Takaful Islamic Insurance

Concepts and Regulatory Issues

Takaful Islamic Insurance

Concepts and Regulatory Issues

Edited by

Simon ArcherRifaat Ahmed Abdel Karim

Volker Nienhaus

John Wiley & Sons (Asia) Pte. Ltd.

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Contents

Dedication ix

About the Editors xi

About the Contributors xiii

Foreword xvii

Acknowledgment xix

1 Conceptual, Legal, and Institutional Issues Confronting Takaful 1Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus

1.1 Introduction 11.2 Developments in International Prudential Guidelines for

Insurance and Takaful 21.3 Contents of this Book 3

Part 12 Business Models in Takaful and Regulatory Implications 9

Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus

2.1 Introduction 92.2 Business Models 112.3 Business Structures and Regulatory Implications 202.4 Regulatory Perspectives 27

3 Shari’ah Principles Governing Takaful Models 31

Dr. Mohd Daud Bakar3.1 Introduction 313.2 Takaful: Nomenclature and Conceptual Meaning 323.3 Shari’ah Principles Governing Takaful Contracts 343.4 Takaful Management Models 42

4 Corporate Governance and Stakeholder Rightsin Islamic Insurance 47Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus

4.1 Introduction 474.2 The Neo-classical and Neo-corporatist Models of Corporate

Governance 494.3 Corporate Governance Issues in the Insurance Industry 534.4 Corporate Governance Issues in Takaful 574.5 Concluding Remarks 65

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5 Legal Issues in Takaful 67

Madzlan Mohamad Hussain5.1 Introduction 675.2 Takaful Models and their Impacts 685.3 The Legal Issues 725.4 The Call for an Effective Framework 815.5 Concluding Remarks 82

6 Business Conduct in Islamic Insurance with Special Referenceto Emerging Markets 85Arup Chatterjee

6.1 Background 856.2 Business Environment in Emerging Markets 866.3 Framework of Business Conduct and Best Practices 906.4 Critical Drivers for Developing Market Infrastructure 1016.5 Conclusion 107

7 Supervisory Issues in Takaful: An Overview 113Peter Casey

7.1 Introduction 1137.2 Governance Issues 1157.3 Financial Issues 1217.4 Market Conduct Issues 1307.5 Market Issues 1357.6 Supervisory Priorities 137

Part 28 Reinsurance and Retakaful 143

Mahomed Akoob8.1 Introduction 1438.2 What is Reinsurance? 1438.3 Functions of Reinsurance 1458.4 Types of Reinsurance 1458.5 Proportional Reinsurance 1478.6 Non-proportional Reinsurance 1498.7 Reinsurance Market 1518.8 Concept of Takaful 1518.9 Need for Retakaful 1548.10 Retakaful Models 1568.11 Main Issues Raised by Retakaful 1628.12 Conclusion 167

9 Risk Management in Takaful 169Abdullah Haron and Dawood Taylor

9.1 Introduction 1699.2 Comparison between Conventional Insurance and Takaful 172

Contents vii

9.3 Fundamental Principles of Takaful from a Risk ManagementPerspective 175

9.4 Risk Issues in Takaful Undertakings 1769.5 Management of Risks in a Takaful Undertaking 1849.6 Concluding Remarks 191

10 Solvency and Capital Adequacy in Takaful 193

James Smith10.1 Introduction 19310.2 The Need for Solvency 19410.3 The Principle of Solvency 19510.4 Traditional Approaches to Insurance Solvency 19710.5 Risk-based Capital 20010.6 Summary 214

11 Investment Portfolios of Takaful Undertakings 217

Dr. Abdulrahman Tolefat11.1 Total Investment Portfolio of Takaful Undertakings

for All Funds 21811.2 Shareholders’ Funds 21911.3 Analysis of Shareholders’ Funds between the GCC Countries

and Malaysia 22411.4 General Fund 22611.5 Analysis of General Fund between GCC and Malaysia 22911.6 Family Fund 23211.7 Influence of Related Parties on the Investment Portfolios of

Participants’ Funds 23411.8 Summary and Conclusions 236

12 Issues in Rating Takaful Companies 239Andrew Murray1

12.1 Introduction 23912.2 What is a Credit Rating? 24012.3 Types of Credit Rating 24012.4 Credit Rating Basics 24112.5 Key Issues for Rating Takaful Firms 24312.6 Conclusion 263

