Takaful

1. The Treatment of Qard in
Takaful
BY: CAMILLE PALDI
CEO OF FAAIF
THE TAKAFUL RENDEVOUS, MANDARIN ORIENTAL HOTEL
ASIA INSURANCE REVIEW; MIDDLE EAST INSURANCE REVIEW
KUALA LUMPUR, MALAYSIA, SEPTEMBER 29-30, 2015

3. Conventional v Islamic Insurance
 A conventional insurance company speculates on the risk by making an
assessment of the risk and then pre-determining profit based on the estimated
payout versus the premium.
 It is in a sense gambling (Paldi: 2014).
 Proprietary insurance is concerned with risk transfer, insured risks being
transferred from the insured to the insurer in return for a premium;

5. Conventional v Islamic Insurance
 Takaful is concerned with risk-pooling, whereby the policyholders (takaful
participants) mutually insure one another in a common risk pool financed by their
contributions (premium payments).
 Takaful, or Islamic insurance, is a cooperative scheme, where in which the
participants pay a premium in the form of donation or tabarru in a common pool
in return for the ability to draw upon that pool upon a valid claim.
 The word takaful originates from the Arabic world kafalah, which means
"guaranteeing each other" or "joint-guarantee."

7. Conventional v Islamic Insurance
 Return on Investment (ROI)
 The funds remaining in the takaful fund on maturity of the policy are distributed
back to the participants after deduction of the charges due to the operator and
according to the type of takaful management model utilized by the fund.
 If the Takaful fund goes into deficit, the takaful operator can provide an interest
free loan (Qard Hassan) into the fund.

9. Qard hassan
 In a situation where the takaful fund is not able to meet its current and future
obligations, the takaful operation will be deemed insolvent (i.e. the takaful fund
has less assets than liabilities).
 The term solvency means the financial ability to pay debts when they become due.
The fund’s inability to pay claims is contrary to the intent of the participants in
joining the scheme and hence, a primary objective of everyone concerned is to
ensure that fund solvency is maintained at all times.

11. Qard Hassan
 The takaful operator plays an important role that the management of a
conventional mutual does not play in the event of a periodic deficit in a takaful
fund that exceeds the reserves of the fund, thereby making it potentially insolvent.
 In this case, the takaful operator acts as a lender of last resort by providing a qard
hassan loan to the takaful fund.
 Such a loan will be repaid out of future underwriting surpluses.

13. Qard hassan
 However, the terms and conditions of repayment are often unclear and sometimes
not stipulated.
 In the event of non-recovery of a qard hassan, is the takaful operator willing to
write it off as the deficit increases?
 What will happen to the qard hassan in the event of insolvency?

15. Qard hassan
 From the operator’s perspective, the qard hassan is a temporary injection of operator
capital into the risk fund and is a particular use of the operator’s capital (which
ultimately comes from the shareholders of the operator).
 There is an opportunity cost for the takaful operator when the operator’s capital is
used for qard hassan.
 It is the availability of affordable capital (either for the takaful operator to inject into
the takaful fund as qard hassan or as the surplus available in the takaful fund, which is
not locked up to ensure continuing solvency) that determines the speed at which a
takaful business can grow.

17. Qard Facility
 The takaful operator grants a qard or interest free loan in the event of a deficit in
the takaful fund (in contrast to mutual insurance).
 The takaful operator is expected to offer a qard loan facility, which can be drawn
down if the fund is unable to meet its obligations (because of a deficit or lack of
liquidity).
 The loan does not remove a deficit, as it increases the fund’s liabilities
simultaneously with the assets, but it provides liquidity to enable the fund’s
obligations to be met.

19. Qard Facility
 The loan should be recoverable by the takaful operator through future
underwriting surpluses.
 As a qard hassan is considered a loan injection into the takaful fund, repayment of
such loans should take precedence over surplus distribution to participants.
 Considering that the takaful fund is under the direct management of the takaful
operator, such a loan may fall under the broader context of ‘related party.’

