Takaful And Actuarial Practices 18 Nove

Takaful and Actuarial Practices (TK “Regulations shape the Industry”. The development of the Takaful (or Islamic insurance) industry is very much dependent on its regulations and related guidelines. In many parts of the world Takaful is hardly visible as there are still subject to the Insurance Law. Only Malaysia has its own set of regulations. The first Takaful Act was promulgated in 1984 and recently was replaced by the Islamic Financial Services Act 2013. Even that many of the provisions of the Act and related guidelines are similar to that of insurance.
a. Discuss whether or not a Takaful Operator can be successful in an environment without its own regulations.
b. Critically examine existing regulations (and if preferred that in your own country) and define the issues that can hinder the growth of takaful.
c. Provide recommendations how the regulation can be modified or enhanced to promote further growth of the Takaful industry.

Abstract
The development of takaful industry is very much dependent on its regulation and guidelines. Malaysia has proven that with robust and effective regulatory framework in place, the takaful industry can be developed and continuously growing. Without its own regulation takaful industry might not be able to success. New regulations and guidelines have been issued in Malaysia recently for the purpose of promoting further growth. However, these guidelines may pose various implication and drawbacks to the industry.

Key terms of Research:
1. Takaful 2. Regulation 3. Islamic Financial Services Act 2013 4. Takaful Operational Framework 5. Risk Based Capital framework for Takaful

Table of Contents
1.0 Introduction………………………………………………………..4
1.1 Insurance……………………………………………….............4-6
1.2 Islamic Insurance (takaful)……………………………………6
1.3 Fundamental difference between Insurance & Takaful…….6-7
1.4 Regulation………………………………………………………7
1.5 Takaful and Regulation………………………………………..7-8
2.0 Regulatory Framework for Takaful………………………………8-9
3.0 Development of Takaful in Malaysia………………………………9-10
4.0 Regulatory Framework for Takaful Industry in Malaysia………10-12
5.0 Regulation and its Impact to Takaful Industry…………………...13-17
6.0 Conclusion and Recommendation………………………………….17-18
7.0 References…………………………………………………………..19

1.0 Introduction
Regulations are the essential parts of any industry. These regulation are the set of rules and norms which are set by the regulatory and authoritative bodies. Malaysia being a pioneer of Islamic Banking has achieve another milestone in becoming pioneer in developing takaful industry. As at to-date there are 11 takaful operators and 4 retakaful operators in Malaysia.

Takaful and conventional insurance have similar philosophy that are to mitigate hazard and perils that one might face in his life. Takaful system consist the elements of mutual cooperation, common interest and joint indemnity.

Takaful consist of 2 tier structure that is hybrid of mutual and commercial form of company. This itself poses significant issues for regulation and supervision. In addition, all function of takaful should follow the rules of Islamic Law (Shariah) and this has other implication in other area of supervision and regulation (Dirir, 2011)

The development of takaful industry in Malaysia is being shaped by the regulation. The latest regulations issued aimed to develop level playing field with its conventional counterparts. However, these regulations has also come with few implication and drawbacks.

1.1 Insurance
Insurance has existed for many centuries, some historian trace the origin of insurance to 215CE, when Roman government required by military supplies to accept all risks arising from enemy attacks, storm and other natural disaster for supplies carried on the ships Modern insurance can be trace to begin in 1600’s, when British merchants and ship owners began to meet at a coffee house called Lloyd’s near Lombard Street in London. They made agreement to mutually share profit and losses of sea voyages (Omar Fisher, 2009).

Insurance is a risk sharing arrangement between 2 parties. It is an agreement between the insurers that agrees to indemnify the insured against losses specified by a contract. It is an economic device by which individuals or organization, transfer pure risk (uncertainty about financial losses) to others (Obaidullah, 2005).

Technically, insurance is where individuals (insured) to company (insurer) and in return insurer received premium. The insurer then take the chance that it will indemnify insured up to certain limit specified in the policy (contract).The insured does not get any benefit except an undertaking stated in the policy that will take care of any loss suffered by insured if risk materializes. If risk does materializes within the period covered, company takes all the premium and insured gets nothing.

