Takaful Insurance Area

Operational and Actuarial
Aspects of Takaful
 Emerging Issues in Takaful
Sub Topics
 Takaful v Insurance: Recap
 Risk assumption & transfer
 Accounting recognition
 Implicit guarantees
 Liberalized market
 Risk based capital (RBC) issues
 Taxation of takaful funds/ operators
 Retakaful
Differences between Takaful and Insurance
Based on mutual cooperation Based solely
and ‘Tabarru’
commercial Contract
Profit sharing between the Exchange of contract between Contract
individual participants and the policyholder and the insurance
pool of participants in the company
Participants own the Takaful Insurance is a buy-sale contract. Contract
funds and managed by the In which policies are sold and the
operator. Participants give up policy-holders are the buyers
contribution and benefits.
Contracts of Agency between The fund belongs
the participants and the Takaful insurance company
operator to manage the fund
the Contract
Differences between Takaful and Insurance
Participants make contributions
to the scheme
Policyholders pay the premiums
to the insurance company
Free from ‘riba’, ‘gharar’ and Presence of ‘riba’, ‘gharar’, and Principles of the
Profit may be shared among
participant on Mudharabah basis
or Performance Investment Fee
on Wakalah.
Underwriting profits belongs to Contract
the Company.
participating policyholders will
received share of surpluses.
Depending on the Biz Model and
line of biz, contributions may be
split in the PIA or wholly credited
to the PSA.
For general Takaful, usually
credited to the Tabarru’ Fund
In Family usually credited into
the PIA then ‘dripped’ into the
In general insurances premium Contractual
credited into the general relationship
insurance account.
In life insurance policy similarly,
the collected premiums are
credited into the life insurance
account or fund
Shariah Perspective on Risk Transfer
 The transfer of risk from one person to another is
allowed in Islam. Can be inferred from acceptable
contracts such as kafalah, dhaman and hiwalah.
 However, the scholars are not in agreement
whether assuming a risk by charging a fee is
permissible. Many scholars are of the opinion that
in order to avoid doubts, there should not be any
fee involved.
Shariah Perspective on Risk Transfer
 In the case of conventional insurance however, most scholars are of the opinion that it is
haram (prohibited); the reasons usually quoted are gharar, maisir and riba.
 To render insurance permissible, Sheikh Yusuf Al-Qaradawi put forth the following
conditions ( which insurance companies do not satisfy) :
1. “Every member who pays his allotted share of money pays it as tabarru’ in the spirit of
brotherhood. From this pool, help is given to those who are in need.
2. If any part of this money is to be invested, it should be invested in halal business only.
3. It is not permitted to the member to donate his share on the condition that he will receive
a pre-determined amount in the event of an unforeseen calamity. Rather, he will be paid
an amount which will compensate his loss or part of it, depending on the resources of the
group, from the pooled moneys.
4. What has been tabarru’ is a gift (hibah) from the donor and the taking of it back is
Shariah Perspective on Risk Transfer
 The underlying philosophy for the prohibition of
insurance is that the insurer assumes the risk for a
fee; and the insurance contract can be analogous to
a contract of exchange, which itself is deduced
from a sale contract. The transfer of risk from the
insured to the insurer and the assumption of the
risk by the insurer for a fee is akin to the contract
of exchange. Under a contract of exchange, one of
the conditions of the subject matter is that there
should not be any gharar.
Shariah Perspective on Risk Transfer
 The prohibition of charging a fee for an
assumption of risk can also be seen from the civil
laws of some Muslim countries that derive from
Islamic jurisprudence. For example, item number
1098 of the civil transaction laws of the United
Arab Emirates states that, “It is not permitted for
the guarantor to charge a fee for his guarantee.”
Scholars from this school of thought only allow
charging of fees to cover costs and expenses for the
assumption of risk, but not to profit from it.
Shariah Perspective on Risk Transfer
 Hence, rather than the takaful operator the
participants themselves should share the risk and
the opertaor is just the manager of the takaful
 The contract between the takaful operator and the
participants can be one of the acceptable contracts
such as musharakah, mudharabah or wakalah
whilst the principle underlying the relationship
among themselves may be one of tabarru’at or
Shariah Perspective on Risk Transfer –
Tabarru’ is Hibah?
 If tabarru’ is hibah, why is it that the takaful operator
determines the amount of hibah? Should not the
participants who decide how much to give?
 If the amount of tabarru’ is decided by participants, the
takaful system breaks down as there is a large probability
that the takaful fund may not be enough, at least for some
 If it is (straightforward) hibah, how does one reconcile the
condition for compensation? It then becomes conditional
hibah as mentioned above and this would render it non
permissible according to some scholars.
Shariah Perspective on Risk Transfer Tanahud
 Principle of tanahud is based on the hadith narrated by
Imam Bukhari and Muslim with respect of the ‘Ash’ariyun.
