirements.

Key Strategic Issues



Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Rising competition and evolving regulations and shortage of Takaful expertise were identified as key risks in both GCC and South East Asia


Key Strategic Issues Financial performance remains a challenge for Takaful operators in many markets

Efficiency in operation Solvency and capital requirements

Quality of underwritten business 1 2 3

► Most Takaful operators are yet to achieve critical business volume, despite incurring substantial establishment costs over formation years.

► Expense ratio remains higher than conventional peers in the GCC market, although improvements have been made in the Malaysian market.

► Distribution capabilities, along with service quality remain a key challenge to better performance for Takaful operators.

► Most takaful operators are startups or small players, limiting their access to quality customers which negatively impacts their loss ratios.

► There is concentration of business in the retail segment. Access to potentially lucrative commercial lines is limited due to underdeveloped broker relationships, limited operational history and scale.

► Complex risks are not well understood and potentially mispriced.

► Stricter solvency and capital requirements will make it harder for smaller players to achieve profitability. Young Takaful players will need to either quickly build scale or consider mergers to meet these requirements.

Key Strategic Issues

33


Takaful Global Business Risks

Key Business Risks 2012

1 Rising competition

2 Evolving regulations

3 Shortage of expertise

4 Misaligned costs

5 Limited financial flexibility

6 High-risks investment portfolios

7 Limited diversification in exposures

8 Enterprise risk management

9 Political risks and implications

10 Inability to tap pent-up demand

Sources: Executives’ and experts’ interviews, Ernst & Young analysis

Takaful business risks Higher competition, evolving regulations and shortage of Takaful human resource expertise are key contemporary business risks for Takaful

High-risk investment portfolios

Financial Compliance

Strategic Operational

Misaligned costs

Competition

Shortage of expertise

Limited financial flexibility

Evolving regulations

Key to Symbols

Up from 2011

Down from 2011

Source: Executives’ and experts’ interviews, Ernst & Young analysis34 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


Takaful business risks Rising competition and evolving regulations have been identified as key risks in both GCC and South East Asia

Takaful in the Gulf Cooperation Council (GCC)

Business Risks in the GCC ► Competition and varying regulatory regimes remain key

business risks for Takaful operators. ► Misaligned costs base have also been identified as a key

area of concern.

Source: Executives’ and experts’ interviews, Ernst & Young analysis

Takaful in South East Asia (SEA)

5

Competition

1

4


Business Risks in SEA ► Inability to tap pent-up demand is pushing up strategic risks,

while varying regulatory regimes have also become more prominent.

Inability to tap pent-up demand

3

2


Limited diversification in exposures

6






6

2

3

4

1




Competition

5

Inability to achieve underwriting profit

Misaligned costs

Source: Executives’ and experts’ interviews, Ernst & Young analysis35


Regulations vary significantly across jurisdictions and continue to evolve: ► A number of regulatory changes were rolled out in different Takaful markets. While most interviewees

agreed that the new regulations were a positive development, there was concern over the increased variances in regulatory regimes in place across jurisdictions. It was felt that such variances in Takaful regulations make it difficult for Takaful operators to function across regions and also lead to confusion for customers and multinational insurers.

► SAMA‟s efforts in creating uniformity in insurance practices in the country were thought to provide an even playing field for insurers and Takaful operators. However, it remains to be seen how Shari‟a scholars and Takaful customers view the Shari‟a compliance of the enforced cooperative model.

► Pakistan has proposed to allow insurers to offer Takaful products through window operations. Whereas this step will enhance market reach of Takaful, it will bring the young pure Takaful operators under considerable competitive pressure.

► Higher solvency and capital requirements being introduced across various jurisdictions is likely to result in better capitalized companies but will impact shareholder profitability in the short term.

► Malaysia has introduced a draft paper on risk-based capital for Takaful firms to strengthen the country‟s governance and risks management practices. Again, the short term profitability is likely to be affected.

► For most interviewees in the GCC, the key regulatory issue for the year was AAOIFI‟s ruling on the sharing of underwriting surplus. The ruling allows sharing of underwriting surplus by management but does not allow for the surplus to be shared with shareholders. Interviewees expressed concern that Takaful shareholders were barred from sharing in underwriting profits but required to indirectly share risk of loss through a mandatory Qard facility. The industry practitioners and regulators are attempting to find a way to implement Takaful‟s conceptual requirements as defined by Shari‟a scholars in a way that is commercially viable for shareholders and considerate of participants interests.


Commentary and contributing factors

“ Bahrain, Malaysia and Pakistan have comprehensive Takaful regulations in place that take into account the unique requirements of the industry.”

- GCC Takaful Executive

“ Regulations are becoming cumbersome to deal with and regulators need to be cohesive in their approach for the growth and stability of the Takaful market.”


“ Self-sustainability and solvency of the pools is the most crucial regulatory challenge for Takaful.”

- GCC Consultant Actuary

Sources: Executives’ and experts’ interviews, Ernst & Young analysis Page 36 The World Takaful Report 2012


Rising competition

Aggressive pricing for market share: ► Young Takaful operators are having to rely upon aggressive pricing strategies to compete against the

established, older, conventional players. Most interviewees agree that such pricing is not sustainable and causing significant pressure on the industry‟s profitability.

► The regional and global economic conditions, together with a stricter stance by regulators, has restricted the entry of additional players in the GCC which already has a high number of operators.

► Malaysia has a larger insurance and Takaful market with higher contributions per operator. However, the recent addition of three new Takaful operators will raise competition in that market.

Market consolidation: ► Most interviewees argued that the industry would benefit from consolidation. There are increasingly

stringent regulatory requirements on capital and solvency, indicating the regulators‟ desired future direction.

► The current economic climate is making it difficult for small operators to survive and remain financially sustainable. Interviewees thought that consolidation would allow Takaful operators to compete with the larger, more established conventional insurers and also reduce unhealthy prices wars.

► However, the industry is still growing rapidly which is keeping shareholders interested in their Takaful operations.

Untapped opportunities for Takaful remain: ► Despite competition in certain customer segments and business lines, there are areas where there is

very limited Takaful presence. Family Takaful in the GCC is underpenetrated and effective distribution still remains a challenge.


“ The industry is too young to be forced to consider consolidation. It needs more time to establish itself before it can be decided which players can sustain themselves and which can not”

- GCC Family Takaful Executive

“ Takaful operators face competition from conventional peers as well as each other.”


“ GCC has some new players building up portfolios. However, focus is on running after the same business and not creating new avenues.”





Regulations vary significantly across jurisdictions and continue to evolve: ► A number of regulatory changes were rolled out in different Takaful markets. While most interviewees

agreed that the new regulations were a positive development, there was concern over the increased variances in regulatory regimes in place across jurisdictions. It was felt that such variances in Takaful regulations make it difficult for Takaful operators to function across regions and also lead to confusion for customers and multinational insurers.

► SAMA‟s efforts in creating uniformity in insurance practices in the country were thought to provide an even playing field for insurers and Takaful operators. However, it remains to be seen how Shari‟a scholars and Takaful customers view the Shari‟a compliance of the enforced cooperative model.

► Pakistan has proposed to allow insurers to offer Takaful products through window operations. Whereas this step will enhance market reach of Takaful, it will bring the young pure Takaful operators under considerable competitive pressure.

► Higher solvency and capital requirements being introduced across various jurisdictions is likely to result in better capitalized companies but will impact shareholder profitability in the short term.

► Malaysia has introduced a draft paper on risk-based capital for Takaful firms to strengthen the country‟s governance and risks management practices. Again, the short term profitability is likely to be affected.

► For most interviewees in the GCC, the key regulatory issue for the year was AAOIFI‟s ruling on the sharing of underwriting surplus. The ruling allows sharing of underwriting surplus by management but does not allow for the surplus to be shared with shareholders. Interviewees expressed concern that Takaful shareholders were barred from sharing in underwriting profits but required to indirectly share risk of loss through a mandatory Qard facility. The industry practitioners and regulators are attempting to find a way to implement Takaful‟s conceptual requirements as defined by Shari‟a scholars in a way that is commercially viable for shareholders and considerate of participants interests.



“ Bahrain, Malaysia and Pakistan have comprehensive Takaful regulations in place that take into account the unique requirements of the industry.”


“ Regulations are becoming cumbersome to deal with and regulators need to be cohesive in their approach for the growth and stability of the Takaful market.”


“ Self-sustainability and solvency of the pools is the most crucial regulatory challenge for Takaful.”



37


Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Regulations from the Islamic finance standards setting bodies, AAOIFI & IFSB and the global accounting reporting standards from IASB & IFRS, need greater convergence. This standardization will make it easier for market regulators to provide a framework to regulate the Takaful Operators.


Shortage of Takaful expertise


“ We have outsourced our investment function because of its critical nature at this point and to capitalize on the expertise of our holding company.”

- Malaysian Takaful Executive

“ Retaining skilled employees definitely remains a challenge.”


Human resources risks continue to be high on the executive agenda: ► Takaful continues to suffer from a shortage of human resources with requisite expertise. This risk was

considered important in both the GCC and South East Asia. According to interviewees, human resource risk is particularly acute in specialist fields, including life insurance, risk management and Shari‟a compliance.

