Standard on Solvency Requirements for Takaful (Islamic Insur
ISLAMIC FINANCIAL SERVICES BOARD
EXPOSURE DRAFT
STANDARD ON SOLVENCY REQUIREMENTS FOR
TAKĀFUL (ISLAMIC INSURANCE) UNDERTAKINGS
Comments on this Exposure Draft should be sent
to the IFSB’s Secretary-General not later than 15 05 2010
at email ifsb_sec@ifsb.org or facsimile +603-26984280
December 2009
ABOUT THE ISLAMIC FINANCIAL SERVICES BOARD (IFSB)
The IFSB is an international standard-setting organisation which was officially inaugurated on
3rd November 2002 and started operations on 10th March 2003. The organisation promotes
and enhances the soundness and stability of the Islamic financial services industry by issuing
global prudential standards and guiding principles for the industry, broadly defined to include
banking, capital markets and insurance sectors. The standards prepared by the IFSB follow a
lengthy due process as outlined in its Guidelines and Procedures for the Preparation of
Standards/Guidelines, which involves, among others, the issuance of exposure drafts, holding
of workshops and where necessary, public hearings. The IFSB also conducts research and
coordinates initiatives on industry-related issues, as well as organises roundtables, seminars
and conferences for regulators and industry stakeholders. Towards this end, the IFSB works
closely with relevant international, regional and national organisations, research/educational
institutions and market players.
For more information about the IFSB, please visit www.ifsb.org
TECHNICAL COMMITTEE
Chairman
H.E. Dr Abdulrahman A. Al-Hamidy – Saudi Arabian Monetary Agency
Deputy Chairman
Mr. Osman Hamad Mohamed Khair – Central Bank of Sudan (until 15 August 2009)
Members*
Dr Sami Ibrahim Al-Suwailem Islamic Development Bank
Mr Khalid Hamad Abdulrahman Hamad Central Bank of Bahrain
Mr Gamaal M. Abdel-Aziz Negm Central Bank of Egypt
Dr Mulya Effendi Siregar
Bank Indonesia
(until 31 Mar 2009)
Mr Ramzi A. Zuhdi
Bank Indonesia
(from 1 April 2009)
Mr Hamid Tehranfar
Central Bank of the Islamic Republic of Iran
(until 31 Mar 2009)
Mr Abdolmahdi Arjmand Nehzad
Central Bank of the Islamic Republic of Iran
(from 1 April 2009)
Dr Mohammad Yousef Al-Hashel Central Bank of Kuwait
Mr Bakarudin Ishak
Bank Negara Malaysia
(until 31 Mar 2009)
Mr Ahmad Hizzad Baharuddin
Bank Negara Malaysia
(from 1 April 2009)
Dr Nik Ramlah Mahmood Securities Commission of Malaysia
Mr Pervez Said
State Bank of Pakistan
(until 31 Mar 2009)
Ms Lubna Farooq Malik
State Bank of Pakistan
(from 1 April 2009)
Mr Mu’jib Turki Al Turki Qatar Central Bank
Dr Abdulaziz Abdullah Al Zoom Capital Market Authority of Saudi Arabia
Mr Chia Der Jiun Monetary Authority of Singapore
Mr Saeed Abdulla Al-Hamiz
Central Bank of United Arab Emirates
(until 31 Mar 2009)
Mr Khalid Omar Al-Kharji
Central Bank of United Arab Emirates
(from 1 April 2009)
- In alphabetical order of the country the member represents
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SOLVENCY REQUIREMENTS FOR TAKĀFUL OPERATIONS WORKING GROUP
Chairman
Mr. Chia Der Jiun - Monetary Authority of Singapore
Deputy Chairman
Mr. Osman Hamad Mohamed Khair - Central Bank of Sudan
Members*
Mr Muhammad Azam The Islamic Corporation for the Insurance of
Investment and Export Credit
Mr Fouad A. Wahid Abdulla Central Bank of Bahrain, Bahrain
Ms Zarita Barkhuizen Hannover Retakaful, Bahrain
Mr Vasilis Katsipis A.M. Best Europe
Dr Manfred Dirrheimer FWU Group, Germany
Mr James A. Smith Ernst & Young (Hong Kong), Hong Kong
Mr Ir. Isa Rachmatarwata M. Math Ministry of Finance, Indonesia
Ms Yatty Nurhayati Ministry of Finance, Indonesia
Mr Murad Al-Haj Mahmoud Insurance Commission of Jordan, Jordan
Mr Alfadino Akbar Ali Akbar Bank Negara Malaysia, Malaysia
Mr Mohamed Hassan Md Kamil Syarikat Takaful Malaysia Berhad, Malaysia
Mr Adel Saleh Abalkhail Saudi Arabian Monetary Agency, Saudi Arabia
Mr Dawood Taylor Prudential Ltd, Saudi Arabia
Mr Wan Siew Wai Fitch Ratings Singapore Pte. Ltd., Singapore
Mr Nazeem Ebrahim Oasis Group Holdings (Pty) Ltd., South Africa
Mr Peter Casey Dubai Financial Services Authority, United Arab
Emirates
Mr Parvaiz Siddiq Noor Takaful, United Arab Emirates
- In alphabetical order of the country of which the member’s organisation represents
ISLAMIC DEVELOPMENT BANK SHARĪ`AH COMMITTEE*
Chairman
Sheikh Mohamed Mokhtar Sellami
Deputy Chairman
Sheikh Saleh Bin Abdulrahman Bin Abdulaziz Al Husayn
Sheikh Dr Abdulsattar Abu Ghuddah Member
Sheikh Dr Hussein Hamed Hassan Member
Sheikh Mohammad Ali Taskhiri Member
Sheikh Mohamed Hashim Bin Yahaya Member
SECRETARIAT, ISLAMIC FINANCIAL SERVICES BOARD
Professor Rifaat Ahmed Abdel Karim Secretary-General
Mr Martin Roberts Consultant
Professor Simon Archer Consultant
Azli Munani Assistant Project Manager
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Table of Contents
ACRONYMS ............................................................................................................................. IV
A. INTRODUCTION ............................................................................................................. 1
Background................................................................................................................... 1
General Principle .......................................................................................................... 1
Main Objectives ............................................................................................................ 2
Scope of Application..................................................................................................... 2
Specificities of Solvency Requirements for Takāful (Islamic Insurance) Undertaking . 2
Valuation of Assets and Liabilities ................................................................................ 5
Valuation of Technical Provisions....................................................................... 5
B. KEY FEATURES FOR MINIMUM SOLVENCY REQUIREMENTS................................. 6
DEFINITIONS .......................................................................................................................... 24
APPENDIX............................................................................................................................... 27
iii
ACRONYMS
BOD Board of directors
IAIS International Association of Insurance Supervisors
ICP Insurance Core Principles of the IAIS
IFSB Islamic Financial Services Board
JWG Joint Working Group between the IAIS and the IFSB
MCR Minimum capital requirement
MTC Minimum target capital
PIF Participants’ Investment Fund
PRF Participants’ Risk Fund
PCR Prescribed capital requirement
PPR Prudent Person Rule
PTC Prescribed target capital
QR Quantitative Restrictions
TO Takāful operator
iv
Bismillahirrahmanirrahim.
Allahumma salli wasallim ‘ala Sayyidina Muhammad wa’ala ālihi wasahbihi
A. INTRODUCTION
Background
1. The Islamic Financial Services Board (IFSB) and the International Association of
Insurance Supervisors (IAIS) established a Joint Working Group (JWG) which
produced a paper “Issues in Regulation and Supervision of Takāful (Islamic
Insurance) published in August 2006. The Issues Paper grouped the issues under the
following four major themes: a) corporate governance; b) financial and prudential
regulation; c) transparency, reporting and market conduct; and d) supervisory review
process, with the conclusion that these issues should be addressed in an integrated
manner. It also identified corporate governance for Takāful as the priority area, as it
embraces the industry’s fundamental issues such as acceptable Takāful models and
their essential parameters, the relationship between Takāful participants’ and
shareholders’ funds, and Sharī’ah governance, among others. In November 2009, the
IFSB issued the Guiding Principles on Governance for Takāful (Islamic Insurance)
Undertakings. This Standard is a successor to, and builds on, that work, in line with
the priorities set out by the JWG.
General Principle
2. In view of the on-going development for an international solvency requirement for
insurance undertakings, the Standard does not prescribe specified quantitative
techniques. Rather, the Standard sets out important key principles for the structure of
solvency requirements for a Takāful undertaking. The IFSB has taken account of the
IAIS’s initiatives on solvency standards and assessment, to benefit from and build on
the established international frameworks set out by the IAIS. This approach is
adopted in order to ensure that the supervision of Takāful is established on sound
regulatory principles which are consistent with, and no less robust than, those
established in conventional insurance. Hence the Standard contained herein is
1
primarily based on the IAIS regulatory capital requirements , with the necessary
modifications and adaptations to cater for the specificities and characteristics of a
Takāful undertaking.