13 Transparency and Financial Reporting in Islamic Insurance 265Elham Hassan and Andre Rohayem

13.1 Introduction 26513.2 Stakeholders Need Transparency in Financial Reporting by

Islamic Insurance Companies 26613.3 Existing Islamic Insurance Financial Reporting

Framework Should be Improved to Achieve GreaterTransparency 274

13.4 Conclusion 283

viii Contents

Part 314 Concluding Remarks 287

Simon Archer, Rifaat Ahmed Abdel Karim, and Volker Nienhaus

14.1 Introduction 28714.2 The Structure of Takaful Undertakings and Resultant

Unresolved Issues 28814.3 Corporate Governance and Related Matters 28914.4 The Need for, and Scope of, a Comprehensive Regulatory

Framework for Takaful 29214.5 The Work of the IFSB in Developing International Prudential

Guidelines for Takaful Undertakings 29314.6 Some Thoughts for the Future 294

Bibliography 297

Index 301

Dedication

We would like to dedicate this book to our wivesIglal, Evelyne, and Hannelor.

About the Editors

Professor Simon Archer is Visiting Professor at the ICMA Cen-tre, Henley Business School, University of Reading (U.K.), wherehe teaches on an MSc program, Investment Banking and IslamicFinance. Previously, he was Professor of Financial Management atthe University of Surrey (U.K.) having been Midland Bank Professorof Financial Sector Accounting at the University of Wales, Bangor.After studies in Philosophy, Politics, and Economics at Oxford Uni-versity, he qualified as a Chartered Accountant with Arthur Andersenin London and then moved to Price Waterhouse in Paris, where hebecame a Partner in Management Consultancy Services. In additionto being co-editor of, and chapter contributor to, Islamic Finance:Innovation and Growth, and Islamic Finance: The Regulatory Chal-lenge (published by John Wiley), Professor Archer is co-author of theCCH International Accounting/Financial Reporting Standards Guideand the author of a considerable number of academic papers on inter-national accounting and on accounting, finance, and related issues inIslamic financial institutions. He also supervises research students inthese areas. He has carried out a number of consultancy assignmentsfor the Accounting and Auditing Organization for Islamic FinancialInstitutions, the Islamic Financial Services Board, and the World Bankon issues connected with Islamic finance.

Professor Rifaat Ahmed Abdel Karim has been the Secretary-Generalof the Islamic Financial Services Board since 2002. Prior to his currentposition, Professor Rifaat was the Secretary-General of the Accountingand Auditing Organization for Islamic Financial Institutions, a posthe held for more than eight years. He was a member of the StandardsAdvisory Council of the International Accounting Standards Boardfor two terms, and is currently a member of the Consultative AdvisoryGroup of the International Auditing and Assurance Standards Board.Professor Rifaat was a Visiting Professor at Surrey University (U.K.)and Honorary Professor at Monash University (Australia). He iscurrently a Visiting Professor at Reading University (U.K.). ProfessorRifaat is the co-author of Business and Accounting Ethics in Islam, theEuromoney bestseller book Islamic Finance: Innovation and Growth,and Islamic Finance: The Regulatory Challenge recently published byJohn Wiley. He is also the author of many academic and professional

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papers on accounting, governance, and finance issues in Islamicbanking and finance.

Dr. Volker Nienhaus was Professor of Economics at the Germanuniversities of Trier (1989–90) and Bochum (1990–2004) beforehe became President of the University of Marburg (election period2004–10). He has published numerous books and articles on Islamiceconomics and Islamic banking and finance since the 1980s. He wasa member of several academic advisory boards of public and privateinstitutions in Germany, including the German Orient-Foundation(1993–2006) and the Federal Ministry of Economic Cooperation andDevelopment (1998–2008). In 2006, he was appointed a member ofthe Governing Council of the International Centre for Education inIslamic Finance (INCEIF) in Kuala Lumpur. He is also consultant tothe Islamic Financial Services Board on governance issues of takafuloperations.

