Standard & Poor's Ratings Services says operational issues ‘commonplace’ in the Takaful sector but it will continue to grow rapidly, relative to the conventional insurance market, and become increasingly meaningful in overall scale in target domiciles
Standard & Poor's believes that while the essential Shari’ah-compliant operational model affords a further level of corporate governance, particularly so in those domiciles where corporate governance is poorly established, often the Shari’ah interpretation creates a more complex, and so inefficient, operational model compared with conventional insurance companies. And since conventional companies employ tried and tested systems, are typically long established, and have larger business volumes, they deliver better economies of scale that some Takaful companies are struggling to achieve. We believe this is creating some difficulties for both Takaful fund members and investors.
In December 2010, the IFSB (Islamic Financial Standards Board) published IFSB 11 Standard on Solvency Requirements for Takaful (Islamic Insurance) Undertakings, while AAOIFI (Auditing & Accounting Organisation for Islamic Financial Institutions) standards also cover the application and interpretation of Shari’ah for the Takaful sector. In a sector where scholarly interpretation of religious texts is essential, but can differ widely, Standard & Poor's welcomes the introduction of a more consistent framework for reporting and controlling Takaful companies.
The variety of interpretations of Shari’ah law within the Takaful sector, and its auditors, is causing material inconsistency in the published accounting information from the sector. As analysts using both published and, where appropriate, confidential information, Standard & Poor's uses the financial statements as a reference point for its credit rating analysis. The ratings agency notes that the IFSB Standard 11 requires the separate solvency monitoring of Takaful funds from shareholder (operator) funds. As Takaful funds are the sole responsibility of the members (contributors), there is regulatory logic in this, although S&P said, “In our view this seems to ignore the role of the shareholder in its active support and management of the Takaful fund, as demonstrated through the provision of Qard Hassan (interest free loans), solvency margin and capital employed.”
In its interactive ratings of Takaful companies, Standard & Poor's is of the opinion that there is real fungibility from shareholder funds (and the attaching assets) to the Takaful fund if the latter is in deficit (unless demonstrated otherwise). At the early stages of a company's development, when Takaful fund deficits could be likely, this standard could create an onerous set of operational constraints. Standard & Poor's said it will continue to monitor the overall capital adequacy of a Takaful company by combining both Takaful funds surpluses (and deficits) with shareholder funds.
Standard & Poor's has some concerns about the management of fund surpluses. AAOIFI proposes that Takaful fund surpluses can only be distributed to the managers of the Takaful fund and therefore not to members, as is commonly understood to date, nor the investors in the company. The agency said there are concerns that this ruling creates real moral hazard for both the fund members and the shareholders. As an example, for certain types of underwriting risk, claims development can happen over many years, and it is conceivable that a fund that is apparently in surplus for years one to four can turn into deficit in year five. Questions that arise from this ruling are: if those surpluses are distributed prematurely to the management team, are they subsequently recoverable from that team? Or is it the responsibility of the current/new members to restore the health of the Takaful fund?
To date, the core business of the Takaful sector has tended toward high volume/low value types of risk with short-tail claims development characteristics, typically the retail sector such as motor and medical. Where the risk profile of the Takaful fund is homogenous, then S&P believes the establishment of and distribution of surpluses to members should be uncontroversial. However, as the Takaful sector grows in scale, it will increasingly seek to underwrite larger risk values in more commercial sectors, for example, marine and aviation. Although use of ReTakaful capacity can control loss exposures from high-value covers, the agency questions the feasibility of a single Takaful fund comprising such a heterogeneous mix of risks. For example, a large commercial loss event on an aviation risk could push a fund into deficit, when the retail contributors from very different risk-types, such as motor and medical, remain in surplus. Therefore, should they realistically be expected, under the cooperative doctrine, to support risks, which as individuals they are totally unfamiliar with? This aspect of Takaful fund management is less of an issue for the ReTakaful sector. The same issue exists in the family Takaful sector. To date, the core business has been very short-tail medical risks, but as the longer-term life risks develop, the members of such different operational risk types could be combined.
From a credit rating perspective, Standard & Poor's expects a Takaful company to have at least good risk-based capital adequacy, which encompasses prudent technical reserving, so the issues highlighted above are very much internal management issues for each company, rather than real external rating constraints. However, they are an indication of the still-evolving operational framework for the sector that creates ongoing uncertainty.
One of the themes of the recent International Takaful Summit was the impact of social media on the development and penetration of Takaful into its targeted communities. Early adopters of services such as Facebook and Twitter typically tend to be relatively young and/or highly proficient users of technology. The relatively low average age of populations in the Middle East and South East Asia, the key areas of growth for Takaful, combined with this population's predisposition to use these services, means that insurance companies will need to embrace different ways of communicating with their target customers, as well as the greater use of technology to drive their businesses forward. A number of insurers in the Gulf are already beginning to use technology, such as SMS, to support their existing customer service infrastructure. Therefore, the integration of more-sophisticated tools to market and win new business can only be a matter of time.
In terms of globalising the Takaful brand – in essence expanding it to the non-Muslim community – efforts are under way to establish Takaful companies in "developed" regions, such as Europe and the US, but so far with limited success. We see part of the problem as the use of sometimes unfamiliar language (to the non-Arab/Muslim), particularly where an established "conventional" equivalent exists. This does not help the value proposition being promoted by the Takaful sector, and, said S&P, needs real definition and promotion. The agency said the successful development of the Takaful sector depends on the identification and promotion of a real value proposition that is distinctive from that being offered in the conventional insurance sector.
(CPIFinancial, 14 Aug 2011)
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