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Developments in the Rating of Takaful / Re-Takaful Companies.
Andrew Murray
Takaful SummitLondon, 1 July 2009
AgendaFitch’s Analytical Process
Focus on Selected Takaful Issues
Ratings in the Financial Crisis
AgendaFitch’s Analytical Process
Focus on Selected Takaful Issues
Ratings in the Financial Crisis
A Difficult Time for Insurance…
> Recent years have featured– Relatively benign claims
environment– Favourable investment returns– Good profitability– Strong solvency
> But, 2008 saw– Substantial investment
challenges– Weaker pricing– Continued support from reserve
releases– Increased uncertainty
Credit Spreads for Selected Major Insurers
0
100
200
300
400
500
600
Mar 08 Jun 08 Aug 08 Oct 08 Jan 09 Mar 09 May 09
(Basis points)
AXA Allianz Aviva Zurich Generali RSA
Source: Fitch RAPP, 1 year credit spreads
Lehman’s Bankruptcy, AIG supported by
Government
H208
The Building Blocks of Credit Risk
Loss Given DefaultProbability of Default
Expected Loss
Recovery Ratings (RR)The Recovery Rating (RR) is based upon the expected relative recovery characteristics of an obligation
Issuer Default Ratings (IDR)Issuer Default Ratings (IDRs) reflect the ability of an entity to meet financial commitments on a timely basis
Issue rating (eg Insurer Financial Strength)An issue rating reflects the likelihood of a specific issue to be paid by the Issuer on a timely basis, as well as some consideration of recovery prospectsIDR RR
IFS Rating
Fitch does not “approve”, certify or evaluate
Shar’iah compliance
Fitch’s Takaful Rating Methodology
> Takaful Rating Methodology Supplements existing Criteria for Conventional Insurers– “Non-Life Insurance Rating Criteria (Global)”, 2 March 2007– “Life Insurance Rating Criteria (Global)”, 2 March 2007– “Reinsurance Rating Criteria: Life and Non-Life (Global)”, 2 March 2007
> Fitch’s Methodology recognises that important differences do exist by country:– Attitude to Shariah compliant purchasing differs by region (Turkey, Malaysia,
UK, Dubai)– Legal and Regulatory Environment– Availability of Shariah Compliant Investments– Corporate Governance, Risk Management etc.
IFS Rating
IDR RR
Ratings Analysis in the Current Environment
> Application of ratings criteria in context of global recession and capital markets crisis
> Ratings criteria not changed – but focus and weighting of analysis adjusted– Liquidity– Idiosyncratic risks– Fixed income / Sukuk securities losses– Equity market scenarios– Leverage analysis– Earnings volatility– Diversification/complexity– Risk mitigants– Government support
AgendaFitch’s Analytical Process
Focus on Selected Takaful Issues
Ratings in the Financial Crisis
Simplified Diagram of a Generic Commercial Takaful Firm
> A. Availability of operator capital to Takaful fund participants
> B. Interest free loan (Qard al-Hasanah)> C. Priority of participants in the event of a winding up> D. Group rating methodology
Selected Important Issues
Shareholders of Takaful Operator
Takaful OperatorManages the Takaful Fund
Fund Participants
Takaful FundMutual Pool for the Collection of Contributions and the Payment
of Claims
Claims/ Distributions ContributionsDividends
Takaful Firm
Wakala Fee or Share of Profits Under Mudaraba
Qard al-Hasanah if Required
Source: Fitch
Affected by Legal,
Regulatory and Other Factors
A. Availability of Operator Capital to Takaful Fund ParticipantsThe Dilemma> 1. Segregation of Takaful operator and
Takaful fund is clear under Shariah principles– Takaful operator does not suffer
downside risk under Wakala or Mudarabah
But> 2. Availability of a Takaful operator’s assets
for the protection of participants is often critical for financial security
Depends on> Applicable laws & regulations> Wording of contracts and certificates> Memorandum and articles of association> Can participants rely on this capital in a
stress scenario?
