Islamic Finance: Takaful - opportunities and challenges

With the size of the Muslim nation exceeding one-fourth of the world's population, takaful holds potential for phenomenal growth.

Furthermore, with its generally superior features and cost-effective nature compared with the conventional insurance policies, takaful is fast gaining the imagination of non-Muslim individuals and businessmen too. Wherever in existence, corporates and multinationals are increasingly allocating part of their insurance business to takaful companies.

Apart from the opportunities, takaful industry is also faced with a number of challenges. Some of the major ones are enumerated below:

Financial capability
There is need for financially strong operators to enter the takaful field. Present existence of not-so-strong players does not provide the capacity and the ability to retain and absorb more of the risk, which is passed on to the conventional re-insurers at an exorbitant cost.

There should be stringent capital adequacy measures for setting up takaful operations in Muslim countries. Adequate capitalisation would certainly provide a meaningful financial strength, enabling takaful operators to meet the expected demand and to be able to wean insurance buyers away from conventional insurance companies.

It is encouraging to note that Gulf's leading Islamic banks are giving due attention to this aspect. While Dubai Islamic Bank recently set up a takaful company - Aman - Abu Dhabi Islamic Bank is on the move to follow suit.

Gulf Finance House recently announced setting up a large takaful operation, which will spread over 10 Muslim countries. There are other similar steps providing much needed momentum to the takaful industry.

Re-takaful
A sound mechanism of re-takaful, which conforms to Sharia requirements and is able to compete with the established conventional re-insurers will take some time to emerge. Till such time, Sharia scholars have allowed takaful companies to deal with conventional re-insurers.

In the absence of the adequate number of takaful companies in the region, it may not be feasible for a re-takaful operator to survive in terms of business support. Perhaps a way out could be that the takaful operators join hands to establish their own re-takaful facility, instead of buying re-insurance from conventional sources.

Political will from Islamic countries to allow and pursue the setting up of new and financially sound takaful companies in their respective countries will create critical mass, thereby paving the way for establishing a meaningful international re-takaful industry, similar to conventional re-insurance market.

Manpower and expertise
Another important challenge faced by takaful industry is the scarcity of trained takaful personnel. Being a service industry, the pace of progress for takaful, no doubt, depends on the availability of expertise in its manpower.

Therefore, there is need to develop special training courses to equip the staff of rapidly emerging takaful companies with the right concept of takaful and the complete background on various products offered in light of Sharia principles.

Takaful operators in the Gulf countries may take a leaf from Malaysia where advanced educational programmes for takaful personnel have been developed.

In addition, there is need for introducing the subjects of Islamic banking and takaful at high school/university levels in the UAE and the Gulf. The move will ensure regular supply of qualified personnel to the expanding Islamic banking and takaful industries.

Dialogue
Though most of the takaful managers are well aware of the insurance needs of their clients, they may not be conversant with interpretation and application of various Sharia principles.

Similarly, scholars certainly possess high Sharia knowledge but may be handicapped in comprehending with the changing commercial requirements sought by the takaful manager.

As such, it is in the best interest of takaful industry that both sides maintain continuous dialogue so as to find pragmatic business solutions under which, on one hand, takaful products continue to remain compliant to Sharia principles and, on the other, they also offer practical and competitive alternative to the conventional insurance.

Investment
As indicated last week, there are limited opportunities for a takaful operator to invest its funds Islamically. Since takaful companies are not left with enough options, they place their funds with Islamic banks at moderate returns.

In order to enhance the return to takaful participants to a decent level, which will, in turn, spur growth by attracting mass business, it is important that takaful operators are allowed to diversify their investment base.

Takaful fund may therefore be invested in buying stocks of companies whose activities are not opposed to Sharia principles or to invest in short-term trade and real estate transactions.

Islamic Development Bank can play its role by tying up any financial assistance to member Islamic countries to a progressive target for promotion of Islamic banking and takaful activities in that country. Such serious efforts will surely provide required thrust in spreading takaful activities.

Unified legislative framework
For takaful to thrive in an orderly and sustained manner, a unified legal framework must be put in place as soon as possible which would enable the authorities of Muslim countries to regulate and supervise its operation. Again, such a stage can only be achieved through the good offices of IDB or ICO where all Muslim countries have representation.

Since most Islamic countries have the dual financial system (Islamic and conventional) side-by-side, it should not be difficult to achieve. For example, what is required of the conventional financial system, such as transparency, good governance, reports and returns, compliance of regulations and other provisions, could also be made applicable to the Islamic financial system.

Competition
In this age of open market attitudes and thrust on globalisation, takaful would also have to face competition, similar to other financial sectors.

Though at present the market for takaful exists, or should I say, has started to thrive essentially in Muslim countries, the day is not far when takaful will also draw the attention of the conventional insurance giants, as in the case of Islamic banking.

Therefore, in order to be able to rise above the occasion, the high performance criteria applied in conventional insurance sector must also be developed and adopted for takaful.

Indeed, the extraordinary high service standards set by takaful operators may prove to be difficult barriers to cross by the conventional insurance operators with takaful offers.

Standardisation
Sharia scholars agree that the contract of takaful must be based on certain tijari (trading) principles that conform to the basic characteristics of Islamic business transactions. As such, consensus is that the contract may be based either on the principles of mudaraba (fund management) or wakala (agency).

Some takaful companies operate on the principle of mudaraba and some o