About the Contributors

Mahomed Akoob (Chapter 8) has been Chief Executive Officer ofthe newly established Hannover ReTakaful B.S.C.© Bahrain sinceNovember 2006. He brings to this role a wealth of experience in gen-eral management, technical insurance and reinsurance underwriting,risk management, and financial management. Prior to this, he wasGroup Chief Financial Officer of Hannover Re Africa from Novem-ber 2002. His responsibilities included corporate finance, investments,information technology, and reinsurance. He was also instrumentalin establishing the first takaful company in South Africa. He beganhis career with Munich Reinsurance Company of Africa in 1976 andwas appointed General Manager in 1996. He currently serves on theAdvisory Committee of Short Term Insurance and the Directorate ofMarket Abuse in South Africa, appointed by the Minister of Finance.He also serves as a director of the South African Reserve Bank Cap-tive Insurance Company (SARBCIC) and Fahmiyah Investments (Pty.)Limited (Investment Company).

Dr. Mohd Daud Bakar (Chapter 3) is currently the President/CEO ofInternational Institute of Islamic Finance (IIIF) Inc. (BVI), IIIF Edu-cation Sdn. Bhd., and Amanie Business Solutions Sdn. Bhd. (KualaLumpur). He was the Deputy Rector (Student Affairs and Devel-opment) and an Associate Professor at the International IslamicUniversity Malaysia. He received his first degree in Shari’ah fromthe University of Kuwait (1988) and a Ph.D. from the Universityof St. Andrews, United Kingdom (1993). In 2002, he completedhis external Bachelor of Jurisprudence at the University of Malaya.He has published more than 30 articles in various academic jour-nals and presented more than 200 papers at conferences both localand abroad. He is now Chairman of the Shari’ah Advisory Coun-cil at the Central Bank of Malaysia, and a member of the Shari’ahAdvisory Council at various regional and global financial institu-tions. He has been involved in advising Islamic funds and Islamicsukuk both local and globally. He is a licensed Shari’ah advisor forIslamic Securities in Malaysia. He was awarded the Islamic BankerAward of 2005 by the Association of Islamic Banking InstitutionsMalaysia.

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xiv About the Contributors

Peter Casey (Chapter 7) is Director, Policy and Head of IslamicFinance in the Dubai Financial Services Authority (DFSA), havingpreviously been responsible for the supervision of banking and insur-ance firms. In this role, he has been a member of several IslamicFinancial Services Board Working Groups, including those on Gover-nance of Takaful Operations, and Solvency Requirements for TakafulOperators. Before joining the DFSA, he was Head of the Non-LifeInsurance Department of the U.K. Financial Services Authority. Beforethat, he held senior regulatory posts in the Treasury, the Departmentof Trade and Industry, and the Office of Fair Trading. Peter waseducated at Cambridge University.

Arup Chatterjee (Chapter 6) is Principal Administrator, InternationalAssociation of Insurance Supervisors (IAIS) at Basel, Switzerland. Hehas over 20 years’ hands-on experience in the insurance industryspanning across operations, regulation, supervision, and policy mak-ing in emerging and developed markets. A former Deputy Directorof the Insurance Regulatory and Development Authority–India, inhis current position at IAIS he focuses on standards setting and itsimplementation, including microinsurance and takaful. An honorsgraduate in Economics from Delhi University, and with a Master’sfrom Jawaharlal Nehru University and the Indian Institute of ForeignTrade, both in New Delhi, he also serves as a resource person in thearea of insurance regulations and risk management.

Abdullah Haron (Chapter 9) is Assistant Secretary General of theIslamic Financial Services Board. Previously, he was a Project Managerwhere his main area of work was on the preparation of guidance onrisk management, the supervisory review process, and special issuesof capital adequacy. He also participated in task forces on, amongother matters, the preparation of an issues paper on prudential takafulregulation and supervision, and a compilation guide on a prudentialdatabase of Islamic financial services institutions. His prior experienceincludes the development of a risk management and measurementframework, and insurance prudential regulation and supervision.Abdullah received a BSLAS in Actuarial Science from the Universityof Illinois and an MBA from Ohio University.

Elham Hassan (Chapter 13) is the Senior Partner of Pricewater-houseCoopers Bahrain. She has more than 25 years’ experience inbanking and financial institutions—more specifically, Islamic bankingand takaful. In 1986, Elham became the first qualified U.S. CertifiedPublic Accountant in the Gulf Cooperation. She is a regular speaker at

About the Contributors xv

banking and capital market conferences. With her vast experience, sheprovided advice to a wide range of regional and international orga-nizations. Elham is active in economic circles in the Middle East andhas been voted as one of the region’s most powerful businesswomenby Forbes magazine. She sits on several professional, academic, andeconomic boards.

