First published in ITIJ 90, July 2008
Recent projections have shown that the global Islamic insurance or ‘takaful’ industry could be worth up to US$15 billion within the next decade. Susan Dingwall and Ffion Flockhart explain what this could mean for travel insurers
Since the establishment of the first takaful operator in the Sudan in 1979, there are now over 250 takaful operators worldwide. In its World Takaful Report 2008, Ernst & Young comments that the takaful market is growing at an annual rate of 20 per cent and will, in all likelihood, reach US$4.3 billion by 2010.
Whilst Malaysia is seen as the most mature takaful market, with a long established regulatory framework and a developed product range, the Gulf Cooperative Countries (GCC) now account for over 33 per cent of the global takaful market, and the region is seen by many as the driver to the development of the industry. Many regional hubs have developed in the GCC, such as the Dubai International Financial Centre, Bahrain and Qatar, each of which is striving to differentiate itself in order to attract both conventional and takaful business. However, whilst there is a boom in competition in the takaful market in the Middle East, arguably, the most interesting developments are occurring in the West, with the 2007 Oliver Wyman report suggesting that, in a market that could potentially amount to more than $20 billion annually, over 20 per cent of the demand could be from non-Muslim customers.
What is takaful?
In simple terms, takaful is Shariah-compliant insurance akin to mutual insurance, whereby the participants (or, in conventional terms, policyholders) pool their funds together to ‘guarantee each other’ in the event of a loss. Losses are paid from the pool of funds created by the donations (in conventional terms, premiums) of the participants. The takaful operator manages the takaful operations on behalf of the participants, deals with any claims and invests the contributions in ethical Shariah-compliant investments. To the extent there is a surplus in the fund at the end of a policy period, the takaful operator will ordinarily make a distribution to the participants in proportion to their participation. This is a unique selling point for takaful compared with conventional insurance which, when coupled with the ethical investment strategy, is also likely to be attractive to non-Muslims. This has certainly proven to be the case in Malaysia where a relatively significant percentage of non-Muslims opt for takaful cover.
For conventional travel insurers who wish to expand their current portfolio to include takaful products, it will be necessary to completely separate the conventional business from the takaful business.
Shariah scholars have determined that conventional insurance products are contrary to the principles of Shariah law as they contain unacceptable elements of risk and uncertainty. In a conventional contract of insurance, the risk of loss passes to the insurer upon payment of a premium by the insured. Since it is uncertain as to whether a loss will in fact occur, the contract is seen as a form of gambling. In 1985, the Islamic Fiqh Academy ruled that a takaful contract, which is based on the principles of charity and co-operation, was acceptable on the grounds that participants co-operate with each other for the common good and no advantage is derived at the cost of others.
On the investment side, Shariah law prohibits investment in certain industries and requires the use of financial instruments that are free of usury. This means that no investments can be made in interest-bearing instruments such as government bonds or equity investments in companies that deal with, for example, the manufacture or sale of alcohol, armaments, gambling or pork products.
Takaful and conventional travel insurers
Currently, the main products offered by takaful operators tend to be personal lines products such as motor and home contents cover as well as life cover in the Middle East. However, the basic principles of takaful will apply in the same way to travel products.
Some Western insurers have entered the takaful market through alliances with Islamic operators. For example, SABB Takaful, an associated member of the HSBC Group operating through a network of 75 branches in Saudi Arabia, offers a fully comprehensive Shariah compliant takaful travel product. SABB Takaful offers a wide range of cover from medical and hospitalisation expenses incurred due to accidental injuries, loss of money and documents and loss of personal belongings to flight delays. Other conventional insurers have obtained licenses to operate takaful companies in various jurisdictions, for example, Hannover Re and AIG have been granted retakaful and takaful licences respectively to operate in Bahrain, and Munich Re is licensed to sell retakaful products in Malaysia.
Shariah scholars have determined that conventional insurance products are contrary to the principles of Shariah law as they contain unacceptable elements of risk and uncertainty.
For conventional travel insurers who wish to expand their current portfolio to include takaful products, it will be necessary to completely separate the conventional business from the takaful business. This will normally necessitate the incorporation of a new company, subsidiary or takaful window to ensure the complete segregation of funds and a Shariah compliant investment strategy. The latter is generally seen as the most problematic for conventional insurers given the relatively small size of the Islamic finance market compared with the conventional investment market. However, this is gradually changing with the UK government recently making a number of announcements that are intended to promote London as the leading centre for Islamic finance.
Potential growth of the takaful market
Since the launch of the first Islamic Bank in September 2004, London has become the centre of Islamic finance in the West, offering Shariah-compliant products in a range of asset classes. Now, the Financial Services Authority has authorised Principle Insurance Company Limited (‘Principle’) as the first takaful operator in the UK. Bradley Brandon-Cross, the Chief Executive of Principle, recently stated: "London is leading the way as the government has introduced reforms to help Islamic finance. [Principle Insurance] will give Muslims in this country the opportunity to choose Shariah-compliant insurance products." Principle forecasts up to 200,000 participants within five years, with strong growth expected over the coming months. This development is significant for the Western market as a whole, as authorisation in one European Economic Area (EEA) state provides a platform for ‘passporting’ into the rest of Europe, leading to the potential for considerable expansion of the global takaful market.
In Europe, takaful products and operators will inevitably be subject to layers of regulation. In addition to operating according to the principles of Shariah law, they will also be subject to the EU regulatory regime for insurers on both federal and state levels. On a federal level, the rights of insurers to carry on business throughout the EEA derive from the European Commission (EC) Treaty, which sets out both the freedom of establishment (Article 43) and the freedom to provide cross-border services (Article 49). A single set of rules has been put into place governing the authorisation and supervision of insurance companies and takaful operators by the Member State in which their head office is located.
The freedoms of establishment and the provision of cross-border services enshrined in the EC Treaty enable takaful operators to carry on business across the EU on the basis of a single authorisation. This enables a takaful operator that has been authorised in one Member State (the home Member State) to carry on its business in any host Member State within the EEA without the need for further authorisation. The passporting process, however, differs depending upon whether the takaful operator wishes to establish a branch in the host Member State or simply provide cross-border services.
One of the most important aspects in determining the continuing success of takaful in Europe is the regulatory landscape, which has the potential both to encourage and inhibit growth.
One of the most important aspects in determining the continuing success of takaful in Europe is the regulatory landscape, which has the potential both to encourage and inhibit growth. Strong regulation can be advantageous, particularly in securing a good rating, an essential element in terms of aiding international investment and growth. On the other hand, strong regulation on a Member State level in areas of business that have not been harmonised at Community level can constrict cross-selling opportunities across European states.
As the market grows, so too will the range of products offered. It is expected that takaful travel products will be in great demand not only amongst the Muslim population but also amongst non-Muslims that are attracted by the unique selling points of takaful, such as the redistribution of profits and the ethical investment policy. In the medium to long term, the maturity of the European insurance markets is likely to provide a strong platform for the growth and development of takaful products across the EEA. In highlighting the growing interest in the takaful and retakaful markets in the West, a recent report by Oliver Wyman stated: “Western Europe, home to less than one per cent of the world’s 1.6 billion Muslims, makes up 40 per cent of the potential Muslim demand…adding the US brings the total up to 60 per cent”. Although there remain challenges, these statistics provide a strong indication that the takaful market in the West is only just beginning to show its true potential.