the asset side of takaful and implications on product design

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The asset side of Takaful and implications on product design

13 November 2012

Hassan Scott Odierno, FSAIstanbul

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Conventional bonds

Bonds are the backbone of conventional life insurance, providing the means to offer investment return and capital guarantees. Conventional bonds provide guaranteed cash flows which can be used to pay insurance liabilities

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Islamic bonds

Takaful does not have this asset class as a backbone, thus requiring product design to be different. A few countries such as Malaysia have Islamic bonds with fixed cash flows, but with questionable shariah acceptability it is not clear how long this will continue.

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The Current Takaful Market

2010 Takaful Sales (US$ million):

Total US$4.37 billion excluding Saudi Arabia and Iran, from 2012 EY World Takaful Report

1. Malaysia 1,441

5. Qatar 260

2. UAE 818

4. Indonesia 314

3. Sudan 363

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Focus on Life

Although general takaful is more common than life (family) worldwide, we will focus on family products as investment returns are more critical

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Current Malaysia Family MarketSplit by Product

Annual Contribution Equivalent Jan – June 2012

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Implied Guarantees

Although we don’t have formal guaranteed investment returns or capital guarantees (yet) in takaful, sometimes guarantees are implied

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Unit Linked Takaful ModelWakala – Drip with incentive compensation

Participant

Contribution (Premium)

Risk Account (PRF / PSA)

Underwriting Surplus

Investment Profit

Unit Linked Account (PIF)

100%

Wakala Fee

(Operator)

NAV and per policy Wakala Fee (Operator)

Wakala

Fees

Operators Fund

Actual Management

Expenses

50%

Policy Benefit

50%

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Used for education and retirement savings, often sold with medical coverage as riders

Usually there are several unit funds, such as cash, balanced (bond) and equity

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Ideal to have assets such as bonds, especially when the policy nears maturity

If there are no bond type investments participant must understand the risks he is taking


Traditional Takaful savings modelWakala With Mudharaba – Drip with incentive compensation

Operates similar to the unit linked model but there is only one savings fund, and the operator shares in investment returns

Benefit illustrations must be carefully shown as they could create expectations


MRTT ModelWakala – Long term risk fund with sharing

Participant

Contribution (Premium)

Risk

Account (Common)

Valuation Surplus

Wakala Fee

(Operator)

50%

Policy Benefit

50%


MRTT ModelWakala – Long term risk fund with sharing

In Malaysia these are single contribution with duration 20 years or more

To match liabilities the assets should be long term Islamic bonds, unavailable in many markets


Future product types

In Malaysia there are discussions on how to provide capital guarantees in takaful (wadiah structure)

Annuities are also being explored

Both will require careful matching of assets and liabilities


Equity

It is possible to invest in equity worldwide on an Islamic basis

Avoid industries such as gambling, pork, alcohol and tobacco

Avoid highly leveraged companies to ensure not indirectly investing in interest bearing asset classes


Islamic Bonds (Sukuk)

Sukuk tends to look like conventional bonds but would have partial ownership in a debt (sukuk murabaha), asset (sukuk ijara), project (sukuk istisna’) or business (sukuk musharaka)


Sukuk Controversy

The president of the Shariah council of AAOIFI estimated that 85% of all sukuk in existence were not shariah compliant

The Malaysian structure in particular appears identical to conventional bonds (fixed returns)


Sukuk Challenges

Should floating rate sukuk become the norm it will be difficult to match liabilities

Sukuk structures can be very complicated, making it difficult for an operator to understand what exactly are the risks it is taking


Fixed Deposits

Islamic fixed deposits are in the form of mudharaba (profit sharing), wadiah (demand deposits) or commodity murabaha (purchase and reselling of commodities)


Real Estate

Investments can be either directly or in the form of Real Estate Investment Trusts (REIT)

A screening process is done similar to equities with a cleansing process to purify rental from non-permissible activities


Conclusion

Assets and investments are an integral part of family takaful.

Product design needs to take account of the types of assets available


Final Thought

With the general lack of guaranteed cash flows of conventional bonds in Takaful, should Takaful have guaranteed features?

Questions

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