Professor Habib Ahmed of Durham University Business School examines the issues of outreach and sustainability in providing microtakaful, and the various models and approaches adopted by some providers.
Microinsurance can play an important role in poverty alleviation by reducing the risks and vulnerability that the poor face. However, the provision of inclusive finance faces supply and demand constraints in Muslim societies.
On the supply side, as providing services to the poor is costly and risky, a key issue in providing inclusive finance is the trade-off between outreach and vulnerability. Other than asymmetric information problems, the cost of providing microfinance services is also high due to small size. This is also because the transaction costs increase due to the lack of economies of scale, and also because contract enforcement mechanisms are lacking (Morduch 2005).
An important demand-side factor that can hinder access to finance to the poor in Muslim countries is cultural norms, whereby people voluntarily choose to exclude themselves from financial services due to religious convictions, which include the prohibition of interest-based financial transactions. Thus, access of finance by the poor in many Muslim countries would require the provision of Shariah-compliant services.
Basic takaful model
Declaring conventional insurance as prohibited in Resolution No. 9 (9/2), the Islamic Fiqh Academy proposes using cooperative insurance based on charitable donations (tabarru’) and cooperation or mutual help (ta’awun) (IRTI and IFA 2000: 13). As a result, various models of takaful (mutual guarantee) were developed as Shariah-compliant insurance schemes. The key organisational feature of the takaful is that of mutual insurance, whereby the policyholder takes up the role of ownership and risk-bearing, and the managerial function is performed by a takaful operator (TO).
The basic structure of takaful model is shown in Figure 1. Depending on the relationship between the takaful participants and the TO and nature of the participants’ takaful fund, two key models of takaful can be identified. The first is a mudarabah (partnership) model in which the TO and the participants have a partnership relationship. The participants contribute (tabarru’) in the participants’ takaful funds, which are managed by the TO. The TO invests the funds in income-generating activities and gets a share of the profit. After meeting the claims of the participants, the surplus is distributed among the participants. A wakala (agency) model is very similar to a mudarabah model, except that the TO acts as an agent, instead of a partner. As such, the TO gets management fees as compensation instead of profit. Note that takaful can include features of both mudarabah and wakala contracts.
Microtakaful provision: Outreach and sustainability
Mosley (2003) identifies key issues related to sustainability and outreach related to microinsurance as information problems of adverse selection and moral hazard. While the former implies that the riskiest households would end up using the insurance services, the latter would induce more risky behaviour after the insurance has been undertaken. Higher risks due to these informational problems mean that the premium charged is high, which makes insurance costly to the poor.
Lack of actuarial data on poor households and limited distribution options make the provision of microinsurance riskier and costly. Along with high risks, high transactions costs associated with low scale of operation and low demand can lead to a situation where the costs of provision of microinsurance becomes exorbitantly high and its sustainability becomes difficult. Thus, commercial insurance companies and their intermediaries shy away from providing insurance to the poor.
One implication of the above is that until a certain scale of operation in terms of client numbers is reached, the provision of microinsurance may require subsidies (Mosley 2003: 147).
Given the above, there are two broad approaches to provision of financial services to the poor. One is the poverty approach that focuses on outreach, but needs subsidies to sustain the activities. The other is the commercial approach, whereby the organisations providing financial services are profitable, partly because they exclude the poor clientele. Non-profit organisations usually adopt the former approach and for-profit firms, the latter.
Microtakaful: Organisational features and approaches
The approaches of providing microtakaful are different, depending on organisational goals, delivery channels, sustainability, and breadth and depth of outreach. While the organisational goals can be broadly classified as commercial and non-profit, the delivery channels can be direct, whereby the takaful company provides services directly to participants or indirectly through agents and intermediaries. Sustainability is the capacity to ability to sustain its activities without subsidies. Whereas breadth of outreach is the number of clients served, depth relates to the number of poor covered by the programme.
The features of various approaches for a sample of organisations providing Islamic microtakaful services based on anecdotal evidence are summarised in Table 1.
Prime Islami Life Insurance, based in Bangladesh, is a commercial life takaful operator providing services to a wide range of customers including the poor. Microtakaful constitutes a significant part of their business and the overall scheme is profitable. Whereas the breath of outreach in terms of number of clients served is good, the poorest sections of the population appear not being served.
Bank Kerjasama Rakyat Malaysia (Bank Rakyat or BR) is the largest cooperative bank in Malaysia. BR also offers microtakaful products as an agent of other takaful operators. The takaful scheme is commercially viable partly because it uses its operational infrastructure to provide the services. While it covers many clients under the takaful scheme, the poorer sections of the population are not covered adequately.
Peramu Foundation (Yayasan Pengembangan Masyarakat Mustadh’afiin), based in Bogor, Indonesia, is a multi-purpose social development organisation. It provides microtakaful using the indirect approach for both its microfinance clients and non-clients. Whereas it is able to provide takaful to the poorer sections of population, its breadth of outreach is still small. Though initially it received some funds from external sources, the scheme is operating at a surplus.
Takaful T&T Friendly Society (TTTFS) is a multi-purpose cooperative established under the Friendly Societies’ Act (18 of 1950) of Trinidad and Tobago. The scheme has covered the poorer sections of the society but their operations are small, with a limited number of members. TTTFS has sustained moderate surpluses over the years, leading to accumulated reserves and distribution of rebates every year.
Synergies between commercial and non-profit sectors can be created
While the benefit of the providing microtakaful by large takaful operators is relatively lower costs resulting from the scale of operations, they are not willing to serve the poorer sections of the population due to high risks and costs. Non-profit organisations can provide services to the poor, but their scale of operation and sustainability can be an issue. The results imply that there can be synergies created in providing microfinance services in general and microtakaful in particular if the commercial and non-profit sectors cooperate. One way to expand the outreach is to channel microtakaful services of established takaful companies through various non-profit organisations that already provide microfinance to the poor.
Dr Habib Ahmed is the Sharjah Chair in Islamic Law and Finance with Durham University Business School.