Takaful islamic insurance concepts and regulatory issues

Takaful Islamic Insurance Concepts and Regulatory Issues www.ebook3000.com Takaful Islamic Insurance Concepts and Regulatory Issues Edited by Simon Archer Rifaat Ahmed Abdel Karim Volker Nienhaus John Wiley & Sons (Asia) Pte Ltd Copyright © 2009 John Wiley & Sons (Asia) Pte Ltd Published in 2009 by John Wiley & Sons (Asia) Pte Ltd Clementi Loop, #02–01, Singapore 129809 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as expressly permitted by law, without either the prior written permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center Requests for permission should be addressed to the Publisher, John Wiley & Sons (Asia) Pte Ltd., Clementi Loop, #02–01, Singapore 129809, tel: 65-6463-2400, fax: 65-6463-4605, e-mail: enquiry@wiley.com This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering professional services If professional advice or other expert assistance is required, the services of a competent professional person should be sought Neither the authors nor the publisher are liable for any actions prompted or caused by the information presented in this book Any views expressed herein are those of the authors and not represent the views of the organizations they work for Other Wiley Editorial Offices John Wiley & Sons, 111 River Street, Hoboken, NJ 07030, USA John Wiley & Sons, The Atrium, Southern Gate, Chichester, West Sussex, P019 8SQ, United Kingdom John Wiley & Sons (Canada) Ltd., 5353 Dundas Street West, Suite 400, Toronto, Ontario, M9B 6HB, Canada John Wiley & Sons Australia Ltd, 42 McDougall Street, Milton, Queensland 4064, Australia Wiley-VCH, Boschstrasse 12, D-69469 Weinheim, Germany Library of Congress Cataloging-in-Publication Data ISBN 978-0-470-82352-1 Typeset in 10.5/13pt Sabon by Laserwords Private Limited, Chennai, India Printed in Singapore by Markono Print Media Pte Ltd 10 www.ebook3000.com Contents Dedication ix About the Editors xi About the Contributors xiii Foreword xvii Acknowledgment xix Conceptual, Legal, and Institutional Issues Confronting Takaful Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus 1.1 1.2 1.3 Introduction Developments in International Prudential Guidelines for Insurance and Takaful Contents of this Book Part Business Models in Takaful and Regulatory Implications Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus 2.1 2.2 2.3 2.4 Introduction Business Models Business Structures and Regulatory Implications Regulatory Perspectives Shari’ah Principles Governing Takaful Models Dr Mohd Daud Bakar 3.1 Introduction 3.2 Takaful: Nomenclature and Conceptual Meaning 3.3 Shari’ah Principles Governing Takaful Contracts 3.4 Takaful Management Models Corporate Governance and Stakeholder Rights in Islamic Insurance Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus 4.1 4.2 4.3 4.4 4.5 Introduction The Neo-classical and Neo-corporatist Models of Corporate Governance Corporate Governance Issues in the Insurance Industry Corporate Governance Issues in Takaful Concluding Remarks v 11 20 27 31 31 32 34 42 47 47 49 53 57 65 vi Contents Legal Issues in Takaful 67 Madzlan Mohamad Hussain 5.1 Introduction 5.2 Takaful Models and their Impacts 5.3 The Legal Issues 5.4 The Call for an Effective Framework 5.5 Concluding Remarks Business Conduct in Islamic Insurance with Special Reference to Emerging Markets Arup Chatterjee 6.1 6.2 6.3 6.4 6.5 Background Business Environment in Emerging Markets Framework of Business Conduct and Best Practices Critical Drivers for Developing Market Infrastructure Conclusion Supervisory Issues in Takaful: An Overview Peter Casey 7.1 7.2 7.3 7.4 7.5 7.6 67 68 72 81 82 85 85 86 90 101 107 113 Introduction Governance Issues Financial Issues Market Conduct Issues Market Issues Supervisory Priorities 113 115 121 130 135 137 Reinsurance and Retakaful Mahomed Akoob 8.1 Introduction 8.2 What is Reinsurance? 8.3 Functions of Reinsurance 8.4 Types of Reinsurance 8.5 Proportional Reinsurance 8.6 Non-proportional Reinsurance 8.7 Reinsurance Market 8.8 Concept of Takaful 8.9 Need for Retakaful 8.10 Retakaful Models 8.11 Main Issues Raised by Retakaful 8.12 Conclusion 143 Risk Management in Takaful Abdullah Haron and Dawood Taylor 169 Part 9.1 9.2 Introduction Comparison between Conventional Insurance and Takaful www.ebook3000.com 143 143 145 145 147 149 151 151 154 156 162 167 169 172 vii Contents 9.3 9.4 9.5 9.6 Fundamental Principles of Takaful from a Risk Management Perspective Risk Issues in Takaful Undertakings Management of Risks in a Takaful Undertaking Concluding Remarks 10 Solvency and Capital Adequacy in Takaful 175 176 184 191 193 James Smith 10.1 10.2 10.3 10.4 10.5 10.6 Introduction The Need for Solvency The Principle of Solvency Traditional Approaches to Insurance Solvency