► Retention was identified as a key element of this risk, where significant competition for resources has led to aggressive recruitment strategies backed by attractive remuneration.

► Key-person-risk was also identified by a number of interviewees as a key concern. Institutionalization of knowledge and expertise was a priority for these companies as they tried to mitigate these risks.

► Interviewees highlighted that inadequate training of people selling Takaful products is hurting the industry as they are not able to differentiate Takaful versus insurance successfully.

► A number of Shari‟a scholars interviewed raised the concern that the senior management at many Takaful operators came from the insurance industry. Whilst they were professionals with deep understanding of insurance, many were not familiar with the key Shari‟a issues associated with the conventional insurance model. Therefore, they were trying to run Takaful as they would run an insurance company.

“ We have a mixed approach with respect to investment management activities, with some being done in-house and others being out sourced to competent asset management partners.”





Contents

Introduction

Industry Growth


Business Challenges


Appendices

► Regulations from the Islamic finance standards setting bodies, AAOIFI & IFSB and the global accounting reporting standards from IASB & IFRS, need greater convergence. This standardization will make it easier for market regulators to provide a framework to regulate the Takaful Operators.

39


The role of the Regulator

Safeguard consumers’

interests Policyholder Protections

Consumer Education

Orderly growth of the Takaful

industry Appropriate Regulations

Licensing Of New Firms

Promote high standards of behaviour,

competence

Fit & Proper Requirement

Monitor Sales

Process

Take punitive action where

needed

Censure Discipline

Fine

Revoke Licence

Ensure financial stability and

soundness of firms and industry

Solvency I & II

Regulatory Capital

Regulators across the world have different objectives and roles to play in their domestic markets. Most have the common goal of protecting consumers and this translates into a number of the activities Takaful operators have to comply with.

License, Supervise, Inspect


Key issues facing the regulators and industry that will influence the industry growth rate As the industry continues to grow and develop, market regulators and the two bodies that set the Islamic finance industry standards, AAOIFI and IFSB, are facing head on the challenges of implementing a successful and effective regulatory framework.

Industry Growth

Follow Principles of

Shari‟a

Consumer Confidence

Safeguard Shareholder /Contributor

Funds

Sustainable Profitability

Compliance with

Solvency I & II



The role of the Regulator

Safeguard consumers’

interests Policyholder Protections

Consumer Education

Orderly growth of the Takaful

industry Appropriate Regulations

Licensing Of New Firms

Promote high standards of behaviour,

competence

Fit & Proper Requirement

Monitor Sales

Process

Take punitive action where

needed

Censure Discipline

Fine

Revoke Licence

Ensure financial stability and

soundness of firms and industry

Solvency I & II

Regulatory Capital

Regulators across the world have different objectives and roles to play in their domestic markets. Most have the common goal of protecting consumers and this translates into a number of the activities Takaful operators have to comply with.

License, Supervise, Inspect


Key issues facing the regulators and industry that will influence the industry growth rate As the industry continues to grow and develop, market regulators and the two bodies that set the Islamic finance industry standards, AAOIFI and IFSB, are facing head on the challenges of implementing a successful and effective regulatory framework.

Industry Growth

Follow Principles of

Shari‟a

Consumer Confidence

Safeguard Shareholder /Contributor

Funds

Sustainable Profitability

Compliance with

Solvency I & II

41


Source: Ernst &Young analysis, Market Regulators

Comparison of capital requirements and integration with AAOIFI A& IFSB across markets Features UAE Bahrain Saudi Arabia Kuwait Malaysia Qatar

Min

imum

Reg

ulat

ory

Cap

ital

Req

uire

men

t (i

n U

S$m

)

General 28.32 13.2 26.64

Domestic insurance

company 0.4

Foreign insurance

company 0.6

31.85 10

Life 28.32 13.2 26.64 Same as above 31.85 10

Reinsurance 70.8 26.4 66.6 n/a 31.85 20

IFSB Standards IFSB Standards are yet to be considered for adoption by most of the countries. Malaysia is taking lead by incorporating various recommendations of IFSB in its regulations.

AA

OIF

I St

anda

rds

Accounting N Y N N N N

Shari’a N Y N N N N

Governance N Y N N N N


Significant developments over the past 12 monthsThere have been 3 major developments which could have a material impact on the future growth story of the Takaful industry.

AAOIFI begins consultation on Takaful companies allowing performance fees for

Management but not the Shareholders


Management but not the Shareholdersgg






Comparison of capital requirements and integration with AAOIFI A& IFSB across markets Features UAE Bahrain Saudi Arabia Kuwait Malaysia Qatar

Min

imum

Reg

ulat

ory

Cap

ital

Req

uire

men

t (i

n U

S$m

)

General 28.32 13.2 26.64

Domestic insurance

company 0.4

Foreign insurance

company 0.6

31.85 10

Life 28.32 13.2 26.64 Same as above 31.85 10

Reinsurance 70.8 26.4 66.6 n/a 31.85 20

IFSB Standards IFSB Standards are yet to be considered for adoption by most of the countries. Malaysia is taking lead by incorporating various recommendations of IFSB in its regulations.

AA

OIF

I St

anda

rds

Accounting N Y N N N N

Shari’a N Y N N N N

Governance N Y N N N N

Significant developments over the past 12 monthsThere have been 3 major developments which could have a material impact on the future growth story of the Takaful industry.


Management but not the Shareholders


Management but not the Shareholdersgg



43


AAOIFI’s decision on performance fee’s Development 1

Takaful Operators have long been making the case to allow participation in any surplus distributions made on an annual basis. An announcement by AAOIFI in May 2011 indicated that performance fees to the Operator could be paid out of surplus This went some way to allowing the Operators to increase their income, however AAOIFI have been very explicit in stating the beneficiaries can only be the management and not shareholders.

Such an arrangement could have difficult practical implications, namely conflict of interest between management and shareholders, and (ii) shareholders loosing the ability to control management as for at least part of the remuneration „by-passes‟ the shareholders representatives (i.e. the boards of directors).

Aligning performance incentives for Takaful operators with the interests of participants is a difficult task. The concept of risk sharing makes a clear distinction of why surplus distribution should go only to the participants and not the Operator. Takaful Operators sharing in the profit of the participants‟ risk fund (the mutual insurance mechanism) is problematic since the operator is not making donations to the participants‟ fund and is not itself a participant in the mutual assistance scheme. However, the commercial realities dictates that the shareholders money is at risk if the participants‟ fund is in deficit.

Takaful, in the same manner as conventional insurance is a commoditized product and pricing remains an important aspect of the buying decision making process for customers. This has led to some leading Scholar‟s and industry professionals to question the importance of surplus distribution as a proposition to attract customers. There is anecdotal evidence to suggest some Takaful Operators are front loading the contribution they expect from customers, in the hope they will be able to give them a surplus distribution, but in doing so, their pricing becomes uncompetitive. With greater use of actuaries and risk based pricing, Takaful Operators would better placed to offer a reduction at the onset to the customers rather than the promise of any surplus distribution.

For the Takaful Operator, this approach would lessen the emphasis on surplus distribution, avoid conflicts between management and shareholders that may arise from AAOIFI‟s ruling and most importantly, compete against conventional insurance companies for the whole of market GWP based upon price as well as service offerings.

AAOIFI Shari‟a Appellate Bench (SAB) Proposes Surplus Participation To Be Available To The Operators Management

A solution that causes governance issues

Ernst & Young Point of View



Saudi cooperative model Development 2

Recent regulatory changes by SAMA

In mid 2011, the insurance regulators engaged with Cooperatives which market themselves as Takaful operators to discuss their approach to the provision of insurance activities. As a result of these consultations, these operators were asked to fully align to the regulations for the cooperative insurance model by the end of 2011. In response, these operators have had to adjust their internal accounting structures, remove the use of Wakala in their financial reporting and subsequently amend product terms and conditions. These changes are not expected to impact on financial performance of these companies and we understand that approval from respective Shari‟a boards has been forthcoming. However, the impact on customer perception may be more significant, particularly if these changes affect the public‟s perception of Shari‟a compliance.

In summary, the regulations issued by SAMA require licensed cooperative insurers to:

► Segregate shareholders‟ and policyholders‟ funds, with all expenses relating to management of insurance operations charged to the policyholders‟ fund; ► Allocate 10% of the net surplus generated from insurance and investment activities in the policyholders fund to policyholders directly, or in the form of

reduction in premiums for the next year. The remaining 90% of the net surplus shall be transferred to the shareholders‟ income statement; ► 20% of the net shareholders‟ income shall be set aside as a statutory reserve until this reserve amounts to 100% of the paid capital; ► Any deficit in the policyholders‟ fund is borne solely by the shareholders; and ► Adhere to further regulations pertaining to solvency, investments, reinsurance and technical provisions.

Summary of regulations

Claiming to be a Takaful operator was considered a unique selling proposition in the religiously sensitive market of Saudi Arabia, particularly for life and savings insurers. Intervention from the regulator has effectively leveled the playing field and all but removed this perceived source of competitive advantage.

