Islamic Insurance

International Journal of Social Economics
Effective supervision of Islamic insurance according to Malaysian experience (1984-2012)

Zoheir Berkem,
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Zoheir Berkem, (2014) "Effective supervision of Islamic insurance according to Malaysian experience
(1984-2012)", International Journal of Social Economics, Vol. 41 Issue: 12,pp. 1220-1242, doi: 10.1108/
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IJSE
41,12
Effective supervision of Islamic
insurance according to Malaysian
experience (1984-2012)
1220 Zoheir Berkem
Received 6 August 2013
Faculty of Economic, Commercial Sciences and Management,
Revised 6 March 2014 Jijel University, Jijel, Algeria
Accepted 14 April 2014
Abstract
Purpose The purpose of this paper is to know the method adopted by the Malaysian supervisor to
regulate the Takaful sector, and to propose a new approach related to the effective supervision.
Design/methodology/approach The key approach in this paper is a case study over a clear period
of time, to discover a wide variety of economical, financial, social, and cultural factors potentially
related to Malaysian Takaful system. In addition, both explanatory and descriptive approaches
are used, to seek explanations of problems, make careful observations, and give detailed
recommendations. The study collected relevant quantitative and qualitative data.
Findings The key findings are: the basis of Takafuls operation is established on the principles of
Islamic Laws, Takaful operations are regulated by the Central Bank, this supervisory body has
adopted elements of the two methods: regulation and supervision, the Malaysian Takaful industry
has experienced rapid growth and transformation, and the proposed approach includes four key elements.
Research limitations/implications This study provides a road map for the next studies in this
new topic.
Practical implications The paper guides the policy makers to giving more independence and
allocating more resources to the supervisory body, for the development of an important component of
the financial system.
Originality/value The essay is distinguished from the previous researches by limiting and
identifying a clear period of the study. Further, the authors have listed the most important elements of
the leading programs. Finally, the approach is more concerned with new aspects of the ongoing
supervision, strategic axis and the supervision stages.
Keywords Takaful, Malaysia, Efficiency, Supervision, Mutual, Islamic insurance
Paper type Case study
Introduction
The Malaysian Islamic Financial System may be, broadly, classified into three
categories such as: the banking system, the non-bank financial intermediaries and the
financial markets (Anwar and Aslam Haneef, 2005).
Regulating or supervising the Takaful sector is accomplished through the regulation or
the supervision of the Islamic financial sector as a component of the whole Malaysian
financial system. Financial sector regulation and supervision can be divided into three
broad categories: bank supervision, securities regulation and insurance supervision.
Financial regulation has, traditionally, proceeded through the route of setting
standards and of externally imposing rules. Although, this approach has worked
reasonably well in limiting systematic damage from financial excesses, it may lead to
International Journal of Social conflicts between the objectives of regulators, who want to reduce systemic risks, and
Economics those of the regulated institutions, which have incentives to take greater risks within
Vol. 41 No. 12, 2014
pp. 1220-1242 internal and regulatory capital constraints.
Emerald Group Publishing Limited
0306-8293
Thus, supervision could be, on one hand, better than regulation. On the other hand,
DOI 10.1108/IJSE-08-2013-0182 regulatory reforms will probably be necessary. The reforms should reexamine, first, the
authenticity of the existing rules, and see whether these latter are still valid and can be Supervision
applied in the future.
In this paper, we will try, after introducing an overview of Takaful sector regulation
of Islamic
and supervision, to identify the leading programs adopted by the supervisor and the insurance
results of their applications. In the last section, a new approach related to the efficient
supervision will be suggested.
1221
Malaysian Takaful system and its supervision characteristics
The first section contains the following elements: definition of Takaful system,
advantages of Takaful plans, Malaysian Takaful Act, the main axes of supervisory
system, supervision body and its approach, the regulator objectives, and the phases of
the oversight policy.
Definition of Takaful system

Malaysian Takaful is a financial institution that provides comprehensive Takaful
Facilities and Services to all Malaysians: Muslims and others (Abdulhamid et al., 2007).
It is a business which includes life insurance, family solidarity business, and non-life
insurance. There is no specific company form required to undertake this business.
Despite few inconsistencies, the Takaful system set up in Malaysia has the merit of
being both comprehensive and properly regulated by law.
So, the Takaful is an insurance system in which the insured persons become group
members, each paying specified amounts into a common fund (Takaful fund) from which
members are entitled to indemnification in case of loss. But given the complexity of the
insurance operations this group will resort to specialized company in the management of
Takaful operations, according to the model chosen (Mudharabah/Wakalah)[1].
Advantages of Takaful plans

The main advantages of Takaful over conventional insurance are as follows:
The participants are insured against various risks. They will, also, benefit from
the surplus distribution[2], and share in the profits that the Takaful operator (TO)
have gained.
Operating costs can either be borne by the shareholders fund (Mudharabah
model) or be charged to the participants as fixed upfront charges (Wakalah
model). These costs may increase the contribution rate and reduce the
participants margin of prot.
In the event of a periodic deficit, the TO acts as a lender of last resort by
providing a qard[3] to the Takaful fund.
Funds are only invested in non-interest bearing investments.
The perception of Takaful plans can raise the awareness of the participants to take
better care of themselves and indirectly raise the overall profit levels of the system.
More emphasis on morality in the investments and dealings of TOs.
Malaysian Takaful Act