Risk-based Capital Summary 11 Investment Portfolios of Takaful Undertakings 193 194 195 197 200 214 217 Dr Abdulrahman Tolefat 11.1 Total Investment Portfolio of Takaful Undertakings for All Funds 11.2 Shareholders’ Funds 11.3 Analysis of Shareholders’ Funds between the GCC Countries and Malaysia 11.4 General Fund 11.5 Analysis of General Fund between GCC and Malaysia 11.6 Family Fund 11.7 Influence of Related Parties on the Investment Portfolios of Participants’ Funds 11.8 Summary and Conclusions 12 Issues in Rating Takaful Companies Andrew Murray 12.1 12.2 12.3 12.4 12.5 12.6 Introduction What is a Credit Rating? Types of Credit Rating Credit Rating Basics Key Issues for Rating Takaful Firms Conclusion 13 Transparency and Financial Reporting in Islamic Insurance Elham Hassan and Andre Rohayem 13.1 Introduction 13.2 Stakeholders Need Transparency in Financial Reporting by Islamic Insurance Companies 13.3 Existing Islamic Insurance Financial Reporting Framework Should be Improved to Achieve Greater Transparency 13.4 Conclusion 218 219 224 226 229 232 234 236 239 239 240 240 241 243 263 265 265 266 274 283 viii Contents Part 14 Concluding Remarks 287 Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus 14.1 Introduction 14.2 The Structure of Takaful Undertakings and Resultant Unresolved Issues 14.3 Corporate Governance and Related Matters 14.4 The Need for, and Scope of, a Comprehensive Regulatory Framework for Takaful 14.5 The Work of the IFSB in Developing International Prudential Guidelines for Takaful Undertakings 14.6 Some Thoughts for the Future 287 Bibliography 297 Index 301 www.ebook3000.com 288 289 292 293 294 Dedication We would like to dedicate this book to our wives Iglal, Evelyne, and Hannelor About the Editors Professor Simon Archer is Visiting Professor at the ICMA Centre, Henley Business School, University of Reading (U.K.), where he teaches on an MSc program, Investment Banking and Islamic Finance Previously, he was Professor of Financial Management at the University of Surrey (U.K.) having been Midland Bank Professor of Financial Sector Accounting at the University of Wales, Bangor After studies in Philosophy, Politics, and Economics at Oxford University, he qualified as a Chartered Accountant with Arthur Andersen in London and then moved to Price Waterhouse in Paris, where he became a Partner in Management Consultancy Services In addition to being co-editor of, and chapter contributor to, Islamic Finance: Innovation and Growth, and Islamic Finance: The Regulatory Challenge (published by John Wiley), Professor Archer is co-author of the CCH International Accounting/Financial Reporting Standards Guide and the author of a considerable number of academic papers on international accounting and on accounting, finance, and related issues in Islamic financial institutions He also supervises research students in these areas He has carried out a number of consultancy assignments for the Accounting and Auditing Organization for Islamic Financial Institutions, the Islamic Financial Services Board, and the World Bank on issues connected with Islamic finance Professor Rifaat Ahmed Abdel Karim has been the Secretary-General of the Islamic Financial Services Board since 2002 Prior to his current position, Professor Rifaat was the Secretary-General of the Accounting and Auditing Organization for Islamic Financial Institutions, a post he held for more than eight years He was a member of the Standards Advisory Council of the International Accounting Standards Board for two terms, and is currently a member of the Consultative Advisory Group of the International Auditing and Assurance Standards Board Professor Rifaat was a Visiting Professor at Surrey University (U.K.) and Honorary Professor at Monash University (Australia) He is currently a Visiting Professor at Reading University (U.K.) Professor Rifaat is the co-author of Business and Accounting Ethics in Islam, the Euromoney bestseller book Islamic Finance: Innovation and Growth, and Islamic Finance: The Regulatory Challenge recently published by John Wiley He is also the author of many academic and professional xi www.ebook3000.com xii About the Editors papers on accounting, governance, and finance issues in Islamic banking and finance Dr Volker Nienhaus was Professor of Economics at the German universities of Trier (1989–90) and Bochum (1990–2004) before he became President of the University of Marburg (election period 2004–10) He has published numerous books and articles on Islamic economics and Islamic banking and finance since the 1980s He was a member of several academic advisory boards of public and private institutions in Germany, including the German Orient-Foundation (1993–2006) and the Federal Ministry of Economic Cooperation and Development (1998–2008) In 2006, he was appointed a member of the Governing Council of the International Centre for Education in Islamic Finance (INCEIF) in Kuala Lumpur He is also consultant to the Islamic Financial Services Board on governance issues of takaful operations 302 business conduct in Islamic insurance (continued) institutional development and marketing, promoting, 106 insurance education, supporting, 104–105 insurance regulation, improving, 101–103 market discipline on institutions, invoking, 101 market-led initiatives, 101 micro-level outcomes, 108 on-the-job training, 104 risk-based approach to business conduct, 108 self-regulatory organizations, promoting, 106 Shari’ah arbitrage, 103 Shari’ah compliance throughout product life cycle, 104 supervision, improving, 101–103 systemic level outcomes, 108 in emerging markets, 86–90 ex ante Shari’ah compliance, 85 framework of, 90–100 IAIS Insurance Core Principles, 91–92, See also individual entry market conduct requirements, 90–91 frequency of reporting, 85 intermediation, 86 issues, 291–292 offsetting factors, 86 ongoing monitoring of compliance, 85 principles for, 99 complaints, 100 conflicts of interest, 100 disclosure of information to customers, 99 Index information about customers, 99 integrity, 99 management and control, 100 prudence, 99 relationship with regulators, 100 skill, care, and diligence, 99 transparency, 85 business continuity risk, in takaful undertaking, 190 business models in takaful, 9–30, See also Shari’ah principles; standard models and variants basic structure, 11–13 for family takaful, 11–12 for general takaful, 11–12 capital adequacy, 20–21 commissions (in family takaful), 23–24 disclosure, 22–25 multiple fees and charges, 22–23 solvency, 20–21 transparency, 22–25 business risk, 171 business structures, 20–27 complexity of, 24–25 white label bancatakaful model, 24 governance structure, embodiment of participants’ interests in, 25–27 C capital, 203–207, See also risk-based capital (RBC) in takaful capital adequacy in takaful, See solvency, requirements issue raised by retakaful, 163–164 capitalization, rating issues, 249–253 303 Index Fitch’s review, 250–253 investments, 255–256 overall undertaking assessment, 251 qard hasan, 252, 253–255 suitable contractual and other documentation, 252 suitable local legislation, 251–252 takaful fund assessment, 250 takaful operator assessment, 250–251 mutual takaful firms, 249–250 ceding, 147–148, 161 challenges facing takaful firms, addressing, 260–261 commissions, in family takaful, 23–24 long-term contracts, 24 pro rata payments, 24 surplus sharing, 24 common authorities, 76 compatibility, retakaful model, 159–160 mudarabah model, 160 wakalah model, 160 premium flow, 161 waqf model, 160 compensation, conventional versus takaful, 32–33 for damages, competence of supervisory staff, issue, 138 in a formal sense, 138 in a practical sense, 138 complexity of business structures, 24–25 compliance risk with regard to Shari’ah rules, 189–190 comprehension issue, 133 comprehensive regulatory framework for takaful, 292–293 need for, 292–293 scope of, 292–293 ‘conditional donation’, concentration risk, 125 concept of takaful, 151–154 dhulum (injustice), 153 gharar (uncertainty), 152 maisir (speculation), 152 riba, 152 tabarru’, 152 conceptual issues confronting takaful, 1–5 conceptual meaning, takaful, 32–34 Consumer Protection, 93–94 contract administration charges, 22 contracts, takaful, shari’ah principles governing, 34–42 basis of, 34–37 gharar, 35 inter alia, 34 riba, 34 Contracts Act, 1950, 75 contractual clauses manipulation issue, 77–78 contractual relationship, conventional versus takaful, 173 control rights, 48 control structure in takaful undertakings, 25 conventioanl mutuals, 53–54 conventional insurance, drawbacks in, 10 sub-marginal risks in, 23 waqf and, 17 conventional insurance and takaful, comparison, 172–174 access to capital, 174 contractual relationship, 173 differences between, 172 mutual insurance, 172–173 www.ebook3000.com 304 conventional insurance and takaful, comparison (continued) proprietary insurance, 172–173 insurer/operator, liability, 174 investment of fund, 174 policyholders/participants responsibility, 173 corporate governance (CG) in Islamic insurance, 47–66, 289–292, See also neo-classical model; neo-corporatist model conventioanl mutuals, 53–54, See also mutual insurance corporate social responsibility issue, 51–52 definition, 47–48 Fitch’s review, 243 governance issues, 60–63 issues, 30, 57–64 policyholders as stakeholders, 59–60 rating issues, 244–246 shareholders as stakeholders, 58–59 underwriting surplus, 60 proprietary companies, 53–56, See also proprietary insurance risk management and investment, 289 corporate sukuk, 225 coverage, reinsurance, 145 credit rating, 239, 