3. This Standard should be read together with the Guiding Principles on Governance for
2
Takāful (Islamic Insurance) Undertakings that outlined, inter alia, key principles on
governance structures, key terminologies, concepts and operations of a Takāful
undertaking. This will facilitate further understanding of this Standard and its
recommended solutions.
1
The IAIS has issued three standards and associated guidance papers and standards on solvency assessment in
October 2007 and October 2008. The papers identify key features which the IAIS encourages supervisors to consider
in their particular solvency regimes to assist them in establishing and maintaining well-regulated insurance industries.
They encompass quantitative and qualitative aspects of solvency assessment and provide guidance to supervisors in
the areas of (a) the structure of regulatory capital requirements; (b) enterprise risk management for capital adequacy
and solvency purposes; and (c) the use of internal models for risk and capital management by insurers. Further
standards and guidance papers are under development.
2
IFSB-8, November 2009.
1
Main Objectives
4. The overall objective of this document is to set forth key principles on the solvency
requirements for Takāful undertakings. This document is built around the following
premises and objectives:
i. To increase the likelihood that a Takāful undertaking would be able to meet
all its contractual obligations and commitments;
ii. To act as an early warning system for regulatory intervention and immediate
corrective action, taking into account that the supervisory authority may
sometimes have access only to incomplete information, and that even
corrective actions may take time to generate the desired impact;
iii. To provide a buffer so that even if the Takāful participants are to suffer a loss
in the event of failure of a Takāful undertaking, the impact can be limited or
reduced especially the systemic effects; and
iv. To foster confidence amongst the general public, in particular Takāful
participants, in the financial stability of the Takāful sector.
Scope of Application
5. This Standard is applicable to all Takāful and Retakāful3 undertakings. However,
supervisory authorities may, at their discretion, extend the applicability to Takāful
“window” operations that fall within their jurisdictions.4
6. This Standard is focused on the Takāful undertaking as a single entity and the issues
of group-wide supervision are not covered in this Standard. The IAIS is actively
developing standards and guidance in this area. The IFSB will monitor these
developments and may make further proposals in the future.
7. This Standard places particular emphasis on the solvency requirements for Takāful
Participants’ Risk Fund (PRF) which are the underwriting funds – i.e. an element of
the business that is inherent in the underwriting activities,, and the contributions to
which are made on the basis of a Tabarru’ commitment. When considering the
solvency requirements for those forms of Family Takāful business which have a
savings element in a segregated fund, called the Participants’ Investment Fund (PIF),
normally this latter fund is not taken into account in assessing whether the solvency
requirements of a Takāful undertaking are met as there is typically no recourse to
certain surplus amounts in individual PIFs in order to meet a deficiency in a PRF. In
addition, a PIF is typically a pure investment fund, and the related investment risks
are fully borne by the Takāful participants with no need for capital backing from the
TO5 in the form of a Qarḍ facility.6 (If in fact an operation is constituted such that
investment profit in PIFs is available to meet deficiencies in a PRF or such that
investment risks of PIFs are not fully borne by the participants, a different treatment
would be necessary.)
Specificities of Solvency Requirements for Takāful (Islamic Insurance) Undertaking
8. Insurance or Takāful undertaking is an inherently risky business, because the fund,
whether conventional or Takāful, is exposed to contingencies whose outcome cannot
be known at the beginning of the contract. For example, it cannot be known whether
a particular driver will crash his car, or whether a particular house will catch fire.
Where a large number of individual risks are involved, the probabilities become more
predictable, which is one rationale for a principle of mutual guarantee. However,
3
In the Standard, any reference to “Takāful” is to be taken to include Retakāful.
4
We note that, while the application of this Standard to Retakāful is relatively straightforward, its application to a
Takāful “window” will need to recognise that the TO’s funds are directly exposed to substantial insurance risk from
the non-Takāful participants. There may also be a question whether some of the TO’s assets, being non-Sharī’ah
compliant, can be available for a potential Qarḍ to the PRF.
5
For convenience, any reference to “TO” in the rest of this document shall mean “Islamic insurance / Takāful
operator”. Reference to “Takāful” shall equally mean Islamic insurance.
6
Operational risk in relation to managing the assets of a PIF is, however, relevant to the capital requirements of a
TO.
2
adverse deviations may still occur. For example, a storm may cause damage to a
large number of houses in a particular area. In addition, because premiums or
contributions are invested until the funds are needed to pay claims (which can be an
extended period, particularly for classes of insurance related to liability), there are
risks on the asset side of the balance sheet. The principal concern of insurance
supervisory authorities is that the undertaking should be able to meet its liabilities,
especially policyholder claims, as they fall due, and that this should remain true even
in adverse circumstances (such as a major storm). Current international thinking7 is
that in modern insurance regimes, it should be made explicit that the undertaking
should have a given probability of meeting all its liabilities over a defined period (such
as 99.5% over 1 year).
9. Similar to conventional insurance, the goal of a supervisory authority in assessing a
Takāful undertaking’s solvency position is to ensure that the solvency levels of all
PRFs are consistent with their overall risk profiles and to enable early intervention if
the solvency buffer does not sufficiently cover the risks. However, in a Takāful
undertaking, a TO is supposed to be the mudarib and/or wakil (depending on which
model is adopted) that administers the PRF, and in return will be remunerated via
profit share (in the Muḍārabah model) or fees (in the Wakālah model) in the PRF.
10. A typical Takāful undertaking thus consists of a two-tier structure that is a hybrid of a
mutual, and a proprietorship company – which is the TO. In a Takāful arrangement,
the Takāful participants contribute a sum of money as Tabarru’ commitment into a
common fund, which will be used mutually to assist the members against a defined
compensation or loss. The distinctive rights and obligations between the TO and
Takāful participants require a clear segregation of the PRF from the TO’s
shareholders' funds. The main reason for this is that, in the absence of misconduct or
negligence, a TO is not contractually accountable for any deficit or loss arising from a
PRF. However, for regulatory solvency purposes a TO may be required to hold
adequate capital in order to provide a Qarḍ facility to meet any deficiency in the PRF
(resulting from a deficit that exceeds the amount of any accumulated reserves in a
8
PRF) or to remedy any situation in which Takāful cannot meet legitimate claims as
they fall due because of liquidity shortage. Such a Qarḍ facility will typically be
essential to enable a Takāful undertaking to meet regulatory solvency requirements,
as there will not be sufficient reserves within PRFs for this purpose.
11. However, the extent to which a Qarḍ facility enables a Takāful undertaking to meet
regulatory solvency requirements depends, inter alia, on the terms on which such
Qarḍ facilities are made available by TOs in the light of the regulations in a particular
jurisdiction, including, in particular, those that determine the status of an outstanding
amount of a Qarḍ facility (that has already been drawn down as a Qarḍ) in the case
where a PRF enters into an insolvent winding-up. In such a case, there are two
possible scenarios (see also paragraph 41 below):
i. Any outstanding Qarḍ would rank pari passu with participants’ claims, so that
the deficiency would be shared pro rata;
ii. Participants’ claims would rank above any outstanding Qarḍ.
Only in the second case should the Qarḍ facility be considered to be fully part of
regulatory capital. In the first case, it might be considered as making some
contribution to regulatory capital.
12. The analysis in paragraph 10 above of differing pools of assets within the same legal
entity is additionally based on the assumption that the boundaries between them will
7
The IAIS Common Structure Paper for Assessment of Insurer Solvency adopted in 2007 says that "Capital
requirements should be calibrated such that, in adversity, assets will exceed technical provisions with a specified
level of safety over a defined time horizon".
8
The term 'deficit' refers to the case where claims and other expenses exceed contributions for a financial period,
while 'deficiency' refers to the situation where a deficit exceeds any reserves in the fund, so that the fund has a debit
balance.
3
be respected both when the entity is a going concern and in any form of insolvency
proceeding. If this assumption is not warranted, supervisory authorities should
address these issues with the relevant authorities in their own jurisdictions. This
Standard does not deal further with the complex issue of insolvency law.
13. An essential part of good governance by a TO is the existence of an appropriate
mechanism for sustaining a Takāful undertaking’s solvency and adherence to sound
risk management. In view of their paramount importance, particularly their effects on
systemic stability, TOs should always bear these in mind while planning and mapping
their governance strategies. This is necessary whatever the strength of the solvency
regime imposed by the supervisory authority. Although, as a matter of principle,
Takāful participants are expected to bear the risk of insolvency of a PRF whenever
the contributions they make (together with income from PRF assets and any reserves
in the PRF) cannot meet the total amount of claims, it has been well accepted as part
of the prudential framework that TOs shall put in place appropriate mechanisms to
buffer any deficiencies suffered by PRFs. (See, however, paragraph 10 above.)