The legal basis for the establishment of TOs was Takaful Act which came into effect in
1984; this act does not prejudice conventional insurance legislation. Conventional
IJSE insurances are still allowed and are governed by their own regulations. The Takaful
Act was born to concurrent with conventional insurance laws and to offer an insurance
41,12 scheme in which Muslims can take part (Khorshid, 2004).
The main axes of supervisory system

There are dangers both in excessively restrictive regulations and in lax enforcement.
1222 The supervisory body, then, has adopted elements of the two, above mentioned, methods.
Thus, the oversight policy includes the following main axes (Nor Shamsiah, 2007):
supporting infrastructure;
macro and micro-surveillance;
crisis management;
financial capability; and
supervisory coordination and cooperation.
Supervision body and its approach

Takaful operations are regulated and supervised by Bank Negara Malaysia (BNM)
since 1988. As a developing country, Malaysia has taken a lighter touch approach in
regulating the insurance industry, i.e. it manages new developments in a gradual and
orderly manner. While the old approach, based on maintaining high standards,
establishing strict rules, and taking minimum risks, is being maintained as the pillar
for sound regulatory principles, new developments such as the rise of consumerism,
convergence of financial industry, globalization and the explosion of information
technology have, somewhat, changed the approach in regulating the insurance
industry in Malaysia to a more proactive and developmental approaches (Majid, n.d.).
The regulator objectives

The regulator has made clear their objectives in regulating the insurance industry.
These latter can be summarized as follows: to protect public interest, to promote
fairness and equity, to foster competence, and to play a developmental role.
Phases of the oversight policy

BNM has outlined a four phases-approach in developing the Takaful industry,
as shown in Table I.
First phase from 1984 to 1992

When the concept of Takaful was first introduced to the Malaysian public in 1985, the
majority of the population were still not aware of the importance of insurance
(Bank Negara Malaysia (BNM), 1999). A Special Task Force was established by the
Government in 1982 to study the viability of the setting up a Takaful company (Lim
et al., 2010). In its report, the Task Force concluded that a Takaful company based on
Table I. the principle of Al-mudharabah would be a viable venture.
The fourth phases-
approach in
developing the
Takaful industry Phase 1 2 3 4
in Malaysia Date 1984-1992 1993-2000 2001-2010 2011-till now
Following the recommendations of the Task Force, the parliament enacted the Takaful Supervision
Act. In November 1984, the first TO, called Shyarikat Takaful Malaysia Sdn Bhd., was
incorporated.
of Islamic
One of the most important events in this period was that created in May 1988 where insurance
BNM entrusted with the regulatory and supervisory role over the insurance and
Takaful industries (Bank Negara Malaysia (BNM), 2004b). As a result, during the first
five years Takaful Business was concentrated in the general Takaful products[4], 1223
which were easy to sell. Family Takaful Business accounted for 30.6 per cent in 1989,
this percentage has risen more than doubled in less than ten years (BNM, 1999).
Second phase from 1993 to 2000

This phase is marked by the introduction of competition with the creation, in 1993,
of another TO, called the MNI Takaful Sdn Bhd.
In this period, large cooperation among TOs appeared in the region including:
the formation of ASEAN Takaful Group in 1995; and
the establishment of ASEAN re-Takaful International Ltd in 1997.
In May 1997, BNM established a national Shariaa[5] Advisory Council for Islamic
Banking and Takaful. The council has issued opinions, including opinions on new
financial instruments and the practices of banking and Takaful operations.
Third phase from 2001 to 2010

The phase began with the introduction of the Financial Sector Master Plan in March
2001. This period also witnessed an increased pace of development and competition
with the licensing of new operators.
To further promote the development of the Takaful Industry, the Malaysian Takaful
Association (MTA) was established in 2002. The MTA aspires to improve industry
self-regulation through uniformity in market practices and in promoting a higher level
of cooperation among the players in developing the industry (Abdulhamid et al., 2007).
Fourth phase from 2011 till now

The last phase began with the introduction of the second master plan, the Financial
Sector Blueprint, in 2011, for the period 2011-2020. An important part of the plan will be
the internationalization of Islamic finance and the development of Malaysia as an
International Islamic Financial Centre (Bank Negara Malaysia (BNM), 2011).
Bank Negara initiatives and the results of its policies

The two major measures implemented by the oversight body are: Financial System
Master Plan (FSMP) and Risk Based Supervisory Framework (RBSF).
FSMP
It is important to know the vision, the recommendations and the implementation of
the FSMP.
Vision of the master plan

