Islamic insurance can take up the growth baton

22 July 2020

In such never-before-seen circumstances, new routes are opening up for Shari’ah products

These are not unprecedented times.

Yes, you heard me right.

For those who are wondering why I say this – and especially for those tired of the overused phrase – let me explain in the words of Stephen Covey, who said: “If there’s one thing that’s certain in business, it’s uncertainty.”

While no one could have predicted the breadth of the devastation to lives and livelihoods caused by the COVID-19 pandemic, much less prepare for it, we aren’t strangers to disasters or disruptions either.

Hurricanes, wildfires, and floods around the world cost hundreds of lives and billions of dollars last year. Closer to home, escalating tensions in the Arabian Gulf aren’t new. Markets have also felt the impact of missile strikes in Iraq, drone strikes in Saudi Arabia, and the seismic shock in oil prices over the past year.

Isn’t some level of uncertainty just expected?

COVID-19’s impact on the economy and society is still rapidly evolving but there is no doubt the effects will be severe, underlining the critical value of ensuring safety and protecting livelihoods for our loved ones – an unequivocal need that is central to our quest for a better life.

Let’s get the cover

Suitable insurance cover is an obvious but often ignored way of mitigating many of the risks and coping with the circumstances people have unfortunately found themselves in during the outbreak. And if there’s one thing the virus has taught everyone, it’s that healthcare and life insurance simply cannot be overlooked.

But when seeking a suitable provider, it is important to understand both the long-term benefits and structures of different types of insurance products.

For example, the operational principles of the Islamic insurance industry, or takaful, place more emphasis on the principle of help as compared to conventional insurance products.

Based on principles of mutuality and co-operation, the Shari’ah model focuses on shared responsibility, joint indemnity, common interest and solidarity. Takaful works on the premise that all human activities are subject to the risk of loss from unforeseen events. The concept of alleviating this burden to individuals, what we now call insurance, has existed since at least 215 BC. The term Takaful originates from the Arabic word ‘Kafalah’, which means “guaranteeing each other” or a “joint guarantee”.

Clear demarcation

Takaful policyholders put money in a common pool of fund claims and benefit if the pool is left in surplus, similar to mutual insurance but with clear segregation of the assets owned by policyholders and those owned by the insurer.

The key difference between takaful and conventional insurance is that takaful is a risk-sharing (cooperative model) whereas conventional insurance is a risk transfer model. Under the takaful model, the takaful insurance company manages the risk on behalf of the policyholders but does not transfer the risk to itself.

Handling operational risks

In modern-day conventional insurance, the insurance vendor takes on the risk in return for premiums. The policyholders take on the risk of the liquidity and solvency of the conventional insurer to pay the policyholder in the event of a claim.

In addition, if the takaful fund goes into a deficit to pay the claims, the takaful operator finances the deficit by way of Qard Hassan (zero interest loan). These loans are repaid from future surpluses that arise from the fund, and in some cases forgiven by the takaful operator if the takaful fund does not generate a surplus. The takaful concept prioritizes policyholder payments over the takaful provider equity capital.

Insurance, especially amid volatile market conditions and public health concerns, has become an urgent necessity. There is an increasing demand for a Shari’ah-compliant insurance system among the ethically minded because Islamic principles put a strong emphasis on the economic, ethical, moral and social dimensions, to enhance equality and fairness for the good of society as a whole.

The Takaful market is expected to grow to USD 40 billion by 2023 from roughly USD 19 billion in 2017, with the largest segment being the life and family market. In addition to the compliance with the principles of Shari’ah, cooperative insurance as a concept is gaining popularity across the world.

Recently, Lemonade Inc. (NYSE:LMND) went public on NYSE to a successful listing. Lemonade offers its insurance policyholders an option to select a non-profit or charity to receive an annual payout from the unclaimed premiums of their cohort. The Lemonade model is similar to the cooperative insurance model followed by takaful insurance providers.

With more than 12 trillion dollars of negative-yielding debt worldwide, insurers with exposure to developed market policyholders may be forced to take additional risks to generate a higher return to meet their future insurance obligations. With increased life expectancy and population de-growth in the developed world, global insurers may not be able to replace their inflows at the same rate as before.

Policyholders should be mindful of the risk and benefits of different product types and structures before making an important long-term decision that is designed to protect themselves and their loved ones.

Disclaimer

The content of this article is informational only and based on information available when created. It is not an offer or a solicitation nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.

Islamic insurance can take up the growth baton

Author:

Ajit Joshi