By Al-Zaquan Amer Hamzah and Bernardo Vizcaino
KUALA LUMPUR, Oct 21 (Reuters) - Expansion of the takaful(Islamic insurance) industry is slowing as firms struggle forscale and face growing competition, but the sector is stillpoised to sustain double-digit growth, according to a report byErnst & Young.
Takaful, an industry which attracted $10.9 billion in grosscontributions worldwide last year, has its core markets in theGulf and southeast Asia and serves as a bellwether of consumerappetite for Islamic finance products.
Driven largely by Saudi Arabia and Malaysia, takafulglobally is expected to grow by 16 percent annually in comingyears compared to an average 22 percent rate between 2007 and2011, said Ashar Nazim, Islamic financial services leader atconsultants Ernst & Young.
That would see the industry edge close to $17 billion inannual gross contributions by 2015, with Saudi Arabia making upalmost half of that figure, the report showed.
But firms have expanded in narrow product segments such asauto insurance which are saturated by competitors, sparkingprice competition to gain market share, Nazim added.
"Unless serious thinking goes into strategising the modeland structures, you'll grow your market share at the expense ofprofitability."
A shift from general insurance to more profitable lifebusiness remains unlikely in the Gulf because of comfortablegovernment-funded safety nets, with general business commandinga market share of as high as 96 percent in Saudi Arabia.
Takaful firms have struggled to control costs because ofexpanding workforces, and they have lost business toconventional rivals which can underwrite larger risks moreefficiently.
Lopsided portfolio allocation is a key problem, especiallyin the Gulf outside Saudi Arabia where firms invest 25 percentin equities but just 2 percent in the more stable sukuk assetclass, the report showed. Saudi takaful firms allocate more tosukuk, 25 percent, but 44 percent is held in low-yielding cashdeposits because of regulatory requirements.
This means profits can swing widely. Return on equity for asample of Gulf firms reached 0.4 percent in 2012, up from minus7 percent in 2011 and minus 4 percent in 2010, the report said. In Saudi Arabia, return on equity jumped to 4 percent last yearfrom minus 6 percent in 2011 and minus 1 percent in 2010.
Such volatility requires greater use of reinsurers, which inturn erodes profits: reinsurance ratios for takaful firms are ashigh as 38 percent in the Gulf and 31 percent in Saudi Arabia,with Malaysian firms at 14 percent.
Geographical expansion is one way out, but this is difficultbecause of expensive regulatory requirements and the lack of astandard approach to sharia-compliance across the world - twomajor barriers which remain unadressed, Nazim said.
"Unless there is regulatory clarity across borders, and acertain level of convergence, we believe this is holding backthe internationalisation of the industry."
Aside from a few operators in Saudi Arabia and Malaysia,most takaful firms lack the balance sheets necessary to exploremarkets such as Indonesia, Turkey, Egypt and Qatar, which offerstrong potential because of their demographics.
Although scale is a priority and there are 77 operators inthe Gulf and 36 in Africa, consolidation looks unlikely.
"We do not see consolidation as a major theme in the nearfuture. For this to happen there needs to be good value in thebusiness. It's still a very young industry and it needs to begiven the room to proliferate and grow in a more entrepreneurialway," Nazim added.
Clearer distinctions between takaful firms and conventionalinsurers are poised to change the sector in countries such asMalaysia and Indonesia.
Malaysia's Islamic Financial Services Act, introduced inJuly, requires the separation of life and general businesslines; firms with composite licences that cover both sectorshave five years to separate them.
Indonesia, which has 46 takaful operators, is poised to moveaway from allowing takaful windows, through which takafulservices are offered by conventional insurers, Nazim said.
"This will create greater clarity and focus in businessmodels, a good thing for the industry. In the near term, it'llrequire some operators doing composite business to repositionthemselves," said Nazim.
"Only once there is clarity, then operators can understandwhat kind of consolidation can create or destroy value." (Editing by Andrew Torchia)
- Saudi Arabia