The overall objective is to create an efficient, progressive and comprehensive Financial
System that contributes significantly to the effectiveness and efficiency of the Malaysian
Financial Sector, while meeting the economic needs of the nation.
IJSE Recommendations
These recommendations including: institutional capacity enhancement, financial
41,12 infrastructure development, and regulatory framework development.
Institutional capacity enhancement. Strategic steps will be taken to prepare the
Takaful industry players to be among the best managed institutions:
(1) enhance knowledge and expertise: the efforts will be directed to promote human
1224 capital development to support the envisaged growth of the industry; and
(2) build strong management teams: to build capable and innovative management
teams, the employment of experienced and qualified staff will be encouraged.
Financial infrastructure development. Specific measures will be taken to promote a
healthy competitive culture, and create sufficient market depth:
(1) Increase the number of TOs: new TOs will be licensed to achieve the following:
to accelerate the expansion of Takaful business; and
to inject greater market competition in terms of pricing, product innovation,
customer service and operational efficiency.
(2) Deepen the Islamic financial market: a deep market structure will be developed
to fulfill the diverse and sophisticated requirements of customers whilst
safeguarding the soundness and integrity of the financial system as a whole.
Regulatory framework development. Concerted efforts will be directed to create
a separate and viable platform for Takaful, to function effectively in parallel with
conventional insurance:
(1) Improve the regulatory framework for Takaful: a comprehensive regulatory
and supervisory framework will be developed to support the sound expansion
of the Takaful industry. Areas covered are as follows:
review the Takaful Act 1984;
progressively increase the statutory minimum paid up capital of TOs;
introduce accounting standards for Takaful business and draft Model
Accounts for TOs; and
monitor and refine further the code of ethics and standard market practices
for TOs.
(2) Establish an effective legal structure: one of the pre-conditions to sustain the
continuous growth of Takaful is a comprehensive legal infrastructure to seek
any legal redress arising from financial transactions.
(3) Create a favourable tax regime: at this stage, some formulations and amendments
of tax policies are necessary to take into consideration the impact on Takaful,
to avoid creating barriers in adopting Takaful concepts and products
(BNM, 2002)[6].
FSMP implementation
When The FSMP entered its fifth year of implementation in 2005, 16 of the 31
recommendations were completed, with the end game of creating a more resilient,
competitive and dynamic insurance industry (Bank Negara Malaysia, 2005).
To date, all recommendations under FSMP have been implemented or are being Supervision
implemented on an ongoing basis (BNM, 2011). The second master plan, the Financial
Sector Blueprint, was released in 2011 for the period 2011-2020. The Blueprint builds on
of Islamic
the achievements of the FSMP (BNM, 2011). insurance
RBSF
What is the RBSF? And what are its principles? 1225
What is the RBSF?
The RBSF is a cyclical, continuous, on-going dynamic process of planning, and
carrying out specific supervision activities. The RBSF was implemented in 2004 with
the continued aim of ensuring that all supervised entities adopt sound business
practices and are financially sound and robust.
The new supervisory process uses a structured approach to assess: TOs risk profile,
its financial condition, the adequacy of its operational management, and risk
management systems. Thus, we can form an overall assessment of the operators
health and the probability of key risks materializing in the future (BNM, 2004a).
The risk assessment process begins with identifying the significant activities of the
supervised entity and the inherent risks associated with these activities. The adequacy
of its capital and profitability will, themselves, mitigate the net risks.
The key principles of the RBSF for Takaful

The key principles, of the RBSF for Takaful, are cited as follows:
(1) Risk focused: different business activities, target markets, product features ,
etc.
(2) Interventionist: degree of intervention commensurate with risk profile;
pre-emptive intervention is based on prescribed guide.
(3) Significant activities focused: major lines of business; process and business unit
depend on materiality.
(4) Timely communication: communication of findings and recommendations to
operators will be timely.
(5) Leverage on oversight functions: review of major risks management control
functions.
(6) Reliance: external auditors appointed actuaries.
(7) Exercise of sound judgment: in identification and evaluation of risks.
(8) Differential supervision: level and frequency of supervision activity performed
depends on risk assessment; well managed institutions will require less
supervision (Yap Lai, 2007).
Malaysian Takaful performance

This main element includes the following important elements: evolution of market
structure, viability and progress of Takaful business, Malaysian TOs and the risk
management, Takaful solvency and capital adequacy, the benchmark Malaysian
Takaful industry, Malaysian re-Takaful challenges, and customer satisfaction for
Takaful services.
IJSE Evolution of market structure
The Malaysian Takaful Industry has experienced rapid growth and transformation
41,12 since its inception 29 years ago, as highlighted in Table II.
The industry has grown from an industry constituted of a single player (till 1993)
with limited products, offices, and agents, to become more competitive: 12 operators,
more than 100,000 agents, and 231 offices at the end of 2012.
1226 Despite the results achieved, Takaful industry is characterized by the relative
weakness of general Takaful. The distribution of family Takaful business may help to
understand why Takaful is successful in this segment:
more agents for family Takaful business (see Table II); and
family Takaful product mix heavily concentrated in mortgage-related products;
health, endowment and annuity underserved in Takaful (Syed, 2011).
Mortgage Takaful plan give Takaful protection for any financial loan taken by
individual(s) from Banks, financial institution or employer in acquiring or purchasing
fixed assets. In Malaysia, most of the TOs part of major financial groups, they have
been leveraging the distribution of Takaful products (mortgage and others) by using
group structures and branch network (Mushtak, 2006). In addition, the banks
increasingly include a suite of family Takaful linked products for their customers
(Sohail, 2006).
Another reason that may explain that success is the many incentives that are given
by the Malaysian government in promoting family Takaful, such tax relief incentives
( Juliana et al., 2013).
Viability and progress of Takaful business

