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New law to spur Indonesia's Islamic insurance market

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(Reuters) — Indonesia's Islamic insurance market will be reshaped over the next decade by a new law that requires conventional firms to spin off their sharia-compliant units, while encouraging more foreign investors to enter the market.

The takaful market in Indonesia, southeast Asia's largest economy, is dominated by so-called “windows” which enable firms to offer sharia-compliant and conventional products side by side.

At present, Indonesia is one of the few markets where that practice is still allowed. The new law, which came in force last month, requires insurers to spin off their windows within 10 years.

There were five full-fledged takaful firms and 37 sharia units of conventional firms as of December 2012, the latest month for which data is available. Their combined assets were worth 13.1 trillion rupiah ($1.1 billion) at that time, data from the regulator showed, representing 2.3% of total insurance industry assets.

Firms offering takaful products include Europe's top insurer Allianz, Britain's biggest insurer Prudential, Toronto-based Manulife Financial Corp. and French insurer AXA.

With relatively low insurance penetration rates, the potential for the sector remains large and it could still attract more foreign players, said Kiswati Soeryoko, chief of sharia and corporate communication at Allianz Indonesia.

“We are confident that with the existing operational infrastructure, we will be ready when it is time to spin off.”

The law maintains an 80% limit to foreign ownership which will keep the market open to new players, while closing some loopholes that allowed foreign firms to have full control of their operations.

Takaful is based on the concept of mutuality; a takaful company oversees a pool of funds contributed by all policy holders, but does not necessarily bear risk itself.

Most firms are likely to meet the spin-off requirement as late as possible and they will first expand their sharia units to ensure they are big enough to be spun off easily, said Jakarta-based Susandarini, partner at law firm Susandarini & Partners.

“Larger firms are more likely to initiate spin-offs, assuming their sharia units have greater potential to be self-sustaining.”

The rules are expected to spur consolidation among conventional firms, although Indonesia's financial services authority, Otoritas Jasa Keuangan, is unlikely to seek mergers among takaful units because many lack full-fledged operations, Ms. Susandarini added.

“Since mergers tend to lead to efficiencies and worker layoffs, the OJK may prefer to support a divestment rather than a merger.”

The rules will also require larger and better trained sales forces. Currently, a single agent can be used to market both takaful and conventional insurance products, but spin-offs will require separate agents for each type of product, Ms. Susandarini added.

Regulators want to encourage firms to increase their use of local reinsurance and retakaful lines, unless they are unavailable in the country.

To address this, the government plans to help set up new reinsurance firms, merge various state-owned reinsurance activities and provide incentives to pool certain risks, law firm Herbert Smith Freehils said in a research note.

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