20. 

21. Qard Facility
 Related party transactions must be publicly disclosed and only carried out on an
arm’s-length basis without any unduly favorable terms.
 In some jurisdictions, independent valuations and appraisals are required before
the regulatory authorities will allow substantial related-party transactions to take
place.
 This is in order to avoid the directors and management of the company
manipulating the movement of funds or assets of the company in favor of certain
parties who are related to or favored by them.

23. Qard Facility
 Should the requirement to publicly disclose the qard facility be similarly imposed
on takaful operators on the basis that it is a related-party transaction?
 Should the existence of the facility be disclosed or only the loan if the facility is
actually drawn down?
 While it would seem desirable to disclose the existence and amount of the facility,
transparency would also require disclosure of the draw-down amount when made.

25. Qard Facility
 Certain safeguards may also be required in order to ensure that the qard is not
employed in a manner that favors certain pools among the many pools of takaful
funds under the management of a takaful operator.
 In countries such as Malaysia, takaful operators are obliged to give an undertaking
to the regulator to provide a qard facility to be drawn down in the event of a
deficit of a takaful fund.

27. Countries with Specific Takaful Legislation
 Malaysia
 Brunei
 Pakistan
 If only three countries possess Takaful legislation, the global Takaful industry is
heavily under-regulated as well as lacks a proper dispute resolution mechanism.

29. Bank Negara Malaysia Guidelines
 Guidelines on Operating Costs of Family Takaful Business;
 Guidelines on Claims Settlement Practices;
 Guidelines on Directorship for Takaful Operators;
 Guidelines on Prohibitions against Unfair Practices in Takaful Business;
 Takaful (Prescribed Financial Institution) Loan and Investments Regulation 2003;
 Guidelines on Financial Statement for Takaful Operators;
 Takaful Operators Statistical System.

31. Takaful financial reporting
 A unique and harmonized regulatory and reporting regime is required for takaful
for many reasons including the two-tier structure of takaful companies, which
includes shareholder and policyholder funds.
 Shareholder and policyholder funds are managed separately and capital may not
be fungible or transferable between the two separate accounts.
 Furthermore, takaful funds have unique policyholder entitlements and rights,
different structures, and face different risks compared to conventional insurance.

33. Takaful financial reporting
 The main difference between conventional and Islamic insurers lies in the fact that
in Islamic finance, the assets underlying the underwriting pools are owned by the
policyholders, whereas assets in conventional proprietary insurance companies are
owned by the shareholders and must at all times be sufficient to cover their
obligations to the policyholders.
 Accordingly, in contrast to conventional insurance companies, takaful companies
must make disclosures about the underwriting pools and underlying assets.

35. Takaful financial reporting
 The AAOIFI regulations FAS 12 General Presentation and Disclosure in the Financial
Statements of Islamic Insurance Companies and FAS 13 Disclosure of Bases for
Determining and Allocating Surplus or Deficit in Islamic Insurance Companies address
many of these issues.
 The AAOIFI standards require disclosures on policyholders’ funds and the
determination and allocation of surplus and financing of deficits.
 However, the requirements in respect of movements between the funds should be
enhanced and the individual rights of the policyholders should be clearly stated in the
financial statements.

37. Takaful financial reporting
 There is also a lack of transparency in the financial statements of some takaful
companies in regards to undistributed fund balances.
 Overall, the current financial reporting practices of takaful companies do not provide
adequate information regarding the company’s investment strategy, funds allocation,
and revenues and expenses accruing to their particular investment funds.
 Exacerbating the situation, takaful companies have not yet adopted a single framework
for financial reporting and this has resulted in the lack of transparency and
comparability of financial statements.

39. Capital adequacy regulation
 In many jurisdictions, solvency and capital requirements for takaful companies
remain simple, however, several countries including Malaysia, Indonesia, and
certain GCC countries are moving towards risk-based capital regulation.
 It may be difficult to apply ratio-based methods as it can be difficult to
accommodate them to the different structures adopted by takaful operations and
their different risk profiles.

