The long-term prospects for takaful Islamic insurance are good, given its focus on populations that are currently underinsured. But intense competition is squeezing profit margins in the short term. Writer James Gavin
Some 30 years on from the establishment of the world's first takaful Islamic insurance company - the Sudanese Islamic Insurance Company - takaful is still a relative fledgling in the sharia-compliant universe. More than 160 sharia-compliant insurance companies and Islamic 'windows' of conventional insurers have sprouted in the past 10 years, yet takaful is still behind the curve of the rest of the Islamic finance sector.
But this may be about to change. The rash of Islamic windows of major multinational insurance companies such as Aviva, Prudential, Allianz, Munich Re and Swiss Re, and the mushrooming of Islamic insurance company franchises from Malaysia to Morocco, suggests that takaful may be poised for an expansionary phase as companies bid for business in regions that are still largely untapped as insurance markets.
Insurers see substantial growth potential in the sector, primarily linked to takaful's relative youth. "I think the sector will witness top-line growth this year as the takaful market is still in nascent stages," says Ashraf Bseisu, deputy CEO of Bahrain-based takaful provider Solidarity Group.
Insulated from the crisis
Although superficially similar to principles of mainstream mutual insurance, takaful businesses must operate under strict religious guidelines, producing Islamic contracts for clients and appointing a board of Islamic sharia scholars to vet business decisions.
Under takaful norms, there must be a clear segregation of the assets owned by members and those owned by the insurer. Investments made using the pool of funds have to adhere to sharia law and avoid haram (forbidden) sectors such as alcohol and gambling.
There is a positive spin-off from this adherence to principle. Takaful providers, although far from immune, have enjoyed greater insulation from global credit crisis in the past two years - the conservative and sharia-directed nature of investments prohibit involvement in exotic derivatives that can cause heavy losses.
Penetration of takaful is low even in countries with Islamic majorities. Despite Muslims constituting about one-quarter of the global population, takaful contributions account for less than 1% of the total insurance premium spend annually. This underinsurance in Muslim countries is not confined to the takaful sector. The $10.5bn in premiums in the Gulf Co-operation Council (GCC) last year represents one-quarter of Belgium's total.
The weak market penetration suggests there is enormous potential for takaful operators to grow their franchises. "There's strong appetite and very strong growth and that really is coming from two sources," says Nick Frei, chief executive of T'azur, a Bahrain-based takaful company established in 2007. "The first source is the fact that the insurance sector as a whole is growing. The Middle East region is very much underinsured and insurance spend as a share of per capita gross domestic product is very much lower than western Europe," he adds.
The second factor of growth is the substitution effect under way, where more and more insurance spend is switching from the conventional to the Islamic. "It is a double whammy - we have an industry growing rapidly and, at the same time, substitution is going on," says Mr Frei.
Ernst & Young, which undertakes an annual survey of the global takaful market, estimates that global takaful market contributions will rise to $7.7bn by the end of 2012, compared with $3.4bn in 2007.
"The takaful market has been growing in double digits in the past few years and the trend is continuing despite the crisis in 2008/09 and the Dubai World problems," says Nejib Boubaker, assistant general manager of Tunisia-based Best Re, which is currently writing $300m of premiums, mainly in south-east Asia.
Alpen Capital, in a report on the GCC takaful industry published in January, says that in the period from 2006 to the third quarter of 2009, the top eight GCC takaful firms registered compound annual growth rates of 26.5%, compared with 19.2% for their conventional peers.
Growing competition
However, despite respectable growth rates, premiums are under pressure due to intense competition for market share. The takaful market is proving a difficult environment in which to generate profits.
Last year, takaful providers were writing for premium volumes rather than necessarily to generate gross profits. "What they were effectively doing was writing very marginal business and writing cheaply to get the premium through the door," says Peter Hodgins, a takaful specialist and partner at the Dubai office of international law firm Clyde & Co.
The reality is that premium rates are still soft and there are players in the market trying to build a share of the premium volumes, which will drive competition. "This is a worry for the takaful industry as it is already carrying a layer of expense that isn't borne by conventional insurers. A lot of takaful companies are relatively small and new and are pricing themselves quite thinly," says Mr Hodgins.
Returns are more complex for sharia-compliant insurers than conventional providers. The question of returns is twofold under the takaful model: one relates to policy-holders from the takaful pool surpluses; and the second is returns to shareholders. "On the former, we have not seen such returns forthcoming, as yet. On the latter, we are beginning to see returns, but not in line with conventional counterparts," says Mr Bseisu.
Asset risks
Like their conventional peers, the takaful players are highly exposed to asset risk, with equities and real estate accounting for the bulk of investments, effectively tying earnings of the sector to the performance of local equity and real estate markets. Profit margins have felt the impact of the exposures to sectors that were both badly impacted by the global downturn.
Profits have also been hit by the lack of long-term liquid investments, another structural failing shared with the wider Islamic finance sector. The limitations on suitable instruments hamper takaful operators from managing their investments as efficiently as possible.
The prohibition against investing in conventional bonds has skewed investment portfolios too heavily towards equities, amplifying their exposure to asset risk; in contrast, conventional insurers in Muslim countries enjoy a more diverse choice including bonds, placements with conventional banks, money market and index funds, and private equity. One solution might be to deepen the tradable market in sukuk (sharia-compliant notes).
"Sukuk is an alternative and despite the setback of Dubai World, there's real demand and insurance companies could access these instruments to diversify their mix on the investment side," says Mr Boubaker.
Allianz Takaful is currently in talks with a regional Islamic institution about issuing a sukuk earmarked for the industry. "As an insurer, if I want to offer annuity products I need to have long-term assets to match my liabilities which are still not available," Abdul Rahman Tolefat, chief executive of Allianz Takaful, told a conference in mid-February.
There are other challenges facing a nascent industry without a common or standard platform or operating principles. "Asset-liability management is naturally one main issue due to the restrictive investment domain. Issues of risk-based capital, solvency and capital adequacy will cause challenges due to the separation of the policy-holders account [takaful pool] from the shareholders account and the role that the 'shareholder' performs as an agent/manager of the takaful pool," says Mr Bseisu of Solidarity Group.
Product offering
Islamic insurers must also develop some attractive products that will appeal to markets where the concept of insurance - whether Islamically tailored or conventional - has yet to make much headway.
Most practitioners' product ranges are targeted at general insurance, but the life and other types of insurance could enable Islamic alternatives to compete more effectively with mainstream products. Demand drivers going forward are likely to be from the retail/personal lines segment and especially the family takaful side, which involves life and savings products.
Malaysia has shown a strong performance on the family takaful front where contributions grew by 20% to $672m in 2008, representing an 11% market share of Malaysia's total life insurance business.
"Family [takaful] is still very underserved, especially in the GCC, though it's different in Malaysia with much more sophisticated demand. People are asking for products for their retirement plans, and for health insurance, which is now compulsory in Saudi Arabia. The GCC will drive demand for those products," says Mr Boubaker.
In Saudi Arabia, the introduction of compulsory health and motor insurance has provided a regulatory push for the uptake of takaful, especially as the government decreed that all insurance must be based on the co-operative model. With motor insurance among the easiest forms of takaful to write, this is an obvious starting point. More complex sectors such as business policies may take longer to unfold. "Accessing the small and medium-sized enterprises will be the real challenge in distributing these products and being competitive with the conventionals," says Mr Boubaker.
