Accounting for insurance is a complicated matter. It took the IASB nearly 20 years to produce IFRS17. Over the period during which IFRS17 was formulated, no submission was made to the IASB to determine its applicability to takaful.
Now that the standard is out, takaful companies are scrambling to determine how to apply the standard to their operation. Actuarial Partners Consulting’s Hassan Scott Odierno sheds some light on this complex area.
In late 2019, MASB recommended a move away from the columnar approach currently applied by takaful operators in Malaysia under IFRS4, to a single column approach where the single column presents the financial results at the takaful entity (TE) level. The MASB rationale for this move can be summarised in two statements:
- The lowest unit of account under takaful is the contract itself, notwithstanding that under takaful there are in effect multiple shariah contracts.
- The takaful operator is obliged to inject a qard (a loan) should a deficit arise in the participants risk fund (PRF). With this obligation there is the understanding that the TE is the ultimate underwriter of the insurance contract.
The intricacies of how the takaful funds are managed under this proposal would have been relegated to the notes to the accounts. This recommendation was, however, not accepted by the regulator or the majority of shariah scholars in Malaysia.
Malaysia, however, is unique in that the roles of each stakeholder and how the funds are managed in takaful are clearly set out in law and regulations. In law although there is one contract underlying a takaful policy, there are in fact two separate ‘services’ under the contract, one being the risk sharing among the participants, the other referring to the takaful administration business being conducted by the operator.
As defined under the Islamic Financial Services Act 2013 (the IFSA), takaful business does not include the underwriting of insurance risk. The requirement for a qard only comes under section 95 of the IFSA and is mentioned as a financial support which does not necessarily have to come in the form of a qard from the operator.
Subsequent to the various inputs received on its initial recommendation, in April 2020 the MASB released a paper outlining their current iteration of how takaful should be accounted for in Malaysia. What has changed in this paper is a recognition that the application of the takaful contract must be guided by the IFSA and Bank Negara Malaysia’s Takaful Operating Framework (ToF).
To be clear, contracts issued by any Islamic financial institution in Malaysia must be shariah compliant. In the takaful contract there are at least two types of shariah contracts mentioned, typically the wakala contract and the tabarru’ contract, and the implementation of takaful must be consistent with these contracts.
The wakala contract is a contract between the participant and the takaful operator (TO), not between the takaful fund (TF) and TO. The wakala fee is therefore deducted from the gross contributions (i.e. premium) and does not make its way first into the TF before being paid to the TO. This reflects the fact that the party contracting with the TO is the participant and not the TF.
Family versus general takaful
The TF can consist of multiple funds. Once the wakala fee has been deducted from the contribution, the remaining includes the tabarru’. This covers the risk element of the contract and is paid into the PRF. In family takaful there can also be a participant’s investment account (PIA). The PIA is where the savings portion of the contribution is accumulated.
In general takaful, however, there is only the PRF. The tabarru’ literally means a donation and needs to be recognized as such for the risk sharing portion of the (common) fund to be shariah compliant. It is paid by the participant to the PRF and in return the PRF is expected to compensate the participant should the contingent event occur.
The following are the conclusions set out in the paper (MFRS is the Malaysian Financial Reporting Standards which is equivalent to the IFRS):
- A separate column for a TF can be presented in the primary financial statements of a takaful entity in a manner that is consistent with MFRSs and, depending on the circumstances, may be required in order to ensure the financial statements provide relevant information that is useful to those users with an interest in the TF’s activities when they make economic decisions.
- Based on cost-benefit considerations, two columns should be presented – one for the TF and one for the takaful entity as a whole.
- The information in the TF column and the information in the takaful entity column should be determined by applying the relevant MFRSs. That is, each column would be MFRS-compliant on a stand-alone basis. In this regard, both the TF and takaful entity would apply MFRS 17.4
- The TF column must not be more prominent than amounts explicitly required to be presented by MFRSs in the takaful entity column.
The paper proceeded to provide the following three options as to how to present the financial results of the reporting entity under IFRS17:
Option 1: Three columns – (1) TF, (2) TO (and adjustments) and (3) TE
Option 2: Three columns – (1) TF, (2) TO and (3) TE
Option 3: Two columns – (1) TF, and (2) TE
All three options recognize three important concepts
- The ownership of the TF is separate from that of the TO
- That the insurance element as traditionally understood takes place in the tabarru’ fund within the TF. As such IFRS17 applies to the tabarru’ funds and possibly those PIAs that house the savings component of the gross contribution
- That the TO is the manager and administrator of the TF providing services for which it earns a fee, and as such IFRS15 may be applicable
Exploring the options
Under Options 1 and 2 it is our understanding that the line items under TF and TO would somehow consolidate into the appropriate line item in the final column for TE. The only difference between these two options is that, under Option 1 there would be an intermediate column to ‘adjust’ the sum of the line items from the TF and TO columns to the TE column, whilst under Option 2 the reconciliation is done instead in the notes to the accounts.
Under Option 3, the entries under the TE column would be derived without constructing the TO column. Given that under all three options, the TE column must be identical, a valid question to ask is: How would the TE column under all three options be determined?
The answer to this question is buried in the last paragraph of Appendix C, which says:
C.9 Note, however, that from the perspective of the takaful entity as a whole, the combined TF and TO activities would constitute insurance services to be accounted for under MFRS17.
It is evident then that the MASB’s conclusion remains unchanged from its late 2019 position, that the TE for all intents and purposes should be accounted as an insurance entity. Effectively, the MASB still concludes that the TE practices risk transfer, and not risk sharing. That is the reason why under all three options the TE column would be the same. The question then remains whether the proposed accounting format would be shariah compliant.
Recently the Islamic Financial Services Board released an exposure draft on transparency and market discipline in takaful. Its purpose is to promote transparency and market discipline by providing sufficient disclosures both to the market and to actual or potential participants.
To ensure that the TE column faithfully reflects the takaful business, the TE column should retain the operating features of takaful, that of a mutual for its insurance business and that of an agent as a manager and administrator for the takaful business. After all, IFRS17 is principles-based and takaful accounting is too important to be left to accountants. Actuarial input is essential to ensure both technical correctness and adherence to the takaful business model in the application of the standard.