Conventional insurance contains 3 elements that contradict to Shariah:-
Uncertainty (Gharar)
It arises when insured pays premium but does not know whether he will makes claims in future, vice versa.
Gambling (Maisir)
It occurs when policyholder hopes to get large sum from his small amount of premium. However, policyholder would lose money if the insured event does not occur and insurer will get all the profit.
Interest (Riba)
When the policyholder expect to get a fix amount (rate) of profit greater than his contribution it is considered as Riba. In addition, the investment of insurance company involves element of Riba.

In view of the elements mentioned above, Muslim needs an insurance scheme (protection scheme) that is in compliance to Shariah. On 24 March 1977 the Saudi Arabian Counsel of Head Scholars denouncing conventional insurance contract are being imbued with Gharar. It is followed by fatwa in numerous Islamic countries including Malaysia.

1.2 Islamic Insurance (Takaful)
Takaful is defined as a scheme based on brotherhood, solidarity and mutual assistance which provides mutual financial aid and assistance to the participants in case of need whereby the participants mutually agreed to contribute for that purpose (BNM, 1984)

The origin of takaful is derived from several practices from ancient Arab tribal custom and companions of the Prophet. For example; under the custom of “Al-Aqilah”, it is mutually agreed among the tribes that if a person is killed unintentionally by a person of another tribe, accuser’s paternal relatives will take the responsibility to make a mutual contribution for the purpose of paying the blood money to the victim’s relatives. The first Islamic insurance was introduced in Sudan in 1979, based on cooperative model similar to conventional mutual insurance and later implemented in other countries i.e. Malaysia and Saudi Arabia.

The 3 mutuality aspects in Takaful are; mutual help, mutual responsibility and mutual protection from losses. It is an arrangement in which participant contributes regularly to a common pool of funds with the intention to jointly guaranteeing each other. When participant enter into a scheme, he is seeking protection as well as cooperating with other participants and contributing to help those in needs. Hence, unlike conventional insurance, takaful is ideally not a contract of buy and sell.

1.3 Fundamental differences between Insurance and Takaful
The fundamental difference between conventional insurance and takaful is its contract. Conventional insurance involves in bilateral contract between insured and insurer. The nature of the contract is at the best probable compensation depending on the event that may occur or may not occur. Whilst, takaful operator is only an administrator of takaful fund responsible in managing and investing fund in accordance to Shariah.

The other significant features that distinguish takaful and conventional insurance is the existence of Shariah Supervisory Board and separation of 2 funds (risk fund and shareholder’s fund) in takaful.

1.4 Regulation
In general regulation is define as principle or rule (with or without the coercive power of law) employed in controlling, directing or managing an activity, organization or system. Law define regulation as rule based and meant to carry out a specific piece of legislation.

Regulation are enforced usually by regulatory agency formed or mandated to carry out the purpose or provisions of a legislations (regulatory requirements). Regulation are indispensable to the proper function of economic and society. Regulation underpinned markets, protect the rights and safety of citizens and ensure delivery of public goods and services.

In Islam we are commanded to obey Allah, The Messenger and the authority. Islam recognized authority and the need of mankind to have some order and rules, as Shariah itself is about moral code of conduct and Islamic Religious Law.

1.5 Takaful and Regulation
Takaful similar to conventional insurance is a service whereby both industries requires their customers to “pay” in advance for the services/benefits in the future (payment of claims should loss occurred). This feature makes takaful a must be regulated industry.

Takaful is different from conventional propriety (company with shareholder) insurance, whereby the participants (policyholders) in takaful shares insurable interest among themselves rather than transferring risks to shareholders. How takaful is implemented determines the level of risk sharing among participants, unless takaful operation is based on pure mutual model, shareholder do carry some risk in the operation. The complexity in determining where risks actually resides makes regulation of takaful important.

Takaful system embodies the element of mutual cooperation, joint indemnity and common interest. Takaful will consist of 2 tier structure that is a hybrid of a mutual and commercial form of company. This poses significant issues of regulation and supervision. In addition, all functions of takaful undertaking should obey the rules fully to Shariah and has in other areas of regulation and supervision (Dirir, 2011).

