GCC Primer

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GCC INSURANCE PRIMER

10 october 2007

01 kindly refer to theimportant disclosures anddisclaimers on back page

uae | insurance

This note serves as a primer to equity research on insurance companies that we will be publishing overthe coming quarters.

The note is divided into five sections. The first relates to the economics of insurance markets and theissues for insurance in the Middle East, but particularly in the GCC. In the second and third sections, wetake a look at the two largest GCC markets; the UAE and Saudi Arabia. In the fourth, we review how thosetop line numbers impact valuations and in the fifth, we provide a list of the larger insurance companies inArab stock markets.

From a macro point of view, we believe that there are three key factors driving insurance sector growthin the region: The high GDP growth rate, the propensity for developing and newly developed countries tospend a disproportionate percentage of any increase in GDP on insurance, and the extremely lowpenetration rate of insurance products in many Middle Eastern countries.

Ultimately, we believe the real key to be whether this underpenetration is here to stay. Ultimately,although there are structural elements to this under-penetration, there are strong economic argumentswhich drive areas of insurance, such as motor, health, liability, and that these are well-understood bygovernments in the region. In some cases, reducing under-penetration is as simple as greater codificationof the law, and bringing business practices in line with international standards.

As well as changing the institutional framework, addressing customer needs through provision ofreligiously acceptable takaful (Islamic non-life insurance) and family takaful (Islamic life insurance) will alsoincrease penetration. Other drivers of structural underpenetration are however very long term - such asthe demographic structure and low tax environment - and consequently we conclude that insurancepenetration will not reach the levels achieved by countries with similar levels of GDP per capita.Nevertheless, from the very low existing base, we conclude there are several years of strong growth ahead

for both the insurance / takaful industries in the region. A look at two individual markets - the UAE and Saudi Arabia - reinforces this view. In the UAE, we see highGDP growth rates and strong immigration driving insurance demand, but the rapid development of themortgage market and strengthening of health insurance legislation providing the uplift over the next coupleof years. In Saudi Arabia, demand in the short term is driven by the creation of a competitive market relievingpressures and changes in motor and health insurance legislation also creating a step change in demand.

However, with 47 insurance companies (including three takaful) in the UAE, and 13 takaful companieslaunched in Saudi Arabia, all recently launched, competition is fierce. It is interesting to note that there are93 listed insurance companies in the Arab world across 9 stock markets, and 57 companies listed in theGCC, with the bulk being listed in the UAE and Saudi Arabia.

Raj Madha, CFA+971 4 363 [email protected]

Over or Under Penetration Relative to Countries of Similar GDP (FY2006)

-150%

-100%

-50%

0%

50%

100%

150%

SaudiArabia

Relative Penetration Non-Life

Relative Penetration Life

Morocco

Jordan

Tunisia

Lebanon

Malaysia

Turkey

Pakistan

Egypt

Oman

Algeria

Qatar

Kuwait

UAE

342%

Source: Swiss Re, EFG-Hermes

contents

I. The Takaful Market 02

II. United Arab Emirates 09

III. Saudi Arabia 11

Appendix A - UnderstandingInsurance CompanyFinancials 13

Appendix B - Selected ListedInsurance Cos. in MENA 16

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02kindly refer to theimportant disclosures anddisclaimers on back page

I. The Takaful Market

The objective of this section is to help clarify the way one should think about the insurance and takafulmarket. We start with a discussion of why insurance grows more quickly than GDP in underdevelopedcountries, followed by statistical evidence suggesting that most markets in the MENA region are severelyunderpenetrated. However, knowing that the region is underpenetrated is not of itself very interesting,unless we understand some of the demographic, cultural, legal and institutional reasons for thisunderpenetration. Armed with this, we can make our first hesitant steps to understanding the currentsituation and forecasting the long term growth of the sector.

Figure 1.1: Apex of Growth

Source: EFG-Hermes

In particular, we believe that growth in the MENA region will be higher than elsewhere for four broad categoriesof reasons: the higher GDP growth rate of the region; the fact that insurance - like other luxury goods - tendsto have increasing penetration as GDP per capita rises; the current low level of penetration compared tocountries with similar levels of economic development; and changes in legal and institutional factors.

Legal &Institutional

Factors

Low

Luxury Good

High GDP Growth

Penetration

Box 1: Definitions of Islamic Insurance

Insurance v Takaful: takaful is the Islamic alternative to conventional insurance products. It is based onthe principle of mutuality with an emphasis (particularly for life) on co-operation, inter-responsibility andassistance between groups of participants. In essence the economic structure of a takaful company can

be seen as a hybrid between that of a mutual insurer and a conventional insurer.

Life Insurance v Family Takaful: while life insurance was seen to be problematic initially, scholars lookedat Islamic principles of mutual insurance and providing a social safety net. This eventually matured intothe concept of family takaful, which provides insurance for the loss of family members.

Reinsurance v Retakaful: just as a primary Islamic insurer can accept primary business from both anIslamic and a conventional customer, a retakaful company can reinsure both an Islamic and aconventional insurer. The main difference lies in the management of its investment portfolio: a retakafulinsurer must ensure that it makes only Sharia-compliant investments.

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A. The Economics of Insurance

Non-life Insurance

Non-life Insurance is generally regarded as a luxury good - that is an economic good which occupies anincreasing proportion of income as income rises. This is unsurprising: as income levels rise, income is firstallocated to basic necessities and consumption spending. Once these basic necessities are fulfilled, anincreasing proportion of income is allocated to the accumulation of capital goods, and once these aresatisfied, an increasing proportion of income is allocated to financial goods.

