Takaful Corner
Potholes In The Streets Of Gold?
| January 21, 2010 by Clyde & Co
The current financial crisis has severely impacted on financial institutions and this recessionary tendency has meant that growth forecasts in global markets as well as various sectors have been affected; major takaful markets are no exception. The short-term performance of takaful operators is reported to have been impacted. Figures published by Ernst & Young in its latest report suggest that in taking a sample of GCC and Malaysian Takaful operators, the average return on equity in terms of percentage has dipped significantly in 2008 (especially in respect of GCC companies) and is estimated to rebound during the course of 2009.
However, as in many other sectors, takaful operators that are able to successfully manage their business during this challenging economic environment will be well placed to take advantage of opportunities that arise when markets begin to pick up. It is also relevant to note that the negative press certain conventional investment products have received in light of recent economic failures, and the causes behind the current economic crisis, means that takaful may also be perceived as being more attractive to consumers as it offers a more conservative method of running a risk-carrying entity.
Further, takaful has broad appeal beyond the Muslim communities who are seeking a shari’a-compliant alternative to conventional insurance and may help to unlock markets that have not historically been accessible to conventional insurers. It can be also attractive to those who are concerned with all forms of ethical finance and finding alternatives which suit this type of ethically conscious consumer. In addition, some non-Muslim customers may be attracted to takaful by the possibility of a return of surplus generated on the contribution they provide in order to receive insurance protection.
Future challenges for takaful
As a nascent industry, there inevitably remain challenges for takaful going forward. Some potential areas which may need to be overcome in the future, if takaful is to continue to develop in accordance with the expectations that the industry has generated in the last few years, include:
Sufficient shari’a-compliant investments: One of the key challenges faced by takaful operators is finding suitable assets in which they can invest the revenues generated by the contributions made to the takaful pool in order to secure the ongoing nature of the business. Since the recent economic crisis, this challenge has intensified in its scope. The Ernst & Young report notes that this financial risk element, (including contributing factors of a restricted investment universe and unbalanced investments, high equity exposures, high counter-party risk and reduced sukuk issuance) is now the number one business risk compared to ranking fourth last year. This lack of diversification in investments limits the flexibility afforded to takaful operators to manage their investments as efficiently as possible.
The sukuk market is a key factor. There is a lack of liquidity in the Islamic bond market and although the sukuk market grew from US$1bn in 2001 to US$35bn in 2007, long-term sukuk are over-subscribed and not traded frequently. This has resulted in operators being overly dependant on regional equity and real estate markets (which has, to some extent, exposed them to the current economic crisis). The lack of long-term sukuk is a problem which is hoped will be addressed by other products coming to the market, such as an equivalent annuity product.
Takaful as a “young” product: Given that takaful is, compared to other financial products, in its early stages of development, this means there inevitably remain uncertainties and divergence of opinion regarding aspects of the takaful models and the way in which business should be conducted. These uncertainties may pose a challenge for takaful in the future to retain its credibility, especially with respect to shari’a compliance.
A useful analogy can be drawn with the sukuk market after well-known shari’a scholar, Sheikh Muhammad Taqi Usmani, chairman of the AAOFI Board of Scholars, claimed that about 85 per cent of Gulf Islamic bonds were not shari’a-compliant in November 2007. The statement had serious implications for the sukuk market and during the next 12 months the level of activity seen was reported as being more than 50 per cent below that of 2007. No doubt this was due in part to the global economic crisis, but investor confidence, in an area driven by ethical considerations, inevitably played a part.
Takaful may also run the same risk. It is necessary for the takaful industry to ensure that the mechanisms by which takaful works are shari’a compliant in order not to lose credibility.
One way takaful may face challenges is in respect to the doctrine of tabarru (donation), which governs the payment and receipt of contributions by participants to the takaful operator. The exactly legal status of the contributions has not been determined. The doctrine of tabarru is traditionally considered to make takaful contracts a form of a unilateral contract with the takaful operator – ie, a donation made without expectation of any return. In turn, the takaful operator also is deemed to enter into a unilateral contract with the donor to cover its risks.
However, this analysis does not reflect what is happening in practice – in reality a customer who provides a contribution will do so expecting something in return, namely, the payment of claims. Consequently many contracts issued by takaful operators appear substantially similar to those provided by their conventional counterparts and take the form of a bilateral contract.
Another example of shari’a risk concerns the distribution of surplus to participants. At present, funds are retained by takaful operators to create reserves and there are few reported examples of distributions to participants. This return of surplus is a cornerstone of takaful and is essentially to generate a “win-win” situation to avoid traditional Islamic criticism of conventional insurance.
