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Takaful: More than just green shoots
Islamic Finance news

With Takaful continuing to be the darling of the insurance industry and one of the fastest growing sectors in the Islamic finance sector, SCOTT WEBER investigates why, with such low penetration rates and high levels of economic growth in its key markets, has Takaful not seen greater success?

Low insurance penetration and strong economic fundamentals in countries with majority Muslim populations should almost guarantee rapid industry expansion. In certain choice jurisdictions this is the exactly the case: however, this rapid growth and nascent business offers its own problems of stability, solvency and supervision that are characterized by fragmented regional approaches, uncertain growth prospects, high levels of competition  and limited premiums.

Issues of solvency continue to loom large over the industry. Aggressive competition between Takaful operators has meant that they are fighting over a saturated demographic and thus failing to gain market share over their domestic competition and limiting opportunities for regional expansion. There is a developing trend in many emerging markets with notable Muslim populations that are embracing Shariah compliant products more willingly than conventional products. As such there are now many market advantages in running Shariah compliant products from a purely business perspective. With a genuine market for such products and services, there is an increasing acceptance and credibility in marketing Islamic products to the population at large. However, Shariah compliance alone does not a successful product make. Any product will certainly become more compelling to a certain target audience but the underlying product has to make financial sense over those available in the conventional market.

As the regional insurance markets continue to open up and multinational insurers reposition themselves on the world stage, the focus is shifting to up-and-coming markets that exhibit high growth potential – with select countries in the Middle East becoming an increasingly important focal point. The insurance industry in the Middle East is expected to experience high growth rates throughout the coming years, and policymakers, regulators and key players in the industry will have to address the challenges that lie ahead of them as the region’s insurance sector is becoming increasingly fragmented, requiring insurers to concentrate on profitability, scale and long-term sustainability.

Meanwhile, Asia has many positives going for it – think robust growth, high liquidity levels, and generally healthy fiscal positions. However, issues of volatility in the financial markets as a whole continue to constrain the industry. One of the key challenges for the Takaful industry at large has been locating appropriate assets for their various products. Taking a disciplined approach in matching assets with liabilities is a constant battle and the skittish state of the market further exacerbates the issue.

As a result Takaful companies are holding significantly more cash now than usual. This is due to their inability to lock in long-term assets that meet their requirement. Therefore Takaful companies are maintaining their liquidity position with a view to only accessing the fixed income and equity markets when the timing will guarantee higher yields.

Poised for growth
The Middle East insurance industry is undoubtedly poised for major growth. As markets become more global, business opportunities in the sector are set to increase. However, as markets change there will also be significant challenges to overcome, and with increases in market volatility and risk, it is essential that the key players in the regional insurance industry engage in discussions that will place the industry on a solid footing for future development.

The insurance industry in the Middle East has tremendous potential for growth given the relatively low insurance penetration levels, positive demographic and economic trends and rapid infrastructure development occurring throughout the region. While this points to the size of the growth opportunity, GCC insurers continue to face a number of challenges. The insurance industry in the GCC is highly competitive, with predatory pricing in the region negatively impacting on profitability and growth. The region also suffers from a significant number of small insurers that lack sufficient capitalization and skills to underwrite or invest funds. The region therefore is highly dependent on reinsurers and is ripe for consolidation.

Economic growth is the single most important driver of current insurance business in the GCC and insurers need to gear up to capitalize on the growth potential of the region’s insurance sector. This growth is also aided by increased government spending due to budget surpluses attained through high oil prices and state-led diversification.

Critically, this tremendous growth trajectory has been slightly skewed by the growth of the Takaful industry rather than underlying demand for Islamic insurance products. To ensure the Takaful sector’s longer-term viability, operators need to focus on product differentiation as opposed to competing on price. However, Takaful is expected to remain among the fastest growing segments of the insurance markets. The ability of Takaful operators to increase insurance penetration is critical to that success.

