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In recent years, Takaful, or Islamic insurance, has recorded very impressive premium growth rates of around 20 per cent. The first Takaful company was established in 1979, and there are now over 250 globally. Total Takaful premiums exceeded $2 billion in 2005, and are expected to reach $7.4 billion by 2015.
The main concept that differentiates Takaful from conventional insurance is that of co-operation or solidarity. The purpose is not to generate profits but to share risk between members, thus making it more manageable for each of them. Importantly, the payment for the insurance service is classified as a "donation" rather than a "premium".
Types of Takaful
There are two main lines of Takaful: General (non-life) and Family (life). These can be provided through three main operational models: Al Wakala, which is particularly common in the Middle East and distinguishes between the operating company and the Takaful fund; Al Mudharaba, common in Malaysia, which stipulates a profit-sharing agreement between the operating company and the Takaful fund; and Waqf, which operates as a public foundation.
Re-Takaful is the Sharia-compliant reinsurance of Takaful companies. Moody's believes that the availability of ample Takaful reinsurance capacity is very important for the further successful development of the primary Takaful industry as a whole, as this is often the most appropriate tool for managing catastrophe exposure and accumulation of risk, particularly bearing in mind that most Takaful companies tend to operate in a single geographical region.
In addition, many Takaful companies are relatively young and therefore tend to use greater amounts of reinsurance capacity, sometimes in the form of quota shares, to meet their capital requirements.
There are substantial similarities between most common types of Takaful and mutual insurance. Generally, Moody's does not view mutual (co-operative) operating structures as better or worse than shareholder structures.
Indeed, many mutual insurers in Western Europe are rated A3 or better for insurance financial strength, generally in line with publicly-traded peers of similar size and business profile.
However, the credit strengths and weaknesses of a typical Takaful company will typically be influenced by a number of considerations that do not apply to a Western mutual insurer. Some of them are detailed below:
Corporate governance
The key performance indicators used by a company's Sharia board to assess the management of the operating company may have a greater focus on compliance with Islamic law than with technical issues, such as underwriting performance and risk management.
The nomination process to the board, as well as the background of members appointed to it, will also be critical in ascertaining the quality of corporate governance and its impact on the financial strength of the Takaful fund.
Strategic asset allocation policy
A diversified and circumspect investment management strategy is a major credit factor for an insurer. The assets of a Takaful company may have different liquidity and volatility characteristics, as well as different risk / return profiles than those of a typical Western insurer.
For example, some Takaful insurers may exhibit a propensity to focus on Sharia-compliant equities and real estate assets. Sharia-compliant bonds may be concentrated in certain geographical areas (e.g. Gulf states or Malaysia) which, in the absence of credit enhancement by an international institution, may increase the risk profile of the Takaful fund.
Structural features
The profit-sharing mechanism of long-term Takaful products may have certain distinctive features. For example, the determination, crediting and payment of profit participation on life policies, as well as the structure of any explicit or implicit guarantees, will need to be carefully examined.
Long-term capitalisation
While the capital structure of a Takaful company is not in itself conducive to large distributions (the fund is in many cases de facto not distributable), ongoing profit sharing may be subject to competitive pressures and as such vary in time and by market.
The position of the supervisory authority with regards to capitalisation and its ability and willingness to enforce the regulation will also influence the Takaful company's financial strength.
Timour Boudkeev is vice-president and senior credit officer of Moody's in London. Simon Harris is team managing director of Moody's in London.
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