The Malaysian Takaful Industry has, consistently, registered strong growth. It has
proven to be resilient in the face of intense competition from the more advanced
insurance industry. The industry has recorded average annual growth rates of 57.9 and
44 per cent in assets and net contributions, respectively, since 1986, as reflected in
Tables III and IV.
The Takaful industry has reached a market penetration of 8 per cent, and in more
than two decades the strength of the industry, in terms of total assets of the Takaful
Funds, has increased from RM1.4 million at the outset to more than RM14 billion by the
end of 2010.
The Takaful Industry has proven its resilience during the period of the Asian Financial
Crisis, maintaining a strong average annual growth rate of 61.9 per cent in terms of assets
from the year 1997 to 2000. The total contributions for both general and family Takaful
business has also, significantly, increased over the period 2003-2010 to RM4.4 billion by
the end of 2010. Family Takaful business has expanded with its share constituting 70.7
per cent of the total net contributions in 2004, as compared with only 37.5 per cent in 1986.
However, BNM had set a target of 20 per cent share of Takaful in insurance market
of Malaysia by 2010, but the actual achievement is just about eight per cent. This
shortfall may be due to the following reasons:
Growth in Takaful industry, like other industries, has slowed slightly as a result
of the recent global financial and economic crisis.
Conventional insurers, having more long term/short term investment options,
have made higher investment income than TOs. Their scale, longer operating
Number of agents
Number of operators Total Family General Number of offices Number of employees
1985 1
1990 1 31
1995 2 1,210 42
2000 2 4,567 124
2003 4 11,433 9,893 1,540 132 2,161
2004 4 14,370 11,842 2,528 134 2,376
2005 5 14,059 11,781 2,278 147 2,670
2006 8 15,194 11,188 4,006 151 2,967
2007 8 43,843 32,987 10,856 154 2,863
2008 8 60,197 44,222 15,975 157 2,411
2009 8 88,895 55,898 32,997 104 2,499
2010 9 74,089 42,692 31,391 106 2,713
2011 11 100,308 66,338 33,970 207 2,846
2012 12 105,552 68,009 37,543 231 3,575
Sources: Bank Negara Malaysia ((BNM) 2004b, p. 3, 2007, 2010, 2012, 2013)
Supervision
insurance
Takaful business
1227
of Islamic
Market structure of
Table II.
IJSE
41,12
1228
Table III.
Takaful fund assets
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Family (RM million) 3,861.0 4,305.1 5,048.4 5,800.9 7,445.2 8,900.1 10,536.2 1,2461.2 1,4377.2 16289.8
General (RM million) 568.1 723.5 830.0 1,098.1 1,373.1 1,669.3 1,909.2 2,259.2 2,571 2,755.9
Combined (RM million) 4,429.1 5,028.6 5,878.4 6,899.0 8,818.3 1,0569.4 12,445.4 1,4720.4 1,6948.2 1,9045.6
Gross national income (%) 1.1 1.1 1.2 1.2 1.6 1.5 1.9 2.0 2.0 2.1
Total assets of the insurance and Takaful (%) 5.6 5.6 5.7 5.9 6.7 7.5 8.0 8.1 8.1 8.2
Sources: BNM (2004b, p. 3), (2007, 2010, 2012, 2013)
2003 2004 2005 2006 2007 2008 2009 2010 2012
Combined contributions (% of GNI)

Family 0.2 0.2 0.2 0.2 0.3 0.3 0.4 0.5 0.6
General 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1
Combined 0.3 0.3 0.3 0.3 0.4 0.4 0.5 0.6 0.7
Per capita contributions RM
Family 30.4 31.0 36.6 46.3 73.3 85.7 96.0 119.8 156.1
General 10.0 12.8 13.4 17.9 21.3 23.5 28.4 36.4 44.8
Total (RM million) 1,014.0 1,123.0 1,333.7 1,720.9 2,565.0 3,025.1 3,521.8 4,421.8 5,887.8
Sources: BNM (2007, 2010, 2012, 2013)
Supervision
insurance
1229
of Takaful sector
Net contributions income
of Islamic
Table IV.
IJSE history and market relationships have allowed them to build a more profitable
business mix, while Takaful has relied predominantly on retail business and
41,12 relatively fewer product classes (Ernst & Young, 2012).
The presence of some psychological hurdles for Takaful market penetration, like
the lack of players (insurers: 35, Takaful: 12), the absence of an established
re-Takaful market, lack of market awareness, and the relative poor culture of
1230 consumer education (Mushtak, 2006).
The lack of innovation and intellectual capital development.
Malaysian TO and the risk management

Risk management in Takaful industry is a process to identify potential losses of an
operator and to select the most appropriate techniques for treating such potential
losses. The risks of the TOs do not significantly differ from conventional system, the
mere difference lies on the administration of the funds as manifested in the segregation
of the two funds: shareholders fund and Takaful fund.
With regard to underwriting risks that are to be borne by the Takaful funds, the TO
is responsible for managing these risks by exercising due diligence in accepting such
risks, avoiding risk concentrations, setting premium contribution levels that properly
reflect the risks being underwritten, and making appropriate use of re-Takaful
(Simon et al., 2009).
Operational risk can be managed by enhancing corporate governance culture in the
organizations. Cash flow modelling and use of liquidity ratios is quite helpful to identify
liquidity constraints.
TOs might face difficulty in managing market and credit risks as Shariaa compliant
nature of Takaful contract does not allow Takaful companies to deal with interest rate.
The non-availability of Islamic derivatives raises the importance of internal control
mechanism for TOs, which ensures that credit risk exposures are maintained within
limits of prudential standards (Waheed, 2010).
Risks associated to Takaful have raised several challenges that need to be
encountered to enhance risk management practices. Regular Shariaa audit is
found to be an integral part of effective internal controls that prevent the companies
from systemic crisis. Corporate governance calls for independence of board of
directors to devise policies for effective risk management, make unbiased
decisions and resolve issues related to functioning of Shariaa Supervisory Board
(Waheed, 2010).
Zulkornain Yusop, Alias Radam, Noriszura Ismail, and Rubayah Yakob investigated
the efficiency of risk management of Malaysian life insurers and TOs, during 2003-2007.
The study results show that the efficiency score of both type of companies (conventional
and Takaful) is relatively high and the standard deviations indicate a decreasing trend.
The authors have explained this by the changes happening in the firms concerning
regulations, policy, strategy and development (Zulkornain et al., 2011).
Takaful solvency and capital adequacy

