IFRS for Takaful

I had recently been invited to an awareness program on IFRS adoption in financial institutions in Brunei.  It was organised by Deloitte and attended by bankers, insurance, takaful, accounting firms, consultants, etc.  It was an informative session for most of the audience nevertheless several parts of the region had taken necessary steps to prepare themselves towards the compliance.  I had taken the opportunity to add several points to draw attention of takaful players and relevant parties on the same subject matter as follows:

1. There are some school of thoughts which had different opinion on IFRS as the IFRS is specifically mention for insurance and not takaful.  The question is whether "takaful equals insurance?".  The key element in the definition of insurance in IFRS is that there is a transfer of risk from policyholder to insurance company.  However, there is no transfer of risk from policyholder or participant in takaful to the takaful operator as the risk is shared among the participants and takaful operator merely act as a caretaker or trustee to the takaful funds.  Furthermore, the risk pool fund is not a legal entity thus whether IFRS is applicable in the case of Takaful.  Well, whatever it is, local regulator has the final say in this matter.

2. If the regulator say yes it is applicable perhaps for harmonization with the conventional insurance, the next issue is whether it is applicable to the shareholder fund only, risk fund only, combined funds or consolidated?  This need to be taken into consideration during the process of adoption.

3.  Qard - takaful operator must by now prepare a management policy pertaining the Qardul Hassan policy and approve by BOD.  It must cover the recoverable policy of the Qard, when and how to recover the Qard. A policy must be drawn on the time limit to write-off the Qard, if applicable, in the event that recoverable is no longer possible.

4.  Surplus distribution policy - there must be a written management policy pertaining the surplus distribution whether at pool level, policy level as well as at participant level. This policy  must be approved by BOD as well as appointed actuary.

5. Next issue is on Actuarial opinion.  Auditor sometimes refer to their own actuary whilst the operator usually has their own.  Furthermore, regulator may also refer to their own actuary whether internal or external.  Thus conflict of opinion may arise between these actuaries pertaining the assumptions used to derive the fair value or best estimates.

6. Takaful Model - all takaful operators will adopt certain type of  takaful models whether mudharabah, wakalah or hybrid.  However, some companies still vary the model at policy level i.e. different type of takaful policy or plan may adopt different component of takaful model instead of the corporate model.  This will complicate the estimate process later on during IFRS preparation.  Thus, consistency and standardization must be adopted.

In general, I personally feel that there might be 2 options in this IFRS preparation namely, (1) Prepare two sets of accounts i.e. IFRS and non-IFRS in order to compare with existing business results; and (2) Prepare IFRS for 2014 and 2013 (retrospective) in order to compare the trend between 2 different financial years.  Definitely, the cost will be much higher than anticipated due to 2 sets of accounts needed for the first adoption year for IFRS.

MRTT vs Conventional Loans

Recently, I met a friend of mine who is an ex-CEO of a retakaful company after industry briefing by AIF (Asian Institute of Finance).  He mentioned to me on a discussion a day before with ISRA and few other relevant parties with regard to MRTT covering the conventional loans.  There is an initiative to prohibit such facility and ISRA is assigned to research on the matter.

I had totally a different opinion on the matter.  First, I strongly believe that the proportion of those conventional loans being covered by Takaful under MRTT is extremely low and perhaps less than 1% of total loans disbursed.  In other words, it is too minor issue to engage ISRA or relevant parties to research as well as debating the matter since there are many other bigger or major issues require urgent attention.

Second, Takaful companies never focus on conventional loans or trying to tap into such market since their resources are fully utilized to serve the Islamic finance industry which is continuously demanding.  If there is any such cases, it is merely on accommodation basis upon special request whether the borrower or the bank. Thus, those policies which are very insignificant in volume are on individual policy basis and never be on group master policy basis.  It means that takaful company does not collaborate with the conventional bank to promote MRTT as a package with their conventional loan.

Third, the nature of MRTT is to cover the lives of the borrower and not the conventional loan like credit takaful or insurance policy which indemnify the bank in the event of default by the borrower.  There have been few shariah scholars which allow takaful company to offer takaful coverage to person who may involve in non-shariah activities such as prostitution, etc with the intention that takaful company is not influencing the person for such activities. Furthermore, one of the main objectives of takaful is to do dakwah thus we hope that the person is given 'hidayah' by Allah swt and slowly move towards Islam in total one day insyaAllah.