Uptake needed
The GCC has one of the lowest penetration and density rates in the world with insurance penetration in the region much lower than the global and emerging market average. While the penetration rates for the GCC as a whole have increased - from 0.6% in 2000 to 1.3% in 2010 - they remain significantly lower than the global average of 6.9%.

Given the high correlation of insurance penetration levels with GDP, the low regional penetration and density levels underscore the significant growth potential of the rapidly growing economies in the GCC. The insurance sector at large has a strong positive correlation with GDP. The IMF estimated real GDP growth for the region at 17.8% in 2010, up from a negative 18.8% in 2009. The region also demonstrates favorable demographics, with a young population and rising birth rates. Alpen Capital estimates that insurance premiums in the GCC currently stand at approximately US$18 billion in 2011 and will rise to US$37 billion by 2015, registering a compound annual growth rate (CAGR) of 20%.

The UAE and Saudi Arabia are likely to remain the two biggest markets in the region and are predicted to hold a 75% combined share in 2015; a slight reduction from the current level as other GCC states such as Qatar continue to register higher growth rates of up to CAGR 30% in the coming years. Saudi Arabia registered the highest penetration of 1.04% followed by Bahrain at 0.45%.

Gaining acceptance
Increasing acceptance of Takaful will continue to provide a strong growth impetus to the insurance sector as a whole, having increased by 31% in 2010 on a year-on-year basis. Ernst & Young estimates that the GCC Takaful market will continue to grow at 31%, reaching US$8.3 billion in 2011. The success of the Middle Eastern banking industry has shown that its participants understand issues relating to distribution better than their insurance counterparts. This has been compounded by a lack of critical mass in many of the GCC states, and over the years, a fragmentation of the industry.

A detailed study carried out by consulting group McKinsey on Islamic financial services has shown that for an Islamic-focused business model to work well, Islamic financial products must have a broad-based appeal. Takaful business will not be feasible if its marketing focuses on Muslims only. It has to appeal to the community at large through its core principles of transparency, ethical investment and equity.

According to a recent report by Moody’s, investment risk - due to the significantly concentrated and highly correlated investments in the local real estate and equity markets - is constraining the growth prospects of Middle East insurers and Takaful providers. The report notes that although Middle Eastern insurers hold very strong levels of capitalization relative to their underwriting risk, their exposure to the property downturn has elevated their credit risk.

It does however note that as more sophisticated regulatory supervision and risk management strategies roll out across the region these pressures will moderate. Moody’s also highlights that Shariah compliance limits the investment choices available to Takaful insurers and singles out the fact that Sukuk is also heavily exposed to the property market.

Viable alternative
Ultimately the Takaful industry in the Middle East continues to offer a viable alternative for the 36.1 million Muslims across the region. Any nascent industry will prove challenging in its formative years and Takaful is no exception. The industry continues to raise numerous issues and provide challenges to all those involved, however the raw figures and economic prospects in the GCC region verify that Takaful is holding its own and will continue its growth trajectory in the short-term.

Tellingly, few if any Takaful operators have failed during the recent economic downturn. While business models have had to be reined in and recalculated, their Takaful proposition and ability to capture a previous untapped segment of the marketplace has allowed them to continue. There are numerous issues that continue to face the Takaful industry across the Middle East, however: primarily a lack of awareness of the alternative Takaful proposition as well as a lack of critical mass attained by the numerous and fragmented operations.

As an emerging industry a number of associated risks also continue to constrain the Takaful industry: primarily rising competition between operators and an alignment into direct competition with the conventional insurance industry through product replication. The industry continues to remain fragmented, with a large number of smaller entities entering the market with limited capital and lax attitude to coverage due to insubstantial regulatory frameworks. However, as these companies grow the awareness and number of participants is only likely to increase. The result is that Takaful in the Middle East has gained initial traction and is now looking to build on its momentum.

