Takaful, or Islam-compliant insurance, operators will need to focus on underwriting quality, cost management and investment discipline as financial performance remains a challenge for many markets in the current fluctuating investment environment.
Investment returns are low under current economic conditions, so takaful operators have to rely more on underwriting profit, said Marcel Omar Papp , head of retakaful at Swiss Re.
Investment is one challenge for takaful operators, who tend to rely on equities or real estate, which are more volatile than other investment opportunities. "It’s often difficult for them to get a share of other Shariah-compliant investment tools such as sukuks [Islamic bonds] as they tend to be oversubscribed," said Papp. "A dearth of Shariah-compliant capital market instruments is exerting pressure on returns," said Brandon Bruce , senior executive officer of assurance at consultancy Ernst & Young.
Some companies have high direct exposure to equity markets to maximize returns. In general, Bruce noted "there is less strategic planning seen and a more ad-hoc approach to investment portfolio management." In several countries, more stringent regulations will restrict this practice. Takaful operators from Gulf Cooperation Council countries including Saudi Arabia, United Arab Emirates, Qatar, Oman, Bahrain and Kuwait adopted a more aggressive investment strategy with 44.3% of the typical portfolio in real estate and equities in 2010, compared to 32.1% for Malaysian operators on average. Consequently, GCC operators recorded more volatile investment returns of 3% in 2010, -4% in 2009 and -2% in 2008, according to Ernst & Young. Malaysian operators on average posted stable investment yields of 3% or 4% over the past five years. Takaful operators mainly raise capital through debt, equity or decreasing risk. Papp said most operators "seem to be well capitalized" as many companies have only been set up in the past few years and their business volumes are not yet significant. Most takaful companies are "highly capitalized" at this early stage of development, with sufficient levels to achieve operational maturity, according to an A.M. Best Co. report. In many cases, takaful funds have low levels of excess resources as these are retained at the operator/shareholder level.
With expected growth and new risk-based capital regulations, this may change. "The volatile capital markets do not help as takaful operators may be over-exposed to religiously acceptable, but potentially volatile of ill-liquid assets such as equities or real estate," said Papp. Papp noted the capital needs of takaful operators may rise in the short to medium term. With rising equity costs and limited Islamic debt instruments, Papp said retakaful may become another viable option to meet increasing capital needs. On the underwriting side, Papp said "there is an inherent danger that a company maximizes its income by increasing its business too much." Companies will be in difficulty once premiums stop rising and claims catch up. Most takaful operators have yet to achieve critical business volume and expense ratios remain higher than conventional insurers. Also service quality remains "sub-optimal" for many operators, said Bruce. Takaful operators need to earn sufficient wakala [agency] fees for the shareholder fund to meet operational expenses.
Ensuring profitability may lead to "substandard risks being accepted to boost volume and growth," bringing negative impacts on loss ratios, said Bruce. Bruce also noted "complex risks are not well understood and potentially mispriced." Portfolio are "sub-optimal" for many operators, with concentrations in motor lines for general takaful and single contribution mortgage and credit term business for family takaful. Access to lucrative commercial lines is limited due to under-developed broker relationships. In various countries, Papp said takaful operators show more mixed results than conventional insurers. General takaful operators in Malaysia recorded better results than conventional insurers but the case was opposite in the Middle East. Most general takaful operators tend to compete with conventional insurers on price because most start-up companies are falling behind their original business plans, said A.M. Best in its report. Takaful operators’ financial performance tend to be inferior to conventional insurers, it added. The nature of risk sharing makes takaful more suited to personal lines, which tend to be less volatile but with lower margins than commercial lines. Takaful operators also encounter additional costs for Shariah compliance. Papp said "the shareholder of a takaful operator should expect a lower profit margin but maybe also more stable profits compared to a conventional insurer." Overall, family business is more profitable than general takaful and is growing at a fast pace, said A.M. Best. "Family takaful is also outpacing conventional life insurance, thereby representing the greatest opportunity for profitable growth of takaful operators," A.M. Best said.