Ethics into insurance

Ratings agency Standard & Poor's yesterday issued a report on the state of the global Takaful industry.

In the report, 'An analysis of Shari'ah compliant cooperative and Takaful insurers in the Middle East focused primarily on financial strength,' the agency commends the growth of the global Takaful sector and the fact that in key markets it is competing strongly with the conventional insurance industry, and in many ways winning the battle for hearts, minds and premiums from Muslims and non-Muslims alike.

However, S&P does frame this praise with the caveat that in some key markets - notably Saudi Arabia and Malaysia - which have national policies to promote Islamic finance that the Takaful industry has been taking on the conventional insurance sector with a lot of backing.

The report also says that this trend is likely to emerge in other countries, especially in the Gulf, where Qatar recently forced conventional banks with Islamic windows to shut their Shari'ah compliant business, and: '...in the UAE and Kuwait, [where] all the insurance licenses issued in recent years have been Takaful ones. It is not known whether there were any requests for new, conventional insurance licenses but the result has been to leave only a limited number of traditional companies to continue to operate in those countries...'

The growth of Takaful in the MENA region, S&P claims, has been a direct result of the role of bancassurance, where retail banks (both conventional and Islamic ones) have been bolting on insurance covers to their bank accounts and some finance products.

In the MENA region - especially the GCC - many banks don't know the religious or ethical persuasion of their customers, so S&P argues, and whereas offering Takaful insurance cover to a non-Muslim is not a bad thing, and sometimes Takaful offers a better deal to policyholders than conventional insurance; offering conventional insurance to a Muslim is a blunder, as this amounts to enticing him to become involved in a number of Haram activities. So, the banks in the GCC region have been erring on the side of caution, and selecting Takaful providers rather than conventional insurers for their bancassurance products.

The report calls into question the sustainability and stability of the Takaful industry's business model, which '...can sometimes be seen as encouraging excessive premium expansion alongside exposure to religiously acceptable, but potentially volatile or illiquid investment assets - notably shares and real estate...' Two of the specific risks in the Takaful industry as interpreted by S&P in the report were the industry's fee structure and firms' exposure to volatile and illiquid assets, where decision making was made on a religious basis, as opposed to a financial and risk management basis.

David Anthony, credit analyst for S&P, told The Islamic Globe: "Beyond the need to make adjustments to the accounts, we have general concerns regarding the Takaful model. For instance, the Wakala fee is levied as a fixed percentage of gross premiums written, and this raises the possibility of moral hazard. A Takaful operator could be encouraged to maximize the income of shareholders by increasing the amount of premium - and therefore risk - being written."

The accounting difficulty, S&P explains, arises from the contracts that Takaful firms use to transfer income and levy charges. In the first instance, the Takaful firm can only transfer income to shareholders through a Wakala contract, whereas it can only charge fees for asset management through a Mudarabah contract. In some domiciles, there are strict regulations dealing with the profit-sharing of the Takaful operator, such as in Saudi Arabia, where there is a statutory 90:10 profit share relationship between shareholders and policy holders. In other domains there is no statutory mandate, such as in Iran where Takaful operates on a loose mutuality agreement.

The lack of global standards has caused problems, as some scholars view traditional conventional insurance as Shari'ah compliant because of the inherent 'risk-sharing' nature of its business, whereas other scholars rule that a Takaful firm is only Shari'ah compliant if it allocates 100% of its profits to policyholders. In different domains this interpretation varies from firm to firm and S&P calls on AAOIFI and the IFSB to collaborate to make one global accountancy standard and policy on profit sharing.

The report argues that where there is uncertainty the temptation is there to inflate Wakala fees, which in the spirit of Takaful are there to cover the firm's operational costs, to generate profits for shareholders, in effect getting the policyholders to pay the shareholders. Firms also hold back surpluses as a hedge against insolvency, but sometimes these surplus funds become very large and technically should be redistributed to policyholders.

The opaque nature of a Takaful firm's book-keeping, juggling between Wakala, Mudarabah and surplus funds, means that the management can often arbitrarily transfer funds to shareholders. This S&P believes is not just 'inappropriate conduct' but could have a detrimental effect to the firm's underwriting. In addition, the 'profit taking' is often written off as an operating expense, which it is not and gives Takaful firms, at an analytical and ratings level, an unfair advantage over conventional insurers.

The compounding of these issues led Anthony to the conclusion that the Takaful industry needs to apply sound corporate governance. He said: "While the need to be Shari'ah compliant may encourage overexposure to religiously acceptable, but potentially volatile or illiquid assets, most of these issues can be addressed or even eliminated by applying sound corporate governance, backed up by effective enterprise risk management, predictable regulation, transparent accounting, and an efficient internal audit function."

Ultimately, therefore, it will be more the principles of managers and management and less the structure of operations that brings ethics into insurance.

© The Islamic Globe 2011

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