Vol: 45 Issue: 2 | July 2022
Takaful, a form of insurance based on the principles of mutual protection, co-operative risk and the sharing of surplus capital, has its origins in Islamic law, but it’s potentially available to anyone.
The word takaful means ‘mutual obligation’ or ‘mutual guarantee’ and it has been around in some form for 1,400 years. Modern takaful insurance products began to emerge in Sudan in 1979, in response to a growing demand for alternatives to conventional insurance, which is considered unlawful due to its in-built uncertainty and the requirement for charging interest.
In 1985, the Grand Counsel of Islamic Scholars gave takaful insurance its seal of approval, declaring it the ‘correct alternative’ to conventional insurance and fully compliant with sharia (Islamic) law.
Since then, takaful has become increasingly popular in the Middle East, where it is now the region’s main form of insurance. However, there’s an important, untapped market in Asia Pacific, which is home to 62 per cent of the world’s Muslims.
According to Allied Market Research, takaful in Asia is expected to witness significant growth owing to ‘rising digitisation in various countries and adoption of advanced technology by takaful insurance service providers to increase sales’.
However, with a lack of standardisation in takaful insurance, its market growth has been limited by factors such as regional differences and lower consumer awareness.
In Malaysia, where 60 per cent of the population is Muslim, more than 38 per cent do not have personal insurance protection, according to a 2021 report in The Edge Markets.
The business news site quotes Zurich Malaysia-commissioned research, which found that 84 per cent of respondents agreed the pandemic had increased their awareness of the need for insurance, but 62 per cent said it had also impacted their ability to afford insurance. About 23 per cent of Malaysians can’t afford personal insurance.
The Malaysian Takaful Association (MTA) says the industry’s penetration rate, which has always been a stumbling block, rose to 18.6 per cent in 2021, from 16.9 per cent in 2020.
Elmie Aman Najas, the organisation’s chair, is bullish about the prospects of takaful. He told The Edge Markets that the increase is the highest to ever be recorded over a five-year period.
The growth, though still comparatively small, was mainly driven by takaful life insurance products known as family takaful. In 2021, he says, ‘in-force family takaful certificates grew to 6.07 million certificates versus 5.51 million in 2020’.
‘The family takaful market has shown exceptionally strong resilience despite the pandemic, with annual takaful contributions of new businesses reaching the two billion ringgit-mark for the first time, recording RM2.23 billion, an increase of 48.8 per cent, compared to RM1.5 billion in 2020,’ he told the site.
Najas is also CEO of AIA Public Takaful Berhad, a subsidiary of AIA Malaysia and part of the AIA group. He says takaful in Malaysia is growing faster than conventional insurance because of Malaysia’s demographics. He sees takaful’s low penetration rate as a growth opportunity.
‘There is strong appeal for takaful among the Muslim market segment as it is sharia-compliant,’ he says. ‘This is [in part] driven by the huge protection gap that exists.’
Role of Islamic finance
Meanwhile, in Indonesia, which has the world’s largest Muslim population, takaful currently has a penetration rate of around 9 per cent, a rise from 7 per cent in 2021 and about 5 per cent the previous year, according to Fitch. Last year, life insurance sharia products made up 86 per cent of the takaful market, followed by general sharia products at 14 per cent.
Tati Febriyanti, head of the Insurance Council of Indonesia’s (DAI) Education and Development Commission, says the local takaful sector continues to expand, driven by growth of the Islamic banking and financial services sector more generally.
‘In 2021 the total gross contribution of sharia insurance increased by 35.2 per cent (YoY), mostly due to a growth in contributions for personal accident and combined endowment business lines,’ she says. ‘Other factors include a growing awareness of, and demand for, takaful products, government support for the Islamic finance industry, and a recovering economy.’
Aside from the expansion of the Islamic finance industry, Tati says several factors will ensure the growth of sharia insurance in Indonesia.
‘First and foremost, the improvement of public understanding and awareness of sharia finance in recent years can potentially aid in the advancement of the industry,’ she says. ‘Secondly, the expansion of the Islamic economy — halal food, halal travel, modest fashion, media and amusement, pharma and cosmetics — necessitates the use of sharia insurance to manage company risks. This becomes a great opportunity for local insurance companies, as well as joint venture insurance organisations, to evolve.’