Since GDP, wealth and income are all closely related, we can conclude that, at least within emergingmarkets, insurance accounts for an increasing proportion of GDP as GDP per capita rises. This is illustratedin Fig 1.2, below.

Life Insurance

For life insurance, we would expect to see a similar relationship. However, since life insurance oftenincorporates a large savings element and is therefore similar in concept to a financial asset we wouldexpect it to have lower penetration at lower GDP levels but higher penetration at higher GDP levels. Thistrend can also be seen in Fig 1.3, which illustrates how life insurance spending increases with GDP. In table1.4, however, we can see that penetration within the MENA region is sharply below any level we mighthave expected. Indeed there are a number of regional trends which are also visible on a closer examination:lower Latin American penetration, lower Eastern European penetration and higher South and South-EastAsian penetration. Similarly penetration in countries where Islam is an important religion, particularly inthe GCC, is significantly below that suggested by GDP per capita alone.

Fig 1.2: General Insurance by Country Fig 1.3: Life Insurance by Country

Source: Swiss Re, sigma, No. 4/2007

Regression Results

While these relationships have clearly not been tested in detail, it seems sensible to look at what issuggested by Figures 1.2 and 1.3. Each figure has a regression equation, that is a formula for the line ofbest fit, and an R-squared number, which indicates how much of the data can be explained by theequation. An R-squared of one, for example would mean that all of the data points were exactly on theline. We can loosely conclude a number of things:

(i) Given the more or less even distribution of data points around the line and the high degree of R-squared(i.e. an R-squared close to one), we regard these relationships as having significant explanatory power.

(ii) The regression coefficient for the non-life equation is 1.362 as can be seen from the graph. This impliesfor every 1% increase in GDP we expect a 1.36% increase in non-life premiums, all other things beingequal.

(iii) The regression coefficient for the life equation is 1.693 as can be seen from the graph. This implies forevery 1% increase in GDP we expect a 1.69% increase in life premiums all other things being equal.

Life Insurance 2006 (USD)

Egypt Algeria Saudi

UAE

y = 4E-05x1.598

R 2= 0.6407

0

1

10

100

1,000

10,000

100,000

1,000 10,000 100,000

GDP per Capita

PermiumsperCapita

General Insurance 2006 (USD)

UAE

Egypt

Algeria

Saudi

y = 0.001x 1.3141

R2= 0.9164

1

10

100

1,000

10,000

1,000 10,000 100,000

GDP per Capita

PremiumsperCapita

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B. The Underpenetration Gap

As well as providing us with information about the general relationship between insurance and economicdevelopment, the regression analysis also provides us with insight as to where each country stands relativeto the others. Given that the regression fit is exponential, a small deviation can mean a very substantialpercentage shortfall. We illustrate this in Fig 1.4 below.

Figure 1.4: Over or Under Penetration Relative to Countries of Similar GDP (FY2006)

Source: Swiss Re, EFG-Hermes

Egypt, Algeria, Oman, Saudi and UAE lie below the line for non-life, and all bar Egypt, Lebanon andMorocco also lie below the line for life insurance. Does this mean they are all on the verge of very strong

growth? We believe not as the reasons for this shortfall in penetration are a mixture of persistent structuraland historical factors. Where it is structural, we look for structural change and evolution to close the gap,but where it is purely historical, we expect countries to converge to similar ultimate penetration levels. Inpractice, it is a mixture of the two.

C. Structural Underpenetration: Change and Persistency

In this section, we look at some of the structural drivers of penetration. Within the capitalist model, theeconomic need for an insurance market - and more generally a risk-transfer market - has been well-established. Consequently, the tendency for an economy moving in a capitalist direction will be for theremoval of institutional barriers, and the construction of efficient risk-transfer markets. Nevertheless,capitalism is not the only force in the region: clearly the economic ideas associated with religion andwelfare economics both have alternative models of risk transfer. Furthermore, the demographics and the

socio-cultural influences also have a strong influence, as does the fiscal environment.

Figure 1.5: Insurance Market Influences

Source: EFG-Hermes

-150%

-100%

-50%

0%

50%

100%

150%

Morocco

Jordan

Tunisia

Lebanon

Malaysia

Turkey

Pakistan

UAE

Egypt

Oman

Algeria

Qatar

SaudiArabia

Kuwait

Relative Penetration Non-Life

Relative Penetration Life

342%

Capitalism

Demographics

FiscalEnviroment

Socio-CulturalFactors

WelfareState

ReligiousContext

The InsuranceMarket

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Cultural and Religious Context

The most important feature of the GCC markets, and to a great extent all markets where Islam is animportant religion, is the injunction on traditional insurance products from Islam. This injunction is,however, not total: In pre-Islamic and early Islamic society, there was little concept of risk-transfer beyondthat of a social insurance obligation. Consequently when it is said that there is a conflict between Islamand the construction of insurance instruments, this is an inferred injunction and not a direct one. In fact,the Islamic injunction against some types of insurance is really an injunction against gambling, althoughin the case of life insurance, there are additional factors. The fact that these are derived injunctions meansthat there is considerably more "wiggle room" than there would be otherwise.

This "wiggle room" has meant that there has - in most places - been an insurance market operating,perhaps unofficially, for a significant amount of time. This has resulted in a section of the population takingout insurance. Nevertheless, clearly the injunctions themselves, as well as the lack of a properly regulatedinsurance market which is a natural by-product of these injunctions have been strong contributors to the

underpenetration of these markets.

