We expect the market for Takaful to keep expanding in the Middle East, supported by strong demand and the spread of compulsory insurance in the Muslim-majority region. Takeup of insurance in the region also remains comparatively low, an indicator of good growth potential. Takaful operators’ profitability is currently under pressure as inflation drives up claims costs, and as claims volumes return to normal after a COVID-19 pandemic-induced decline. We expect a combination of weak profitability and rising regulatory costs as supervisors tighten their scrutiny of the sector to drive industry consolidation.
Review of 2022
Takaful premiums/contributions in the GCC, the Middle East’s biggest Takaful market, grew at a compound annual rate of 6% between 2018 and 2021, compared with 3% in 2016–21. We expect continued strong growth over the next two to three years.
Our view primarily reflects increased demand as countries in the Middle East and in particular the GCC introduce or expand compulsory health cover.
The introduction of compulsory medical insurance over the past three to five years in Oman, Qatar, Saudi Arabia and Kuwait, and the implementation of mandatory motor insurance in Saudi Arabia in 2022/23,will help sustain Takaful premium growth at least at the levels seen in 2018–21. Takaful operators are well positioned to benefit from compulsory medical and motor cover, as they focus mainly on retail lines.
Governments in the region are also encouraging consumers to build up their savings and make greater use of protection insurance. This will underpin growth in Family Takaful products, prompting insurers to acquire relevant licenses and expand their life insurance capabilities.
A further supportive factor is the current strong economic growth in the key hydrocarbon-rich Takaful markets of the Middle East, where governments are also attempting to diversify economically. Insurance penetration (premiums/GDP) remains relatively low in these countries, leaving ample room for growth. Takaful premiums in the GCC market grew by 21% in the first six months of 2022 compared with the same period a year earlier, reflecting a post-pandemic economic recovery across the region as well as pricing corrections in Saudi Arabia.
Higher claims weigh on profitability
Inflation is driving up Takaful operators’ claims costs, while claims frequency is also rising as economic growth picks up following a pandemic-related downturn in 2020. With inflation also eroding household incomes, the Takaful sector has been unable to push through matching price increases, leading to a decline in its profitability. This is reflected in a 70% decline in the overall GCC Takaful market’s profits in the first six months of 2022 compared with the same period a year earlier. The deterioration came despite higher returns on deposits and fixed income investments as interest rates rose globally, although this will provide some counterbalancing uplift in the future. Weaker profitability has also reduced potential synergies from mergers and acquisitions (M&A) activity.
Preview of 2023
M&A momentum remains strong
We expect Takaful insurers to continue investing in digitalization to improve their efficiency. The industry stepped up its digitalization efforts in response to the coronavirus pandemic, which encouraged consumers to interact with their insurers mainly through online platforms. Digital channels allow insurers to reach more customers at a lower cost and may allow some Takaful operators to boost their premium growth. However, switching from traditional to online channels can require significant upfront investment. As a result, we foresee that many small Takaful players will seek M&A opportunities to spread their digitalization costs.
Furthermore, supervisors in the key Takaful markets are raising minimum requirements around governance, risk and capital management. This is adding to Takaful operators’ compliance costs, particularly for smaller players. Smaller operators may also seek mergers to help them comply with increased capital and other regulatory requirements, particularly in Kuwait, Saudi Arabia and the UAE.
In Saudi Arabia, recent legislation gives the regulator the power to raise the minimum capital for insurers to at least SAR300 million (US$79.89 million) from SAR100 million (US$26.63 million) currently, with the final regulatory implementation expected soon.
Similarly, in March 2021, Kuwait’s insurance regulator published new executive directives that increase insurers’ minimum capital and introduce risk-based capital measures and actuarial-led reserving.
Conclusion
While we expect the changes in capital regulation to strengthen the industry over time, they pose some implementation and operational hurdles in the short term. It is therefore important for Takaful operators to achieve the scale required to absorb these costs.
As a result, while better governance is supportive of credit quality in the longer term, rising regulatory costs are a source of additional profitability pressure, and will continue to spur M&A activity across the sector.
Mohammed Ali Riyazuddin Londe is the vice-president and senior analyst at Moody’s Financial Institutions Group. He can be contacted at [email protected].