240, See also Fitch’s review basics, 241–243 qualitative factors, 242 quantitative fcators, 242 sukuk ratings, 242 Fitch’s review, 242 international scale, 240 ‘investment grade’ rating scale, 240 Index national scale ratings, 240 speculative grade rating scale, 240 types, 240 credit risk, 209–210 D data, collecting and sharing, for business conduct, 103–104 Dawawin, 37 deficits, cover, 10 takaful participants in, 10 dharuura (necessity), 162 dhulum (injustice), 153 different tiers of capital, 207–208 disclosure issue, 22–25, 131–133 disclosures to market, 127–128 distribution channel, 18 donation (tabarru’), 9–10, 33, 37, 175 ‘conditional donation’, ‘double-gearing’, 204 E educating markets and consumers on standards, for business conduct, 105–106 emerging markets, 85–111, See also business conduct in Islamic insurance business environment in, 86–90 accounting systems, 87 gambling, 89 lax management problem, 87 regulation framework, 86 reliable basic data, 88 reliable mortality tables, 88 supervision framework, 86 take-up of insurance, 89 common market conduct compliance criticisms, 88 ethical market discipline, encouraging, for business conduct, 106 305 Index ex ante Shari’ah compliance, 85 ex gratia payments, 135 explicit solvency requirements, 199 F facultative/obligatory reinsurance, 146 facultative reinsurance, 145 family fund/family takaful, 217 commissions in, 23–24 investment portfolio composition, 218, 232–234 equities, 233 investment accounts, 233 long-term investments, 234 risk protection, 233 savings, 233 short-term investments, 234 sukuk, 233 ownership of funds in, 38–39 pension plans, 179 run-off, 130 structure of, 11–12 participants’ investment accounts (PIAs), 12 participants’ investment fund (PIF), 12 participants’ risk accounts’ (PRAs), 11–12 participants’ takaful fund (PTF), 11–12 shareholders’ fund (SHF), 11–12 undertakings, risk issues in, 178, 191 fatwa (religious edict), 35, 45, 74, 280–281 fiduciary risk management in takaful undertakings, 171, 185–190 investment risk, 186 underwriting risk, 186–187 final risk bearer, conventional versus takaful, 28–29 financial flexibility, rating issues, 249–253 financial inclusion, promoting, for business conduct, 107 financial issues, 121–130 asset risk, 125 assets valuation, 122 concentration risk, 125 disclosures to the market, 127–128 displaced commercial risk, 124 family takaful business, 123 group supervision, 126–127 insolvency, 128–129 liabilities valuation, 122 in prudential supervision, 124 reinsurance receivables, 125 run-off, 129–130 family takaful, 130 general takaful, 130 takaful-specific issues, 123 entities identification, 123 legal entity, 123 financial reporting in Islamic insurance, 265–284, See also stakeholders need of transparency AAOIFI standards, 275 financial review, Fitch’s, 243 financial strain, 136 ‘firm within a firm’ dichotomy, 70–72 Fitch’s review of insurance company, 239, 242–243, See also under capitalization corporate governance review, 243 financial review, 243 industry review, 242 management review, 243 operational review, 242 organizational review, 242 www.ebook3000.com 306 formal training programs, for business conduct, 104 fraud, 92, 96–97 frequency of reporting, 85 fund deficit, qard facility to meet, 78–79 fund management charges, 22 G general funds/general takaful, 217 GCC versus Malaysia, 2002–, 05, 227–229 aggressive investment, 230–231 analysis, 229–232 long-term investment portfolio, 229 short-term investment portfolios, 229 investment portfolios, 218, 226–229 ownership of funds in, 38 structure of, 11–12 participants’ risk accounts’ (PRAs), 11–12 participants’ takaful fund (PTF), 11–12 shareholders’ fund (SHF), 11–12 total general fund investment portfolio, 226 undertakings, risk issues in, 178 gharar (uncertainty), 35, 67, 152 Glass-Steagall Act, 82 global standard of retakaful, 162–163 globalization challenge of corporate governance, 52 Governance Committee (GC) set up proposal, 27 governance issues, in Islamic insurance, 60–63 dissatisfaction with TO, 61 Index in supervision, 115–121, See also under supervision underwriting surplus, 62 governance risk, 188–189 governance structure, embodiment of participants’ interests in, 25–27 government sukuk, 225 growth related issues, 136 Gulf Cooperation Council (GCC) group study, 218–221, See also under general funds H ‘hybrid’ approach, 69 I IAIS Insurance Core Principles, 2, 91–92, 197 ICP 24 Intermediaries, 92–93 ICP 25 Consumer protection, 92, 93–94 ICP 26 Information, disclosure and transparency toward the market, 92, 95–96 ICP 27 Fraud, 92, 96–97 ICP 28 Anti-money laundering, combating the financing of terrorism (AML/CFT), 92, 97–100 ijarah, 294–295 implied authorities, 76 indemnity, 33, 77 industry review, Fitch’s, 242 information rights, 48 insolvency, 