Solvency tests are becoming increasingly sophisticated, but the essence of such test
is a comparison between an institutions capital the excess of its assets over its
liabilities and a required minimum amount (Simon et al., 2009).
Technical reserves and provisions. What of are the technical reserves[7] and
provisions for both general and family Takaful?
General Takaful. Data related to the Technical Reserves are shown in Table V. Supervision
From the Table V, we note that the value of unearned contribution reserves[8] have
climbed steadily and has made important strides during the period 2004-2010.
of Islamic
However, the ratio was volatile with the highest percentage of 2005 and the lowest insurance
one in 2010. That is the same as observed for the other indicators in Table V
(provision for outstanding claims, technical reserves), which can be explained by the
difficult situation of financial institutions and markets since 2007 and, especially, 1231
during 2008.
The remaining ratios, however, are good. The achievement of the ratio 80.9 per cent
means that the profits of previous years may be sufficient alone to cover more than
80 per cent of the subscriptions.
The values of technical reserves have increased continuously during the period
studied, despite the low reserve ratios to net contributions during the last two years.
For that matter, however, TOs enjoy good financial health since the ratios are more
than 150 per cent.
For the third indicator, we note that the rates of provision for outstanding
claims to net contributions are acceptable, their ratios ranged between 56.2 and
77.2 per cent.
Family Takaful. Table VI demonstrates statistics related to the statement of
liabilities. We note that the funds allocated to the payment of compensations due at
the end of the year have risen from 43.8 in 2003 to 200.2 RM million in 2010. The rise
percentage was estimated at 63.46 per cent between 2008 and 2009. This is what
makes the family Takaful companies to be able to meet their obligations to their
insured.
For the amount due to income statement/Takaful funds, it returned to the normal in
2009 after it had been negative in 2006 and peaked out in 2007.
Table VI, also, shows the sound policy pursued by the Central Bank, which took into
account the characteristics of Takaful investment. For example, BNM allowed operators
to make provisions for impairment in value of investments since 2007, because there is
a possibility of loss (or profit). The provision was between 1.6 and 1.7 RM million, if we
exclude the special circumstances of 2008.
Capital adequacy. Capital adequacy ratio (CAR)[9] measure the adequacy of the
capital available in the insurance and shareholders funds in order to support the total
capital required. The regulator mentions that companies need to achieve a supervisory
target of at least 130 per cent to avoid any regulatory action. Companies are expected to
set an internal target capital level higher than the supervisory target (say e.g. 150 per cent)
that will better reflects its own risk profile and risk management practices.
As reflected in Figure 1, the combined capitalization level of insurance industry
(including all components) remained strong with the aggregate CAR at 222.3 per cent
(2010: 225.5 per cent), well above the supervisory minimum capital requirement (130
per cent). For instance, MAA TO currently has a CAR at 320 per cent. This was
partially sustained by higher retained profits which boosted total capital available.
Thus, many experts think Malaysian TOs are well capitalized[10].
The benchmark Malaysian Takaful industry

In order to determine the level of Takaful efficiency compared to conventional
insurance we can use many ratios, as combined operation ratio (COR)[11], which
measures insurance underwriting profitability. In fact, Malaysian TOs have better COR
IJSE
41,12
1232
Table V.
General Takaful-
technical reserves
Unearned contributions reserves Provision for outstanding claims Technical reserves
Amount RM million % of net contributions Amount RM million % of net contributions Amount RM million % of net contributions
2003 149.9 58.8 170.9 68.0 318.8 126.7

2004 306.7 93.3 188.7 57.4 495.4 150.7
2005 350.6 98.3 205.6 57.7 556.2 156.0
2006 452.8 94.5 269.4 56.2 722.1 150.7
2007 528.3 91.6 445.3 77.2 973.6 168.9
2008 568.6 87.2 482.1 73.9 1,050.7 161.1
2009 650.0 80.9 589.6 73.3 1,239.6 154.2
2010 742.2 72.0 728.6 70.7 1,470.8 142.7
2011 811.3 70.0 942.4 81.3 1,753.7 151.3
2012 842.1 64.1 1,044.9 79.6 1,887 143.7
Sources: BNM (2007, 2010, 2012, 2013)
2003 2004 2006 2007 2008 2009 2010 2012
Takaful funds
Amount RM million 3,656.9 4,089.3 5,430.0 6,763.0 8,192.1 9,789.0 11,196.9 15,890.8
Share (%) 94.7 95.0 93.6 90.8 92.0 92.9 89.9 72.1
Provision for outstanding claims
Amount RM million 43.8 39.2 95.1 138.1 105.9 173.1 200.2 1,1380
Share (%) 1.1 0.9 1.6 1.9 1.2 1.6 1.6 6.3
Amount due to income statement/Takaful funds
Amount RM million 26.0 49.9 29.3 144.2 32.0 65.5 196.6 0.1
Share (%) 0.7 1.2 0.5 1.9 0.4 0.6 1.6 0.0
Provision for impairment in value of investments
Amount RM million 0.0 0.0 0.0 1.7 0.2 1.6 2.5 1.5
Share (%) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Other liabilities
Amount RM million 134.3 126.6 305.1 398.1 570.4 507.0 865.1 2,264.4
Share (%) 3.5 2.9 5.3 5.3 6.4 1.8 6.9 10.3
Total liabilities
Amount RM million 3,861.0 4,305.1 5,800.9 7,445.2 8,900.1 10,536.2 12,461.2 22,045
Share (%) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Sources: BNM (2007, 2010, 2012, 2013)
Supervision
insurance
Family Takaful-
1233
of Islamic
statement of liabilities
Table VI.
IJSE than conventional peers, as reflected in Figure 2, while the reverse is true for the Gulf
Cooperation Council (GCC).
41,12 The industry has, also, proven its viability in achieving an average return on equity
(ROE) of 22.1 per cent between 2000 and 2004 (BNM, 2004b). In addition, Malaysian
Takaful Industry can be considered matured as compared with other countries. This is
reflected by the underwriting capability, better returns and stable operation efficiency
1234 (Syed, 2011), as reflected in Table VII[12].
In 2012 ROE are struggling for profitability in Saudi Arabia (4 per cent) and GCC
area (0.4 per cent) in general. In Malaysia instead, the ROE has been positive over
RMbn (%)
50 225.7 225.5 222.5 222.3 250
40 200
30 150
20 100
10 50
0 0
2008 2009 2010 2011 2012
Figure 1. TCA (LHS) TCR (LHS) CAR (%) (RHS)
Industry CAR trend Source: BNM data cited in RHB Research (2013, p. 5)
92% 91% 92%