Fees
Takaful Operator:Manages theTakaful Fund
Participants
Takaful FundMutual Pool for the
Collection of Contributions and the
Payment of Claims
Management Services
Qard al-Hasanah
B. Interest Free Loan (Qard al-Hasanah)
> Provided by Takaful operator to Takaful fund
> Mainly provides a short term financing function
> Much less important if participants have full recourse to Takaful Operator’s assets
Credit for existing loans> If meets Fitch’s hybrid criteria for
equity credit– Subordinated to policyholder interests– Restrictions on repayment (eg can only
be repaid from future surplus, no fixed maturity date)
– OR mandatory conversion to “equity” (ie donation)
Credit for future loans> Only if compulsory and suitable
triggers exist> Must also meet Fitch’s hybrid criteria
for credit
Fees
Takaful Operator:Manages theTakaful Fund
Participants
Takaful FundMutual Pool for the
Collection of Contributions and the
Payment of Claims
Management Services
Qard al-Hasanah
C. Priority of Participants in the Event of a Winding Up
> Example: Malaysia> Insurance Act 1996> 122. (1) In the winding up of an insurer,
the assets of an insurance fund shall be applied to meet its liabilities to policy owners and claimants under policies of that class of insurance business and these liabilities shall have priority over unsecured liabilities other than preferential debts specified under subsection 292 (1) of the companies Act 1965 to the extent that they are apportioned to the insurance fund.
> Not necessarily policyholder priority for Takaful firm
> No specific provisions in Takaful act 1984
Country Priority of policyholders?Australia Life Yes Non-life NoBarbados NoBermuda YesCanada YesCayman Islands NoFrance YesGermany YesIreland YesJapan Life Yes Non-life NoUnited Kingdom YesUnited States YesEuropean reinsurers NoUS reinsurers No
Description of Regulatory Environments(Select Jurisdictions Only)
Source: Fitch
D. Group Rating Methodology
> Having formed stand-alone view of financial strength – Assess potential group support based on– Ability to support
> 1. External barriers> 2. Financial strength
– Willingness to support> 1. Relationship with parent> 2. Support agreements
– Formal– Informal
> Fitch has internal guidelines to assess how much uplift to apply based on these elements
Holding Company
Sub-Holding Company
Asia Conventional
Insurer
Middle East Family Takaful
Retakaful
Middle East General Takaful
Asia Family Takaful
AgendaFitch’s Analytical Process
Focus on Selected Takaful Issues
Ratings in the Financial Crisis
Net Upgrades Less Downgrades
-25
-20-15
-10-5
05
1015
20
Q10
2Q
202
Q30
2Q
402
Q10
3Q
203
Q30
3Q
403
Q10
4Q
204
Q30
4Q
404
Q10
5Q
205
Q30
5Q
405
Q10
6Q
206
Q30
6Q
406
Q10
7Q
207
Q30
7Q
407
Q10
8Q
208
Q30
8Q
408
Q10
9
(No.)
Source: Fitch
Sliding Equity Markets
0
50
100
150
200
250
Jan 07 Jul 07 Dec 07 May 08 Oct 08 Mar 09
S&P 500 FTSE DAX CAC 40Italy Malaysia Egypt China
Source: Bloomberg/Yahoo finance
H208(31 Jan 07 = 100)
Yield on Government Securities Falls Sharply
0
1
2
3
4
5
6
Dec 07 Mar 08 Jun 08 Sep 08 Dec 08 Mar 09
Germany US UK ItalyFrance Spain Japan Malaysia
Source: Bloomberg, 5 year Generic Government Securities
H208(%)
Basis points 2 Jan 08 1 Jul 08 31 Dec 08 31 Mar 09AAA 6 +5 11 +49 60 +4 64AA 34 +24 58 +58 116 -13 103
A 46 +31 77 +45 122 +40 162
BBB 61 +69 130 +200 330 -35 295
BB 208 +105 313 +560 873 -138 735B 414 +165 579 +716 1,295 -304 991
Credit Spreads Increase Substantially
Source: Fitch RAPP
Takaful Developments…
The Takaful Industry has:> Avoided investing in Structured and Complex Products> Avoided providing Guarantees> Limited Investments in high profile failures (Lehman, AIG etc.)> Made Some Progress Towards a Clearer Regulatory
EnvironmentBut,> Losses from Equities> Credit losses expected to increase> Global downturn affects Takaful firms as well as Conventional
Insurers
Conclusion
> Takaful firms benefit from:– Absence of exposure to structured credit market, some other difficult assets– Absence of guarantees offered– Generally Low leverageBut:– Some Takaful firms hurt by high exposure to equity markets– Credit risk could also cause difficulties, especially where there are investment
concentrations
> Selected Developments– Challenging time for Insurers globally although important differences exist
between types of firm and specific organisations.– Some Progress Towards an Exposure Draft on Measuring the Solvency
Requirements of Takaful firms– Greater emphasis on some areas of rating process (investments, liquidity etc)
The Fitch Group Fitch Ratings Algorithmics Fitch Solutions
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