LONDON: It’s a tale of two markets! The one, Malaysia, with the most advanced Islamic finance ecosystem in the world with a 37% market share of total banking assets, and the other Indonesia, the most populous Muslim nation on earth with a market share of a mere 9.6% of total banking assets.

This contrast is repeated in the Takaful (Islamic mutual insurance) industry where the market share of Syariah-compliant assets of the total insurance market in the two neighbouring countries is even more stark. In the case of Malaysia, Takaful market penetration for life insurance (euphemistically called Family Takaful) accounted for 38% of the total life insurance market in First Half 2020 (up from the 34% for the same period in 2019) and general Takaful (fire, motor insurance et al) for 16% of the total general insurance market.

Despite the above progress in the Malaysian Takaful sector, it seems to have been left behind to a certain extent by the country’s 'Islamic First' strategy.

This suggests that Takaful, unlike the much more mature Islamic banking industry, remains at best an ‘evolving’ sector and a ‘work in progress’ in the global market per se.

In Indonesia, the Takaful market share of the total insurance market based on new business contributions is a mere 7% in 2020, up from 5.9% in 2019. At best, the Takaful sector in Indonesia is ‘nascent’.

So why does Takaful remain the ‘Cinderella’ segment of the Islamic finance industry and ecosystem? Especially when its market potential is just as huge as the banking sector, if not bigger. When analysts talk about Takaful/insurance they usually refer to the general and life components. Yet the credit insurance/Takaful (export and import credit insurance), investment or political risk insurance and cover associated with new and emerging segments such as terrorism, catastrophe, climate-related and disaster risks, are a multi-billion dollar business, albeit some 60% of the global market remains under-served.

Takaful

In the early days of the contemporary development of Islamic finance, the painstakingly slow uptake of Takaful was put down to the ambiguous messaging and marketing of the Takaful concept; unfounded and misplaced doubts about the validity of Takaful from a Syariah point of view; the reluctance of government policy makers and regulators to upset the conventional insurance cart; absence of enabling Takaful regulation and regulatory oversights; the small size and number of Takaful operators; their very low capitalisation which restricted the volume of business insured; ambiguity over the most suitable Islamic financial contracts to be used – Mudaraba and/or Wakala plus Tabarru; limited product development and innovation; limited market competition and uncertainty about premiums, claims handling and performance; and in the case of Saudi Arabia the use of Cooperative Insurance, whose very processes are questioned by some Takaful experts and operators.

While some of the above hurdles to market entry and penetration have long since been overcome, a number still persist. The adoption of various standards relating to financial reporting of Takaful operators and treatment of products; solvency regimes for Takaful operators; protocols relating to Takaful investments; Syariah governance, etc. by industry bodies such as the KL-based Islamic Financial Services Board (IFSB) and the Bahrain-based accounting body, AAOIFI, have helped in establishing the structural credibility and Shariah certainty of Takaful industry and products. The downside risk is that both these organisations are severely hampered by their lack of resources, institutional structures and staffing, and leadership dynamics.

The impact of the COVID-19 pandemic on the insurance/Takaful and reinsurance markets has been mixed. The true extent of payouts, claims ratios and investment dynamics of contributors’ funds related to 2020 business insured will only become clear later this year as financial reporting, data collation and analysis gathers momentum.

The pandemic has highlighted the need for and expected increased demand for health and education insurance, life insurance, credit and investment insurance and cover for business disruption and continuity and their Syariah-compliant equivalents. Several traditional markets are now requiring expatriates and permanent residents to have mandatory medical insurance. Qatar, for instance, is about to adopt legislation to that effect.

Outlook

So, what is the outlook for the Malaysian and Indonesian Takaful sectors, potentially the two largest sectors in the world, in the next year and beyond?

In terms of market share, the Indonesian Takaful sector will continue to be a nascent industry albeit steadily gaining ground and should continue on an upward trajectory towards a 10% market share by 2025. In 2020, Family (Life) Takaful products made up 86% of the Takaful market, followed by General Takaful products at 14%. This suggests a very low base for motor, fire, mortgage and house contents Takaful, which in turn means huge growth potential. Not surprisingly, Fitch Ratings, in its latest report on the Indonesian Takaful sector in March 2021, concurs that “the long-term growth potential of the Takaful sector is high, as Indonesia’s life insurance penetration is low – it totalled 1.4% in 2019 – and the country has the largest Muslim population in the world.”

In contrast, Fitch in a similar report on the Malaysian Takaful industry in March 2021, “expects Takaful penetration to keep rising, supported by government initiatives to provide financial assistance for the bottom 40% of income earners to purchase insurance and Takaful coverage under the Perlindungan Tenang Scheme.” This scheme was announced by Finance Minister Tengku Datuk Seri Zafrul Tengku Abdul Aziz in the National Budget 2021 and in his follow-up statements.

Malaysian Takaful, which mainly consists of family products, continued to gain ground in the insurance market during the 2020 coronavirus pandemic, accounting for 38% of the domestic life insurance market in First Half 2020 compared to 34% in the same period in 2019. General Takaful accounts were stable, at 16% of the overall general insurance market.

Takaful’s low market share, according to Fitch Ratings, is driven partly by Indonesia’s still developing Islamic finance ecosystem. The Indonesian Islamic finance market share reached only 9.6% in 2020, which limits the number of customers that seek Takaful products. Limited Sukuk issuance, especially corporate and social Sukuk, also constrains Takaful’s investment options.

Raising Takaful awareness

Indonesia’s latest Islamic bank, PT Bank Syariah Indonesia, was officially launched at end January 2021 by President Joko Widodo. As the largest Islamic bank, it could help raise Takaful awareness. Around 20% of takaful products in Indonesia are distributed through bancassurance.

