The Central Bank of Bahrain is planning to introduce new rules to enhance the operational model of Takaful, but how will this affect the market? Islamic Business & Finance went to Bahrain to find out
While attending the Middle East Insurance Forum in Bahrain, Islamic Business & Finance learned that the Central Bank of Bahrain (CBB) is planning to revamp the existing Takaful model, with the objective of facilitating a faster growth of Takaful business in Bahrain while protecting the interest of all stakeholders, vis-à-vis participants, shareholders, and Takaful operators.
"We've been working very closely on a model related to Takaful whereby we calculate the solvency a little bit differently from the standard that is already in place.," Abdul Rahman Al-Baker, Executive Director of Financial Institutions Supervision at the CBB, said. "We are in the process of finalising it and issuing it within the coming few months. We have already received the approval of more than 20 Shari'ah scholars, so we have already done our homework and are at a very advanced level on reaching the final stages."
The idea behind the new rules is to create a model that is suitable for the existing activities of Takaful companies and is more in line with international practice. "We are talking more about the existing solvency that is more relevant to Takaful companies. We take into consideration a mixture of Solvency I and II on this. At the end of the day, you need to tailor these ratios to be in line with the best international practice. The existing model needs to be revamped in a way that better addresses the Takaful business in terms of risk and the ability to calculate the soundness of the capital adequacy."
GETTING MORE IN THE DOOR
The hope is that the new rules will attract more players to Bahrain. "This model will open the door for several of the new players in the market - specifically international players. I think through the adoption of that solvency, the door for many more players will be open; lately, big multinational players have been entering the Bahrain market, such as Hannover Re and ACR... These are big, worldwide players. We're talking about companies that rank among the best in the world."
But is there room for them? Bahrain, the GCC's insurance capital, now has a large number of local players that may struggle if bigger players were to enter. Because Takaful companies are competing for the same market as conventional insurers, with much the same product offering, local markets could come under strain.
"Very few Takaful companies have actually focused in developing new offerings, they are competing with a Shari'ah-compliant product for the same type of business," said Vasilis Katsipis, General Manager of Market Development for A.M. Best. "A Takaful company's portfolio doesn't differ much from a conventional insurer's. If you look at the average portfolio of a Takaful company, it's mainly motor insurance followed by medical and the question is, how do they differentiate? They don't. There is very little differentiation other than the fact they are Shari'ah-compliant.
"For that reason, most of what these Takaful players are doing is putting pressure on the market, and they have the same impact as a conventional insurer when they enter a market. They will need to offer something new to add value."
Younis J. Al Sayed, Chief Executive of Takaful International, Bahrain's first Takaful company, disagrees. "When it comes to the region's capacity, you have two different markets," he said. "Either you go for an A-rated company or you want regional capacity where you will have a lower price. Honestly speaking, the new rules will attract more companies because this is the right place to be, and there is the capacity for it here."
Sayed argues that while the conventional insurance market is saturated, the younger Takaful market will benefit from the expertise more players will bring. "There is still a market here for companies to come with new products," he said. "We need companies who are specialised in medical, life insurance and bancassurance."
Al-Baker also believes more players will enhance Takaful companies' products, especially multinational companies. "There are very successful marriages happening between them [multinationals] and the local players, who understand Takaful, Shari'ah and the local market. Those multinational players will give local companies the knowhow to boost the number of services that they offer. During the past six or seven years, Legal & General, Alliance and Hannover Re have all jumped on the Takaful bandwagon, which clearly shows that multinational players believe they need to have at least part of this business, which is growing at double digits. They cannot afford to ignore it."
One multinational company that was drawn to the Bahrain market was Hannover Re. "Any ReTakaful business, be it in Sri Lanka, Pakistan or Europe, will operate ReTakaful out of the centre of competence, which is here [Bahrain]," said its Managing Director, Mahomed Akoob. "The reason for us setting up in Bahrain was that it provided us with the infrastructure and regulations which will foster the smooth development of ReTakaful."
"Competition is a challenge, as it is for conventional," Akoob agrees. "There are no price differentials between conventional reinsurance and ReTakaful. So when the market is under stress we have the same challenges. I don't think the challenges in ReTakaful are any different from those in conventional reinsurance.
"I think the only thing that's different is, on top of all that, you have to make sure you are Shari'ah-compliant. There is no such element in conventional. You have a reputational risk which is unbelievably strong, and it is an ethos I have pushed through our organisation - Shari'ah compliance must come before everything else."
Akoob also strongly argues against the idea that Takaful offers the same as conventional insurance, albeit under an Islamic brand. "There is a clear advantage over the conventional reinsurance side, and that's surplus distribution. If the pool behaves as it should there is the potential to get a payout which is not the case with conventional. It also serves a need - until now there were many who would not subscribe to the conventional. It has to be noted that ReTakaful exists to serve a niche which needed a type of cooperative insurance."