14. Some TOs may use different operational models or product terms as part of their
market differentiation or a commercial expression. While it is not the intention of the
IFSB to require TOs to change the way they manage the business and risks, TOs are
required to use the substance of the Sharī’ah rules and principles governing the
contracts to form the basis for an appropriate treatment in deriving their minimum
solvency requirements.
15. Apart from that, the solvency requirements for Takāful undertakings should take
account of the Sharī’ah-compliant assets in which the undertakings will invest.
Depending on the nature of the solvency regime, risk weightings or quantitative
restrictions (QR) may need to be applied to these assets. In some instances, for
example cash or equities, the treatment will parallel that for conventional insurers. For
other Sharī’ah-compliant instruments, the IFSB’s Capital Adequacy Standard for
Institutions (other than Insurance Institutions) Offering Only Islamic Financial Services
(December 2005) provides a helpful analytical background in addressing these
questions.
4
Valuation of Assets and Liabilities
16. The IFSB recognises that it is essential to assess the overall financial position of a
Takāful undertaking based on consistent measurement of assets and liabilities
particularly the identification and measurement of risks and their potential impact on
all components of the balance sheet. To a significant extent the detailed requirements
in relation to a solvency buffer depend on the valuation of assets and liabilities in the
solvency regime. The development of this Standard, and of the IAIS's work on
solvency requirements and assessment, has taken place in parallel with that of
international financial reporting for insurance. The intention is that all of these should
be based on a market consistent approach to the valuation of both assets and
liabilities.
17. However, until further progress is made on internationally agreed accounting
standards for insurance it is inevitable that solvency requirements in different
jurisdictions will be heavily influenced by the accounting and actuarial framework that
applies in each jurisdiction (in terms of the valuation basis and assumptions that may
be used and their impact on the values of assets and liabilities that underpin the
determination of regulatory solvency requirements). In this regard, this Standard is
not intended to deal with such issues as restrictions on categories of assets that
"count" for solvency purposes, the determination of any risk margin within technical
provisions, and the methods to be used for calibrating of solvency requirements.
Rather, the Standard outlines the key features of solvency requirements for Takāful
undertakings and sets out a number of principles to be followed by supervisory
authorities in structuring such requirements within their jurisdiction.
18. In considering asset values for the purposes of assessing the financial position of a
Takāful undertaking, supervisory authorities should take account of the suitability of
those assets for the purposes of backing the undertaking's liabilities and absorbing
the risks to which it is exposed. This Standard is not intended to determine whether,
in addition, there should be any QR on assets which "count" for solvency purposes;
or to specify any restriction or risk weighting "haircut" that should be applied.
However, where such QR are not applied, TOs, and supervisory authorities should
follow a "prudent person"9 approach.
Valuation of Technical Provisions
19. The valuation of technical provisions in the PRF should be undertaken on a market-
consistent basis that is consistent with the assessment by market participants of
value and risk or the principles, methodologies and parameters that market
participants expect to be used. Technical provisions shall comprise two components
– the current central best estimate of the Takāful underwriting obligations (discounted
to the net present value) and a risk margin. The risk reflected in the risk margin in
technical provisions relates to all liability cash flows and thus to the full time horizon of
the Takāful contracts underlying these technical provisions. It should generally not be
less than that necessary to bring the technical provisions to an amount, in return for
payment of which a willing third party, acting on an arms length basis, would be
prepared to accept those liabilities through a (hypothetical) portfolio transfer. Each
component of the technical provisions shall generally be explicitly determined in order
to support the objectives of transparency and comparability and also to facilitate
convergence.
9
There are essentially two types of regulations which are applied across the world. They are QR, which impose
explicit limits on holdings in risky asset classes, and the Prudent Person Rule (PPR), which requires firms to invest
prudently and follow broad principles of portfolio diversification and asset-liability matching. Where undertakings
exceed QR then the value of assets held in excess of these restrictions are not taken into account for solvency
purposes. Where QR do not apply and the PPR approach is followed, then the supervisor should take account of the
extent to which assets (a) are not adequately diversified; (b) are inappropriately illiquid; (c) are not readily
marketable; or (d) do not reasonably match liabilities in duration and currency, in determining the undertaking's
solvency requirements
5
B. KEY FEATURES FOR MINIMUM SOLVENCY REQUIREMENTS
20. As mentioned in paragraph 2, the Standard is intended to complement the existing
work of the IAIS on putting in place a sound solvency regime for insurance. While
generally Takāful undertakings share some similarities with conventional insurers in
attempting to serve certain economic objectives, it should be noted that structurally
Takāful undertakings can be distinguished from conventional insurers. These
differences are the key conceptual factors for developing the solvency requirements
for a Takāful undertaking.10
Key Feature 1: The solvency requirements for Takāful undertakings must adopt a total
11
balance sheet approach to ensure that risks are appropriately recognised and
consistently valued and to identify the interdependence between assets, liabilities,
regulatory solvency requirements for PRF and the shareholders’ funds of the TO.
However, the total balance sheet approach must address the clear separation of PRF
and the shareholders’ funds of the TO.
21. Given that one of the key specificities of a Takāful undertaking is a distinct separation
between the Takāful and TO’s shareholders’ funds, the solvency requirements for
Takāful undertakings should be set separately as illustrated in Figure 1. The first level
of solvency requirements is to ensure adequate solvency resources in the PRF to
provide assurance (on a defined probabilistic basis, and taking account of the
possibility of adverse developments in all the areas of risk to which the fund is
exposed) that the PRF can meet claims from Takāful participants. The second level
of solvency requirements is to ensure adequate capital resources of the TO to meet
its own financial and legal obligations, including the possible need to provide capital
backing in a way of a Qarḍ facility to the PRF.
Figure 1: General approach to the solvency and capital requirements for a Takāful
12
Undertaking
Panel A: Takāful Undertaking where the PRF is self-sufficient
Shareholders' Fund PRF
Excess
PCR
MCR
Excess Risk Margin
PTC
Assets
MTC
Central Technical
Assets Estimate of Provision
Takaful
Underwriting
Liabilities Liabilities
10
Refer to Paragraph 18 in the Guiding Principles on Governance for Islamic Insurance (Takāful) Operations.
11
The term ‘total balance sheet approach’ needs to be understood subject to the distinction between the
shareholders’ funds and the funds of Takāful participants (PRFs and investment accounts). Of the shareholders’
funds, only the amount of the Qarḍ facility may be counted as capital in assessing the solvency of a PRF.
12
Refer to paragraph 34 for further explanation of the abbreviations used.
6
Panel B: Takāful Undertaking where the PRF relies on a Qarḍ Facility to meet
Solvency Requirements
Shareholders' Fund PRF
Excess
"Notional Assets"
right to call Qard
PCR
MCR
Assets "earmarked" to
back Qard facility Excess Risk Margin
Qard Facility
PTC
Technical
Provision
MTC
Central
Estimate of
Assets Takaful
Underwriting
Liabilities
Liabilities
Where a Qarḍ facility is required to enable a PRF to meet its solvency requirement, it
should generally be set up at a value which will provide some buffer over and above
the minimum solvency requirement. This is to allow the PRF to meet its requirements
on a continuous basis notwithstanding reasonably foreseeable fluctuations in asset
and liability valuations. The assets backing a Qarḍ facility should be `earmarked’ for
this purpose. That is, they should be specifically identified and held in a discrete
account separately from other assets in the shareholders’ fund. In assessing the
adequacy of a Qarḍ facility for solvency purposes, the supervisory authority should
look through to the earmarked assets in the same way as provided in paragraph 18.
22. To determine the basic structure of solvency requirements for PRFs and the TO’s
funds respectively, the obligations of the whole undertaking need to be identified.
Here are the main obligations (financial and legal) of the Takāful undertaking in the
context of solvency requirements:
A. PRFs
i. The objective of solvency requirements at PRF level is to provide a high
degree of confidence that the PRF can withstand adverse conditions over the
expected term of its assets and liabilities. Therefore, the PRF should hold
assets equal to the technical provisions of that PRF (valued in the manner
described in paragraph 16) plus additional solvency resources (sometimes
referred to as solvency margin reserves). The additional solvency resources
are the amount of additional assets a PRF must hold to cover (1) possible
underestimation of the technical provisions and (2) the risk of measurement
error inherent in determining the economic values of assets, namely that their
13
realisable values may be less than their carrying amounts . Subject to
paragraph 10 above, the additional solvency resources may include a
standby back-up facility provided by the TO on a Qarḍ basis (see B.ii below).
Where such a facility does not fully meet the requirements for inclusion in
regulatory capital, but the regulator nonetheless allows some credit to be
taken for it for solvency purposes (see paragraph 11.ii), the amount of the
solvency margin reserve in the relevant PRF will need to be correspondingly
greater.