Insurance with values
Mukesh Dhawan is the former CEO of Zurich Takaful Malaysia Bhd and is now founder and CEO of embedded insurtech company Drivn Fintech Sdn Bhd, which operates out of Kuala Lumpur. He says takaful thrives on mutual benefit and that its unique design —incorporating the sharing of surplus capital and in-built environmental social and governance (ESG) — means it holds wide appeal.
‘Every takaful operator must share the surplus made from every product with the customer, who is the product owner. In simple English, this can be called profit sharing. In takaful, we don’t use the word profit. It is more about surplus or gains.’
In Malaysia, he says the most common ratio is 50:50. So, in motor insurance or health, as in conventional products, you have a no-claim bonus. ‘But over and above that, takaful gives you 50 per cent of any surplus after claims that must be paid.’
In addition, Dhawan says sharia law ensures takaful guidelines for operations and investment are aligned with ESG. ‘Islamic banks have always practised ESG; it’s not a new development over the last five years,’ he says. ‘Takaful guidelines never allowed investment in companies or organisations that are harmful to society or the environment. For example, takaful never allowed us to invest in tobacco. Takaful insurance operators will not invest in a company that is not eco-friendly.’
Sharing the risk
For Tati, the most essential and unique distinguishing feature of takaful insurance is its concept of managing risk.
‘In sharia insurance, risk is shared, whereas in conventional insurance, risk is transferred,’ she explains.
‘The concept of sharing risks among fellow participants, or risk owners, is implemented through two contracts — the tabarru between fellow participants, and the wakalah bil ujrah between participants and the insurance company that manages the funds.’
Participants make contributions to tabarru funds in the form of grants or donations based on their risk profile. ‘Tabarru funds are kept strictly for compensating participants who have been legitimately affected by losses or claims,’ Tati says.
‘In addition, fees come out of tabarru funds to pay the insurance company for its role managing the funds. These fees also go towards taking care of any issues that might arise and undertaking investments on behalf of participants.’
Tati says this risk-sharing approach has the advantage of being a non-commercial contract. ‘The entire sharia insurance system is in accordance with Islamic law where the management of participant tabarru funds, corporate/operator funds and investment funds being free of gharar (uncertainty), riba (usury), maysir (gambling) and other practices prohibited by Islamic law.’
Given the religious ethical requirement and the fact that the takaful industry is relatively new, regulation and governance are a work in progress.
Notably, Malaysia took a step forward in 2013 by amending the previous Takaful Act 1984 to improve several aspects of the regulation and supervision of Islamic finance.
‘In the past, Islamic finance was governed under the same Act as conventional insurance,’ says Najas. ‘Under the Islamic Financial Services Act (IFSA) 2013, the takaful sector in Malaysia underwent one of the biggest policy changes to date, whereby operators needed to hold separate capital requirements for general and family takaful businesses.’
Najas says that, comparatively, the Malaysian takaful market is more advanced than others because the country’s central bank, Bank Negara Malaysia, ‘has established a sound framework and market environment for its growth’.
As well as the IFSA, operators are regulated by the Risk-based Capital Framework for Takaful Operators, the Financial Services Act (FSA) 2013 and the yet-to-be-implemented IFRS 17. ‘A key difference between the FSA and the IFSA is the introduction of a new provision to strengthen sharia governance, whereby Islamic financial institutions shall ensure end-to-end sharia compliance with regard to policies, procedures and operations,’ says Najas.
However, according to Fitch, implementation of IFRS 17 remains a challenge. ‘The takaful industry continues to face uncertainty over the interpretation and application of IFRS 17 as the January 2023 implementation deadline draws nearer,’ says the organisation, adding that ‘the selection of measurement models and treatment of various funds will be resolved’.
Spinning off sharia units
In Indonesia, the Financial Services Authority (OJK) and Ministry of Finance have taken a proactive approach to the financial services industry; however, specific laws governing Islamic insurance are lacking.