Madzlan Mohamad Hussain (Chapter 5) is Senior Project Manager,Islamic Financial Services Board (IFSB). Madzlan has been with theIFSB since April 2004, when he first joined as a Project Manager andwas later promoted to Senior Project Manager. He is responsible foroverseeing the development of IFSB prudential standards on corporategovernance practices for all segments of Islamic financial services,including banking, capital markets, and insurance. Prior to joining theIFSB, Madzlan practiced law at one of the premier legal firms in KualaLumpur, where he specialized in capital markets practices, corporateand debt restructurings, and Islamic finance. Madzlan graduated witha Bachelor of Laws (Hons.) from the International Islamic UniversityMalaysia and obtained his Master of Science in Islamic Economics,Banking and Finance from Loughborough University (U.K.).

Andrew Murray (Chapter 12) is a Senior Director within Fitch’sinsurance department. Since joining Fitch in May 2002, his role hasincluded rating various insurance and reinsurance companies in theU.K. and Northern Europe. He now also has responsibility for the rat-ing of insurance-linked securities, hybrid capital securities, and takafulfirms. Prior to joining Fitch, Andrew worked for Deloitte in its finan-cial services practice, which included experience in insurance companyaudits. He graduated in Economics from Cambridge University, andis a qualified Chartered Accountant and a CFA charter holder.

Andre Rohayem (Chapter 13) is the Partner leading the insurancepractice of PricewaterhouseCoopers in the Middle East. He has14 years’ experience in the insurance and reinsurance industry inEurope and the Middle East. Andre has been actively involved inauditing and providing advisory services to insurance and reinsur-ance companies. He has also advised and assisted several investorsand multinational companies in the establishment of insurance andtakaful companies in the Middle East.

James Smith (Chapter 10) is an Executive Director in the HongKong firm of Ernst & Young. During his career, he has specializedin providing services to the insurance industry, including audit, due

xvi About the Contributors

diligence, and regulatory consultancy. Originally from the U.K., he hasalso lived and worked in Australia and several Asian countries, duringwhich time he developed an interest in takaful. A chartered accountantand certified insurance professional, James holds Scottish and Englishuniversity degrees. He has written and spoken extensively on financialservices regulatory issues, and currently serves on the Islamic FinancialServices Board’s Working Party on Solvency Requirements for TakafulOperators.

Dawood Taylor (Chapter 9) has recently been appointed SeniorRegional Executive–Takaful, Middle East for Prudential PLC, wherehis role is to develop takaful throughout the Gulf region. Previously,Dawood was the General Manager of the Bank Aljazira TakafulTa’awuni operation, where he was at the forefront of Islamic lifeinsurance development in Saudi Arabia and the Middle East. Heand his team developed the Takaful Ta’awuni program, a hugelysuccessful and multi-award-winning Islamic life insurance and sav-ings program for Bank Aljazira. Dawood conceived and developedthe initial wakalah-based Takaful Ta’awuni concept that is now theIslamic contract model of choice for most new takaful operators.Dawood is a member of the Islamic Financial Services Board TakafulGovernance and Takaful Solvency committees, and of the Inter-national Cooperative and Mutual Insurance Federation IntelligenceCommittee.

Abdulrahman Tolefat (Chapter 11) is the Chief Executive Officer ofAllianz Takaful BSC. He began his career as a Mathematics lecturerin the University of Bahrain and later moved into the fast-growingfinancial services field in Bahrain. Profound knowledge of the regionand outstanding credentials have driven his career graph in the Cen-tral Bank of Bahrain–CBB (formerly known as Bahrain MonetaryAgency). After nine years, Dr. Tolefat took charge of Allianz Takafulin Bahrain, the global hub for Islamic insurance (takaful) of AllianzGroup. As a member of various committees and boards in the financialfield, he has played an instrumental role in imparting internationalstandards to Islamic banking and takaful. Dr. Tolefat pursued highereducation following his graduation from the University of Bahrain,including being awarded an MBA from the prestigious DePaul Uni-versity in the U.S. and a Ph.D. from the renowned Durham Universityin the U.K.

