Takaful - Distribution Costs, Technology and the Need for Innovation

Concise Overview

Selling insurance already involves substantial distribution costs because insurers must reach customers, explain products, market them, and complete the sales process. Takaful faces an additional challenge because operators must often educate customers about what Takaful is and how it differs from conventional insurance before they can sell the product. Technology may help reduce these costs, but simply copying conventional insurance products and practices is unlikely to create a strong or sustainable Takaful industry.

The purchase of insurance generally requires considerable effort by the insurer. Customers normally do not automatically seek out and understand protection products, so insurers must spend money on agents, brokers, branches, advertising, sales staff, customer education, and administrative processes. These activities create significant distribution costs.

Traditional insurers have historically relied on brick-and-mortar distribution, meaning physical branches, offices, agents, and face-to-face sales channels. Although these methods can build trust and provide personal advice, they are expensive because insurers must pay for premises, staff, commissions, training, and other operating expenses.

Technology-based firms have attempted to disrupt this traditional model by using digital channels to reach customers more cheaply. Customers may be able to compare products, obtain quotations, purchase policies, make payments, and submit claims through websites or mobile applications without relying heavily on physical branches or agents.

One example has been the development of peer-to-peer insurance, where technology is used to create groups of customers who share certain risks. Some of these businesses achieved rapid customer growth in their early stages. However, rapid growth does not necessarily mean that the business is profitable.

A company may attract thousands or even millions of customers but still lose money if its marketing expenses, technology costs, claims, administration, and customer-acquisition costs are greater than its income. Therefore, some early technology-based insurance pioneers have still not demonstrated that their business models can provide sustainable long-term profits for investors.

Simple Idea

Fast growth ≠ Profitability

A company can have many customers and still be financially unsustainable.

The challenge is even greater for Takaful operators. A conventional insurer generally needs to convince the customer that a particular insurance product is suitable. A Takaful operator may first need to explain what Takaful itself means before discussing the specific product.

Many customers may not understand concepts such as:

• Tabarru’
• Mutual risk sharing
• Participants’ Risk Fund
• Shari’ah-compliant investment
• Relationship between participants and the Takaful operator
• Difference between Takaful and conventional insurance

Therefore, customer education becomes an additional stage in the sales process.

Example

A conventional insurer may tell Ahmad:

“This motor insurance costs RM1,200 per year and provides these benefits.”

The insurer mainly needs to explain the coverage, exclusions, and price.

A Takaful operator may need to explain:

“This is a Shari’ah-compliant mutual protection arrangement. Part of your contribution goes into a common risk fund through tabarru’, and participants collectively help one another when covered losses occur.”

Only after Ahmad understands this concept may the operator then explain the actual motor Takaful product.

This additional education requires more time, trained staff, marketing material, customer communication, and possibly more interaction before the sale is completed. As a result, Takaful distribution costs may be higher than conventional insurance distribution costs.

Simple Process

Conventional Insurance

Customer needs protection

→ Product explained

→ Customer buys insurance

Takaful

Customer needs protection

→ Takaful concept explained

→ Difference from insurance explained

→ Product explained

→ Customer buys Takaful

Therefore:

More education stages → More distribution effort → Potentially higher cost

To become successful, Takaful operators should learn from the experience of both traditional insurers and technology-based insurers. Traditional insurers provide lessons in underwriting, claims management, customer service, risk management, and distribution. Fintech-based insurers provide lessons in digital sales, automation, data analytics, mobile applications, and lower-cost customer access.

However, Takaful should not simply adopt a “cut-and-paste” approach by copying conventional insurance products and changing only the terminology. For example, merely replacing the word “premium” with “contribution” or “policyholder” with “participant” does not create a genuinely distinctive Takaful model.

A successful Takaful product should reflect its own principles of:

• Mutual assistance
• Risk sharing
• Tabarru’
• Shari’ah-compliant investment
• Transparency
• Fair treatment of participants
• Appropriate management of the Participants’ Risk Fund

Therefore, innovation should be based on the real objectives and structure of Takaful rather than merely reproducing conventional insurance practices.

Example of a Cut-and-Paste Problem

Suppose a conventional insurance product is copied exactly into a Takaful product.

The operator changes:

Premium → Contribution

Policyholder → Participant

But everything else remains unchanged.

If the product does not properly reflect mutual risk sharing, fund separation, tabarru’, or Shari’ah governance, then the product may be Islamic mainly in terminology rather than in substance.

For this reason, increasing attention has been given to the use of technology to disrupt traditional Takaful and insurance models. Digital platforms can potentially reduce reliance on expensive branches and agents while making products easier to understand and purchase.

Technology may allow customers to:

• Learn about Takaful through digital education
• Obtain quotations online
• Purchase protection using mobile applications
• Make digital contribution payments
• Submit claims electronically
• Upload supporting documents
• Receive claim updates instantly
• Communicate with the operator through digital channels

Technology can therefore be particularly valuable to Takaful because it may reduce both the cost of customer education and the cost of distribution.

Example

Instead of an agent spending 30 minutes explaining Takaful individually to every customer, the operator could develop:

• Short educational videos
• Interactive explanations
• Frequently asked questions
• Automated chat support
• Simple comparison tools

Thousands of customers could receive the same explanation at a much lower average cost.

However, technology should not be viewed as an automatic solution. A digital Takaful business must still achieve sufficient customer volume, control claims costs, manage cyber and operational risks, provide good customer service, and generate enough income to remain financially sustainable.

The key lesson is therefore that technology should improve the Takaful model, not simply digitise an inefficient traditional model. If an operator has a poorly designed product and simply puts it into a mobile application, the fundamental weaknesses of the product remain.

Easy Way to Remember

Traditional insurance challenge:

High distribution cost

Additional Takaful challenge:

High distribution cost + Customer education cost

Possible solution:

Technology + Better product design + Digital education

But:

Technology alone ≠ Guaranteed profitability

Simple Formula

Takaful Success = Shari’ah-Compliant Product Design + Customer Education + Efficient Distribution + Technology + Good Service + Financial Sustainability

Not:

Conventional Insurance Product + Islamic Terminology = Successful Takaful