This underpenetration has not been without economic costs, particularly in areas such as personal andcommercial financial planning and the efficient calculation of risk-adjusted pricing. Nor has it been withoutsocial costs, particularly where catastrophic losses (that is catastrophic in terms of the individual or entitysuffering the loss), such as motor and health losses or commercial liability losses, which have had no adequateremedy. In recognition of this, the concept of takaful (Islamic mutual insurance) was created which embodiesthe economic benefit of an insurance contract without contravening the principles of Shariah.

Takaful made rapid progress in Sudan and then Malaysia, but relatively little progress in the MENA region,perhaps as much for cultural associations as for religious ones. Nevertheless, in-roads were gradually made,and penetration gradually increased, led by commercial insurance and then personal general (non-life) andfinally, to a much lesser extent, family takaful (life).

Taxation and Long Term Savings IncentivesFiscal factors are perhaps as important as cultural and religious influences on the take-up of, especially, life& pension products. In many countries around the world, governments have recognised that it is sociallybeneficial to build long term private sector savings. Consequently, to encourage strong private sectorsaving (as opposed to public sector saving) they have provided strong fiscal incentives to setting up asavings plan, typically with payments into the scheme being tax deductible, as well as returns on assets inthe scheme being tax-exempt. Although payments out of the schemes are typically taxed, this is usuallyat a lower marginal and average rate as it is frequently deferred until after retirement.

However, in a country where there is no tax, there can be no fiscal incentives. In fairness, the publicisedaim of raising the savings rate is really to deal with aging populations, and in most of the gulf countriespopulation ageing is a problem that is several decades away, in contrast with most developed countries.

Nevertheless, the issue of maintaining an adequate private sector savings rate is not immediately over. Theissue with an aging population refers to the problem caused by an increasingly large retired population whoare looking to rely on a semi-fixed resource - a labour force which is growing far more slowly. A similarproblem exists in the oil-rich countries: a rapidly expanding population which is looking for social benefitsfunded from a finite funding source.

The lack of an inheritance tax also has a negative impact on penetration. In many western societies,intergenerational financial planning means passing on as many of your assets as possible in advance ofdeath. This can be greatly facilitated by buying an annuity, and therefore guaranteeing oneself a fixedannual spending power regardless of eventual lifespan. Without either an inheritance tax or a gift tax, andparticularly with the existence of traditional family structures, the demand for more complexintergenerational wealth planning products is non-existent.

DemographicsDemographics also play a part. There are two key aspects to demographics in the GCC: the huge expatriatepopulations in many states and the relative youth of the domestic population. Both of these havesignificant impact on the demand for long term collective savings schemes.

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2 Promoting the Growth and Competitiveness of the Insurance Sector in the Arab World3 Thorsten Beck & Ian Webb "Determinants of Life Insurance Consumption across Countries"

For tax and/or liquidity reasons, the large and temporary expatriate population is better off building up

liquid funds while they are in the GCC and maximizing pension contributions when they return to theirhome countries. Furthermore, we believe many expatriates feel they trust and understand financialinstitutions from their home country more than a local one. Consequently, they are more likely to want tobuild up those liquid funds in their home countries. In addition, for many of them, one of the main reasonsto leave their home countries is so as to be able to make remittances.

For the National population, there is currently relatively little interest in retirement planning. Most of thepopulation is young, and therefore naturally more interested in maximising current liquidity, and are alsocontent to rely on a strong social and public safety net, given the significant oil driven budget surplusesand traditionally high level of state support.

Some of these will change going forward, although not necessarily in the short term. Clearly the Nationalpopulation will stabilize and start to age, although this should become an issue in decades rather than in

years. Over a similar time-span, we might see the profile of the expatriate population become more settledand therefore increasingly inclined to localize long term financial arrangements. However, near term, thekey drivers are likely to be cultural in nature. This will severely limit the upside potential, but for themoment, coming from such a low base, is unlikely to inhibit growth rates. Nevertheless, we noteparticularly the study by Booz, Allen, Hamilton2 wherein they note that up to 60% of GCC Nationals areactively considering life insurance.

Corporate Sponsored Life Assurance

There can be little doubt that in many countries, governments have encouraged corporates to lead theway. The principle manner of doing this is to oblige corporates to set up a formal pension scheme foremployees. While this was once an unfunded reserve, increasingly this has become funded, off balancesheet and ring fenced. There is little will at present for voluntary or regulatory corporate contributions toa ring-fenced funding pool, as expatriates will usually prefer the liquidity of cash in hand, given the lack of

personal taxation, and corporates receive no tax advantage given the lack of corporate tax. Nevertheless,with a population that is increasingly long term resident and perhaps with a desire to shift pensions forNationals to the private sector, this provides some upside potential.

Mortgages and Life AssuranceMost mortgage companies offer a life insurance policy along with mortgage products. Consequently, wewould expect these products to grow at least as fast as the mortgage market. Until now, there has beenlittle penetration of family takaful into this area, perhaps due to the lack of availability of products. Inprinciple, given that the main mortgage providers in the UAE - Amlak and Tamweel - are both Islamicproviders, we would expect them to favour providers of Islamic insurance, and indeed Tamweel now insistson a life insurance policy taken out with any mortgage loan to cover any outstanding balance, and haveappointed Salama, a provider of Islamic insurance, as its in-house insurance company. Amlak, by contrast,offer the option of insurance but have Arab Orient Insurance company, a conventional insurer, as their in-

house insurance company.

