Reviving ‘takaful’: Reflections on the Islamic New Year

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The country's sharia insurance industry lacks optimal support from the sharia finance ecosystem and regulations, particularly in investment-related matters.      

The Islamic New Year observation on Wednesday was an opportune time to reflect on the principles of hijrah (migration) and their application in the realm of economics, particularly within the context of the growing sharia economy.

In Islamic teachings, hijrah is divided into two aspects. The first aspect, known as makaniyyah, relates to "place". An example of this is the migration of the Prophet Muhammad from Mecca to Medina. The second aspect is called hijrah haliyah, which pertains to changing behavior as a transformative process to strengthen faith and become a better individual.

From an economic standpoint, the changing behavior aspect of hijrah aligns with the global rise of the sharia economy, where the halal industry has emerged as a vital pillar of growth both globally and domestically. Projections from the Dinar Standard indicate that Muslims worldwide will spend up to US$2.8 trillion on halal products by 2025.

Indonesia, with its sizable Muslim population of 229.6 million in 2020, has the potential to lead the halal industry. The State of the Global Islamic Economy Report 2022 reveals that Indonesia's sharia economic indicators continue to improve, with the country ranking fourth globally. It is also one of the largest consumers of halal products, accounting for 11.34 percent of global halal expenditure.

However, despite the significant growth in the overall sharia economy, the takaful (insurance) sector has faced challenges. In Indonesia, sharia insurance represents the smallest sector of the Islamic finance industry, comprising only 2.52 percent of its assets. While there are 15 full-fledged sharia insurance companies in Indonesia, there are 43 Shariah Business Units (SBUs) that still need to spin off by the 2024 deadline.

The performance of Indonesia's takaful industry, as shown by an IFG Progress study, has remained below that of conventional insurance, with total assets growing at a 1.8 percent compounded annual growth rate (CAGR) between 2018 and 2022. The sharia insurance penetration rate in Indonesia also remains low at 0.19 percent of gross domestic product (GDP), despite the country's Muslim population comprising 87 percent of the total population.

There are significant challenges on both the demand and supply sides of the sharia insurance industry. On the demand side, literacy rates in the sharia insurance industry are notably lower compared with the conventional insurance industry. From the supply side, there is a lack of product differentiation, with sharia insurance products often resembling conventional counterparts, merely Islamized versions.

Furthermore, the sharia insurance industry lacks optimal support from the sharia finance ecosystem and regulations, particularly in investment-related matters. The performance of Shariah investment instruments and unit links remains below that of their conventional counterparts.

During the period 2017 to 2021, the gross contribution (premiums) from the sharia insurance industry recorded significant growth of 14 percent annually. This growth was mainly driven by the performance of sharia life insurance contributions, which saw an average increase of 16 percent per year (CAGR 2017-2021).

However, similar to conventional insurance, the growth in gross claims for sharia insurance outpaced the growth in contributions, averaging 42 percent per year, with the highest increase coming from the life insurance sector at 51 percent per year (CAGR 2017-2021).

Although the nominal contribution amount is still higher than the claims, the substantial increase in claims, nearly three times that of contributions, can potentially impact future underwriting surplus.

Drawing lessons from Malaysia, where the sharia insurance industry has experienced rapid growth, a competitive sharia financial sector ecosystem and robust regulatory framework have been key factors. Malaysia has strategically placed investments in sharia private debt securities and equity, with a majority in corporate sukuk (sharia-compliant bonds), benefiting from a well-developed sukuk market, which ranks second globally in terms of issuances.

The Islamic insurance industry in Malaysia is one of the leading players in the global sharia insurance industry, with a contribution of over 70 percent in the Southeast Asian region. The significant growth of Malaysia's sharia insurance industry is evident in the continuous positive growth in premium penetration and assets over the past 10 years.

Interestingly, there has been a substantial increase in premium penetration in both life and general insurance during the pandemic period, from 2020 to 2021. This can be attributed to the growing awareness among the public about the importance of insurance in providing financial protection. Additionally, the increase in premium penetration is supported by incentives provided by insurers and takaful operators (ITOs), who have implemented re-pricing strategies to alleviate the financial burden for policyholders.

From the regulatory perspective, Bank Negara Malaysia, the central bank and financial services authority, has implemented regulatory transformations in the sharia insurance industry over the last decade. These include spinning off sharia insurance business units from conventional insurers and establishing a strong regulatory framework with provisions and regulations related to guidelines, licenses, operations, market conduct and governance.

These changes have led to significant improvements in the number of sharia insurance companies and asset growth.

Indonesia can expect a similar journey in the future, as the Financial Services Authority (OJK) pursues the Sharia Unit Separation Work Plan, mandating the complete spin-off of SBUs from conventional insurers by 2024. However, specific challenges need to be addressed, such as capital requirements, human resources capacity, infrastructure, limited investment activities and the implementation of branding and awareness strategies for SBUs.

By addressing these challenges and learning from Malaysia's best practices, Indonesia can pave the way for a thriving takaful industry, contributing to the growth of the sharia economy and providing ethical and responsible financial services aligned with Islamic principles.  

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The writers are research associates at IFG Progress. The views expressed in this article are their own.

 

This article was published in thejakartapost.com with the title "". Click to read: https://www.thejakartapost.com/paper/2023/07/21/reviving-takaful-reflections-on-the-islamic-new-year.html.