 But an analogy cannot be made between the hadith and the
fees and/or profits charged under the wakalah or
mudharabah contracts.
 In the hadith, the contributions differ but the wealth is
distributed evenly whereas in takaful practice the
contributions match the compensation.
 The practice of sharing of surplus is also strictly not in line
with the hadith
Shariah Perspective on Risk Transfer –
Surplus Sharing
 AAOIFI recommends that the takaful operator should not participate in the
surplus. It is valid ruling as surplus sharing would effectively mean that risk, at
least in part, has been assumed by the operator which they do not. Takaful
operators should not be like conventional insurer where sharing of the
underwriting surplus is key.
 But takaful operators may lack sufficient financial incentive to operate the
business, especially for non-tariff general takaful business. Does AAOIFI
ruling, puts the takaful operator in a position of disadvantage and inhibit the
growth of takaful?
 The same impact may not be felt as much in life (family) takaful business since
other factors are involved and that in many cases and jurisdictions,
conventional insurers are also required to give back a large proportion of
surplus to policyholders. In this respect most jurisdictions only allow
conventional life insurers to take up between 10% to 20% of the life fund
surplus only.
Shariah Perspective on Risk Transfer –
Surplus Sharing
 The issue of assumption of risk by the takaful
operators still exists as statutory provisions in almost
all jurisdictions demands that takaful operators
assume the risk in the event of inadequate
contributions to operate the takaful fund (providing a
qardhal hasan facility) !
Shariah Perspective on Risk Transfer –
Capital Adequacy
 Any regime must recognized differences between a
Takaful operator and an insurer
 Need to take account of the conceptual separation
between policyholders’ and shareholders’ funds
 The asset profile of a Takaful operator (General or
Family), is likely to be very different from an
insurer. Hence, risk weights for Islamic
instruments should be different under a RBC
 Different contractual models gives rise to different
treatment to capital adequacy
Accounting Issues
 Currently, the accounting treatment for premiums
(contributions) and other income is based on the accrual
concept as required by most insurance/takaful regulators
in the different countries.
 For a takaful operator it was argued that there is an issue of
gharar if the accrual method is used. Also, one cannot
distribute the surplus from the unpaid contributions since
we are not sure whether these contributions will be
 On the other hand, most operators have used the accrual
Accounting Issues
 The accrual basis of accounting extends to other
income such as investment income and rental
income. In this respect investments of a Takaful
operator are to be shown in the balance sheet at
their “current value” implying "market value”.
 Market value at an earlier date is permitted in the
case of land and buildings, provided that they are
properly valued at least once every five years and
account is taken of any diminution in value since
the last valuation.
Accounting Issues
 For debt securities the market value is, by implication, to
be a “clean” value, excluding the value of any accrued
interest, since such interest must be shown separately on
the face of the balance sheet.
 An alternative treatment is permitted for fixed-income
securities. A company may amortise the difference between
the purchase price and the amount payable on the
redemption of the security over the period to the
redemption date instead of marking it to market.
Accounting Issues
 The use of the amortised cost basis is appropriate for
redeemable fixed income securities (intended to be held on
an ongoing basis) but is inappropriate for irredeemable
fixed interest stocks and accordingly these should be
accounted for at current value.
 This method give rise to first, use of conventional interest
and second, the issue of unrealized profit which has
attracted debates amongst scholars. Scholars may not allow
its amortisation due to the perceived “gharar” element.
Accounting Issues
 However, many scholars allow income to be
recognised on an accrual basis if they can be
reliably estimated. Use of estimates has been
allowed by the tradition of the Prophet and salafi
scholars such as Ibn Musayyab. Otherwise, income
is recognised on actual distribution.
 Rental income, on the other hand, is recognised on
an accrual basis.
Implicit Guarantees
 The issue of implicit guarantees may be seen in two areas.
 One is the guarantees that may be implied in the
marketing process which gives rise to expectations in the
mind of the participant as to the benefits that will be
payable (concept of PRE).
 The other aspect of implied guarantees relates to the
pricing product process. Does the operator has a fiduciary
responsibility for guaranteeing the set of assumptions
which is considered reasonable and prudent at the time of
product pricing?
Implicit Guarantees
 A takaful contract, unlike the conventional
insurance policy, places a greater burden on
participants collectively to absorb fund
insufficiencies due to the principle of mutual
indemnity, but regulators could place financial
responsibility and take action against operators for
such fund deficiencies, especially if they are found
to be willfully negligent in their role as takaful
Liberalized Market
 A liberalized market means the removal of obstacles to market access
particularly in the areas of :
 Government intervention in the domestic financial system
 Capital controls and restrictions on the convertibility of the
 Discriminatory treatment between foreign and domestic companies
and cross-border provision of financial services
 Liberalization can have the following positive impact:
Promotes efficiency
Promotes financial depth
Supports business
Enhances financial systems
Liberalized Market
 In the takaful industry protective barriers have
been gradually removed and international players
have made their presence felt in several Muslim
countries through the setting up of takaful
windows or separate subsidiaries.
