View source for Different Takaful Business models by Zainal Kassim

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                                     Different Takaful Business

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                                     Model in Practice

                                     - Concept and Modalities

                                     Zainal Abidin Mohd. Kassim, FIA

                                     Langham Hotel, London

                                                                     www.mercer.com


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client logo in this space.           Why not Insurance?

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Why conventional insurance is not Sharia compliant

 From the insured perspective

     – Insurance is a (pure) risk transfer mechanism, the insured loss is

       restricted to his premium

     – Insurance companies investments are not in Sharia compliant

       assets (e.g. interest bearing bonds, investments in prohibited

       businesses)

     – Certain insurance products may lack transparency (e.g. how much

       is the insurer charging for managing the policy is not known to the

       policyholder)

 From the (insurance) investors perspective

     – Underwriting profits are subject to an element of chance

       (speculative risk)

     – Investments are not Sharia compliant

Mercer                                                                     2


Basis of operation of a conventional General Insurance company

 There is typically no identifiable policyholders fund

 Premiums once paid becomes part of the assets of the company. The

   company in turn becomes liable to pay all insured claims arising

 All investment income on these assets and any underwriting surplus or

   losses accrue to the shareholders of the company

 Policyholders typically do not know how much of his premium goes

   towards claims, expenses and profit to the company

 Only restrictions on investments relate to the Asset Liability

   Management constraints imposed by management and/or Regulators

Mercer                                                                  3


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 What enabled the establishment of Takaful?

 The Islamic Fiqh (Muslim Jurisprudence) Academy under the auspices of the

  Organization of Islamic Conference ruled in 1985 that : “Insurance through the

  concept of a cooperative (founded on the basis of Tabarru’) is acceptable in

  Islam”

 This is the basis of modern Islamic Insurance where the insured is also the insurer

  (risk sharing rather than risk transfer) and Gharar is overcome through

  premiums being Tabarru’.

 Mercer                                                                               5


 The Takaful Fund - Risk

 Gharar (uncertainty) is present in any insurance type arrangement. When you buy

  an insurance policy you may or may not claim from the insurer depending on

  whether the insured event transpired or not during the duration of the policy.

 Premiums are donated to the Takaful Risk Fund by the participants or

  policyholders. Tabarru’ is a sharia approved gratuitous contract, which by its nature

  accommodates Gharar.

 Mercer                                                                                 6


Islamic Contracts of Compensation

(sample)

                                  Partnership between capital providers.

                       Musharaka  Profit, shared in an agreed percentage

                                  (e.g. Joint stock companies)

                                  Partnership between capital provider

                                  and entrepreneur. The former brings

                                  capital, the latter brings

                       Mudharaba  expertise/effort. Profit is shared in

CAPITAL                           agreed percentages. Losses accrue

                                  to capital provider only.

                                  Entrepreneur bears his own expenses.

                                  Entrepreneur given a fixed fee for this

                                  expertise/effort. Does not share in

                        Wakala    profit or loss which accrues to the

                                  capital provider. Entrepreneur bears

                                  his own expenses.

Mercer                                                                   7


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Basis of Operation – the Cooperative model

 Set up as a cooperative but with a small shareholders fund to meet statutory

   requirements. Premiums are deemed to be tabarru’.

 All expenses (including management and acquisition costs) are met by the cooperative

   fund

 All surpluses belong to the policyholders, shareholders returns are restricted to the

   investment income on the shareholders fund.

 If the shareholders sets up a separate management structure for investing the assets of

   the cooperative fund, the shareholders will be entitled to a share of the investment

   profits. Investment management expenses are not charged to the cooperative fund.

   Effectively the investment services are contracted out by the policyholders on the basis

   of the mudharabah contract.

 Policyholders are represented on the Board of Directors of the company.

 There is a Sharia Supervisory Board responsible for ensuring the company’s operation

   complies with Sharia law.

Mercer                                                                                      9


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Basis of Operation - the Company / Cooperative approach

The Mudharabah model

 The first Takaful Operator in Malaysia is Syarikat Takaful Malaysia. It has a separately

   identified shareholders and policyholders (Takaful) fund. It follows the Mudharabah

   model on the basis of the following interpretation of the insurance process;

     – The policyholders are designated as the capital providers to the Takaful Fund

     – The shareholders are designated as the entrepreneur whose tasks is managing the

       Takaful Fund

     – Surplus arising in the Takaful Fund arises from both the underwriting of risk and the

       investment of assets and is shared on a pre agreed profit sharing percentage

       (normally 50:50 for non life operation). All management expenses are met entirely

       by the shareholders fund. However, all deficits in the Takaful fund accrue to the

       policyholders only, not the shareholders.

Mercer                                                                                       11


Basis of Operation - the Company / Cooperative approach

The Wakala/Mudharabah model

 The later Takaful Operators opted for the Wakala Model for the underwriting portion of

   the operation. Under the wakala contract;

     – The Operator takes a fee expressed as a percentage of the premium. This premium

       net of the fee is then deposited in the Takaful Fund from which claims are paid.

     – In return for the fee, all management and distribution costs are met by the

       shareholders fund.

     – Underwriting surplus and deficits accrue to the policyholders

     – Some Takaful Operators take a share of the underwriting surplus as an “incentive”

       wakala fee while not sharing in the underwriting losses

 Concurrently the Takaful Operators opted for the Mudharabah Model for the investment

   portion of the operation;

     – The Operator takes a percentage share of the investment income but does not

       share in investment losses

     – All investment management expenses are borne by the shareholders fund

 For unit linked type of Takaful Life (called “Family”) products the Takaful Operator may

   choose the Wakala model where they take a percentage of the NAV under investment

   as their fee instead of Mudharabah profit share model

 There are no policyholders representatives on the Board of Director.

