Mitigating climate change with Takaful insurance
David Crawford, Dr Mohammed Kroessin and Karsten Loeffler explain how Sharia-compliant products are boosting insurance penetration in Bangladesh. By courtesy of the Micro Insurance Network.
Karsten Loeffler is Co-head of the Frankfurt School — UNEP Collaborating Centre for Climate & Sustainable Energy Finance.
David Crawford is Head of Islamic Relief’s Humanitarian Department.
Dr Mohammed Kroessin is Head of Islamic Microfinance at Islamic Relief Worldwide.
The number of people affected by humanitarian crises has almost doubled from 40 million to more than 75 million over the past decade, with associated aid costs tripling from US$4 billion to more than $13 billion. Sustainable Development Goal (SDG) 13 recognises climate change as one of the main drivers of disasters, and that national risk reduction strategies are critical. Insurance could play a crucial role in this, but penetration in many of the worst hit countries remains low, especially in many Muslim majority countries where significant microinsurance penetration is further hampered by an absence of Islamic products.
A pilot project in Bangladesh demonstrates that low-cost Islamic risk financing works in principle, presenting opportunities to scale up insurance against extreme weather events. Islamic insurance, or Takaful – which translates as ‘solidarity’, or ‘mutual guarantee’ – can make a positive impact on people’s lives, livelihoods and assets.
At the heart of the value proposition of Islamic insurance lies a concern about the ethical propriety of conventional insurance business models. Muslim scholars argue that insurers seek to make commercial profit by gambling that claims approved will be less than premium income, albeit using sophisticated statistical methods. Takaful is an alternative, Shariacompliant co-operative system of payment in case of loss.
Conventional insurance contracts are too uncertain, as the payment of the premium provides an undefined benefit (or in the absence of a risk event no benefit at all), making such a contract invalid under Islamic jurisprudence and financial ethics. Moreover, conventional insurers invest premiums in interest-bearing instruments, which Islam also prohibits. Muslims believe proprietary insurance is essentially unethical because ownership of the premium pool should remain with those who contribute to it rather than with the insurance company.
This requires a business model close to that of a mutual or co-operative insurance. Individual or corporate Takaful members do not pay premiums. Instead they make regular ‘donations’ and receive a pre-defined pay-out in the event of loss, plus a return on the investments made in the insurance fund. This fund is managed on their behalf by a Takaful operator, which invests the contributions in a Sharia-compliant manner and receives a management fee for its services.
Lessons learned from piloting micro-Takaful in Bangladesh
‘Mithapukur Sonirvor Mohila Somobay Somity’ brings together representatives of all the SelfHelp Groups (SHGs) set up by Islamic Relief Bangladesh in the Mithapukur Upazilla District in 2015. The organisation has overall coordination and management responsibility for 153 SHGs, which provide savings and interest-free loans to their 3,500 members.
A small contribution of 100 taka per year (approximately US$1.15) is collected from each SHG to manage the scheme. Individual members each pay 100 taka annually to trigger pre-defined benefits in the event of hazards such as death, disability, hospitalisation and business loss, including those caused by weather-related events.
Tables 1 and 2 show the Mithapukur Takaful pilot has been performing successfully by settling claims from community members whilst also generating investment income without eroding the pool fund, making an operating profit of 180,000 taka (US$2,106).
The scheme has gone some way to enhancing beneficiaries’ ability to withstand external shocks, without the burden of excessive premiums. In total, 90% of SHG members have taken up the scheme, demonstrating a clear demand for Sharia-compliant, low-cost community-based Takaful.
Community-based micro-Takaful could be a catalyst to help reduce vulnerability and build resilience among poor members by expanding risk coverage to include a wider range of extreme climatic events. Combined with awareness-raising campaigns and other measures to strengthen preparedness and resilience, Takaful provides an individual and community safety net and an environment for investment.
What we learned from product development
Takaful could close the current risk gap, but uptake will only increase if the benefits are more appropriate to the size of potential loss and damage. Takaful operating principles mean benefit pay-outs from the solidarity fund are fixed, rather than being based on a detailed assessment of the loss or damage incurred.
