A spiritual path into an emerging market

Insurers are converging on the Middle East because of the rising value of crude oil and natural gas buried under the desert sands that is fueling an emerging insurance market.

At $65-plus per barrel, profits from oil revenues have raised per capita income for the 100 million people living there and funded many infrastructure improvements, experts say. The export-related wealth also is increasing demand for goods and services, including insurance.

It remains to be seen, though, which insurance providers will benefit most. A broad range of factors, including religious and regulatory ones, will impact the market and determine which companies will succeed.

A key consideration is the potential $4 billion market in the Middle East for takaful, a type of mutual insurance that adheres to Islamic principles, and for retakaful, its reinsurance equivalent, observers say.

"The Gulf states are transforming and diversifying their economies facilitated by unprecedented income from energy exports," according to a 2006 analysis by Lloyd's of London.

According to the U.S. Department of Energy, the entire Middle East has about two-thirds of the world's known oil reserves and about 40% of known natural gas supplies.

While insurers' geographic description of the Middle East varies, most focus on the nations belonging to the Gulf Cooperation Council, which includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. Many also include Iran.

"Over time, if the world average insurance premium of $550 per capita is achieved and applied to the Gulf states, the GCC insurance market has a potential size of $20 billion" vs. its current $4.6 billion, said Jelena Bjelanovic, a London-based credit analyst with Standard & Poor's Corp.

High oil prices have fueled infrastructure developments such as highways and hospitals. The nonlife insurance market is "strong" with premiums growing about 10% to 15% on average since 2004, she said in an April research report.

Even so, personal lines insurance coverage, particularly in life insurance, "remains low," she said.

A major driver in the future of personal lines will be an "exponential" increase in demand for health services, said Hugues de Roquette-Buisson, managing director for the Middle East and Africa for Allianz A.G.'s French subsidiary, Assurances Générales de France.

For example, lower mortality rates among infants and the elderly are increasing the size of the population and its average age. Citizens also have some unique health risk factors because of "usually high" rates of Type 2 diabetes and obesity, according to a McKinsey & Co. report.

Overall, regional health care spending is expected to rise to $60 billion in 2025, or about five times the current level, they predicted.<,p>

Also, the governments are expected to begin using public funds to reimburse nationals for the private health care they receive locally. Under a typical system, governments now provide free public care, and some reimbursement for care received abroad, but patients must pay for private treatment themselves, McKinsey researchers said.

Evolving industry

Takaful "has now evolved into a rapidly growing industry," according to preliminary analysis of the topic by the International Assn. of Insurance Supervisors and the Islamic Financial Services Board, two groups of regulators.

The first takaful company was established in 1979, and there are more than 250 globally, said Timour Boudkeev, a vp with Moody's Investors Service in London. Total takaful premiums exceed $2 billion in 2005 and are expected to reach $7.4 billion by 2015, he said in a report last August.

"The GCC takaful market is currently growing at about 40% per year," which is impressive compared with the average 2005 premium growth of 2.5% in world markets, Ms. Bjelanovic said in the research report.

"Islam is not against the concept of insurance itself but against some of the means and methods that are currently used in conventional insurance," the regulators said in their report.

To be acceptable to Islamic law, called the Shariah, any form of insurance should avoid the element of "riba" (interest), "maisir" (gambling) and "gharar" (uncertainty), although elements of uncertainty may be forgivable depending on the circumstances, they said.

Conventional insurance conflicts with Islamic law because it is thought to have a large element of "gharar" because the payoff from an insurance policy is dependent on occurrence of uncertain events in the future, and the amount of compensation has no predictable relationship with insurance premium, Mr. Boudkeev said.

In addition, many conventional insurers' investment strategies are not acceptable because some earned interest is forbidden; so many bonds and other sources of funding are not acceptable.

Also, equity investments can only be made in Shariah-compliant companies that exclude alcohol sales, pork-related products and conventional financial services, observers said.

"The origin of takaful--which means 'solidarity'--can be traced to several practices from ancient Arab tribal custom and the companions of the Prophet Muhammad," the regulators said. "For example, under the custom of 'al-aqilah,' it is mutually agreed among the tribes that if a person is killed unintentionally by a person of a different tribe," the accused's paternal relatives will take the responsibility to make a mutual contribution for the purpose of paying the blood money to the victim's relatives, they said.

Takaful offers general or nonlife protection as well as family coverage, which includes medical, health, education, accident and long-term care. There are some products, such as whole life and defined benefit pensions, that takaful does not offer because they are not Shariah-compliant, the regulators said.

Under current takaful requirements, each company has a Shariah board to determine compliance with Islamic law in addition to a typical board of directors.

In many arrangements, a takaful company manages two separate funds, one for policyholders and one for shareholders. Participants pay a fixed fee and may pay a performance-based fee, or both.

Policyholders own any surplus and are liable for any deficit. If a deficiency occurs, the takaful operator is expected to provide an interest-free loan to the fund to cover it. The fund assets are invested in Shariah-compliant instruments.

"The differences between takaful and conventional insurance clearly have regulatory implications," and "regulatory regimes developed for conventional insurance cannot necessarily be applied uncritically," the regulators said. They urged taking an integrated view of the takaful industry that includes analysis of corporate governance; financial and prudential regulation; transparency, reporting and market conduct; and the supervisory review process.

Potential for conflict

Among concerns the regulators cited were potential conflicts of interest if members of a takaful company's Shariah board are significant shareholders or participants in managing the takaful operator or its competitors.

"The main challenge for takaful still remains: to increase awareness of the benefits--social as well as individual--of insurance among retail customers," Ms. Bjelanovic said. Among key elements that will determine whether it will be a success are product innovation and quality of service. "The challenge for takaful operations in developing family takaful will be to structure the products in such a way as to meet any religious and cultural obligations and still offer comprehensive cover," she said.

In addition, the average combined ratios of takaful companies in 2004 and 2005 have been higher than conventional peers in the region, she said. Takaful operators "are currently suffering from a lack of economies of scale and an inability to more effectively diversify their risks," she said. Over time, though, Ms. Bjelanovic expects growth and competition will help remedy those problems.