Time for Takaful to Swim, or Sink

Providers of Sharia-compliant insurance products are under increasing pressure to produce returns for their shareholders. This focus means that there is a real danger that takaful operators cannot build the scale and capacity to meaningfully participate in the commercial lines sector. As such, they risk being overtaken by their conventional counterparts who are increasingly looking at the opportunities in Sharia-compliant insurance. Thankfully, a potential solution exists – should they choose to take it.

Going for Growth

In recent years takaful has experienced strong double-digit growth. Global gross takaful contributions for 2012 are estimated at US$11bn, up from US$9.4bn in 2011 and a recent EY report suggested that by 2017 the annual figure could exceed US$20bn. However, the report also noted that year-on-year (YoY) growth has slowed from the 2007-11 compound annual growth rate (CAGR) of 22% to a more sustainable growth rate of 16%.

The industry fared better during the 2008-09 global financial crisis than its traditional counterpart due to the nature of its investments, which were less volatile. However, as equity markets recovered takaful operations did not benefit to the same extent as their conventional counterparts for the same reason.

More fundamentally, recent studies also suggest that shareholders in takaful operators receive, on average, a lower return on equity than in traditional insurance. Overall, the sector is failing to live up to shareholder expectations and is not delivering the expected returns on equity (ROE). It remains to be seen if this is an inherent aspect of the takaful structure, or a reflection of the relative youth of the industry.

Whether or not future growth will allow takaful operators to offset their initial start-up costs, is a factor which is currently exerting additional pressure on the management of these operators. There is also the looming threat from larger, conventional insurance players moving into the sector. This has been seen, for example, with the establishment of Cobalt at Lloyd’s to offer Sharia-compliant coverage backed by marketing leading capacity including insurance giants AIG and XL.

There is a considerable risk that, if takaful players don’t act now, they risk entirely losing out in the commercial lines space. Yet what can operators do to improve their performance?

Jumping into the Pool

There is a compelling argument that the solution is to create a pool of takaful insurers to bring together providers from multiple locations. This would increase capacity, allow larger exposures to be underwritten and create a platform for knowledge-sharing that would allow the industry to grow more rapidly.

Pooling of risks is not a new concept. In fact in other parts of the insurance industry, such Protection & Indemnity (P&I), terrorism and aviation, it is a well established concept. The longest standing example of a pooling arrangement is between the International Group of P&I Clubs – which between them provide indemnity cover to shipowners for approximately 90% of the world’s ocean going tonnage. The arrangement also provides considerable opportunity for co-operation in representation and the exchange of information.

This example of pooling is one where all the Clubs carry out the same business. However, there have been other examples where mutuals that carry out different types of business have merged, thereby reducing the risk to all members through diversification. Other benefits of creating a significant pool include higher economies of scale, increased revenues and reduced distribution costs.

Operators Getting their Feet Wet

In practical terms, there are a number of challenges to confront in making the creation of a takaful pool a reality. For example, to get the concept off the ground would require:

  •  International cooperation.
  •  Increased regulatory awareness – and a more unified approach by regulators.
  •  Familiarity with the pooling structure and with the other member organisations within it.
  •  The ability to move from consumer lines (the current primary focus for takaful) to larger commercial risks.

In the regulatory arena, there are some steps being taken that could be helpful. For example, a number of countries have announced forthcoming regulations governing the takaful market, with Oman being the latest in the Middle East region. Like the wider industry sector, governments are concerned at the number of small, local players without scale and are hoping to facilitate consolidation and produce a smaller, stronger number of providers.

It might be that the improving economic picture, as well as new markets opening in North Africa and improved education among populations unaware of the concept of takaful, will lead to continued and improving market growth. However the challenges to the sector are clear, and there is a dearth of takaful operators who are capable of providing leadership to the growing internationalisation of the industry. So could the answer be closer collaboration – and not more competition?

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