Takaful companies have gained momentum significantly in the last 15 years. Except for Saudi Arabia (where all insurers operate under the unified co-operative insurance model, which is distinctly different from the traditional Takaful model), A.M. Best believes that most of the remaining Takaful operators in MENA have struggled to establish competitive positions in their respective markets.
A recent report by the ratings agency highlighted that despite some market consolidation, the business profiles of most Takaful companies remain limited. A.M. Best considers the Middle East insurance markets to be concentrated with a few large players dominate their respective markets, and others competing for the remaining premium.
For example, the UAE insurance market has over 60 insurers with the five biggest companies accounting for more than one third of gross premium written. Most Takaful operators generally fall into the latter group, where emphasis is placed on growth over profitability. This often leads to intense levels of competition, with Takaful companies competing directly with conventional insurers. Given their relatively new status and position in these markets, Takaful operators often lack sufficient size to achieve economies of scale.
Their weaker cost efficiencies and start-up nature translates into high cost bases and higher expense ratios which dampen operating performance. It has been noted that the Shari'ah-compliant nature of Takaful companies is not a specific draw for Muslim consumers. This extends further into the Shari’ah-compliant insurance eco-system, with Shari’ah boards of Takaful companies being reluctant to obligate their companies to seek Retakaful capacity for their reinsurance programmes.
This has been one of the drivers for Retakaful operators failing to establish strong business profile. Takaful companies generally compete on pricing and servicing, and not through offering a separate unique value proposition (UVP). One of the biggest areas of contention is the return of surpluses to policyholders.
Apart from a few companies, Takaful operators have generally not made any distributions to policyholders, mostly because they have been unable to build up sufficient surpluses. Nevertheless, this has impaired what should have been one of the Takaful market’s key UVPs Additionally, for many years, MENA Takaful companies have hoped the family/life Takaful market will gain traction and have developed products designed to meet this expected demand. This follows the Malaysian and Indonesian experience, where family Takaful is well established and remains profitable for operators.
OPPORTUNITIES AND CHALLENGES
The past few years have seen an uptick in merger and acquisition (M&A) activity in the MENA region, and a large part of this has been in the Takaful space. The industry has seen a couple of mergers in Bahrain (Takaful International and Solidary Group), Jordan (Yarmook Insurance) and in the UAE (Takaful Emaraat). A.M. Best believes that the lack of scale and size for Takaful companies should encourage more acquisitions to allow operators greater market presence. With the increase of new players in countries such as Egypt and the UAE, the research and ratings agency also noted that the trend of conventional companies operating or acquiring Takaful branches or subsidiaries is not new and is driven by the attractiveness of an additional distribution platform, rather than for the purpose of achieving scale or gaining market share. In terms of financial performance, MENA Takaful companies have underperformed compared to their conventional counterparts.
According to A.M. Best, return on Equity (ROE) metrics over the five-year period between 2012 and 2016 show Takaful operators struggled to match returns achieved by their conventional peers. The underlying reason for poorer ROE metrics is the underwriting profitability, which Takaful operations have found challenging. Combined ratios for the Takaful market remained above 100 per cent between 2012 and 2016, whilst conventional insurers demonstrated profitable sub-100 per cent combined ratios over the same period. The key driver of the higher combined ratios for Takaful operators is the expense ratio. This is further exacerbated by the high level of Wakalah fees charged by most Middle Eastern companies. Over the five-year period between 2012 and 2016, A.M. Best notes that the spread of Wakalah fee against shareholder expenses (including net incurred commissions) has consistently remained excessive, peaking at 46 per cent in 2015.
The margin reduced significantly in 2016, due to changes in the UAE market, after the regulator imposed a cap on the level of Wakalah fees that can be charged. Additionally, accounting changes in the UAE meant that all acquisition expenses have to be incurred in the shareholder account, reducing the differentials earned. As a result, Wakalah margins in the UAE reduced to a more reasonable four per cent in 2016, the lowest in the region. Additionally, the balance sheet of Takaful companies remain unbalanced.
Continued annual deficits in policyholders’ funds, reflective of poor underwriting and excessive Wakalah fees mentioned above, are increasing the level of accumulated deficit and therefore weakening the financial strength of the policyholders’ funds. Uneven distribution of profit between policyholders and shareholders could be attributed to inadequate incentive structures and governance. Wakalah fees are charged as a percentage of gross contributions, incentivising shareholders and operators of companies to concentrate on top-line growth to maximise fee income, rather than profitability which can improve policyholder surplus generation.
Unlike other mutual companies, Takaful companies do not have policyholder representation on their boards of directors. Instead, these are made of shareholders and independent professionals. Therefore, there is less pressure on management to act in the interest of participants.
Due to a lack of sufficient differentiation, Takaful providers remain subject to fierce price competition with larger, more established insurers that already benefit from greater brand awareness and established distribution networks. Furthermore, additional support from Shari’ah scholars in promoting Islamic financial products is essential for the growth of the Takaful sector. When an improved level of profitability is achieved, it is important that companies achieve a balance of earnings between policyholders and shareholders.
Shareholders require dividends to justify their capital investment, but policyholders also have the right to a share of the surplus accruing from the good management of the Takaful fund. Retention of surpluses in policyholders’ funds will improve mutuality in line with the Takaful model, as well as the level of policyholder protection. This alignment of policyholder and shareholder interests will also help operators differentiate themselves from conventional insurers. Developments in regulation are also key for policyholder protection.
Takaful companies will do well to lobby for more robust, comprehensive and consistent rules to improve confidence in the industry and create the right environment for growth. This is particularly important in countries where the regulatory code does not yet deal specifically with Takaful. A.M. Best believes that once the industry tackles these challenges, it will be better placed to serve the needs of the enormous potential market for Shari’ah-compliant insurance, to the benefit of all stakeholders.