Tomorrow's Takaful Products
By Ikram Shakir

Contemporary Western products are considered "unIslamic" as they contravene many of the Islamic principles. For instance, it is considered gambling to lose an insurance premium to an insurance company if the insured event does not take place (and gambling is prohibited by Islam) and the investment of the policyholders' funds may not be based on Riba.

Takafol is the Islamic alternative to contemporary insurance.

Islamic insurance products have existed, in one shape or another, for several years but the real impetus came during the early 1980s when such products appeared in Western Europe mainly due to the efforts of Dar Al-Mall Al-Islami, one of the biggest Islamic financial institutions in the world, through its Takafol subsidiaries. Business conditions for Islamic financial institutions were very favourable at the time and Takafol products were well received by the ethnic Muslim community living in Western European countries. The first generation of emigrant Muslims to Western Europe had established themselves successfully. The prejudices and discriminations of the host communities were coming to surface, Muslims were facing a crisis of identity and this created a chain reaction. These social problems were expressed through the establishment of a number of mosques and Halal meat and Islamic food shops throughout Western Europe. Simultaneously, non-interest bearing bank deposits and Islamic savings funds became more popular within Muslim communities.

The prevailing social and economic environment in Western Europe gave an encouraging start to Takafol operations in Western Europe. The early types of Takafol products were unit-linked savings plans where the benefits of the policy were notionally linked to the value of the underlying assets in the internal funds of the Takafol company. Those products were, in general, complying with Islamic sharia principles regarding the type of investment and risk. In particular, the following principles were observed in the product design:

In order to comply with the above rules, the Takafol policyholders' funds were invested in short term assets without any fixed interest or guarantee of capital and the mortality risk was shared on a solidarity basis so that any loss or profit due to mortality was shared between the policyholders. However, the Takafol savings products only offered a small death cover, which limited their appeal to prospective customers.

It was expected that other Islamic insurance products would be made available to cater for a variety of insurance needs amongst the Muslim community, such as term assurance, mortgage protection or old age annuities, but the process of introducing new Takafol products has been very slow and, to some extent, non existent.

In order to be successful and profitable, it is imperative for a Takafol company to offer a wide range of products and Takafol should not remain to be seen as a very narrowly based product operation. The Muslim communities in Western Europe have very high expectations from Islamic institutions in offering a complete Islamic system for their daily financial and insurance needs. However, until recently, only a part of this Islamic financial system was offered. Just imagine how difficult it would be to explain to a prospective policyholder that he should take out a Takafol savings plan for savings purposes but should rely upon the Western insurance industry for other insurance needs. It is therefore imperative to design and market Islamic products, which can meet wider insurance needs of the Muslim community.

WHAT ARE THE LIKELY PRODUCTS FOR TOMORROW?

The Western insurance products have evolved over the last 2 centuries to meet the social and economic needs of the population. As Muslims in Europe are living in the Western social and financial environment, they have similar social and financial problems and their insurance needs are therefore very similar. In order to identify which products may have a wider appeal for Muslims in future in Western Europe, it may be helpful to first identify the factors which affect the insurance market. Some of the primary factors are as follows:

The most important factors affecting the insurance industry are perhaps the ageing population, due to the baby boom/baby bust cycle in the 1950s and 1960s, and longevity due to the improvement in health care and economic living conditions. Other key factors are political and fiscal: the EU Member States are facing State budgetary deficit and constraint due to the introduction of the single European currency and the increasing cost of pensions and health care.
This suggests that insurance products for which there will be a higher demand in future are likely to be old age pension, annuity, medical care and long term care products.

Pension and Annuity Products

We are all very familiar with the three pillars of the Western pension system:

In the EU Member States, the State is by far the biggest provider of retirement benefits. However, the system is now being questioned. Studies indicate that a male joining the State scheme at normal age and retiring at normal retirement age will receive on average 62% of his contributions, which may not be considered as a good investment. In addition, the current system is based on "pay-as-you-go", which means that .the State collects contributions form the working population and pays it out to pensioners.

This system works as long as there are more contributors than pensioners but it will come under tremendous pressure as the number of pensioners grows. It is a well-known fact that the population in Western Europe and North America is ageing, i.e. that the ratio of older people to younger people is constantly increasing. Clearly, as a result of the excellent health service provided by the State, people are living longer than ever before (on average life expectancy has increased by 4 years over the last twenty years). However, this is not the only cause of ageing. The other cause is to be found in the sudden increase of fertility rates between 1950 and 1960 (a phenomenon known as the baby boom) and the subsequent drop in those rates (the baby bust). The graph below illustrates fertility rates in Western Europe from the twenties to the eighties-

It can be seen that there was a sharp rise in fertility rates after World War II, followed by a sudden drop in the late 1960s. Some people call this phenomenon a time bomb, but it can be better described as a tidal wave because a time bomb explodes only once whereas this phenomenon has recurrent long-Iasting consequences. As the baby boomers aged it created temporary demand for age-specific products but as the baby boomers were replaced by the baby busters, these areas of temporary high demand immediately contracted. In the 1950s, there was a high demand for kindergartens and schools, which had to close down later on for lack of attendance. In the late 1960s, the demand was in the higher education sector, which was followed by a recession with the consequence that many teachers were made redundant and many schools were closed. In the 1980s it was housing, appliances and commercial office space. In the year 2020, the demand will probably be in the medical, pharmaceutical and old care houses sector.

