Takaful Investment Portfolios: A Study of the Composition of Takaful Funds in the GCC and Malaysia
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About this ebook
The Islamic finance industry has witnessed remarkable growth over the last decade, and one of the most successful segments—poised for even greater expansion—is the Islamic insurance (takaful) industry. In Takaful Investment Portfolios, distinguished takaful scholar Abdulrahman Khalil Tolefat explores the investment portfolios of takaful companies in both the GCC countries and Malaysia, the tip of Islamic finance industry. Investigating the trends and patterns of investment of takaful companies, the book looks at shareholders as well as general and family funds to determine where these companies are investing today, and where they are likely to invest in the future.
Presenting new and novel research on the investment patterns of takaful companies, Takaful Investment Portfolios covers the history of the industry and takaful models and how they work, and presents in-depth studies of both their real-world and desired portfolio investments.
- Presents unique new research into the investment portfolios of takaful companies in the GCC and Malaysia
- Examines the gap between desired and actual investment portfolios of takaful companies
- Explores expected areas for future investment
Groundbreaking in its depth, Takaful Investment Portfolios is an unprecedented study of the investments of takaful companies.
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Takaful Investment Portfolios - Abdulrahman Khalil Tolefat
Chapter 1
Introduction
RATIONALE FOR RESEARCHING INVESTMENT PORTFOLIO COMPOSITION OF TAKAFUL COMPANIES
Islamic finance has been one of the fastest-growing industries over the past decade, with an average annual double-digit growth rate. The total Shari’ah-compliant assets worldwide were estimated at US$700 billion in 2007 compared with US$150 billion in the mid-1990s (Grewal, 2008), and are expected to reach US$1.2 trillion in 2012 (The Banker, 2011). The Islamic banking sector dominated the Islamic finance industry, with assets representing 78.6 percent of total worldwide Shari’ah-compliant assets in the mid-2000s (Grewal, 2008). Moreover, the Gulf Cooperation Council (GCC) countries account for two-thirds of global Islamic assets (The Banker, 2009), where Islamic banking and finance is expected to become the major banking alternative by 2025. Some believe that the industry would be able to serve 40–50 percent of the total 2.5 billion Muslims worldwide in the next eight to ten years (Grewal, 2008). According to Moody’s Report (2008), the growth of the Islamic finance industry has been driven by the increase in oil prices, which signals that there will be no slowdown in the growth of this industry in the future. Furthermore, all other parts of the Islamic finance industry are also expected to register substantial growth, such as the Islamic bonds (sukuk) market, Islamic funds, and Islamic insurance (takaful), despite the impact of the global financial crisis.
The research presented in this book is concerned with the Islamic insurance industry, which has registered rapid growth over the years. During the period covered by this study, 2002–2005, there were 133 takaful operating companies in the world, of which 59 were located in the GCC market, which is the largest market for the takaful industry and represented 50% of the takaful global market as of the end of 2006 (Ernst & Young, 2008), demonstrating substantial growth in recent years. The global takaful industry has maintained a growth rate of 20% per annum; the contributions underwritten rose to more than US$4.3 billion by the end of 2010 compared with US$2 billion in 2006 (Ernst & Young, 2008), and are expected to increase to US$12 billion by the end of 2012 (Ernst & Young, 2012). The tipping point for the takaful industry remains the GCC region despite the fact that Malaysia has demonstrated important achievements in a proactive manner for the development of takaful industry. The growth of Shari’ah-compliant products sold by Islamic banks, reduction in government welfare benefits, and economic and demographic growth in the Muslim countries will be among the factors that will see the growth of this industry soar in the GCC region (Ernst & Young, 2008). The growth and development in Malaysia can be explained by the political will and business appetite for Shari’ah-compliant business. There have also been important developments in terms of Islamic finance as well as takaful in other countries that benefit from a plural financial system.
