Aug 1, 2007

Islamic Insurance - a change of mindset

Conventional insurance involves the elements of uncertainty, gambling and interest, all of which are unacceptable under Islamic law. Muslims around the world have for generations grown up with the mind set that insurance is forbidden because it contravenes some of the Islamic doctrines. However, the 1985 Fiqh Academy ruling declared that conventional commercial insurance was forbidden but insurance based on the application of cooperative principles, Shari’ah compliance and charitable donations, was acceptable. This allowed the creation on a new industry, takaful, offering risk protection and savings products to the world’s 1.6 billion Muslims.

Takaful, meaning “guaranteeing each other” in Arabic, is an Islamic system of mutual insurance built around the concept of donation. Each participant contributes to a fund to cover expected claims, while also benefiting from a share of investment returns. There are some parallels between takaful and mutual or cooperative insurance. There must be cooperative principles in takaful, but there need not necessarily be Islamic principles in conventional mutual or cooperative insurance.
 
The past twenty years have seen takaful operations opening in Islamic countries as well as countries having large Muslim communities. There is no doubt a tremendous opportunity for takaful in those Western countries that have large Muslim communities, but significant investment is required to compete with the conventional insurance industry, and regulatory changes would be necessary, as seen in the Malaysian market, to allow takaful to compete on equal terms.

Estimating its size presents challenges as there is no single body that tracks reported premiums for this segment. However, the Institute of Islamic Banking and Insurance has projected that the market will reach $7.4bn in premium by 2015. Growth rates are estimated between 15% and 20% per annum.

Many of the challenges facing takaful operators are strategic as this formative market tries to establish itself. There is little infrastructure for the new business. While skills and resources can be borrowed from conventional insurance markets, there is significant investment required creating the business: establishing the Shari’ah board, developing technical expertise on Shari’ah compliance, training staff, creating brand awareness among customers, and implementing the appropriate technology. Alongside all this, the operator will need to work with the national regulator to bring them on board.
Most takaful operators are also in emerging markets, and as such, they face challenges such as immature banking infrastructure, poor communications infrastructure, and small pockets for IT investment.

Takaful is a viable alternative to conventional insurance for the world’s Muslim community, and this market is set to grow substantially in the coming years. Malaysia and the Middle East are where the much of the current and future business will be secured. More licenses are being awarded in these regions to both local operators and traditional insurers. The market faces many challenges, not least of which is the awareness that takaful is a Shari’ah-compliant form of insurance.

Celent is a research and consulting firm focused on the application of information technology in the global financial services industry. This extract was taken from a recent report  ‘An overview Islamic insurance: Market Trends and Technology considerations’, November 2006. For more information on this report, please contact the author, Catherine Stagg-Macey at cstagg-macey@celent.com