Yardstick measure
Malaysia continues to provide the yardstick measure for Takaful regulation and remains the most mature market by some margin. However, this position should not create complacency and insurers must apply prudent risk management and underwriting discipline. As always, good distribution and investment strategies are required to succeed in any insurance business but the nascent Takaful business requires companies to go the extra mile. In Malaysia, where less than 45% of the population posses Life or Family Takaful policies, a multi-channel distribution strategy, supported by a network of Takaful agents, bancassurance and direct sales, comprise a key growth strategy for Islamic insurance providers.

Indonesian potential
Much has been said about Indonesia’s potential in terms of future Takaful penetration. With a population in excess of 245 million, the majority-Muslim nation offers fertile ground for the industry. However, Takaful development has begun to fall behind the conventional insurance sector and has not garnered quite the same public acceptance as it has in many other key Islamic financial markets.
Development of new distribution channels and products combined with an open attitude and cleverly targeted approach to marketing are essential to guarantee continued success. In order to meet current demand and future growth a rapid recruitment of insurance agents to sell dedicated Islamic products is required. Of Indonesia’s 226,000 insurance agents, who account for 85% of the total insurance market distribution, only 2% are dedicated to selling Islamic products.

Low Islamic banking penetration of only 3.4% and a limited number of physical branch locations in the vast nation are also hindering future growth and limiting bancaTakaful distribution. Alternative distribution channels such as telemarketing and direct marketing are also required to meet this shortfall and attract potential customers to the inherent values offered by Takaful: such as justice, mutual assistance, cooperation, trust and transparency.
Based on capital market figures and data from the ministry of finance’s supervisory agency, as of May 2011 there were three fully-fledged Family Takaful operators, 17 Family Takaful windows, two fully-fledged General Takaful firms, 18 General Takaful windows and three re-Takaful companies in Indonesia. The total insurance premiums offered in Indonesia in 2010 were approximately US$12.5 billion. As of December 2010, the market share of Family Takaful based on gross contribution was 5.85%, General Takaful and re-Takaful 2.09%, and the total market share of Family, General and re-Takaful was 4.71%.

Developing Takaful in Indonesia
Although Indonesia offers huge potential due to the number of possible participants, contributions are still low. This can be primarily be attributed to a lack of awareness of the benefits that Takaful can offer individuals, coupled with a lack of awareness of long-term financial planning and lower income levels.
Given the relatively limited exposure of Takaful in Indonesia, the regulatory framework offers ample operating license for small scale Takaful operations. Draft regulations are currently being prepared to further augment those already in place: including the standardization of Family and General Takaful terminology, draft proposals on good corporate governance, and legislation that will allow for the conversion of the Shariah unit of a conventional insurer into a fully-fledged Takaful operator. Encouraging Takaful windows to convert into fully-fledged Takaful providers will increase the overall market share and contributions; further boosting the industry’s credibility.

Indonesia does highlight several key issues within current Takaful offerings. Of primary concern is the lack of awareness in Takaful products due to limited promotional activities by banks and operators. This is coupled with a lack of simple products offered with affordable contributions that can be targeted to the middle and lower-middle class market to increase market share.

BancaTakaful has tremendous potential to be marketed in line with the growth of Islamic banking. Ultimately, there are many people who do not understand the unique proposition offered by Takaful, and tying Takaful into existing financial products could go a long way towards guaranteeing their acceptance. Existing agents in Takaful windows also need the necessary training to instill confidence when selling Takaful products.

Turning tide
In many of these key jurisdictions insurance is a relatively new concept, and Takaful is equally misunderstood. Changing attitudes and gaining acceptance is critical in this instance. As customers become increasingly sophisticated in their purchase of financial products Takaful operators need to step up their products and services to capture more than just the low-lying fruit and become mainstream candidates. With a sustained track record and revised operating and business plans put into effect, Takaful could easily benefit from the turning economic tide and the stronger investment markets it will bring. 

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