Other FactorsAcademic studies suggest also that individual educational attainment, banking sector development andinflation3 may be big factors. These will at some point support higher life spend in the region compared tocountries of similar GDP. Nevertheless, at these penetration levels, there are currently greater things afoot.

Other factors we consider relevant include:

- The fact that GDP in the GCC includes a substantial amount of oil revenue, some of which is sterilised(reinvested abroad), meaning that the level of development of the domestic economy is much lower thanthat initially suggested by GDP figures;

- The high wealth to income levels and the high income disparities that effectively lock a portion of the

population out of the market.We do, however, consider the above as being only second tier effects.

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Regulation and non-life

Although it is less sensitive to regulations than life insurance, non life insurance can also be driven bychanges in regulation. We consider the impact of changing regulations on health, motor insurance and fireinsurance segments.

For car insurance, the GCC will have penetration of almost 100% by the end of 2007. Premiums are aroundAED500 for third party in the UAE, or about 4% of car value for fully comprehensive policies. Third party(compulsory) motor insurance rates are frequently capped by the government, suggesting that openmarket rates may be a little higher. Where compulsory motor insurance is only now being introduced, it islikely that individuals will opt initially for the cheapest option, which is clearly third party, and thengradually move to comprehensive. We would expect that 75% of cars under five years old, and 25% of thecars over five years old will have comprehensive insurance, once the market reaches maturity. Furthermore,where compulsory car insurance rates are liberalised, if 3rd party rates increase markedly this may promptsome switching to the more expensive comprehensive policies as the value gap between them narrows.

With health insurance, given the very large expatriate population in many GCC countries, there has beenincreasing demand on the health systems of the countries in the region. In an effort to bring healthprovision for this population up to world standards (without putting a strain on the public purse) healthinsurance has been made mandatory for expatriates in Saudi Arabia and Abu Dhabi, with other GCC statesexpected to follow shortly. Prior to passing the law, only a few companies, mostly international, offeredhealth insurance to their employees. It is estimated that premiums are likely to be in excess of AED1,000per annum per person insured.

Fire and Property insurance is also expected to increase as the property market develops, as mortgagedproperty is usually required to be insured against damages. As mortgages for commercial and residentialproperty increases, this is likely to drive demand. Liberalisation of ownership will therefore be a key driverof this segment of insurance going forward.

D. Takaful versus conventional insurance

Takaful, or Islamic Insurance has had a slow start overall with cultural factors playing a strongly suppressiverole. The first takaful company was founded in Sudan in 1979 and since then the takaful industry hasgrown in size and acceptability. Malaysia is the leading takaful country, with South East Asia as a wholeaccounting for 56% of premiums. Arab Countries account for only 36% of global takaful premiums due tominimal penetration of family takaful.

Within SE Asia, family takaful accounts for a good half of all premiums. From small beginnings there hasbeen rapid growth with currently over one hundred takaful companies and five dedicated retakafulcompanies. This growth has in turn led to greater demand, and is beginning to tempt in the multinationalplayers.

We assume that the creation of an efficient and compliant takaful market will not only attract businessaway from conventional insurance as moderately compliant Muslims take advantage of the possibility ofswitching to insuring themselves in a religiously ethical manner, but will also grow the market as a wholein those regions as the industry begins also to attract more religiously conservative customers who wouldhave not otherwise been willing to accept insurance.

If pricing becomes as efficient as conventional products, and distribution is able to attain economies ofscale at least within the local market, perhaps the addressable market might also include conventionalcustomers, who are clearly looking only for pricing and service.

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4 Takaful Re, Middle East Insurance Review Jan '075 Insure Magazine 2007

Conclusions for Growth Overall

Global insurance premiums have been growing slowly but steadily, reaching USD3.7 trillion in 2006.However, the relatively staid growth in the global insurance market is in no way reflective of the growthof insurance within the GCC. We believe there are a number of reasons why this might be so; a stronglysupportive economy, the multiplier effect; shifts in regulatory patterns, supportive demographics, strongimmigration, changing consumer behaviour and increased take up facilitated by the greater availability ofculturally sensitive takaful products.

Fig 1.6: Insurance Premiums by Region Fig 1.7: Growth of Insurance Premiums

Source: Swiss Re Sigma Report

Outside of the GCC we also expect takaful to be a growing opportunity. Muslims account for 25% of theglobal population but account for only 5% of insurance premiums. The fact that the takaful marketaccounted for premiums in the region of USD4 - 5 billion4 at the end of 2005 suggests that only 2.5% ofthose insurance premiums are takaful.

Figure 1.8: Insurance Penetration in Selected MENA / SE Asian Countries as % of GDP (2006)

Source: Swiss Re Sigma Report

Consequently we project the takaful market to grow at a rate of 20% p.a for the next 3-5 years. Industryanalysts have forecast a threefold increase of the takaful market between 2005 and 20155, which is byimplication more or less in line: implying 20% growth for three years, followed by 8% growth for a furtherseven years.

We believe these forecasts to be conservative, talking into account the strong growth dynamic, a youngand growing Muslim population, the increased economic need, regulatory change, cultural and religiousacceptance.

