Extending capital requirements: The market is poised for a flurry of activity and consolidation

A second wave of mergers and acquisitions in the Malaysian insurance and takaful markets is about to get under way, linked to new regulatory requirements, market liberalisation and new strategies for entry into one of the world’s most potentially lucrative markets. This follows a first wave that came after the country’s insurance authorities moved to implement risk-based capital (RBC) requirements for conventional insurers. In 2012 the RBC regime was extended to Islamic insurance, or takaful, players as well, giving fresh impetus to market consolidation.

LEANER, STRONGER: As part of the country’s 2001 Financial Sector Master plan, the central bank, Bank Negara Malaysia (BNM), issued the RBC framework for conventional insurers and reinsurers back in 2007, with this coming into force on January 1, 2009. Under RBC, capital requirements are more effectively linked to risks undertaken, with an eye to creating a more robust insurance sector. The rules require both stronger corporate governance and better risk-management practices. In Malaysia’s case, BNM placed a 130% capital adequacy ratio (CAR) requirement on insurers, while also granting itself the right to intervene if that CAR target was not met. A company’s available capital is also separated into Tier 1 and Tier 2 varieties – the latter forbidden from exceeding the former. While one result of this higher CAR was to temporarily suppress insurers’ margins, it also spurred mergers and acquisitions (M&A). This worked in tandem with general financial sector liberalisation from 2009. Thus, in 2010, Jerneh Asia sold its 80% stake in the general insurer Jerneh Insurance to the US-based ACE INA International Holdings, while Pacific Insurance was sold to Fairfax Asia. Additionally, BH Insurance was acquired by AXA Affin General Insurance, which then merged. In 2011 MAA Holdings sold its insurance unit, Malaysian Assurance Alliance, to Zurich Insurance. Thus, foreign insurers have increased their stakes in the Malaysian market, with some major international players making their entrance or expanding their existing holdings. The strategy of opening the sector up while strengthening its capital base has been successful.

NEXT STAGE: The same move to RBC is now starting in the takaful branch of the sector. In Islamic finance terms, where risk sharing is the basis of operations, the mechanisms regarding CARs are slightly different. With conventional insurers, capital charges on the company’s assets vary with the risk underlying that asset and its volatility. In takaful, the equivalent is the effect on the tabarru, or donation, with an interest-free loan from the takaful operator, known as a qard, used to ensure that claims are paid. RBC is intended to ensure operators have sufficient capital to support the tabarru, while the savings part of certain takaful products may need no capital guarantees, if there is no associated investment guarantee in the product.

The same 130% capital requirement will thus apply to takaful operators as well, while each company will also have to establish an internal target capital level – as with conventionals – using the same formula for establishing Tier 1 and Tier 2 capital. Where the difference comes in is rules adjusting RBC to sharia-compliance issues. The takaful operators are now obliged to provide qard from the shareholders fund in the event of a deficit in the tabarru fund, with this qard qualifying as Tier 2 capital. In determining the CAR, however, qard does not count as available capital.

These differences, some analysts argue, mean that the RBC requirements may sit heavier on some takaful companies than on conventional ones, making for a less smooth transition to the new regime. In respect of this, full introduction of RBC has been delayed, with new regulations now expected to be implemented by the end of 2013. The new rules will likely hit less well-provisioned takaful operators, while encouraging more M&As. Indeed, in May 2012 Takaful Malaysia announced at its annual general meeting that it would be looking into M&As with firms that were finding RBC challenging. The year ahead will likely be one of heightened activity as a more robust and well-capitalised industry emerges.