The Takaful landscape in Malaysia is evolving at a fast pace, faster even than developments in the conventional insurance sector
In its 'Standpoint Commentary' Malaysian Insurance and Takaful: Stable Fundamentals Amid Evolving Dynamics, RAM Ratings highlights the high growth prospects for Takaful in Malaysia. The country's financial sector had previously been governed by a clutch of separation pieces of legislation until June 2013, when the various laws were amalgamated into a single legislative framework, i.e. the Financial Services Act 2013 (FSA) and the Islamic Financial Services Act 2013 (IFSA).
Under the new Acts, composite insurers and Takaful operators (TOs) are required to legally separate their general and life/family businesses by 2018. While RAM Ratings believes this would strengthen regulatory oversight of the sector, the additional capital and resource requirements could be significant for smaller players. Meanwhile, tariff deregulation for the motor sector - the largest general business segment in Malaysia - is expected to come into effect in 2016 (fire tariffs could also be deregulated in the near future).
Capital requirements
On the Takaful front, the main changes involve capital requirements. The Risk-based Capital Framework for Takaful Operators (RBCT), which came into effect on 1 January 2014, requires them to maintain capital-adequacy levels that are in line with the risk profiles of their operations. For some Takaful operators, this could mean additional capital injections or borrowings to shore up their capital bases. RAM Ratings notes that it is not yet known if all 11 of the Takaful operators now active in Malaysia have fully met their RBCT requirements. Another imminent regulatory change for the industry is the IFSA requirement for composite Takaful operators to legally separate their general and family businesses by 2018; this would affect eight out of the 11 operators.
The additional capital and resource requirements imposed by these changes could drive the sector's consolidation over the next few years, particularly among smaller operators with insufficient scale to justify the additional investment in separate licences, particularly with respect to the general Takaful segment, which is about a third the size of family Takaful. As it is, the size (and penetration rate) of the Malaysian Takaful industry is about a fifth of that of conventional insurance, with the top three firms collectively commanding 70 per cent of the industry's contributions, which largely stem from family Takaful.
However, RAM Ratings believes the sector holds significant growth potential. Takaful contributions have charted double-digit growth (5-year CAGRs: 16 per cent for general and 14 per cent for family) and expanded at twice the rate of conventional insurance (Figure 4). Optimistically, if the industry continues on its high-growth trajectory of about 15 per cent to 20 per cent per annum, it could reach half the size of the conventional industry by 2018, making the sector potentially much more lucrative to investors. The growth of Takaful is also well supported by the country's developed Islamic finance industry.
Tariff deregulation
Another imminent change is the deregulation of motor tariffs, largely expected in 2016. This is in line with Bank Negara Malaysia's New Motor Cover Framework, which aims to redress the structural issues in the motor sector. There are significant mismatches in the present structures, as statutory-controlled motor premiums have not changed much since 1973 despite increasingly more accidents and claims costs. The claims ratio for motor insurance remained relatively high at 72.7 per cent in fiscal 2013 (last five-year average: 76.5 per cent), compounded by cover claims that have historically come in well over 200 per cent. In preparation for the transition to market pricing, BNM has allowed premiums to be adjusted upwards annually since 2012, although these increments have been nominal to date.
The lifting of tariffs bodes well for both conventional insurers and Takaful operators, according to RAM Ratings, as it will alleviate cost pressures from underwriting the largest segment of general insurance, motor constitutes 47 per cent of gross general premiums. The move will also spur greater competition and, possibly, some price-undercutting during the initial stage as policy providers strive to retain market shares and attract new customers via differentiated premiums. Such an environment will favour established insurers and Takaful operators with strong balance sheets and the right expertise to accurately price risks based on driver and vehicle traits. Eventually, however, premiums are likely to rise to levels that reflect the underlying claims experience, in addition to providing reasonable underwriting margins. On the other hand, the lifting of fire tariffs would potentially trigger more intense competition and price wars among players, given the lucrative margins of the segment.
Despite the evolving landscape brought on by the recent regulatory developments, RAM Ratings has a stable outlook on the Malaysian insurance and Takaful sector, premised on the respective segments' favourable growth prospects, the insurers' strong capitalisation levels and a stable regulatory framework. Malaysia is also largely spared from natural catastrophes. As at end-December 2013, the insurance sector's consolidated risk-based capital-adequacy ratio stood at 245.9 per cent, affording a comfortable buffer to meet its liabilities.
RAM Ratings believes that the consensus medium-term forecast of 7-10 per cent growth for general and life insurance and double-digit growth for Takaful is largely achievable. Meanwhile, any price war arising from 'detariffication' is not expected to last while the industry adjusts to a new pricing structure.
Moving forward, the industry's consolidation and the entry of global players will not only result in larger and stronger insurers, but also greater sophistication for the domestic industry -- through product innovation, pricing and risk-management expertise as well as multi-channel -- including digital -- distribution. In turn, consumers will benefit from better access to more product choices that suit their individual needs.
© Islamic Business and Finance 2014