The impact on consumer behaviors is uncertain, particularly given the multifaceted approach cooperatives have taken to addressing Shari‟a compliance (i.e. positioning as a Takaful operator, use of Shari‟a committees). This uncertainty is exaggerated by the low levels of insurance product knowledge held by Saudi consumers relative to mature markets.

What is certain is that these regulatory changes, paired with intense competition across the insurance industry (clearly evident in general insurance and set to emerge in life and savings) will require cooperative insurers to carefully consider their market positioning and propositions. The sensitivity of the customers to Shari‟a compliant solutions remains and awareness of conflicts between Takaful and cooperative models will inevitably grow thereby providing a dilemma that will need addressing by the regulator.


45


Accounting regulations – applicability of IFRS 4 Solvency – treatment of funds 1 2

► In the regions where IFRS is the regulatory accounting framework, there are significant issues arising on the matter of applicability of IFRS framework on Takaful entities, particularly IFRS 4 (Insurance Contracts)

► The list of issues is a long one, including how to tackle the policyholders‟ fund, whether or not to apply IFRS 4 on the company as a whole, how to treat financial instruments, how to treat Al-Qard Al-Hasan, and so on.

► Malaysia is taking a lead by trying to come up with a conceptual basis for applying IFRS 4 to Takaful business, looking at IFRS requirements on consolidation and control. Moreover, it is expected a revised IFRS 4 will be issued in the next couple of years, addressing measurement issues that are not currently dealt with.

► Accounting standards issued by AAOIFI are not being followed generally by the Takaful Operators in most parts of the world. However, applying IFRS without suitable modification is also not suitable for the Takaful business. As a result, the regulators are facing the daunting challenge of setting-up accounting regulations for the Takaful industry.

► A key issue is the solvency for the policyholders‟ funds. IFSB solvency standard and almost all regulatory regimes require the company as a whole to be solvent. This is on the ground that through a mandatory or constructive obligation of payments of Al-Qard Al-Hasan, Takaful Operators (TO) eventually become subject to a similar risk level, as of a conventional insurance company.

► IFSB standard further requires that TOs need to endeavor to ensure that the policyholders‟ funds also become solvent at their own. A balance between the two is probably amongst the most important regulatory challenges that regulators are facing. This is also important to note that Shari‟a scholars throughout the world are discouraging the increasing use of Al-Qard Al-Hasan and hence the need for self-solvent funds is increasing.

► As of today, very few policyholders‟ funds in across most regions cannot be considered to be solvent by themselves, and accordingly, taking this challenge can prove to be an uphill task.

Sources: Discussion with regulators and experts, Ernst & Young research and analysis

Key strategic issues Mitigating key regulatory challenges – the way forward


Preparing for IFRS 4, IFRS 9 & Solvency II Development 3

Numerous regulatory changes coming at once which could require overhaul of data systems

The development of a new standard to replace IFRS 4 Insurance Contracts will profoundly change accounting for insurers, both for insurance contracts issued and for investments held. Under IFRS 4 Phase 1, there were limited changes to statutory accounting rules for insurers. However, the complexity of implementing IFRS 4 Phase II in conjunction with IFRS 9 Financial Instruments is likely to be at the level of a full IFRS conversion or a large Solvency II project, and will significantly impact accounting, processes, systems and people. Furthermore, in the next two years insurance groups will simultaneously have to consider and implement other accounting changes issued by the International Accounting Standards Board (IASB) on topics such as consolidation, leases, fair value measurement and revenue recognition.

Feeder systems like policy administration, claims, investment or pricing systems deliver the input data for actuarial modeling and financial reporting and, therefore, need to be adjusted. Key design decisions must be made around changes to source systems versus building data warehouses. While source system changes are often not feasible due to legacy system landscapes in many insurance companies, designing and building data warehouses for Solvency II purposes takes significant time. Some leading insurance groups are currently in the process of building Solvency II data warehouses, leaving a placeholder to extend the development to cover future IFRS data requirements. Other institutions are currently heading towards interim non-sustainable solutions, building upon existing data tools across the organisation. Actuarial systems (or alternative tools) will have to be significantly enhanced or developed to comply with new measurement rules. Insurance companies developing an internal Solvency II model should analyze to what extent their solution can be enhanced to include IFRS 4. Accounting and reporting systems need to be adjusted to provide new output data, e.g., residual margin, risk margin, effect of changes in assumptions, stress test data and new KPIs. New internal and external reporting templates will also be required, with typical functionality systems that include multiple GAAP accounting, and support changes to the reporting content and structure. Systems also must be ready to provide two different complete sets of financial statements during the transition period.

Main impacts on systems

The size and complexity of IFRS 4 Phase II, IFRS 9 and Solvency II implementation will place enormous demands on insurers and Takaful operators alike, requiring the establishment of significant programme infrastructure that has the ability to deal with and respond to changing requirements and timetables. For Takaful Operators, there is the added complexity of the segregation of the Shareholder fund and the Participant‟s fund for accounting and solvency purposes. In addition, different Operators have different methods of allowing and calculating surplus distribution and this technical calculation requires complex financial modeling which would itself then have to feed into the regulatory requirements. Takaful Operators should have begun the planning by now and must cross reference Solvency II requirements against the best practice promoted by IFSB. The reporting requirements set out by IFRS 4 & IFRS 9 should also be understood at the earliest and the data sources needed to achieve this. Changes to IT applications and infrastructure will require considerable lead times and capital expenditure so it is in the Shareholders interests that Management undertake this planning across all the regulatory changes and then map out an implementation plan to ensure compliance by the deadlines being set out in a cost effective way.




Accounting regulations – applicability of IFRS 4 Solvency – treatment of funds 1 2

► In the regions where IFRS is the regulatory accounting framework, there are significant issues arising on the matter of applicability of IFRS framework on Takaful entities, particularly IFRS 4 (Insurance Contracts)

► The list of issues is a long one, including how to tackle the policyholders‟ fund, whether or not to apply IFRS 4 on the company as a whole, how to treat financial instruments, how to treat Al-Qard Al-Hasan, and so on.

► Malaysia is taking a lead by trying to come up with a conceptual basis for applying IFRS 4 to Takaful business, looking at IFRS requirements on consolidation and control. Moreover, it is expected a revised IFRS 4 will be issued in the next couple of years, addressing measurement issues that are not currently dealt with.

► Accounting standards issued by AAOIFI are not being followed generally by the Takaful Operators in most parts of the world. However, applying IFRS without suitable modification is also not suitable for the Takaful business. As a result, the regulators are facing the daunting challenge of setting-up accounting regulations for the Takaful industry.

► A key issue is the solvency for the policyholders‟ funds. IFSB solvency standard and almost all regulatory regimes require the company as a whole to be solvent. This is on the ground that through a mandatory or constructive obligation of payments of Al-Qard Al-Hasan, Takaful Operators (TO) eventually become subject to a similar risk level, as of a conventional insurance company.

► IFSB standard further requires that TOs need to endeavor to ensure that the policyholders‟ funds also become solvent at their own. A balance between the two is probably amongst the most important regulatory challenges that regulators are facing. This is also important to note that Shari‟a scholars throughout the world are discouraging the increasing use of Al-Qard Al-Hasan and hence the need for self-solvent funds is increasing.

► As of today, very few policyholders‟ funds in across most regions cannot be considered to be solvent by themselves, and accordingly, taking this challenge can prove to be an uphill task.



Sources: Discussion with regulators and experts, Ernst & Young research and analysis47


Shari‟a compliance Governance – Policyholders‟ interest 5 6

► Globally, Shari'a compliance is a crucial issue for Islamic financial institutions, including Islamic insurance / Takaful companies. The role and responsibility of insurance regulators on this issue varies. While a number of regulators are seriously chasing experts and market players to devise and implement standards for insuring Shari'a compliance, others are more prepared to leave it to market forces. Political will and public demand play an important part in the approach taken.

► Regulators are not necessarily formally tasked with supervising Shari‟a compliance in Takaful companies. However, from the point of view of stakeholders, Shari'a non-compliance is a serious matter and potentially damaging to the sector as well as individual institutions, and regulators may reasonably be expected to require a company to have a proper governance framework for Shari'a compliance, even if the regulator does not have explicit responsibility for supervising Shari'a compliance. IFSB standards provide some light on the supervisory role in Shari'a compliance. National practices are likely to continue to vary, as conditions vary country to country and achieving a standard practice on this issue will not be easy.


► Governance for Islamic financial institutions has to address additional concerns compared to their conventional counterparts. The most distinctive additional issue relates Shari'a compliance, but the additional fiduciary responsibilities that arise because of the unique relationship between a TO and the participants is also key.

► Governance in Islamic finance and insurance is not only about following a set of legal principles. It involves following a defined set of values and ethics as well. And when dealing with a diversified set of individuals, trusting you with their moneys and to manage their risks, the additional fiduciary responsibilities are also central. While Shari'a compliance is, and always remains, a great challenge in itself, the associated governance issues pose challenges for regulators, not only because of their inherent importance, but also because of practical difficulty in regulating and supervising them.

► Regulation alone is not sufficient to ensure fair treatment, honesty and trust relationships. Unlike Shari'a compliance, which may or may not be an assigned responsibility of the regulators, ensuring fair and transparent treatment of stakeholders is invariably within the regulators' area of responsibility.

