building value together The asset side of Takaful and implications on product design 13 November 2012 Hassan Scott Odierno, FSA Istanbul

2 Actuarial Partners Conventional bonds Bonds are the backbone of conventional life insurance, providing the means to offer investment return and capital guarantees. Conventional bonds provide guaranteed cash flows which can be used to pay insurance liabilities

3 Actuarial Partners Islamic bonds Takaful does not have this asset class as a backbone, thus requiring product design to be different. A few countries such as Malaysia have Islamic bonds with fixed cash flows, but with questionable shariah acceptability it is not clear how long this will continue.

4 Actuarial Partners The Current Takaful Market 2010 Takaful Sales (US$ million): Total US$4.37 billion excluding Saudi Arabia and Iran, from 2012 EY World Takaful Report 1. Malaysia 1, Qatar UAE Indonesia Sudan 363

5 Actuarial Partners Focus on Life Although general takaful is more common than life (family) worldwide, we will focus on family products as investment returns are more critical

6 Actuarial Partners Current Malaysia Family Market Split by Product Annual Contribution Equivalent Jan – June 2012

7 Actuarial Partners Implied Guarantees Although we don’t have formal guaranteed investment returns or capital guarantees (yet) in takaful, sometimes guarantees are implied

8 Actuarial Partners Unit Linked Takaful Model Wakala – Drip with incentive compensation Participant Contribution (Premium) Risk Account (PRF / PSA) Underwriting Surplus Investment Profit Unit Linked Account (PIF) 100% Wakala Fee (Operator) NAV and per policy Wakala Fee (Operator) Wakala Fees Operators Fund Actual Management Expenses 50% Policy Benefit 50%

9 Actuarial Partners Unit Linked Takaful Model Wakala – Drip with incentive compensation  Used for education and retirement savings, often sold with medical coverage as riders  Usually there are several unit funds, such as cash, balanced (bond) and equity

10 Actuarial Partners Unit Linked Takaful Model Wakala – Drip with incentive compensation  Ideal to have assets such as bonds, especially when the policy nears maturity  If there are no bond type investments participant must understand the risks he is taking

11 Actuarial Partners Traditional Takaful savings model Wakala With Mudharaba – Drip with incentive compensation  Operates similar to the unit linked model but there is only one savings fund, and the operator shares in investment returns  Benefit illustrations must be carefully shown as they could create expectations

12 Actuarial Partners MRTT Model Wakala – Long term risk fund with sharing Participant Contribution (Premium) Risk Account (Common) Valuation Surplus Wakala Fee (Operator) 50% Policy Benefit 50%

13 Actuarial Partners MRTT Model Wakala – Long term risk fund with sharing  In Malaysia these are single contribution with duration 20 years or more  To match liabilities the assets should be long term Islamic bonds, unavailable in many markets

14 Actuarial Partners Future product types  In Malaysia there are discussions on how to provide capital guarantees in takaful (wadiah structure)  Annuities are also being explored  Both will require careful matching of assets and liabilities

15 Actuarial Partners Equity  It is possible to invest in equity worldwide on an Islamic basis  Avoid industries such as gambling, pork, alcohol and tobacco  Avoid highly leveraged companies to ensure not indirectly investing in interest bearing asset classes

16 Actuarial Partners Islamic Bonds (Sukuk) Sukuk tends to look like conventional bonds but would have partial ownership in a debt (sukuk murabaha), asset (sukuk ijara), project (sukuk istisna’) or business (sukuk musharaka)

17 Actuarial Partners Sukuk Controversy  The president of the Shariah council of AAOIFI estimated that 85% of all sukuk in existence were not shariah compliant  The Malaysian structure in particular appears identical to conventional bonds (fixed returns)

18 Actuarial Partners Sukuk Challenges  Should floating rate sukuk become the norm it will be difficult to match liabilities  Sukuk structures can be very complicated, making it difficult for an operator to understand what exactly are the risks it is taking

19 Actuarial Partners Fixed Deposits  Islamic fixed deposits are in the form of mudharaba (profit sharing), wadiah (demand deposits) or commodity murabaha (purchase and reselling of commodities)

20 Actuarial Partners Real Estate  Investments can be either directly or in the form of Real Estate Investment Trusts (REIT)  A screening process is done similar to equities with a cleansing process to purify rental from non-permissible activities

21 Actuarial Partners Conclusion  Assets and investments are an integral part of family takaful.  Product design needs to take account of the types of assets available

22 Actuarial Partners Final Thought With the general lack of guaranteed cash flows of conventional bonds in Takaful, should Takaful have guaranteed features?

Questions