Saturday, February 26, 2011

What microtakaful needs to grow

Reuters reports that Tokio Marine Middle East is considering offering microtakaful in Egypt where it already owns 2 of the 8 takaful companies. The article specifically suggests that microtakaful could be offered for life, disability and accident insurance as well as livestock and crop insurance. Takaful is a Shari'ah-compliant form of insurance similar to mutual insurance where the takaful policy holders' premiums are invested separately than the firm's capital to cover the expected claims.

There is definitely a role for microtakaful to play alongside of Islamic microfinance because it will limit the chances that death, injury or a natural disaster (unpredictable events) could cause the MFI client to be unable to continue either their microbusiness or the payments on items or services financed by an Islamic microfinance instutiton. Even on the conventional microfinance side, there are many fewer institutions that offer microinsurance compared to the number offering microfinance (or more specifically microloans).

The CEO of takaful for Tokio Marine Middle East offered his case for microtakaful in an article from July 2010 in the Middle East Insurance Review (page 60-61, available as a pdf).

One issue that could become problematic for microtakaful firms is that in the absence of retakaful, the institutions could find it difficult to manage the claims when they are most likely to be made (and most likely to be needed by takaful members). Some of the risks that are insured against by microtakaful companies, specifically death, natural disaster and agriculture losses (including livestock) are likely to occur for many takaful members at the same time if the microtakaful firm is small and geographically undiversified.

For example, assume that 1,000 people in one region of a country form a takaful company that pays out $2,000 if a member dies, $500 in case of crop loss and $100 for each animal that dies. In exchange, each member pays $2 per month (these numbers are not based on any specific case). The takaful company estimates that it will have claims of 5 individuals who die, 10 cases of crop failure and 50 animal deaths. This would lead to the company collecting $24,000 per year in premiums and paying out $20,000. The surplus gets carried over to future years. In normal years, this works fine and the fund builds up assets.

However, imagine that a drought hits the region and causes widespread crop failures and animal deaths with also more people dying than in a normal year. Assume, for example, that there are 100 crop failures, 25 deaths and 250 animal deaths. This would cause the claims to be $125,000, compared with only $24,000 in premiums. Based on the normal years before (with $4,000 in surplus every year), it would take over 25 years of "normal" years to cover the extra loses from the one bad year. If that bad year happened in year 4, the takaful company would be unable to fully pay claims and without the benefit of retakaful (or a larger parent company with operations across many regions and countries), it could fail to support its members when they need it the most. A few failures of microtakaful (or conventional microinsurance) companies could hurt the aacceptance of microinsurance because of their vulnerability to catastrophic events.

Unlike Islamic microfinance, which will be affected by catastrophic events because of widespread business failures, the failure of a microtakaful company because of a widespread event which causes the failure is directly connected to what the company is offering protection against (rather than being a casualty of an unrelated external event.

The point of this long tangent from the initial story about the prospects for microtakaful in Egypt is that there is much more infrastructure needed to set up microtakaful in one country or region within a country than just opening the microtakaful company. If the macrotakaful industry wanted to assist microtakaful institutions, perhaps the best way would be to provide retakaful to microtakaful providers. Even if they cannot fully diversify the retakaful coverage they offer, it could be a diversification tool for their overall risk profile because the likelihood of a catastrophic event happening in one part of the world is unlikely to affect claims by their customers in another part of the world.

1 comment:

Maylene Vidler said...
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