Middle Eastern insurers have been met in recent years with the sudden and often aggressive rise of Takaful. The rapid growth and multiplication of these new entrants has been impressive, but has occasionally brought into question the stability of their business model, which focuses heavily on illiquid investment assets: notably equity and real estate. These assets are then balanced against presumed expansion, with operators targeting double digit growth in annualized premiums and gross written premiums, driven primarily by Family Takaful uptake.
As many Takaful operators are start-ups seizing the potential to enter an emerging marketplace, many have struggled to meet their initial business plans; particularly those that have tried to be strict in their definition of Takaful and Shariah compliance. As such, many Takaful operators have relaxed their criteria and have become more flexible in accepting conventional risks in order to allow them to compete in what has become a crowded marketplace.
When compared with conventional insurance companies, Takaful operators can generally be characterized as remaining under-developed due to the short-term and illiquid nature of investment and their current low capitalization; which has resulted in the under-utilization of capacity and as a result their immediate potential to compete in the short to medium term.
Furthermore, Takaful operators are generally unable to generate sufficient surpluses within their Takaful funds as management expenses and fees charged are generally higher. As a result, Takaful operators’ financial performance tends to be inferior to conventional insurers. Instead of product differentiation being a unique selling point, Takaful operators are all too often competing on price. These inherent dangers will likely remain implicit within Takaful insurance for the foreseeable future.
The main attribute of this rise in Takaful companies has helped to create new classes of insurable activity changing regional consumer mindsets, particularly in the retail sector. According to Standard & Poor’s (S&P), insurance buyers are now seeking quotations from compliant Takaful and cooperative insurers, with many preferring them over traditional providers if they can offer competitive pricing and good service quality. Even in the commercial sector, buyers will seek quotations from Takaful and cooperative companies if they know their insurer financial strength to be secure. As a result a well-designed, well-managed Takaful policy can be attractive to all, as conventional assurance risks continue to prove contentious for many in the region.
According to S&P, taking a purely analytical perspective, many of the specific features of a fully compliant Takaful insurance have little direct bearing on an insurance or reinsurance company’s fundamental performance or financial strength. Whether conventional, cooperative or Takaful, an insurer will still receive revenue from both policyholders and investments, and pay claims and expenses out of this income. Ideally, they will be left with a surplus that can be either distributed in whole or in part, or retained to help reinforce solvency.
As S&P states, it is not particularly relevant (analytically at least) how or to whom profits are distributed. The important consideration in financial strength terms is that both the balance sheet and income statement be resilient, with total income reliably exceeding total outgoings in a normal year. This allows risk-bearing capital to be built up over time on both the policyholder and shareholder accounts through the retention of earnings. This helps to maintain appropriate levels of solvency relative to underwritten and investment exposures, which are likely to be increasing over time.
While consolidation has been widely mooted, no candidates have emerged as possible M&A targets, suggestive that the industry has yet to make a viable business case for itself. Ultimately, competition is healthy for the industry. Until an operator can emerge in the region with significant enough scale premised purely on Shariah compliant operations it is unlikely that the Takaful industry will be able to go much further beyond its current retail-focused niche. — SW