In an effort to further improve the overall Takaful regulatory framework in Malaysia, Bank Negara Malaysia (BNM), the central bank, is set to introduce a series of sweeping regulatory changes into its burgeoning Takaful industry. These regulations are: the Shariah governance framework (SGF); the Takaful operational framework (TOF) and finally the risk-based capital framework (RBC).
The Takaful RBC mirrors almost completely the recently introduced RBC framework for the conventional insurance industry. The draft framework was initially released for feedback in April 2011 and has progressed largely untouched from the original.
Thus, indicators of financial strength will now be assessed at an operator level based on a capital adequacy ratio of 130%, while senior management are responsible for setting up individual target capital levels reflecting the operators risk profile and risk management strategy.
In the draft framework the total capital required is to be the sum of the capital required for the shareholders’ fund and for each of the Takaful funds, while further changes have also been made in an attempt to account for the differing concepts of Takaful and conventional insurance.
The SGF attempts to directly address the current shortcomings of the industry, bringing Shariah compliance to the forefront. It will separate underlying Shariah principles from ultimate financial objectives, bringing them directly accountable to board level management. It is hoped that this greater independence will promote further innovation in an industry all too willing to replicate its conventional peers.
The TOF takes effect on the 1st October 2011, and governs all operational aspects of a Takaful operator to ensure it complies with the underlying Shariah principles laid down in the SGF and implements them to safeguard the interests of the participants.
Risk sharing versus risk transfer
One requirement of the RBC framework, however, is at odds with the Shariah; and this underlines the dilemma between both the regulator and the Takaful industry when implementing Shariah requirements.
This is due to the mandatory legal provision of a Qard (loan) in case of a deficit in the Takaful fund, which is meant to enable the participants’ risk fund to meet its Takaful benefit payout obligations.
However, this measure effectively puts the Takaful operators on the same level as a conventional insurer, as the underwriting risk is shifted from the Takaful fund to the shareholders’ fund. This means a breach of a fundamental Takaful principle as these funds are deliberately segregated in order to meet Shariah compliance and ensure that it is the Takaful pool and not the operator that meets any payout obligations.
One might argue that the risk of a Qard is negligible but this is not necessarily the case for small newly operational Takaful funds yet to achieve critical mass; or those funds with volatile risks, such as commercial risk.
While the mandatory Qard, necessitated by the RBC framework, is probably a necessary evil the industry has to deal with for solvency purposes, it also poses the question as to who actually owns the risk: the shareholders or the Takaful participants?
With many Takaful operators yet to reach critical mass in their business models, many operators may find it challenging to meet the imposed regulations without severely impeding their competitiveness against the conventional industry, potentially slowing the impressive growth figures that the Takaful industry has been rallying behind.
For BNM good governance naturally comes at a cost and ultimately, Malaysia’s Takaful operators will have to mitigate this additional financial burden if they want to remain relevant within an increasingly skewed playing field.