the treatment of qard in takaful (short version)

The Treatment of Qard in TakafulBY: CAMILLE PALDI CEO OF FAAIF THE TAKAFUL RENDEVOUS, MANDARIN ORIENTAL HOTELASIA INSURANCE REVIEW; MIDDLE EAST INSURANCE REVIEW KUALA LUMPUR, MALAYSIA, SEPTEMBER 29-30, 2015

Conventional v Islamic Insurance

A conventional insurance company speculates on the risk by making an assessment of the risk and then pre-determining profit based on the estimated payout versus the premium.

It is in a sense gambling (Paldi: 2014).

Proprietary insurance is concerned with risk transfer, insured risks being transferred from the insured to the insurer in return for a premium;


Takaful is concerned with risk-pooling, whereby the policyholders (takaful participants) mutually insure one another in a common risk pool financed by their contributions (premium payments).

Takaful, or Islamic insurance, is a cooperative scheme, where in which the participants pay a premium in the form of donation or tabarru in a common pool in return for the ability to draw upon that pool upon a valid claim.

The word takaful originates from the Arabic world kafalah, which means "guaranteeing each other" or "joint-guarantee."


Return on Investment (ROI)

The funds remaining in the takaful fund on maturity of the policy are distributed back to the participants after deduction of the charges due to the operator and according to the type of takaful management model utilized by the fund.

If the Takaful fund goes into deficit, the takaful operator can provide an interest free loan (Qard Hassan) into the fund.

Qard hassan

In a situation where the takaful fund is not able to meet its current and future obligations, the takaful operation will be deemed insolvent (i.e. the takaful fund has less assets than liabilities).

The term solvency means the financial ability to pay debts when they become due. The fund’s inability to pay claims is contrary to the intent of the participants in joining the scheme and hence, a primary objective of everyone concerned is to ensure that fund solvency is maintained at all times.

Qard Hassan

The takaful operator plays an important role that the management of a conventional mutual does not play in the event of a periodic deficit in a takaful fund that exceeds the reserves of the fund, thereby making it potentially insolvent.

In this case, the takaful operator acts as a lender of last resort by providing a qard hassan loan to the takaful fund.

Such a loan will be repaid out of future underwriting surpluses.

Qard hassan

However, the terms and conditions of repayment are often unclear and sometimes not stipulated.

In the event of non-recovery of a qard hassan, is the takaful operator willing to write it off as the deficit increases?

What will happen to the qard hassan in the event of insolvency?

Qard hassan

From the operator’s perspective, the qard hassan is a temporary injection of operator capital into the risk fund and is a particular use of the operator’s capital (which ultimately comes from the shareholders of the operator).

There is an opportunity cost for the takaful operator when the operator’s capital is used for qard hassan.

It is the availability of affordable capital (either for the takaful operator to inject into the takaful fund as qard hassan or as the surplus available in the takaful fund, which is not locked up to ensure continuing solvency) that determines the speed at which a takaful business can grow.

Qard Facility

The takaful operator grants a qard or interest free loan in the event of a deficit in the takaful fund (in contrast to mutual insurance).

The takaful operator is expected to offer a qard loan facility, which can be drawn down if the fund is unable to meet its obligations (because of a deficit or lack of liquidity).

The loan does not remove a deficit, as it increases the fund’s liabilities simultaneously with the assets, but it provides liquidity to enable the fund’s obligations to be met.

Qard Facility

The loan should be recoverable by the takaful operator through future underwriting surpluses.

As a qard hassan is considered a loan injection into the takaful fund, repayment of such loans should take precedence over surplus distribution to participants.

Considering that the takaful fund is under the direct management of the takaful operator, such a loan may fall under the broader context of ‘related party.’

Qard Facility

Related party transactions must be publicly disclosed and only carried out on an arm’s-length basis without any unduly favorable terms.

In some jurisdictions, independent valuations and appraisals are

required before the regulatory authorities will allow substantial related-party transactions to take place.

This is in order to avoid the directors and management of the company manipulating the movement of funds or assets of the company in favor of certain parties who are related to or favored by them.

Qard Facility

Should the requirement to publicly disclose the qard facility be similarly imposed on takaful operators on the basis that it is a related-party transaction?

Should the existence of the facility be disclosed or only the loan if the facility is actually drawn down?

While it would seem desirable to disclose the existence and amount of the facility, transparency would also require disclosure of the draw-down amount when made.

Qard Facility

Certain safeguards may also be required in order to ensure that the qard is not employed in a manner that favors certain pools among the many pools of takaful funds under the management of a takaful operator.

In countries such as Malaysia, takaful operators are obliged to give an undertaking to the regulator to provide a qard facility to be drawn down in the event of a deficit of a takaful fund.

Countries with Specific Takaful Legislation

Malaysia Brunei Pakistan

If only three countries possess Takaful legislation, the global Takaful industry is heavily under-regulated as well as lacks a proper dispute resolution mechanism.

Bank Negara Malaysia Guidelines

Guidelines on Operating Costs of Family Takaful Business; Guidelines on Claims Settlement Practices; Guidelines on Directorship for Takaful Operators; Guidelines on Prohibitions against Unfair Practices in Takaful Business; Takaful (Prescribed Financial Institution) Loan and Investments

Regulation 2003; Guidelines on Financial Statement for Takaful Operators; Takaful Operators Statistical System.