Mercer                                                                                     12


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Basis of Operation – The Takaful Window

 Apart from two companies, all the other takaful operations in Indonesia

   are “window” based operation.

 Under a window operation a notional takaful fund is set up within the

   conventional insurance fund. Assets are ring fenced within this

   notional fund and consists of only sharia approved investments.

 It is notional in that there is no legal separation of assets and in any

   winding up it is doubtful that the assets in the takaful window is

   provided any protection from the liability of the other (conventional)

   policyholders

 The dominant Takaful Model in Indonesia is the Mudharabah model for

   both underwriting and investment business within the takaful

   operation. However, notwithstanding this model there is provision to

   treat commissions as a first charge on takaful premiums

 There are no policyholders representatives on the Board of Directors

Mercer                                                                     14


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Basis of Operation – Islamic Contracts for Takaful

 The Wakala and the Mudharabah contracts are the choice contracts

   for Takaful in the Middle East. With some exceptions the Mudharabah

   contract is solely used only for investments of Takaful Funds

 There is a particularly unique form of the wakala contract practiced by

   many Takaful Operators in the Middle East;

     – Instead of stating the wakala fee explicitly in each takaful contract,

       the wakala fee is announced (usually through the printed press) at

       the beginning of each financial year of the Takaful Operator and is

       fixed for the duration of the year

 Underwriting surplus, if provided as an incentive fee for the Takaful

   Operator under the wakala contract, starts at a higher threshold rather

   than the first dollar of surplus as in Malaysia

 There are no policyholder representatives on the Board of Directors

Mercer                                                                        16


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Basis of Operation – Wakala with Waqf

 While the wakala contract still applies between the Takaful Operator

   and the Takaful Fund, Pakistan’s Shariah Scholars raised certain

   issues with the accompanying Tabarru’ contributions which is

   considered as a conditional gift;

     – As a conditional gift, the contributions are specifically to be used to

       pay claims with any underwriting surplus still accruing to the

       Tabarru’ contributors. Under this assumption there is a concern that

       the transaction has the characteristic of a contract of compensation.

       Under such conditions the underlying gharar would have

       invalidated the transaction under Sharia law. There is also the issue

       of the fairness of intergenerational subsidies between different

       generations of participants if such ownership links prevails.

     – To avoid such doubts, the Sharia proposed the use of an Islamic

       Trust Fund, a waqf.

     – Under a waqf the any lingering ownership by the policyholders to

       the Tabarru’ contribution is legally severed

Mercer                                                                         18


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 Role of Capital

 Although risks are retained within the Takaful Funds, a mechanism is required to

  smooth out the expected claims fluctuations

 Under the Sudan Model there is explicit provision for policyholders to contribute

  additional premiums should a deficit occur. However, this is not usually done in

  practice. No such provision exist elsewhere.

 Typically, funding of these volatilities comes first through utilization of reserves built

  from past surpluses and next from loans made from the shareholders funds. These

  can be seen as subordinated interest free loans (Qard Hasan)

 Loans to be repaid (and are a first charge) from future Takaful surpluses

 Mercer                                                                                      20


 ReTakaful

 The need for Qard can be minimized through appropriate retakaful arrangements.

 Retakaful is different from reinsurance in that;

    – The reinsured is not the TO but instead it is the Takaful Risk Fund

    – The TO acts as the agent to the Takaful Risk Fund to secure the necessary

        retakaful programs

    – While reinsurance acts to spread the volatility of the insurer over time, retakaful

        is more akin to a risk pool at a specific time

 Mercer                                                                                   21


The Challenges for a viable Takaful business model

 Mudharabah model likely to be limited to investment rather than the

   underwriting process in Takaful

 Regulators interpretation of the role of stakeholders and role of capital

 General (Casualty) Takaful

     – Easily adaptable for personal lines (high volume with low volatility)

     – Problems of capacity for commercial lines (high volatility) without

       sufficient Retakaful support

     – Lack of suitable Sharia compliant assets

 Life (Family) Takaful

     – Apart for in Malaysia, Family Takaful is still underdeveloped

       elsewhere

     – What constitute an acceptable Family Takaful product?

     – Limited availability of Sharia compliant asset classes imposes a

       limitation on product innovation

Mercer                                                                       22


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    The Muslim Population

 1.84 billion worldwide in 2007

 1.24 billion in Asia (including Middle East)

 490.9 million in Africa

 50.7 million in Europe

 Muslim population is increasing at a rate of 2% p.a. around the world.

 Source: www.islamicpopulation.com

    Mercer                                                               24


Muslims make up 1.84 billion of the world’s population

Mercer                                                 25


 Potential Takaful Market by Region

       Taking into account the likely penetration among Muslims, adjustments for non-Muslim potential,

       there is worldwide Takaful premium potential of at least US$ 20 billion annually, compared to

       current figure of US$ 4 billion*

       *Source: Oliver Wyman in their publication “Takaful: A new global insurance growth opportunity”

Mercer                                                                                                 26


Zainal Kassim                     Simon Grout

Suite 17.02 Kenanga International 1 Neal Street

Jalan Sultan Ismail               London

50490 Kuala Lumpur, Malaysia      WC2H 9QL England

zainal.kassim@mercer.com          simon.grout@oliverwyman.com www.mercer.com