Takaful Islamic Insurance

Concepts and Regulatory Issues

Simon Archer, Rifaat Ahmed Abdel Karim, Volker Nienhaus, Simon Archer, Rifaat Ahmed Abdel Karim, Volker Nienhaus

• Publisher: Wiley
• Year: 2011
• ISBN:
  9781118179055
• Edition: 1
• Topic: Commerce
• Subtopic: Banque et finance islamique

Authors Rifaat, Archer and Volker bring an international perspective to the growing Islamic Insurance industry. Drawing on contributions from leading experts around the world, they present a comprehensive view of the very issues governing the industry and its future direction. As top financial institutes around the world seem to enter the lucrative Takaful markets, this timely book offers crucial background information and advice, invaluable for any serious player in the market.

Chapter 1

Conceptual, Legal, and Institutional Issues Confronting Takaful

Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus

1.1 INTRODUCTION

While the last decades of the 20th century saw the emergence of Islamic banking as a significant development in a number of predominantly Muslim countries, takaful (Islamic insurance) has been slower to emerge. This is in spite of the fact that schemes for mutual protection against losses have traditionally existed in Islamic societies. As will be seen from the analyses presented in this book, modern versions of such schemes face a number of highly complex juristic,1 institutional, legal, and regulatory issues some of which are far from being resolved. In addition, it should be noted that the conventional insurance industry also faces major regulatory issues, in which it may be thought to lag behind banking with particular respect to international prudential standards on solvency, capital adequacy and related matters (there being as yet no insurance equivalent to Basel II), and financial reporting. Work is, however, in progress, which will be described briefly below.

The first modern takaful undertaking was founded in Sudan in 1979. Its foundation was due to the solution by a Sudanese Shari'ah scholar2 of a juristic problem: how may the Shari'ah prohibition of trading in insurance (and in indemnities and guarantees more generally) be overcome? Part of the solution lies in the adoption of a mutual structure for underwriting insured risks: the insureds (participants) mutually insure one another, on a non-profit basis, according to the principle of takaful (the Arabic word for “solidarity”). Another aspect of the solution consists of characterizing the policy contributions (premiums) to the risk fund as incorporating an element of conditional and irrevocable donation (tabarru'), the donor making the contribution to the risk fund subject to being entitled to benefit from mutual protection against insured losses.

However, the adoption of a mutual structure runs into two kinds of institutional obstacles. First, the legal systems of many countries do not accept mutual or cooperative forms of company without share capital. Second, even if such forms of company are accepted for insurance undertakings, they need to be able to raise enough capital from policyholders to meet regulatory capital adequacy and solvency requirements. To surmount these two obstacles, the vast majority of takaful undertakings have a two-tier, hybrid structure in which the risk funds operate on a mutual basis but are managed by a takaful operator, which is a company with shareholders. However, this hybrid structure involves complexities and raises juristic and legal issues which are yet to be satisfactorily resolved.

In addition to the need to overcome juristic and institutional problems, the development of takaful is inevitably constrained by the economic and social development of predominantly Muslim countries, which affects the market for and the propensity (especially at the retail level) to take up insurance cover. At the same time, takaful can contribute to economic development at the micro level by enabling more efficient risk management by firms and households, and at the macro level (particularly in life or family takaful) by mobilizing savings and providing funding for investment in long-lived assets.

1.2 DEVELOPMENTS IN INTERNATIONAL PRUDENTIAL GUIDELINES FOR INSURANCE AND TAKAFUL

As noted above, the development of international prudential standards for insurance has lagged behind that for banking. However, there has been a significant amount of work in this area. The International Association of Insurance Supervisors (IAIS) has issued a number of important documents, including the Core Principles of Insurance Supervision, and the European Commission is developing a new prudential system for the insurance industry in the European Union (known as Solvency II to distinguish it from the existing EU guideline which is considered to be obsolete). As its name suggests, Solvency II is considered to be the insurance counterpart of Basel II, and is likewise constructed around three “pillars.”