Foreword

The emergence of takaful, or mutual insurance arrangements thatconform to the principles of Shari’ah, is a welcomed developmentthat enhances and completes the Islamic financial system. Throughtakaful, consumers and providers of Islamic financial services areprovided with a Shari’ah-compliant means to obtain insurance coveragainst personal and business losses. Takaful companies supportIslamic capital markets through their active subscription of andtrading in Islamic financial instruments. Insurance coverage for theassets underlying Islamic financial contracts can also now be done ina Shari’ah-compliant manner.

Growth in the takaful industry has been robust in recent years.Nonetheless, the industry is still in its early stages of developmentrelative to the other sectors of Islamic finance in banking and capitalfund-raising. Industry estimates put takaful contributions globallyat about US$3.4 billion in 2007. This figure is creditable given thelow penetration rates for takaful in many jurisdictions and thatthe industry is presently more focused on the retail markets, withwholesale needs largely yet to be addressed. Herein lies the still largelyuntapped potential of takaful. There are now about 150 takafuloperators worldwide, including those in non-Muslim countries. InSingapore, takaful products have been available since 1995 and thefirst retakaful company started operations in 2004.

One of the main challenges confronting the takaful industry israising awareness among its various stakeholders. Misconceptionsabout insurance cover among potential consumers would have tobe dispelled, so as to foster greater acceptance of takaful. Providersof takaful would need to acquire stronger and more in-depth under-standing of the technical, operational, legal and Shari’ah requirementsfor takaful operations, if they are to broaden the range of takafulproducts they offer and raise the quality of their services. Regulatorstoo would also need to develop a full understanding of the risksto ensure that takaful operations within their jurisdictions are ade-quately regulated and supervised. All stakeholders, including ratingagencies and standard-setting bodies, should also not lose sight of animportant objective in the takaful industry—that is to ably meet therising consumer demand in the most cost-effective manner. Only thencan this nascent industry grow and develop in a sustained path and

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reach a wider segment of consumers, both Muslim and non-Muslims.Drawing lessons from the present financial crisis, takaful operatorswill also need to have in place robust risk management and corporategovernance systems in order to be able to serve their customers wellover the longer-term.

Against this perspective, Takaful Islamic Insurance: Concepts andRegulatory Issues is a timely and welcomed addition to the growingbody of literature on takaful. The book is edited by three emi-nent scholars and practitioners in Islamic finance, Professors RifaatAhmed Abdel Karim, Simon Archer and Volker Nienhaus. Distill-ing from their considerable expertise, they have joined other notablescholars, regulators, and industry practitioners to contribute insight-ful chapters to this book. Part 1 of the book examines the businessmodels and conduct, the Shari’ah principles, corporate governance aswell as regulatory, legal and supervisory issues in Takaful. Part 2 thendelves in detail into the technical and operational issues of takaful andretakaful encompassing solvency and capital adequacy, investment ofcontribution, risk management, risk ratings, transparency and finan-cial reporting. This publication is therefore well placed to help raisethe much-needed awareness and understanding amongst stakeholdersof the takaful industry and contribute to its sustained development.

Heng Swee KeatManaging Director

The Monetary Authority of SingaporeJune 2009

Acknowledgment

We would like to thank each of the contributing authors fortaking the time to write their chapters. Their insights and practicalexperiences have made the book much richer.

Special thanks go to Mrs. Marni Rafiza Mohammad for herenthusiastic support. Her relentless energy and valuable assistancehave made this book possible.

Also thanks to Nick Wallwork, Fiona Wong, Joel Balbin, and theteam of John Wiley & Sons (Asia) for getting the book into shape andguiding us through the publishing process.