The global credit crisis has in one way or the other negatively impacted all financial institutions including takaful. The direct consequences were felt on both top line and bottom line, with lower returns to both shareholder’s fund and risk fund. In addition, there was slower new business growth on the back of slowing economy. This crisis has highlighted the need for regulatory bodies to strengthen their supervisory role to ensure stakeholders of takaful industry are protected and buffered from another crisis.

Growth and profitability prospects for takaful operators vary significantly by market and sectors depending on market economics, maturity and regulatory structures (Ernst&Young, 2013). The decision of the regulator as to how takaful is regulated will have significant impact on whether takaful is simply a change of name or develop into a different offering to the customer.

2.0 Regulatory Framework for Takaful
There are 3 levels of regulation and supervision of takaful industry:
i. Local Jurisdiction – Countries like Malaysia, Bahrain has special legislation for takaful industry whilst other countries i.e. UK has single legal and regulatory framework for both conventional insurance and takaful. ii. Islamic Financial Services Board (IFSB) – Among key objectives of IFSB are to:
Encourage and further craft and develop transparent and prudent Islamic Financial Services Industry and to introduce new or existing international standards that is in line with Shariah
Set up criteria for standardizing institutions offering Islamic finance services and products. iii. International Association of Insurance Supervisors (IAIS) – IAIS is a voluntary membership organization of insurance supervisors and regulators from more than 200 jurisdiction in nearly 140 countries. The mission of IAIS is to promote effective and globally constant supervision of insurance industry in order to develop and maintain fair, safe, stable insurance market for the benefit and protection of policyholder and contribute to financial stabilities. IAIS develops principles, standard and other supporting materials for supervision of insurance sector.

3.0 Development of Takaful in Malaysia
Malaysia was already well a long way to an Islamic Finance System when Tabung Haji being established in 1963. The first takaful fund was started in Malaysia in 1984 a year after the establishment of the first Islamic bank, Bank Islam Malaysia Berhad.

The prevailing need of Malaysian’s Muslim towards Islamic insurance and the issuance of fatwa by Malaysian National Fatwa Committee (MNFC) has inspired the development of Takaful Industry in 1980’s. MNFC has ruled out that conventional life insurance policies were fasid due to presence of excessive uncertainty (Gharar), Usury (Riba) and Gambling (Maisir). The decision by the Jurist to formulate the takaful program as in agreement with the shariah legal maxim “all things originally are permissible unless there is evidence to prove their prohibition”. According to the Quran (Verse 31:10): “Do not see that Allah has subjected to you whether is in the heavens what is on earth and has showered upon unseen? Allah has given man control over their use and it is not logical that (may He be glorified) their use is forbidden as He has bestowed man with His “favours”. In fact He has prohibited only few things for specific reasons because they are harmful to man, the true negative repercussion of which is in the hands of Allah. Allah know what man does not.”

In 1982, a Special Task Force was established by Malaysian Government to study the viability of the setting up of takaful fund. Following the recommendation, in 1984 the Takaful Act was enacted and the first takaful operator Syarikat Takaful Malaysia was incorporated in November 1984.

After 30 years, takaful industry has shown tremendous growth. As at to-date, there are 11 takaful operators and 4 retakaful operators in Malaysia. As at 31 December 2013, total assets of takaful and retakaful industry in Malaysia stood at RM25.2billion and RM1.4billion respectively. The average growth for family business is at 14.7% whereas, for general business at 9.1%. Net contribution for family and general businesses stood at RM1.13billion and RM0.41billion respectively.

The growth and success of takaful industry in Malaysia was achieved as a result of various efforts undertaken by Government of Malaysia specifically Bank Negara Malaysia (BNM) and takaful operators in developing resilient and efficient industry.