► Good governance mechanisms are essential to address these issues. AAOIFI‟s and IFSB‟s governance and Shari'a governance standards, as well as nationally endorsed codes of conduct and ethics provide guidance. Formal representation of participants or their nominees (as in Sudan) may be beneficial.



Standardization 3

► Throughout the world, a number of Takaful and insurance models are in place, claiming to be Shari‟a-compliant insurance solutions. Even within those models, there can be a number of variants that can be identified between regions and countries, or even those the players within the same market.

► While having flexibility is generally considered to be a benefit, at times it makes other tasks difficult. For the purpose of global acceptability, growth and stability, there is an increasing need of standardizing the models and eliminating differences between them. This is currently a major barrier to cross-border operation and merger and acquisitions activity, limiting access to scale.

► The state of compliance with the only available Shari‟a standard i.e. AAOIFI‟s Shari‟a Standard on Takaful / Islamic Insurance is not satisfactory. Even the regulators and the market players have not considered the same something important to be complied with.

► Accordingly, it is now becoming a severe challenge for the regulators to standardize the models and practices within their markets, as well as cross various jurisdictions for global acceptability.



Risk management

► Whilst risk management is intertwined with capital needs, it also has a broader spectrum. Risk management in Takaful is complicated by the existence of the segregated funds and the fact that the TO is managing the risks on behalf of the participants and therefore needs to stand in their shoes. A TO cannot generally look to participants' funds to meet risks that are those of the TO alone, though as a matter of commercial reality the TO‟s fund are standing behind the participants' risk fund, because of regulatory requirements for Al-Qard Al-Hasan.

► Risk management is a central pillar of Solvency II, and of the IAIS ICP and has also been given due recognition by the IFSB solvency standard. According to IFSB standard, the TOs is managing two distinct sets of risks i.e. the TO‟s fiduciary responsibility to manage the policyholders‟ funds so as to protect the interests of the participants and the risks relating to the TO itself in the process of meeting its financial obligations. The TOs need to have risk management processes and controls in place. Risk computations should be available for both of these distinctive sets of risk.

► The regulators face a real challenge in enforcing risk management measures that are commensurate with the business of Takaful.

4

Sources: Discussion with regulators and experts, Ernst & Young research and analysis48 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


Shari‟a compliance Governance – Policyholders‟ interest 5 6

► Globally, Shari'a compliance is a crucial issue for Islamic financial institutions, including Islamic insurance / Takaful companies. The role and responsibility of insurance regulators on this issue varies. While a number of regulators are seriously chasing experts and market players to devise and implement standards for insuring Shari'a compliance, others are more prepared to leave it to market forces. Political will and public demand play an important part in the approach taken.

► Regulators are not necessarily formally tasked with supervising Shari‟a compliance in Takaful companies. However, from the point of view of stakeholders, Shari'a non-compliance is a serious matter and potentially damaging to the sector as well as individual institutions, and regulators may reasonably be expected to require a company to have a proper governance framework for Shari'a compliance, even if the regulator does not have explicit responsibility for supervising Shari'a compliance. IFSB standards provide some light on the supervisory role in Shari'a compliance. National practices are likely to continue to vary, as conditions vary country to country and achieving a standard practice on this issue will not be easy.


► Governance for Islamic financial institutions has to address additional concerns compared to their conventional counterparts. The most distinctive additional issue relates Shari'a compliance, but the additional fiduciary responsibilities that arise because of the unique relationship between a TO and the participants is also key.

► Governance in Islamic finance and insurance is not only about following a set of legal principles. It involves following a defined set of values and ethics as well. And when dealing with a diversified set of individuals, trusting you with their moneys and to manage their risks, the additional fiduciary responsibilities are also central. While Shari'a compliance is, and always remains, a great challenge in itself, the associated governance issues pose challenges for regulators, not only because of their inherent importance, but also because of practical difficulty in regulating and supervising them.

► Regulation alone is not sufficient to ensure fair treatment, honesty and trust relationships. Unlike Shari'a compliance, which may or may not be an assigned responsibility of the regulators, ensuring fair and transparent treatment of stakeholders is invariably within the regulators' area of responsibility.

► Good governance mechanisms are essential to address these issues. AAOIFI‟s and IFSB‟s governance and Shari'a governance standards, as well as nationally endorsed codes of conduct and ethics provide guidance. Formal representation of participants or their nominees (as in Sudan) may be beneficial.



Standardization 3

► Throughout the world, a number of Takaful and insurance models are in place, claiming to be Shari‟a-compliant insurance solutions. Even within those models, there can be a number of variants that can be identified between regions and countries, or even those the players within the same market.

► While having flexibility is generally considered to be a benefit, at times it makes other tasks difficult. For the purpose of global acceptability, growth and stability, there is an increasing need of standardizing the models and eliminating differences between them. This is currently a major barrier to cross-border operation and merger and acquisitions activity, limiting access to scale.

► The state of compliance with the only available Shari‟a standard i.e. AAOIFI‟s Shari‟a Standard on Takaful / Islamic Insurance is not satisfactory. Even the regulators and the market players have not considered the same something important to be complied with.

► Accordingly, it is now becoming a severe challenge for the regulators to standardize the models and practices within their markets, as well as cross various jurisdictions for global acceptability.



Risk management

► Whilst risk management is intertwined with capital needs, it also has a broader spectrum. Risk management in Takaful is complicated by the existence of the segregated funds and the fact that the TO is managing the risks on behalf of the participants and therefore needs to stand in their shoes. A TO cannot generally look to participants' funds to meet risks that are those of the TO alone, though as a matter of commercial reality the TO‟s fund are standing behind the participants' risk fund, because of regulatory requirements for Al-Qard Al-Hasan.

► Risk management is a central pillar of Solvency II, and of the IAIS ICP and has also been given due recognition by the IFSB solvency standard. According to IFSB standard, the TOs is managing two distinct sets of risks i.e. the TO‟s fiduciary responsibility to manage the policyholders‟ funds so as to protect the interests of the participants and the risks relating to the TO itself in the process of meeting its financial obligations. The TOs need to have risk management processes and controls in place. Risk computations should be available for both of these distinctive sets of risk.

► The regulators face a real challenge in enforcing risk management measures that are commensurate with the business of Takaful.

4

Sources: Discussion with regulators and experts, Ernst & Young research and analysis49


A brief history of Takaful (7th Century – 1995)

1979: Sudan Takaful launched with the establishment of

Islamic insurance company

1980: Saudi Arabia Islamic Arab insurance company formed, later

relocated to UAE

1984: Malaysia Takaful Act 1984

enacted

1991: Bahrain Accounting and Auditing

Organization for Islamic Financial Institutions (AAOIFI) was registered

in Bahrain. AAOIFI issues accounting, auditing, governance

and Shari‟a standards for IFIs

1976: Makkah First international

conference on Islamic economics

1983: Luxembourg Takaful launched with the establishment of Takaful

S.A.

1981: Switzerland Dar Al Maal Al Islami Trust

formed to setup Islamic banks and Takaful companies

7th Century

GC

C &

MEN

A SA

& S

EA

1977: Saudi Arabia Fatwa issued by higher council in favor of Islamic insurance model

Euro

pe

1995: Singapore Takaful launched with the establishment of Syarikat

Takaful

1995: Qatar Takaful launched with the establishment of

Qatar Islamic insurance company

1975 1995

System of Kafala and Akhuwat A system of community self help and financial assistance developed in early 7th century. Emergence of Takaful and mutual risk sharing concepts Between 7th-13th century arrangements were developed in response to perils and risks associated with long-distance trade via caravans or sea voyage that gradually evolved into a system of community self-help and financial assistance which formed basis for modern day Takaful.

1980 1990

1985 Tunisia: Re-Takaful launched

with the establishment of Saudi Takaful Limited

1994: Indonesia

Takaful launched with

the establishment of PT Syarikat

Takaful

1984: Malaysia Takaful launched

with the establishment of Takaful Malaysia

Note: This chart intends to provide timelines of certain important events with reference to evolution of Takaful and the same shall not be construed to include all significant events.

1985 Saudi Arabia OIC Islamic Fiqh Academy

Resolution No. 9 (9/2) prohibited conventional

insurance and allowed Islamic cooperative insurance i.e.

Takaful


Contents

Introduction

Industry Growth


Business Challenges


Appendices

► A history of Takaful ► Business models ► Report methodology and

interviews ► Sources of data and

samples ► References and

Acknowledgments



A brief history of Takaful (7th Century – 1995)

1979: Sudan Takaful launched with the establishment of

Islamic insurance company

1980: Saudi Arabia Islamic Arab insurance company formed, later

relocated to UAE

1984: Malaysia Takaful Act 1984

enacted

1991: Bahrain Accounting and Auditing

Organization for Islamic Financial Institutions (AAOIFI) was registered

in Bahrain. AAOIFI issues accounting, auditing, governance

and Shari‟a standards for IFIs

1976: Makkah First international

conference on Islamic economics

1983: Luxembourg Takaful launched with the establishment of Takaful

S.A.