13
The IAIS Draft Guidance Paper on the Structure of Capital Resources for Solvency Purposes (January 2009)
suggests that for solvency purposes adjustments to the carrying values of assets may be made either by making a
7
ii. The additional solvency resources will be calculated for all risks that could
have a negative financial impact on a PRF. They will be calculated to cover
risks over the expected term of the assets and liabilities. The framework
should identify the main categories of risks such as credit, market,
underwriting, liquidity and operational. With regard to the treatment of assets,
their carrying values would normally be fair values in accordance with
international financial reporting standards, but the solvency margin reserve
would include an amount to cover the risk of the realisable value being less
than the carrying amounts (if the carrying value is not in fact fair value,
appropriate adjustments may be required to the solvency margin reserves).
In the case of conventional insurance contracts involving significant
acquisition costs, for solvency purposes exit or similar values would be used
(rather than deferring and amortising acquisition costs), but the intangible
nature of such assets would require the inclusion of an appropriate amount in
the solvency margin reserve.
B. Shareholders’ Funds
i. The TO needs to have sufficient capital resources to be able to withstand
unexpected increases in management expenses or reductions in income
which could cause operating losses to the TO leading to financial distress if it
were undercapitalised.
ii. In addition, subject to the applicable regulations, the TO's capital resources
may need to be sufficient to allow it to provide additional capital (as a Qarḍ
facility available to be drawn down) to the PRF should this be necessary to
cover a shortfall in that fund’s capital resources or a short-term liquidity need.
iii. The assessment of the amount of the capital resource requirements for the
TO should be generally based on the potential volatility of expenses, and
most importantly, the level, volatility and flexibility of the TO’s income, after
taking account of the amount needed for the Qarḍ facility (that is, on the
potential call on the TO to provide additional capital in the form of Qarḍ if
required).
23. The TO is expected, through licensing and regulatory requirements, to offer a Qarḍ
facility out of its shareholders’ funds where this is necessary to meet the required
solvency level of the PRFs, with repayment of any Qarḍ drawn down to be made from
future participants’ surpluses arising from the PRFs. The right to receive repayment in
respect of a Qarḍ already provided should not be counted as an asset for the purpose
of assessing the TO's ability to meet its own solvency resource requirements as set
out in paragraph 22.B above. Similarly, any assets representing a standby facility
(see A.i above) that has been accepted by the regulator as regulatory capital for the
purposes of a PRF cannot also be counted as assets supporting the solvency of the
shareholders’ fund (see paragraphs 26 and 27 below)
deduction from their values or by making a capital charge of the same amount (or by a combination of both methods).
The wording adopted here assumes that the capital charge approach is used.
8
Key Feature 2: The solvency requirements should be established at a level such that
the respective amounts of solvency resources in the Takāful and shareholders’ funds
are adequate to meet their respective financial obligations as they fall due, bearing in
mind that part of the shareholders’ funds may be ‘earmarked’ to cover a Qarḍ facility.
24. In assessing the solvency requirements of a Takāful undertaking, it is essential to
ensure that there are adequate and appropriate solvency resources in the PRFs and
shareholders’ funds to support the respective financial obligations of each of the
funds as they fall due, with the TO’s capital resources being sufficient to cover its
own business risks. In this connection, without prejudice to the operation of any Qarḍ
facility, it is crucial that there be a clear separation between Takāful and
shareholders’ funds so that there is no possibility of contagion between them.
25. In addition to ensuring that the solvency requirements of all funds under its control
are met, a TO should manage these funds in a sound and prudent manner, In
particular, the TO should endeavour, over time to bring the reserves in a PRF to a
level at which the fund becomes self-sustaining with sufficient resources to meet
solvency requirements without the need to rely on a Qarḍ.
Earmarked amount
26. Where a TO provides capital backing in the way of a Qarḍ facility, the undrawn Qarḍ
facility should be considered as being ‘earmarked’ within the shareholders’ funds to
meet the solvency requirements of the PRF. (See Figure 1 panel B above.) This
amount should be distinct from the amount of the TO’s capital required to meet its
own solvency requirements. Capital available for solvency purposes for the PRF
would therefore consist of (i) reserves in PRFs (retained underwriting surplus or
investment profit) i.e. Takāful participants’ equity, plus any amount of drawn-down
Qarḍ, and (ii) undrawn Qarḍ facility (an earmarked amount within the shareholders’
14
equity) . Any amount drawn down from the Shareholders' Fund as Qarḍ facility is
part of the assets of the recipient PRF. Correspondingly, this drawn down amount
will be part of the Shareholders' equity and is represented by a Qarḍ repayable by the
PRF. As noted in paragraph 24 above, it is expected that the Takāful participants’
equity would gradually become sufficient to meet the solvency requirements, thus
making the Qarḍ facility superfluous.
27. Where there are ring-fenced PRFs, any such earmarked Qarḍ amount held in respect
of an individual PRF must not be double counted for solvency calculation purposes.
28. To ensure the adequacy of a Qarḍ facility, a TO should carry out regular actuarial
appraisals of the solvency of the relevant PRF, so as to determine the amount of any
shortfall with respect to the solvency requirement which would need to be covered by
the Qarḍ facility. Moreover, the assets represented by a Qarḍ facility should be kept
in a suitable form to serve for draw-down of the Qarḍ facility into the PRF.
14
This is dependent on the Qarḍ facility meeting the conditions to count as capital as discussed in paragraphs 11 and
41.
9
Transferability between the PRFs
29. The solvency requirements for a Takāful undertaking should reflect and take account
of any limitations on the transferability of funds within the undertaking. Such
limitations may arise from the contractual terms or the legal framework that governs
the undertaking's operations. Some Takāful products may be written in so-called ring-
15
fenced funds , where part of the business is clearly segregated from the rest. In
such cases the assets or retained underwriting surplus of the fund may be strictly
isolated from the other lines of business so that they can only be used to meet the
Takāful and Retakāful obligations with respect to which the ring-fenced fund has been
established.
30. For this reason, when assessing the solvency of the PRFs, the amount of solvency
resources eligible to cover the solvency level must be adjusted to take account of the
“non-transferability” of solvency resources between ring-fenced funds. Depending on
the nature of the restrictions on transferability, it will generally be appropriate for each
ring-fenced fund to be subject to its own specific solvency requirements. In such
circumstances, the technical provisions should be calculated and reported separately
for each PRF and these technical provisions together with appropriate solvency
requirements should be covered by assets of appropriate value and quality in
accordance with the applicable QR or PPR.
31. It is important that the supervisory authority be fully aware of any restrictions on the
transferability of assets between lines of business. Takāful participants should also be
informed of this, so that they understand the risks (if any) to which they may,
indirectly, be exposed through lines of business other than those in which they
directly participate, and understand too any limitations on the extent to which losses
arising in "their" business may be absorbed by surplus funds in another. Accordingly
the regulatory or supervisory regime should ensure that, wherever possible, there is a
clear contractual term or legal framework. Should this be absent, the default
assumption must be that there is no transferability, and this will generally imply a
higher total capital requirement in the undertaking.
32. To the extent that either integrated or separate Takāful PRFs or line-of-business
classes are supported by the shareholders’ funds through a Qarḍ facility, the amount
of shareholders’ funds that has been earmarked for the Qarḍ facility (but not any
other part of shareholders’ funds) should in principle count fully for the purpose of
determining the solvency of the PRFs. But such shareholders’ funds should not be
capable of being "double counted" (for example, in determining the solvency of the
TO itself as a business undertaking). In practice, this might be best achieved by
requiring that:
i. Individual PRFs, non-transferable between lines of business, should each
meet the solvency requirement;
ii. Where the assets of a group of PRFs are fully transferable between those
funds, the solvency requirements should be applied to the totality of those
funds;
iii. In both cases, for the purpose of complying with the solvency requirement,
PRFs should be able fully to count earmarked funds available from a Qarḍ
16
facility as well as those actually drawn down under a Qarḍ facility .
15
This is sometimes done in conventional insurance for with-profits or investment linked policies.
16
This is dependent on the Qarḍ facility meeting the conditions to count as capital as discussed in paragraph 11.
10
Key Feature 3: The solvency requirements should establish solvency control levels at
the respective Takāful and shareholders’ funds, that trigger proper interventions by TO
and the supervisory authority when the available solvency is less than the solvency
control level.
33. The solvency requirements for Takāful undertakings should emphasise the
importance of setting up the solvency control at two levels, in both shareholders’ fund
and the PRF. By setting up the solvency control at two levels, a set of prompt actions
could be taken by the TO and the supervisory authority to avert possible loss to
participants arising from an insolvency position. These control levels should be set
such that intervention actions may be taken at a suitably early stage in a Takāful
undertaking’s difficulties. In this context, any adverse condition could be addressed in
a realistic timeframe, and the appropriateness of the control levels should be
examined in relation to the nature of the intervention actions..