Finally, we are indebted to our families, who have been a greatsource of encouragement and support every step of the way.

xix

CHAPTER 1Conceptual, Legal, and Institutional Issues

Confronting Takaful

Simon Archer, Rifaat Ahmed Abdel Karim,and Volker Nienhaus

1 . 1 I N T R O D U C T I O N

While the last decades of the 20th century saw the emergence ofIslamic banking as a significant development in a number of predom-inantly Muslim countries, takaful (Islamic insurance) has been slowerto emerge. This is in spite of the fact that schemes for mutual pro-tection against losses have traditionally existed in Islamic societies.As will be seen from the analyses presented in this book, modernversions of such schemes face a number of highly complex juristic,1

institutional, legal, and regulatory issues some of which are far frombeing resolved. In addition, it should be noted that the conventionalinsurance industry also faces major regulatory issues, in which itmay be thought to lag behind banking with particular respect tointernational prudential standards on solvency, capital adequacy andrelated matters (there being as yet no insurance equivalent to Basel II),and financial reporting. Work is, however, in progress, which will bedescribed briefly below.

The first modern takaful undertaking was founded in Sudan in1979. Its foundation was due to the solution by a Sudanese Shari’ahscholar2 of a juristic problem: how may the Shari’ah prohibition oftrading in insurance (and in indemnities and guarantees more gen-erally) be overcome? Part of the solution lies in the adoption of amutual structure for underwriting insured risks: the insureds (partici-pants) mutually insure one another, on a non-profit basis, according

1

2 Takaful Islamic Insurance

to the principle of takaful (the Arabic word for ‘‘solidarity’’). Anotheraspect of the solution consists of characterizing the policy contri-butions (premiums) to the risk fund as incorporating an element ofconditional and irrevocable donation (tabarru’), the donor makingthe contribution to the risk fund subject to being entitled to benefitfrom mutual protection against insured losses.

However, the adoption of a mutual structure runs into two kindsof institutional obstacles. First, the legal systems of many countriesdo not accept mutual or cooperative forms of company withoutshare capital. Second, even if such forms of company are acceptedfor insurance undertakings, they need to be able to raise enoughcapital from policyholders to meet regulatory capital adequacy andsolvency requirements. To surmount these two obstacles, the vastmajority of takaful undertakings have a two-tier, hybrid structure inwhich the risk funds operate on a mutual basis but are managed bya takaful operator, which is a company with shareholders. However,this hybrid structure involves complexities and raises juristic and legalissues which are yet to be satisfactorily resolved.

In addition to the need to overcome juristic and institutionalproblems, the development of takaful is inevitably constrained by theeconomic and social development of predominantly Muslim countries,which affects the market for and the propensity (especially at theretail level) to take up insurance cover. At the same time, takaful cancontribute to economic development at the micro level by enablingmore efficient risk management by firms and households, and atthe macro level (particularly in life or family takaful) by mobilizingsavings and providing funding for investment in long-lived assets.

1 . 2 D E V E L O P M E N T S I N I N T E R N AT I O N A LP R U D E N T I A L G U I D E L I N E S F O R I N S U R A N C EA N D TA K A F U L

As noted above, the development of international prudential standardsfor insurance has lagged behind that for banking. However, there hasbeen a significant amount of work in this area. The InternationalAssociation of Insurance Supervisors (IAIS) has issued a number ofimportant documents, including the Core Principles of InsuranceSupervision, and the European Commission is developing a newprudential system for the insurance industry in the European Union(known as Solvency II to distinguish it from the existing EU guidelinewhich is considered to be obsolete). As its name suggests, Solvency II is

Conceptual, Legal, and Institutional Issues Confronting Takaful 3

considered to be the insurance counterpart of Basel II, and is likewiseconstructed around three ‘‘pillars.’’

At the same time, the Islamic Financial Services Board (IFSB)has been working on two international prudential guidelines for thetakaful industry sector, and another that will be applicable to firmsin the sector. The Guiding Principles on Corporate Governance ofIslamic Insurance (Takaful) Operations and the Guiding Principleson Conduct of Business for Institutions Offering Islamic FinancialServices (applicable to takaful operators) have been issued as exposuredrafts, while an exposure draft on capital adequacy and solvency oftakaful undertakings was in the course of preparation when this bookwent to press.

1 . 3 C O N T E N T S O F T H I S B O O K

The rest of the book is divided into two main parts, followed by aconcluding chapter by the editors.

Part 1 (Chapters 2–7) deals with the business models used intakaful, from the perspectives of their regulatory implications, therelevant Shari’ah principles, stakeholder rights and corporate gover-nance issues, and legal issues, as well as issues of business conductand policyholder (or consumer) protection, with particular referenceto emerging markets, and with supervisory issues more generally.