0

0.5

1.0

1.5

2.0

2.5

3.0

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2001 2002 2003 2004 2005 2006

Asia and the Middle EastEuropeAmericas

2001 2002 2003 2004 2005 2006

Non-LifeLife

0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

(USD mn)(USD mn)

Saudi

Arabia

UAE

Algeria

Egypt

Pakistan

Morocco

Jordan

Tunisia

Turkey

Malaysia

Lebanon

Oman

0%

1%

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II. United Arab Emirates

The UAE is one of the most developed of the GCC insurance markets, dominated by non-life insurancewhich constitutes 85% of total premiums. However, taking a broader international comparison the marketis massively underpenetrated. We estimate that penetration even of non-life is 56% below GDP-adjustedinternational levels, while that of life is 88% underpenetrated, in spite of premiums increasing at a CAGRof 26% from 1999 until 2005.

Fig 2.1: UAE Premiums (USD million) Fig 2.2: UAE Penetration

Source: Swiss Re Sigma Reports

The country's penetration rates remain low, but it is expected that greater penetration of existing lines,driven by population and economic growth, and the further development of emerging sectors, driven bynew legislation and/or changing consumer trends, will drive these levels upwards. The low penetration oflife insurance and long term savings products are mostly structural, driven by the lack of income taxation.The unusual demographic, with 80% of the population being expatriate, also plays its part.

One significant legislative change has been that relating to Abu Dhabi's health sector. Abu Dhabi passed anew law obliging companies to buy health insurance for their employees. The first phase, for companieswith over a thousand employees, came into effect in July 2006, and the second phase covering allexpatriates six months later. It is estimated that this will raise approximately AED1.2 billion in premiums.However, as the law is expanded more generally to include the rest of the UAE, this is likely to grow toabout AED4 billion.

Growth in the mortgage market is also likely to be a supportive factor. So far the real estate boom hasbeen restricted to Dubai, but increasingly this will shift to Abu Dhabi and the other emirates as the recentchanges in property ownership rules feed through. With property ownership, particularly by expatriates,comes mortgages, and with mortgages, property insurance.

One thing tempering the excitement of insurers though is the sheer volume of competition. The EmiratesInsurance Association lists 23 National insurance companies and 24 foreign insurance companies, meaningone insurance company for every 100,000 individuals in the country. The top three companies by marketshare of gross written premiums are Oman Insurance Company, controlled by Mashreqbank (17% marketshare), Abu Dhabi National Insurance Company, minority controlled by the government (15% marketshare), and Arab Orient Insurance Company, owned by the Al Futtaim Group (8% market share). Thisleaves more than 40 companies competing for the remaining 60% of the market.

Although this seems like an overcrowded market, the current figure of 47 insurers is down significantlyfrom a high of 126. At this level, the regulator felt regulatory risk from an unstable market was excessive,and stopped issuing new licenses and tried to encourage some consolidation of the sector, which iscontinuing. Nevertheless, given even the current number of players, the market is clearly overpopulatedand prone to intense competition, and it will be very difficult for any insurance company to make much in

the way of market share gains. Furthermore, many of the participants in the UAE market are linked to largeindustrial groups, and thus have a certain amount of captive business. We do not believe this degree offragmentation is sustainable and expect significant consolidation in the industry.

0

500

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2002 2003 2004 2005 20060%

5%

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35%

40%Non-L ife Life GDP Growth

0.0%

0.2%

0.4%

0.6%

0.8%1.0%

1.2%

1.4%

1.6%

1.8%

2002 2003 2004 2005 2006-10%

-5%

0%

5%10%

15%

20%

25%Penetration (Premiums/ GDP)Penetration Growth

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Other developments include the recent announcement by the ministry of economy of the formation of a

new insurance regulator that is expected to commence activities by the end of 2007. Very littleinformation is currently available on the scope of responsibilities of the new regulator, but we regard it asa promising sign that the government appreciates the importance of the insurance sector to the economyas a whole.

The main distribution channel for UAE insurance companies has been direct selling though an insurancecompany's sales force. The major constituent of non-life, motor insurance, is usually sold while registeringvehicles in police departments where representatives from different insurance companies quote premiumsto customers who are registering or re-registering cars. Bancassurance has been only a marginal feature forthe industry as banks are prohibited from selling insurance. However, some, insurance products are bestsold through banks, such as those that are related to mortgages, education funding or pensions.Consequently, one solution has been for the banks to encourage insurance companies to maintain arepresentative within their branches. Many large insurers are associated with banks.

Insurance consumers in the UAE have a low level of brand awareness, partially because quotes, at least formotor insurance, are virtually identical, and advertising is minimal. Consequently they tend not to developany sense of brand loyalty or discrimination (save for a bad previous experience). Online distribution is nota major feature of distribution in the UAE. However, online distribution still represents an underutilisedchannel given the UAE's strong IT infra-structure and the increase in general comfortability levels withelectronic transactions. We believe the entrance of multinational players (like AXA) is set to revitalize thevarious distribution channels and intensify competition on that front.

ConclusionWe believe there is significant growth in the UAE market driven by nominal prices, sustained real GDPgrowth, and increasing penetration levels of life and non-life insurance. This increased penetration is drivenby the GDP multiplier effect, as well as an increased awareness of the benefits of long term savings

products driven by a high level of government promotion. Non-life insurance should also see higher levelsof assimilation although motor insurance may be limited to population growth.

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III. Saudi Arabia

To a much greater extent than in the UAE, the Saudi insurance market is at an embryonic stage, withinsurance being limited to a limited cross-section of corporates. However, market potential is far greatergiven the absolute size of the population and the growth dynamic is better given the exceptionally lowcurrent penetration rates, even when compared to the UAE.