34. The solvency requirements should be based on the following four concepts: minimum
capital requirement (MCR) and prescribed capital requirement (PCR) for the PRFs,
and minimum target capital (MTC) and prescribed target capital (PTC) for the
shareholders’ funds. Any amounts earmarked as a Qarḍ facility are part of the
shareholders’ funds but would for solvency purposes be treated as part of the PRFs
for which they were earmarked. 17
35. The PCR/PTC signifies the highest solvency level that enables the funds to absorb
significant unexpected losses while MCR/MTC signifies a solvency level of which a
breach will invoke the strongest regulatory actions. Any breach of
MCR/PCR/MTC/PTC at the level of either the PRF or shareholders’ funds should
trigger immediate attention from the TO and the supervisory authority. In any case
where a TO is unable to restore the required solvency control level applicable to any
PRF, or its own shareholders’ funds, or the whole undertaking, the TO should put
forward a plan acceptable to the supervisory authority to meet the solvency
requirement within a short period. Where no acceptable plan is put forward and
implemented within a reasonable time specified by the supervisory authorities or laid
down in law, the undertaking should be prohibited from continuing to write further
business.
18
36. Possible intervention actions that could be taken by a supervisory authority include :
i. measures to address solvency levels such as the draw-down of the Qarḍ
facility from the shareholders’ fund to the PRF, requesting capital and
business plans for restoration of solvency resources to required levels,
limitations on redemption or repurchase of equity or other instruments and/or
dividend payments etc;
ii. measures intended to protect Takāful participants pending the restoration of
the solvency levels, such as restrictions on undertaking new business,
investments, Retakāful/reinsurance arrangements etc;
iii. measures that are intended to enable the supervisory authority to better
assess and/or control the situation, either formally or informally, such as
increased supervision activity or reporting, or requiring external auditors or
actuaries to undertake an independent review or extend the scope of their
examinations; and
iv. measures that strengthen or replace the TO’s management and/or risk
management framework and overall governance processes in the Takāful
undertaking.
Illustrations of types of intervention actions are provided in the Appendix.
17
Refer to paragraph 26.
18
These are based on the actions described in the IAIS Guidance paper on the structure of regulatory capital
requirements, dated October 2008.
11
37. With regard to the draw-down of a Qarḍ facility to a PRF, the regulatory framework
should either define, or allow discretion to supervisory authorities to determine, the
19
control level applicable to the PRF. The supervisory authorities would then be able
to request the TO to draw down the Qarḍ facility to the PRF immediately once the
control level is breached in order to expedite the restoration of the required solvency
control level.
19
While it will be for the relevant authorities in individual jurisdictions to specify the control level, breach of which
would trigger an immediate requirement to draw down Qarḍ, this should never below the level of the technical
provisions (ie the best estimate of the insurance liabilities plus the required margin), and should normally not be less
than the level of the minimum capital requirement.
12
Key Feature 4: The solvency requirements should establish criteria for assessing the
quality and suitability of solvency resources in the Takāful and shareholders’ funds to
absorb losses in different financial stages of the respective funds.
38. The solvency requirements for Takāful undertakings should take into account the
quality of solvency resources to absorb losses in different financial stages of a
Takāful undertaking, namely as a going concern, in run-off, winding up and
insolvency.20 This is because the extent of its loss absorption depends on the type of
capital, e.g. equity or other capital such as the Qarḍ facility. A holistic approach needs
to be taken in order to evaluate the extent of loss absorbency overall, and should
establish criteria that should be applied to evaluate capital elements in this regard.
39. Given that there is a clear separation between the shareholders and the PRFs in
Takāful undertakings, the quality of solvency resources should be assessed
separately to meet the respective solvency requirement. For the shareholders’ funds,
the assessment of the quality of solvency resources is relatively straightforward as
the solvency resources should be fully available to meet any financial distress
affecting the shareholders’ funds. However, in assessing the ability of solvency
resources to absorb losses in the PRFs, the following characteristics are usually
21
considered (see paragraph 11 above and paragraphs 41-43 below ):
i. Availability - the extent to which the capital element is fully paid and can be
called up on demand to absorb losses as well as upon winding up;
ii. Permanency - the extent to which the available capital element cannot be
withdrawn; and
iii. Absence of encumbrances and mandatory servicing costs - the extent to
which the capital element is free from mandatory payments or
encumbrances.
40. The supervisory authority may apply potential limits for the solvency resources to be
qualified to cover different levels of the solvency requirements of the shareholders’
and PRFs. In determining the amount of a Takāful undertaking’s solvency resources
to meet different solvency levels, the supervisory authority may choose a variety of
approaches: 22
i. approaches which categorise solvency resources into different quality classes
(“tiers”) and apply certain limits/restrictions with respect to these tiers, (within
which individual tiers may be further subdivided) (tiering approaches);
ii. approaches which rank capital elements on the basis of the identified quality
characteristics (continuum approaches);
iii. approaches which do not attempt to categorise or rank capital elements, but
apply individual restrictions or charges where necessary.
To accommodate the quality of capital elements, combinations of the above
approaches have been widely used. It is likely that, in relation to Takāful, an
approach with a high degree of granularity – whether within a tiered approach within
which individual tiers are further divided, or through a less formulaic continuum
approach – will be appropriate.
Treatment of the Qarḍ facility for solvency requirements
41. In order for a Qarḍ facility or Qarḍ to be accepted for solvency purposes, supervisory
authorities should satisfy themselves that the following conditions are met:
(i) the Qarḍ facility provided to a PRF cannot be withdrawn by the TO before the
PRF is considered to meet solvency requirements independently of any Qarḍ
facility;
20
The determination of suitable capital within a solvency regime is critically dependent upon the legal environment of
the relevant jurisdiction particularly in recognising a clear separation of Takāful and shareholders’ funds.
21
Adopted from the IAIS Draft Guidance Paper on the structure of capital resources for solvency purposes.
22
Adopted from the IAIS Draft Guidance Paper on the structure of capital resources for solvency purposes.
13
(ii) the TO has given its consent to the supervisory authority that, in a winding-up
situation, it will treat any part of the Qarḍ facility that has been drawn down as
a Qarḍ as being donated to the PRF to the extent that is necessary in order
for participants’ claims to be met in accordance with regulatory obligations (or
some other arrangement to the same effect).
42. The treatment of the Qarḍ facility is a fundamental issue. Any draw-down of a Qarḍ
facility into a PRF should in principle be repaid from future surpluses of the PRF. A
particular issue arises in relation to a run-off process, particularly regarding the status
of claims from Takāful participants on the PRF. It is likely that prior to the run-off of a
particular PRF, the draw-down of the Qarḍ facility will have been initiated with the
intent of enabling the PRF to meet its regulatory obligations. Indeed, the supervisory
authority should not allow a PRF to be run off without a sufficient draw-down of a
Qarḍ facility to provide reasonable assurance that adequate resources will be
available within the PRF to meet any obligations arising in the process of run-off. In
this connection, a voluntary winding-up (as an alternative to run-off) would require the
supervisor’s authorisation, in which case the supervisor might require that a draw-
down of a Qarḍ facility had been made prior to the initiation of the voluntary winding-
up.
43. The legal and regulatory framework should provide for the determination of the point
at which it is no longer permissible for a Takāful undertaking to continue its
23
business . The procedures for dealing with insolvent winding-up of a Takāful
undertaking should be clearly set forth in the law. Due consideration must be given by
the supervisory authorities to analysing the quality of capital that the Qarḍ facility
represents when it is drawn down into the PRF particularly in the context of the
payment priority of a drawn-down Qarḍ in a wind-up situation. The payment priority of
a drawn-down Qarḍ in a winding-up situation should be clearly stated in the law
regarding insolvency and winding up and should be disclosed by the TO to the
policyholders.
23
The IAIS Insurance Core Principle (ICP) 16 on “Winding-up and exit from the market”.
14
Key Feature 5: The solvency requirements for Takāful undertakings must have
separate risk adjusted computation and assessment. The risk management framework
must be comprehensive and cover all risks to which the PRFs and the shareholders’
funds are exposed.
44. Takāful undertakings are in a similar position to conventional insurance undertakings
with regard to the management of risk. They face similar risk exposures in the
management of underwriting funds. In this respect, the solvency regime for a Takāful
undertaking must place emphasis on the undertaking's risk management framework
and on ensuring that it is appropriate to the complexity, size and mix of the Takāful
undertaking’s operations. At the same time, the risk management framework has to
be supported by thorough monitoring and internal control systems.