Last but not least, it can be viewed as less of two evils.  For instance, assuming that the person had no choice but to take conventional loan due to whatever reason maybe an employee of such conventional bank.  Now, he has a choice whether to cover himself with conventional MRTA or shariah MRTT and he is incline towards MRTT to ensure compliance with shariah principles. Unfortunately, takaful declines his application merely because his loan is conventional. Do we have the authority to reject those who want to come to Islam even not in totality?  Can we reject someone who wants to embrace Islam because he want to marry a Moslem?  Do we really know what is inside his heart or 'qalb" pertaining his real intention?   Who will answer in front of Allah swt when he claimed that he had tried to participate in shariah compliant product but turned down by takaful?

In a nutshell, this is too minor issue to elaborate further.

New Takaful Venture

I have been approached by few potential investors to explore on the possibility to setup new takaful company in certain countries.  I always ask myself what is a simple yardstick to determine whether the investment to setup a new takaful company is really worthwhile or gives a reasonable ROI.  Thus, I had formulated a simple formula to derive a simple result which can help to determine on a crude basis as follows:
TEP = {M x (1 - p%)} / (N + 1)
where,
TEP - Takaful Economic Potential
M - Total Moslem population in the desired country
p% - poverty rate of the desired country
N - existing Takaful operators in the desired country

Thus, High economic value for takaful if
TEP > 1 mil  - for normal insurance/takaful market
TEP > 0.5 mil - for advance/matured market

For example,
Let's choose Nigeria as desired country therefore,
M = 75,728,000
p% = 47.9%
N = 1 (yet to be verified)

Thus, TED > 19 mil.

Therefore, Nigeria provides a huge market potential for takaful and it is strongly recommended for potential investors not to miss this golden opportunities.  It means that there is easily 19 mil potential customers ready on average per takaful operator upon entrance of a new one to be penetrated.  If success rate is say 1% (due to startup company in first year), avg case size is 1200 (annualised), this will lead to about 237 mil (local currency).  Subsequently, when the infrastructure is in place and competitive products available with effective distribution channels, success rate may easily increase to 5% which will lead to an annuliased contribution of about 1.2 billion (local currency).  These simple statistics should lure potential investors to pool their capital into this industry as soon as possible.

Takaful Assets is only 1% of Global Islamic Finance Assets

Mid 1990's, global Islamic finance assets recorded a total amount of USD 150 billion worldwide in view of it's infancy stage in most markets.  By end of 2012, the amount has reached approximately USD 1.6 trillion or an average of 15% CAGR.  This is a very promising performance for the Islamic finance industry despite of numerous challenges globally including severe global financial crisis 2007-08 which is considered as the worst financial crisis since Great Depression 1930s. It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world.

Out of USD 1.6 trillion, only approximately USD17.2 billion is contributed by Takaful industry worldwide or only 1%.  Banking assets constituted 80.4%, whilst Sukuk outstanding and Islamic fund assets constitute 14.6% and 4.1%, respectively.  It means that takaful is still insignificant in economic determinant in most markets. There shall be more initiatives by the industry players to increase their market penetration and subsequently become dominant contributors to the economy.  Areas like retirement and pensions should be on top list of their strategic plan which can assure long term sustainability and profitability. In addition, takaful operators should explore on enhancing their strategic distribution channels to improve market penetration. Current strategy perhaps is to tap into the mass market instead of niche market as this will help to create market awareness on the takaful concept and advantages such as profit sharing and transparency.

It is expected that global Islamic finance assets to surpass USD 6.5 trillion or 16% CAGR by end of 2020.  Takaful industry should strive harder to increase their market share of at least 5% overall.  Governments should facilitate in setting up more takaful operators in high potential markets such as Indonesia, North Africa, Middle East, India, Bangladesh, Pakistan and China.  Matured Islamic finance markets like Malaysia can play bigger role in supplying right talents to new markets and continuously working together to develop those markets to become major contributor to domestic economy respectively.  Global takaful industry should capitalize on several talents development institutions such as IBFIM, INCEIF, ISRA, etc in Malaysia which have accumulated decades of industry experience and ready to contribute successfully.  Finally, IDB (Islamic Development Bank) can also contribute the necessary capital, if need be.