128–129 institutional development and marketing, promoting, for business conduct, 106 institutional issues confronting takaful, 1–5 mutual structure adoption, obstacles, 307 Index insurance education, supporting, for business conduct, 104–105 insurance regulation, improving, for business conduct, 101–103 Insurer Financial Strength (IFS) rating, 240 insurer/operator liability, conventional versus takaful, 174 inter alia, 34 interest-free loan, See qard hasan, intergenerational equity issue in mutual insurance, 56 intergenerational equity, 206 intermediaries, 108, 134 essential criteria, 93 ICP, 24, 92–93 supervision issues in, 134 intermediation, Islamic financial, 86 internal capital model, 211–212 International Association of Insurance Supervisors (IAIS), See IAIS, International Financial Reporting Standards (IFRS), 274 international prudential guidelines for takaful undertakings, developments in, 2–3 IFSB in, 293–294 international scale, 240 investment activities of takaful operators, 80 ‘investment grade’ credit rating scale, 240 investment of fund, conventional versus takaful, 174 investment portfolios of takaful undertakings, 217–238, See also family fund; general funds; share holders’ funds Gulf Cooperation Council (GCC) group study, 218–219 family funds, 219 general funds, 219 shareholders’ funds, 219 participants’ funds, related parties influence on, 234–236 non-parametric Wilcoxon Ranked Signed Test, 235 total investment portfolio, 218–219 investment risks, 169, 186 in takaful undertakings, 180–181 investments, rating issues, 255–256 Islamic Financial Services Board (IFSB), K kafalah, 37 L legal issues in takaful, 1–5, 67–83, 290–291 conflict of laws and their interpretation, 72–73 contractual clauses manipulation, 77–78 effective framework, call for, 81–82 ‘firm within a firm’ dichotomy, 70–72 ‘hybrid’ approach, 69 investment activities of takaful operators, 80 in Malaysia, 73–75 mandate (and breaches of it) by takaful agent, 75–76 common authorities, 76 express authorities, 75 implied authorities, 76 nomination clause effect, on mirath, 74 www.ebook3000.com 308 legal issues in takaful (continued) on wasiyah, 74 proprietorship licensed as takaful operator, 69 qard facility to meet fund deficit, 78–79 retakaful, 77 Shari’ah boards status, 80–81 Shari’ah issues, 72 structure through which takaful undertaking is offered, 69 waqf framework, 74–75 licensing process issues, 136 life insurance, 54, 169 CG issues in, 55 liquidity risk, 169, 181, 209–210 loss distribution under proportional reinsurance, 149 M maisir (speculation), 67, 152 management review, Fitch’s, 243 management strain, 136 management takaful models, 42–45 mudarabah, 42–44 TO engagement modes in, 43 wakalah, 42–44 and mudarabah combination, 42–44 mandate (and breaches of it) by takaful agent, 75–76 common authorities, 76 express authorities, 75 implied authorities, 76 Mann-Whitney U Test, 231 market, reinsurance, 151 market conduct issues, 130–135 capital adequacy, 132 comprehension, 133 contract terms, 131 disclosure, 131–133 ex gratia payments, 135 market conduct regimes, 131 Index point of sale, 131 pricing, 131 suitability, 131–133 market discipline on institutions, invoking, for business conduct, 101 market issues, 135–137 growth related, 136 financial strain, 136 internal new product approval process, 136 licensing process, 136 management strain, 136 supervisory considerations, 135 market-led initiatives, for business conduct, 101 market risk, 180, 209–210 micro-level outcomes, for business conduct, 108 models of takaful and their impacts, 68–72 modified mudarabah model, 13–14 monitoring, neo-classical model of CG, 50 mudarabah (profit-sharing) model/contracts, 13, 62, 68, 245 in Malaysia, 15 management, 42–44 practical features, 43 modified mudarabah model, 13–15 mudarabah and wakalah contracts, comparison, 182–183 investment, 182 management expenses, 182 underwriting, 182 pure mudarabah model, 14 Shari’ah compliance of, 14–15 mudarib share, 59 multiple fees and charges, 22–23 contract administration charges, 22 309 Index fund management charges, 22 upfront payment, 22 mutual insurance, 10 mutual insurance, CG issues in, 56–57 governance structure creation, 56 underwriting reserves related, 56 equitable life crisis in U.K, 57 intergenerational equity, 56 ‘orphan assets’, 57 policyholders failure to exercise control rights, 57 mutuality element, 31 in risk pool for takaful, 28 N national scale ratings, 240 neo-classical model of CG, 49–52 considerations, 49–51 bonding, 50 monitoring, 50 principal–agent problems, 49–50 in U.K., 50 in U.S., 50 corporate social responsibility issue, 51–52 globalization challenge, 52 ‘responsible shareholder’ concept, 51 neo-corporatist model of CG, 52–53 corporate social responsibility issue, 52 globalization