4.0 Regulatory Framework for Takaful Industry in Malaysia
Malaysia is among pioneering jurisdictions that have successfully developed and incorporated Islamic Finance into its modern financial system (Islamic Finance News, 2012). The regulatory part of Islamic Financial Institutions including takaful is being carried out by BNM. Regulatory framework for insurance and reinsurance are broadly applicable to takaful and retakaful. However, it requires adaptation to be more takaful and retakaful attuned whereby, specific rules has been put in place to address takaful peculiarities:
i. Shariah compliant in all aspects of takaful and retakaful operations ii. Balance between interest of shareholders and participants iii. Seperation of funds between shareholders and takaful/retakaful fund

Gradual approached has been adopted by BNM in developing takaful industry in Malaysia. Basically the development can be divided into 3 stages:
i. Stage 1 (from 1982 to 1992) – mainly focusing on establishment of basic takaful infrastructure.
BNM has established Takaful Act and Framework in 1984 (Takaful Act 1984) to provide clear guidance and direction on how takaful operators should conduct their business to in in accordance to Shariah as well as Law of Malaysia. In addition various guidelines and circulars were issued to takaful operators to provide updates on latest requirement as well as clearer direction on how takaful operators should run their business.
Establishment of the first takaful operator in November 1984, Syarikat Takaful Malaysia. ii. Stage 2 (from 1993 to 2000)
New entrance of takaful operator in 1993(Takaful Nasional Sdn. Bhd.)
ASEAN Takaful Group was established in 1995
Asean Retakaful International (L) Ltd was established to facilitate retakaful arrangement among takaful operators in Malaysia and in the region.
Appointment of Members of Shariah Advisory Council for Islamic Banking and Takaful iii. Stage 3 (from 2001-2010)
Introduction of Financial Sector Master Plan in 2001 – partly aim to enhance capacity of takaful operators and to strengthened legal, shariah and regulatory framework,
Establishment of Malaysia Takaful Association in 2002 to improve industry self-regulation through uniformity in market practices.
4 new takaful licenses issued by BNM between 2005 to 2007
Malaysia Islamic Financial Centre (MIFC) was established in 2006 to develop linkages to the global marketplace.
Liberalization of takaful industry in 2009, which then resulted in 4 new foreign based family takaful operators given a licenses to operate in Malaysia.

iv. Stage 4 (2011 to current)
Financial Sector Blue Print (FSBP) was introduced in 2011 – it is a strategic plan that chart the future direction of Malaysia’s financial system, as Malaysia aspires to transform into a develop and more competitive economy in 2020. The transformation will rely largely on private sector to drive greater productivity and innovation. Among recommendation outlined in FSBP are:
Strengthened financial institutions’ including Islamic financial institutions’ knowledge of different markets to support internationalization of Malaysian business.
Enhance capacity and capability of insurance and takaful industry to provide higher value added medical and health insurance
Established well developed financial infrastructure to facilitate cross border financial intermediation.
Enactment of comprehensive legislative framework for conventional and Islamic Financial System
Strengthened institutional structure of financial institutions to provide adequate safeguard against contagion risk and excessive laverage.
Participate in greater cross border arrangement and supervisory cooperation to support the development of International Islamic Financial Industry
Introduction of various regulation that took place within 2011 to 2013 to support the objectives of FSBP, among others:
Islamic Financial Services Act 2013 (IFSA)
Shariah Governance Framework (SGF)
Takaful Operational Framework (TOF)
Risk Based Capital Framework for Takaful Operators (RBCT)
Guidelines on Appointment and Duties of Appointed Actuaries

5.0 Regulation and its Impact to Takaful Industry
In ensuring continuous growth and to further develop the takaful industry, various regulation have been introduced in recent years.

A. Islamic Finance Services Act (IFSA) 2013
IFSA which took effect on 30 June 2013 replaces previous Takaful Act 1984. IFSA is a combination of both regulation of Islamic Banking and Takaful. The purpose of IFSA is to:
Promote financial stability and compliance with shariah
Strengthen regulation of Islamic financial Institutions
Protects right and interest of consumer services and products

IFSA enables more comprehensive regulation and supervision of the takaful and retakaful industry. Areas of coverage under IFSA are:
Shariah Governance
Prudential Requirement
Business conducts and consumer protection
Financial Groups
Intervention and remedial actions i.e. winding up

Among key changes under IFSA requirement which will affect the takaful industry are:
i. Composite takaful operators are required to split its general and family business into 2 separate entities. Takaful operators are given 5 years from effective date of IFSA to comply with this requirement. ii. Takaful operators are required to held separate capital requirement for its general and family business (previously RM100m capital requirement for both businesses) iii. Requirement to set-up financial holding company whereby, any takaful operator that is subsidiary of financial holding company will be subjected to a capital requirement in Malaysia. iv. Principle based regulation in IFSA will require takaful operators to come up with its own capital framework based on the nature and complexity of its business.