1981: Switzerland Dar Al Maal Al Islami Trust

formed to setup Islamic banks and Takaful companies

7th Century

GC

C &

MEN

A SA

& S

EA

1977: Saudi Arabia Fatwa issued by higher council in favor of Islamic insurance model

Euro

pe

1995: Singapore Takaful launched with the establishment of Syarikat

Takaful

1995: Qatar Takaful launched with the establishment of

Qatar Islamic insurance company

1975 1995

System of Kafala and Akhuwat A system of community self help and financial assistance developed in early 7th century. Emergence of Takaful and mutual risk sharing concepts Between 7th-13th century arrangements were developed in response to perils and risks associated with long-distance trade via caravans or sea voyage that gradually evolved into a system of community self-help and financial assistance which formed basis for modern day Takaful.

1980 1990

1985 Tunisia: Re-Takaful launched

with the establishment of Saudi Takaful Limited

1994: Indonesia

Takaful launched with

the establishment of PT Syarikat

Takaful

1984: Malaysia Takaful launched

with the establishment of Takaful Malaysia


1985 Saudi Arabia OIC Islamic Fiqh Academy

Resolution No. 9 (9/2) prohibited conventional

insurance and allowed Islamic cooperative insurance i.e.

Takaful


Contents

Introduction

Industry Growth


Business Challenges


Appendices

► A history of Takaful ► Business models ► Report methodology and

interviews ► Sources of data and

samples ► References and

Acknowledgments

51


A brief history of Takaful (1996 – 2012)

GC

C &

MEN

A SA

& S

EA

Euro

pe

1997: Dubai Takaful launched with the establishment of

Dubai Islamic insurance company

2002: Lebanon Takaful launched with the establishment of

Al Aman Takaful

2009: Malaysia

IFSB -8 issued on Takaful governance

2012: Pakistan SECP draft Takaful Rules

2012 allowing window Takaful operations

2008: Britain Takaful launched with the

establishment of Salaam Insurance

2011: Kenya Takaful launched with the

establishment of Takaful Insurance Africa

2010: Brunei Takaful launched with the

establishment of Takaful Brunei Darussalam

2009: Switzerland Swiss-Re entered the re-

Takaful industry

2010: Germany Munich-Re entered the re-

Takaful industry

2007: Germany Hannover-Re entered the re-

Takaful industry

2005: Pakistan SECP issued Takaful

Rules

1996 2012

2010: Malaysia IFSB-11 issued on solvency

for Takaful

2010: Bahrain AAOIFI Islamic

insurance Standards No. 26 issued

2000 2005 2010

2011: Palestine Takaful launched with the

establishment of Al-Takaful Palestinian Insurance

2002: Malaysia Islamic Financial Services

Board (IFSB) inaugurated. IFSB issues global standards and

guiding principles for IFIs

2003: Pakistan Takaful launched with the establishment of

First Takaful Company incorporated

1999: Sri Lanka Takaful launched with the establishment of

Amana Takaful

2005: Bahrain Bahrain Monetary Authority

Rules enacted which included rules for Takaful

companies

2005:Saudi Arabia SAMA regulations for cooperative insurance supervision enacted

2009: Malaysia IFSB -10 issued on

Shari‟a governance principles




Notes

1. Generally this model, as prevalent in Malaysia, is not accepted by scholars from other regions. Critics of the Mudaraba model argue that, the technical result should not be considered a profit and the Takaful operator does not therefore, have any right to it. Additionally, sharing surplus fails the overall concept of Takaful and makes it a remunerative arrangement. Any deficit, however, relates to the Takaful fund which is normally covered through provision of Qard Al-Hasan by the Takaful operator. As a result, the overall resemblance with conventional insurance is increased. Moreover, Mudaraba is basically an instrument for business and investment per se and using it as a main Takaful component, brings Shari’a complications.

2. This illustration covers the risk pooling and risk sharing part only.

Contributions

Claims

Surplus

Mudarib‟s Share

Qard Al-Hasan

Return of Qard

Re-Takaful Contributions

Re-Takaful Claims

Surplus (as per policy)

Source: Ernst and Young analysis

Business models: Mudaraba

(Percentage share of underwriting results and total surplus including investment returns – in case of surplus only)

(in case of deficits)

(in case of surplus)

Re-Takaful Commission

Takaful Company / Operator

Policyholders / Participants

Takaful Fund / Policyholders’

Fund

Funds invested in Shari‟a compliant

opportunities – adequate

reserves and provisions

created

Re-Takaful Fund

(through Re-Takaful

Operator)

The policyholders are considered

to be the capital providers of the

Takaful fund. The shareholders

are designated as the Mudarib /

entrepreneur whose task is the

management of investment and

underwriting functions. Net

surplus in the Takaful pool is

shared with the Takaful operator

as Mudarib as per an agreed ratio

considering it to be its share of

profit / surplus against both, good

investment management and

prudent underwriting.


A brief history of Takaful (1996 – 2012)

GC

C &

MEN

A SA

& S

EA

Euro

pe

1997: Dubai Takaful launched with the establishment of

Dubai Islamic insurance company

2002: Lebanon Takaful launched with the establishment of

Al Aman Takaful

2009: Malaysia

IFSB -8 issued on Takaful governance

2012: Pakistan SECP draft Takaful Rules

2012 allowing window Takaful operations

2008: Britain Takaful launched with the

establishment of Salaam Insurance

2011: Kenya Takaful launched with the

establishment of Takaful Insurance Africa

2010: Brunei Takaful launched with the

establishment of Takaful Brunei Darussalam

2009: Switzerland Swiss-Re entered the re-

Takaful industry

2010: Germany Munich-Re entered the re-

Takaful industry

2007: Germany Hannover-Re entered the re-

Takaful industry

2005: Pakistan SECP issued Takaful

Rules

1996 2012

2010: Malaysia IFSB-11 issued on solvency

for Takaful

2010: Bahrain AAOIFI Islamic

insurance Standards No. 26 issued

2000 2005 2010

2011: Palestine Takaful launched with the

establishment of Al-Takaful Palestinian Insurance

2002: Malaysia Islamic Financial Services

Board (IFSB) inaugurated. IFSB issues global standards and

guiding principles for IFIs

2003: Pakistan Takaful launched with the establishment of

First Takaful Company incorporated

1999: Sri Lanka Takaful launched with the establishment of

Amana Takaful

2005: Bahrain Bahrain Monetary Authority

Rules enacted which included rules for Takaful

companies

2005:Saudi Arabia SAMA regulations for cooperative insurance supervision enacted

2009: Malaysia IFSB -10 issued on

Shari‟a governance principles


Source: Ernst and Young analysis53


Contributions

Claims

Surplus

Mudarib‟s Share (for investment

management – in case of investment profits)

Qard Al-Hasan

(in case of deficit)

Upfront Wakala Fee (for underwriting activity – irrespective of surplus

or deficit)

Notes: 1. There is growing consensus that the combined model be considered leading practice. It is now mandatory in a number of markets including Bahrain and Malaysia. 2. Critics of the combined model claim that there is a conflict of interest between the operator which seeks to maximize shareholder profits and the participants which seek to collectively and sustainably

indemnify themselves from risk and benefit from any surplus that is created. Furthermore, the Shari'a board is tasked with representing the rights of participants, but this feature of Islamic corporate governance does not provide input at the executive decision making level.


Return of Qard (in case of surplus)

Business models: Combined (Hybrid)





Fund




created

Re-Takaful Fund

(through Re-Takaful

Operator)

This model is a combination of

Mudaraba and Wakala model,

where Wakala contract is used for

underwriting activities while

Mudaraba contract is adopted for

investment management activities


Re-Takaful Claims




Notes: 1. Generally, all Takaful fees are preapproved as limits by the Shari'a board and vary between general and family offerings. The actual fees charged to participants is at the discretion of management. For

example, if the Shari’a board approves a Wakala fee of up to 40% the operator is permitted to charge anything equal to or below that number. 2. In a variation of such an arrangement, the Takaful operator is also entitled to variable returns (or incentives) based on investment returns or underwriting surplus, or both. 3. This illustration covers the risk pooling and risk sharing part only.

Contributions

Claims

Surplus

Upfront Wakala Fee

(both, for underwriting activity and investment

management – irrespective of surplus

or deficit)

Qard Al-Hasan

(in case of deficits)

Return of Qard

(in case of surplus)

Business models: Wakala


Re-Takaful Fund

(through Re-Takaful

Operator)




Fund




created

Fee driven Wakala contract in

which policyholders collectively

own the Takaful pool while the

operator manages the investment

and underwriting function against

a known fixed fee irrespective of

results.

The surplus in the fund relates to

the participants.


Re-Takaful Claims



Source: Ernst and Young analysis54 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


Contributions

Claims

Surplus



Qard Al-Hasan

(in case of deficit)


or deficit)

Notes: 1. There is growing consensus that the combined model be considered leading practice. It is now mandatory in a number of markets including Bahrain and Malaysia. 2. Critics of the combined model claim that there is a conflict of interest between the operator which seeks to maximize shareholder profits and the participants which seek to collectively and sustainably

indemnify themselves from risk and benefit from any surplus that is created. Furthermore, the Shari'a board is tasked with representing the rights of participants, but this feature of Islamic corporate governance does not provide input at the executive decision making level.