challenge, 53 two-tier board structure, 52 nomenclature, takaful, 32–34 nomination clause effect, Malaysia, 74 on mirath (succession or inheritance), 74 Pakistan, 74 on wasiyah (will or bequest), 74 Nominations Committee, 51 non-commercial takaful business model, 246 non-life insurance, 54, 169 non-parametric Wilcoxon Ranked Signed Test, 235 non-proportional reinsurance, 146, 149–151 first layer reinsurers, 150 loss allocation of, 150 second layer reinsurers, 150 structure of, 150 third layer reinsurers, 150 non-Shari’ah-compliant, 80 O obligatory reinsurance, 145–146 ongoing monitoring of compliance, 85 on-the-job training, for business conduct, 104 operational review, Fitch’s, 242 operational risk, 169, 171, 188–189, 209–210 operator’s (or shareholders’) fund, 204 organizational review, Fitch’s, 242 ‘orphan assets’ issue in mutual insurance, 57 ownership of takaful fund, 38–39 family takaful, 38–39 in general takaful, 39 participants, 38–39 P participants’ interests, in governance structure, embodiment of, 25–27 actuarial recommendations, 26 Governance Committee (GC) set up proposal, 27 mandate of the Shari’ah board extension proposal, 26 proposals for, 26–27 participants’ investment account (PIA), 123–124 www.ebook3000.com 310 participants’ investment fund (PIF), 11 participants’ risk accounts (PRAs), 11 participants’ special accounts (PSAs), 11 participants’ takaful fund (PTF), 11–12 policyholders, needs, in financial reporting, 272–273 policyholders/participants responsibility, conventional versus takaful, 173 as stakeholders, issue in CG, 59–60 status issue in proprietary insurance, 54 premium, 144 flow of proportional reinsurance, 148 pricing issue, 131 pro rata payments, 24 ‘profit equalization reserve’ (PER), 62 profitability, rating issues, 257 property rights, 48 proportional facultative reinsurance, 146 proportional reinsurance, 147–149 loss distribution under, 149 premium distribution under, 147 premium flow of, 148 proportional treaty reinsurance arrangements, 148 reinsurance commission, 148 risk under, 147 proportional treaty reinsurance, 146 proprietary insurance, 66, 70–72, 172 CG issues in, 53–56 neo-corporatist perspective, 55 Index policyholders status, 54 regulatory requirements regarding information rights, 55 prudential standards for insurance and takaful, developments in, 2–3 pure mudarabah model, 14 Q qard hasan (interest-free loan), 11, 16, 33, 40–41, 66, 155, 159, 172, 204, 252, 253–255, 290–291 credit for existing interest-free loans, 254–255 equity credit, 254 Fitch’s ‘weakest link’ methodology, 254 credit for potential future interest-free loans, 255 to meet fund deficit, 78–79 as regulatory capital of risk fund, 204 R rating issues in takaful companies, 239–264, See also accounting; capitalization; credit rating fitch ratings, 239 key issues, 243–263 accounting, 258–263 business structure, 244 capitalization, 249–253 CG and management, 244–246 effective business model, 244 financial flexibility, 249–253 investments, 255–256 legal and regulatory framework, 246–248 mudarabah contracts, 245 311 Index non-commercial takaful business model, 246–247 products, 248–249 profitability, 257 rating methodology issues, 261–262 regulation, 258–263 reinsurance, 256 risk management, 257–258 shareholders’ fund separated from policyholders’ fund, 250–253 Takaful Act of, 1984, 246 wakalah contracts, 245 methodology issues, 261–262 takaful/retakaful firms, 261–262 raised by retakaful, 164 typical ratings process, 241 ratio-based solvency requirements, 198 regulation, rating issues, 258–259 key challenge for regulators, 258 protection of participants, 259 regulatory implications, 20–27 regulatory perspectives, 27–30 and supervision, 115, 120 reinsurance, 143–168, See also non-proportional reinsurance; proportional reinsurance; retakaful description, 143–145 facultative reinsurance, 145 facultative/obligatory reinsurance, 146 functions of, 145 market, 151 methods of, 146 non-proportional facultative, 146 non-proportional treaty, 146 obligatory reinsurance, 145 proportional facultative, 146 proportional treaty, 146 rating issues, 255–256 reinsurance coverage, 145 treaty reinsurance, 146 types, 145–146 related party influence, on participants’ funds, 238 related party transactions, 79 Remuneration Committee, 51 remuneration structure of TO, 22 reputational risk, 171, 189 ‘responsible shareholder’ concept, 51 retakaful, 77, 143–168 advantages, 155 arrangement, 77 global standard of, 162–163 main issues raised by, 162–167 asset-management capabilities, 164 capital requirements, 163–164 full Shari’ah compliance, 162 handling high-severity, low-frequency risks, 166 rating, 164 retakaful pool, building, 164–165 need for, 154–155 retail takaful operation, 216 retakaful arrangements, 12 solvency computing