JOHANNESBURG (Reuters) - South African insurer Mutual & Federal posted an 11 percent drop in first-half headline earnings per share on Wednesday, but its shares rose after the group said it would pay a special dividend.

Mutual & Federal said headline earnings fell to 211 cents per share as claims rose and competition in the industry increased.

However, its shares rose as much as 12 percent after the group said it would return 2.3 billion rand or 8.00 rand per share to shareholders via a special dividend. The company said it was making the payout after assessing optimal capital levels within the group.

The short-term insurer, majority-owned by insurer Old Mutual, said its net asset value per share for the six months to end-June increased by 26 percent to 20.28 rand.

Shares in Mutual & Federal were 9.1 percent higher at 36.0 rand by 0757 GMT, outperforming the JSE Securities Exchange's All-share index which was flat.

The group said trading conditions within the short-term insurance industry deteriorated during the period following a severe escalation in average claim costs.

"Premium growth proved difficult and there was intensive competition following the highly profitable market conditions in 2004 and 2005. Certain insurers attempted to gain market share using reduced pricing structures and this resulted in uneconomic premium levels in a number of portfolios," Mutual & Federal said.

Mutual & Federal said the special dividend award represented 40 percent of the group's net asset value. Since September 1999, the group has returned 24.50 rand per share to shareholders.

"This is indicative of the ongoing focus on optimal capital levels and finding the right balance between return on capital and risk appetite," Mutual & Federal Managing Director Bruce Campbell said.

The group maintained its interim dividend of 40 cents per share.

Gross premiums written rose 8 percent to 4.26 billion rand.

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