45. In the management of risks, a TO faces challenges in adequately defining, identifying,
measuring, selecting, pricing and mitigating risks across business lines and asset
classes in the PRFs as well as its own risk exposures with respect to the
shareholders’ funds. The management of these risk exposures is a continuous
process that should be carried out in the implementation of the strategy of the
undertaking and which should allow an appropriate understanding of not only the
nature and significance of the risks to which the undertaking is exposed but also the
Sharī’ah rules and principles to which the TO and the Takāful participants are
contractually bound. Thus, TOs must adopt a sound risk management framework for
PRFs and the shareholders’ fund.
46. In this respect, TOs might be seen as managing two distinct sets of risks. The first set
relates to the TO’s fiduciary responsibility to manage the PRFs under its management
so as to protect the interests of the Takāful participants. This set of risk components
is related to the management of PRFs so that they can meet their financial obligations
as they fall due. The second set of risks relates to the TO itself in the process of
meeting its financial obligations. It is important that a TO should have adequate
capital to back the risks arising from its business operations in addition to any capital
backing provided in the form of a Qarḍ facility to meet possible deficiencies of the
PRFs. These two sets of risks are the crucial risk components that need to be
considered in order to determine the solvency control levels for a Takāful undertaking
as a whole.
47. The asset-liability matching policies for the PRFs and shareholders’ funds may be
significantly different. The asset strategies adopted by a TO for the PRFs and the
shareholders’ funds will be based on their respective financial liabilities profiles, and
the need to ensure that the undertaking holds sufficient assets of appropriate nature,
term and liquidity to enable it to meet the respective funds’ liabilities as they become
due. In addition, part of the shareholders’ funds will normally be earmarked as a Qarḍ
facility, and the assets financed by this part of the shareholders’ funds are to be
counted for the purposes of meeting the capital requirements of the PRFs. An
earmarked Qarḍ facility should generally be held in a form in which it may quickly be
24
drawn down in the form of assets appropriate to the PRF they are to back up . The
analysis of types of risks for the shareholders’ funds and Takāful PRFs can be
summarised as in Figure 2.
48. As indicated in Paragraph 21 above, the basic objectives of solvency requirements
are to provide assurance that:
i. On a probabilistic basis and taking account of the possibility of adverse
developments in all areas of risk to which the fund is exposed the PRF can
meet claims from Takāful participants; and
ii. The TO can meet its own financial and legal obligations, including the
possible need to provide capital by way of a Qarḍ facility to the PRF.
24
The capital requirement will include an amount that reflects the riskiness of the assets held to support the
underwriting funds, including the assets of the underwriting funds and those financed by the Qarḍ facility.
15
49. The approach adopted is to:
i. Determine the economic value of the assets and liabilities; and to
ii. Calculate the additional capital required to offset the potential impact of each
of the identified components of risk.
50. The assessment of the quantum of additional capital required for each risk
component, and of the overall capital requirement should be through a modelling
approach (whether using a standard model prescribed by the supervisory authority, or
through the use of internal models approved by the supervisor). In either case, the
model should test the ability of the fund, or of the operation as a whole, to meet its
obligations with a defined level of probability (e.g. 99.5%) over a specified period (e.g.
25
1 year) .
51. The following table sets out the main risks to which the PRF and the Takāful operator
are potentially subject. With the exception of liquidity risk, (for which a quantifiable
and effective capital requirement is generally not an effective risk mitigant) these
should be taken into account in determining the capital requirements for each of the
funds. In the case of liquidity risk, the supervisor might impose a capital requirement
depending on the extent to which the risk was considered to be effectively mitigated
by asset-liability management.
25
See Footnote 7 above. The The IAIS Common Structure Paper for Assessment of Insurer Solvency referred to in
"Structure Element 3" provides that: A solvency regime should address all relevant potentially material risks, including
underwriting risk, credit risk, market risk, operational risk and liquidity risk. All risks should, as a minimum, be
addressed by the insurer in its own risk and capital assessment.
• Risks that are generally readily quantifiable should be reflected in sufficientlyrisk sensitive regulatory financial
requirements.
• For risks that are less readily quantifiable, regulatory financial requirements may need to be set in broad terms
and complemented with qualitative requirements.
16
Figure 2: Risks faced by the respective funds in a Takāful undertaking
Categories of risks PRFs Shareholders’ funds
Provisioning and
Reserving Risks
The risks of under- General Takāful is exposed
estimation of the to losses due to random
underwriting liabilities and events such as natural
adverse claims perils, fire, pollution, crime,
experiences war, terrorism, and others.
Family Takāful is exposed
to losses arising from
severity and frequency of
claims due to changes in
anticipated mortality,
morbidity and longevity as
well as catastrophic events
such as epidemic, major
accident or terrorist attack.
Underwriting
Management Risks
The risks of poor Family Takāful and General
management of accepting Takāful are exposed to
risk and claim payouts losses arising from poor
selection, pricing and
acceptance of risks and
inappropriate product
design.
Credit Risks
The risk of a counterparty Exposed to profit and Exposed to risk of non
failing to meet its capital receivables from receipts of profit and
obligations in accordance invested assets, Takāful capital receivables from
with agreed terms contributions receivable invested assets, Wakalah
and Retakāful recoveries. fee (due to contributions
receivable) and other trade
26
debtors
Market Risks
The risk of losses arising The risks relate to the The risks relate to the
from movements in market current and future volatility current and future volatility
prices i.e. fluctuations in of market values of specific of market values of
values in tradable, assets (for example, the specific assets (for
marketable or leaseable commodity price of a Salam example, the commodity
assets (including Sukūk) asset, the market value of a price of a Salam asset, the
and a deviation of the Sukūk, the market value of market value of a Sukūk,
actual rate of return from assets purchased to be the market value of assets
the expected rate of return delivered to a Murābahah purchased to be delivered
customer over a specific to a Murabahah customer
period, the market value of over a specific period, the
Ijarah assets) and of foreign market value of Ijarah
exchange rates. assets) and of foreign
exchange rates.
26
The risk of non-recovery of a Qarḍ which has been drawn down is a credit risk, but falls on the ‘earmarked’ portion
of the TO’s shareholders’ funds, which are not included in the TO’s capital for regulatory purposes.
17
Categories of risks PRFs Shareholders’ funds
Operational Risks
The risk of loss resulting Loss of income from the Administration and
from inadequate or failed purification of tainted acquisition expenses for
internal processes, people income due to Sharī’ah developing and
and systems or from rulings. Losses due to maintaining the Takāful
external events. Sharī’ah claims fraud. Losses due contracts. This relates to
non-compliance risk to legal risk (e.g. in court the business risks whereby
should also incorporate interpretations of policy the fund will not have
possible causes of loss terms). adequate cash flow to
resulting from non- meet the operating
compliance and failure in expenses.
the TO’s fiduciary
responsibilities Also liable for losses
arising from its negligence,
misconduct or breach of
fiduciary duties in the
management of PRFs
(fiduciary risk).
Liquidity risk
The potential loss to a Additional costs through Additional costs through
Takāful undertaking arising raising additional funds at a raising additional funds at
from its inability either to premium on the market or a premium on the market
meet its obligations or to through the sale of assets or through the sale of
fund increases in assets which simultaneously affect assets which
as they fall due without the overall appropriate simultaneously affect the
incurring unacceptable provisioning and reserving overall appropriate
costs or losses methodologies of PRFs. capitalisation and
reserving.
52. Hence, the general formulae for the solvency requirements for a Takāful undertaking
could be as follows:
For PRF:
SR = RCPR + RCUR + RCCR + RCMR + RCOR where
SR = Solvency requirement
RCPR = Risk component for provisioning and reserving risk
RCUR = Risk component for underwriting risk
RCCR = Risk component for credit risk
RCMR = Risk component for market risk
RCOR = Risk component for operational risk
For Takāful operator
CR = RCCR + RCMR + RCOR where
CR = Capital requirement
CRCR = Risk component for credit risk
CRMR = Risk component for market risk
CROR = Risk component for operational risk
In assessing the overall solvency requirement, due allowance may be made for the
degree of correlation or diversification between the individual risk components.
53. With regard to the choice of the risk measure and confidence level to which solvency
requirements for Takāful undertakings are calibrated, the supervisory authorities may
set a confidence level for regulatory purposes.
18
54. Where the supervisory regime may allow the use of approved more tailored
approaches such as internal models for the purpose of determining solvency
requirements, the target criteria should also be used by those approaches for that
purpose to ensure broad consistency within the solvency requirements as compared
to those entities using a standard approach.27 The appropriate parameters and target
criteria for these elements in the solvency framework should be outlined to provide
clearer guidance to determine regulatory solvency requirements. Importantly, the use
of these internal models must have prior approval from the supervisory authorities to
ensure that the internal models are appropriately adjusted to the standard solvency
requirements.