Although the takaful industry has been growing and gaining substantial interest, there are still several challenges facing this industry, such as asset management problems, limited re-takaful capacities, and lack of expertise. This research focuses on the asset management of takaful operating companies in the GCC and Malaysia by exploring their investment compositions and the gaps in the asset classes required by the companies in these regions. This research is conducted in absence of adequate literature and statistics pertaining to the industry, particularly in the area of asset management. Hence, this research is essential, and therefore the data gathered and presented in this study could be considered a first step toward exploring the investment behaviour of takaful operating companies.
The rationale for the interest in the Islamic insurance industry in general was motivated by many factors. First, the Islamic insurance industry has been registering substantial growth during the last five years and gaining a lot of interest from international players, including the leading international insurers and reinsurers such as American Insurance Group, Allianz SE, Hannover Re, Swiss Re, and the Lloyd’s market. Second, the Islamic insurance industry is a complementary part of the Islamic banking industry, whose assets are expected to grow significantly in the near future. Finally, the booming of economies in Islamic countries and particularly those within the GCC will cause this industry to flourish. The amount of infrastructure projects to be conducted in the region and mega-projects handled by Islamic banks will lead to the growth of general takaful business. However, reduction in government support, economic and demographic growth, and increase in cost of education could lead to the growth of family takaful business.
Despite the importance of the Islamic insurance industry, there has been very limited research and literature related to this industry. In particular, not much is known about the structure of takaful operating companies. For example, the current model being adopted by takaful operating companies has not yet been explored in detail and documented. Some researchers believe that the Islamic insurance industry has been neglected in the literature because of the specialised nature of insurance as a subject (Mervyn, 2005). Moreover, there is a lack of standardisation and statistics pertaining to this industry. All of the above mentioned problems would make understating of the operation of this industry very difficult for international players, regulators, and customers, whose fears might affect the growth of this industry.
The interest behind choosing asset management of Islamic insurance companies was due to several reasons. First, the Islamic insurance industry will not be able to grow and support the development of the Islamic banking industry without proper investment channels that are suitable to cover their insurance liabilities. Second, the asset management of takaful could be a first step toward attracting Islamic banks to give further attention to this industry. The highlighting of the gaps in asset classes that takaful operating companies require may attract some Islamic banks to play a role in developing the required asset classes, especially with the potential for growth of the assets of this industry.
Until now, there has been no study conducted on the investment behaviour addressing each of the funds individually. Likewise, detailed statistics about investment portfolio composition for each fund are not available. Therefore, this study was conducted with the aim to explore the asset classes comprising investment portfolio of the shareholders’ fund, general funds, and family funds of takaful operating companies. Moreover, this study compared the current and desired levels of the investment portfolio composition for each of the abovementioned funds.
The hybrid structure of takaful, which is in contrast to that of conventional insurance undertakings, requires special attention once an investment strategy is under investigation. In particular, the investment strategy for each of the funds under the takaful structure should be individually studied. These funds comprise the shareholders’ funds of the takaful operator on the one hand, and the funds of takaful participants (policyholders) on the other hand. Moreover, the latter include underwriting or risk funds and, in the case of life (or family) takaful, the participants’ investment funds. The underwriting or risk funds include mortality risk funds in family takaful and, in the case of general (non-life) takaful, the relevant underwriting funds (e.g., that for motor insurance), referred to below as general funds. The reason for the need for individual study lies in the different nature of the liabilities under each fund, which calls for a different investment strategy or composition.
The research presented in this book aims to explore the portfolio composition and hence investment behaviours of takaful operating companies beyond the observed trends and developments. Thus, in terms of subject matter, analysis, and findings, this new research line is expected to contribute to the literature.
AIMS AND OBJECTIVES
The research presented in this book aims to explore the investment behaviour of the takaful operating companies in the GCC and Malaysia by focusing on investment composition of shareholders’, general, and family funds individually. Also, the study aims to identify the gaps in the asset classes that the takaful operating companies in both of these regions require to cover their liabilities under each of the abovementioned funds. Given the research problems and questions, the following objectives and hypotheses have been identified:
1. To explore the asset classes comprising investment portfolio composition of shareholders’ funds, general funds, and family funds of takaful undertakings in the GCC and Malaysia.