With new and enhanced requirements being put towards takaful operator under IFSA it is expected that:
There will be further merger and acquisition as few operators may find difficulties to get to hold separate capital requirement. Nevertheless, it may encourage growth of general business.
It will raise the issues as to whether takaful operator’s subsidiaries outside Malaysia will also be subjected to Malaysian capital required though Malaysia’s capital requirement are less stringent?
Takaful operator need to come up with their own capital framework that is robust enough depending on the nature and complexities of its business. It may require them to engage external consultants to come up with an extensive framework.
As some responsibilities of appointed actuary being shifted to Board of Directors of the takaful operator there might be increased in numbers of independent director with technical expertise i.e. actuarial, accounting etc.

B. Risk Based Capital Framework for Takaful Operators (RBCT)
RBCT sets BNM’s expectation for takaful operators, maintenance of capital adequacy level to commensurate with risk profile of takaful operations and act as financial buffer for takaful exposure. The framework aims to achieve the following objectives:
Enable all obligations under takaful contract to be met
Provide flexibility for a takaful operator to operate at different risk levels in line with its business strategies, so long as it holds appropriate level of capital and observe prudential safeguards.
Industry that promotes public confidence and contribute to us overall financial system stability.

The major changes in requirement is that, under RBCT is all payment of dividend is subjected to prior approval from regulators regardless of takaful operator’s capital position. Previously, dividend payments were permitted without prior approval from regulator subject to the capital position of takaful operators being above its internal capital target level (ITCL).

C. Takaful Operational Framework (TOF)
Takaful Operational Framework (TOF) was issued to achieve the following purposes:
To enhance operational efficiency of takaful business
To build healthy takaful funds which are sustainable
To safeguard interest of participants
To promote uniformity in takaful business practice

The most significant changes upon implementation of TOF is that, takaful operators are permitted to distribute surplus from the risk fund to shareholders’ fund regardless whether there is an outstanding Qard position in the risk fund. Shariah Advisory Council (SAC) of BNM resolved that, surplus from risk fund can be distributed despite an outstanding Qard position in the risk fund due to the clear distinction between the obligation of the risk fund to distribute surplus to takaful operator and obligation to repay Qard, where mechanism of respective payments are subjected to different requirement by regulator. However, the requirement that surplus distribution payable to the operator must not exceed the amount paid or accrued to participants remain.

D. Appointed Actuary: Appointment and Duties
The policy documents provide for the duties of an Appointed Actuary and the Bank’s expectation of the roles and responsibilities of the Board and the Board Nominating Committee in respect of Appointed Actuary. The policy aims to reinforce the professional standards expected of an Appointed Actuary in carrying out his specific duties and overall responsibilities as a control function. There are various significant potential areas that can be highlighted:
Potential requirement for Appointed Actuary to be employed by takaful operator rather than being an external consultant.
Pricing Actuary role to be separated from Appointed Actuary role.

In view of the above potential, takaful operator might view it as challenges as there are limited number of Actuary with sufficient experience in Malaysia. In addition, as there will be a separation between general and family businesses there will be increasing demand for Appointed Actuary.