 International players can own up to 50% of the
takaful operation and at least one country has
allowed majority foreign ownership.
 International players provide new capital,
technical expertise, extensive distribution
experience and other resources.
Liberalized Market
 Shariah scholars have not disagreed with the
participation of international non-shariah
compliant companies in the industry.
 These international players have also established
their own shariah committees, in line with
expected requirements of the regulators such as
Bank Negara Malaysia.
 Is the entrance of international players a positive
move for the industry??
Risk Base Capital
 RBC reflects the risk tolerance of the company and the way
management gauges risk. Risk-based capital is used to set
capital requirements considering the size and degree of
risk taken by the insurer.
 It is the capital required to cover the risk the company
takes. It is derived from the evaluation of the different
risks. It is the virtual amount of capital that needs to be
covered by the asset side of the balance sheet.
 RBC methods used by different regulators could be slightly
different from one another.
Risk Base Capital
 The theory behind RBC is as follows:
- assess the level of security of a company;
- determine the rate at which profits are expected to
become distributable for the purposes of
calculating the Embedded Value;
- assess the volatility of the company profits;
- determine the discount rate to be applied to
expected future profits
Risk Base Capital
 In RBC a Risk-Based Capital is determined, which is the
amount of capital (assets minus liabilities) an insurance
company must have as a basis of support for the degree of
risk associated with its company operations and
 A RBC ratio is developed by dividing the company's capital
by the minimum amount of capital that the regulatory
authorities feel is necessary to support the insurance
operations. A ratio of 1.00 or greater may be set to be
 This standard can be used to identify inadequately
capitalized companies, thereby enabling regulatory
authorities to intervene before a company becomes
Risk Base Capital
In US four major categories of risk must be measured to arrive at an
overall risk-based capital amount. These categories are:
Asset Risk- a measure of an asset's default of principal or interest or
fluctuation in market value as a result of changes in the market.
Credit Risk- a measure of the default risk on amounts that are due
from policyholders, reinsurers or creditors.
Underwriting Risk - a measure of the risk that arises from underestimating the liabilities from business already written or
inadequately pricing current or prospective business.
Off-Balance Sheet Risk - a measure of risk due to excessive rates of
growth, contingent liabilities or other items not reflected on the
balance sheet.
Taxation Issues
 In some countries, the tax laws have not have considered the peculiar
nature of takaful contracts have put the takaful operators in a
disadvantage vis a vis conventional insurers. This is especially true for
general takaful business .
 For example, the insurance/takaful regulator may require that takaful
operators in their jurisdiction comply with reporting revenue on a given
statutory basis which may result in the operator being liable to tax
which it would not otherwise have been subject to had the reporting
been on a different basis.
 An additional tax liability by the takaful operator may also be due to
some other reason not necessarily due to regulatory requirements. An
example would be if the shariah council require the takaful company to
follow a certain basis of reporting.
Taxation Issues
 Another issue with respect to taxation is the payment of
zakat. Many contemporary scholars advocate the payment
of zakat by takaful operators, including the operators’
shariah council.
 In some countries where zakat is not a rebate against tax
or even tax-deductible. This problem is compounded by
the fact some shariah council require that the zakat payable
be based on net current assets and not on profits;
discriminating the takaful company further especially in
the early years.
Retakaful Issues
 Retakaful has the following uses:
 The takaful operator or cedant, can take on more risk in
areas where the rewards may be higher, effectively
creating value.
 As a source of Capital for developing and expanding
other areas of business
 Help takaful operators in their risk management
(underwriting and claims administration) of the takaful
Retakaful Issues
 Retakaful operators are generally lowly capitalized and
therefore takaful operators would then need reinsurance
from conventional reinsurers.
 In this respect the Accounting and Auditing Organisation
of Islamic Financial Institutions (AAOIFI) has put limits on
purchases of conventional reinsurance cover up to 45% of
the total retakaful contributions ceded out.
 Many takaful operators argue that conventional
reinsurance is preferred over retakaful as conventional
reinsurers are better rated.
Retakaful Issues
 Financial Retakaful may be advantageous in the short term
but adverse effects may result in higher cost of retakaful in
the future. For family retakaful, specifically term, it is
generally best to set the retention at the lowest level as the
difference in the mortality pricing assumption and
retakaful cost for mortality may vary by a huge margin.
 The other issue, as has been mentioned briefly above, is
the balance between reinsurance and retakaful. Almost
always, it has been argued that reinsurance is cheaper than
retakaful and therefore more capital can be released
through purchasing reinsurance than retakaful.