TAKAFUL, A CATALYST FOR CHANGE

Sohail Jaffer

FWU Group

Partner, Head of International Business Development

Socially responsible investing (SRI), commonly defined as the practice of integrating values and societal concerns with investment decisions, is becoming a booming market in several countries and a valuable segment in the investment world.

SRI has its roots in the 1700s, when the members of the Religious Society of Friends in Pennsylvania, known as Quakers, refused to invest in businesses associated with slavery.

From the 1970s on, SRI began to bloom, fed by strong social movements focusing on the environment, fair labour and trade practices, the military-industrial complex, the use of nuclear technology and the rights of minorities and women.

As the popular consciousness of social movements has begun to penetrate the previously socially unaware financial world, the SRI movement has been growing in strength.

Socially responsible investors include both individuals and institutions, such as corporations, universities, hospitals, insurance companies, non-profit organizations, foundations and religious institutions. Institutional investors represent, at the present time, the largest and fastest growing segment of the SRI world.

Generally socially responsible investors seek to own profitable companies that make positive contributions to society, screening out corporations involved in industries such as tobacco, alcohol, gambling, military weapons and nuclear power.

The practice of evaluating investment portfolios or mutual funds based on social, environmental and good corporate governance criteria is called screening, however, it would be a terrible mistake to assume that SRI screening is simply exclusionary, or only involves negative screens.

In reality SRI funds use more and more frequently positive screening as well, favouring investment in companies that are involved in activities that benefit the environment or society.

Through the years, also the misperception that socially responsible investments are characterised by a low return is miserably collapsed. In fact, SRI funds have widely demonstrated their financial soundness.

Apparently the reason why SRI companies perform well is due to their management that is generally more focused on the reputation of their companies and far-sighted enough to avoid or reduce risks and liabilities.

An example of how much progress has been achieved in the development of Socially Responsible Investing is the increasing community banking appeal of Takaful related products.

The term Takaful originates from the Arabic verb "kafala", meaning to guarantee, and is commonly referred to as Shari' a compliant insurance or assurance. Takaful is not a new concept, as it has been practised in ancient Saudi Arabia for over 1400 years.

The principle of Takaful is to protect against vulnerability or risk arising from untoward events those individuals who need it most. It differs from conventional commercial insurance in the fact that the premium, calculated by actuaries, must be paid on the basis of Tabarru' (donation).

The Tabarru' concept is the main core of the takaful system due to its capacity to eliminate the elements of uncertainty and gambling. In fact, with the intention of Tabarru' the insurance transaction becomes valid and permissible from the point of view of Shari' a.

Each participant, known as a policyholder in a conventional sense, must present the sincere intention to donate to other participants faced with difficulties.

Therefore, Takaful exists where each policyholder relinquishes, as a donation, a certain proportion of the contribution in order to fulfil his obligation of mutual help and joint guarantee should any of his fellow participants suffer a defined loss.

The sharing of profit or surplus that may emerge from the operations of takaful is made only after the obligation of assisting the fellow participants has been fulfilled.

In addition the operation of a Takaful provider must also be free from Riba (interest) before it can be regarded as Shari' a compliant.

The takaful product family spans across non-life (general takaful), life (family takaful), health and pension business lines. However, the majority of the Takaful products fall into the non-life and life areas.

Until now, the Takaful industry has succeeded in distributing products through agencies sales force and direct channels. But we are witnessing the emergence of a new phenomenon with new actors flourishing in the industry.

In addition to the Shari' a compliant mutual funds that have existed for a number of years, Islamic banks are becoming providers of those products, entering the realm of Bancassurance or more precisely BancaTakaful.

This is the shift taken by the Emirates Islamic Bank and also new Takaful companies that flourish in Saudi Arabia, Bahrain, Pakistan and Malaysia. Those financial institutions buy "white label" products from companies specialised in creating customised products and distribute them through their already existing outlets.

The diversification of Takaful providers also includes an increasing number of financial services providers from North America and Western Europe. Recently, American Insurance Group (AIG) and Prudential received Takaful licenses to launch ventures either singly or with the cooperation of regional Islamic partners.

Other global insurance brands such as AXA, Allianz, Fortis and Tokio Marine have also entered the business.

Indeed, the Takaful system, as a component of the SRI trend, has some special socially responsible characteristics which make it attractive:

not only is it ethical in term of investment, but it is also transparent (as it focuses on the first principles of insurance) and fair to all parties (with the principle of mutual surplus sharing for example).

Yet, the emergence of Takaful as a viable and profitable form of insurance has been enabled by the arrival of a new category of actors: the Shari'a reinsurance agencies.

These new reTakaful players, such as Hannover Re, Munich Re and Swiss Re, are allowing nascent providers to take on higher investment risks while being backed by large groups against huge losses.

The increasing number of Takaful providers demonstrates a growing potential and existing market for these products. Primarily, the Takaful system appeals to Muslim customers, who may be reluctant to buy conventional insurance products as those are inconsistent with religious principles.

In most Islamic countries, the penetration of insurance has historically always been very low. Although economics and demographics are good in most GCC countries, insurance penetration in those markets often range from 0,5 per cent to 5 per cent compared to 10 per cent to 15 per cent in markets where insurance is developed.

This represents a tremendous potential growth and this explains why there is considerable activity in the Takaful industry in the Middle East, and especially in Malaysia, Indonesia, Sri Lanka, Bangladesh and Pakistan.

However, the stakeholders of the Takaful industry still have some challenges to face to expand further in that highly promising market and to woo Muslim buyers.

They have to increase the awareness of the need to insure, which is not yet rooted in the culture of most Islamic countries. Furthermore, the low level of education and the lack of efficient communication regarding those Shari' a compliant insurance products are major reasons that could limit the growth of the industry for a while.

But Takaful products are also able to appeal to non-Muslim buyers, more broadly interested in Socially Responsible Investing. For example, 60 per cent of people buying Takaful products in Malaysia, one of the countries where the Takaful industry booms, are non-Muslim.

While SRI has been a more and more significant trend for the past 30 years, that ethical approach of investing has a very promising future with the soaring development of the Takaful industry.

The positive screening approach, that characterises Islamic insurance, succeeded to woo a broad range of stakeholders and customers. Implementing cross-border standards and achieving solid financial ratings are some of the challenges that will enable the Takaful industry to flourish beyond its religious origins.