August 3, 2009

Presentation on Takaful InvestmentsDr. Omar Clark Fisher, PhD Takaful

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KHIDRSOLUTIONSAgendaAgenda

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•• Investment Objectives & Asset Classes permitted Investment Objectives & Asset Classes permitted under Shariahunder Shariah

•• Examples of Islamic Assets available for Takaful Examples of Islamic Assets available for Takaful CompaniesCompanies

•• What Takaful companies are doing nowWhat Takaful companies are doing now•• What rating methodology says about TakafulWhat rating methodology says about Takaful•• Challenges Ahead for Asset managementChallenges Ahead for Asset management•• ConclusionsConclusions

Disclaimer

The opinions herein are those of the author and do not necessarily reflect those of Unicorn Investment Bank BSC nor t’azur bsc nor does this presentation contain any investment advice or solicitations to invest.

Some information is simplified as between Life and Non-Life insurers as this is meant to be an overview presentation only. As many Takaful Operations are composite, including both Life and Non-Life programs, and fall under varying insurance regulatory regimes, this information is descriptive and neither definitive nor normative.

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Scope of Islamic InsuranceScope of Islamic Insurance

133 Takaful companies in +26 countries yet only 4 OIC countries have specialized Takaful regulatory framework(Malaysia/Sudan/Bahrain/Pakistan)Gross revenues/premiums were $3.7 Bil* (2007) up from $600 Mil (2002)- growth rate is +25% annually [compared with $4 Tril conventional gross premiums]; GCC Takaful revenues ~$2.0 Bil Conventional multi-national brand name insurers [AIG/Allianz/Axa…] entering Takaful will heat up competitionAbsence of “benchmarks” to judge excellence in Takaful operationsWide scope for prudential rules on Islamic securities and investmentsImprovement needed in Customer Services – instill excellence Limited supply of trained Takaful/Insurance experts- especially as actuaries, accountants, underwriters, direct sales, etc.Development/application of new IT technologies – systems and productsUtilization of Re-Takaful capacity remains constrained – perhaps fulfilling 15% of Takaful primary gross premiums written [~ $555 M]

• Large number of operating insurers (366): Domestic 191/Foreign+120/Takaful Operators 55

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*Note: accounts only 5-6% of Iran’s total premiums as Takaful contributions.

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• Golden Triad- Safety, Security and Liquidity• Asset diversification• Geographical dispersion• Avoid concentration in volatile currencies – FX risk• Adequate matching of Assets and Liabilities in support of solvency ratios• Sharia’h compliance is added challenge for Takafuls

According to Swiss RE : “Insurance performance is a reflection of capital”• Without adequate capital an insurer cannot retain risks• Minimum capital and solvency ratio is a regulatory requirement for license• Operations are managed using key indicators – insurance leverage

[technical reserves/equity]; solvency [equity/ net premium earned]; ROE [profit/equity] and weighted cost of capital.

• Note --that more Equity Capital reduces ROE

Key Objectives for Takaful InvestmentsKey Objectives for Takaful Investments

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Strategy should reflect:

• Separation of Sources and Uses of Capital (eg. Shareholders’ Funds

separate from Policyholders’ Funds; Premia/Contributions separate from

Investment accounts; Reserves separate from Surplus; etc)

• Separation of risk exposures into “pools”

• AAIOFI standards for expense accounting and disclosure of fees

• Matching Assets and Liabilities – short-term/long-term

• Linkage to Contract-Product specifics for Life Insurers– ie. “Pooled”

investments vs. Unit-Linked investments

ShariaSharia’’h Aspects of Assets underh Aspects of Assets underManagement strategyManagement strategy

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• Whatever is not prohibited is allowed• Screening investments can be done in stages:

• Permitted types of activities – this excludes armaments, alcohol, illegal, gambling, etc.

• Permitted structures – this excludes heavy debt, leveraged or non-asset-backed transactions

• Permitted format for transaction – excludes non islamic contracts or agreements

Asset Classes permissible underAsset Classes permissible underShariaSharia’’hh

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• According to AM Best’s Rating methodology * “the starting point for assessing financial strength of a particular insurance company is Best’s Capital Adequacy Ratio (BCAR)”, which in the case of a Takaful company is applied to a) Policyholders’ funds (1st tier) and to b) Shareholders’ funds (2nd tier).