BOD - duties and responsibilities under IFSA

"Section 65(3) In carrying out its functions or duties under this Division—
(a) the board of directors of an institution shall have regard to
the interests of, as the case may be, depositors, investment
account holders and takaful participants of the institution or
participants; and
(b) the board of directors of a licensed takaful operator shall, in
the event of conflict between the interest of the takaful
participants and the shareholders, give priority to the interest
of the takaful participants."

Under Division 2 on Corporate Governance in IFSA, section 65(3) emphasizes that BOD duties and responsibilities shall be more towards the interest of customers particularly takaful participants in the case of takaful business.  It further states that in the event of conflict between the interest of shareholders and participants, BOD shall give higher priority to the interest of participants.  This is very interesting provision as it will have impact on areas like surplus distribution, and qard hasan.  CEO and management shall give the appropriate advise to BOD for approval which shall in most situation favors the participants.

Nevertheless, the spirit of this provision has been well practiced by all Shariah boards or committees as they will, at all times, ensure that the interest of public is well taken care of under equity, fairness, transparency and honesty.

Appointed Actuary Guidelines

Bank Negara Malaysia had recently issued a concept paper titled “Appointed Actuary: Appointment and Duties” where the consultation period for the paper ended on 2nd August 2013. The concept paper proposed BNM’s enhanced supervisory expectations on the duties and responsibilities of the Appointed Actuary as well as greater clarity on the Appointed Actuary’s relationship and interaction with various stakeholders. Some of the major changes are: Appointed Actuary requirement extended to general insurance business, removal of product pricing duty from the Appointed Actuary and, greater oversight by the Board of Directors on actuarial issues. The introduction of the Appointed Actuary system to the general insurance industry is a timely development as it moves towards a de-tariffied business environment. Furthermore, this is also in tandem with the new regulation under FSA and IFSA to split composite license into separate life/family and general entities. The removal of the pricing role from the Appointed Actuary will necessitate more clarity on the requirements and duties of the Pricing Actuary which will hopefully be addressed soon. Additionally, it is a welcome development that the concept paper proposes an explicit condition on the appointment of an Appointed Actuary, that the candidate meets relevant CPD requirements. The final major change, the greater oversight by the Board of Directors on actuarial issues, means that actuaries must rise up to the communication challenge of explaining technical issues using less jargon and to make complex issues comprehensible to non-actuarial stakeholders.

Islamic Finance Services Act

Bank Negara Malaysia had recently introduced Islamic Finance Services Act which replaces all relevant Acts for Islamic Financial Institutions.  Under Part III Div 2 Sec 16 of IFSA, it prohibits any takaful operator to transact both family and general business under one entity.  Consequently, existing 8 composite TOs are given 5 years to restructure their organisation and capital to comply with the provision.  Frankly speaking, it is rather complicated matter and challenges are different from one to the other.  My personal opinion is that few shareholders will give up their general licenses and retain solely their family business only.  Reason is simply because of family takaful generally contributes higher profit margin as compared to general takaful and furthermore it is a long term in nature thus kind of guarantees future profit for shareholders.  Comparatively, general takaful is usually short term contract with normal one year tenure. There are few composite TOs are not developing their general business significant enough as their resources are fully utilized for family business. We would expect to see some M&A to happen in the next 2-3 years arising from the above argument.

For those which decide to retain both family and general business, they will need to setup a separate entity for family and general with definitely separate resources. However, BNM may allow some shared services for a certain period of time after which there might be a requirement to split 100%.  The challenge now is to look for the right talent to lead and manage those 2 separate entities from CEO, senior mgmt team, heads of divisions etc.  Moreover, BNM had also required general takaful to engage a qualified Actuary to supervise their fund accordingly as required under family.  Again, whether the industry is ready to supply sufficient actuaries qualified in property and casualty which is totally different than the currently widespread actuaries in Malaysia. As an interim measures, partly qualified Actuaries who had attained Associateship should be given certain authorities to certify.

I believe setting up a holding company to manage both subsidiaries in family and general will create more problem as the holding company must employ the right talents which is scarce and the new IFSA requires such holding company to be registered as a financial institution within 12 months (if ownership > 50%).  As a result, the current shareholding structure will remain as long as possible.  

If you are interested to learn further on this matter, you can study the takaful or insurance industry in Indonesia where their law does not allow any composite business. In particular, you can study Syarikat Takaful Indonesia which is merely a holding company with 2 subsidiaries ie. PT Asuransi Takaful Keluarga (family) and PT Asuransi Takaful Umum (general).