55. The determinants of the risk exposures of the Takāful and the shareholders’ funds will
reflect and may depend on the Takāful product structure and specification. For
instance, in a single contribution mortgage reducing term Family Takāful, Wakālah
fees are received mainly at the inception of the cover, whereas the administration
expenses are expected to be incurred throughout the duration of the contract. In
conventional insurance, the provisioning for conventional single premium of life
insurance mortgage term assurance includes a provision for expense. Nevertheless,
taking into account the conservative mortality assumption used, the actuary, who is
responsible for advising on the valuation of the insurance liabilities, is likely to keep
28
this expense provision minimal. However, for Family Takāful, the mortality and
expenses provisions would need to be made in separate funds i.e. the mortality
provisions are held within the Family PRF and its expenses provisions could be held
against the shareholders’ fund. In this circumstance, the shareholders’ fund may need
to hold adequate expenses provisions to cover the long term maintenance of the
product.
56. Another instance is the split of expenses between acquisition and maintenance. In
conventional insurance, this split is typically based on the insurer’s judgement. If too
many expenses are allocated to the acquisition category, then a forward looking view
of the insurer’s on-going maintenance expenses will be understated. This may result
in the under-provisioning of such expenses in the liabilities and an overly optimistic
29
view of the insurer’s future financial condition. However, in a Takāful undertaking,
especially Family Takāful, it is dependent on the product specification of the Takāful
products. The identification of the split of expenses between acquisition and
maintenance cost is essential to determine the computation of the solvency
requirements for a Takāful undertaking i.e. whether the risk component for the
expenses provisions of the acquisition and maintenance cost lies in the PRFs or the
shareholders’ fund.
27
Refer to the IAIS’s Guidance paper on use of internal models for risk and capital management purposes by
insurers.
28
Refer to A Global Framework for Insurer Solvency Assessment A Report by the Insurer Solvency Assessment
Working Party of the International Actuarial Association
29
Refer to A Global Framework for Insurer Solvency Assessment A Report by the Insurer Solvency Assessment
Working Party of the International Actuarial Association
19
57. Each class of asset needs to be assessed in terms of its contribution to the risk profile
of the undertaking. For example, supervisory authorities in a number of jurisdictions
permit Takāful undertakings to invest in real estate. Real estate is widely regarded as
a permissible asset class under Sharī’ah rules and principles. However, investments
in real estate can be generally characterised as risky in terms of both potential market
volatility and lack of liquidity, and this may pose significant risks to the PRFs in terms
of meeting financial obligations or the ability of the TO to provide an effective Qarḍ
facility. Hence, the supervisory authority may, in defining its solvency resources
regime, impose restrictions on the type, level and concentration of real estate
investment by the Takāful undertaking. These limits may be different for different
types of Takāful, reflecting the fact that investment in real estate is likely to be less
problematic in relation to long-term savings products in Family Takāful than in
General Takāful. Alternatively, the supervisory authority may set capital charges in
relation to real estate investment which recognises its risky nature through the capital
requirements.
20
Key Feature 6: The adequacy of regulatory solvency requirements for a Takāful
undertaking depends on the maintenance of a sound risk management framework. An
essential part of the supervisory review process is to assess for each undertaking that
adequate risk management arrangements are in place through which the TO can, and
does, monitor, measure, report and control the management of the assets and
liabilities in a coherent and integrated manner.
58. Takāful undertakings, and through them participants, can be exposed to the risk of
financial loss, not only through underwriting and investment failures but through lack
of liquidity, particularly in the event of unexpected volumes of claims or of withdrawals
from, or surrenders of, family Takāful schemes. Moreover Takāful operations are
also at risk from litigation, fraud, theft, lost business, and wasted capital from failed
strategic initiatives. Losses from Takāful activities typically result from or are
exacerbated by inadequate internal controls, weak risk management systems,
inadequate training, or deficient board and management oversight. Maintaining a
good reputation and positive public image is also vital to a successful Takāful
business.
59. While regulatory capital provides a buffer to absorb loss it is not a sufficient risk
mitigant on its own.30 Accordingly a TO should have in place a comprehensive risk
management framework and its reporting process, including appropriate board and
senior management oversight, to identify, measure, monitor, report and control
relevant categories of risks and, where appropriate, to hold adequate capital against
material risks. The framework should allow appropriate steps to comply with Sharī`ah
rules and principles and to ensure the adequacy of relevant risk reporting to the
supervisory authority. In the context of its overall enterprise risk management
framework, a TO should perform its own risk and solvency assessment (ORSA) and
have risk and capital management processes in place to monitor and manage the
level of its financial resources relative to its economic capital and the regulatory
capital requirements set by the solvency regime.31 This is to mitigate the
consequences of adverse events that may occur by taking early corrective measures
intervention so that the solvency control level can be restored or an orderly exit can
be arranged. The ORSA will help the TO and the supervisory authority in assessing
32
the need for any additional capital or draw-down of the Qarḍ facility to the PRFs. It
should be undertaken at each level to which a solvency requirement applies. In
particular, it should be undertaken for the PRF(s) and shareholders’ fund separately.
60. As noted in paragraph 7 a PIF operated by a family Takāful undertaking is normally a
pure investment fund in which the investment risks are borne fully by the participants.
Accordingly it will not be exposed to risks arising in the PRF. Accordingly a PIF will
not need to meet the capital requirements appropriate to a PRF, and no capital will
need to be held, within either the PIF or an earmarked Qarḍ facility, for credit or
market risk arising in relation to the assets held by the fund. But the TO’s risk
management framework should nonetheless extend to ensuring the sound operation
of the PIF. In particular assets should be held which are appropriate to the purpose
for participants contributed to the PIF, and should be sufficiently liquid to allow for
withdrawals and surrenders. In the event that the assets are not sufficiently liquid to
meet demand for withdrawals and surrenders it is possible that a Qarḍ will need to be
provided to allow the PIF to meet its liabilities as they fall due.
30
Failure to put in place, operate and maintain an adequate risk management framework should result in a higher
capital requirement for both PRA and Takāful Operator through an increase in the operational risk component.
31
Adopted from IAIS Guidance paper on the structure of regulatory capital requirements (October 2008).
32
Refer to section 4 in the IAIS Guidance paper on enterprise risk management for capital adequacy and solvency
purposes (Oct 2008).
21
61. Since the TO acts in a fiduciary capacity on behalf of the Takāful participants in
performing underwriting and managing the PRFs as well as ensuring an adequate
level of solvency in the both Takāful and the shareholders’ funds, it is the role of the
board of directors of a TO and its senior management to provide reasonable
assurance of effectiveness and efficiency of operations, reliability of financial and
non-financial information, an adequate control of risks, a prudent approach to
business and compliance with laws and regulations, and internal policies and
procedures. In addition, the solvency requirements regime should place emphasis on
the TO having appropriate controls in place and taking great care to ensure that all
persons or entities with operational and oversight responsibilities act in the best
interests of Takāful participants and beneficiaries.
22
Key Feature 7: Information regarding the solvency requirements for a Takāful
undertaking that is material and relevant to the market participants should be publicly
disclosed to enhance market discipline and the accountability of the TO.
62. The existence of such an environment, where material and relevant information on
solvency requirements for a Takāful undertaking is readily accessible, works as a
strong incentive to TOs to conduct their business in a sound and efficient manner,
including an incentive to maintain an adequate solvency position that can act as a
cushion against potential losses arising from risk exposures. This will lead to more
effective accountability and thus helps to safeguard the integrity of Takāful
undertakings, as well as guiding potential Takāful participants in their decisions on
whether or not to participate in a Takāful scheme. Adequate disclosure assists
potential and existing Takāful participants, as well as other market participants, to
evaluate the financial standing of Takāful undertakings and the risks to which they are
exposed.
63. Thus, disclosures regarding the solvency requirements should be subject to a
requirement for public disclosure of adequate qualitative and quantitative solvency
information, excluding commercially proprietary information and other information
subject to confidentiality considerations to the Takāful undertaking. (These types of
information, however, should be disclosed to the supervisory authority.) For public
disclosure, a TO should describe the overview of the risk management framework for
identifying, measuring, monitoring and controlling relevant risks in maintaining the
solvency control level in its annual report.
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DEFINITIONS
The following definitions are a general understanding of the terms used in this document. It is
by no means an exhaustive list.
Acquisition cost Upfront costs incurred by a Takāful undertaking at the issuance of new
business such as commissions to sales agents, underwriting and other
acquisition expenses.
Asset-Liability The on-going process of formulating, implementing, monitoring and
Matching revising strategies related to assets and liabilities to achieve the
financial objectives, given the risk tolerances and other constraints.
Current central The present value of probability-weighted cash flows expected to arise
best estimate from PRFs’ portfolio of Takāful contracts considering all currently
available information.
Exit value The net realisable value of an asset, i.e. its market price at the date of
a balance sheet less the selling expenses, or in the case of a liability
the amount for which it could be settled or transferred at that date plus
the costs of doing so..
Going Concern The expectation that the Takāful undertaking will continue its
operations and take on new risks.