of retakaful undertakings, 166–167 retakaful models, 156–162 basic features of, 156 mudarabah model, 156 wakalah model, 156 waqf model, 156 basic model, 157–159 retakaful contracts, 158 retakaful contribution, 158 retakaful operator, 157–161 retakaful pool, 157–161 tabarru’, 159 compatibility, 159–160 in the market, 156–157 retakaful operators, 164 www.ebook3000.com 312 retakaful pool, building, issue raised by retakaful, 164–165 retrotakaful firms, 167, 256 riba (usury), 34, 67, 152, 175 risk, definition, 143–144 handling high-severity, low-frequency risks issue raised by retakaful, 166 risk cover, in conventional insurance, 11 risk fund, 33 risk-based approach, to business conduct, for business conduct, 108 to solvency, 193–194 risk-based capital (RBC) in takaful, 193–194, 200–214 Basel Accords framework, 201–202 capital adequacy requirement, 203 capital for regulatory purposes, 203 credit risk, 209–210 different tiers of capital, 207–208 difficulties in, 202 funds in, 204 operator’s (or shareholders’) fund, 204 risk fund, 204 internal capital model, 211–212 liquidity risk, 209–210 lower-quality capital, 207 market risk, 209–210 minimum capital requirement, calculating, 211 nature of capital, 203–207 operational risk, 209–210 qard hasan as regulatory capital, 204 Solvency II, 211 Index solvency requirements, 208–214 benchmark, 208 risk analysis, 208 standard risk weighting models, 201 top-quality capital, 207 underwriting risk, 209–210 risk issues in takaful undertakings, 176–183 actuarial risk, 178 associated with funds, 177 balance sheet analysis, 176 family takaful, 176 shareholders’ funds, 176 underwriting (takaful) funds, 176 contractual relationship between TO and participants analysis, 176 family takaful pension plans, 179 family takaful undertakings, 178–179 general takaful undertakings, 178–179 investment risk, 180–181 asset risk profile, 180 ‘liquidity risk’, 181 ‘market risk’, 180 solvency, 179 TO and takaful participants, relationship between, 181–183 underwriting risk, 177–179 risk management in takaful, 169–191 business risk, 171 fiduciary risk, 171 fundamental principles, 175–176 ceding, 175 riba, 175 tabarru’, 175 importance of, 170 investment risks, 169 liquidity risk, 169 313 Index operational risk, 169, 171 rating issues, 257–258 reputational risk, 171 risk management in takaful undertaking, 184–190 broad-based risk management system, 185 business continuity risk, 190 compliance risk with regard to Shari’ah rules, 189–190 fiduciary risk, 185–190 governance risk, 188–189 investment risk, 186 objectives, 184–185 operational risk, 188–189 relating to TO, 188–190 reputational risk, 189 risk–reward in takaful undertakings, 25 ´ risk sharing vis-a-vis risk transfer, 37–38 risk transfer, conventional versus takaful, 28–29, 32–33 risks, takaful operators (TOs) exposed to, 171 run-off, 129–130 general takaful, 130 S self-regulatory organizations, promoting, for business conduct, 106 separate fund solvency, 197 share holders’ funds (SHF), investment portfolios, 219–223 2002–, 05, 222 in Bahrain, 221 in GCC countries, 220 between GCC countries and malaysia, analysis, 224–226 GCC versus Malaysia, 2002–05, 222–223 Malaysia, 221 management strategies, 225–226 sukuk proportion in, 221–224 shareholder surplus and regulatory surplus, relationship between, 196 shareholders as stakeholders issue in CG, 58–59 Shari’ah arbitrage, for business conduct, 103 Shari’ah board, extension mandate for participants’ interests, 26 status issue in takaful, 80–81 Shari’ah compliance, 80 issue raised by retakaful, 162 throughout product life cycle, for business conduct, 104 Shari’ah principles governing takaful models, 31–45, See also management takaful models commercial perspective, 34 donation, 33, 37 economic perspective, 33–34 fatwa, 35 liquidation of TO, 39 ownership of takaful fund, 38–39 qard hasan, 33, 40–41 risk fund, 33 ´ risk sharing vis-a-vis risk transfer, 37–38 risk transfer, 32–33 tabarru’, 35–36 takaful contracts, governing, 34–42, See also contracts takaful operator obligation in takaful fund deficit, 40–42 TO’s perspective, 33134 underwriting surplus, 34 www.ebook3000.com 314 solvency in takaful, 20–21, 193–215, 290–291, See also risk-based capital (RBC) computing of retakaful undertakings, 166–167 need for, 194–195 principle of, 195–197 separate fund solvency, 197 shareholder surplus and regulatory surplus, relationship between, 196 Solvency I, 215 Solvency II, of takaful undertaking, 179 traditional approaches to, 197–200 explicit solvency requirements, 199 International Association of Insurance Supervisors, 197 ratio-based, 198 specificities of Islamic insurance companies, 270–272 conventional and takaful, comparison, 271–272 speculative grade rating scale, 240 stakeholder rights in Islamic insurance, 