Whether the new bank and the growth of Islamic finance in the world’s most populous Muslim country raises unrealistic expectations, only time will tell. The Islamic finance sector has traditionally lagged behind its conventional counterpart and has been faced with several hurdles, including policy shortcomings. The country last year launched an Islamic Finance Road Map but there has been little information about the progress of implementation.

The operational challenges for Takaful operators amid the COVID-19 pandemic was only too apparent. According to Fitch Ratings, General Takaful products experienced a decline in contributions of 10% year-on-year in 2020; similarly, conventional general and life insurance fell by 10% and 9%, respectively. Family Takaful products were still in demand, with growth of 10%. “Mass movement restrictions, which prevented insurers from physically operating, contributed to the overall decline along with the fall in the purchasing power to afford insurance products,” says Bashar Al Natoor, Global Head of Islamic Finance at Fitch Ratings.

In contrast, Malaysia has a supportive and proactive Islamic Finance Ecosystem. Malaysia’s Islamic finance ecosystem is vibrant and comprehensive. It includes Islamic banks, Syariah-compliant corporates and corporates accessing Islamic debt products such as Sukuk and Tawarruq, Islamic fund managers and halal industries that seek Takaful products.

Bancasssurance is one of the main distribution channels of Takaful products, although the digitisation of the sector began well before the onset of the pandemic. Takaful demand also arises from Sukuk issuance, which makes up more than 60% of outstanding domestic issues and is often linked to projects and insuring the underlying assets. Takaful firms can also invest their liquidity in diverse Sukuk and other Islamic liquidity management and HQLA options.

While the Malaysian Takaful industry, like other financial sector segments, was similarly affected by the pandemic, the economic and market recovery challenges remain the same for all. “The Takaful industry faced low top-line growth in 2020 due to a fall in new contributions under pandemic-related movement restrictions. Consequently, the contribution of Family Takaful to overall growth dwindled to 2% in First Half 2020, against 25% in 2019, while General Takaful contributions rose by only 0.6%, from 20%. Nonetheless, Takaful growth remained steady compared with general and life insurance contribution growth, which shrank by 3.6% and 12.6%, respectively,” adds Al Natoor.

Underlying resilience

In terms of profitability and capital adequacy, Malaysian Family Takaful funds showed their underlying resilience despite recording a 28% drop in profitability in First Half 2020 due to unrealised losses from equity investments and lower new contributions. However, this was a smaller fall than for conventional life insurance funds, whose profitability declined by 79%. Similarly, the Malaysian Takaful sector’s capital adequacy ratio reached 240%, above the conventional insurance sector’s 226%.

The relaxation in Adopting IFRS 17 (the international reporting standard for insurance/Takaful operators) deferred for two years to 1 January 2023, will give some breathing space to Takaful operators. While Indonesian Takaful operators remain uncertain over the interpretation and application of the rules to their business, most Malaysian Takaful companies have already started implementing IFRS 17.

However, uncertainty over interpretation and application of IFRS 17 to their business remains a challenge, albeit the adoption deferral will give Takaful operators more time to interpret how the accounting principle and measurement affects their business.

Going forward, Fitch Ratings expects improvement in Indonesian Takaful contributions growth and investment yield in 2021, on the back of the Indonesian economy’s expected recovery, which is forecast to register a GDP growth rate of 6.6% in 2021, rising government support as part of the Islamic Economic Masterplan 2019-2024 and accelerated financial sector digitalisation. Fitch expects Takaful firms to maintain capitalisation levels against a potential spike in claims as the pandemic continues to have an impact on Indonesia.

Another potential driver of the Indonesian Takaful sector over the next few years is the approval by the Indonesian House of Representatives of the 7th ASEAN Framework Agreement on Services (AFAS) Protocol, which aims to partner ASEAN General Takaful operators with domestic players under the Spinoff Programme. “We expect the partnerships will not only provide capital inflow from ASEAN players in supporting the spinoff requirement but will also provide the necessary know-how. Insurers are required by law to spin off their Takaful units by 2024,” explains Al Natoor.

The Indonesian Takaful sector also received a major boost recently when global insurance giant Zurich announced plans to convert one of its business entities, Zurich Insurance Indonesia (ZII), to a Syariah-compliant general insurance (Takaful) company, subject to regulatory approval. This follows Zurich’s acquisition of an 80% equity stake in Asuransi Adira Dinamika in November 2019. The new entity, Zurich General Takaful Indonesia (ZGTI), is expected to start operations later in 2021. Existing Adira policy holders will have a choice to continue with their conventional insurance policies or opt for a Takaful policy with ZGTI, which reportedly sees Indonesia is an important market for growth in Takaful products and services.

A recent survey comprising 5,000 respondents conducted by Prudential Indonesia, a subsidiary of global insurance giant, Prudential, showed that public interest, especially from Millennials and the middle and upper classes, in and understanding of Takaful products is increasing. The potential demand is largely from Muslim customers but a substantial minority interest also comes from non-Muslim customers. The favoured products include health, education, investment, personal accident, life and retirement (pension) Takaful.

The 2021 Takaful sector outlook for Malaysia is far more impressive and stable. “We believe Malaysia will maintain its position as the largest Takaful, Islamic banking and sukuk market in the South East Asian region,” maintains Fitch’s Al Natoor. “We expect the country’s Takaful industry to continue its steady growth during 2021 amid various government initiatives, with support from our forecast Malaysian economic growth of 6.7%, increased financial sector digitalisation, higher awareness and low life-insurance penetration rate.”

-- BERNAMA

Mushtak Parker is a London-based independent economist and writer.