41. Rbc framework malaysia
 In Malaysia, a RBC framework has been implemented in the conventional
insurance industry since 2009.
 A RBC framework for Malaysia was intended to be implemented in 2012/2013.
 The proposed RBC Framework for Takaful Operators will apply to all Takaful and
Retakaful Operators registered under the Takaful Act 1984.

43. Risk-based capital
 Risk-based capital is used to set capital requirements, bearing in mind the size and
degree of risk taken by the insurer.
 It is the capital required to cover the risks the company undertakes.
 It is derived from the evaluation of different risks.
 It is the amount of capital that needs to be covered by the assets of the business.

45. Proposed rbc framework for takaful
operators malaysia
 The Framework requires the maintenance of adequate capital at levels
commensurate with the risk profile of the takaful operations to act as a financial
buffer against any exposure to risks.
 It is the takaful operator’s fiduciary duty to manage the capital and risks prudently,
and in line with the objectives of Shari’ah.

47. Proposed rbc framework for takaful
operators malaysia
 In takaful, the concept of RBC is applied on the understanding that it is the takaful
risk fund (representing all participants as a single collective fund) that needs to
have sufficient assets to meet minimum solvency or RBC requirements.
 Under the new Framework, the regulators, based on their assessment of a takaful
product design or features, may require takaful operators to establish other funds
to clearly reflect the specific nature, purpose, or risk of a component of the
contribution or other elements of the takaful product.

49. Proposed rbc framework for takaful
operators malaysia
 This is intended to protect the interest of the participants, the soundness of the
takaful funds and where appropriate, to reflect Shari’ah requirements.
 Given the requirement for the takaful operator to extend a qard hassan in the
event of a fund in financial distress, the Framework is designed to ensure that the
takaful operator has the appropriate amount of capital to meet the qard
obligation as well as to support its business operations.

51. Proposed rbc framework for takaful
operators malaysia
 Each takaful operator is therefore required to maintain adequate capital in its
shareholders’ fund to support its business.
 For this purpose, the capital available in the fund will be recognized in the capital
adequacy measurement of risk by the takaful operator to the extent that this is
consistent with the underlying responsibility and ownership of the various funds in
the takaful business.

53. Proposed rbc framework for takaful
operators malaysia
 To this effect, the Framework provides incentive for the takaful operator to build a
strong risk fund, thus reducing the amount of capital needed to be held by
shareholders to support potential qard hasan obligations.

55. Proposed rbc framework for takaful
operators malaysia
 In the case of a takaful business, the CAR measures the adequacy of the capital in
the shareholders’ and takaful funds to support the total capital required for the
takaful business.
 The CAR is the ratio of the business’s capital to its risks.
 Capital Adequacy is the key indicator of the takaful operator’s financial resilience
and will be used to determine the appropriate level of supervisory interventions by
the regulatory authorities.

57. Capital adequacy ratio
CAR =Total Capital Available (TCA) x 100%
Total Capital Required (TCR)

59. Proposed rbc framework for takaful
operators malaysia
 The Malaysian regulators’ approach of pre-emptive intervention means that
supervisory action is taken in the early stages of a takaful operator’s financial
difficulties.
 To do this, they have set a supervisory target capital level of 130%, below which
supervisory actions of increasing intensity will be taken to resolve the financial
problems of the takaful operator.
 The takaful operator is then required to establish a higher internal individual
target capital level.

61. Proposed rbc framework for takaful
operators malaysia
 The regulator will assess whether this target capital level is appropriate for the
takaful operator’s risk profile and risk management practices; if it is not, the
operator will be required to make adjustments.

63. Proposed rbc framework for takaful
operators malaysia
 A takaful operator will not pay shareholders dividends if its CAR position is less
than its individual target capital level or if the payment of dividend will impair its
CAR position to below its individual target capital level.

64. THE END