Business models: Combined (Hybrid)





Fund




created

Re-Takaful Fund

(through Re-Takaful

Operator)

This model is a combination of

Mudaraba and Wakala model,

where Wakala contract is used for

underwriting activities while

Mudaraba contract is adopted for

investment management activities


Re-Takaful Claims





Notes: 1. At times the investment management function is also based on Wakala or Wakalat Al Istithmar 2. Generally the Waqf cede money is an immaterial amount. 3. A few scholars argue that Waqf must be created on immovable property. 4. Scholars supporting Waqf model argue that creation of Waqf ensures real Tabarru. This is because in this model, the ownership of the participants over Takaful fund is not created. Hence, the issues of Zakat and inheritance etc. out of

Takaful fund are avoided. Additionally, the second Tabarru i.e. loss / claim payments become fully independent of the first Tabarru. This avoids a small link between the two Tabarru transactions as prevalent in other models. 5. This illustration covers the risk pooling and risk sharing part only.

Contributions

Claims

Surplus (discretionary)


or deficit)

Waqf Cede Money



Qard Al-Hasan (in case of deficits)


Business models: Wakala Waqf


The Wakala Waqf model has

proved popular in Pakistan. It

mandates creation of a legal entity

through an initial donation from

the shareholders to a Waqf for the

benefit of the participants. Only

the investment and returns from

this fund, (and not the Waqf

amount itself), may be used to pay

claims. Other characteristics are

similar to combined (or at times,

Wakala) model.




Fund




created

Re-Takaful Fund

(through Re-Takaful

Operator)


Re-Takaful Claims



Source: Ernst and Young analysis56 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


Notes: 1. For the purpose of this report cooperative model is represented separately from Takaful, where ever possible. 2. This illustration covers the risk pooling and risk sharing part only.

Premiums

Claims

Surplus

(Minimum of 10%. Can be more at the managements

discretion)

Surplus (90%)

Deficit (in full)

Reinsurance Premiums

Reinsurance Claims

Business models: Cooperative Insurance



Cooperative model is the only

permissible model in Saudi

Arabia.

The regulator does not allow Qard

facility or charging of Wakala fee.

However, a percentage of

premium is allowed to be

deducted as shareholder income

if net surplus is sufficient

Cooperative Insurance

Company’s Shareholders


Policyholders’ Fund

(Fund managed, controlled

completely by the cooperative

insurance company and no separate

legal status of the Fund exists although by law it is required to be separated

from shareholder

funds)

Funds invested in various

investment opportunities –

adequate reserves and

provisions created

Re-Insurance Company



* Note: See subsequent page on regional characteristics.

Business models: comparison of features From the investors‟ perspective, the four Takaful models entail a few differences, and significant commonalities

Mudaraba Wakala Combined Wakala Waqf

Share of technical results N/A (see “share of surplus” below)

None (fixed Wakala fee without any consideration to the technical results – certain variants of Wakala / Combined model, however, include an incentive)

Share of investment result N/A (see “share of surplus” below)

None (at times include an incentive profit)

Agreed profit sharing ratio

Agreed profit sharing ratio (at times a fixed fee

or a fixed fee with incentive profit)

Share of surplus (technical and investment results) Percentage of surplus None

Loss on investments None (unless found negligent)

Operating expenses Borne solely by shareholders‟ fund; direct expenses may be passed on to the policyholders‟ fund

Investment instruments Acceptable Shari‟a compliant instruments

Deficit in the policyholders’ fund Al-Qard Al-Hasan provided to policyholders‟ fund

Creation of Takaful fund Policyholders‟ contributions

Initial Waqf ceding by shareholders and

policyholders‟ contributions

Liquidation of policyholders’ fund

Accrue to policyholders only, except provisions and reserves that have to be paid in charity

Waqf cede money must go to another Waqf;

balances to be paid in charity or disbursed amongst participants

Prevalent in countries Partially in Malaysia,

Brunei and Saudi Arabia*

Sudan, UAE and United Kingdom

Bahrain, Malaysia and Sudan

Pakistan and South Africa




Notes:

1. Wakala Waqf model may be formed by Wakala on both ends.

2. Only Sudan’s model is an exception whereby policyholders have been provided some rights.

3. At times in Wakala and combined models, there is a surplus sharing option for shareholders in various forms for incentive purposes.

Business models: strengths and constraints Each model has its own inherent strengths and constraints

Characteristics Mudaraba Wakala Combined Wakala Waqf

Stre

ngth

s

► Comparatively simple model

► Enhanced profitability as the operator shares in the surplus

► Excessive risk taking in investments mitigated as no upside exists for the operator

► Two sources of revenues – Wakala from contributions and Mudaraba from investments

► The provision of Al-Qard Al-Hasan partially limits excessive risk taking by operators

► Incentive for prudent underwriting / /

Con

stra

ints

► Shareholders are permitted to share in the technical results

► Legal framework support is limited and complicated

► The operator has incentive to take on excessive risk in investments (partially mitigated through Al-Qard Al-Hasan) /

► Direct financial incentives to improve technical results are limited (indirect benefits are realized through distributions to participants and through increased fund size)

► No system of corporate governance that effectively addresses and represents the rights of the participants

► No accounting policy which addresses issues of equitable distribution of surplus over time given varied entry and exit by participants


59


Notes: * There are no conventional commercial insurance operators in Saudi Arabia

Regional characteristics and comparison The business execution of Takaful varies significantly between key markets

Characteristics Saudi Arabia Malaysia Bahrain UAE

► Started in 1986 1985 1979 1995

► Windows allowed *N/A N/A N/A N/A

► Model used Cooperative model Mudaraba / Combined model Combined model Combined Model / Wakala Model

► Surplus sharing with Shareholders Yes - 90% Yes - -

► Regulator Saudi Arabian Monetary Agency Bank Negara Malaysia Central Bank of Bahrain The UAE Insurance Authority

► Regulations

Law On Supervision of Cooperative

Insurance Companies

Takaful Act 1984 Central Bank of Bahrain and

Financial Institutions Law 2006

Federal Law Number 9

► Separate Participants Investment Account (PIA) for Family Takaful

- - Yes Yes

► Special characteristics / Comments

Certain companies endeavor to follow Takaful principles and have

appointed Shari‟a boards to supervise business operations,

including investments and ensure compliance with Islamic law.

Situation will change with recent changes in regulations.

New companies are following combined model.

Benefits from both the Wakala and Mudaraba models can be enjoyed

by the operators. CBB requires each Takaful operator to have a

Shari‟a Supervisory Board.

Benefits from both the Wakala and Mudaraba models can be enjoyed

by the operators.

Source: Ernst and Young analysis Source: Ernst and Young analysis



Regional characteristics and comparison The business execution of Takaful varies significantly between key markets

Characteristics Indonesia Kenya Sudan Pakistan

► Started in 1994 2008 1979 2003

► Windows allowed Yes Yes - No *

► Model used Wakala / Mudaraba Combined model Wakala / Combined model Wakala Waqf model

► Surplus sharing with Shareholders Yes Yes - Yes

► Regulator

The Capital Market and Financial Institution Supervisory Board

(BAPEPAM)

Insurance Regulator Authority - Securities and Exchange Commission of Pakistan

► Regulations Article 3 Minister of Finance Decree No:503/KMK.01/1997 Insurance Act of 2009 Insurance Act 2003 Insurance Ordinance 2000,

Takaful Rules 2005

► Separate PIA for Family Takaful Yes Yes - Yes

► Special characteristics / Comments - -

Takaful companies in Sudan are founded as shareholding companies but operate the

basic system of Takaful.

The Takaful fund is created in form of charitable trust fund

i.e. Waqf.

Source: Ernst and Young analysis Source: Ernst and Young analysis61


Source: Ernst & Young research and analysis

Key features of IFSB solvency standard compared with leading practices

IFSB Solvency Standard Solvency II [Future good practices]

Issued by Islamic Financial Services Board Commission of the European Communities

Effective from December 2010 January 2014

Approach Total balance sheet approach Proposes the adoption of total balance sheet approach

Whereas traditionally insurance solvency requirements have been based on simple metrics such as percentages of premiums or of actuarial reserves, this approach is now widely regarded as inadequate. Solvency requirements based on risk are now seen as a core element of an effective regulatory framework. And many countries now use such an approach (including several where Takaful is also present). The International Association of Insurance Supervisors endorses risk-based solvency in its Insurance Core Principles and its Common Structure for the Assessment of Insurance Solvency. In addition, it is now widely recognized that capital is not a sufficient guarantee of solvency and that whilst capital is a vital pillar of a solvency regime, proper risk management and governance, and adequate disclosure to regulators and to the public, are also essential elements. The 'three-pillar' approach to solvency supervision, familiar from banking regulation, is now widely seen as necessary for insurance as well. Among different national approaches to the implementation of the Insurance Core Principles, proceeding at different paces, the European Union's Solvency II project, due for implementation in 2014, stands out as cutting-edge. Although Solvency II is not unique and a number of countries are revising their solvency frameworks along similar lines, Solvency II is widely known and we have selected this as a leading example of good practice, against which to compare the IFSB Solvency Standard.