Internal Model A risk measurement system developed by a TO to analyse its overall
risk position, to quantify risks and to determine the economic capital
required to meet those risks.
Liabilities The financial obligations of both the shareholders’ and the PRFs.
Detailed descriptions are set out below.
i. Liabilities of the shareholders’ funds are all financial obligations of
those funds, and do not include technical provisions which are
liabilities of the PRFs
ii. Liabilities for PRFs include financial obligations owed by the
funds particularly amounts payable to participants in respect of
valid expected benefits. In addition, PRFs’ liabilities include
technical provisions in respect of potential liabilities from business
already written.
Market consistent A valuation of the PRFs’ assets and liabilities that is consistent with
valuation either the assessment of their risk and value by market participants
(“mark-to market” valuation) or, in the absence of a direct market
evaluation, the valuation principles, methodologies and risk
parameters that market participants would expect to be used (“mark-
to-model” valuation).
Minimum Capital The minimum solvency control level set for the PRF at which the
Requirements supervisory authority would invoke its strongest actions, if corrective
(MCR) actions are not implemented.
Minimum Target The minimum solvency control level set for the shareholders’ fund at
Capital (MTC) which the supervisory authority would invoke its strongest actions, if
corrective actions are not implemented.
Muḍārabah A contract between the capital provider and a skilled entrepreneur
whereby the capital provider would contribute capital to an enterprise
or activity that is to be managed by the entrepreneur as the Muḍārib
(or labour provider). Profits generated by that enterprise or activity are
shared in accordance with the terms of the Muḍārabah agreement,
while losses are to be borne solely by the capital provider unless they
are due to the Muḍārib’s misconduct, negligence or breach of
contracted terms.
24
Own risk and A Takāful undertaking’s assessment of the adequacy of its risk
solvency management and current, and likely future, solvency position. Such an
assessment assessment should encompass all reasonably foreseeable and
(ORSA) relevant material risks, should identify the relationship between risk
management and the level and quality of financial resources needed
and available and should determine the overall financial resources the
Takāful undertaking needs to manage its business given its own risk
tolerance, business plans, and supervisory requirements.
Participants’ A fund to which a portion of contributions paid by Takāful participants
Investment Fund is allocated for the purpose of investment and/or savings.
(PIF)
Participants’ Risk A fund to which a portion of contributions paid by Takāful participants
Fund (PRF) is allocated for the purpose of meeting claims by Takāful participants
on the basis of mutual assistance or protection.
Provisions The amounts set aside on the balance sheet to meet liabilities arising
out of Takāful contracts, including provision for claims (whether
reported or not), provision for unearned contribution, provision for
unexpired risks, Takāful provision, and other liabilities related to
Takāful contracts (e.g. contributions, deposits, savings accumulated
over the term of Takāful contract).
Prescribed Capital The solvency control level set for the PRFs which, if breached, would
Requirements require action by the TO to increase its solvency resources or reduce
(PCR) the risks undertaken by the PRFs.
Prescribed Target The solvency control level set for the shareholders’ fund which, if
Capital breached, would require action by the TO to increase its capital
(PTC) resources to meet its financial obligation.
Prudent person The ‘prudent person’ approach requires the TO to act in the way that a
Rule (PPR) prudent person would, e.g. by considering the risks involved, obtaining
and acting upon appropriate professional advice and suitably
diversifying the investments.
Qarḍ A non-interest-bearing loan intended to allow the borrower to use the
funds for a period with the understanding that this would be repaid at
the end of the period.
Quantitative Specific limits on holdings in risky asset classes imposed by the
Restrictions supervisory authority.
Reserves Amounts set aside to meet unforeseeable liabilities or statutory
requirements and stemming either from shareholders’ capital or from
accumulated surplus.
Risk weightings The assigning of greater importance to particular assets or liabilities
based on the risk profiles.
Risk management The process whereby the Takaful undertaking's management takes
action to assess and control the impact of past and potential future
events that could be detrimental to the undertaking. These events can
impact both the asset and liability sides of the undertaking's balance
sheet, and its cash flow.
Risk Margin The component of the PRF’s technical provisions that reflects the level
of risk and uncertainty in the determination of the current estimate and
produces a technical provision that reflects the value that another TO
would be expected to require in order to take over (hypothetically) the
portfolio of obligations.
Run-off The situation where a TO no longer undertakes new business for a
PRF but continues to meet the fund’s obligations in respect of in-force
Takāful contracts until the end of their terms, including benefits arising
from those contracts.
Solvency Control Levels of regulatory solvency requirements which, if breached, trigger
levels restrictions on the TO or interventions by the supervisory authority.
25
Solvency The financial requirements that are set as part of the solvency regime
Requirements and relate to the determination of amounts of solvency resources that
a Takāful undertaking must have in addition to the assets covering its
technical provisions and other liabilities.
Solvency The surplus of assets in excess of liabilities that is regarded as
Resources available for solvency requirements, in accordance with domestic law
or supervisory regulations.
Tabarru’ The amount of contribution to be relinquished by a Takāful participant
Commitment as a donation for fulfilling the obligation of mutual help and to be used
to pay claims submitted by eligible claimants.
Takāful Takāful is derived from an Arabic word which means solidarity,
whereby a group of participants agree among themselves to support
one another jointly for the losses arising from specified risks. In a
Takāful arrangement, the participants contribute a sum of money as
Tabarru’ commitment into a common fund, which will be used for
mutual assistance of the members against specified loss or damage.
Takāful participant A party that participates in the Takāful product with the TO and has the
right to benefit under a Takāful contract (similar to a “policyholder” in
conventional insurance).
Takāful operator Any establishment or entity that manages a Takāful business.
(TO)
Takāful A hybrid structure comprising a Takāful Operator (TO) and one or
undertakings more underwriting funds (PRFs) that are attributable to the Takāful
participants.
Time horizon The period of time over which the adequacy of solvency resources is
measured. For solvency purposes this is often set to approximate the
length of time that a Takāful undertaking or a supervisory authority
would reasonably need in order to take effective action after the
revelation of an adverse event in a Takāful undertaking’s internal or
regulatory reporting. The time horizon is part of the target criteria in the
calibration of regulatory solvency requirements.
Technical The value set aside to cover expected obligations arising on Takāful
Provisions contracts. For solvency purposes, technical provisions comprise two
components, namely the current central best estimate of the costs of
meeting the Takāful underwriting obligations, discounted to the net
present value (current estimate), and a margin for risk over the current
estimate.
Total balance An approach to assessing the overall financial position of a Takāful
sheet undertaking that recognizes the interdependence between the risks
approach associated with a Takāful undertaking’s assets, liabilities, regulatory
solvency requirements and solvency resources and the potential
impact of those risks upon the Takāful undertaking’s balance sheet.
Underwriting The process of evaluating new applications, carried out by a TO on
behalf of the Takāful participants based on an established set of
guidelines to determine the risk associated with an applicant. The TO
could accept the application or assign the appropriate rating class or
decline the application for a Takāful contract.
Underwriting The PRF’s financial outturn from the risk elements of its business,
surplus or deficit being the balance after deducting expenses and claims (including any
movement in provisions for outstanding claims) from the contribution
income and adding the investment returns (income and gains on
investment assets).
Wakālah An agency contract where the Takāful participants (as principal)
appoint the Takāful operator (as agent) to carry out the underwriting
and investment activities of the PRF on their behalf.
26
APPENDIX
INTERVENTION CONTROLS
Breaches the
Between the PTC /PCR
PTC/PCR but above Below the MTC/MCR
and MTC/MCR level
MTC/MCR level
Supervisory • Request for a • Closely monitors the • Take actions to
authority restoration plan from implementation by protect the interest of
TO the TO including the Takāful
• Continuous requisition of participants
discussion with the evidence that actions
TO as to the reason have been
for the breach and implemented
the potential for
corrective measures
Takāful • Formulation of a • Implement the agreed • Take actions to
operator restoration plan corrective measure protect the interest of
• Continuous dialogue and closely monitor the Takāful
the supervisory for adjustment participants
authority to justify the
breach and the
potential for
corrective measures
Possible • Restoration plan Between the PCR and For breach of MCR
Intervention which include: MCR level
actions ► Reason of the • Restoration plan • further draw-down of
breach which includes a the Qarḍ facility to
► Potential proposed timeline for the PRF; or
corrective improving the • Plan for run off of the
measures solvency level with PRF, or transfer to
► a proposed and without the draw- viable third party
timeline for down of the Qarḍ
improving the facility.
solvency level • Draw down of the
with and without
Qarḍ facility to the
the draw-down of
PRF in order to
the Qarḍ facility. expedite the
restoration of the
PCR level
• TO may not be
allowed to undertake
new business for
PRF
Between the PTC and For breach of MTC
MTC
• initial capital injection • further capital
could be required injection into the
shareholders’ fund or
transfer to viable
third party
27
