Growth drivers. The insurance industry is expected to see a high single-digit growth in premium income,  supported  by:  i)  growing  affluence  among  the  middle-income  population  and  healthy consumer  spending  power,  ii)  an  underpenetrated  market,  compared  to  that  of  developed nations (the penetration rate is 4.5% to GDP, according to the 2011 ETP Annual Report), and iii) innovative  products  through  channels  like  bancassurance  and  agencies  have  enhanced  the profits from life insurance. We believe the industry's growth will continue to outpace GDP growth as  the  Government  has  pledged  to  increase  insurance  protection  of  the  low-income  household segments, which bodes well as the Asian region as countries are facing pressure to elevate their respective minimum wage. Should Malaysia follow on this this trend, it should be able to channel more  disposable  income  to  purchases  of  insurance  policies.  The  Government  also  recognizes the need to safeguard savings, retirement funds and provide health protection for the people. As such, it aims to increase life insurance penetration from 2.8% currently to at least 4% of GDP, or 75% in terms of number of policies over population, by 2020.

Unimpeded growth. The takaful segment is expected to continue registering a high double-digit growth  of  around  20%  through  2014.  Insurers  increasingly  identified  takaful  as  a  high-growth, profitable segment. The penetration rate of ~13% for family takaful (measured by number of life policies over population) is an indication of the latent potential for takaful versus conventional life insurance's 55%.  That  said,  the  takaful  industry  is  still  at  an  early  stage  of  development,  with growth expected to outpace the growth of conventional insurance, supported by the following: i) increasing  awareness  to  diversify  takaful  from  being  a  niche  segment  catering  to  Muslim communities,  ii)  enhanced  regulatory  reforms  to  support  takaful  infrastructure,  iii)  identifying common  grounds  or  workable  solutions  for  issues  faced  by  Shariah  committees  and  industry leaders,  iii)  stronger  participation  and  liquidity  in  sukuks  and  Shariah-compliant  instruments  to support investment income, and iv) strengthening takaful and retakaful capacity. The risk-based capital  (RBC)  framework  for  Islamic  banking  and  takaful,  expected  to  be  finalized  soon,  is  not expected  to  significantly  differ  from  the  framework  applied  to  conventional  insurers,  but  will nonetheless enhance valuations in the takaful sector.

Further consolidation. The surge in M&A activities as a result of the industry's liberalisation has re-rated  industry  valuations.  The  weighted  average  PBVs  arising  from  the  transaction  values were recorded at above 2.2x, with the latest deals being the acquisition of ING's business by AIA, CIMB  Aviva's  stake  sale,  P&O's  divestment  to  Sanlam  and  UMW's  divestment  of  its  insurance unit. This is due to: i) the ceiling for foreign ownership being raised from 49% to 70% since 2009, ii)  increased  participation  of  foreign  insurers  with  greater  regional  scale  and  access  to  capital, and iii) attaining strategic fits to fulfill capital adequacy requirements of the RBC framework and changing regulatory requirements. We believe the industry consolidation will progress as players are  still  aligning  their  operational  efficiency  to  adapt  to  an  increasingly  competitive  and  free market. Any changes in the rules of the game, like BNM's decision to take the cap off acquisition costs  and  commission  rates,  may  further  spur  the  industry's  consolidation  as  the  smaller insurance players may lack the capital and size to compete in a free market. Therefore, we view the  RBC  framework  for  takaful  and  the  Competition  Act  as key  determinants  of  the  direction  of M&As  in  the  insurance  industry.  The  industry  capital  adequacy  ratio  (CAR)  of  222.5%  in  2011 was  above  the  comfortable  internal  target  capital  level  (ITCL)  and  supervisory  CAR  of  130% each insurer is required to comply with.

Maintain  NEUTRAL.  We maintain our NEUTRAL call on the insurance sector  given that it has been substantially re-rated due to M&A activities. We like Syarikat Takaful Malaysia (BUY, FV: RM8.02), for its long operating history and leading position in the takaful segment and attractive dividend  yields.  We  maintain  our  NEUTRAL  call  on  LPI  Capital  (FV:  RM14.82)  and  Allianz Malaysia (FV: RM8.02) for their resilient underwriting strengths and solid financial performance.

Source: OSK