89% 87%
78%
72% 70%
59% 61%
Figure 2.
Combined operating ratio 2007 2008 2009 2010 2011
for Malaysian insurers Insurance Companies Takaful Operators
and Takaful operators
Source: Ernst & Young (2012, p. 25)
Indicators Malaysia GCC
Return on equity 7.6% 6.5%

Net retention ratio 95.5% 63.0%
Net claim ratio 28% 50%
Net income break up (investment income:underwriting Income) 22:78 16:84
Table VII. Contribution/shareholder equity 263% 150%
Key financial Investment yield 5.0% 3.5%
indicator of 2008 Combined ratio 53.3% 71.9%
(Malaysia vs GCC) Source: Syed (2011, p. 9)
the last three years (2010-2012) and is growing year by year (2012: 13 per cent). Supervision
The expense ratio measures the insurers business efficiency to investors. The average
ratio of TOs in the analysed regions is narrowed, because they cant control costs being
of Islamic
still far from reaching an economy of scale (Fatima Zahra, 2013). Expense ratio remains insurance
higher than conventional peers in the GCC market, although improvements have been
made in the Malaysian market (Ernst & Young, 2012).
1235
Malaysian re-Takaful challenges
The two main challenges are the re-Takaful leakage and the new financial instruments.
The re-Takaful leakage. To enable the TO to declare that its products are fully
Shariaa compliant, it has to reinsure with Shariaa-compliant reinsurers (re-Takaful).
However, owing to the lack of re-Takaful capacity in the market, Shariaa scholars have
granted temporary permission, allowing TOs to reinsure with conventional reinsurers

on the basis of necessity (Simon et al., 2009). This process can be considered as
a re-Takaful Leakage.
In Malaysia, there is increasing trend of re-Takaful ceded to conventional players
despite growing re-Takaful capacity in the market, as reflected in Figure 3.
However, this leakage represents a dilemma, as it is contrary to the customers
preference of seeking cover on Islamic principles (Tobias, 2012).
New financial instruments and re-Takaful business. Islamic financial market
provides a secondary market for trading of Islamic financial instruments. In the
absence of this market, it will be extremely difficult for Takaful/re-Takaful companies
to maintain their liquidity position to make prompt claim payments when they become
due. Retaining a large portion of Takaful fund to maintain high liquidity ratio will
affect the efficiency of the firm and its competitiveness as compared to conventional
insurance companies that have ready access to liquid bonds and t-bills. Islamic
Financial Market will greatly facilitate the Takaful companies to invest large portion
of their fund in Islamic financial instruments and increasing their efficiency and
competitiveness (Waheed, 2010).
In Malaysia, Labuan International Business and Financial Centre (Labuan IOFC)
has embarked on a serious effort to establish an International Islamic Financial Market,
to stimulate the creation of liquidity and financial instruments, as well as enhance
investment opportunities aimed at greater mobilization of Islamic funds.
RM 318 m
RM 187 m
RM 170 m
150
105
71
Figure 3.
2008 2009 2010 Distribution of
Insurance/Reinsurance companies Takaful/Retakaful companies re-Takaful ceded
in Malaysia
Source: Syed (2011, p. 24)
IJSE Customer satisfaction for Takaful services
In order to know the level of customer satisfaction for Takaful services, we point out
41,12 the study conducted by Lukman Olorogun and Abdelghani (2012). The main purpose
of the study is to examine the Malaysian customers willingness to adopt Islamic
insurance services as well as the factors that may influence their behaviour. The results
indicate that the customers seem to positively perceive the compatibility of the Islamic
1236 insurance with their social and religious values, financial needs, as well as their life style
(Lukman Olorogun and Abdelghani, 2012).
Effective supervision approach

After identifying the most important features of the Malaysian experience relating to
Takaful, BNM and the results achieved, we will try to present the approach[13] of
the effective supervision by following four steps: objectives and pre-conditions
of supervision, the supervisory plan for TOs, strategic axes of the approach, and the
phases of the approach.
Objectives and pre-conditions

