By Isla MacFarlane
Despite rising contributions (premiums), which Standard & Poor's Rratings Services (S&P) estimates grew at over 15 per cent in 2012, the UAE Takaful sector is not performing effectively for either the fund members, through generation of reliable fund surpluses for distribution, or shareholders, through generation of profits, says S&P.
“We see that overall, Takaful fund deficits are increasing, at least in the United Arab Emirates (UAE) and Kuwait, thereby eroding capital strength and ultimately weakening the sector's financial strength,” said S&P in a statement. “The continuing weak performance of the Takaful insurance sector, particularly in UAE and Kuwait, cast a shadow over proceedings at the World Takaful Conference held in Dubai earlier this year.
“As an indicator, we note that no listed UAE Takaful company has accumulated a distributable surplus for Takaful fund members. In the first quarter of 2013, we note that the Takaful fund deficits in UAE rose by over 70 per cent from Dec. 31, 2012, and that in 2012, those same companies saw their fund deficits increase by almost 40 per cent from Dec. 31, 2011. Excluding new capital introduced to the sector in 2012, UAE Takaful companies recorded zero growth in shareholder funds, after providing for the deficits in Takaful funds, which the shareholders covered through qard hassan facilities. This is in marked contrast to the UAE conventional insurance sector, where total shareholder funds grew by five per cent in 2012 (before any new capital injections), with a smaller growth in premiums.
“Why is the Takaful sector underperforming? The key reason, in our view, is that it must compete directly with conventional insurance companies that benefit from established economies of scale, have longer service track records, and have more established distribution mechanisms to the marketplace--on balance the conventional insurance sector companies are less intermediary-dependent for their revenue streams. It would also seem that there is no meaningful uninsured Islamic community that the Takaful sector can rely upon to provide business stream--it is already serviced by the conventional sector.
“We also share the opinion of many that the Gulf Cooperation Council (GCC) insurance markets are now overpopulated with insurers. This is giving rise to overcapacity with the predictable, and expected, response of price competition in the insurance market. Insurance companies require considerable capital investment to become established, and new, usually small, companies are under pressure to deliver healthy returns to their investors. In the short-tail lines of motor and medical insurance that predominate in GCC markets, under-pricing will become evident very quickly and we believe this is in part evidenced by the poor technical results of the Takaful sector.
“We estimate that in 2012, the Takaful combined ratio (loss ratio plus Wakala fee expense ratio) in the UAE rose to 115 per cent from 109 per cent in 2011. In the first quarter of 2013, this deteriorated markedly to 143 per cent. Net claims costs are not so out of line with the market norms as represented by the conventional sector. What we see as significant, therefore, is that the level of Wakala fees charged on the Takaful funds have risen from 13 per cent of gross contributions in 2011 to 18 per cent in 2012, and 22 per cent in the first quarter of 2013.
“At first sight, these percentage increases in the Wakala fee ratio may appear insignificant. But when we look at the Wakala fee as a percentage of net contributions earned, the disparity is more marked. At the end of 2012, Wakala fees rose to 54 per cent of net contributions earned from 33 per cent in 2011. And in the first quarter of 2013, Wakala fees were 66 per cent of net contributions earned. The comparator to this is the level of general expenses borne by the fund operators (the shareholders) as a percentage of net contributions earned, and in the first quarter of 2013 this was 43 per cent, compared to the 2012 level of 53 per cent and 43 per cent in 2011. So, we see an increasing margin being demanded by the operator from the Takaful fund members. In 2011, the operators were effectively subsidising the Takaful funds, but this is not so in 2013.
“The Takaful model as commonly used in the GCC, is a sharing of risks among the fund members, in contrast to the transfer of risk in the conventional model. As a result, therefore, the underpricing of risks, as evidenced by increasing deficits on Takaful funds can only be recovered through higher contributions--effectively higher premiums--paid by fund members. Yet, based on our experience of the mutual insurance sector elsewhere in the world, it is difficult to recover past losses through supplementary calls on policyholders or raise premium rates for Takaful members."
“Despite the aforementioned shortcomings, we still consider the core GCC Takaful insurance model to be sound. However, the proliferation of insurance sector participants, coupled with robust competition for risks, is making it difficult for many of the Takaful companies established in the past few years to deliver a sustainable level of performance. As the loss ratios being suffered are within market norms, it is the expense bases that need controlling, and to be matched to the operational scale.
“On the positive side, we believe the UAE and Kuwait insurance markets could deliver relatively strong growth in new premiums in the coming years, a reflection of these states' growing economies. The challenge for Takaful insurers, as for any new insurer, is to attract and sustain a well-priced volume of stable business at a scale sufficient to cover their cost bases.”