Arthur White: Takaful and Takaful models by The International Takaful Summit

Financial Services 30th June 2009

Takaful and Takaful models

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Objectives for today

Short recap of Takaful worldwide opportunity

Discuss some of the challenges Takaful players are facing to go “from walking to running”

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There has been significant competitor movement in Takaful in the last few years, with particular focus on Malaysia and the Middle East

Global competitors in Malaysia

Global competitors elsewhere (examples)

Fortis: Expanded JV in Malaysia (Mayban Fortis), acquired Takaful Nasional Sdn Bhd

Swiss Re: Announced launch of “family” (life) retakaful product

Prudential Asia (PCA): Awarded Malaysian Takaful license with Bank Simpanan Nasional

AXA aiming to treble revenues from the Middle East in five years, including Takaful entry

Munich Re: Wins general insurance retakaful licence, sets up Munich Re Retakaful

Hannover Re: General and life retakaful license in Bahrain

Scor Global Life granted operating license for retakaful

Friends Provident purchased 30% stake in AmBank's life unit, AmLife Insurance Bhd

Zurich Financial Services has signed an agreement with Abu Dhabi National Takaful Company to establish a joint venture company to create a new business based in DIFC.

Allianz announces plans to partner with a local takaful operator to enter retakaful

Allianz launched Takaful subsidiary in Bahrain

L&G granted Takaful (and conventional) license in Bahrain

Friends Provident have a distribution partnership with Riyadh Bank in Saudi Arabia

Converium: License for international retakaful from Malaysian offshore base

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However, Takaful is not necessarily just for traditional Islamic countries (or just for Muslims)

Share of today’s potential Islamic market by region

100%

E Europe Africa

90%

S Asia

80%

Mid East

70% Asia Pacific

60% USA

50% 40% 30% 20%

W Europe

10% 0% Muslim worldwide population

"Muslim GDP"

"Muslim insurance premium potential"

Source: Swiss Re Sigma, census data, Oliver Wyman analysis 1. Muslim insurance premium potential insurance spend’ estimates the amount spent by the Muslim population on insurance products (conventional or otherwise) today

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Different regions will clearly need different approaches Classification of potential markets

Examples

Existing Takaful countries

Developing Islamic markets

Major developed markets

Malaysia, Singapore

Middle East, e.g. Bahrain, Saudi, Turkey

W Europe (e.g. UK, Germany) USA

Muslims as % population

Medium

High

Low

Wealth levels (GDP/capita)

Medium

Low-Medium

High

<1%

8-12%

Typical insurance 5% penetration (as % GDP1) Key challenges for insurers

“Building out the existing model” – Getting foothold in already “proven” concept – Growing insurance penetration – Capturing share from existing insurers

“Raising insurance penetration “Capturing share with a new rates” model” – Building insurance awareness in lowpenetration markets

– Getting premium from already-insured Muslims and non-Muslims – Some potential to increase penetration among non-insured Muslims

1. Source: Sigma, including Life and non-Life premiums

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A Takaful model needs to be designed carefully

Business Design framework

Examples of key questions to resolve What target customer segments, with what needs ? What proposition and products? Through which channels?

Customer Selection & Value Proposition

Economic Model

What are the potential premium, claims & expense flows? What are the risks and likely economic/regulatory capital costs? Where will Takaful requirements create new cost or risk factors? What will the potential reinsurance/retakaful needs be?

Organizational Systems

Make versus outsource? With which partners? Strategic Control

Scope How to build a differentiated retail or commercial brand? How to build a defensible long term position?

What resources, staffing is needed? What IT / systems requirements? What governance, reporting and risk management model?

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For example a key question in all markets is the marketing & distribution approach

Example of attitudinal segmentation (Disguised non-UK client example)

Segment

Est. % of population

Size (MM)

Likely Main affinity for locations Takaful

Examples of potential marketing approaches/channels

Client current positioning

Channel

Description

Mosque marketing

Faith-based associations Devout

Ethical product

“Affinity marketing” approach in co-operation with mosques Marketing direct to a “faith based” associations Aim to market products as “ethical investments” (not directly religious) – Targeting moderate and secular customers

Mutual insurance

Moderate

Highlighting the cooperative/mutual nature of insurance, not Islam – E.g. Turkish “Participation bank” approach

Ethnic marketing

Secular

Primarily targeting ethnic angle (e.g. Bangadeshi/Pakistani) rather than religious – E.g. Deutsche Bank “Bank Amiz”

Also needs to take into account (e.g.) location, ethnic background, demographics, etc

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Another major challenge is manufacturing/sourcing the product with sufficient cost efficiency and a suitable risk profile

Example: Wakalah model

Example of cost/risk analysis: NPV sensitivity to Takaful “price premium”

Shareholder

Policyholder

Shareholder Fund

Premium Agency fee (pre defined)

Takaful Fund Inv. profit income on s/h Fund

General

NPV

Wakala fee income

Wakalah

Conventional

Policyholder Fund

All expenses

Investment Fund

Family Risk Fund

Mudhabarah

Claims Profit

Underwriting surplus (less investment and operating expenses) returned to policyholder

Policyholders share all underwriting risk

Price premium for Takaful over conventional

Operator (shareholder) is paid a set fee to cover expenses. Fee expressed as a percentage of premium and Takaful fund under management. Operator is also required to fund policyholder deficits interest free until repaid from profits