Though the development in takaful regulation has tremendously improve the performance and growth of takaful business in Malaysia, new regulations has also comes with few drawbacks as below:
Regulation on takaful ensures that takaful operators meet its obligation to the same extent as Islamic Bank. This “certainty” comes with cost. Additional regulatory cost and capital are likely to be passed on to consumers, thus making takaful poducts more expensive compared to its conventional counterparts.
IFSA requires takaful operator to be established as public companies. However, given the nature of mutual assistance in takaful, it will be more appropriate for firm to be set up as cooperative or mutual. By being public firms, takaful will become wholly commercial venture which will eventually focus more of profitability rather than fulfilling social needs.
There will be a possibilities that few takaful operators might withdrawn products that require high capital i.e. annuities and long term care and replace it with products with lower capital i.e. Investment Linked Products to fulfill RBCT’s requirement.
IFSA requires takaful operators to be established as public companies. However, given the nature of mutual assistance in takaful, it will be more appropriate for firm to be set up as cooperative or mutual. By being public, takaful firms will become wholly commercial venture. Thus, make profitability as main aim of takaful operator rather than fulfilling social needs.
Lower income group will continuously be underserved as premium/contribution are small in size. In addition the takaful operator has to bear the distribution cost as regulatory compliance cost. The issue here is whether there is still room to accommodate the need of the society if regulation that govern takaful as business still applies.
IFSA requires stricter shariah requirement as these are the foundation of takaful. Efforts in ensuring Shariah compliance will increase operation costs. Therefore, in principal takaful will have to charge higher price compared to conventional. However, this is impossible in the current competitive environment in Malaysia. Thus, it is difficult for takaful operator to achieve the same return as its conventional counterparts.
Under IFSA the role and function of BNM has been enhanced which include; power to issue directions to institutions, carry out intervention and remedial actions to reduce any risk to Malaysia’s financial stability. Hence, the quality of BNM’s takaful regulator and supervisors need to be enhance. A question here, is to whether they are ready to take additional roles and have sufficient check and balance in place.

5.0 Conclusions and Recommendations.
From the above facts, it can be clearly seen that registration drove the success of takaful industry. The takaful regulatory framework in Malaysia is the most robust and effective in the world. Hence, Malaysia continue to be the model of takaful industry globally.

The latest regulation aimed to develop level playing field between takaful and its conventional counterparts as well as promoting further growth and development of the industry. However, there are various implication and drawbacks of these regulation to the takaful industry.

In view of these implications and drawbacks it is recommended that:
i. The takaful operators should be given an opportunity to decide as to whether to operate as co-operative or mutual rather than to be forced to be public company. This is to divert back to the purpose of setting up takaful, which is on mutual assistance concept in order to fulfill the need of the society. ii. In determining the Supervisory Capital Adequacy Ratio required to each takaful operator, regulator should take into consideration the business and risk profile of the takaful operator and not only setting it at certain % across the board. iii. The regulator has to give full cooperation to the takaful industry, especially in building public awareness towards takaful products, its benefits, its differences compared with conventional insurance as well as its Shariah value. This may reduce further questioning if customers feels that takaful products is more expensive than conventional insurance products. iv. In view of the enhanced role of takaful regulators and supervisors as outlined in IFSA, regulators and supervisors of BNM has to be fully equipped with the knowledge that they need to assess the takaful operator under their supervision. In addition, they need to be fully ready to take an additional role as well as to have sufficient check and balance in place.
v. Regular discussion between the regulator and takaful player need to take place to get the feedback especially on the possible implication and drawbacks of the guidelines. Revision to the guidelines has to take place, if huge negative implication persist and might impact the industry.

References
1. http://www.bnm.gov.my
2. Islamic Finance News Suplement, May 2012
3. Take 5: Issues by Ernst & Young Volume 1 – Issue 1-5 April 2013
4. Dirir, A.S (2011), Issues and Challenges Facing Takaful Industry in Dual System
5. IFSB and IAIS (April 2006), Issues in Regulation and Supervision of Takaful
6. Zainal Abidin Kassim (2013), Update on Takaful: Regulating the way forward.

References: 1. http://www.bnm.gov.my 2. Islamic Finance News Suplement, May 2012 3. Take 5: Issues by Ernst & Young Volume 1 – Issue 1-5 April 2013 4. Dirir, A.S (2011), Issues and Challenges Facing Takaful Industry in Dual System 5. IFSB and IAIS (April 2006), Issues in Regulation and Supervision of Takaful 6. Zainal Abidin Kassim (2013), Update on Takaful: Regulating the way forward.