Ethical, varied and a growing market – ‘takaful’ Islamic insurance is worth knowing about, wherever you’re from and whatever your beliefs, says Ali Asghar Bhuriwala
Insurance is generally understood as a promise made by a company to compensate policyholders for losses caused by specific events, in exchange for periodic pre-payments (premiums) to the company. The ‘takaful’ Islamic insurance model is no different, in that it is also a system of reimbursement that compensates policyholders (participants) for losses incurred as a result of specific events.
Where it differs, however, is in the management of the risk. The term ‘takaful’ is derived from the Arabic word ‘kafala’, meaning guaranteeing each other. In insurance, there is a risk transfer from the policyholder to the insurance company, while under takaful, the participants jointly agree to cover themselves against loss via the pooling of the risk, managed by the takaful operator (takaful company).
The premiums are deemed to be donations into a risk pool, through which the participants indemnify each other; they also share any surplus arising from the pooled money. Any deficit is met through an interest-free loan (‘qard hassan’), financed by the shareholders’ fund. Shareholders then have a first charge on future surpluses in the risk pool until the debt is cleared.
Another differing feature of takaful is in the investment of both the participants’ and shareholders’ funds. Takaful companies must invest funds in ethical avenues, in order to be compliant with Islamic law, or Sharia. Therefore, any interest-bearing investments are disallowed because interest or usury is considered to be exploitative.
When determining their investments, takaful companies are required to ensure that the funds are not interest bearing and are not directed into businesses that may lead to social ills or that Islam considers unethical or immoral, such as those involved in alcohol, arms and adult entertainment. Both conventional insurance and takaful companies follow local statutory regulations, but the latter also have a supervisory board that ensures compliance with Sharia.
How it works
There are different ways in which takaful can work. The takaful operator can receive a fee from participants’ contributions, known as a ‘wakala’ fee, to pay for the costs of running the business (this is the ‘pure wakala’ model). Another method allows a performance fee to come from any underwriting surplus, in addition to the wakala fee (the ‘modified wakala’ model). Then there is the system in which the takaful operator forgoes a wakala fee and covers its costs from a larger share of underwriting surplus (the ‘pure mudaraba’ model).
Other approaches in vogue include the co-operative model, which is followed in Saudi Arabia, and the ‘wakala waqf’ model in Pakistan. The modified wakala model is the one most used in the Gulf Cooperation Council region, which is made up of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE.
The key differences
Most of the product characteristics of conventional insurance are mirrored in takaful, and it is common to see unit-linked savings and pure protection plans (level or decreasing term). Products with a capital-guarantee element are not usually offered under takaful.
Due to the similarity, most actuarial work around takaful products follows standard actuarial principles. However, there are three main areas that will require additional consideration:
The first is product design and pricing. While the principles remain the same, a basic difference in takaful is the requirement to separate the shareholders’ fund from the participants’ fund. Both cashflow streams need to be simultaneously produced, and the pricing needs to ensure the sustainability of the participants’ fund while also making it commercially viable for the shareholders. The investment mix assumed, and the underlying assumptions for investment returns and discount rates, are set keeping in mind the nature of allowable investments under the takaful spectrum. Solvency is also viewed at a fund level and in totality.
Second, actuaries are also required under most takaful regulations to advise on the distribution of the surplus in the participants’ fund. Depending on the model in place and the net surplus emerging to participants, this may be done in proportion to the net earned contributions or on some other fair basis, commensurate with the exposure to risk faced by each participant during the relevant period.
Third, the level of wakala fees is a factor. Most jurisdictions in the Middle East require the actuary to certify the level of wakala fees being charged and whether they are equitable. This is a broad term; generally, in practice, it gives the actuary considerable say over determining the appropriate fee level, which is essentially to be used to meet expenses and contribute towards the profits for the shareholders. A high fee may mean that the shareholders are making a profit at the expense of the participants, whereas a low fee may mean the company has insufficient funds to pay for the expenses incurred during the period. Some jurisdictions apply a maximum cap on the wakala fee that can be charged.
Sizing up the market
While reports paint a rosy picture around the growth of takaful and how it has outpaced conventional insurance growth during the past few years (which it has), the fact remains that takaful premiums still account for less than 1% of the world’s insurance premiums.
The pace is picking up but the low base means that there is a lot of catching up to do. To give perspective, in 2021, global takaful premiums totalled around US$28bn, compared with world insurance premiums of US$6.9trn. By 2028, takaful premiums are expected to grow to US$58bn. Even if we conservatively consider that world insurance premiums will remain at similar levels, the proportion of takaful insurance will still constitute less than 1% of the global total.
Of the 20 countries that account for 90% of the world’s insurance premiums, none are known to have any takaful market volume of note, and most do not have any takaful product availability.
From a geographical point of view, almost half of the global takaful premiums are concentrated in the Gulf Cooperation Council and wider Middle East and North Africa markets, with Saudi Arabia leading the pack. Malaysia is the largest player on the Asia-Pacific side, while takaful insurance also has a decent footprint in the African market.
The idea that takaful is only for Muslims is one of the core hindrances to the growth of takaful beyond the established markets. Industry practitioners who champion takaful will need to undertake a paradigm shift in the way they position takaful offerings for the wider masses. Given that its principles are ethically driven, it should be promoted that takaful is good for all – not just for Muslims.
Ali Asghar Bhuriwala is executive director at Badri Management Consultancy in Dubai
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