Best Comments on IFSB’s Exposure Draft Standard for Takaful Solvency

A.M. Best Co. issued a bulletin that said it believes that the new “Exposure Draft (ED) Standard on Solvency Requirements for Takaful (Islamic Insurance) Undertakings,” published by the Islamic Financial Services Board (IFSB), “provides a good basis for evaluating the capital of Takaful insurers, and therefore will provide sound guidance to regulators of such companies.”

The guidance that solvency requirements should be set for both the Takaful Fund and the Shareholders’ Fund is “particularly important given the quasi mutual status of these companies and the segregation of funds,” Best continued. “The principle provides much needed clarity to both regulators and Takaful operators alike. This provision is indeed likely to result in greater transparency for the Takaful industry in that it will encourage those of the Takaful companies, which do not already do so, to establish and publish the accounts for the separate funds.”

The segregation of funds is also “the source of the current uncertainty surrounding the Qard (benevolent loan to be provided from the Shareholders’ Fund to the Takaful Fund in times of need),” Best explained. “This ED provides for the treatment of Qard, depending on its seniority relative to the policyholder obligations and indeed its permanence in its capital structure. The latter is provided for by the provision that Takaful operators give their consent for the drawn Qard facility to be deemed as a permanent donation to the Takaful Fund.”

Best said it believes that “while currently this is seldom followed, it should be relatively easy to implement. However, the treatment of Qard, depending on its seniority in relation to policyholder obligations, may first require clarity around the prevailing law of the land (i.e., would seniority be decided based on Shari’a or secular law in cases where these have opposing views). Still, this is a significant improvement from the current state, where it is often assumed that Qard is permanent and subordinate to policyholder obligations, thus being eligible for solvency purposes even for its undrawn part.”

Best added that it believes this provision also aligns the provision of capital to Takaful companies to what is generally accepted for proprietary insurers around the world.

Thhe direction of the ED, according to best’s analysis, is “likely to assist the future stability of the Takaful industry. The provision that Takaful operators should try to ensure that enough profits are accumulated at the Takaful Fund to ensure its independent solvency is particularly important given that a great proportion of Takaful undertakings are in their start-up phase when profit accumulation is critical.”

Best concluded its analysis with an indication that it believes its “methodology on analyzing Takaful companies (http://www.ambest.com/ratings/methodology/TakafulInsurance.pdf)
is broadly in line with the provisions of this ED and does not expect to make any substantive changes to it.”

Source: A.M. Best – www.ambest.com