• Findings – “Given the comparatively restricted investment policy of a typical Takaful company- its consequent higher levels of counterparty risk, geographical concentration, and higher than average proportion of stock holdings, capital requirements in many cases are significantly larger than for a conventional company of similar size.”

Viewpoint of Rating AgencyViewpoint of Rating Agency

* Best’s Rating Methodology- Takaful Insurance Companies, Feb. 2008

KHIDRSOLUTIONSViewpoint of Rating AgencyViewpoint of Rating Agency--22

Takafuls have “inherent lack of financial flexibility”* (ie. Ability to raise equity capital) – hence investment portfolio and quality of re-Takaful/reinsurance programmes assume high importance

In general, Takaful investment returns on average are lower thanconventional insurers (espec. on risk-adjusted basis) when taking into account increased counterparty risks, concentration of asset classes, exposure to equities and potential of volatility and credit defaults.*

When compared to conventional insurers (which are larger, more experienced management, with geographic spread of risks and decades of operating history), Takafuls offer only a limited operating platform, limited track record and limited scope of investments- resulting in significant and material competitive disadvantages in the rating process.

Note: Investment of policyholders premiums and of shareholder capital is a critical component in financial stability of the Takaful model, operating performance, claims paying capacity as well as rating determination.

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* Best’s Rating Methodology- Takaful Insurance Companies, Feb. 2008

KHIDRSOLUTIONSObservationsObservations## about GCCabout GCC

InsurersInsurers-- TakafulsTakafuls

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• Data on cash, deposits and cash equivalents as liquidity measures is mostly unavailable

• Govt. Paper, Bonds, Loans seem under- represented and some samples are less than one-half

OECD figures

• Domestic equities/shares seem over-represented among GCC insurers with some allocations

2X OECD values (74% vs. 33%)

• Real Property assets seem over-represented among GCC insurers with some allocations 10X

the relative OECD values (42% vs. 4%)

• Islamicly managed funds among GCC insurers cannot be compared as no such category exists

among OECD data

• Foreign assets and Other Equities seems over-represented among GCC insurers with some

allocations ranging from 3X to 9X (27% vs. 8%)…which may be partly explained by limited

scope of listed public shares in some countries

#Source: OFisher PhD 2005 – to be updated in 2009

KHIDRSOLUTIONSWhat Avenues are Open to What Avenues are Open to

Takaful Players?Takaful Players?

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• Local and International Equities• Sukouks• Real Estate and REITs• Private Equity• Mutual Funds• Cash and money market instruments

• However, what are Takaful investments now?

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Asset Classes available for Islamic Asset Classes available for Islamic investmentsinvestments

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Rapid growth of Islamic Equity and other funds overshadows limited non-Equity instruments such as leased assets, sukouks and Money market funds.

Source: World Takaful Report, 2009 and Eurekahedge Islamic funds.

KHIDRSOLUTIONSTakaful Distribution by lines of business Takaful Distribution by lines of business

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Keep in mind that Motor, Marine/Aviation, Property/Accident and Medical are typically one year renewable policies- only Family Takaful (<25%) represents multi-year policies (requiring LT investments).

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OECD Insurer AllocationsCash/Deposits 4% Govt.Paper/Bonds 33%Loans/Borrowers 13%Equities/Shares 33%Real Property 4%Foreign Assets 8%Other 5%

Source: OECD Report of Investment funds and Pension Funds, 2000.

GCC Insurers AllocationsCash/Deposits naGovt.Papers/Bonds 4% - 29%Equities/Shares 25% - 74%Islamic Funds 15% - 70%Real Property 2% - 42%Foreign Assets 27% - 71%

Source: OFisher PhD October 2005

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Asset Allocations OECD vs. GCC InsurersAsset Allocations OECD vs. GCC Insurers

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Asset Allocations Samples ofAsset Allocations Samples ofGCC InsurersGCC Insurers

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• Takaful Sector Allocations• Cash/Deposits 16%• Govt.Paper 19%• Corp Bonds 56%• Equities 3%• Real Property 5%• Other Foreign.Assets 1%

• Source: Bank Negara Annual Takaful Report, 2003

• Sample Takaful Allocations• Cash/Deposits 10%• Loans 20%• Borrowers/PH 5%• Quoted Shares 35%• Prop. In Trust 10%• Real Property 20%