Source: Ernst and Young research and analysis62 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE




IFSB Solvency Standard Solvency II

[Future good practices]

Solvency control levels

Solvency control levels should be established at the respective Takaful and shareholders‟ funds. The solvency requirements should be based on the following four concepts: - minimum capital requirement (MCR) - prescribed capital requirement (PCR) - minimum target capital (MTC) - prescribed target capital (PTC)

Proposes Minimum Capital Requirement (MCR) and Solvency Capital Requirement (SCR)

Assessment of solvency resources

Criteria be established for assessing the quality and suitability of solvency resources in the Takaful and shareholders‟ funds to absorb losses in different stages

Proposes the asset valuation method(s) adopted internationally

Risk management framework Takaful undertakings must have separate risk adjusted computation and assessment

This framework should enable risk profiling, risk qualification and assessment, risk warning, risk supervision and disclosure

Supervisory reviews

Supervisory review process is to assess for each undertaking that adequate risk management arrangements are in place through which the TO can, and does, monitor, measure, report and control the management of the assets and liabilities

Supervisory reviews from designated qualified party. Such review will enable supervisory intervention if an insurer‟s capital does not sufficiently buffer the risk

Disclosure of material information

Information regarding the solvency requirements for a Takaful undertaking should be publicly disclosed to enhance market discipline and the accountability of the TO

Solvency II requires the production of following documents: - Solvency and Financial Condition Report - Report to Supervisors (RS)




IFSB Solvency Standard Solvency II [Future good practices]

Issued by Islamic Financial Services Board Commission of the European Communities

Effective from December 2010 January 2014

Approach Total balance sheet approach Proposes the adoption of total balance sheet approach

Whereas traditionally insurance solvency requirements have been based on simple metrics such as percentages of premiums or of actuarial reserves, this approach is now widely regarded as inadequate. Solvency requirements based on risk are now seen as a core element of an effective regulatory framework. And many countries now use such an approach (including several where Takaful is also present). The International Association of Insurance Supervisors endorses risk-based solvency in its Insurance Core Principles and its Common Structure for the Assessment of Insurance Solvency. In addition, it is now widely recognized that capital is not a sufficient guarantee of solvency and that whilst capital is a vital pillar of a solvency regime, proper risk management and governance, and adequate disclosure to regulators and to the public, are also essential elements. The 'three-pillar' approach to solvency supervision, familiar from banking regulation, is now widely seen as necessary for insurance as well. Among different national approaches to the implementation of the Insurance Core Principles, proceeding at different paces, the European Union's Solvency II project, due for implementation in 2014, stands out as cutting-edge. Although Solvency II is not unique and a number of countries are revising their solvency frameworks along similar lines, Solvency II is widely known and we have selected this as a leading example of good practice, against which to compare the IFSB Solvency Standard.

63


IFSB solvency standard – key requirements

Source: IFSB - Standard on Solvency Requirements for Takaful (Islamic Insurance) Undertakings ]

Key

feat

ures

Balance sheet approach

It ensures that risks are appropriately recognized and consistently valued and identifies the interdependence between assets, liabilities, regulatory solvency requirements for Participants‟ Risk Fund (PRF) and the shareholders‟ funds of the Takaful Operator (TO).

Solvency resources in the

Takaful and shareholders’

funds be adequate to meet their respective financial

obligations

The TO should endeavour, over time, to bring the reserves in a PRF to a level at which the fund becomes self-sustaining with sufficient resources to meet solvency requirements without the need to rely on Al-Qard Al-Hasan.

Solvency control levels should be

established at the respective Takaful and shareholders’

funds

Regulatory framework should either define, or allow discretion to supervisory authorities to determine the control level applicable to the PRF.

Criteria be established for assessing the

quality and suitability of

solvency resources in the

Takaful and shareholders’

funds to absorb losses in different

stages

Supervisory authority may choose a variety of approaches which categorize solvency resources into different quality classes and apply certain limits; ii. approaches which rank capital elements on the basis of the identified quality characteristics; or iii. approaches which apply individual restrictions or charges where necessary.

Takaful undertakings must have separate risk

adjusted computation and

assessment

The TOs might be seen as managing two distinct sets of risks.

Supervisory review is to

assess for each undertaking that

adequate risk management

arrangements are in place through

which the TO monitor, measure, report and control the management of the assets and

liabilities

Solvency requirements regime should place emphasis on the TO having appropriate controls in place and taking great care to ensure that all persons or entities with operational and oversight responsibilities act in the best interests of Takaful participants and beneficiaries.

Information regarding the

solvency requirements for a

Takaful undertaking

should be publicly disclosed to

enhance market discipline and the accountability of

the TO

A TO should describe the overview of the risk management framework for identifying, measuring, monitoring and controlling relevant risks in maintaining the solvency control level in its annual report.

Effe

cts

Solvency requirements

Governance framework

This standard refers to and suggests that the same should be read together with IFSB-8 Guiding Principles on Governance for Takaful (Islamic Insurance) Undertakings.

The total balance sheet approach must address the clear separation of PRF and the shareholders‟ funds of the TO.

The supervisory authorities would then be able to request the TO to draw down the Al-Qard Al-Hasan facility to the PRF immediately once the control level is breached in order to expedite the restoration of the required solvency control level.

The first set relates to the TO‟s fiduciary responsibility to manage the PRFs under its management so as to protect the interests of the Takaful participants.

The second set of risks relates to the TO itself in the process of meeting its financial obligations.

Source: IFSB - Standard on Solvency Requirements for Takaful (Islamic Insurance) Undertakings ]64 THE WORLD TAKAFUL REPORT 2012: InDUsTRy gROWTH AnD PREPARIng FOR REgULATORy CHAngE


MENA Ashar Nazim +973 1751 2808 [email protected]

MENA Abid Shakeel +973 1751 2916 [email protected]

Bahrain Noman Mubashir +973 1751 2818 [email protected] Kuwait Walid Al Osaimi +966 5000 0938 [email protected] Qatar Robert Abboud +974 4573 444 [email protected]

Saudi Arabia Abdulaziz Al Sowailim +966 1215 9438 [email protected]

UAE Michael Hasbani + 971 505515628 [email protected]

Pakistan / Afghanistan Omar Mustafa Ansari + 92 21 3565 0007 [email protected] China Dong Xiang Bo +86 10 5815 2289 [email protected] Indonesia Yasir Yasir +62 21 5289 4171 [email protected] Malaysia Brandon Bruce +603 7495 8762 [email protected] Russia Jahangir Juraev +7 727 259 7206 [email protected] France Jean-Paul Farah +33 1 46 93 64 15 [email protected] Luxembourg Pierre Weimerskirch +352 42 124 8312 [email protected] United Kingdom James Smith +44 7920 701102 [email protected] United Kingdom Mark Stanley +44 7557 089884 [email protected]

Ernst & Young’s Islamic Financial Services Group

Mid

dle

Eas

t & N

orth

Afri

ca

Asi

a P

acifi

c E

urop

e

65


Sample of Takaful operators and insurance companies Takaful operators: Qatar ► Qatar Islamic Insurance Company

Bahrain ► Takaful International Company

Malaysia ► Allied Cooperative Insurance Group E C ► CIMB Aviva Takaful Berhad ► Etiqa Takaful Berhad ► Hong Leong Tokio Marine Takaful Berhad ► Takaful Ikhlas Sdn. Bhd.

UAE ► Abu Dhabi National Takaful Company PSC ► Dar Al Takaful ► Methaq Takaful Insurance Company ► Islamic Arab Insurance Company (Salama) ► Takaful Al Emarat - Insurance

Bahrain ► Al Ahlia Insurance ► Bahrain Kuwait Insurance Company ► Bahrain National Insurance

Malaysia ► Lonpac Insurance Bhd ► Allianz Life Insurance ► PacificMas Berhad ► Manulife Malaysia ► MNRB Holdings Berhad ► Jerneh Asia Berhad ► Kurnia Asia Berhad ► MAA Holdings Berhad ► Pacific & Orient Berhad

UAE ► Abu Dhabi National Insurance Company ► Al Ain Ahlia Insurance Company ► Al Buhaira National Insurance Company ► Al Dhafra Insurance Company ► Al Fujairah National Insurance Company ► Al Khazna Insurance Company ► Al Sagr National Insurance Company ► Al Wathba National Insurance Company ► Arab Orient Insurance Company ► Arabian Scandinavian Insurance Company ► Dubai Insurance Company ► Emirates Insurance Company ► Green Crescent Insurance Company ► National General Insurance ► Oman Insurance Company ► Sharjah Insurance Company ► Union Insurance Company

Cooperative insurance companies:

Saudi Arabia ► Allied Cooperative Group ► Sanad for Cooperative Insurance and Reinsurance ► Alahli Takaful Company ► Company for Cooperative Insurance - Tawuniya ► SABB Takaful ► Saudi Indian Company for Cooperative Insurance ► Saudi IAIC Cooperative Insurance Company ► Saudi Fransi Cooperative Insurance Company ► Saudi Arabian Cooperative Insurance Company ► AXA Cooperative Insurance Company ► Al Sagr Cooperative Insurance Company ► Amana Cooperative Insurance Company ► Arabian Shield Cooperative Insurance Company ► BUPA Arabia for Cooperative Insurance ► Gulf General Cooperative Insurance Company ► Gulf Union Cooperative Insurance Company

Insurance companies: Kuwait ► Al Ahleia Insurance Company ► Gulf Insurance Company ► Warba Insurance Company Qatar ► Qatar Insurance Company ► Doha Insurance Company


Report methodology and our interviews

Business Risks Radar ► The Ernst & Young risk radar is a simple device that allows us to

present the top 6 business risks in the Takaful industry. ► The risks at the center of the radar are those that the individuals

we interviewed thought would pose the greatest challenge to the industry in 2012.