What are the objectives and pre-conditions?
Objectives of supervision
The clear definition of the objectives at the level of insurance companies and
supervisory body, will achieve the growth and continuity of these institutions.
The most important objectives are as follows:
protection of policyholders rights;
instill public confidence in the Takaful industry (Yap Lai, 2007);
preserve the stability of Takaful industry;
promote strong governance standards;
ensure fair competition between companies;
strengthening the role of insurance as a tool to preserve the wealth and to finance
the development;
ensure compliance of financial policy for insurance companies with the general
economic policy of the country; and
increase the retention capacity of the domestic market.
Pre-conditions for effective supervision

There are pre-conditions relating to the supervisory authority and other pre-conditions
relating to the sector in general.
The supervisory authority. The insurance supervisory authority should:
have the power to license insurance companies and apply prudential regulations
(International Association of Insurance Supervisors (IAIS), 1997);
be independent from both political authorities and controlled companies;
have broad and ample knowledge and experience;
have the powers and sufficient resources to co-operate and exchange information Supervision
with other authorities; and
of Islamic
be able to treat confidential information appropriately. insurance
The sector. The essential pre-conditions are as follows:
private market arrangements;
setting appropriate and comprehensive insurance policies;
1237
sound institutional and legal framework;
effective and reliable judiciary;
efficient financial markets with relevant information available; and
sufficient and appropriate human resources.
As previously, we can add the following conditions related to the TOs (Yap Lai, 2007):
development of effective framework for compliance; and
Integrated Islamic Financial market infrastructure.
The supervisory plan for TO

Supervisory approach has to take into account these factors: operating models of
Takaful and investment policy, licensing and ongoing supervision.
Operating models of Takaful and investment policy

It is important to identify the operating models and the investment policy.
Operating models of Takaful. The first TO in Malaysia follows the Mudharabah
model, while the later operators opted for the Wakala model (Mohd Kassim, 2007).
The Mudharabah model: TO will accept payment of the Takaful Contributions from
Takaful participants. The contract specifies how the surplus, from the operations
managed by the operator, is to be shared between the participants and the TO.
The sharing of such profit may be in a ratio 5:5 (in some cases 6:4, 7:3, etc.) as mutually
agreed between the contracting parties. In this model, the entrepreneur needs
to provide interest-free loan to make good of the deficit, in the event of deficits in
underwriting account.
The Wakalah model: this model is a contract of agency, which replaces surplus
sharing with performance fee. 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 (Mohd Kassim, 2007).
Investment policy. The supervisory authority must require that:
insurers have an overall strategic investment policy, approved and reviewed
annually;
insurers have, in place, effective procedures for monitoring and managing their
asset/liability position; and

IJSE key staff involved with investment activities have the appropriate levels of skills,
experience and integrity (IAIS, 2003).
41,12
Licensing
Licensing control is the main supervisory means by which unsound insurance
companies are prevented from entering the market. Lax licensing control often allows
1238 undercapitalized and poorly managed insurance companies to enter the market, and
subsequently suffer from financial problems.
Ongoing supervision
In this section, we will study the technical aspects related to mechanisms of supervision
and regulation, which are: risk management, on-site inspections, capital adequacy,
market conduct and consumer protection.
The risks: assessment, management and concentration. Supervisors play a critical

role in the risk management process by reviewing the monitoring and controls
exercised by the insurer. The supervisory authority develops prudential regulations
and requirements to contain these risks (IAIS, 2003).
Practice on supervision. On-site inspections are, particularly, important in allowing
a supervisory authority to evaluate a managements effectiveness and its compliance
with supervisory standards.
On-site inspection and off-site inspection of the same company should, in principle,
be performed by the same person or group so as to ensure rational use of the information
provided and supervisory powers.
Capital adequacy. A sound solvency regime is essential to the supervision of
insurance companies and the protection of policyholders. Capital adequacy requirements
are part of a solvency regime. A solvency regime should take into account not, only, the
sufficiency of provisions to cover all claims and expenses but, also, the sufficiency of
capital to absorb significant unexpected losses.
Market conduct and consumer protection. Market conduct and consumer protection
is another crucial consideration (Yap Lai, 2007):
(1) Consumer protection: the supervisory authority should set requirements with
which insurers and intermediaries must comply.
(2) Information and transparency towards the market: supervisory authorities are
concerned with maintaining efficient, fair, safe, and stable insurance markets.
Strategic axes of the approach

The most important key strategic elements are proposed below.
The development of human talent

To sustain and support the future growth of the Takaful industry, an important prerequisite
is the development of the talent and expertise that is needed to drive innovation and to raise
the performance of the Takaful industry to greater success (Sohail, 2007).
The promotion of a dynamic, consumer-centric approach

Takaful companies should make more efforts to understand the needs of different
customer segments, building a good relationship with customers and meet the
demands of particular sectors of them. The Takaful market must provide a wider range Supervision
of products, such as annuities, medical and health products, etc. (Sohail, 2007).
of Islamic
Efficient disclosure of company information to the supervisory body insurance
The improvement of the information quality which interested to the oversight body can
be obtained by the harmonization of the various reports presented to the board of
directors, in particular the reports about: solvency, employment, reinsurance, internal 1239
control system, and the report about the functioning of the board itself.
Approach phases
According to the Malaysian Master Plan for Takaful, the implementation of the
approach can be undertaken under three phases.
First phase: strengthening the operational and institutional infrastructure