• Source: Takaful Operator, 2000

Investment Allocations of Malaysian TakafulsInvestment Allocations of Malaysian Takafuls

• Sample UAE Insurers show strong (net) underwriting results, due to reliance upon reinsurance [which is a substitution for capital]

• Investments in GCC fuel more that 2/3 of profits in recent years due to favorable stock markets and other economic conditions (2006-2007)

• Enterprise Risk Management – specifically Asset – Liability matching --is limited, which exposes the insurer to liquidity and other risks

• Compared to G-6 Benchmark, many GCC insurers appear to be more Asset management/Investment companies than Risk-Taking Insurers

0

20

40

60

80

100

120

G6 Typical UAEcompany

% n

et p

rem

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s ea

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Investment income (inclrealized & unrealizedcapital gains), in % NPEUnderwrit ing result, % ofNPE

Pre-tax return on equity +capital gains(%)

*Source : Robert Wiest, Swiss RE Opportunities and Challenges in GCC Insurance Sector, speech, Doha March 2008

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Comparison of GCC Insurers and GComparison of GCC Insurers and G--6 6 BenchmarkBenchmark

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Stock market Performance 2006Stock market Performance 2006--mid 2007mid 2007

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Regional Stock markets lost $1 Trillion dollars since 2006 and such volatility is a major challenge for insurance companies investing in local Equities.

Source: E&Y 2007 Report on Islamic Funds & Investments

KHIDRSOLUTIONSGrowth of BondGrowth of Bond--equivalent securitiesequivalent securities

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While more Sukouks are being issued globally, the pool of bond-like securities in GCC remains small ($15-$25 Bil since 2004) and mostly non-traded securities; such unlisted securitiespotentially represents a liquidity risk.

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Dominance of “Short-tail” personal lines risks which generate high cash

flows are being channeled largely into short-term (i) Equity-based

investments and (ii) real estate projects

The axiom of Risk-Return rewards states that high Returns relate to

high Risks……as 2006-08 market collapses serves to remind

Thus, insurers so exposed may be vulnerable to (i) high volatility in

assets valuations (due to equities exposures) and in projected earnings,

especially over time and (ii) an illiquidity crunch if a severe correction

were to occur in either stocks or land/ real estate prices.

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Conclusions and Challenges AheadConclusions and Challenges Aheadfor Premiums Investment for Premiums Investment

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Also, GCC Insurers, especially Takaful Operators, may not be well-

positioned to innovate and develop Family Takaful – Life Plans which are

Long Term because of limited capacity to match long term Liabilities with

long term, secure Islamic assets/investments with predictable cash flows

Allocation of investment assets seems to be over-weighted in Stocks and

Real Estate/Property for regional insurers

Finally, note that rating agencies typically apply a higher capital charge to

insurers with over-weighing in equities and illiquid assets, such a “risky”

assets profile reveals limited ERM practices and “weak” corporate

governance

Conclusions and Challenges AheadConclusions and Challenges Ahead--22

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Thank you for your attention on this topic.

For more information contact:

Dr. Omar Clark FisherOmar.fisher@gmail.com

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KHIDRSOLUTIONSBackgroundBackground

Islamic finance principles include:No interest (fixed premium/riba) charged or paidNo benefit from another’s uncertainty (gharar)…trading on risk or sale of unknown quantity or qualityInvestments must be halal/acceptable and Shari’ah compliant as to activity and contractual agreements. Prohibited are: alcohol, pork, gambling, weapons, munitions, lewd entertainment, tobacco.Investments should conform to specific financial ratios re liabilities and be asset-backedImpermissible income must be cleansedZakat must be acknowledged and paid annuallyGovernance should be informed by Islamic rules and ideally a Shari’ah audit occur at least annually

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KHIDRSOLUTIONSBackground Background --22

Islamic finance is NOT:Against private property ownershipContradictory to profit – only the hoarding of goods/services to manipulate priceExclusive to Muslims – but inclusive of all members of communityAgainst capitalism nor shareholder’s rights

Note: Islamic finance can be symbiotic with capitalism- viz HSBC, UBS, Deutsche Bank, Tokio Marine and Calayon Group all have Islamic divisions.

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