Sayed added that Takaful will always have an edge because it can serve two markets, while conventional can only serve one. "The beauty of the Takaful is you have access to conventional as well as the Islamic," he said. "For example, I can write Gulf Air or Bahrain Islamic Bank... But the conventional companies can't write Bahrain Islamic Bank. Technically Takaful is exactly like conventional insurance. But, at the same time, you need to segregate the shareholder from the policy holder, pay Zakat and pay a distribution... This is not available in conventional insurance, and it works in the consumer's favour - and this works to your advantage."
Al-Baker also believes that as well as attracting new players into Bahrain, its progress in Takaful will win the Kingdom business abroad. "Multinational players that come here may need our knowledge for their domestic market," he said. "There are a lot of Islamic communities in the UK, Germany, France and several European cities where they would love to see this happen. The Islamic Bank of Britain, which set up eight years back, was set up through companies in Bahrain. That idea transferred from Bahrain to set up a Shari'ah-compliant bank in the UK, and the same could well happen with Takaful."
MOVING WITH THE MARKET
Sayed believes that the new rules will boost capacity because they have been developed with the market. "They [CBB] never do anything without consulting the industry. They communicate with us; we give our comments which are passed to the regulator where all the feedback is consolidated before any new law is implemented. They never implement anything without consulting the market."
Al-Baker explains that this is because you need to tailor regulations based on market development. "You need to end up with an acceptable level of risk where you make sure the model you introduce would be acceptable to the whole industry - today, I think regulators have very difficult equations of balancing this risk with market practice," he said. "If you go to a level whereby you calculate the model on a basis which is quite different than the existing market practice, then there is a great possibility you will hold up the market.
"Whenever you introduce regulation you should have a base - you cannot introduce regulations out of the blue. Regulators today must understand how the market works, and come up with the right dosage of regulation relevant to the existing market. We need to take into consideration what's happening with the global economy - there are several issues we need to address with respect to risk as well as liquidity. This is part of the whole equation you need to take into account when calculating solvency."
Al-Baker believes that because the new rules are based on industry practice Takaful companies can only benefit from them. "I think Takaful companies will end up with better capital requirements," he said. "The model takes into consideration the level of risk in the business; it takes the nature of the Takaful operators into consideration.
"There are certain issues that you need to look at and tailor-make to be in line with Shari'ah requirements. Take solvency, for example; you could not calculate the solvency based on the conventional model - it's not acceptable. You need to come up with certain calculations where you end up with the same result calculating the risk. The same is true of other aspects of Takaful. I still need to emphasise that you should not deviate from the best international standards, to make sure you are working to the same core principles of insurance. That's the name of the game."
PREMIUM PROBLEMS
Another difficulty is that Takaful companies require greater capital than their conventional peers. "In conventional insurance the premiums are mingled - but that's not the case in Takaful," explained Al-Baker. "Premiums related to policyholders are separated from those of the company. Based on that you need to make sure your capital does not end up with any deficit where the shareholder needs to borrow money to cover solvency requirements. You need to sort out this equation where you end up with the right model."
Does this mean Takaful companies need to charge higher premiums? Apparently not - Akoob argues that Takaful could not survive by charging higher premiums. "In terms of pricing, it is equal to that of conventional," he said. "If anyone says it is more expensive, I would challenge that, it is not the case. The market is fluid, open and would punish you for that."
Another alleged cost is that of Shari'ah boards. However, Akoob says these costs are exaggerated. "This is not an issue for us, I assure you," he said. "At Hannover Re, we are not in the market to compete on price for Shari'ah boards. We make it clear that this is what the organisation pays, if you're happy to join that's fine. We have some excellent, renowned scholars on our board and the fees were never in question. I know it is flouted around that Shari'ah scholars have six-digit salaries but for Hannover Re, it's not an issue. We pay them what we think is commensurate, and respectfully to them, they are happy to be on our board because it's about pushing forward developments in ReTakaful."
Al-Baker added that they didn't see the need to focus on the credentials of scholars within the new rules. "We vet the control functions, which consist of those on top management as well as the board. The board should ensure when they appoint Shari'ah boards that they have the ability and expertise to be able to address issues related to Takaful business. Today, everyone should be responsible for his action. That's part of what we ensure in our corporate governance model. Vetting the control functions is part of it, and the Shari'ah board is usually appointed by the board of directors where they make sure they would be able to do the job correctly. Board members make sure that the scholars are acceptable to the industry, and are able to add value."
Nonetheless, Shari'ah boards do add an expense to Takaful companies, however big or small, that the conventional competition does not need to worry about, on top of greater capital requirements. Because higher premiums aren't viable, Al-Baker believes that Takaful companies must attract more volume. "You need to optimise that volume and find a more productive way of managing premiums to end up with a good mark up on your Takaful business," he said. Which is, he says, ultimately what the new model is all about; encouraging new players and boosting volume.
Currently, Takaful premiums represent almost 23 per cent of Bahrain's insurance industry. The growth over the past five years has ranged from 20 to 30 per cent. In the third quarter of 2012 the market grew 24 per cent over the third quarter in 2011. Sayed puts the size of Bahrain's insurance market at $250 million, with Takaful accounting for $42 million. If this continues, volume may be the least of the Takaful industry's concerns.
© Islamic Business and Finance 2013