Fig 3.1: Saudi Premiums (USD million) Fig 3.2: Saudi Penetration

Source: Swiss Re Sigma Reports

Until recently, the regulatory framework in KSA was a mix of ad hoc policies leading to a poorly regulatedinsurance market, in which the main competitors were Bahraini domiciled insurers and the state-ownedNCCI. In the interests of establishing a healthy, well-regulated, modern insurance market, the frameworkwas overhauled in the years running up to 2004.

The most important development since then has been the bringing into effect of the Control ofCooperative Insurance Companies Regulation, improving regulatory oversight significantly and opening themarket to more transparent private sector investment under the new regulator SAMA. With the newframework came the possibility of solving two perennial issues: the drain on the public finances ofhealthcare, and problems with the non-insurance of motor vehicles. Both laws had actually been passedearlier but were awaiting the regulatory structure before being brought into effect.

The health insurance issue came to a resolution with the implementation in 2006 of the new compulsoryhealth insurance law, obliging companies to take out health insurance for their employees. This is beingimplemented in stages, initially affecting companies with more than 500 employees, then companiesgreater than 100 employees and finally all companies.

The changes to motor insurance regulation have been initiated with the implementation of the compulsory

motor insurance law, whereby from the beginning of 2007 all cars whose registration came up for annualrenewal would have to take out compulsory third party insurance.

We expect that by 2008 all cars will be insured, at least third party, and that, progressively, individuals willswitch from third party insurance to fully comprehensive. There are no reliable figures on the size of thenational car fleet, but it has been estimated that there are between four and six million cars on the road, witharound 200,000 cars sold each year. Ignoring the potential impact of the high Saudi accident rate ofapproximately 12% (of which about one in thirty includes a fatality), we estimate that third party premiumamounts to about SAR500. This suggests a market size of approximately SAR2.0 billion initially. We expect thisto change to being 50% fully comprehensive, with an estimated average premium of SAR3,000. This suggeststhe size of the market could treble, to approximately SAR6 billion over a three year acclimatization period.

In terms of health insurance, we estimate that the Saudi expatriate population is similar in size to that of

the UAE (based on 20% of 27 million), suggesting that the potential market size is similar to that of theUAE, at perhaps AED5 billion. This again will be realized over a three year period.

We do not believe that this will be the end of the Saudi growth story. There may be a third leg to Saudimarket growth coming from the development of the property and religious tourism sectors. Although thiswill be an element of future growth, we expect to see growth across all sectors of the Saudi insurancemarket until penetration levels rise somewhat.

0

200

400

600800

1,000

1,200

1,400

1,600

1,800

2002 2003 2004 2005 20060%

5%

10%

15%

20%

25%

30%

Non-LifeLifeGDP Growth

0.42%0.43%0.44%0.45%0.46%0.47%

0.48%0.49%0.50%0.51%0.52%0.53%

2002 2003 2004 2005 2006-10%

-8%

-6%

-4%-2%

0%2%

4%

6%

8%

10%Penetration (Premiums/ GDP)Penetration Growth

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10 october 2007


The Saudi insurance sector was very limited in scope until the recent changes in regulation. This has

reflected on the competitive structure of the industry, with a small number of participants. Until May2007, NCCI (Tawuniya) was the major insurance provider in the kingdom and the only listed localinsurance provider. However, 1H2007 saw the listing of five insurance companies. These companiesinclude Saudi Cooperative Insurance, Malath Coop Insurance, and SAAB Takaful and IAIC Saudi Arabia. Intotal, of the 28 licensed takaful companies in the GCC, 13 have been launched in Saudi Arabia mostly overthe last few months. Industry competition is set to be fierce over the short term as companies compete incapturing the biggest share of the newly founded demand for insurance.

ConclusionThe Saudi market is in its infancy and offers a period of prodigious growth. As Motor insurance and healthinsurance regulations come into effect next year, the Saudi insurance market is expected to witnessexponential growth. A number of takaful providers have raised capital through IPOs in order to be bestpositioned to capture the biggest market share.

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10 october 2007


Appendix A - Understanding Insurance Company Financials

Like any other company, the key elements to analyse for an insurance company are revenues, grossmargins, costs, and capital intensity. In addition, insurance companies can generally defer paying theirliabilities while receiving cash payments for their premiums up-front, which means they can invest thesefunds in the mean time and obtain a cash return. We present this free cash flow analysis in the chart below.

Figure 1: Cash Flow Chart

Source: EFG-Hermes

A. Premiums

Revenues - earned premiums and premiums ceded

Revenue is the key indicator of the amount of business being performed. Revenue for an insurancecompany starts from the amount of premiums received (gross written premiums). However, since aninsurer often passes on a portion of the risk, and therefore also cedes (pays over) a portion of the premiumsto the reinsurer, we adjust this figure to obtain net written premiums. However before we get to the actualtop line, we need to adjust this by pricing adjustments - such as policy fees, commissions et al - and timingdifferences, which are listed typically as "net movement in unearned premium reserve".

These timing adjustments reflect the fact that premiums are received at the beginning of a policy term,while claims are incurred on average in the middle of a policy term. To match the revenues against the

claims, the company reports these timing adjustments, so that the revenue is earned in the same timeperiod as the risk is borne. In most cases the premium is paid at the beginning of a contract period thatwill span across more than one underwriting period. The result is known as net earned premiums. This alsoapplies for reinsurers - typically they will not retain all this risk, and will look to pass on some of their risk.