47–66, See also neo-classical model; neo-corporatist model board of directors (BoD) in, 50–51 control rights, 48 information rights, 48 property rights, 48 stakeholders need of transparency in financial reporting, 266–274 comparability, 269 definition, 266–267 financial information disclosure, 267 information disclosure, 266 Index meaning, 266 sound reporting, criteria for, 268–270 specificities, 270–272 timeliness, 269 understandability, 269 voluntary financial reporting, 267–268 current market practice, 267 future financial reporting trends, 268 stakeholders of Islamic insurance companies, financial reporting needs of, 272–274 existing reports, improving, 274–283 IFRS, 274 policyholders, 272–273 regulators, 272 shareholders, 272 Shari’ah supervisors, 272 stakeholders, 272 standard models and variants in takaful, 13–20, See also bancatakaful model;mudarabah (profit-sharing) model;wakalah (agency) model sub-marginal risks, in conventional insurance, 23 in takaful, 23 subrogation, 77 Sudan, Islamic insurance model in, 63–64 Policyholders Protection Fund (PPF), 63 policyholders rights, 63 shareholders rights, 64 suitability issue, 131–133 sukuk credit ratings, 242 sukuk proportion in share holders’ funds, 221–227 315 Index corporate sukuk, 225 in GCC countries, 225 government sukuk, 225 supervision/supervisory issues in takaful, 113–139, See also financial issues; market conduct issues; market issues governance issues in, 115–121 conflicts in investment management, 118 failures of Shari’ah governance, 116 firms operation, 117 misalignment of the interests in arrangement, 116, 118 policyholders’ interests protection issue, 119 at regulatory level, 116 shortage of Shari’ah scholars, 117–118 takaful-specific issues, 115–117 improving, for business conduct, 101–103 preconditions for, 113 in prudential supervision, 124 regulatory provisions and, 115, 120 supervisory competence, 138–139 supervisory priorities, 137–139 windows, 120–121 ‘surrender value’, 54 systemic level outcomes, 108 T ta’awun (solidarity and mutual assistance), 67–68 tabarru’ (donation or contribution) concept, 35–36, 45, 67–68, 152–153, 162, 175 Takaful Act, 1984, 73, 76, 81, 246 takaful fund, 39, 158 takaful operators (TOs), 11–12, 69 obligation in takaful fund deficit, 40–42 takaful participants (TPs), 11 in deficit cover, 10 takaful scheme, 39, 69 takaful undertakings, 170, 175, 178 international prudential guidelines for, IFSB in, 293–294 structure, unresolved issues of, 288 temporary interest free loan, 30 total investment portfolio of takaful undertakings, 218–219 traditional approaches to insurance solvency, 197–200 Transactions Cost Economics (TCE), 47–48 transparency in Islamic insurance, 22–25, 85, 265–284, See also stakeholders need of transparency creation, ways of, 279–283 enhanced disclosures, 281–282 proper application of the financial reporting framework, 280 robust CG rules, implementation, 282–283 Shari’ah supervisory boards’ decisions and fatawa, proper communication, 280–281 treaty reinsurance, 146 ‘tri-partism’, 52 turnover-related fees, 13 U uncertainty, 143–144 frequency, 143–144 severity of the occurrence, 143–144 www.ebook3000.com 316 underwriting in takaful, 170, 176–179, 186–187, 209–210 deficit in waqf model, 17 underwriting surplus, 34, 60, 66 unresolved issues, takaful undertakings structure, 288 upfront payment, 22 V variants in takaful, 13–20 modified mudarabah model, 13 wakalah model with performance fees, 13 voluntary financial reporting, transparency in, 267–268, See also under stakeholders need of transparency W wakalah (agency) model, 13–14, 68, 156 management, 42–44 practical features, 43 Index with performance fees, 13–14 turnover-related fees, 13 wakalah mudarabah model, 13, 15 wakalah mudarabah waqf model, 13, 15–17 wakalah contracts, 59, 62, 245 wakalah/mudarabah combination, management, 42–44 practical features, 43 waqf (endowment) models, 15–17, 68, 156 issue in takaful, 74–75 purpose of, 16 Shari’ah scholars, 16 in underwriting deficit, 17 ‘weakest link’ methodology, Fitch’s, 254 white label bancatakaful model, 19–20 Wilcoxon Ranked Signed Test, 235 windows, 120–121 existence, implications, 120 ... perspective, Takaful Islamic Insurance: Concepts and Regulatory Issues is a timely and welcomed addition to the growing body of literature on takaful The book is edited by three eminent scholars and practitioners... auditing and providing advisory services to insurance and reinsurance companies He has also advised and assisted several investors and multinational companies in the establishment of insurance and takaful. .. encouragement and support every step of the way xix www.ebook3000.com Takaful Islamic Insurance: Concepts and Regulatory Issues Edited by Simon Archer, Rifaat Ahmed Abdel Karim and Volker Nienhaus