2. To compare the actual and desired levels of the investment portfolio composition of shareholders’ funds, general funds, and family funds between GCC and Malaysia.
This second objective was formulated into three testable hypotheses:
1. There is no significant difference between the actual and desired levels of composition of shareholders’ fund investment portfolio in the GCC and Malaysia.
2. There is no significant difference between the actual and desired levels of composition of general fund investment portfolio in the GCC and Malaysia.
Due to the negligible business of family takaful in the GCC, the third hypothesis is confined to Malaysian takaful undertakings:
3. There is no significant difference between the actual and desired levels of composition of family fund investment portfolios in Malaysia.
As regards the research questions, the existing research in the field of Islamic insurance, particularly the investment side, has been facing several difficulties regarding the research methodology that will require further investigation. For example, a conclusion was made from a previous study that the takaful investment undertakings in the GCC countries are heavily invested in equities; however, this conclusion might be wrong as some of the takaful operating companies invested their shareholders’ funds in equities rather than participants’ funds (Fisher, 2005; Jaffer, 2008). Therefore, the study research problem breaks down into the following questions:
1. What was the investment portfolio composition of takaful undertakings during the years 2002 to 2005?
2. Did the investment portfolio composition of Shareholders’ funds, general funds, and family funds in takaful undertakings differ in the GCC and in Malaysia during the years 2002 to 2005?
3. Did the takaful undertakings desire to change the current composition of their investment portfolios as of the end of 2005?
SCOPE AND DELIMITATION
In terms of scope and delimitation, this study was confined to two geographical groups, namely the GCC countries and Malaysia, for several reasons. First, the majority of takaful undertakings in the world are concentrated in the GCC countries and Malaysia. It should be noted that although Saudi Arabia is the biggest insurance market in the GCC, the coverage of this country was excluded at the time the study was conducted for several reasons. One of these included (at the time the study was conducted) the absence of regulation of insurance as a consequence of which all operating companies in Saudi Arabia were either unregulated or registered as offshore companies in Bahrain or as divisions operating under existing licensed banks. Oman was also excluded due to the nonexistence of takaful operating companies in that country. Furthermore, although there were many takaful operating companies in Sudan, this market was excluded due to the difficulties faced in gathering the required information.
Second, the Islamic finance industry, which includes banking, insurance, and capital markets, has been established in these regions, which continuously represents the hub of this industry. At the time this study was conducted, the number of takaful operating companies in the market was small, so the author tried to cover the total population. Complete coverage was not achieved, but the author covered 90% of the GCC market and 95% of the Malaysian market.
It should also be noted that the research covered by this study focuses on the 2002–2005 period, and therefore the findings should be contextualised within this initial period of the emergent takaful industry. Since then, the takaful industry and also the Islamic finance industry have demonstrated unprecedented growth and development. The development of Islamic finance and product diversification have increased the investment opportunities for takaful operating companies as well in recent years.
RESEARCH METHODOLOGY
In order to achieve the designated objectives and hypotheses, a multistrategy research approach, known as triangulation, has been employed in this study. Under this approach, the data was gathered using a quantitative research strategy reinforced by a qualitative research strategy. As this is an exploratory study, the use of such a multi strategy research approach is very crucial for several reasons, which are discussed in detail in Chapter 4.
The data has been collected through an e-mailed prestructured questionnaire followed by a mix of structured and unstructured interviews. The purpose of the interviews was to verify the data collected and to inquire about any certain trend or data that needed to be justified. Given the detailed data required and in order to achieve the cooperation of the takaful operating companies, the regulatory authorities for the insurance sector in these countries—except Qatar—were approached to gain their approval and to ask the takaful operating companies under their supervision to cooperate to fill out the required questionnaire.
