Ashar Nazi, Executive Director and MENA Head of Islamic Financial Service Ernst & Young, answers a few queries from Banking & Business Review (BBR) on certain issues in takaful industry
Takaful companies sell basically conventional products to their clients - barring the Life takaful. The only difference between the conventional insurer and takaful is that the latter makes investments only in Sharia-compliant areas of investments. What is your view on this observation?
We disagree with that statement. The concept of takaful is quite different from conventional insurance. For instance, the takaful policy is different from conventional insurance, as it is not based on a sale contract but on the principles of risk sharing or mutuality. Participants contribute towards a common pool and this pool is used to support the participants in their hardships.
There also other key differences like:
A) Interest (riba): Difference between premiums paid and claims received by customer is termed as interest by religious scholars. Also, interest is earned on investments made by conventional insurers.
B) Excessive uncertainty (gharar): Any valid sale contract in Islam must be very clear in its terms. In conventional insurance, the insurer does not know how much he will eventually owe; the insured does not know how much he will ultimately pay and the time of this payment is not specified either.
C) Gambling and speculation (qimar and maysir): One party's benefit is dependent upon the loss of another. There is speculation, where the insurer pays a small sum of premium hoping to gain a big sum in claims.
D) Risk Transfer: There is total loss for the insured if the claim does not occur. If it does occur, the insurer loses out. The insurer is incentivised to price for exploitation.
There is no sufficient re-takaful capacity available and hence the reinsurance is mostly being done with conventional insurance companies. When do you think the region will have re-takaful capacity to serve all takaful companies?
The retakaful industry has grown considerably over the past few years and has substantially bridged the capacity gap that existed some time back. In fact, with the entry of global players such as Munich Re and Hannover Re, the retakaful industry has been injected with sufficient capacity to meet most re-takaful requirements. As a direct consequence of this growth in capacity, Shariah scholar's are now insisting operators use retakaful and not re-insurance. However, there are certain lines of businesses, which still face capacity issues. This is generally because there are not enough takaful contributions to form a sufficient risk sharing pool of funds. Eg. There is very little capacity in aviation business lines or other small frequency large exposure business lines.
Most takaful companies do not have sufficient capital. There are companies whose shareholders' equity has fallen below their paid-up share capital. Do you believe that they should/can raise fresh capital and re-capitalise the company once again?
Between 2005-2008, a large number of takaful companies were formed and in some jurisdictions, shareholder capital required by the regulator was a relatively small amount of money. Many of these companies were formed on the basis of the healthy returns being seen by conventional insurance companies coupled with the opportunity to grow the takaful industry. For many of the new start-ups, their business plans did not take into account the severity in business conditions that the current financial crisis brought about. Most projections were based on pre-crisis growth patterns, which were in hindsight, unrealistic. This has placed considerable pressure on companies with shareholder capital being eroded to allow companies to continue trading. With so much competition now in the market coupled with a more savvy and demanding consumer, some takaful operators will need to invest money into changing their operating model and this then becomes a decision for shareholders to make. Those who are in it for the long term will make the investment to allow for the changes for the growth. For other shareholders, they may choose to find an exit strategy, which could result in the company being acquired. Many markets present a strong case for consolidation. However, we are yet to see strong growth in mergers and acquisitions.
Takaful companies are required to distribute their surplus to the policyholders. But we have learnt that in the UAE [at least] hardly any companies distribute their surplus to their policyholders even during a year when the company has booked a net profit. Do you think the regulators are going easy on this aspect? Or can the takaful companies use these surpluses to set off losses made in any of the past?
In certain jurisdictions where the wakala waqf model is in place, the operator is not permitted to distribute surplus. Even in jurisdictions where surplus distribution is permitted by Shari'a, the regulators allow for the shareholders to first reclaim any loan (qard al hassan) that they have made to the operator to bridge the gap between claims and premiums. For many young takaful operators that have not yet reached critical mass, the underwriting results are often negative and require for the shareholders to provide a loan to meet operational needs. If there is a good year of performance, this loan is first returned. As a benchmark, the takaful market in Malaysia is more mature than that of the GCC and here we see surplus distribution more frequently than in other markets.