The pilot scheme threw up several challenges. Members were sceptical about receiving a reasonable benefit despite their low contribution; Re-Takaful possibilities should be investigated to avoid a fund shortfall; pay-outs were only made to 1.5% of the membership; and small increases can easily wipe out the pool fund. In addition, ensuring Shariah compliance with appropriate scholars is important for the credibility and acceptability of the scheme. As well as considering conventional insurance products as being un-Islamic, they were also sceptical about the Takaful branded product itself and sought additional assurance of its compliance with Islamic law.
Product development drivers of climate risk insurance
The pilot shows that Takaful only works if the benefits are well understood by the community, yet the high uptake of members in self-managed SHGs also demonstrates real demand. The question remains of how to scale up the current offering – for example, by offering cover against additional hazards to agriculture and livestock from extreme weather events, or including parametric insurance features to make it fit for climate change. This might be extremely challenging for a communityadministered scheme, but with Bangladesh signing up to the SDGs, government agencies could provide support. Under SDG13, adaptation must go hand in hand with efforts to integrate disaster risk financing measures into national strategies.
Evaluation of the pilot threw up a number of key challenges to developing an effective climate risk insurance product. Given that the scheme was initiated by a non-governmental organisation (NGO) but implemented by the SHGs themselves, further product development will add complexity to the management of a community Takaful scheme. Sophisticated technical expertise will be required for the pricing mechanism – for example, by using insurance consultants or drawing on the modelling expertise of Re-Takafuls.
The lack of current and historical weather data represents a significant barrier, particularly when combined with the high-risk margins of climatevulnerable countries. Accessing and analysing such data proved a major challenge during the pilot, and external assistance from either industry or government agencies dealing with climate change adaptation will surely be necessary. Satellite data might help with modelling, but only if available in sufficient detail over time.
Affordability is another challenge, given the high risks of extreme weather events. It is unlikely the current low-cost set-up will be sustainable, with implications for affordability and uptake. Further expansion would require support from government and/or donors. 
A further problem with offering microinsurance against weather-related disasters is that disasters usually affect whole communities or regions (covariate risk), triggering a large number of claims at the same time.  In order to work, schemes must generate large-scale diversified sales – something that has rarely been achieved so far. 
The pilot has laid a foundation by incorporating climate risk into community-based Takaful microinsurance. However, it is unlikely the scheme can be scaled up without a large part of the risks being pooled among Re-Takaful institutions. If Muslim-majority countries incorporate Takaful-based climate risk insurance into their national strategies to meet SDG13, it could be a real game changer. Given the ambition of G7 countries to reach 400 million uninsured people by 2020, a multi-stakeholder effort to invest, build capacity and promote communitybased Takaful in addition to sovereign schemes could be critical. Since community buy-in is essential, Takaful should become the intervention of choice in Muslim-majority nations.
 Development Initiatives, Global Humanitarian Assistance Re – port 2017, (Development Initiatives, 2017). Available at http:// devinit.org/wp-content/uploads/2017/06/GHA-Report2017-Full-report.pdf (accessed on 6 September 2018).
 Ali, N. & Nisar, S. Takaful and Islamic Cooperative Finance: Challenges and Opportunities, (Edward Elgar Publishing, 2016).
 Chartered Institute of Securities & Investment, Islamic Finance Qualification: Islamic Insurance – Takaful (2016).
[4.] See Investopedia website for more information: https:// www.investopedia.com/terms/t/takaful.asp (accessed on 6 September 2018).
 Mechler et al, ‘Assessing Financial Vulnerability and Coping Capacity: The IIASA CATSIM Model’. In J. Birkmann (ed.). Measuring Vulnerability and Coping Capacity to Hazards of Natural Origin. Concepts and Methods, (Tokyo: United Nations University Press, 2006).
 Intergovernmental Panel on Climate Change, Managing the Risks of Extreme Events and Disasters to Advance Climate Change Adaptation, (IPCC, 2012), p.323
 International Labour Organization (ILO), Protecting the poor: A microinsurance compendium, (ILO, 2012).