Despite ongoing, rapid growth in the Sharia-compliant insurance markets, operational issues remain commonplace in the sector, according to Standard & Poor’s Ratings Services.
These challenges being faced by the Takaful Industry took center stage and generated some heated discussion at the International Takaful Summit, held in London last month.
Standard & Poor’s views such discussions within the takaful (Islamic insurance) and retakaful community as understandable given that it is still a relatively new business sector. Nevertheless, we expect it will continue to grow rapidly, relative to the conventional insurance market, and become increasingly meaningful in overall scale in its target domiciles.
Standard & Poor’s believes while the essential Sharia-compliant operational model affords a further level of corporate governance, particularly so in those domiciles where corporate governance is poorly established, often the Sharia interpretation creates a more complex, and so inefficient, operational model compared with conventional insurance companies. And since conventional companies employ tried and tested systems, are typically long established, and have larger business volumes, they deliver better economies of scale that some takaful companies are struggling to achieve. We believe this is creating some difficulties for both takaful fund members and investors.
“The variety of interpretations of Sharia law within the takaful sector, and its auditors, is causing material inconsistency in the published accounting information from the sector. As analysts using both published and, where appropriate, confidential information,” it said.
In its interactive ratings of takaful companies, Standard & Poor’s is of the opinion that there is real issue from shareholder funds (and the attaching assets) to the takaful fund if the latter is in deficit (unless demonstrated otherwise). At the early stages of a company’s development, when takaful fund deficits could be likely, this standard could create an onerous set of operational constraints. Standard & Poor’s will continue to monitor the overall capital adequacy of a takaful company by combining both takaful funds surpluses (and deficits) with shareholder funds.
Standard & Poor’s has some concerns about the management of fund surpluses. AAOIFI proposes that takaful fund surpluses can only be distributed to the managers of the takaful fund and therefore not to members, as is commonly understood to date, nor the investors in the company. We observed at the Takaful Summit last month that there are concerns that this ruling creates real moral hazard for both the fund members and the shareholders. As an example, for certain types of underwriting risk, claims development can happen over many years, and it is conceivable that a fund that is apparently in surplus for years one to four can turn into deficit in year five.
From a credit rating perspective, Standard & Poor’s expects a takaful company to have at least good risk-based capital adequacy, which encompasses prudent technical reserving, so the issues highlighted above are very much internal management issues for each company, rather than real external rating constraints. However, they are an indication of the still-evolving operational framework for the sector that creates ongoing uncertainty.