What do Accountants Think of Takaful?

With IFRS 17 we have seen significant discussions on Takaful, in particular how to classify Takaful under IFRS 17. Whilst this is a very technical discussion a more fundamental discussion is what is Takaful and what do accountants think of Takaful? Is Takaful actually a mutual insurance product or perhaps Takaful is simply participating insurance in another form?

Takaful has different forms by country and even within a country. The current IFRS 17 discussions on Takaful have been active in Malaysia. Thus, we can start with Malaysian Takaful models as an example. The typical Takaful model in Malaysia is one with a risk fund (PRF) and operators fund (OF), with a savings fund (PIA) also present sometimes. The Takaful operator receives fees (Wakalah fees) to pay for expenses, commissions and profit in the OF with benefits paid from the PRF. Surplus is shared 50:50 between the operator and the participant.

At one extreme Takaful might be considered mutual insurance. If it is considered mutual insurance then we have a certain methodology under IFRS 17 (slides given from IASB in July 2018 discussing this). IFRS 17 would still apply, but participants play two roles: one role as a shareholder and another role as a policyholder. Thus under IFRS 17 we would determine the rights and payments to a participant purely as a policyholder and then any residual amount due to being a shareholder. The key is in the treatment of surplus. In a pure mutual structure it is understood that all participants have joined together to help one another. Thus the surplus being shared to a participant might not simply be the actuarially derived surplus for that policy but rather every policy in the pool share in the risks and there is an element of cross subsidization. This cross subsidization might be for different products in the pool as well as different issue years. Of course it is good actuarial practice to ensure the expected surplus for each product and issue year would be the same, but that there are natural variations over time. This is what we like to think of as Takaful, the element of mutuality with large groups of participants helping each other in times of need. From an actuarial point of view as well we like the concept of large groups of participants in the same pool as this allows the law of large numbers to be valid to the greatest extent possible, minimizing the risk of deficits in the fund. Should there be deficits in Malaysia an interest free loan (Qard) must be given from the operator, thus guaranteeing the benefits would be paid. This guaranteeing is a complicated issue in Takaful, and something we would like to minimize to the extent possible. An alternative structure would be discretionary mutual, whereby benefits are reduced or delayed if needed to avoid deficits in the fund.

At the other extreme Takaful might be considered similar to participating insurance. With participating insurance the policyholders are paid discretionary benefits depending on the experience of the fund. Worldwide there are two general views of participating: those where the discretionary benefits (bonuses) are basically fixed or vary according to a particular index such as investment yields and those where bonuses vary according to asset shares. Asset shares are a methodology used by actuaries to ensure all policies are given a fair amount of surplus in relation to its contribution to the overall surplus of the fund. In this case depending on the level of detail used the experience of each product and each issue year is used to minimize cross subsidization and maximize fairness.

With this in mind there is little in the way of mutuality, which is seen in that participating products are rarely if ever considered mutual in nature. Takaful on the other hand regularly allows and even encourages cross subsidization between issue years as well as plan types. As an example, there could be a major loss in the risk fund which causes a loss (qard). When a new policy enters the fund the following year it had nothing to do with that loss, but nonetheless would not receive surplus sharing until the loss is paid off. Going one step further, if that new policy is profitable, it would have negative reserves (for a regular contribution plan, future outgo is less than future income). This negative amount is not saved for that particular policy but is also used to pay off the qard.

Globally these are not the only models in use. There are also models where participants receive surplus from the PRF but not the operator. There had been some companies using this model in Malaysia as well, but it is currently not in use. For this model the operator does not receive any share of surplus in the PRF but reaps the profit from the wakala fee.

The goal of IFRS 17 is the fair and accurate depiction of the accounts (and thus profitability) of an insurer. Thus the question: what do accountants (and auditors) think of Takaful? Is there mutuality whereby different products and issue years (cohorts) assist each other, or is it more of a participating plan where mutuality is not present or at least minimized? The current thinking is for the PRF to be split into cohorts by issue year (at least) and likely by product type. The PRF itself will not be an integral part of the accounts but rather be relegated to the back of the accounting statements in the notes. This implies that the PRF is simply a notional means of allocating surplus rather than its own entity whereas traditionally it has been said or at least implied that the participants are the owners of the PRF.

IFRS 17 is coming worldwide, including the Takaful world. This is inevitable. It is vital for your voice to be heard, what is Takaful currently and what should Takaful be? If you are a Takaful operator, you must understand how these nuances will affect your accounts and affect the perceptions of your participants towards you. Will they continue to consider you to be an Islamic structure which is unique from conventional insurance or are you simply a name change from conventional insurance?

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