B. Underwriting Income

Claims and the Claims Ratio / Loss RatioWhile claims may seem to be a simple concept, insurers need to ensure that claims are for the applicable timeperiod (known as claims incurred), and that the reinsurer's share of the claim is deducted, just as the reinsurer'sshare of premiums was deducted from revenues, to arrive at net claims incurred. Claims incurred not onlyincludes claims paid, but also an allowance for claims payable (paperwork in progress), and claims unclaimed(paperwork not yet filed), as well adjusting for claims falling within previous time periods. Instead of breakingit down this way though it is more easily calculated as claims paid plus the movement in the claims reserves.The loss ratio (claims ratio) is the ratio of net claims incurred plus associated expense to net earned premiums.

Expenses and the Expense RatioExpenses include those relating to sales and sales processing (known as acquisition costs), claimsprocessing, as well as central operating costs, such as middle office, IT, management, human resources etc.Claims processing costs are already included in the claims ratio, so the expense ratio includes all the othercosts - acquisition and operating costs - as a proportion of earned premiums.

Operational Cash Flow Free Cash Flow

Acquisitions

Dividends

C.Investment

Portfolio

D.Investment

Income

E.Operating

Profit

B.Underwriting

Income

A.Premiums

Equity

Retained Earnings

Loss

ratio

Expense

ratio

WorkingCapital

Portfolio return

rate

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Technical Profits - underwriting income

The claims ratio plus the expense ratio is known as the combined ratio. The underwriting margin is oftendefined as one minus the combined ratio. Net Earned Premiums multiplied by the underwriting margingives the underwriting result or technical profits and is equal to profits after expenses and claims.

C. Investment Portfolio

The Cash Cycle & Working Capital FinancingCash cycles for insurance companies can be looked at in much the same way as those for industrials.Premiums provide funding for investment, while claims take away that funding. However, sale of the goods(premiums received) occurs before the cost of providing the goods (claims expense), rather than the otherway around. Consequently, instead of requiring financing for working capital as in a typical non-financialcompany, working capital can generate funds to finance an investment portfolio. The chief complicationsto this are (i) the impact of reinsurance and (ii) the difficulties of ascertaining which assets and liabilities

are working capital in nature. The first of these turns out to be relatively minor, as complications go, as thepositive attributes of the cash conversion cycle are shared between the primary and the secondary insurer(the reinsurer). The second difficulty is a purely practical one.

D. Investment Income

Having generated the investment portfolio, the insurer invests this, typically in low risk short term bonds,which are matched for duration and convexity against the expected liability portfolio. In some casesinsurers will also look to add value through managing an active investment book, and while this raisesexpected returns, it also raises risk and management costs.

E. Operating Profits

Operating Profits, Free Cash Flow, and Discounted Free Cash Flow Valuation

Adding Investment Income to Underwriting Income gives operating profit. This operating profit can be usedfor three purposes: increasing the equity base, making acquisitions or paying dividends, the last two of whichconstitute free cash flow. Capital required by an insurance company is essentially a risk-based capitalrequirement (unless equity is required directly for funding purposes). The absolute risk-based capitalrequirement is given by minimum solvency standards, soon to be updated to "Solvency II" - the insuranceindustry's equivalent to Basle II Banking benchmarks. In practice, however, the capital constraint is usually thecredit rating, as it determines both the cost of debt issuance and the counterparty risk in many insurance andreinsurance transactions. Consequently insurers need to set aside enough capital to satisfy the credit agenciesenough to obtain the desired rating, and this will depend on the amount of business the company is writing.Given we now have the required level of capital retention, we also have, by implication free cash flow.

Combined ratio and Investment returnsPremium growth however cannot be looked at in a

vacuum. To ascertain economic value added weneed to look also at the operating margin, and theinvestment returns.

When analysing the insurance sector, the margin(underwriting margin) is usually discussed byreferring to the combined ratio, which is roughlyspeaking one minus the margin. The higher thecombined ratio, therefore, the lower the profitcontribution from a line of business.

Broken down by product line, though, a highcombined ratio (and so a low underwriting margin)

is not necessarily a bad thing, because it may becompensated by having a good cash cycle, resultingin greater investment income.


10 october 2007


Technical Definition

The combined ratio is the sum of the loss ratio andthe expense ratio.

The loss ratio is the percentage of total expensesfor claims incurred, change in the provision forfuture policy benefits, and net interest on technicalprovisions to net earned premiums. Looselyspeaking this approximates to the ratio of claims topremiums.

The expense ratio is the percentage ratio ofexpenses for premium refunds, and net operatingexpenses to net earned premiums. Loosely speakingthis approximates to the ratio of expenses topremiums.

(Source: Munich Re)

As investors, we cannot directly observe the cash cycle, but for some products (such as casualty) we knowthat there is a considerable period between a claim being incurred and the claim being payable.

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10 october 2007


Claims & Pricing

The above comments notwithstanding, pricing is usually set by looking at claim frequency and claim size.Consequently, if there is a shock on claims being higher than expected, the first impact would be to triggerany non-proportional reinsurance claim, limiting the downside losses.

However, if the increase is seen as a step change rather than as a temporary spike, the insurer is likely toadjust its pricing to reflect the shift in claim frequency. It is suggested that a shift in loss frequency formotor business is likely to be detectable after three months, and be reflected in pricing after six months,in principle limiting the ability of claims pressure to inflict significant negative surprise.

Unfortunately, when it comes to car insurance prices for third party liability are regulated in many GCCstates. Furthermore, collision rates are double those of the US, and there has been a sharp rise in claiminflation over the last decade or so. Consequently with a rising incidence and claim size, it is no longerprofitable for companies to sign third party liability, across much of the GCC. Furthermore, the lack of

any ability on the part of the insurance companies to price dependent on claim history makes turning aprofit harder.