Under this phase, the focus of implementation will be to prepare a viable platform for
the sound expansion of Takaful. This involves establishing the industry-owned
research and training institute, preparing a preliminary legal structure as well as
creating market depth. Efforts to enhance the capabilities of TOs will also begin under
this phase to prepare them for the increased competition.
Second phase: stimulating competition and upgrading the infrastructure

Under the second phase, new licenses will be issued to qualified domestic industry to
stimulate increased competition. The focus in this phase will be to enhance
performance as well as to upgrade the infrastructure of the Takaful industry.
Third phase: raising performance standards through progressive liberalization and

ensuring an effective infrastructure
This phase will involve the issuance of Takaful license to qualified foreign financial players.
In addition, measures will be directed to ensure the development of a comprehensive and
effective infrastructure to support the financial operations of Takaful.
Conclusion
The basis of Takaful Malaysias operation is established on the principles of Shariaa
with the primary objective to provide comprehensive Takaful facilities and services to
the Muslims and non-Muslins. The legal basis for the establishment of TO was the
Takaful Act 1984.
Takaful operations are regulated by BNM since 1988 with the appointment of the
BNM governor as the Director-General of Insurance and Takaful. This supervisory
body has adopted elements of the two methods: regulation and supervision.
The Malaysian Takaful industry has experienced rapid growth and transformation
since its inception 28 years ago, and the Takaful companies are, currently, enjoying
good financial sheet.
The Approach includes four key elements:
(1) determine the objectives of supervision;
(2) setting the supervisory plan for TO;
(3) strategic axes of the approach; and
(4) follow the stages of supervision.
IJSE Notes
41,12 1. Mudharib: entrepreneur; Wakil: Agent.
2. Surplus: excess of the Takaful fund carried forward over the actuarial liabilities.
3. Qard: interest-free loan.
4. General Takaful: protection to participant for losses arising from perils such as accident,
1240 fire, flood, liability and burglary.
5. Shariaa: Islamic laws.
6. FSMP recommendations are, also, available at: www.bnm.gov.my/
7. Technical reserve: unearned portion of Takaful contribution, known as unearned
contribution reserve. Sufficient provision for claim must be made before the profit is
distributed. Provision must also be made for claims forwarded after the expired date of
Takaful cover for the accident claim that occurs during the Takaful cover (Azmi, 1996).
8. Unearned contribution reserves: contributions already received in respect of risks which are
still unexpired at the end of the accounting period.
9. CAR Total capital available=Total capital required 100%
10. MTA Chairman, Zainudin Ishak, said that the most of the Takaful players are well
capitalized.
11. COR net claims ratio + net commission ratio + net expenses ratio.
12. Claims ratio claims incurred/earned contribution.
Average commission ratio net commission/net earned premium.
Average yield on investments total investment returns/total investment.
Average expense ratio general and administrative expenses/net earned premium.
ROE net profit/shareholders equity.

13. We have developed this approach according, basically, to the Malaysian experience and,
especially, the FSMP implementation. We have, also, used the publications of International
Association of Insurance Supervisors and Islamic Financial Services Board (see e.g. Islamic
Financial Services Board and International Association of Insurance Supervisors (2006). In
addition, we found that the publications of some researchers may be useful (see e.g. Sohail,
2007). Then, we have added some elements, such as the efficient disclosure of information
and, finally, we have organized the recommendations.
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About the author

Zoheir Berkem since 2006 works as an Assistant Professor in the Department of Management
Sciences, charged of applications in the field of Accounting and Financial Management. In
the domain of research, the author is interested in the field of social economics, especially
the mutuals. Sometimes, he presents public lectures. Assistant Professor Zoheir Berkem can be
contacted at: [email protected]
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Definition of Takaful system

Advantages of Takaful plans

Malaysian Takaful Act

The main axes of supervisory system

supervisory coordination and cooperation.

Supervision body and its approach

The regulator objectives

Phases of the oversight policy

First phase from 1984 to 1992

Second phase from 1993 to 2000

Third phase from 2001 to 2010

Fourth phase from 2011 till now

Bank Negara initiatives and the results of its policies

Vision of the master plan

The key principles of the RBSF for Takaful

Malaysian Takaful performance

Viability and progress of Takaful business

2003 2004 2005 2006 2007 2008 2009 2010 2012

Combined contributions (% of GNI)

Malaysian TO and the risk management

Takaful solvency and capital adequacy

The benchmark Malaysian Takaful industry

2003 149.9 58.8 170.9 68.0 318.8 126.7

2003 2004 2006 2007 2008 2009 2010 2012

92% 91% 92%

Indicators Malaysia GCC

Return on equity 7.6% 6.5%

granted temporary permission, allowing TOs to reinsure with conventional reinsurers

Effective supervision approach

Objectives and pre-conditions

Pre-conditions for effective supervision

The supervisory plan for TO

Operating models of Takaful and investment policy

The risks: assessment, management and concentration. Supervisors play a critical

Strategic axes of the approach

The development of human talent

The promotion of a dynamic, consumer-centric approach

First phase: strengthening the operational and institutional infrastructure

Second phase: stimulating competition and upgrading the infrastructure

Third phase: raising performance standards through progressive liberalization and

Average commission ratio net commission/net earned premium.

Average yield on investments total investment returns/total investment.

Average expense ratio general and administrative expenses/net earned premium.

ROE net profit/shareholders equity.

About the author

To purchase reprints of this article please e-mail: [email protected]

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