Business Risk Categories ► The radar is divided into four sections that correspond to the Ernst

& Young Risk Universe™ model. ► Compliance threats originate in politics, law, regulation or

corporate governance; ► Financial threats stem from volatility in markets and the real

economy; ► Strategic threats are related to customers, competitors and

investors; and ► Operational threats impact the processes, systems, people and

overall value chain of a business.

Anonymity and Quotes ► All interviewees were assured of anonymity and minutes were

documented during our discussions. ► Quotations have been used to support arguments made in the

report.

Survey Methodology ► Our survey sought to identify key trends and business risks for

the global Takaful industry through in-depth interviews with executives, experts and industry observers.

► These discussions were used to gauge business sentiment and identify key areas for inquiry.

► Interviews were conducted in February and March of 2012. A total of 11 interviews (and surveys excluding informal discussion) were conducted in five different countries by Ernst & Young staff.

► Interviews centered on three main topics of discussion, namely: ► Business confidence, demand and supply; ► Mega trends; and ► Business risks .

Business Risk Ratings ► Ernst & Young subject matter experts from the Middle East,

Asia and Europe developed a list of Takaful business risks and contributing factors.

► All interviewees were provided with a list of business risks and requested to rate each to reflect its severity to their respective business over the coming 12 months. Interviewees were also asked to add any additional risks they felt were important.

► The results of this rating process were tabulated and a relative ranking assigned to each. This rank formed the basis for our comparative study with 2011 results.



Sample of Takaful operators and insurance companies Takaful operators: Qatar ► Qatar Islamic Insurance Company

Bahrain ► Takaful International Company

Malaysia ► Allied Cooperative Insurance Group E C ► CIMB Aviva Takaful Berhad ► Etiqa Takaful Berhad ► Hong Leong Tokio Marine Takaful Berhad ► Takaful Ikhlas Sdn. Bhd.

UAE ► Abu Dhabi National Takaful Company PSC ► Dar Al Takaful ► Methaq Takaful Insurance Company ► Islamic Arab Insurance Company (Salama) ► Takaful Al Emarat - Insurance

Bahrain ► Al Ahlia Insurance ► Bahrain Kuwait Insurance Company ► Bahrain National Insurance

Malaysia ► Lonpac Insurance Bhd ► Allianz Life Insurance ► PacificMas Berhad ► Manulife Malaysia ► MNRB Holdings Berhad ► Jerneh Asia Berhad ► Kurnia Asia Berhad ► MAA Holdings Berhad ► Pacific & Orient Berhad

UAE ► Abu Dhabi National Insurance Company ► Al Ain Ahlia Insurance Company ► Al Buhaira National Insurance Company ► Al Dhafra Insurance Company ► Al Fujairah National Insurance Company ► Al Khazna Insurance Company ► Al Sagr National Insurance Company ► Al Wathba National Insurance Company ► Arab Orient Insurance Company ► Arabian Scandinavian Insurance Company ► Dubai Insurance Company ► Emirates Insurance Company ► Green Crescent Insurance Company ► National General Insurance ► Oman Insurance Company ► Sharjah Insurance Company ► Union Insurance Company

Cooperative insurance companies:

Saudi Arabia ► Allied Cooperative Group ► Sanad for Cooperative Insurance and Reinsurance ► Alahli Takaful Company ► Company for Cooperative Insurance - Tawuniya ► SABB Takaful ► Saudi Indian Company for Cooperative Insurance ► Saudi IAIC Cooperative Insurance Company ► Saudi Fransi Cooperative Insurance Company ► Saudi Arabian Cooperative Insurance Company ► AXA Cooperative Insurance Company ► Al Sagr Cooperative Insurance Company ► Amana Cooperative Insurance Company ► Arabian Shield Cooperative Insurance Company ► BUPA Arabia for Cooperative Insurance ► Gulf General Cooperative Insurance Company ► Gulf Union Cooperative Insurance Company

Insurance companies: Kuwait ► Al Ahleia Insurance Company ► Gulf Insurance Company ► Warba Insurance Company Qatar ► Qatar Insurance Company ► Doha Insurance Company


Report methodology and our interviews

Business Risks Radar ► The Ernst & Young risk radar is a simple device that allows us to

present the top 6 business risks in the Takaful industry. ► The risks at the center of the radar are those that the individuals

we interviewed thought would pose the greatest challenge to the industry in 2012.

Business Risk Categories ► The radar is divided into four sections that correspond to the Ernst

& Young Risk Universe™ model. ► Compliance threats originate in politics, law, regulation or

corporate governance; ► Financial threats stem from volatility in markets and the real

economy; ► Strategic threats are related to customers, competitors and

investors; and ► Operational threats impact the processes, systems, people and

overall value chain of a business.

Anonymity and Quotes ► All interviewees were assured of anonymity and minutes were

documented during our discussions. ► Quotations have been used to support arguments made in the

report.

Survey Methodology ► Our survey sought to identify key trends and business risks for

the global Takaful industry through in-depth interviews with executives, experts and industry observers.

► These discussions were used to gauge business sentiment and identify key areas for inquiry.

► Interviews were conducted in February and March of 2012. A total of 11 interviews (and surveys excluding informal discussion) were conducted in five different countries by Ernst & Young staff.

► Interviews centered on three main topics of discussion, namely: ► Business confidence, demand and supply; ► Mega trends; and ► Business risks .

Business Risk Ratings ► Ernst & Young subject matter experts from the Middle East,

Asia and Europe developed a list of Takaful business risks and contributing factors.

► All interviewees were provided with a list of business risks and requested to rate each to reflect its severity to their respective business over the coming 12 months. Interviewees were also asked to add any additional risks they felt were important.

► The results of this rating process were tabulated and a relative ranking assigned to each. This rank formed the basis for our comparative study with 2011 results.

67


Ernst & Young

Assurance Tax Transactions Advisory

About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. The MENA practice of Ernst & Young has been operating in the region since 1923. For over 85 years, we have evolved to meet the legal and commercial developments of the region. Across MENA, we have over 4,000 people united across 18 offices and 13 Arab countries, sharing the same values and an unwavering commitment to quality. For more information, please visit www.ey.com/mena © 2012 Ernst & Young. All Rights Reserved This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.


Sources ► Global Insight – Comparative World Overview Tables ► Middle East Insurance Review ► World Islamic Insurance Directory (WIID) 2008 – 2011 [Author: Takaful Re] ► Saudi Arabian Monetary Agency (SAMA) Insurance Review ► Annual Insurance Statistics – Insurance Authority (UAE) ► CBB Insurance Annual Reviews ► Annual Insurance Statistics 2011 - Bank Negara Malaysia ► Companies Annual Reports (published information for Takaful operators and insurance companies) ► Alpen Capital Report (GCC Insurance Industry 2011) ► Pew Forum

Ernst & Young’s Project Team Ashar Nazim Omar Mustafa Ansari Abid Shakeel Muhammad Shahzad Khan Mehdi Zaidi Rima Farooq Noman Mubashir Mark Stanley Danish Iqbal James Smith For questions or comments, please contact : Noman Mubashir: [email protected]

References and acknowledgements



Ernst & Young

Assurance Tax Transactions Advisory

About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. The MENA practice of Ernst & Young has been operating in the region since 1923. For over 85 years, we have evolved to meet the legal and commercial developments of the region. Across MENA, we have over 4,000 people united across 18 offices and 13 Arab countries, sharing the same values and an unwavering commitment to quality. For more information, please visit www.ey.com/mena © 2012 Ernst & Young. All Rights Reserved This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.


Sources ► Global Insight – Comparative World Overview Tables ► Middle East Insurance Review ► World Islamic Insurance Directory (WIID) 2008 – 2011 [Author: Takaful Re] ► Saudi Arabian Monetary Agency (SAMA) Insurance Review ► Annual Insurance Statistics – Insurance Authority (UAE) ► CBB Insurance Annual Reviews ► Annual Insurance Statistics 2011 - Bank Negara Malaysia ► Companies Annual Reports (published information for Takaful operators and insurance companies) ► Alpen Capital Report (GCC Insurance Industry 2011) ► Pew Forum

Ernst & Young’s Project Team Ashar Nazim Omar Mustafa Ansari Abid Shakeel Muhammad Shahzad Khan Mehdi Zaidi Rima Farooq Noman Mubashir Mark Stanley Danish Iqbal James Smith For questions or comments, please contact : Noman Mubashir: [email protected]

References and acknowledgements

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©2012The World Takaful Report is documented for the World Takaful Conference.No part of this document may be republished, distributed, retransmitted, cited or quoted without the prior written permission from MEGA or Ernst & Young.

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