Takaful and the Opportunity for Peer-To-Peer Insurance
There has been much talk about peer-to-peer (P2P) insurance, and a number of startups in this space are emerging globally and in Asia. But while P2P insurance is a new disruptor in the insurance market, it is not a new concept.
“Takaful”—an Islamic alternative to conventional insurance that’s been around since 622 CE – shares several similarities with P2P insurance, and for Malaysia, which is one of the world’s largest Takaful markets, there are opportunities aplenty if the country can ride the growth in the popularity of P2P insurance.
Some aspects of conventional insurance are prohibited by Islam, and Takaful shifts the focus away from individual contractual agreements to insurance’s benefit to society as a whole. Takaful is in line with Islamic principles of mutuality and cooperation, encompassing the elements of shared responsibility, joint indemnity, common interest and solidarity. The system is a collective enterprise that allows a community to pool together resources in order to assist its members in times of need.
In Takaful, the participants of the pool are joint investors with the operator. The participants contribute to a fund that is separated into a Takaful fund and a shareholders’ fund. Any losses experienced by the participants can be claimed from the Takaful fund, and any amount remaining is distributed back to the participants. The shareholders’ fund holds the seed money provided by the operator’s shareholders. It pays administrative expenses, and the remaining capital is invested in sharia-compliant investments.
The operator is remunerated through various contract forms, the two most common being “wakalah” and “mudharabah”:
- Under wakalah, the operator acts as an agent for the participants and manages the fund. In return, the operator receives a management fee from the participants. Any returns from the sharia-compliant investments go back to the participants only.
- A mudharabah contract is a profit-sharing agreement between two parties. Here, one party supplies the capital (shareholders) while the other manages the business (operator), and profit is shared among the parties according to an agreed-upon ratio. The key difference between mudharabah and wakalah is that a portion of the surplus from the Takaful fund and the sharia-compliant investments goes to the participants as well as into the shareholders’ fund.
It’s also very common to have a mix of these contract forms. Regardless of the contract form, any deficit faced by the Takaful fund requires the operator’s shareholders to provide an interest-free loan to the Takaful fund to meet its claims obligations.
‘Takaful’—an Islamic alternative to conventional insurance that’s been around since 622 CE—shares several similarities with Peer-to-Peer insurance.
P2P insurance uses the latest technological advances in social networking to pool friends, family members, or individuals with similar interests to contribute to each other’s losses. By pooling with known acquaintances, the model promotes transparency and disincentivizes fraud. Most P2P insurers take a fee off the premiums paid for their overheads and reinsurance.
Any losses experienced by the members of the pool can be claimed from the fund, and any remaining amount is distributed back to the members. Lemonade, a U.S. P2P insurance company that made headlines in 2015 when it received $13 million in a round of seed funding from Sequoia Capital, goes a step further and allows members to designate a charity that can receive payouts from their unclaimed insurance. Lemonade stands to gain as members are less likely to make fraudulent claims and there are tax benefits from these donations.
There are a variety of P2P insurance models that range from true mutuality to more traditional insurance, each employing group concepts to influence customer behavior. On one end of the spectrum, Teambrella’s pool determines its own rules and is self-responsible for approving or denying claims. On the other end of the spectrum, Bought By Many’s broker model builds groups with similar insurance needs and works with insurers to build more bespoke products for them with better pricing.
The degree of technology between P2P insurers varies; Teambrella does away with traditional premium payment, instead using digital wallets and bitcoin to reduce transaction costs. Lemonade uses algorithms to underwrite, chatbots instead of brokers, and AI and machine-learning to handle claims.
Both Takaful and P2P insurance provide for a degree of risk pooling by the participants/members. Their models are much more transparent on premiums/contributions and claims than conventional insurance. They look to transition from an individual-insurer relationship to a balanced one between individuals, and in doing so bring a greater element of trust back to insurance.
There are some differences though—the use of technology being the most obvious one. There’s also a difference in the size of the pools, and this can have an impact on customer trust. P2P insurance’s pools are based on a community “unit,” whereas in Takaful there are no limitations as to who can join the pool (even people of non-Islamic faith can be a Takaful customer). Both go a long way in improving trust with their customers, but the P2P insurance model does it better; trust is placed as much in the P2P insurer as it is in the unit that you are a part of.
The Opportunity in Malaysia
Malaysia is among the largest Takaful markets globally and comfortably the biggest in Asia, totaling just over MYR$60 billion ($15.2 billion). The country has been very encouraging of Takaful and was the first country to adopt legislation specifically geared toward Takaful operations, accommodating both conventional insurance and Takaful within the same regulatory and legal framework. Various tax incentives and less onerous capital requirements compared to conventional insurance were allowed, but this is no longer the case, and it is now a much more level playing field.
Malaysia has been progressive in taking up Takaful. The hope is that the country can be just as progressive in adopting the technology and positive social aspect of P2P insurance to make it more relevant to today’s customers.
This is the first in a series of BRINK Asia articles this week focused on Malaysia.