Underwriting Profit Difficult to Achieve in Takaful Markets

The takaful, or Islam-based insurance industry, is expected to surpass US$8.8 billion in contributions this year but the challenge to achieve profitable growth in its early stage of development is vexing many global operators.

Opportunities for takaful business are plenty, and so are the risks, said Ernst & Young in its global takaful report. Many takaful operators are start-ups or small player which have been finding difficult to make profits in a tough financial environment.

Global contributions to takaful, which adheres to Shariah (Islamic) insurance practices, increased 29% to US$5.3 billion in 2008. Saudi Arabia and Malaysia were the two largest takaful markets with contributions of US$2.9 billion and US$900 million, respectively.

The global takaful sector reported compound annual growth of 39% between 2005 and 2008. The Indian subcontinent and United Arab Emirates grew fastest globally, at 135%. Indonesia achieved the quickest growth of 35% in Southeast Asia, which had a regional growth rate of 28%. The growth rate for Gulf Cooperation Council countries was 45%.

GCC countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

Although the takaful sector's growth has remained strong, underwriting losses remains a source of worry for many operators.

"It's worth noting that most takaful operators are yet to achieve critical business volume despite incurring substantial establishment costs over the year," said Sameer Abdi, head of the Middle East Islamic financial services group at Ernst & Young.

These young takaful players have limited access to quality business and their primary challenge remains the shortage of skilled professionals across key functions in underwriting, risk management, claims management and technology deployment, according to Ernst & Young.

"It's important that they rethink their market approach if they want to achieve critical mass and become sustainable in the long run," said Abdi. A lot of priority should be given to controlling operational costs and creating leaner and more efficient operations, he added.

Overall, quality of underwriting is one of the key strategic issues for the takaful industry given the challenge of complex risks and limited access to quality customers, said Ernst & Young in the report.

Investment discipline is strategically important due to limited access to Shariah-compliant capital markets. Also, the operators had high direct exposures to equity markets with an ad-hoc approach to portfolio management, according to the report.

"Globally, performance has been mixed," said Abdi. GCC takaful operators reported comparably high yields but volatile results. Malaysian operators posted stable returns due to better underwriting results.

Takaful is at different stages of development in the GCC countries and Malaysia, and each region has faced unique challenges.

Average combined ratios of takaful companies in GCC countries reached 72 in 2009, indicating improving operational efficiency. "While the industry may seem to be temporarily bogged down by market troughs, the long-term outlook seems very positive," said Abdi.

In the GCC, Abdi said "we expect some consolidations across several markets over the next three years, leading to the creation of financially stronger market leaders."

The global financial crisis further exerted stress on takaful operators' investment portfolios due to volatile capital markets and distressed asset values.

The real challenge is growth with profitability given the basic underwriting capacity at many of takaful operators and the impact of heavy investment losses. Specialization and improvement in risk analysis and pricing are essential considerations, according to Ernst & Young.

The financial crisis adversely hit the profit margin of GCC takaful operators, whose return on equity dropped from 6.2% in 2007 to negative 5.3% and 6.5% in 2008 and 2009, respectively.

GCC operators had 97% and 80% of their net income from investment returns in 2006 and 2007, respectively, but the proportion abruptly declined to 16% in 2008.

Malaysian operators' return on equity increased from 5.7% in 2007 to 11.1% and 7.6% in 2008 and 2009, respectively. Underwriting income has consistently contributed to the profitability of Malaysia operators, said Ernst & Young. Investment income accounted for 27%, 22% and 19% of the operators' net income in 2006, 2007, and 2008, respectively.

Ernst & Young said more attention is drawn to governance. Many takaful operators have initiated "a rigorous review" of their strategies and financial plans. Abdi said quality of strategy execution and stronger capital plans are "at the top of management agenda."

"It's about time that the industry lobbies for deeper local Islamic capital markets and diversifies its business mix in favor of areas with substantial growth potential," said Abdi.

Recent economic events led the takaful industry to play a more active role in facilitating consistent regulatory, legal, accounting, capital market and tax regimes. These events are driving "constructive evolution" of regulatory frameworks, which would change the way the takaful industry operates, said Ernst & Young in the report.

For international conventional insurers with a growth strategy in emerging takaful business, successful investment lies in a clear understanding of local market practices and use of the right takaful model, mode of entry and local partners, cited Abdi.

However, newly established operators in the GCC region and additional licenses in Malaysia "have pushed competition up the risk agenda," according to the report. In additional to achieve critical business masses through organic growth and acquisition, specialization, governance and quality services are among the key concerns. There would be consideration to pursue stronger alignment between intermediaries and operators in commission structures.

Increasing family and medical takaful demands have fueled the sector's business growth. Southeast Asia is the most highly penetrated family and medical takaful market, accounting for 73% of net contributions in 2008. In Malaysia, family takaful represented 73% of net contributions, according to Ernst & Young.

In the Middle East and North Africa region, Ernst & Young cited a high growth of gross domestic product, a decreasing government safely net, low insurance penetration and favorable demographics contributing to strong growth potential.

Compulsory medical insurance in Saudi Arabia led to increasing contributions to family and medical takaful, bringing in 49% of gross contributions in the Middle East and North Africa region. However, family takaful is estimated to provide only 5% of these total contributions, according to Ernst & Young.

(By Iris Lai, Hong Kong bureau manager: [email protected])