On the positive side, there are relative low payouts for third party liabilities and few associated legal costs.

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10 october 2007


Appendix B - Selected Listed Insurance Cos. In MENA

Co

mpanyName

Country

MCAP

12mV

alue

Traded

Premiums

toEquity

MCAPto

Premiums

PER06

PBR06

NC

CI

Saudi

1,549

5,940

176%

5.8

12.3

3.3

Ma

lathCooperativeInsuranceandReinsurance

Saudi

1,058

33,574

N/A

N/A

N/A

N/A

Me

diterranean&GulfCooperativeInsurance&Reinsurance-Saudi

Saudi

844

45,879

N/A

N/A

N/A

N/A

AlahliTakafulCompany

Saudi

466

31,249

N/A

N/A

N/A

N/A

SA

BBTakaful

Saudi

482

39,416

N/A

N/A

N/A

N/A

SaudiFransiCooperativeInsuranceCompany

Saudi

301

45,123

N/A

N/A

N/A

N/A

ArabianShieldCooperativeInsuranceCompany

Saudi

267

53,412

N/A

N/A

N/A

N/A

SanadforCooperativeInsuranceandReinsurance

Saudi

267

470,060

N/A

N/A

N/A

N/A

SaudiIAICCooperativeInsuranceCompany

Saudi

296

70,298

N/A

N/A

N/A

N/A

SaudiUnitedCooperativeInsuranceCompany

Saudi

276

48,916

N/A

N/A

N/A

N/A

SaudiArabianCooperativeInsuranceCompany

Saudi

224

33,369

N/A

N/A

N/A

N/A

AlliedCooperativeInsuranceandReinsurance

Saudi

212

38,372

N/A

N/A

N/A

N/A

SaudiIndianCompanyforCooperativeInsurance

Saudi

212

28,497

N/A

N/A

N/A

N/A

IslamicArabInsuranceCompany

UAE

1,000

10,603

225%

6.5

20.3

2.9

Ab

uDhabiNationalInsuranceCompany

UAE

715

266

590%

9.0

8.7

1.5

Om

anInsuranceCompany

UAE

687

36

284%

5.0

12.4

1.8

Al

BuhairaNationalInsuranceCompany

UAE

469

158

476%

13.4

14.4

2.8

AlAinAhliaInsuranceCompany

UAE

441

362

529%

9.4

8.8

1.8

Em

iratesInsuranceCompany

UAE

278

159

1285%

11.9

12.3

0.9

Na

tionalGeneralInsurance

UAE

212

0

182%

6.8

N.R.

3.7

KuwaitInsuranceCompany

Kuwait

401

107

418%

6.4

23.9

1.5

Gu

lfInsuranceCompany

Kuwait

342

778

166%

2.7

11.8

1.6

AlAhleiaInsuranceCompany

Kuwait

319

100

815%

9.9

6.5

1.2

WarbaInsuranceCompany

Kuwait

218

120

458%

6.0

7.6

1.3

Qa

tarInsuranceCompany

Qatar

1,596

875

706%

15.7

15.0

2.2

Qa

tarGeneralInsuranceandReinsuranceCompany

Qatar

323

28

554%

7.7

19.5

1.4

Qa

tarIslamicInsuranceCompany

Qatar

285

1,921

430%

19.3

28.3

4.5

ArabInsuranceGroup

Bahrain

572

145

201%

3.9

18.9

1.9

WafaAssurance*

Morocco

1,109

499

59%

6.1

48.4

10.4

USDmn

*WafaAssuranceonlyhas2005data

Sources:Zawya,www.Oanda.com,andExchange

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disclosuresI, Raj Madha, hereby certify that the views expressed in this document accurately reflect my personal views about the securities and companies that are the subjectof this report. I also certify that neither me nor my spouse or dependants (if relevant) hold a beneficial interest in the securities that are traded in the UAE stock

exchanges.

EFG-Hermes Holding hereby certifies that neither it nor any of its subsidiaries owns any of the securities that are the subject of this report. Funds managed byEFG-Hermes Holding and its subsidiaries for third parties may own the securities that are the subject of this report. EFG-Hermes may own shares in one or moreof the aforementioned funds or in funds managed by third parties. The authors of this report may own shares in funds open to the public that invest in the securitiesmentioned in this report as part of a diversified portfolio over which they have no discretion.

The Investment Banking division of EFG-Hermes may be in the process of soliciting or executing fee earning mandates for companies that are either the subject ofthis report or are mentioned in this report.

disclaimerOur investment recommendations take into account both risk and expected return. We base our long-term fair value estimate on a fundamental analysis of thecompany's future prospects, after having taken perceived risk into consideration. We have conducted extensive research to arrive at our investmentrecommendations and fair value estimates for the company or companies mentioned in this report. Although the information in this report has been obtained fromsources that EFG-Hermes believes to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. Readers shouldunderstand that financial projections, fair value estimates and statements regarding future prospects may not be realized. All opinions and estimates included in thisreport constitute our judgment as of this date and are subject to change without notice. This research report is prepared for general circulation and is intended forgeneral information purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security. It is not tailored to the specificinvestment objectives, financial situation or needs of any specific person that may receive this report. We strongly advise potential investors to seek financialguidance when determining whether an investment is appropriate to their needs. No part of this document may be reproduced without the written permission ofEFG-Hermes.

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