The Indonesian Government is attempting to strengthen sharia insurance and reinsurance (retakaful) through its Insurance Law of 2014 and OJK provisions, which require sharia window businesses (which dominate the Indonesian takaful market) to spin off from their non-sharia parent companies into fully-fledged takaful businesses.To support the process, the government has partnered ASEAN general insurers with domestic ones under the spin-off program and exempted new sharia entities from the 80 per cent limit on foreign ownership. The OJK called for those eligible to submit their plans of action by October 2021, with a deadline of October 2024 for strategic business units (SBUs) to be spun off or face losing their licence.
‘In general, the insurance industry has responded positively to the spin-off requirement for sharia insurance units into independent entities,’ says Najas.
So far, just five companies have completed the spin-off process. According to Fitch in 2021, most were ‘progressing slowly’ and struggling to spin off SBUs in the short term ‘due to high capital requirements and operating expenses, while the implications for profitability and financial viability are unclear’.
Fitch further argues that for the sector to continue growing, ‘several structural constraints need to be addressed’. These include ‘developing an Islamic finance ecosystem that supports takaful operators, attracting adequate capital, strengthening the regulatory framework, providing additional incentives for takaful operators, introducing new products, raising awareness of insurance products and Islamic finance in particular, and developing human capital’.
Refining marketing and skills
Despite global takaful marketing efforts, Dhawan says the use of sharia terminology is currently a barrier to the market awareness required for significant growth. He says if takaful companies simplified their communications, product acceptability and penetration would improve.
‘For the general buyer, the language in the documentation immediately comes across as jargon and therefore fails to get read properly,’ he says. ‘That’s human nature. But if you tell a customer they’ll get more money back than in conventional insurance, it makes more sense to them.
‘That’s why in my three years as CEO of Zurich Takaful, I tried to de-jargonise as much as I could, whether through the PDS, agency training, seminars or other kinds of communications.’
Developing talent is urgent. ‘Managers, especially on the money management side, whether it’s investment or accounting, must be qualified as per sharia guidelines,’ says Dhawan. ‘Currently in Malaysia, we need more people to undertake the many available courses and qualify, because there aren’t sufficient numbers in the market.
‘In addition, I would say that organisations that haven’t opened or expanded takaful businesses are concerned about costs because of the need to source people who are high in demand and to pay them a premium. It’s a similar situation in Indonesia.
‘Growing the number of sharia-qualified people is a key critical need for the takaful industry, but the increase in technology and algorithms that are inherently free of any specific religion will support this need. Malaysia’s digital roadmap and that of other parts of the Asia Pacific will bring a much greater awareness of and penetration for takaful products in the future.’
Takaful vs. conventional insurance
Most Islamic jurists conclude that conventional insurance is unacceptable in Islam because it does not conform to sharia law for the following reasons:
- Conventional insurance includes an element of al-gharar or uncertainty.
- Conventional insurance is based on the concept and practice of charging interest. Islamic insurance, on the other hand, is based on tabarru, where a portion of the contributions made by participants is treated as a donation. This is why policyholders in takaful are usually referred to as participants.
- Conventional insurance is considered a form of gambling.
An Islamic insurance company operating a takaful fund must abide by the following principles:
- It must operate according to Islamic co-operative principles
- A reinsurance commission may only be received from or paid out to Islamic insurance and reinsurance companies
- The insurance company must maintain two separate funds: a participant and policyholder fund, and a shareholder fund.
Eyes on Indonesia
Tati Febriyanti, head of the Insurance Council of Indonesia’s (DAI) Education and Development Commission, says there are several key factors contributing to the growth of sharia insurance in Indonesia of the next three to five years:
- a large Muslim population (237.53 million people), which accounts for 86.9 per cent of the country’s overall population
- the growth of the Islamic financial services sector
- the growth of the sharia economic sector, which includes halal goods and services
- an increase in awareness of sharia insurance
- strong support from government and the Financial Services Authority through the Indonesian financial services sector master plan 2021-2025, which focuses on strengthening resilience and competitiveness, developing a financial services ecosystem, and accelerating digital transformation.