Market statistics indicate that the general takaful business in Malaysia is predominantly dominated by the personal lines segment. In 2015, motor takaful, the largest personal lines segment, contributed close to 62% of all takaful business. Compared to 2009, this is a 9% increase. The remaining 38% contribution mostly comes from other personal lines such as personal accident and homeowner policies.
In comparison, the uptake of conventional general insurance in 2015 has been pretty stable. Motor insurance makes up 46.4% of all general insurance premiums and the contribution has been stable over the years, ranging between 44% and 46% each year.
If one compares conventional insurance with takaful, the over-reliance on personal lines and motor in takaful could also mean that the takaful industry plays a lesser role in supporting Malaysia’s economic development. The growth of takaful should ride on the growth of the Islamic banking and finance sectors. The Islamic banking sector in Malaysia has been very active in providing financing to many commercial projects in the country. Malaysia also has one of the most vibrant sukuk market globally.
Ironically, despite the strong support of the government and the push for government and government-linked companies’ (GLC) assets to be covered by Islamic insurance, takaful’s penetration into commercial lines remains low.
Challenges faced by takaful operators in Malaysia
What are some of the challenges faced by takaful operators to grow its participation in commercial lines?
Firstly, this relates to the nature of the takaful’s business model. Takaful works on a risk-sharing basis. Instead of transferring the risk to insurance companies, risks are shared among people or organisations who own or are exposed to the same or similar risks when they contribute to a pool of funds.
Unlike conventional insurance companies, the role of a takaful operator is no longer that of a risk carrier. The operator is a manager for the takaful scheme and receives a mandate from risk owners or participants. When claims are low, the pool of funds may result in a surplus that can be distributed to both the participants and operator. In bad times where there are many claims, the pooled fund is inadequate to pay for losses and participants would, at least in theory, either have to top up the fund to close the gap or claimants would be compensated lower than their actual losses.
Given the nature of takaful, it is fair to argue that it fits well with the nature of the personal lines risk portfolio where this is low volatility and high predictability. Furthermore, customers of personal lines are mostly individuals whose decision-making is shaped by personal beliefs (including religion) and values. An interplay of these factors is the main reason why takaful personal lines have been so successful.
On the other hand, the commercial lines risk portfolio is highly volatile due to a smaller population but with a very wide range of sum insured. The portfolio can be very heterogeneous, varying in terms of occupations, industries, and the types of properties and exposures, leading to a high unpredictability of outcomes.
This also explains why the performance of the commercial lines portfolio is highly volatile. Their customers are mostly commercial organisations which are very rational and financially-driven. In this case, Shariah compliance does not seem to be relevant. Many also doubt if the takaful mutual model would fit in with such a scenario.
The second challenge is the fact that there are many substitutes for commercial insurance or takaful. These include using retention, captive, pools and the capital market. Companies tend to retain risks that they perceive to be low and manageable. Some companies go even further by institutionalising self-retention by either setting up or renting captive in order to achieve better bundling and diversification of risks.
As a result, these companies benefit from loss prevention incentives and claim settlements. They still enjoy direct access to open the insurance/reinsurance markets and can transfer residual risks. There are some captives that cover their group’s assets only and others may offer protection against third-party risks to gain better diversification.
Pools are risk-sharing arrangements between member corporations or insurers to mobilise their capacity for large or complex risks. It is not unusual to have pools organised on a national basis and administered by a national re/insurer. Some examples in Malaysia include the aviation pool (MAP) and the energy pool (MERIC).
Capital markets have begun to involve themselves in insurance risks via risk securitisation. An example is the Insurance Linked Security, developed post-Hurricane Andrew, back in 1992. This is a win-win solution for everyone. For the insurance industry, money from the capital market would generate more capacity for insurers to absorb more risks. This presents a perfect solution for insurers to tackle the significant shrinking of underwriting capacity after a natural catastrophe. From the investors’ point of view, it would be an attractive diversification since insurance risks, especially from natural catastrophes, are not correlated to economic risks.
The third challenge is a critical question of whether the commercial market is accessible by the takaful industry and whether it is large enough for necessary diversification. As corporates tend to transfer only the high volatile risks, would there be enough of such risks for re/takaful operators to effectively diversify such a volatile portfolio? Perhaps, but in Malaysia at least, it would definitely need a bigger portfolio than today.
The fourth challenge is about DNA. Re/takaful operators need to have the right DNA to venture into the commercial field. They need to secure and develop the mindset and capabilities to handle the various aspects across the commercial lines value chain, from marketing and business development, to risk selection and underwriting, portfolio management, risk engineering, claim management and rating/pricing. So far, all the takaful operators are concentrating on personal lines, hence building up this capability may not be an easy task. The good news is that retakaful operators can help.
Lastly, there is severe leakage of takaful risks to conventional reinsurance. This is partially due to takaful’s limited capacity, expertise, capability and appetite towards commercial risks. Moreover, commercial customers may prefer conventional risk transfer solutions over the risk-sharing alternative of takaful, due to the characteristics mentioned above.
Potential solutions to overcome the challenges
So how we can overcome these challenges to grow commercial takaful? The following are three potential solutions.
First, the takaful industry is in serious need of specialist takaful operators for commercial businesses that can lead the industry to compete with conventional insurers and penetrate into the commercial lines business. Nevertheless, there are also doubts about whether there are enough commercial business to make it viable and attractive for specialists to enter the industry.
The second solution is in providing alternative Shariah-compliant (re)insurance solutions for commercial risks in addition to existing retakaful operators’ capacity. A good example to illustrate this is the setting up of a specialist commercial Shariah-compliant underwriting agency by Cobalt in the London market in 2012. This is a unique London market syndicated placement model whereby the capacity is provided (mostly) by insurers and Lloyd’s syndicates rather than by (re)takaful operators.
The last possible solution is to set up a retakaful market pool. The Malaysian Takaful Association (MTA) is currently spearheading a project to establish market pools so as to allow the market to combat the deficiency of both capacity and expertise on an individual company basis. So far, Bank Negara Malaysia has shown its support, but will there be enough commitment from the local takaful industry?
What we have discussed above are not conclusive. The takaful industry still needs to come up with more ideas and innovations to overcome challenges in penetrating the commercial lines segment. It is not easy, but collaboration among all relevant stakeholders in the industry will make it possible.
Mr Marcel Omar Papp is Head, Retakaful, and Mr Delil Khairat is Client Manager, both of Swiss Re Retakaful.