At the same time, the Islamic Financial Services Board (IFSB) has been working on two international prudential guidelines for the takaful industry sector, and another that will be applicable to firms in the sector. The Guiding Principles on Corporate Governance of Islamic Insurance (Takaful) Operations and the Guiding Principles on Conduct of Business for Institutions Offering Islamic Financial Services (applicable to takaful operators) have been issued as exposure drafts, while an exposure draft on capital adequacy and solvency of takaful undertakings was in the course of preparation when this book went to press.

1.3 CONTENTS OF THIS BOOK

The rest of the book is divided into two main parts, followed by a concluding chapter by the editors.

Part 1 (Chapters 2–7) deals with the business models used in takaful, from the perspectives of their regulatory implications, the relevant Shari'ah principles, stakeholder rights and corporate governance issues, and legal issues, as well as issues of business conduct and policyholder (or consumer) protection, with particular reference to emerging markets, and with supervisory issues more generally.

Chapter 2, by the editors, examines the business models employed for takaful undertakings, both non-life and life (or family) takaful. These models involve complexities resulting from the hybrid nature of takaful undertakings: risk funds that function on the basis of mutuality (the equity of which belongs to the policyholders) being managed by a company with shareholders. The chapter addresses the daunting challenge that these complex business models, which raise a number of unresolved issues, represent for insurance industry regulators.

The models also raise important Shari'ah issues, which are the concern of Chapter 3 by Daud Bakar. The fact that there are two categories of equity holders in a takaful undertaking, shareholders as well as policyholders, also raises important issues regarding stakeholder rights and corporate governance, which form the subject of Chapter 4, by the editors.

The business models and structure of takaful undertakings also entail knotty legal issues, which are examined in Chapter 5 by Madzlan Mohamad Hussain. The author points out that these issues tend to be aggravated by the fact that the notion of mutual insurance, while intrinsic to takaful, is unknown in the legal and regulatory systems of most of the countries in which takaful undertakings operate.

In Chapter 6, Arup Chatterjee emphasizes that a sound regulation and supervision framework is essential for improving the efficiency of the market for insurance generally and for takaful in particular. He describes the work of the IAIS in developing its Solvency Structure, and the importance of principles of good business conduct with particular respect to managing reputation risk. He also draws attention to the need for good data on losses and expenses per unit of exposure in pricing insurance products.

Chapter 7, by Peter Casey, also refers to the work of the IAIS, with particular reference to its 2005 paper, “A New Framework for Insurance Supervision.” He points out that while for an insurance supervisor governance issues are among the most difficult to deal with, in the case of takaful undertakings, the key governance risks are failures of Shari'ah governance, misalignment of interests between shareholders and policyholders, and inadequate consideration of the interests of the latter.

Part 2 (Chapters 8–13) addresses issues of risk, solvency, and capital adequacy in takaful, the investment portfolios of takaful undertakings, and the transparency of, and market information on, takaful undertakings, including ratings by external credit assessment institutions and external financial reporting.

In Chapter 8, Mahomed Akoob explains the importance of retakaful (Shari'ah-compliant reinsurance) to the takaful industry, especially for those takaful undertakings that are of relatively small size. He then explains how reinsurance may be structured so as to be Shari'ah compliant.

Chapter 9, by Abdullah Haron and Dawood Taylor, deals more generally with risk management in takaful undertakings, which is the responsibility of the takaful operator and needs to take account of the hybrid, two-tier structure of takaful undertakings (entailing underwriting and other risk exposures of the takaful policyholders' funds, and risk exposures of the takaful operator itself).

In Chapter 10, James Smith focuses on the key topic of solvency and capital adequacy, which is problematic because of the structural complexities of takaful undertakings with both shareholders' and policyholders' equity.

Chapter 11, by Abdulrahman Tolefat, analyzes the investment portfolios of takaful undertakings, comprising the assets of the participants' risk funds, participants' investment funds in family takaful, and shareholders' own funds. He shows how investment strategies deal with the need for liquidity, but points to possible dangers of related party investment transactions, and consequent risk concentrations.

In Chapter 12, Andrew Murray points out how the structural complexity of takaful undertakings raises difficult issues for external credit assessment institutions, and indicates how these may be dealt with.

Chapter 13, by Elham Hassan and...