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The Takaful market opportunity is no longer questioned – the focus is increasingly on creating an efficient operating model

Entry of multinational players

Regulation and standards

Surplus and accounting issues

Consumer education

Local smaller “first movers” will be challenged by the entry of multinational players with scale and international competencies – We expect to see increased use of hub and spoke models with a single manufacturing platform but wide variation in local product and distribution skills

Takaful players recognise the benefits in theory of increased harmonisation and standardisation of Shariah regulation, standards and interpretations However, global Takaful standards unlikely to in the short term as competing associations and standards boards attempt to reconcile different approaches Surplus calculation and distribution methodologies in use vary tremendously between Takaful players and regions with active debates amongst Takaful actuaries on their treatments – A highly flexible surplus calculation and distribution functionality will be required to meet the different methodologies Takaful players face the same consumer education issues as conventional players in low-penetration markets, but also a number of Takaful-specific challenges – Local regulators also likely to apply transparency regulations to Takaful players, adding further pressure to educate consumers and agents

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Entry of Multinational (MNC) players The entry of MNC Takaful players will be a serious challenge to existing local players Greenfield/stand-alone (local/regional players) Branch Y

Channel X

Conventional financial institution Shariah compliant Takaful

Description Stand-alone Takaful operators selling only Shariah-compliant products and services

Current status

Takaful window (global players)

First wave of Takaful primarily smaller / local players with first-mover advantage and local knowledge

Shariah compliant Takaful

A window within a conventional financial institution/insurer via which customers can conduct business utilising only Shariah compatible instruments MNC’s are quickly catching up: exploiting parent company economies of scale in front and back offices, and wider international experience

However, ability to expand beyond national Typically examining “hub and spoke” models with borders has been hampered by lack of capital single manufacturing platform but distribution in multiple locations/markets and/or experience Organic growth of operations and supporting technology makes for an inflexible base for international growth and adaptation

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Regulation and standards Takaful players recognise the benefits of increased harmonisation…but global Takaful standards are unlikely to emerge in the short term Varying standards across regions

Cross-border groups emerging (but slowly)

Malaysia and Bahrain: Only countries with a national Takaful specific regulatory framework running in parallel with conventional regulation. Malaysia additionally has a national Shariah council

Rest of the world: Governed by conventional regulatory framework with individual Shariah boards informing each Takaful operator

Some emerging regulatory / accounting bodies, but guidelines are not yet binding, e.g. – Islamic Financial Services Board (IFSB): aiming to develop Shariah-consistent standards to be adopted globally – Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI): Publishing guidelines for Islamic accounting, auditing, governance and Shariah standards,

A number of trade federations e.g. – International Cooperative and Mutual Insurance Federation Takaful (20 Takaful operators from SE Asia and ME) – Global Takaful Group (20 Takaful operators (mostly S.E. Asian region) – International Takaful Association (15 Middle Eastern Islamic banks as initial members) – etc

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Surplus issue The surplus calculation and distribution methodologies in use are highly differentiated between Takaful players and regions, requiring a highly flexible surplus calculation function

Surplus calculation variables

Surplus distribution variables

Frequency of surplus calculation (e.g. biannual, annual or multiyear)

Timing of surplus distribution (e.g. before or after renewal)

Need to maintain separate pools for each line of business or fund

Need to use different models for different pools within the same provider

How the surplus is to be distributed: % of premium paid vs. % of sum assured; taking account of duration of contract

Region/country-specific regulations

Means of distribution: Cash vs. “contra” discount on policy renewals

To whom the surplus should be distributed: Policyholders existing at time of distribution/policyholders that were “live” during the period of contribution

Surplus calculation issue examples

“Calculating surplus on an underwriting year basis will result in distribution some time (2 to 3 years) after the end of that underwriting year. Is this generally accepted among current Takaful providers?”

“Where there is a number of product lines, is it essential that the surplus is calculated for each product which could leave the company in deficit but paying surpluses on individual lines? Could it be argued that as a collective enterprise its the good derived by all that drives the shared result as opposed to breaking it down to subsets of clients.”

“Regarding the distribution of surplus, which of the following is the “best” method?:

Surplus distribution issue examples

Surplus for year one goes to all policyholders who renew in the next year

Surplus goes to policyholders who took out or renewed a policy in the year in question irrespective of whether they renew in the next year or not

Surplus from the prior year goes to all current policyholders at the time that surplus is distributed; irrespective of whether they are new or renewal policyholders in the next year ”

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Consumer education The added complexity of the Wakala or Mudharaba models will pose further hurdles in educating consumers about Takaful

Regulator

Objectives

Key considerations

Ensure consumer protection

Regulators will continue to push for transparency and accountability by the Takaful operator across all Takaful and non Takaful processes

Prohibit unfair trade practice

Priority will be on sufficiently recruiting, educating and equipping a Takaful agency force

Operator

A wider consumer education and marketing campaign to promote Takaful in the target markets Consumer

Competitive pricing Ease of understanding/overcoming complexity Customer service

A two prong approach addressing external (consumers) and internal (agency force) to – Enhance agency force knowledge and professionalism – Enhance consumer knowledge Consumers will increasing be more aware of the product and as more products come online, will begin to compare. They will also increasingly demand the same level of customer service as provided by (larger) conventional operators

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Contact details

Arthur White: arthur.white@oliverwyman.com

ÂŠ 2009 Oliver Wyman www.oliverwyman.com

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