Takaful operations and issues faced by Takaful operators

Takaful operations and issues faced by Takaful operators

From a consumer perspective, Takaful is superior to conventional insurance in several ways. Firstly, it is more cost effective as underwriting surpluses are redistributed among the participants. Moreover, there is a strong emphasis on transparency due to the collaborative nature of Takaful and the added requirement of shariah compliance. Correspondingly, Takaful supports ethical investments and eschews investments that support undesirable industries. Finally, for the faithful, it is a shariah-compliant alternative to conventional insurance, one that emphasizes community betterment and mutual assistance.

Despite its benefits and the fact that Muslims form 24% of the global population, Takaful still represents less than 1% of the global insurance market. Adoption of Takaful has been hamstrung by a number of challenges:

1. Inconsistent regulatory environments that inhibit global scaling, resulting in a lack of access for people outside of Muslim countries;

2. Lack of transparency resulting in low consumer trust;

3. Lack of business and operational excellence that make takaful insurance less attractive than conventional insurance.

Challenge 1: Regulatory compliance

An overview of key challenges in the Takaful insurance market by Deloitte’s ME Islamic Finance Knowledge Center highlighted governance and regulatory compliance as the most significant challenge for Takaful adoption. Typically, starting a Takaful company requires paid up capital of approximately $20-$25 million, eliminating the possibility of startups entering the space. Further exacerbating the regulatory environment are the reporting requirements, which take up resources that could otherwise be applied to product development or translate into cheaper prices. As an example, quarterly reporting and analysis of investment portfolios are required in the UAE, these reports have to be prepared by teams of internal accountants and auditors and authenticated by external auditors. In addition to these quarterly reports, annual reports on strategy and processes verified by compliance teams and oversight committees, signed off by boards of directors and externally audited, also need to be filed. There is no evidence that the amount of human resources that go into reporting produce better results for the Takaful company and its participants.

In Saudi Arabia, the insurance law is further supplemented by “Implementing Regulations” and a battery of 18 other regulations issued by the Saudi Arabian Monetary Agency (SAMA) and 27 “Directives” by the Saudi Central Bank and SAMA. Each of these regulations number between 15-25 pages, representing over a thousand pages of regulations to comply with. While regulations are important to protect consumers, overly restrictive regulations that are not up to date with market realities can only stifle innovation.

Perhaps the biggest impediment to the growth of Takaful is the lack of standardization in regulatory environments across national borders, resulting in Takaful operators that are limited to one country at a time. Furthermore, Takaful regulations don’t exist in most non-Muslim countries in the world, regardless of the size of the Muslim populations.

To reiterate, regulations are a necessary part of modern societies and some regulation is generally beneficial to consumers. However, the current regulatory environments for Takaful do not allow the industry to scale and to provide access to people outside of a few key countries. In insurance, the law of large numbers prevails; in order to reduce the individual participants' risk, there should be a large number of participants. The failure of Takaful funds to scale is a fundamental impediment to Takaful being a genuine player in the insurance industry.

Challenge 2: Lack of consumer trust

The highly centralized nature of Takaful regulations doesn’t account for the original ethos of Takaful, which is founded on mutual aid and cooperation among a community of people. In contrast, in today’s Takaful system government regulations centralize control of takaful operations and funds in the hands of the takaful operator, taking the community out of the equation. In takaful funds today, communities are largely divorced from the decision-making process of the funds, mirroring the centralized nature of conventional insurance. While this is an efficient management process, it removes agency from the community and leads to a lack of consumer trust, a fundamental flaw of both takaful and conventional insurance.

The lack of consumer trust further stems from a lack of transparency in takaful finances and operations. While regulators receive regular reports from takaful operators, the majority of these reports are not publicly available. As a result, the consumer is left in the dark about how the takaful fund that partially belongs to her/him is being managed. Unlike conventional insurance, in takaful, contributions made belong to the fund and the fund in turn belongs to the contributor, who therefore bears the risk of takaful operations. It is therefore not unreasonable for the Takaful participant to demand a certain level of transparency in takaful finances and operations.

Arguably, the lack of transparency is not intentional from the part of the takaful operator. Up until the invention of the blockchain in the late 2000s and DAOs in the mid 2010s, there haven’t been bona fide technologies that would allow takaful operators to engage in radical transparency without taking on a lot of additional costs. The same cannot be said today as the blockchain has become the third leg in “triple entry” accounting, a trustless accounting system that enables transparency without additional effort. DAOs and the use of tokens also allows a number of innovations that ensure transparency and engage the community in governance.

Furthermore, takaful suffers from a branding problem. Most Muslim consumers today, even those who engage in Takaful, don’t really understand what it is or how it works. In truth, takaful can be seen as a response to conventional insurance and inevitably, it is communicated as an alternative to such. However, it is time to reframe the narrative and return to the roots of takaful, with foundations built upon the decentralized technologies of today. We cannot truly have Islamic finance and banking without first disentangling from traditional finance and banking. Likewise, we cannot have true takaful insurance without first decoupling from the structures of centralized takaful operations and regulatory environments. For consumers, takaful on the blockchain will represent a clear break from conventional insurance and its constraints.

Challenge 3: Business and operational excellence

From a consumer perspective, a superior product at a comparable price is always more desirable. Takaful is a product that serves a need like conventional insurance products. However, takaful operations today suffer from a number of business and operational challenges that produce a lackluster customer experience.

We already discussed the high burden of regulatory compliance that increases the costs of takaful operations and diverts operator attention away from consumers to regulators. We also discussed the lack of transparency and branding problems that plague takaful. In addition, there is a scarcity of takaful-trained human resources to staff operations, especially in key operations like underwriting, regulatory compliance, shariah compliance, Islamic accounting standards, and most critically, technology. It doesn’t help that takaful operators can only source talent from local sources since a globally distributed workforce is still not on the table for most legacy industries.

Distribution of takaful products follows in the footsteps of conventional insurance, through a complex network of agents, brokers, bank partnerships and direct to consumer efforts. Licensed insurance agents and brokers continue to play the salesman role despite rapid advancements in web2 technologies that have mostly disintermediated middlemen in the way of travel agents. Islamic banks continue to have the most reach when it comes to takaful due to the practice of bundling Islamic financial services together. All this means that distribution is localized and only available within a single nation’s borders. A Nigerian cannot buy into an Emirati takaful fund even if the Emirati operator was willing to accept him.

Not unlike the rest of the insurance industry, takaful suffers from a lack of investment in product development and technological transformation. As “software eats the world,” industries are aggressively taking a software-first approach to re-inventing themselves. Yet, insurtech is in its infancy as insurance incumbents happily use regulatory hurdles as a moat to protect their legacy business from disruption by tech startups.

All of this means that takaful is poised to flourish if the right ingredients are added. Building upon the web3 foundation, TAKADAO will reduce regulatory compliance burdens, bring transparency into takaful operations and take a technology-first approach to building a trustless community organized for mutual aid.