"16. (1) A licensed takaful operator, other than a licensed
professional retakaful operator, shall not carry on both family takaful
business and general takaful business.
(2) Notwithstanding subsection (1), a licensed family takaful
operator may carry on the general takaful business relating to
medical by reason of disease or sickness or medical expenses subject
to such requirements and conditions as may be specified by the
Bank.
(3) Any licensed takaful operator who contravenes subsection (1)
commits an offence and shall, on conviction, be liable to
imprisonment for a term not exceeding eight years or to a fine not
exceeding twenty-five million ringgit or to both."

Window vs Full-fledged Takaful

In Malaysia, all takaful operators are operating based on full-fledged takaful business model. Comparatively, most of takaful operators in Indonesia are based on window concept business model.  Window takaful concept are more towards product manufacturer and distributor relationship where takaful operator will launch takaful products to meet with the need of conventional insurer which act as distributor.  Moreover, takaful operator is established with minimal infrastructure where most of the core back-end and supports are outsourced to the conventional insurer which has comprehensive infrastructure and establishment.  Nevertheless, regulator in Indonesia is trying to move towards full-fledged model.

Coming back to Malaysia takaful landscape, there are several takaful operators particular new ones are more towards window concept business model where their main shareholders, established insurers, are responsible to distribute the takaful products via their existing conventional distribution channels.  In addition, several core functions including actuarial, IT, underwriting, etc are heavily outsourced to the conventional expertise.  This should be allowed by regulator only for newly setup companies with limited duration say 3 years after which the takaful operator shall manage internally with few exception like IT which may require longer period say 5 years.  By imposing such condition, takaful industry shall see strong development of talents to boost the market penetration in the medium term.  When Bank Negara approved 4 new takaful licenses in 2010, it has selected those with strong and established conventional insurers (mainly foreign) with the intention to promote the transfer of knowledge and technology to takaful operators. This can only be achieved provided that the takaful operator is required to be independent from the conventional insurer within specified timeframe. Therefore, all those relevant takaful operators must establish a clear roadmap to indicate their specific deadline to separate themselves from the conventional insurer in totality. The separation between conventional and takaful is vital to ensure that the takaful business is 100% sharia compliance end to end.  

ING PUBLIC Takaful Ehsan part of AIA AFG Takaful

18 December 2012 marked a historic date for ING Malaysia group of companies where the acquisition by AIA Malaysia was completed.  Companies affected were ING Insurance Berhad, ING Employees Berhad and ING PUBLIC Takaful Ehsan Berhad (IPTEB).  With the closure, AIA now owns two takaful licenses thus it must relinquish one of the licenses under several options.  It may sell one of the entities entirely to any interested party without affecting the business as well as the resources.  However, after several meetings with Bank Negara Malaysia (BNM), AIA had decided to merge the two entities and return one of the licenses to BNM for their further action to offer to new investor.  In the process of integrating the two takaful entities, four senior management including CEO of IPTEB have been terminated and it is expected similar casualties may happen to other levels in the near future.  It is interesting to note that the four senior management terminated had a total relevant working experience of close to 100 years. Whilst the regulator and industry had identified shortage of talent as one of critical success factors for takaful industry, it is amazing to note that talents with about 100 years of relevant working experience can easily be laid off.

Takaful Ehsan was established on 11 March 2011, obtained takaful license from BNM on 1 April 2011 and officially launched the operation and business on 5 April 2011.  It embarked on a multi-distribution channel strategy namely agency, bancatakaful and employees benefit (EB) or corporate business.  Among several achievements, Takaful Ehsan had successfully introduced a full-fledged e-submission or iPOS since it launched it’s business thus making it the first among takaful companies to embark on full-fledged iPOS.  With the facility, customer or intermediary can easily submit cases via online and can print the letter of approval on the spot within 1-2 minutes upon successful online underwriting using smart underwriting.  Takaful Ehsan had also received tremendous acceptance on it’s EB business in view of stability of the system.

Now, upon completion of integration between the two takaful operators which is expected by mid of 2013, Takaful Ehsan will no longer exist in the industry.  It may be the shortest life span for a takaful company in the world and should be recorded accordingly.  May Allah bless all those who had contributed tremendously in the establishment of Takaful Ehsan and wish them all the best in the future pursuit to enhance Islamic financial sector in Malaysia as well as global.