Takaful - Higher Operating and Distribution Costs

Concise Overview

Insurance has traditionally been a product that is sold rather than actively bought by customers. This means insurers must spend heavily on agents, branches, marketing, bancassurance arrangements, and other distribution channels to reach customers. Takaful faces an even greater challenge because operators must often educate customers about Takaful and its Shari’ah principles before selling the actual product, which can increase operating and distribution costs.

Insurance Is Usually “Sold Rather Than Bought”

Many consumers do not actively search for insurance unless they have a specific need or legal obligation. Therefore, insurers often have to approach customers, explain why protection is necessary, and persuade them to purchase a policy.

This makes success strongly dependent on having access to customers and carrying out prudent underwriting, meaning that the insurer must carefully assess and price risks so that the premiums collected are sufficient to cover expected claims and expenses.

Importance of a Large Distribution Network

Profitable insurers often have a large distribution network, such as:

• Agents
• Brokers
• Branches
• Online platforms
• Bank partnerships

A large network allows the insurer to reach more potential customers and generate a greater volume of business.

For example, an insurer with thousands of agents and hundreds of branches can reach far more customers than an insurer operating through only a few offices.

Bancassurance Gives Access to Bank Customers

Another important distribution method is bancassurance, where an insurance company sells its products through a bank.

The insurer benefits because the bank already has a large number of customers. Instead of finding every customer independently, the insurer can market protection products directly to people who already use the bank’s services.

For example:

Bank provides home loan → Customer also offered house insurance

This gives the insurer access to a ready-made or captive customer base.

Captive Customer Base Can Improve Pricing

A captive customer base means the insurer already has relatively direct access to customers through its distribution network.

Because customer acquisition may be easier and cheaper, the insurer may be able to offer more competitive pricing while still maintaining profitability.

Simple Idea

Large distribution network → More customers → Lower average acquisition cost → Better pricing ability

Insurers Without Distribution Networks Face Greater Competition

An insurer that does not have its own strong distribution network may have to compete heavily for customers.

It may need to:

• Reduce premiums
• Pay higher commissions to intermediaries
• Spend more on advertising
• Offer discounts
• Compete through price

This can reduce profit margins and make the business more difficult to sustain.

Simple Idea

Weak distribution access → Greater price competition → Lower profit margin → Sustainability problem

General Insurance Often Depends on Compulsory Products

For many general insurers, a significant amount of business comes from products that customers are required to purchase, such as compulsory motor insurance or certain legally required medical or liability protection.

These products generate a regular flow of customers because people may have no choice but to obtain the required coverage.

For example:

Own a vehicle → Motor insurance required → Automatic demand for the product

Problem of Commoditised Products

Products such as basic motor insurance can become commoditised products.

A commoditised product is one where customers see very little difference between the products offered by different insurers.

For example, if ten insurers offer almost the same basic motor protection, customers may simply compare:

Insurer A = RM900

Insurer B = RM850

Insurer C = RM820

The customer may choose the cheapest option.

When products are difficult to differentiate, insurers often compete mainly on price. Strong price competition can reduce premiums and profit margins, making it more difficult for insurers to earn sustainable profits.

Simple Formula

Similar products → Price competition → Lower margins → Greater profitability pressure

High Distribution Cost of Insurance

Insurance generally requires significant effort to sell. Insurers must spend money on:

• Customer acquisition
• Advertising
• Agent commissions
• Branches
• Staff
• Product explanation
• Administration
• Sales support

Therefore, distribution can represent a major part of the insurer’s operating expenses.

Can Technology Reduce Distribution Costs?

Technology-based companies have attempted to replace traditional distribution channels with:

• Mobile applications
• Websites
• Online quotations
• Automated underwriting
• Digital payments
• Online claims
• Artificial intelligence
• Peer-to-peer platforms

The objective is to reduce dependence on expensive physical branches, agents, and manual processes.

Peer-to-Peer Insurance and Profitability

Some peer-to-peer insurance businesses initially achieved rapid growth because technology allowed them to attract customers quickly.

However, growth does not necessarily mean profitability.

A company may have many customers but still lose money because of:

• High marketing costs
• Claims
• Technology development costs
• Administration
• Fraud
• Customer acquisition expenses

Therefore, some digital insurance pioneers have yet to demonstrate that their models can remain profitable and sustainable over the long term.

Simple Idea

Rapid growth ≠ Sustainable profit

Additional Challenge for Takaful

Takaful faces an even greater distribution challenge than conventional insurance.

A conventional insurer mainly needs to explain:

• The product
• The premium
• The coverage
• The exclusions
• The claims procedure

A Takaful operator may first need to explain:

• What Takaful is
• How Takaful differs from conventional insurance
• Mutual risk sharing
• Tabarru’
• Participants’ Risk Fund
• Shari’ah compliance

Only after this education can the operator begin selling the actual Takaful product.

Example

Conventional Insurance

Agent tells Ahmad:

“This motor policy costs RM1,000 and covers these risks.”

The agent mainly explains the product.

Takaful

The Takaful agent may first explain:

“Takaful is based on mutual assistance. Participants contribute through tabarru’ into a common risk fund, and claims are paid from this fund.”

Then the agent explains:

• Contribution amount
• Coverage
• Exclusions
• Claims procedure

Therefore:

Takaful requires product selling + Takaful education

Why Takaful Distribution Costs Can Be Higher

This additional educational requirement can increase:

• Agent training costs
• Customer education expenses
• Marketing costs
• Sales time
• Communication costs
• Customer acquisition costs

Therefore, Takaful may face a higher distribution cost than conventional insurance, particularly in markets where customers are unfamiliar with the Takaful concept.

Learning From Traditional Insurers and Fintech

To become more successful, Takaful operators should learn from both traditional insurers and technology-based insurers.

Traditional brick-and-mortar insurers provide lessons in:

• Distribution
• Underwriting
• Claims management
• Customer service
• Risk management

Fintech and digital insurers provide lessons in:

• Online distribution
• Automation
• Data analytics
• Digital customer service
• Lower-cost access to consumers

Takaful Should Not Simply Copy Insurance

A simple “cut-and-paste” approach is unlikely to be successful.

Takaful should not merely copy a conventional insurance product and replace:

Premium → Contribution

Policyholder → Participant

Instead, products should reflect genuine Takaful principles such as:

• Mutual assistance
• Risk sharing
• Tabarru’
• Shari’ah-compliant investment
• Transparent fund management
• Proper separation of participants’ and shareholders’ funds

Technology as a Possible Solution

Increasing attention is therefore being given to using technology to transform both Takaful and conventional insurance.

Technology can potentially:

• Reduce distribution costs
• Reach more customers
• Provide cheaper customer education
• Simplify product purchase
• Automate underwriting
• Speed up claims
• Improve customer experience
• Extend protection to underserved populations

However, technology alone cannot guarantee success. The underlying product must still be well designed, financially sustainable, competitive, and suitable for customers.

Easy Way to Remember

Insurance problem:

High distribution cost because insurance usually has to be sold.

Takaful problem:

High distribution cost + additional customer education

Commoditised products:

Similar products → customers compare mainly on price → lower profit margins

Possible solution:

Technology + Efficient Distribution + Better Product Design + Customer Education

Simple Formula

Strong Distribution + Prudent Underwriting + Competitive Product = Better Insurance Sustainability

For Takaful:

Strong Distribution + Customer Education + Technology + Genuine Takaful Innovation = Better Takaful Sustainability