Chapter 2, by the editors, examines the business models employedfor takaful undertakings, both non-life and life (or family) takaful.These models involve complexities resulting from the hybrid nature oftakaful undertakings: risk funds that function on the basis of mutuality(the equity of which belongs to the policyholders) being managed bya company with shareholders. The chapter addresses the dauntingchallenge that these complex business models, which raise a numberof unresolved issues, represent for insurance industry regulators.

The models also raise important Shari’ah issues, which are theconcern of Chapter 3 by Daud Bakar. The fact that there are twocategories of equity holders in a takaful undertaking, shareholdersas well as policyholders, also raises important issues regarding stake-holder rights and corporate governance, which form the subject ofChapter 4, by the editors.

The business models and structure of takaful undertakings alsoentail knotty legal issues, which are examined in Chapter 5 byMadzlan Mohamad Hussain. The author points out that these issuestend to be aggravated by the fact that the notion of mutual insurance,

4 Takaful Islamic Insurance

while intrinsic to takaful, is unknown in the legal and regulatory sys-tems of most of the countries in which takaful undertakings operate.

In Chapter 6, Arup Chatterjee emphasizes that a sound regulationand supervision framework is essential for improving the efficiency ofthe market for insurance generally and for takaful in particular. Hedescribes the work of the IAIS in developing its Solvency Structure, andthe importance of principles of good business conduct with particularrespect to managing reputation risk. He also draws attention to theneed for good data on losses and expenses per unit of exposure inpricing insurance products.

Chapter 7, by Peter Casey, also refers to the work of the IAIS,with particular reference to its 2005 paper, ‘‘A New Framework forInsurance Supervision.’’ He points out that while for an insurancesupervisor governance issues are among the most difficult to dealwith, in the case of takaful undertakings, the key governance risksare failures of Shari’ah governance, misalignment of interests betweenshareholders and policyholders, and inadequate consideration of theinterests of the latter.

Part 2 (Chapters 8–13) addresses issues of risk, solvency, andcapital adequacy in takaful, the investment portfolios of takafulundertakings, and the transparency of, and market information on,takaful undertakings, including ratings by external credit assessmentinstitutions and external financial reporting.

In Chapter 8, Mahomed Akoob explains the importance of retaka-ful (Shari’ah-compliant reinsurance) to the takaful industry, especiallyfor those takaful undertakings that are of relatively small size. Hethen explains how reinsurance may be structured so as to be Shari’ahcompliant.

Chapter 9, by Abdullah Haron and Dawood Taylor, deals moregenerally with risk management in takaful undertakings, which isthe responsibility of the takaful operator and needs to take accountof the hybrid, two-tier structure of takaful undertakings (entailingunderwriting and other risk exposures of the takaful policyholders’funds, and risk exposures of the takaful operator itself).

In Chapter 10, James Smith focuses on the key topic of solvencyand capital adequacy, which is problematic because of the structuralcomplexities of takaful undertakings with both shareholders’ andpolicyholders’ equity.

Chapter 11, by Abdulrahman Tolefat, analyzes the investmentportfolios of takaful undertakings, comprising the assets of the partici-pants’ risk funds, participants’ investment funds in family takaful, and

Conceptual, Legal, and Institutional Issues Confronting Takaful 5

shareholders’ own funds. He shows how investment strategies dealwith the need for liquidity, but points to possible dangers of relatedparty investment transactions, and consequent risk concentrations.

In Chapter 12, Andrew Murray points out how the structuralcomplexity of takaful undertakings raises difficult issues for exter-nal credit assessment institutions, and indicates how these may bedealt with.

Chapter 13, by Elham Hassan and Andre Rohayem, addresses thethorny topic of external financial reporting by takaful undertakings.There is no comprehensive set of International Financial ReportingStandards applicable to takaful, and the applicable standards issuedby the Accounting and Auditing Organization for Islamic FinancialInstitutions provide useful but far from comprehensive guidance.

The final chapter, by the editors, presents some overall conclusionsthat may be drawn from the preceding chapters.

E N D N O T E S

1 The term ‘‘juristic’’ is used here to refer to issues of Shari’ah commercial jurisprudence (Fiqh alMuamalat), as distinct from matters of secular law.

2 Professor Al-Sideeq Mohammed Alamin Al-Dareer.

Part 1