Takaful financial reporting

A unique and harmonized regulatory and reporting regime is required for takaful for many reasons including the two-tier structure of takaful companies, which includes shareholder and policyholder funds.

Shareholder and policyholder funds are managed separately and capital may not be fungible or transferable between the two separate accounts.

Furthermore, takaful funds have unique policyholder entitlements and rights, different structures, and face different risks compared to conventional insurance.


The main difference between conventional and Islamic insurers lies in the fact that in Islamic finance, the assets underlying the underwriting pools are owned by the policyholders, whereas assets in conventional proprietary insurance companies are owned by the shareholders and must at all times be sufficient to cover their obligations to the policyholders.

Accordingly, in contrast to conventional insurance companies, takaful companies must make disclosures about the underwriting pools and underlying assets.


The AAOIFI regulations FAS 12 General Presentation and Disclosure in the Financial Statements of Islamic Insurance Companies and FAS 13 Disclosure of Bases for Determining and Allocating Surplus or Deficit in Islamic Insurance Companies address many of these issues.

The AAOIFI standards require disclosures on policyholders’ funds and the determination and allocation of surplus and financing of deficits.

However, the requirements in respect of movements between the funds

should be enhanced and the individual rights of the policyholders should be clearly stated in the financial statements.


There is also a lack of transparency in the financial statements of some takaful companies in regards to undistributed fund balances.

Overall, the current financial reporting practices of takaful companies do not provide adequate information regarding the company’s investment strategy, funds allocation, and revenues and expenses accruing to their particular investment funds.

Exacerbating the situation, takaful companies have not yet adopted a single

framework for financial reporting and this has resulted in the lack of transparency and comparability of financial statements.

Capital adequacy regulation

In many jurisdictions, solvency and capital requirements for takaful companies remain simple, however, several countries including Malaysia, Indonesia, and certain GCC countries are moving towards risk-based capital regulation.

It may be difficult to apply ratio-based methods as it can be difficult to accommodate them to the different structures adopted by takaful operations and their different risk profiles.

Rbc framework malaysia

In Malaysia, a RBC framework has been implemented in the conventional insurance industry since 2009.

A RBC framework for Malaysia was intended to be implemented in 2012/2013.

The proposed RBC Framework for Takaful Operators will apply to all Takaful and Retakaful Operators registered under the Takaful Act 1984.

Risk-based capital

Risk-based capital is used to set capital requirements, bearing in mind the size and degree of risk taken by the insurer.

It is the capital required to cover the risks the company undertakes.

It is derived from the evaluation of different risks.

It is the amount of capital that needs to be covered by the assets of the business.

Proposed rbc framework for takaful operators malaysia

The Framework requires the maintenance of adequate capital at levels commensurate with the risk profile of the takaful operations to act as a financial buffer against any exposure to risks.

It is the takaful operator’s fiduciary duty to manage the capital and risks prudently, and in line with the objectives of Shari’ah.


In takaful, the concept of RBC is applied on the understanding that it is the takaful risk fund (representing all participants as a single collective fund) that needs to have sufficient assets to meet minimum solvency or RBC requirements.

Under the new Framework, the regulators, based on their assessment of a takaful product design or features, may require takaful operators to establish other funds to clearly reflect the specific nature, purpose, or risk of a component of the contribution or other elements of the takaful product.


This is intended to protect the interest of the participants, the soundness of the takaful funds and where appropriate, to reflect Shari’ah requirements.

Given the requirement for the takaful operator to extend a qard hassan in the event of a fund in financial distress, the Framework is designed to ensure that the takaful operator has the appropriate amount of capital to meet the qard obligation as well as to support its business operations.


Each takaful operator is therefore required to maintain adequate capital in its shareholders’ fund to support its business.

For this purpose, the capital available in the fund will be recognized in the capital adequacy measurement of risk by the takaful operator to the extent that this is consistent with the underlying responsibility and ownership of the various funds in the takaful business.


To this effect, the Framework provides incentive for the takaful operator to build a strong risk fund, thus reducing the amount of capital needed to be held by shareholders to support potential qard hasan obligations.


In the case of a takaful business, the CAR measures the adequacy of the capital in the shareholders’ and takaful funds to support the total capital required for the takaful business.

The CAR is the ratio of the business’s capital to its risks.

Capital Adequacy is the key indicator of the takaful operator’s financial resilience and will be used to determine the appropriate level of supervisory interventions by the regulatory authorities.

Capital adequacy ratio

CAR =Total Capital Available (TCA) x 100%

Total Capital Required (TCR)


The Malaysian regulators’ approach of pre-emptive intervention means that supervisory action is taken in the early stages of a takaful operator’s financial difficulties.

To do this, they have set a supervisory target capital level of 130%, below which supervisory actions of increasing intensity will be taken to resolve the financial problems of the takaful operator.

The takaful operator is then required to establish a higher internal individual target capital level.


The regulator will assess whether this target capital level is appropriate for the takaful operator’s risk profile and risk management practices; if it is not, the operator will be required to make adjustments.


A takaful operator will not pay shareholders dividends if its CAR position is less than its individual target capital level or if the payment of dividend will impair its CAR position to below its individual target capital level.

THE END

the treatment of qard in takaful (short version)

Economy & Finance