The data collected were analysed by utilising various statistical methods through Statistical Package for Social Science (SPSS) software. Moreover, two nonparametric statistical techniques were used, namely the Mann-Whitney U Test and the Wilcoxon Signed-Rank Test. Descriptive statistics were also applied in the analysis of the data.
OVERVIEW OF THE BOOK
The study comprises eight chapters. This first chapter is an introductory one that highlights the research problem, the motivation for, and the significance of the study, and the research objectives, hypotheses, and research design.
The literature review is presented in Chapters 2 and 3. The review of legal aspects of insurance contracts under Islamic law is covered in Chapter 2, and Chapter 3 covers the Islamic insurance practices, with special comparisons between Islamic and conventional insurance.
The empirical work commences in Chapter 4 by first presenting the research methodology applied in the study. The chapter covers all aspects of the chosen research methodology, including the research designs and methods, with special highlights of the limitations of the study and the sample chosen.
Chapters 5 and 6 present the empirical findings. The results for the first objective of the study are presented in Chapter 5, and the findings related to the second objective are presented in Chapter 6. The analysis and discussion of results for both objectives of the study are presented in Chapter 7 by linking the findings of both objectives.
Chapter 8 summarises the thesis and draws the study conclusion. Moreover, it offers recommendations for regulatory authorities, takaful operating companies, and Islamic banks based on the findings of the study.
Chapter 2
Insurance and Islamic Law: An Introduction to Takaful
The teachings of Islam have to be consulted and considered fully in all aspects of Muslim life regardless of time and era. This is due to the fact that Islam includes comprehensive and flexible doctrines that are applicable to all circumstances. All practices, both new and old, must be filtered through and investigated according to Shari’ah (Islamic law) principles in order to decide whether they are acceptable in Islamic terms; this includes economics, finance, and insurance contracts and transactions. As insurance is a new financial contract, it is crucial that it be examined to ascertain whether it is permissible under Islamic law. This chapter provides a summary of the opinions of jurists and researchers who have examined the insurance contract from the perspective of Islamic law.
The literature review is divided into three parts. The first part deals with the validity of insurance as a concept in order to ascertain whether it complies with Shari’ah principles. The second part goes on to outline contemporary jurists’ views regarding the insurance contract in its different forms (i.e., cooperative, mutual, and commercial). A distinction has been made between the jurists’ individual judgments and their collective verdict to determine whether their decisions differ. The third part looks comprehensively at the various arguments as expressed by jurists and researchers to either validate or invalidate the insurance contract. Finally, a summary and conclusion is given.
THE CONCEPT OF INSURANCE IN ISLAMIC SOURCES
According to the majority of jurists, commercial insurance is prohibited in Islam since it contravenes Shari’ah principles (Baltiji, 1987). In spite of this, Islam is not against the concept of insurance itself but against the means and methods that are used in commercial insurance (Al-Qaradawi, 2003; Hassan, 1979). In order to examine the validity of the insurance concept under Shari’ah law, it is necessary to find some relevant evidence from both primary and secondary sources. The Holy Qur’an, Sunnah, ijma (consensus), and quyais (individual reasoning based on analogy) remain the primary and fundamental sources for Islamic law. There are also secondary sources such as maslahah mursalah (public interest) and uruf (custom) (Ismail, n.d.). However, in all circumstances the secondary sources must conform to the primary sources.
The insurance concept is based on mutual cooperation and solidarity between the policyholders in order to protect each other against any unexpected risk or misfortune in the future. This concept is considered an extremely good example of cooperation for the right reasons, which Allah has encouraged the Muslims to practice: Help ye one another in righteousness, and piety, but help ye not one another in sin and rancour
(Qur’an, 4:2). In addition, the Sunnah has stimulated the concept of mutual cooperation in many Ahadeeth such as The believers, in their affection, mercy, and sympathy to each other, are like the body; if one of its organs suffers and complains, the entire body responds with insomnia and fever
(Sah’ih Muslim). Moreover, the insurance concept embodies the practice of distributing risk among a large number of people to minimise the overall risk for each individual, which in turn contributes to the reduction of poverty rates in society