What will happen when baby boomers reach retirement age? Baby-boomers, who were trying to save the world in the 60s, will find it very hard to save their State retirement income. It is expected that by the year 2020, in Europe, there will be only two workers contributing to the State scheme for every pensioner.

With the State schemes being "pay-as-you-go", it becomes obvious that the State pension system will face serious financial challenges by the year 2020. There will be a systematic reduction in benefits with an increase in contributions and one can expect that the demand for personal pension products and occupational pension schemes will therefore grow dramatically. This will be equally applicable to the Muslims living in Western countries. There will be a real opportunity for Takafol companies and they should be ready to offer private pension plans to their niche market.

In particular, life annuities will be in higher demand, where Takafol companies will be required to cover the longevity and investment risks. However, Takafol companies should bear in mind that, due to the increase in life expectancy, the mortality of pensioners has shown remarkable improvements in recent years and the actual mortality improvements are much higher than the projected improvements used in the pricing of annuity products. An analysis carried out recently shows, in particular, that the improvement in male rates and in the annuity amounts is significant and clearly warrants a health warning. Consideration should therefore be given to those factors when designing pension and annuity contracts.

Long Term Care Products

Due to old age, or as a result of an accident or disease, some people lose some of their mobility and need special assistance to carry out daily activities. In the worst cases, 24-hour assistance may be required. The average length of such assistance normally varies between 6 to 12 years but it can be longer in certain circumstances. In the past, the family used to provide such assistance. However, because of the changing family structure (single parent families, divorces, working women, etc.), it appears that the family is no longer in a position to do so and, therefore, some external assistance is required. This can be quite expensive and, as State pension benefits and disability benefits are usually insufficient, extra cover could be provided through Takafol policies. The current estimate is that about 25% of retired people will require some long-term care at one time or another, which offers big potentials to Takafol companies. Benefits normally cover the cost of any external assistance required to carry out such activities as feeding, bathing, dressing, transferring to and from bed or chair, going to the toilet, etc. The target market for long term care products could be the middle-income group and the distribution could be through Islamic banks, occupational pension schemes and normal Takafol distribution channels.

Medical Care Products

Modern medicine and health care in the European Union has helped to improve the life expectancy but it has not improved the health and quality of life at older ages. In a recent research carried out in the USA, it was found that on average 77% of all health care expenses occur during the last six months of our life.

As a result of the ageing population, one can expect that the demand in the medical care sector will become higher. However, as a result of budgetary constraints, EU States may not be able to finance medical care expenses and there is a risk that the benefits paid out by the sickness fund may be reduced in future. This is already happening in some countries where hospitals are being closed, the availability of hospital beds is being restricted for people above a certain age, and medical subscription charges are being increased.

This indicates that private individuals have to find extra cover from the private industry .As a result, the demand for medical care products is likely to increase and Takafol companies should be ready to provide such products to the Muslim communities. Takafol companies could, for example, offer the following covers:

The word "Takafor' may portray the real meaning of risk sharing on a solidarity basis in the Arabic language, but it is not commonly used and understood by the Muslim community living in Western Europe. It is already difficult for a Takafol salesman to convince somebody that he should take a Takafol policy and having to explain what Takafol is, adds even more difficulties in the selling process. It would perhaps be better to use "Islamic insurance". This method was successfully used by the Islamic banking industry and a similar process could be employed by the Islamic insurance industry.

One of the main difficulties probably experienced by Islamic financial institutions is to design products, which can meet the insurance needs of the Muslim community living in Western Europe without contravening the basic Islamic (sharia) principles.

When designing a new product, considerations should be given not only to its adequacy, but also to its competitiveness. For that purpose, both the investment strategies and the product charging structure need to be carefully defined. For example, it should be noted that funds invested in short-term assets usually provide lower returns than those invested in longer term assets -since the liabilities of a Takafol company towards its policyholders are longer term by nature, it is considered prudent to invest the policyholders' funds in long term assets. As regards the charges, the use of single mortality rates puts some people at a disadvantage, which may reduce the product attractiveness to some prospective policyholders. Takafol should devise systems under which it should be possible to invest in longer-term assets and to use different mortality rates without contravening sharia principles.

Takafol managers are well aware of the insurance needs of their customers but may not be well experienced in the interpretation and application of sharia principles, whereas Sharia experts (religious leaders) may not fully comprehend the commercial requirements of a Takafol company. Therefore, there is a need to educate both sides into the other discipline and to maintain a continuous dialogue between them so as to find pragmatic business solutions under which the Takafol products are acceptable on sharia principles but offer competitive terms to the Muslim community for their insurance needs.
Institutions like DMI and the Islamic Institute for Banking and Insurance are already doing an excellent job in the development and promotion of Islamic financial systems. They should try to accelerate this process further by providing a forum where Takafol managers and sharia experts could communicate with each other.

According to some estimates, there are over 6 million Muslims living in Western European countries. That offers a very substantial market size to Islamic financial institutions. The Western insurance industry is facing problems in identifying its market and is going through a phase of consolidation and repositioning. With a defined market in Europe, Takafol companies do not face this problem. They potentially have a very prosperous future ahead of them, provided they can offer efficient Takafol solutions to the Muslim communities.